BT Group plc
Annual Report 2017

Plain-text annual report

BT Group plc Annual Report & Form 20-F 2017 Welcome to BT Group plc’s Annual Report and Form-20F for 2017 Where to find more information www.btplc.com www.bt.com/annualreport Delivering our Purpose Report We’re using the power of communications to make a better world. That’s our purpose. Read our annual update. www.btplc.com/purposefulbusiness Delivering our Purpose Report Update on our progress in 2016/17 Contents This is the BT Annual Report for the year ended 31 March 2017. It complies with UK regulations and comprises part of the Annual Report and Form 20-F for the US Securities and Exchange Commission to meet US regulations. This is the third year that we’ve applied an Integrated Reporting (IR) approach to how we structure and present our Annual Report. IR is an initiative led by the International Integrated Reporting Council (IIRC). Its principles and aims are consistent with UK regulatory developments in financial and corporate reporting. We’ve reflected guiding principles and content elements from the IIRC’s IR Framework in preparing our Annual Report. This is most obvious in the representation of our business model. This year, we’ve focused on the resources and relationships that set us apart and the outcomes we generate for our stakeholders. Icons provide a mapping to the IIRC’s ‘capitals’. The strategic report Review of the year How we’re organised An introduction from our Chairman A message from our Chief Executive Operating Committee Our strategy Our strategy in a nutshell How we’re doing – Delivering great customer experience – Investing for growth – Transforming our costs Key performance indicators Our business model Our business model What we do Resources, relationships and sustainability – Financial strength – Our people – Our networks and physical assets – Properties – Research and development – Brand and reputation – Stakeholders – Protecting the environment – Our performance as a sustainable and responsible business Our risks Our approach to risk management Our principal risks Our viability statement Our lines of business Consumer EE Business and Public Sector Global Services Wholesale and Ventures Technology, Service and Operations Openreach – Openreach chairman’s introduction Group performance Group Finance Director’s introduction Group performance Governance Financial statements Additional information Throughout the report look out for these. Reference to other pages within the report Reference to further reading online Critical accounting estimates and key judgements Please see the cautionary statement regarding forward-looking statements on page 260. Pages 2 to 102 form the Strategic Report. It includes Our strategy, Our business model, Our risks, Our lines of business and the Group performance section. The Governance section on pages 103 to 152 forms the Report of the Directors. 2 3 8 10 12 14 16 17 18 19 20 22 24 26 26 30 31 32 34 34 41 43 44 45 55 56 62 66 70 75 81 83 91 92 103 153 251 1 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION The strategic report “ This has been a challenging year for BT. We’ve faced headwinds in the UK public sector and international corporate markets and must learn from what we found in our Italian business. Openreach also received a fine from Ofcom after an investigation into historical Deemed Consent practices revealed it fell short of the high standards we expect. We take these issues extremely seriously and are putting in place new measures, controls and people to prevent them happening again. Learning from the challenges of this year will make BT a stronger company for the future. However, we’ve also made good progress in a number of areas. Our integration of EE is going well, our UK consumer, SME and corporate businesses are performing strongly, and we’ve made significant progress in improving customer experience across the group. Our agreement with Ofcom on Openreach governance brings to an end a period of uncertainty. And securing exclusive rights to top-flight European football until 2021 puts our consumer businesses in a strong position. BT is well positioned for the future, and we’ll continue to seek business cases to invest more in the UK’s digital infrastructure.” This Strategic Report was approved by the Board on 11 May 2017 By order of the Board Dan Fitz Group General Counsel & Company Secretary 11 May 2017 Gavin Patterson Chief Executive 2 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Review of the year We announced that Jan du Plessis will join our Board on 1 June 2017 and become chairman of BT Group with effect from 1 November 2017. PG106 to read more about our Board Strategic progress – Focused on improving customer experience across the group. – EE integration is going well, we’re ahead of target on first-year cost synergies. – Restructuring announced, accelerating our cost transformation. – Continued investment for growth and aspiration to become the UK’s digital champion. PG16 to read more about our strategy Openreach – Enduring and comprehensive agreement reached with Ofcom on future Openreach governance. – Openreach board created with Mike McTighe appointed as Openreach chairman. – Ofcom’s investigation into the historical use of Deemed Consent by Openreach resulted in a £42m fine and c£300m of compensation payments that will be paid in 2017/18. PG83 to read more about Openreach Annual Report 2017 BT Group plc 3 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Review of the year continued Our investigation into our Italian business £268m prior years’ adjustments £260m specific item charge Adjustments relating to the investigation of our Italian business amount to £268m for errors in prior years, for which we’ve revised prior periods, and a specific item charge of £245m for changes in accounting estimates and investigation costs of £15m. To respond, our actions have included: – detailed balance sheet reviews in seven selected country operations in Global Services. Issue isolated to Italy; appointed a new CEO and CFO of our Italian business, as well as a new president of European operations; and reviewed and improved financial processes, systems and controls across the group. – – PG6 to read more Market environment Headwinds in the UK public sector and international corporate markets. Low interest rate environment increasing our IAS 19 pension deficit by £2.4bn net of tax. EE integration Cross-selling opportunities being realised – Business mobile net adds up strongly over the year. – Hundreds of thousands of EE customers taking BT Sport. – Trial of selling BT products in EE stores has gone well. c£150m per annum run-rate cost synergies achieved in first year – Ahead of £100m target due to synergies being realised early. – Early focus on renegotiating supplier terms, insourcing and estate rationalisation. Taking the best of both cultures PG93 to read more about the EE integration 4 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 5 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 100% 100% of EE calls now handled in UK and Ireland contact centres, and Consumer now at 86% 7.7m premises connected to fibre broadband, 29% of those passed 53% of retail broadband customers now on fibre 500,000 premises now built to with ultrafast broadband 30m mobile customers using our network 18.6m mobile customers using 4G 80% UK’s land mass now covered by 4G BT Sport BT Sport won exclusive rights to UEFA Champions League and UEFA Europa League until the end of 2020/21 season. Global Services strategic review We have undertaken a strategic review of Global Services, with the objectives of improving its market and financial performance, its risk profile, and the long-term value that it delivers to BT. Global Services is most differentiated with large, multinational customers, who demand high-quality, secure communications. Its product portfolio is industry-leading across a range of areas, including networking, security, cloud collaboration and contact centres. Technology trends mean that we are now less dependent on owning physical local network access assets around the world, creating the opportunity to reposition Global Services as a more focused digital business. We will prioritise innovation of cloud-based platforms that deliver our products and services, with BT’s global network at the core, to support the digital transformation of our customers. As we implement this strategy, we will ensure that we optimise the value of our global and our local network assets. To enable this strategic repositioning, we are restructuring our Global Services organisation to a simpler operating model. This will involve a two-year restructuring of our operations, the costs of which will be treated as a specific item. 4 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 5 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Review of the year continued Our investigation into our Italian business What we found In the summer of 2016 we received a whistle-blower report of inappropriate behaviours in our Italian business. We instigated an investigation, which included an independent review by KPMG LLP, with support and oversight from our Legal, Governance & Compliance function and Freshfields Bruckhaus Deringer, reporting directly to both the chair of the Audit & Risk Committee and BT Group chairman, and our own comprehensive balance sheet review, which revealed improper accounting practices and a complex set of improper sales, purchase, factoring and leasing transactions in our Italian business. The investigation identified collusion, circumvention and override of controls within our Italian business that was not identified by our monitoring controls thereby resulting in the misstatement of results going undetected for a number of years. These activities resulted in the overstatement of profits amounting to £268m in our Italian business over a number of years. We concluded that the errors were not individually material to any of the group’s previously issued financial statements; however, we did conclude that the correction of the full £268m in the current year would materially misstate the current year. To avoid this we corrected the errors by revising prior year income statements, balance sheets and cash flow statements. The effect of these revisions is set out in note 1 to the financial statements. The findings from the investigation in Italy led us to review the carrying value of the assets and liabilities on the balance sheet, taking into account changes in facts or circumstances since 31 March 2016 and whether additional exposures had arisen due to events in the current year. This exercise required a level of judgement, in many cases taking a more cautious view based on our current understanding of circumstances surrounding each item. This exercise concluded that it was appropriate to write-down the value of our balance sheet assets and increase our balance sheet liabilities. The resulting charge of £245m is presented as a specific item in the current year. Changes in facts or circumstance of items arising in the current year have been recorded in Global Services’ current year trading results. How we responded The inappropriate behaviour in our Italian business is an extremely serious matter. It has no place in BT and we took immediate steps to improve the financial processes and controls in that business. We suspended a number of BT Italy’s senior management team who have now left the business. The president of our European operations has also left the business. We have appointed a new president of our European operations and a new CEO and CFO of BT Italy, from outside the Italian executive management team, and they are working hard to reposition and restructure the business for the future including implementing improvements to the