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First, today’s call refers to slides that we will be using during the webcast. If you are
listening on the phone, these are available to download from the investor center on
our website, bp.com. Those of you on our e-mail list should have already received a
copy of both the slides and our prepared remarks. If you haven’t, and would like to
be placed on our list, please do let us know.
Second, I would like to draw your attention to this slide. We may make forward
looking statements which are identified by the use of the words ‘will’, ‘expect’ and
similar phrases. Actual results may differ from these plans or forecasts for a number
of reasons, such as noted here.
Agenda
Today’s presentation covers five topics. These are:
• First, adoption of FRS 17, the new UK standard for pension and post-retirement
benefit reporting
• Second, implementation of new UK reporting requirements related to our
Employee Stock Ownership Plans
These first two items reflect new external standards or requirements and will
impact our reported UK GAAP result.
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• Third, further consolidation of our global NGL operations into our Gas, Power and
Renewables Segment. This is merely a movement between Segments and does not
impact the overall Group result
• Fourth, changes in the way we will handle identified non-operating items when
reporting our results
• Fifth and finally, some additional disclosure and reporting on operating cash flow.
This is intended to provide greater transparency and comparability with others in
our industry
After our prepared remarks, Byron, Mike and I will be pleased to take your questions
on the technical changes shown here. In the spirit of fair disclosure, we will ask you
to defer broader strategy or policy questions to our more extensive strategy
presentation on March 29th. As always, my Investor Relations team and I are
available to address any follow-up questions.
I’d now like to introduce Byron Grote, our Chief Financial Officer.
Summary
Thank you Fergus.
This is a somewhat detailed presentation, so before diving into the technical content
I’d like to take a step back and expand on why we are making these changes. As
shown here, there are two fundamental drivers.
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Standards, which will replace UK GAAP for reporting in 2005 and beyond. We
expect IFRS to continue evolving beyond 2005, as the standard setters address
additional topics.
Thus, we are entering a period of change in the way BP and other international
companies will present their results. None of these changes impact cash flow, and we
are not changing our longstanding financial framework.
I will now describe each of the items Fergus listed. Some of these are quite technical.
You will find all of the information I will present, along with further supporting
detail, on our website.
FRS 17
The first, and most extensive, of our 2004 changes involves the adoption of FRS 17.
This is the new UK standard for reporting pensions and other post-retirement benefits.
Adoption is optional before 2005, but is encouraged. We have shown the impact in
our financial statement footnotes increasingly since 2001. With the recent indications
that IFRS will ultimately adopt a similar approach, we believe it is now time to
elevate FRS 17 from the footnotes to the body of our financial statements.
FRS 17 replaces the legacy UK Standard, SSAP 24, which is equivalent to FAS 87 in
the US. This moves us from “smoothed” reporting to “mark-to-market” reporting of
pension and benefit plans. We are adopting FRS 17 now, rather than waiting for the
new IFRS, because we believe this accounting treatment better reflects current
economic reality. This is how we view our business internally. We are not alone in
this. Bond rating agencies use “mark-to-market” data disclosed in the footnotes to
assess creditworthiness, and many investors are moving in the same direction. More
than 10% of the FTSE 100 have already adopted FRS 17. We believe adopting it now
places us ahead of the curve amongst our peer group.
Before walking through how FRS 17 impacts our financial results, let me describe the
approach conceptually. This standard separates the operating and financing elements
of pension and benefit plans. The cost of benefits earned by the workforce, as well as
the impact of changes in benefit plans and pension-related early retirement costs, are
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treated as operating items, reported through Replacement Cost Operating Profit. The
expected return on pension funds and the accretion of the discount on existing
liabilities are treated as financing items, and reported alongside interest expense.
Income Statement
I’ll start by summarizing how the previous approach for pension and benefit reporting
has been reflected in our earnings.
Under SSAP 24 and FAS 87, all earnings impacts were netted together and shown
with the results of operations in Replacement Cost Operating Profit. So, RCOP
included not only the cost of benefits actually earned by employees in the current
period, it also included a “smoothed” representation of surpluses and deficits,
including any structural changes in benefit plans, as well as a “smoothed”
representation of financing elements such as the actual return on pension assets and
the change in the economic value of benefit liabilities.
This spread the actual impact of changes in pensions and benefits costs over time.
The financing element reflected, among other factors, how many of the prior fourteen
or so years were bull or bear markets. Thus, the total charge to earnings in any given
year often related more to the distant past than to the current period.
As shown on the top line, the current service cost increased by around $100 million
pre-tax from 2002 to 2003. This was driven mainly by falling interest rates and
higher medical costs. However, the swing in financing effects was by far the largest
factor behind the $400 million post-tax increase in pension and benefit costs shown at
the bottom of the slide.
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As shown on the top line, the current service cost continues to flow through RCOP,
with no change between the two approaches.
As shown in the second line, changes in benefit plans and the impact of early
retirements are reported in the year they occur, rather than being spread over several
years under the “smoothed” approach. The $648 million credit in 2003 under FRS 17
reflects the changes we made in our US retiree medical plans last year to contain
rising medical costs.
FRS 17 removes all financing impacts from RCOP, so that RCOP reflects only the
actual benefits earned, the impact of any benefit plan changes and any pension-related
early retirement costs incurred during the year.
Under FRS 17, the expected pre-tax return on pension assets fell from around $1.8
billion in 2002 to $1.5 billion in 2003. This reflects global equity market declines
during 2002, which reduced our pension fund balance at the start of 2003. The 2003
figure incorporates the lower starting balance, as well as our adoption of more
conservative return assumptions.
The pre-tax charge for accretion of the discount on benefit liabilities increased from
around $1.7 billion in 2002 to more than $1.8 billion in 2003. This reflects assumed
higher future medical costs and inclusion of Veba pension liabilities for the full year,
partly offset by a lower discount rate on liabilities.
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Combining these elements, the total pre-tax financing cost under FRS 17 increased by
nearly $500 million, from a $139 million net credit in 2002 to a $340 million net
charge in 2003. $84 million of the additional charge was due to new return
assumptions, which are now among the most conservative in our peer group.
The middle columns in the circled area show the net P&L impact of the change.
Compared with the “smoothed” approach, net income under FRS17 is reduced by $50
million post-tax in 2002, and increased by around $200 million post-tax in 2003. The
2003 increase is due entirely to the benefit plan change.
Starting at the top, we expect current service cost to increase by a further $100 million
pre-tax. This reflects the higher cost of pensions being earned by current employees,
due mainly to a lower discount rate on future pension obligations, as well as assumed
greater longevity based on actuarial studies.
As noted earlier, the 2003 result benefited from retiree medical plan changes made
last year. Although we continue to focus on all costs of doing business, including
employee benefits, we do not foresee similar benefit plan changes in 2004.
We are not showing any early retirement impacts in 2004, although history suggests
these may occur.
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We expect a lower net financing expense in 2004. The $240 million pre-tax year-on-
year improvement shown here reflects our larger asset base at the start of the year, due
to additional pension funding in 2003, as well as the equity market recovery
experienced last year.
Thus, the higher overall cost compared with 2003 is driven by the absence of the one-
time gain from last year’s benefit plan changes, which more than offsets a net
improvement in the other elements.
Balance Sheet
Like the income statement, under the old approach the balance sheet reflects a
“smoothed” value of pension and benefit assets and liabilities. The impact of most
current year actions and all changes in actuarial assumptions is spread across future
years.
The balance sheet at the end of each year fully reflects actual contributions, actual
market performance, actual plan changes, and all changes in actuarial and return
assumptions. Actual market returns and changes in assumptions are recorded directly
in year-end equity, without impacting current year earnings. All these items, in turn,
drive the charge to earnings in the following year.
Thus, under FRS 17 our 2003 pension contributions are evident in the move of our
funded pension plans from deficit to a small net surplus.
Similarly, the retiree medical changes we made in 2003 helped reduce our net year-
end balance sheet liability in this area.
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When we include unfunded pension and retiree medical plans, the net pre-tax deficit
shown under FRS 17 was around $10 billion in 2002, declining to around $8 billion at
year-end 2003.
FRS 17 Summary - 1
Before moving on to the other changes, let me summarize. We are making this
change to better reflect the current economic reality of our pension and benefits
situation.