governance, compliance and control culture and the capabilities of our people in the organisation. To ensure independence, KPMG and our internal investigation team, with support and oversight from the Legal, Governance & Compliance function and Freshfields Bruckhaus Deringer, reporting directly to both the chair of the Audit & Risk Committee and BT Group chairman, conducted an investigation of the systems and controls relating to our Italian business. We also conducted a broader review of financial processes, systems and controls across the group. We are acting on both the recommendations of KPMG and our own observations and have taken steps to improve our controls within Italy. We have also taken steps to enhance the wider controls that monitor our overseas operations in our shared service centres, Global Services and at a group level. Beyond Italy, we have completed detailed balance sheet reviews in seven selected country operations in Global Services outside of the UK. These thorough reviews were supported by EY. Together with the investigation in Italy these covered around two-thirds by asset value of the operations outside the UK, representing 4% of the group’s total assets. Our review did not identify any similar issues or areas of concern elsewhere giving us comfort that the inappropriate behaviours were isolated to Italy. This along with other additional substantive assurance activities that we have undertaken enables us to conclude that the financial results and balance sheet as of 31 March 2017 position give a true and fair view of the group. As a result of our US listing we are required to make certain assessments of our controls as of 31 March 2017 for the purposes of the US Sarbanes-Oxley Act 2002 (Sarbanes-Oxley). Despite the remediation steps we took, the controls had not operated for sufficient time to allow assurance testing to confirm their effectiveness under Sarbanes-Oxley. We have therefore concluded for these purposes that our controls were ineffective as of 31 March 2017 due to a material weakness with regards to our Italian business. The BT Group Remuneration Committee has also considered the wider implications of the BT Italy investigation; see page 122 for further details. What we will do going forward While we have taken steps to improve our control environment, we recognise we have more to do. We will continue to take steps to improve further our control, governance and compliance environment. These steps include increasing the resources and improving the capabilities of the controlling function and the audit function outside the UK, and further developing our integrated risk and assurance reporting processes. We are also enhancing our controls and compliance programme to strengthen awareness of the standards we expect, the capabilities of our people, and to reinforce the importance of doing business in an ethical, disciplined and standardised way. The new CEO and CFO of BT Italy will continue to review the Italian management and finance teams and work with BT Group Ethics and Compliance to improve the governance, compliance and financial safeguards. Going forward, we will also continue to rotate senior management among countries to ensure an independently governed and rigorously controlled organisation throughout all parts of Global Services. 6 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 7 As a result of the findings, Openreach has agreed to compensate CPs and Ofcom has imposed a fine of £42m, reflecting the seriousness of the failings. This includes a 30% maximum discount for BT admitting its liabilities and agreeing to compensate the affected CPs in full. The precise amount of these compensation payments will result from discussions with the affected parties and is currently estimated at £300m. The fine and associated compensation payments are treated as a specific item charge in this year’s income statement, with the cash expected to be paid in 2017/18. We take this matter very seriously and we’ve put in place additional controls to safeguard against this happening again and to make sure that we’re providing the highest standards in serving our customers. Deemed Consent On 26 March 2017, Ofcom published the findings of its investigation into the historical use of Deemed Consent by Openreach. Deemed Consent is an agreed process between Openreach and its Communications Provider (CP) customers, which allows Openreach to halt the installation and reschedule the delivery date for providing dedicated business services (known as Ethernet) in a number of specific circumstances which are beyond its control. Ofcom found that Openreach had breached its contractual and regulatory obligations by inadequately and retrospectively applying Deemed Consent to reduce compensation payments to CPs between January 2013 and December 2014. Financial results Proposed final dividend of 10.55p, up 10%, giving a full year dividend of 15.40p, also up 10% Reported measures Revenue Profit before tax Basic earnings per share Adjusted measures Change in underlying revenuec excluding transit adjusted for the acquisition of EE Adjustedd EBITDA Change in underlying EBITDAc adjusted for the acquisition of EE Adjustedd profit before tax Adjustedd basic earnings per share Normalised free cash flowe Net debt PG91 to read the Group Performance PG20 to read our KPIs Performance against 2016/17 outlook In January we revised our outlook as a result of the pressures in the UK public sector and international corporate markets and the outcome of the investigation into our Italian business. Year to 31 March 2017 £m 24,062 2,354 19.2p (0.2)% 7,645 (2.9)% 3,532 28.9p 2,782 8,932 Changea,b 27% (19)% (33)% 18% 5% (9)% £(316)m £(906)m Outlook Our outlook for 2017/18 is now as follows: 6 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 7 a The results for the period include EE which we acquired on 29 January 2016. Unless referred to as underlying adjusted for the acquisition of EE, comparatives only include EE from the date of acquisition. b Certain prior year results have been revised to reflect the outcome of the investigation into our Italian business. See note 1. c Excludes specific items, foreign exchange movements and disposals and is calculated as though EE had been part of the group from 1 April 2015. This differs from how we usually adjust for acquisitions as explained on page 252. d Before specific items, which are defined on page 252. e Before specific items, pension deficit payments and the cash tax benefit of pension deficit payments. 2016/17 initial outlook 2016/17 revised outlook 2016/17 performance 2017/18 outlook Change in underlying revenuec excluding transit Growth Adjustedd EBITDA c£7.9bn Normalised free cash flowe £3.1bn - £3.2bn Dividend per share Share buyback Broadly flat c£7.6bn c£2.5bn ≥10% growth ≥10% growth 15.40p, +10% £206m c£200m £206m (0.2)% Broadly flat £7,645m £7.5bn - £7.6bn £2,782m £2.7bn - £2.9bn Progressive c£100m THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION How we’re organised We have six customer- facing lines of business: Consumer, EE, Business and Public Sector, Global Services, Wholesale and Ventures, and Openreach. They’re supported by our internal service unit, Technology, Service and Operations as well as Group Functions. PG56-90 to read more about our lines of business Employees by division 28% Openreach 4% Wholesale and Ventures 8% Consumer 9% EE 10% Business and Public Sector 12% TSO 13% Group Functions 16% Global Services Consumer We’re the largest provider of consumer fixed- line voice and broadband services in the UK. We’re also the second-largest provider of pay-TV sports channels in the UK and a leading innovator in broadcasting technology. During the year we secured an extension to our broadcast rights for the UEFA Champions League and the UEFA Europa League until 2021 which puts our business in a strong position. 2nd largest provider of pay-TV sports channels in the UK Openreach Business and Public Sector We build the network that connects Britain’s homes and businesses to the future. We sell communications and IT services in the UK and the Republic of Ireland. We’re responsible for providing services over the local access network, sometimes referred to as ‘the last mile’, as well as installing and maintaining the fibre and copper communications networks that connect homes and businesses. We’ve around 1.2m business and public sector customers and lead the field in fixed-voice, networking and broadband. We have three customer-facing units providing communications solutions and IT services to SMEs, corporates and public sector customers. 26.5m premises passed by our fibre network c1.2m customers 8 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Adjusted revenuea by line of business Year ended 31 March 2017 Adjusted EBITDAa by line of business Year ended 31 March 2017 20% Consumer 9% Openreach 21% Openreach (including internal) 8% Wholesale and Ventures 23% Global Services 19% Business and Public Sector 21% EE a Before specific items. EE 15% EE 13% Consumer 34% Openreach 11% Wholesale and Ventures 7% Global Services 20% Business and Public Sector a Before specific items. Wholesale and Ventures We’re the UK’s largest mobile network operator and we also offer fixed broadband and TV. We help other companies provide fixed or mobile telephony services, as well as running a number of BT’s specialist business units. We employ 9,000 people with 67% directly helping customers through our shops and contact centres. Our 4G mobile network is the biggest and fastest in the UK. We provide wholesale fixed network services to over 1,400 customers. We support 30 mobile virtual network operators. And our ventures provide mass market services such as directory enquiries and payphones, as well as enterprise services. 80% 4G geographic coverage (99% population coverage) 1,400 wholesale customers Global Services We’re a leading global business communications provider, supplying ICT services to 5,500 multinational companies in 180 countries. Our performance for the year has been impacted by the challenges in the international corporate markets and the outcome of our investigation into our Italian business. We will be implementing a new operating model in response to these challenges, explained on page 70. Technology, Service and Operations We’re the internal technology unit responsible for creating and operating our global networks, platforms and IT systems. We work closely with each of our lines of business, creating new products for them and making sure that services evolve to reflect the changing needs of their customers. And we make sure that BT’s networks and systems are reliable and resilient. We also manage BT’s research and development and our worldwide patent portfolio. 180 countries served 4,900 worldwide portfolio of patents and applications Annual Report 2017 BT Group plc 9 An introduction from our Chairman As I write my tenth and final chairman’s letter, I look back at the progress BT has made over the past decade. Investing in the UK’s digital future As we look ahead to the UK’s exit from the European Union, it is more important than ever that we have strong British companies investing in our country’s future. We invested around £2bn in the UK’s fixed and mobile communications networks this year, taking fibre broadband further and vastly expanding 4G mobile network coverage. Looking ahead, we have bold ambitions to reach 12 million premises with ultrafast broadband by the end of 2020, as well as covering 95% of the UK’s landmass with 4G. We also take seriously our responsibility to invest in the UK’s workforce. We hired 900 apprentices this year, with plans to increase this to over 2,000 next year. And our investment in people is leading to better outcomes for our customers. We hired 1,500 people into Openreach this year, mostly engineers, helping to halve the number of missed customer appointments in the fourth quarter, year on year. Meanwhile, we have also hired more than 5,000 new people into customer-facing roles at our contact centres in the UK and Ireland, meaning that 100% of EE’s contact centre calls are now handled in the UK and Ireland, with considerable onshoring progress also made at Consumer this year. We are also investing in innovative technologies, continuing BT’s proud history in this area. We have been the UK’s third largest investor in research and development over the past decade, and this year launched the Tommy Flowers Institute, a new Higher Education ICT training institute at our research laboratories at Adastral Park. We are also using technology to support communities. This year we helped generate £95m towards good causes. We also continue to train teachers in tech literacy, giving more than a million children the skills they will need for the future, with an aim to reach five million by 2020. As I write my tenth and final chairman’s letter, I look back at the progress BT has made over the past decade. It has been a privilege to oversee a period in which BT took the decision in 2008, at a time of great macroeconomic uncertainty, to begin a rollout that has now passed over 26.5 million premises with fibre broadband. Other highlights include launching BT Sport in 2013 and acquiring EE in 2016. Over the past decade, we have also returned over £1 per share to shareholders in the form of dividends. I am pleased to say that BT is an immensely stronger company than it was ten years ago. However, 2017 has presented its challenges. While we have made significant progress in many areas, concluding the Ofcom Openreach review and successfully integrating EE into the BT Group, we have also had to address some significant issues. In particular the fraud in our Italian business, trading in the UK public sector and international corporates, and the fine that we received from Ofcom for historical process failures in Openreach are very disappointing. This report includes further information on these matters, as well as details of the measures we have put in place to resolve them. The Board takes them very seriously and has extensively investigated the causes to ensure that they cannot happen again. Changes to the Board In March, we announced that Jan du Plessis will join the Board on 1 June 2017, before becoming chairman on 1 November 2017, when I retire. I am delighted Jan has been chosen to succeed me as chairman. He brings great experience, having been chairman of British American Tobacco, SABMiller and Rio Tinto. I wish him every success as he leads BT at this important time. Simon Lowth joined the Board on 12 July 2016 as group finance director. Simon brings a wealth of knowledge having previously been CFO of BG Group, AstraZeneca and ScottishPower. 10 BT Group plcAnnual Report 2017As I leave BT I would like to thank my colleagues on the Board, Gavin Patterson, our CEO and the management team whose support I have valued highly over the years. In my first chairman’s message ten years ago, I closed by saying there was every reason for optimism. Looking forward, I have great confidence that remains the case today. Sir Michael Rake Chairman 11 May 2017 Investigation into BT Italy Following allegations of inappropriate behaviours in our Italian business, we conducted an investigation, including an independent review by KPMG LLP. I am very disappointed by what we discovered, including extensive improper accounting practices and a complex set of improper sales, purchase, factoring and leasing transactions. These activities led to the overstatement of earnings and assets in our Italian business. We have detailed on page 6 the issues that arose and the steps that we have taken in relation to these matters. Agreement with Ofcom on Openreach governance An important step this year was the agreement reached in March with Ofcom on the future governance of Openreach. This agreement comes after two years of discussions, and will see Openreach become a distinct, legally separate company within the BT Group. It will see Openreach assume greater independence under its own board. We appointed Mike McTighe as Openreach chairman in November 2016. Sir Brendan Barber, Edward Astle and Liz Benison then joined the new Openreach board as independent members in early 2017. Clive Selley, the Openreach CEO, will report into Mike McTighe, with accountability to the BT Group, as the CEO of a wholly-owned subsidiary. This includes accountability to the BT Group chief executive with regards to certain legal and fiduciary duties that are consistent with BT’s responsibilities as a listed company. Rewarding our shareholders Our goal remains to deliver sustainable, profitable revenue growth. Together with our cost transformation activities, this will support long-term cash flow growth and therefore create value for our shareholders. The strength of our business means that despite some difficulties this year, we can still fulfil our policy of paying a progressive dividend. The Board is proposing a final dividend of 10.55p, up 10%. This gives a full year dividend of 15.40p, also up 10%. However, given the importance of maintaining flexibility for investment, dividend growth in 2017/18 will be lower than the 10% previously anticipated. The rate of future dividend growth will reflect a number of factors, including underlying medium-term earnings growth, the level of investment spending and other cash commitments. The Board believes that this dividend policy appropriately balances the interests of all stakeholders and provides a solid foundation for future growth, underpinned by an ongoing commitment to investment that delivers sustainable long- term value for customers and shareholders. Whilst we have undoubtedly faced challenges this year, we must not lose sight of the people, infrastructure and services that make BT a great company, with an important role to play in the future of how people in the UK and around the world live their lives. 11 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION A message from our Chief Executive Whilst we’ve continued to bring new services to our customers, invested in our digital infrastructure and made significant improvements to the customer experience, I’d be the first to say that 2016/17 has been a challenging year, and one that has been humbling for us all at BT. The behaviours and practices we found in our Italian business, as well as Ofcom’s findings around Openreach’s use of the Deemed Consent process a number of years ago, have no place in BT. We take these extremely seriously and have reviewed all aspects of our governance, putting in place new measures and controls to prevent them from happening again. In addition, we’ve also faced difficult market conditions in both the UK public sector and international corporate markets. Despite these challenges though, I believe we’ve made good progress in many areas across the business. After a two-year negotiation, we reached a comprehensive and enduring agreement with Ofcom on the long-term governance of Openreach. This brings to a close a period of uncertainty; protects the interests of millions of UK households, businesses and service providers who rely on our infrastructure, and it’s good news for pensioners and colleagues too. We’ve continued to invest in the UK’s digital future. We’ve now passed over 26.5 million premises with our superfast fibre broadband network. Our ultrafast deployment, which provides speeds of 100Mbps and above, is also making great progress, with 500,000 homes and businesses now passed – using a mix of fibre-to-the-premises and G.fast technologies. Our mobile investment is also performing strongly. Our 4G coverage now reaches 80% of the UK’s geographical coverage, the largest of any UK operator. And we’re on track to reach 92% by September 2017. The integration of EE into the BT family continues to go well, and we have delivered cost synergies earlier than originally planned in our first year. We believe online usage through mobile devices is set to increase in the future. And we also believe that everyone in the UK should be able to access superfast broadband, wherever they are and as fast as it can be. That’s why in May 2016 we committed to invest £6bn in our wireless and fixed networks over the next three years. This investment will enable the UK to make social and economic progress, consolidate our position as the UK’s digital champion and create growth over the long- term for our stakeholders. This year, through our continued innovation, we’ve also launched a range of new products, services and content. Our new BT Call Protect service is proving popular, helping two million customers avoid nuisance calls. We’ve secured exclusive rights to the UEFA Champions League and UEFA Europa League until the end of the 2020/21 season, covering double-header nights during the group stages and free-to-air broadcast. These rights are in addition to FA Cup and Premier League football, live rugby, cricket, UFC and now boxing. And we’ve brought BT Sport content to millions of additional sport fans through digital channels such as BT Sport’s YouTube channel, where we will show this year’s UEFA Champions League 12 BT Group plcAnnual Report 2017We remain committed to our strategy of broadening and deepening customer relationships and to using the power of communications to make a better world. This year has presented us with challenges and we’ve learnt from them. I know we have the ability to emerge stronger and better, whatever challenge we face. We take our role as the leading investor in the UK’s digital infrastructure very seriously. I’m determined to make sure that we remain at the heart of what’s to come and that we continue to add value for our customers and employees and for shareholders and society as a whole. We’re excited about the opportunities we’ll create to use our unique set of assets and capabilities; the innovative new products and services we’ll bring to customers and the new skills and career possibilities we’ll provide for our people. Gavin Patterson Chief Executive 11 May 2017 and UEFA Europa League finals. We’re also pleased to be the first operator to offer Dolby Atmos sound. We’re working with local authorities to launch our next generation of payphone kiosks, which you’ll start to see shortly. And we’ve built a unique security platform that integrates best-in-class technology from our partners, with our own award- winning innovation – to protect our multinational customers and the UK’s critical national infrastructure. Customer experience remains our top priority. We’ve listened to criticism and have a well-developed improvement plan in place. Our efforts are starting to bear fruit and customers are benefiting – with significantly more calls answered onshore, shorter call waiting times, faster repair times, fewer missed appointments, and our best Right First Time performance this decade. All of this is showing in our Group Customer Perception Score, the way we measure customer experience, which has improved for the last ten consecutive months. While we’re making progress, we know our service must continue to get better and our focus will remain on delivering further improvements in the coming year. We’ve also significantly invested in our people – recruiting thousands into engineering and customer-facing roles, and providing thousands of hours of training and development. We’ve also created more than 1,700 new apprenticeship and graduate jobs and provided 2,000 vocational training and work experience placements, mainly for out-of-work youngsters. For so many people, BT is a source of pride and honour and we want that to always be the case. 13 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Operating