Compared with the previous “smoothed” approach, FRS 17 increases our 2003
headline earnings and reduces our year-end capital employed. This combination adds
1.5 points to our 2003 ROACE. The earnings impact is due entirely to the retiree
medical plan changes in 2003. Absent these changes, earnings would have declined
by around $200 million post-tax.
The FRS 17 change has no cash flow impact, so the 1.7 percent gearing increase
reflects a reduction in capital employed, rather than a change in debt.
This move impacts all Segments, but by differing amounts depending on their
workforce composition. The inset table summarizes the changes in Segment earnings
and capital employed. Consistent with the FRS 17 principle of separating operating
and financing impacts, we have moved all pension and benefit assets and liabilities
into our Other Business and Corporate Segment. Thus, OB&C now contains the full
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“mark-to-market” recognition of net benefit liability, which was masked by the
previous “smoothed” approach.
Under FRS17, operating impacts are held across the Segments. Financing impacts are
held at Group level, as are Balance Sheet impacts.
All of this restated data is available on our website or from Investor Relations.
Over the last five years, our ESOP share purchases have ranged from $18 million to
$77 million, averaging around $50 million per year. We reported these purchases as
capital expenditures in our Other Business and Corporate segment. Under the new
law, we will show these as share buybacks.
ESOP shareholdings have been reported at their historic purchase cost, and not
marked to market. Thus, this change has no earnings impact.
Over the past five years, we have reduced the book value of our ESOP shareholdings
from around $450 million to less than $100 million. Under the previous UK
requirements, we reported ESOP shareholdings as long-term investments on the
balance sheet. Under the new law, we will remove these shareholdings from the
balance sheet, thus reducing our assets and equity by the amounts shown.
This will reduce our historical capital employed. For example, as shown in the last
line, our 2003 average capital employed declines by $128 million – less than 2 tenths
of one percent.
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Summary of Changes - 2
As shown here, the mandated new ESOP accounting approach does not impact
earnings or cash flow. The ROACE and gearing impacts of the relatively small
reduction in our 2003 year-end capital employed are lost in the roundings.
I’d like to now move from GAAP-related matters, and cover several other changes.
As with prior organization changes, we will restate historical data for the last five
years to reflect this transfer. Financial results of the operations, as well as marketing
volumes, will become part of the GP&R Segment. There is no change in the reserves
and production volumes or realizations reported by the E&P segment.
The table shows the financial amounts to be added to the GP&R Segment. These will
move from E&P, so there is no net impact on the Group totals. As shown, the
operations being transferred earned between $43 and $118 million over the past five
years, fluctuating with absolute prices and margins. The capital employed grew from
less than $250 million to nearly $400 million over the 1999 to 2003 period as a result
of capital expenditures, as well as the assets acquired with ARCO in 2000.
The additional NGL volume relates to sales directly from E&P assets to third parties
and traded volumes under contracts that result in physical delivery. This aligns our
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reporting of NGL sales with our reporting of natural gas sales, and reflects the
integrated management of our NGL business.
Summary of Changes - 3
Again, summarizing: This transfer has no impact at the Group level. The impact on
E&P metrics is small relative to the scale of our E&P operations, but the impact on
GP&R is of course proportionately larger.
The remaining changes that I will cover involve voluntary additional disclosure we
intend to provide starting in 2004.
Starting in 2004, we have chosen to include all items previously referred to as either
specials or exceptionals in our headline proforma result. As I noted last month, these
items have become less material as BP has moved from an era of major portfolio
activity and consolidation into the current era of profitable organic growth. This
format change is also consistent with emerging industry reporting practices, and
feedback from many of you who prefer the additional transparency. This will allow
you to make your own assessment of what to include or exclude when assessing our
underlying business performance.
In order to help you analyze our results, we will continue to identify material non-
operating items. As we are a UK GAAP reporter, these necessarily fall into two
categories.
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include the cost of ongoing restructuring activity, impairments, provisions for
environmental remediation (which we now normally review and adjust in the third
quarter) and litigation provisions or settlements. We will also continue to identify
accounting adjustments for Unrealized Profit In Stock, or UPIS, which can have a
significant quarter-to-quarter impact on results in E&P as it did in 4Q 2003.