Committee This is our key management committee. It meets weekly and is chaired by the chief executive. The Operating Committee has collective responsibility for running our business and executing our strategy. It monitors the group’s financial, operational and customer service performance, and has cross-business oversight of all our lines of business. It also reviews the group’s principal risks and considers potential opportunities. Gavin Patterson Chief Executive Appointed as chief executive in September 2013 and on the Board since June 2008. Gavin was previously CEO, BT Retail and from 2004 to 2008 was managing director, BT Consumer (BT Retail). Before joining BT, Gavin was managing director of the consumer division of Telewest (now Virgin Media). Prior to that, he spent nine years at Procter & Gamble, rising to become European marketing director. Simon Lowth Group Finance Director Appointed to the Board as group finance director in July 2016. Simon was CFO and executive director of BG Group before the takeover by Royal Dutch Shell in February 2016. Previously Simon was CFO and an executive director of both AstraZeneca and ScottishPower. Prior to that, Simon was a director at McKinsey & Company. Marc Allera CEO, EE Appointed February 2016. Marc was formerly chief commercial officer for EE from 2011 to 2015. Prior to EE, Marc spent ten years at Three UK where he held a number of senior positions, including chief commercial officer and sales and marketing director. Prior to his 16 years’ experience in the mobile industry Marc was GM for Sega UK and Europe. Luis Alvarez CEO, Global Services Appointed October 2012. Luis was formerly president of the Europe, Middle East, Africa and Latin America operations of BT Global Services serving some of our biggest global customers. Luis also led BT Global Services Telecom Markets unit, managing business with carriers and operators outside the UK. Before joining BT, Luis worked at Ericsson, IBM and Grupo Santander. Luis has a telecommunications engineering degree. Gerry McQuade CEO, Wholesale and Ventures Appointed March 2016. Gerry was formerly chief sales and marketing officer at EE responsible for the Business, Wholesale Product and development areas which he had overseen since the merger in 2010 of Orange and T-Mobile. He joined the board of Orange in January 2008, and prior to Orange he was founding director of Virgin Mobile. – More specifically the Operating Committee: develops BT’s strategy and budgets for – the Board’s approval; recommends to the Board capital expenditure and investment budgets; allocates resources across BT within plans agreed by the Board; prepares and delivers major programmes; and reviews the senior talent base and succession arrangements. – – – The Operating Committee can approve, up to certain limits set by the Board, capital expenditure, disposals of fixed assets, investments and divestments. Some of these approvals are passed to sub-committees such as the Design Council (page 25) and to senior executives. Tony Chanmugam, formerly group finance director, left during the year. Ed Petter Group Corporate Affairs Director Appointed November 2016. Ed was previously deputy director of corporate affairs at Lloyds Banking Group and prior to that had held corporate affairs roles at McDonald’s Europe, McKinsey & Company and the Blue Rubicon communications consultancy, having previously worked as a news producer and editor at the BBC. John Petter CEO, Consumer Appointed September 2013. John was formerly managing director, BT Consumer (BT Retail) and prior to that, chief operating officer in BT Consumer. John was appointed chairman of the Plusnet Board in 2008 and has overseen its development as a key part of BT’s strategy. Prior to joining BT, John held roles as marketing and commercial director at Telewest (now Virgin Media) and brand manager at Procter & Gamble. Graham Sutherland CEO, Business and Public Sector Appointed September 2013. Graham was formerly managing director, BT Business, responsible for the small and medium-sized enterprises unit within BT Retail and prior to that, CEO of BT Ireland. Before joining BT, Graham held a number of senior management positions including managing director of NTL in the Republic of Ireland. Graham is qualified as a chartered management accountant. Howard Watson CEO, Technology, Service & Operations Appointed February 2016. Howard was formerly chief architect and managing director global IT systems and led the technical teams behind the launch of BT Sport in 2013. Howard joined BT in 2011 and has 30 years of telecoms experience having spent time at Telewest (now Virgin Media) and Cartesian, a telecommunications consultancy and software company. Alison Wilcox Group HR Director Appointed July 2015. Alison was formerly regional HR director for Vodafone Europe and prior to that, regional HR director for Vodafone’s Africa, Middle East and Asia Pacific footprint. Alison joined Vodafone in 2006 as group director of leadership following a career in consulting. Sean Williams Chief Strategy Officer Appointed June 2016. Sean has led BT’s Group strategy, product portfolio, regulation and policy since 2011 and previously for BT Retail. Before joining BT in 2008, Sean was an executive director on the board of the OFT, of Ofcom, a partner of the strategy consulting firm LEK Consulting LLP and a non-executive director of Williams Lea Group. Dan Fitz Company Secretary Dan is the group general counsel & company secretary of BT Group plc. He joined BT in April 2010 as its group general counsel and was appointed company secretary in November 2012. Dan previously spent six years at Misys and 12 years at Cable & Wireless. Dan attends all Operating Committee meetings. Clive Selley Invitee, CEO, Openreach Clive was appointed CEO, Openreach in February 2016. He was formerly CEO, BT Technology, Service & Operations, CEO BT Innovate & Design and before that president, BT Global Services Portfolio & Service Design. He is an ‘invitee’ because the CEO of Openreach cannot be a member of the Operating Committee under the provisions of the Undertakings. 14 15 BT Group plcBT Group plcAnnual Report 2017Annual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our strategy Our strategy has evolved since last year. The three main pillars are broadly the same but we’ve placed more emphasis on the overall customer experience (rather than just on customer service). Following the acquisition of EE, our investment areas have evolved to focus on having the best network in the UK and being a fully converged service provider. In order to achieve our purpose and reach our goal we’ve adopted a strategy based on broadening and deepening our customer relationships. To create sustainable profitable revenue growth, we need stronger relationships with our customers. The three pillars of our strategy help us build these relationships, providing great customer experience, transforming our costs and enabling us to invest for growth in the process. They work together: the better our customers’ experience, the more we’ll sell and the less time and money we’ll spend putting things right. And the better we manage our costs, the more we can invest in improving our customers’ experience and in products and services that will create growth. Our strategy in a nutshell The diagram below shows the main elements of our strategy and how they work together to support our purpose and goal. More details on our purpose and goal, in the context of our business model, can be found on page 24. Our purpose Our goal Our strategy A healthy organisation To use the power of communications to make a better world Growth – to deliver sustainable profitable revenue growth Broaden and deepen our customer relationships Deliver great customer experience Invest for growth Transform our costs Differentiated content, services and applications Best network in the UK Fully converged service provider Market leadership in all UK segments Focus on multinational companies globally Best place to work 16 16 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc 17 How we’re doing 1 Delivering great customer experience Everything we do influences our customers’ opinion of BT. Whether it’s fixing a fault, marketing a new product or fulfilling a new contract, it’s the total customer experience that matters. That’s why it’s so important we work together across our entire business to improve our customers’ experience. As a result our strategy now emphasises the importance of improving every aspect of the customer experience. Customer service is at the heart of this goal. We’ve really improved our service levels this year, but we can do more. Our focus on customer experience means that everyone in BT, from marketing to contact centre, and front-line engineer to senior executive, has a role to play – and this includes the digital experience offered by online, apps and social media. – – Deliver a consistent and reliable service – All our Consumer customers have been given an improved level of care and on average, have landline faults fixed 24 hours quicker than last year. Consumer has created more than 2,200 new roles to help answer 90% of customer calls in the UK and Ireland by Spring of 2017. They are on track to meet this target, with around 86% of calls now answered in the UK and Ireland. EE now handles 100% of its customer service calls in the UK and Ireland. Openreach achieved or is on track to achieve all of Ofcom’s copper Minimum Service Levels (MSLs). There’s been a material improvement in how we deliver Ethernet with Openreach achieving five of the six Ofcom MSL targets. Openreach has recruited over 1,500 people, mostly engineers. It also halved its number of missed customer appointments by the end of the financial year. We’ve made it even easier to interact with us online, for example 9m customers have signed up to ‘My EE’ via the app or online. – – – – – – A great customer experience from our network – We’ve improved the weather proofing of our networks. This year we’ve halted the growth in network faults following six consecutive years of increasing faults. Global Services is enabling better monitoring of network, IT and applications. Openreach is offering to connect fibre-to-the-premises for free to all developments of new sites with over 30 plotsa. Products that improve customer experience – Consumer upgraded all its superfast broadband (Infinity 1) customers from 38Mbps to 52Mbps where available. Business and Public Sector upgraded over 80,000 UK Business Fibre broadband customers from up to 38Mbps to speeds of up to 76Mbps. We launched BT Call Protect to divert nuisance and unwanted calls to junk voicemail. It’s free to all our customers. – – Our top priorities Looking ahead, we’re focused on: – improving every interaction between our contact centre advisers and customers, with further investment in skills and tools; – developing all our digital channels to enable more customers to adopt online as the best method of interacting with us; – extending the reach of our fibre and mobile networks, and reducing network faults; – improving our Ethernet delivery processes, enhancing the experience for our business and corporate customers; and – enabling all our people to put customers’ needs at the heart of their decision making. We believe that improving our customers’ experience will create more growth. That’s why it’s such an important part of how we judge the group’s performance. Our key measures of customer experience include customer perception (based mainly on the industry standard of Net Promoter Score) and getting things done Right First Time. How we did in the year We’ve seen a steady improvement in our customers’ perception of us, increasing by five points since last year, with improvements across all lines of business. Our Right First Time performance has also improved, by 6.4% compared to -3.0% last year. EE and our corporate businesses performed particularly well and we’ve prepared and responded much better to difficult weather conditions in the UK. What difference did our customers see? Customers judge us on their day-to-day interaction with BT. They want a consistent, reliable service, a network that offers a great experience and products that improve their lives. It’s in these three areas – service, network and products – where we can most clearly see the progress we’re making, progress we’re committed to continuing over the coming year. a New sites with over 30 plots registered from 10 November 2016. 16 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 17 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION How we’re doing continued 2 Investing for growth We’re putting money and resources in five strategic areas that we believe will deliver sustainable, profitable revenue growth. They underpin our strategy and our operational and financial performance, which in turn contribute to our KPIs (on page 20). Differentiated content, services and applications Launch of BT Smart Hub Launch of BT Family SIM BT Sport daily viewing up 12% My BT, My EE app improvements a MVNO World Congress 2016. Best network in the UK Fully converged service provider Market leadership in all UK segments Focus on multinational companies globally 26.5m premises passed with fibre £150m 37% cost synergies in the first year of EE integration retail broadband share 180 countries PG88 PG93 PG56 PG70 G.fast pilots in 17 locations PG88 80% of UK landmass now covered by 4G PG63 5G research with a range of partners 29% mobile market share PG62 W&V Cloud of Clouds PG71 NFV W&V named Best Wholesale Operatora Network Function Virtualisation PG76 3.8m PG71 SDN mobile customers of Mobile Virtual Network Operators we support Software Defined Networking made available to EE customers £1.6bn target Net Present Value of revenue synergies from EE acquisition Trial of selling BT products in EE shops (PHOTO) PG33 PG75 PG71 18 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 19 We’ve insourced engineering roles in IT and networks 3 Transforming our costs Our approach to cost transformation Operating as cost efficiently as possible is at the heart of our strategy. We’ve honed our approach and methodology over the past decade. It’s focused on simultaneously driving customer experience improvement and cost transformation, and it’s underpinned by rigorous analysis, operating management leadership and strong governance. Programmes this year included: – realising the cost synergies created by bringing together BT and EE, including buying synergies, rationalising our property estate, insourcing roles in both IT and networks, and creating a shared call centre planning function for the group; – re-engineering important processes to improve our delivery of Ethernet, which has led to shorter lead times, higher output and improved quality of delivery; – reducing our network costs in the UK and overseas by consolidating our technical facilities and deploying tools to better manage third-party costs; and – reviewing the operating model for main areas of our business, see pages 70 and 93. We still benchmark our cost of doing business against other companies inside and outside our sector to see where we can do even better. Our largest programmes span multiple lines of business or complex changes within a single line of business. Continuous Improvement (CI) provides a complementary ‘bottom-up’ approach, empowering our people to make small but significant changes to how we do things every day. The result improves customer service and employee engagement while reducing the cost of failure. Training is an important part of our approach, led by our in-house Cost Transformation Faculty, part of the BT Academy (page 53). The faculty is responsible for the continued development of both our change methodology and our ‘change professionals’. This year alone we trained and coached more than 1,000 people. BT is the only UK organisation licensed by the British Quality Foundation to certify qualifications on such a scale at the most advanced levels in Leana, Six Sigmab and Change & Project Management methodologies. We’re now sharing our approach with other organisations. How we did in the year We’ve continued to pursue opportunities to further transform our costs. Despite this, our underlying operating costs excluding transit were up 1%, reflecting our investments in mobile, BT Sport and customer experience. You can read about cost transformation within Our lines of business from page 56, and the group’s operating costs on page 94. a Lean is a methodology for achieving small, incremental changes in processes in order to eliminate waste and improve efficiency and quality. b Six Sigma is a data-driven methodology for eliminating defects in processes. Our top priorities Looking ahead, we’re focused on: – establishing a new unit that brings together our customer experience and our group transformation teams. The new unit will enable us to make investments and take decisions about business performance that are more clearly aligned with our customer experience and productivity priorities; – continuing to create synergies from the integration of BT and EE by sharing best practice on cost transformation; – gaining greater efficiency from our shared service functions and operating model in the UK and internationally; and – addressing the customer experience and cost of failure impacts in our consumer and business products. Restructuring We are also expanding and accelerating areas of our cost transformation programme. We are simplifying our central Group Functions and our internal service unit, Technology, Service & Operations to improve the effectiveness and efficiency of the services and infrastructure delivered to our lines of business. We are also restructuring the Global Services organisation and accelerating ongoing transformation programmes in other lines of business. We anticipate that these transformation programmes will save in total around £300m over two years, with a restructuring charge of around £300m over the next two years, with most of this being incurred in 2017/18. This restructuring cost will be treated as a specific item. These changes will clarify accountabilities, remove duplication and improve efficiencies, removing around 4,000 roles mainly from managerial and back-office areas. The cost savings will provide headroom to offset market and regulatory pressures and support increased investment in delivering great customer experience and leading networks. 18 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 19 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Key performance indicators We’ve achieved our customer service performance goal for the year, but need to do better. We hit our revised financial guidance set in January 2017, but fell short of our financial targets set at the start of the year due to the issues in our Italian business and headwinds in UK public sector and international corporate markets. Progress against our KPIs We use four key performance indicators (KPIs) to measure how we’re doing against our strategy. Our financial KPIs include: the trend in underlying revenue excluding transit adjusted for the acquisition of EE; our adjusted earnings per share; and normalised free cash flow. Customer service improvement is the key non-financial KPI for us. Our KPIs are chosen because they reflect the key elements of our strategy. We use these to measure the variable elements of our senior executives’ pay each year, as we’ve explained in the Report on Directors’ Remuneration (see page 122). We’ve outlined our performance against each KPI here, together with an explanation of how we define each measure. You can find reconciliations of the financial measures to the closest IFRS measure in the Additional information section on pages 252 to 254. Our key measure of the group’s revenue trend, underlying revenue excluding transit adjusted for the acquisition of EE, was down 0.2% (2015/16: up 1.9%c) which is broadly consistent with our revised outlook. Trend in underlying revenue excluding transit Year ended 31 March % 3 2 1 0 (1) (2) 1 3 (3) ( . 5 0 . ) 9 1 . ) 4 0 . ( ) . 2 0 ( (4) 2013a 2014a 2015a 2016a 2017b Our customer service measure Right First Time was up 6.4% compared with down 3.0% last year. Customer service improvement At 31 March 4 6 . . 1 2 2 . 7 4 . 5 1 ) 0 3 . ( 0 3 . . 0 3 . 5 0 1 % 25 20 15 10 5 0 ) 0 4 . ( 2010 2011 2012 2013 2014 2015 2016 2017 2017 Cumulative improvement from 1 April 2009. Performance Our revenue performance has been heavily impacted by the challenging conditions we’ve seen in the UK public sector and international corporate markets. This was offset by strong performance in our customer-facing lines of business driven by EE and Consumer. We explain more about the performance of our lines of business from page 56. Definition Underlying revenue reflects the overall performance of the group that will contribute to sustainable profitable revenue growth. We exclude the impact of specific items, foreign exchange movements and disposals and from 2016/17 this measure is calculated as though EE had been part of the group from 1 April 2015. This differs from how we usually adjust for acquisitions as explained on page 252. We focus on the trend in underlying revenue excluding transit because transit traffic is low margin and is affected by reductions in mobile termination rates, which are outside our control. Performance Improving the service we deliver is key. Our Right First Time measure was up 6.4% (2015/16: down 3.0%). We’re making good progress in some areas. Openreach achieved or is on track for all 60 of the minimum service levels (MSLs) set by Ofcom for copper, but disappointingly we missed one of the six MSLs for Ethernet. Despite these improvements, we’re not where we want to be, across all of our lines of business. You can read more about our customer service on page 17. Definition Right First Time is our key measure of customer service. This tracks how often we keep the promises we make to our customers. This could be about keeping to appointment times, completing orders when we agreed or fixing faults within an agreed period. As well as improving service and the customer experience, keeping our promises should mean that there is less work to do to correct our mistakes, and so reduces our costs. a Calculated as though EE was not part of the group until 1 April 2016. b Calculated as through EE had been part of the group from 1 April 2015. c Certain prior year results have been revised to reflect the outcome of the investigation into our Italian business. See note 1 to the consolidated financial statements. 20 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 21 Outlook for 2017/18 For 2017/18, we continue to expect underlying revenue excluding transit to be broadly flat year on year. Adjusted EBITDA is expected to be £7.5bn – £7.6bn. Our outlook for normalised free cash flow over the cumulative two- year period 2016/17 and 2017/18 remains broadly unchanged. However, normalised free cash flow in 2016/17 of £2,782m was almost £300m above our outlook of around £2.5bn, due to early customer collections that will reverse in 2017/18. As such, normalised free cash flow in 2017/18 is now expected to be £2.7bn – £2.9bn, from £3.0bn – £3.2bn previously. This outlook is provided on the basis of our existing investment plans. However, we continue to evaluate a range of additional investment opportunities. Our decision on whether to move forward with these will be affected by a number of factors, including the outcome of Ofcom’s Wholesale Local Access Market Review, responses to Openreach’s consultations and the results of any future spectrum auctions. Adjusted earnings per share decreased 9% to 28.9p. Adjusted earnings per share Year ended 31 March pence 35 30 25 20 15 10 5 0 . 