Summary of Changes - 4
Including items formerly referred to as specials and exceptionals increases our 2003
headline proforma result by $264 million. This, in turn, increases 2003 ROACE by
three-tenths of a point. Cash flow and capital employed do not change; hence there is
no impact on gearing.
Reported results in all Segments will change to some extent, and the change will of
course vary over time. For example, in 1Q 2004 we will show a large gain from the
sale of our investments in Petrochina and Sinopec. We will provide supplemental
disclosures to help you identify the impact of these items on our earnings.
Including special and exceptional items changes reported earnings, but not capital
employed. As noted earlier, FRS 17 impacts both earnings and capital employed,
while the ESOP accounting change impacts only capital employed.
Incorporating all these changes reduces our 2002 headline result from $8.7 billion to
$8.3 billion, and increases our 2003 result from $12.4 billion to $12.9 billion.
Unusual and non-recurring items, including the $648m pre-tax one-time gain from
2003 retiree medical benefit plan changes, drive the higher 2003 earnings. This
reinforces the importance of continuing to identify material non-operating items
included in our reported results.
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Turning to capital employed, FRS 17 and, to a much smaller extent the ESOP
accounting change, reduce our capital employed by around 7%, in both 2002 and
2003. This will impact all metrics derived from capital employed, including ROACE
and gearing.
Identified special and exceptional items were a net negative in 2002. Including them
reduces earnings by about the same percentage as the FRS 17 and the ESOP
accounting change reduce average capital employed, so that 2002 ROACE moves
only slightly – a reduction of a tenth of a point.
In 2003, the changes increase earnings and reduce capital employed, both of which
contribute to an increase in ROACE of 1.8%.
Since this impact is small, we will make no change in our 25-35% target gearing
band.
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The main changes are in operating cash flow, where UK GAAP differs significantly
from US GAAP and IFRS. As shown at the bottom of this slide, this additional
disclosure has several elements:
• First, we will use a more inclusive definition of operating cash flow to reflect the
growing importance of dividends from related companies, such as TNK-BP.
• Secondly, we will include financing elements in operating cash flow, consistent
with US GAAP and IFRS.
• Thirdly, we will show cash flows after tax. Although not required to do so, we
will allocate income taxes between operations and disposals to better reflect the
true contribution from each cash flow source.
The table at the bottom of the slide shows the division of tax payments between
operations and disposals. This disclosure goes beyond IFRS or US GAAP, which
allocate all tax payments to operations.
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Net cash flow – the difference between sources and uses - is identical in both cases.
We have simply allocated the components differently to provide a more complete
view of each element of sources and uses.
Conclusion
In summary, the changes we are making in 2004, as well as the future changes IFRS
will bring in 2005 and beyond, have several drivers. First, they reflect both new
external requirements and emerging practices in our industry. They also reflect our
desire to go beyond the minimum transparency required by accounting standards, and
to give you the additional information many of you have asked for to better assess our
performance against our peers.
That brings me to my final point – back to where I started. We have shared with you
several items impacting the way we will present our results. None of these changes
impacts our bottom line cash flow. Cash flow remains the cornerstone of our
financial framework, and this framework has not changed.
I’d now like to pass the presentation to Fergus for some closing remarks.
Further Information
Thank you Byron.
As a former analyst myself, I recognize that you require comprehensive historical data
to allow you to forecast our future results. This presentation, although detailed,
cannot by its very nature provide all the information you need to update your models.
Therefore you will find substantial additional resources on the investor center of our
website, bp.com. These include restated history for FRS 17 and the ESOP accounting
changes, as well as the transfer of NGL assets. They also include a detailed
breakdown of the UK GAAP exceptional items on a quarterly basis for the past five
years, shown both by business segment and by geography. We have also provided
advance copies of several tables that will appear in due course in our 2003 Financial
and Operating Information report. We hope this is useful to you in your work. My
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colleagues in Investor Relations and I would be happy to take you through any of this
material off-line.
This slide also shows external websites that you may find useful for further
information on FRS 17 and the emerging International Financial Reporting Standards.
Q&A Session
That concludes our prepared remarks. We’d now be pleased to take your questions
over the phone or Internet.
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