3 6 2 . 2 8 2 . 6 0 3 . 8 1 3 . 9 8 2 2013 2014 2015 2016 2017 Our underlying dividend policy remains unchanged: to deliver progressive dividends while balancing the need to invest in the business, support the pension fund and maintain a strong balance sheet. The Board has concluded that a dividend increase of 10% in 2016/17 remains appropriate. However, given the importance of maintaining flexibility for additional investment and the range of potential outcomes, dividend growth in 2017/18 will be lower than the 10% previously anticipated. The rate of future dividend growth will reflect a number of factors, including underlying medium-term earnings growth, the level of investment spending and other cash commitments. The Board believes that this dividend policy appropriately balances the interests of all stakeholders and provides a solid foundation for future growth, underpinned by an ongoing commitment to investment that delivers sustainable long-term value for customers and shareholders. We expect to buy back around £100m of shares in 2017/18 to help counteract the dilutive effect of all-employee share option plans maturing in the year. This is below the £206m buyback we completed in 2016/17 reflecting the lower number of shares that are expected to be required for our share option plans. Performance Adjusted profit after tax grew 5% to £2,869m this year reflecting the impact of the acquisition of EE. Adjusted earnings per share decreased 9% to 28.9p. The weighted average number of shares in the market increased 15%. Definition Adjusted earnings per share is the adjusted profit after tax attributable to our shareholders, divided by the weighted average number of shares in issue. Being an ‘adjusted’ measure, it excludes the impact of specific items and as such it is a consistent way to measure the performance of our business over time. We generated normalised free cash flow of £2,782m. This was down £316m compared with last year, but is above our revised outlook of around £2.5bn due to earlier than expected customer collections which will reverse next year. Normalised free cash flow Year ended 31 March £m 5,000 4,000 3,000 2,000 1,000 0 0 0 3 2 , 0 5 4 2 , 0 3 8 2 , 8 9 0 3 , 2 8 7 2 , 2013 2014 2015 2016 2017 Performance The decrease of £316m or 10% in our normalised free cash flow primarily reflects the impact of cash outflows in our Italian business as we unwound the effects of inappropriate working capital practices, as well as higher capital expenditure in relation to Emergency Services Network (ESN) and EE integration, partially offset by the benefit of an additional ten months of EE. Definition Free cash flow is the cash we generate from our operations, less capital expenditure and finance costs. It represents the cash available to invest in the business, repay debt, support the pension scheme and pay dividends to our shareholders. Normalised free cash flow excludes significant non-operational payments and receipts that distort the trend in our cash flow. So in calculating normalised free cash flow we take out the impact of specific items, purchases of telecommunications licences, pension deficit payments and the tax benefit from pension deficit payments. 20 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 21 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION The resources and relationships that set us apart What we do Stakeholder outcomes Our business model We create value for our stakeholders by developing and selling products and services that are an essential part of modern life. Who we are We’re one of the world’s leading communications services companies. We’re based in the UK but we serve customers across 180 countries (see page 70). Financial strength We’re focused on growing our cash flow over the long term. £2,782m normalised free cash flow generated in 2016/17 Our people Their commitment, expertise and diversity are key to our success. 106,400 employees IIRC Capitals This key provides a mapping to the ‘capitals’ of the IIRC’s Integrated Reporting (IR) Framework. You can find out more at: www.theiirc.org Networks and physical assets We continue to invest in these to improve the experience we offer our customers. 26.5m premises passed by our fibre footprint 5.6m BT Wi-fi hotspots Financial Human Manufactured Intellectual Social Natural Our strategy The main elements of our strategy are outlined on page 16. Our principal risks Our approach to risk management and our principal risks are described on page 45. Our viability statement Our directors’ assessment of the prospects and viability of the group is on page 55. Governance How we govern the group is described from page 103. Remuneration The report on directors’ remuneration can be found on page 122. Research and development We’re one of the largest investors in research and development in the UK. Stakeholders and relationships Key stakeholders include our customers, communities, shareholders, lenders, our pension schemes, suppliers, government and regulators. Our brand Our brands are a key asset. Natural resources We use some natural resources in doing business. c£520m R&D spend 102 patents filed 790,000 shareholders $18.6bn Millward Brown valuation of the BT brand 82% of the worldwide electricity we buy comes from renewable sources S R E UR STAKE H O L D L O L R A O F E U L A V G N I T A E R C Our purpose is to use the power of communications to make a better world. Our goal is growth, in particular the creation of sustainable, profitable, revenue growth. In order to achieve our purpose and reach our goal we’ve adopted a strategy based on broadening and deepening our customer relationships. IN V E S T I N G I N W H A T S E T S U S A P A R T D E R N LIFE O SELLING SERVICES INTE G R A L T Oversight and Gove r n a n c e O M How we’re organised Our business is structured in a way that enables us to serve our customers, respond to their needs and consistently create value. We have six customer-facing lines of business supported by our internal service unit. Customers Consumer EE Business and Public Sector Global Services Wholesale and Ventures Openreach Technology, Service and Operations Customers 6.4% improvement in Right First Time performance 2m BT Call Protect customers Community £35.6m investment in society 31% BT volunteer people £471m UK corporation tax £95m raised for good causes Employees 71% employee engagement outcome 52% saveshare participants 88% maternity return rate 6% improvement in sickness absence Suppliers £14.1bn spent with suppliers 65% with top 100 suppliers Shareholders 15.40p full year dividend 10% increase year on year 22 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 23 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION What we do In this section, we provide more details on our purpose, goal and strategy in the context of our business model. It shows how we create value for our stakeholders over the short, medium and long term. Our purpose, goal and strategy Investing in what sets us apart Our purpose Our purpose is as simple as it is ambitious: to use the power of communications to make a better world. We invest in building and maintaining communications networks in the UK and overseas, as well as developing products and services that run over those networks. Some investments, such as TV sports rights (page 58), have a lifespan of just a few years. Other investments, such as our fibre broadband network, are much longer term, with a pay-back period that lasts more than a decade. We have a strong combination of people, technology, networks and other physical assets that sets us apart from our competitors. Importantly, we also have the financial strength to continue to invest in these areas. Our most important resources and relationships are described from page 26. The world is changing. Political upheaval, social and demographical changes, increasing economic inequality and worsening environmental impacts are becoming the new norm. We believe that technology has an important part to play in addressing these challenges and creating opportunities. Our goal Our goal is growth, in particular the creation of sustainable, profitable, revenue growth. We aim to achieve profitable revenue growth by delivering both a great experience and valued products and services to our customers. Profitable revenue growth, combined with continued transformation of our cost base and productivity, will drive strong, sustainable operating cash flow. We will reinvest a significant proportion of our operating cash flow in networks, products and services that will drive long- term growth and value for our customers and shareholders. We will use the residual cash flow to fund our pensions, pay dividends to shareholders and maintain a strong balance sheet. Our strategy In order to achieve our purpose and deliver our goal we’ve adopted a strategy based on broadening and deepening our customer relationships. To create sustainable profitable revenue growth, we need stronger relationships with our customers. The three pillars of our strategy help us build these relationships, providing a great customer experience, transforming our costs and enabling us to invest for growth in the process. They work together: the better our customers’ experience, the more we’ll sell and the less time and money we’ll spend putting things right. And the better we manage our costs, the more we can invest in improving our customers’ experience and in products and services that will create growth. 24 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 25 Selling services integral to modern life Creating value for all our stakeholders Oversight and governance We sell fixed-voice, broadband, mobile and TV products and services to individuals and households in the UK. For businesses we offer a variety of communications services ranging from phone and broadband through to complex managed networks and IT services and cyber security protection. Many public services rely on our technologies and in the UK we help other communications providers to service their own customers. We see growing demand for many of our products and services because they play such an integral role in modern life. We sell our products and services through our customer-facing lines of business, and continuously improve our costs and productivity to drive revenue, margins and strong operating cash flow. We reinvest a significant proportion of this operating cash flow in the business, creating a virtuous circle that delivers value for our stakeholders over the short, medium and long term. We use a range of channels to sell our products and services, including online, contact centres and account managers. We also have around 570 EE shops in the UK. Our revenue is mostly subscription or contract-based. Individuals, households and SMEs pay for standalone or bundled services, typically on 12- to 24-month contracts. Large corporate and public sector customers usually buy managed networked IT services on contracts spanning several years. Our wholesale customer contracts range from one month for regulated products, to five years or more for major managed services deals. Generating strong cash flow enables us to invest in the business, reduce net debt, support our pension fund and pay progressive dividends (see page 26). But there’s much more to what we do than just making money. What we do matters. It helps millions of people communicate, enjoy entertainment, do business and generally live their lives. We help our customers reduce their carbon footprint and we contribute directly to communities and the health of the UK by providing jobs, supporting suppliers, paying tax and encouraging our employees’ volunteering activities. All of which contribute to the strength of our brands – which in turn influences whether a potential customer buys from us or one of our competitors. Communications markets are dynamic and very competitive, particularly in the UK. There are multiple risks and opportunities, so it’s important our business model is flexible and sustainable. To help us we: – – – – have a framework to identify and mitigate the challenges we face (see page 44); use ‘insight’ teams to make sure we stay in tune with market opportunities and customer expectations; undertake an annual materiality review to understand the social and environmental issues that are important to our stakeholders; and use governance committees, such as our Design Council, to make sure we’re making the right investments. Together, these help us anticipate and respond to changes in our markets including ‘macro events’ like Brexit and the prospect of the UK leaving the single European market. That’s why we’re confident we can deliver value over the short, medium and long term. It’s this confidence that underpins our assessment of the future prospects and viability of the group (see page 55). Design Council The Design Council is a sub-committee of the Operating Committee (page 14). It normally meets monthly and is responsible for aligning our capital investments in our networks, systems, platforms and products so that they reflect our strategy, serve the needs of our customers and are delivered cost-effectively. 24 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 25 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability In this section we describe the key resources and relationships that underpin our business model. We also report on how our purpose can help to protect the environment. Financial strength Our financial strength means we can take a long-term view of investments. Our goal is to deliver sustainable profitable revenue growth. Together with further cost transformation, we aim to grow our EBITDA and cash flow over the long term. Our financial strategy has been consistent for a number of years: Deliver sustainable profitable revenue growth Our people Our people help shape the modern world. The products and services they create and manage underpin everything from global trade and industry, to economic growth and social infrastructure. Our people are a vital part of our ambition to deliver a great customer experience and sustainable, profitable revenue growth. Our people strategy supports this ambition by creating an environment where great people can do brilliant things as part of a dynamic business. Grow EBITDA Grow free cash flow Invest in business Reduce net debt Support pension fund Pay progressive dividends We have a prudent financial policy and strong governance, both of which help us make the right decisions in terms of planning investments, managing our debt and growing our business. Strategic investment, based on our financial strength, will ensure the long-term growth and health of our business. At the same time, we’re working hard to reduce our net debt, support our pension fund in a responsible way and pay progressive dividends to our shareholders. Our financial strength also means we can support the business in other ways, for example by making sure we continue to innovate and stay at the forefront of a rapidly-changing industry, and by investing in the training, development and support of our people. We recruited 3,600 new people into customer-facing roles at our BT UK contact centres How our people make a difference Our success isn’t just about what we do; it’s how we do things that really makes the difference. We want great people to work for BT. We want them to feel engaged and inspired to be the best they can be. Together we create a high- performing, thriving organisation, where difference is celebrated and innovation is a big part of who we are. At the heart of this are our people values. They’re aspirational, but realistic, capturing the spirit of BT at our best and reflecting how our customers want us to understand their needs, be easy to deal with and show we care. 26 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 27 This led us to three words: Personal Simple Brilliant Everyone in BT has a role to play in bringing these values to life. That’s how we’ll deliver on our purpose and use the power of communications to make the world a better place, every single day. This year we were deeply disappointed with the improper practices of a few individuals in our Italian business and the investigation into historical Deemed Consent which identified poor processes at Openreach. We know the vast majority of our people want to do, and will do the right thing, but this highlights the necessity to live our new values and work in an ethical way at all times. Our workforce At 31 March 2017 we had 106,400 full-time equivalent (FTE) employees in 63 countries, with 82,800 based in the UK. Like any successful business, we continually redeploy our people to meet the needs of our customers and ensure they get a first-class experience long into the future. Last year in the UK we redeployed 1,070 people, avoiding the need for redundancy. An integrated workforce Following the acquisition of EE we’re harmonising our policies, cultures and working practices to achieve our goal of becoming a truly integrated organisation. We’ve identified examples of best practice from both organisations that will act as building blocks for our ‘better than both’ ambition. Our new values reflect this. Recruiting talented people In December 2016 we launched an exciting new career website, showing the world what makes BT such a great place to work. This year, excluding acquisitions, we recruited nearly 17,500 people, almost 10,500 of whom are UK-based. A customer-connected workforce Improving the quality of our customer relationships remains central to our people strategy. We’ve recruited more than 1,500 people into Openreach and 3,600 new people into customer-facing roles at our BT UK contact centres. We’ve also hired 1,400 people into EE stores and filled more than 1,700 positions in EE contact centres. Allowing for people leaving, the result is a net increase of 200 FTE employees across EE. Finally, we continue to recognise the importance of retaining experience by converting almost 1,600 skilled agency workers to permanent employees. Hiring more graduates In 2016/17 we hired 300 graduates globally. We have plans to hire more than 450 in 2017/18 – our highest-ever intake. Once again we’re in the top half of The Times Top 100 Graduate Employers. We’re one of only five companies in the IT and telecoms sector to feature in the top 100. Hiring more apprentices We hired 900 new apprentices across the group in 2016/17. Our contribution to the new Apprenticeship Levy Fund means we’re able to offer more apprenticeship opportunities than ever before – over 2,000 next year. 900 new apprentices hired across the group 26 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 27 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued Investing for growth At BT, we never stop learning – whether that’s on the job, with colleagues or in a formal training environment. It’s how we adapt to a changing world and rise to the challenges of tomorrow. Around 25,000 of our people use our interactive Academy website every month and 7,000 of our EE employees used the EE Digital Academy this year. It’s a great way to build online learning communities where learning materials and events can be easily shared. Leadership We’re still investing in our leadership capability, developing effective leaders at all levels and in all parts of our business. Our main leadership programmes, Challenging Leadership in Action and Pioneers have reached 1,400 leaders globally over 2016/17. As well as welcoming EE to the BT family and introducing our new values, we’ve created two new leadership development programmes: Future Leaders and Connected Leaders. FUTURE LEADERS Develops high-potential people, enabling them to become leaders for the first time. CONNECTED LEADERS Launching in 2017/18, Connected Leaders emphasises the importance of connection with our customers, our people and different parts of our organisation as the key to creating a truly aligned BT. Engaging our people During the year we revised our employee survey and approach; the result (called Your Say) is shorter and features questions clearly linked to our strategy and values. We’ve made our report simpler for managers and their teams to understand so they can take action on the key priorities that will improve levels of engagement and better serve our customers. – The first full Your Say survey using the revised format attracted over 85,000 responses, representing around 80% of our people. – Almost 93,400 people (86%) responded to the January 2017 Your Say survey. – The result has generated momentum in every engagement driver category, with 18 of the 20 driver items starting to move in the right direction; the following table provides a snapshot of this: DRIVER Engagement outcome Leading our people Managing our people Empowering and equipping our people Enabling outstanding customer experience Working together Personal growth SCORE 71% 53% 78% 58% 59% 60% 69% PERCENTAGE CHANGE SINCE PREVIOUS SURVEY -1% -1% +3% +3% +3% +4% +3% We keep our people informed about company results, major business decisions and other things that affect them using a variety of digital channels. Leaders regularly connect with their teams through roundtable meetings, town hall debates, site visits, webcasts and blogs. EE was voted in the Top 3 in The Sunday Times’ Top 30 Best Big Companies to Work For awards 2017 Awards won this year Our Academy won a Silver Award at this year’s Learning Awards for its social and collaborative learning. EE won a Princess Royal Training Award in 2016, training 358 employees over eight days following our takeover of 58 stores. EE’s Priority Launch programme which is dedicated to improving employee performance won another Princess Royal Training Award in 2016. 28 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 29 We’ve run recruitment campaigns for graduates and apprentices that aim to attract more women and black and minority ethnic background (BAME) candidates. We’ve also rolled out unconscious bias training for all those involved in recruitment. We’re proud that BT was named in The Times’ Top 50 Employers for Women awards 2017. Over 27,000 women now work for us, that’s 25% of our entire workforce. Our management team includes more than 10,000 women, representing 26% of the total, while our Board is now 27% female, with women accounting for three out of 11 Board members. We want to create an environment where our people can feel open about being themselves at work. As part of this, our LGBT+ employee network is asking people across the business to stand by LGBT+ colleagues to create a respectful and supportive working environment. The LGBT+ Allies programme calls on them to be visible and vocal in their support, and take an active interest in LGBT+ topics. We’re a founder member of the Equality & Human Rights Commission Working Forward initiative, and our maternity handbook is being widely used as an example of best practice. Our maternity return rate continues to improve and currently stands well above the industry average at 88%, measured one year after women returned. Along with Business in the Community, we sponsored The Race at Work reporta that informs the development of our diversity initiatives. We’ve also appointed a Race Champion to oversee this work and have seen a rise in BAME employees to 12%. We are a ‘Disability Confident’b employer and we actively encourage the recruitment, development and retention of disabled people. We’ll automatically put an applicant with a disability or long-term health condition, who meets the minimum criteria for a vacancy, through to the first stage of a recruitment process. An inclusive culture is fundamental to ensuring our diverse workforce can develop and thrive. We’ve focused on embedding themes of inclusivity within all our leadership development programmes for senior management teams, with a specific focus on developing diverse future talent. Promoting wellbeing We recognise that the wellbeing of our people feeds directly into our customers’ experience of BT and helps ensure the ongoing profitability of our business. We’ve looked at what we can do to increase wellbeing through our refreshed people strategy, drawing on the latest scientific evidence. We’re working hard to eliminate all avoidable health and safety incidents by investing in improved training and equipment. A safe work environment is fundamental to our success, and we’re pleased to say we’ve cut our accident rate even further this year by 18%. Our sickness absence rate was rising but we’ve turned that around this year and it’s now dropped by 6%. We’ve made particular progress in reducing mental ill health, which is down by 13% (excluding EE). Our other main sickness area is musculoskeletal disorders; in response we’ve developed a major initiative to help people avoid strains that’s part of our wider Fit for Life campaign. We’re pleased to say that in January we hit our five-year target of getting 10,000 people more active three years early. a http://race.bitc.org.uk/all-resources/research-articles/race-work-report Challenge Cup Challenge Cup is our flagship people engagement programme. It’s an annual competition that encourages people to work as a team to develop new ideas that improve customer experience, save money and create innovation. Our people genuinely love it. The number of people taking part increases every year – this year more than 5,500 people came together to form over 1,100 teams across 28 countries, including people entering the competition for the first time. >5,500 participants this year Volunteering Our people can use up to three working days a year for volunteering activities. Some choose to help charities with particular challenges that need their expert input and knowledge. Others use their energy and enthusiasm to make a practical difference in their local communities. This year more than 31% of our people spent over 39,000 days volunteering their time, with more than 2,000 people helping children and young adults improve their skills through our Tech Literacy and Work Ready programmes (see page 35). Our 2020 ambition Inspire two-thirds (66%) of our people to volunteer their time and skills 66% 11,000 £5.1m volunteers took part in our Stand Up To Cancer and Comic Relief campaigns helping to raise £1.3m and £3.8m respectively Diversity at work Diversifying the mix of our people continues to be a priority within our people strategy. We’re particularly keen to encourage women into technology careers through our Tech Women programme. 28 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 29 b Disability Confident is an accreditation which includes Two Ticks that is given to organisations that are committed to employing disabled people. THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued We’ve extended our programmes to EE which has already helped bring sickness absence down across the group. We’re always looking for ways to improve, and have introduced prehabilitation - designed to shorten recovery time for our people undergoing surgery. In short, we know that keeping our people healthy and happy is good for them, good for business and good for society. Our networks and physical assets Our network, service and IT platforms support the products our customers rely on around the world. Pay and benefits We regularly review our pay and benefits to make sure our remuneration is competitive when compared to other companies of a similar size and complexity. Most of our UK-based engineering and support people are paid using terms and conditions negotiated through collective bargaining with our recognised trade unions, ensuring fairness for all. Our managers’ pay ranges are also set at competitive levels. Bonuses are determined through a combination of business performance and their personal contribution to the company. Our executives may also get long-term share awards to reward the creation of shareholder value. The value they ultimately get is determined by the group’s performance over a three-year period. Executive directors must retain incentive shares for a further two- year period. In line with regulatory obligations, incentives for people in Openreach are tied to a combination of personal contribution and Openreach’s performance, rather than that of the wider group. These incentives are paid in cash, as opposed to BT shares. We support our people by providing a range of retirement savings plans and country-specific benefits. In the UK, our main defined benefit scheme is the BT Pension Scheme, while our main defined contribution scheme is the BT Retirement Saving Scheme. You can read more about these on page 101. Sharing in success Around 52% of our people take part in one or more of our savings- related share option plans (known as saveshare), which operate in over 25 countries. In August 2016 almost 9,000 people in our 2011 saveshare plan were able to buy shares at 156p, representing an average gain of around £5,000 each. Network platforms Our UK fixed-line network is one of our most valuable assets and our investment in fibre broadband is key to providing services to UK consumers. Our fibre broadband network now passes more than 26.5m UK premises, and we provide FTTP to more customers than any other UK service provider. To meet the demand from businesses, we’re continuing to expand the availability of Ethernet. This year we’ve had record levels of traffic across our UK network, yet the investments we’ve made in broadband technology mean that more customers continue to get faster speeds over our network. Our global reach Our global network is supported by in-country networks and infrastructure. We offer our widest range of network services, access technologies and coverage in the UK, with extensive networks in Germany, Italy, the Netherlands, the Republic of Ireland and Spain. The scale and reach of our global multi-protocol label switching (MPLS) network is a key competitive differentiator, and we’ve enhanced it this year with the launch of a software-defined wide area network capability. We’re selectively expanding the reach of our network to support multinational companies in other regions. Virtual private network (VPN) services are integral to our ‘Cloud of Clouds’ vision (see page 71). They provide the convenience and security of a private network but over the public internet. We use our MPLS network together with a combination of owned and leased fibre connections to connect our points of presence (PoPs) around the world. For the final connection into the customers’ premises, we either use our own circuits, or lease connections from telecoms operators in that country. Where we need to serve customers in very remote locations, we make use of our extensive satellite connections. Security is an important part of our business. The expertise we’ve gained from protecting our own networks helps us secure our customers’ networks. The EE network is the UK’s largest 4G network, now covering 80% of the UK’s geography and reaching over 99% of the population 30 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 31 Mobile network We’ll keep investing in 4G geographic coverage and capability, consolidating the EE network’s position as the biggest and fastest in the UK. Specifically we aim to expand 4G to reach 95% of the UK’s geography by the end of 2020. EE customers already enjoy the fastest 4G speeds in the UK, while technology such as LTE Advanced Pro gives them much greater capacity. We have 120MHz of paired mobile spectrum. This means we’re able to offer speeds of up to 360Mbps in areas served by our 4G+ network. We have access to over 18,500 basestation sites including those via the MBNL joint operation between EE and Hutchison 3G UK. – IT systems platforms Our IT systems let us manage our processes, handle customer information and deliver our products and services. They’re critical to serving our customers and running our business. We’ve been simplifying the different technologies we use across BT. For example we’ve been migrating EE people to BT systems so we can all benefit from using a single, consistent set of applications. Progress this year This year we’ve: – introduced systems and processes that mean we can sell BT products to EE customers; and delivered the technology behind the new BT Call Protect Service (page 57). And we’ve improved the way we maintain and manage key mobile sites. By insourcing work and integrating the EE and BT engineering workforce we’ve achieved real service and productivity improvements. Wi-fi We run one of the world’s biggest wi-fi networks, with around 5.6m BT Wi-fi hotspots. Progress this year This year we’ve: – upgraded almost 500 mobile basestations to offer up to 360Mbps. We’ve also switched on our first Gigabit-enabled basestations in London, with Cardiff following in April 2017; addressed the growing demand for digital transformation through the introduction of a cloud-based unified communications service for business customers offering voice, messaging, conferencing and presence; demonstrated a world-record speed of 2Tbps over a 700km live network fibre between London and Dublin. This gives us confidence that our core network will be able to cope with the growth of data traffic; and demonstrated the first live customer trial in Europe delivering increased capacity by using three different passive optical network technologies over the same fibre. – – – Service platforms We run a number of service platforms that combine our network and IT resources. They underpin many of the key products we offer. Our BT TV platform supports a growing number of customers and we’re increasing the range of services it delivers. We support BT Mobile, Plusnet Mobile and EE with our Mobile platform; it also underpins the Emergency Services Network (ESN). Progress this year This year we’ve: – extended our BT Sport app to provide extra features during Premier League and FA Cup matches; added Dolby Atmos surround sound to Ultra HD football matches; and carried over one billion minutes per month on our BT Conferencing service platform. – – Properties We have around 7,000 properties in the UK and 1,700 across the rest of the world. We lease the majority of our UK properties from Telereal Trillium, part of the William Pears group, as part of a sale and leaseback arrangement we signed with them in 2001. 88% of our UK properties are operational sites housing fixed and mobile telecoms and broadband equipment. The rest are retail outlets, offices, contact centres, depots and data centres. We also have our BT Sport TV studios in London. In the UK, we’ve been busy rationalising office space, vacating offices in Belfast, Darlington, Langley, Leeds, Newcastle-under-Lyme and the former EE headquarters building in Paddington. Outside the UK, we’ve consolidated a number of our key office locations in Amsterdam, Hong Kong, Madrid and Sydney to improve operational efficiency. BT property portfolio (UK)a 6,126 operational sites 21 data centres 268 offices and depots 574 retail outlets a Excludes leased cell sites, retail concessions within other retailers’ premises and franchisee-owned leases. 30 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 31 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued Research and development Commercial success increasingly depends on innovation – that’s why we invest so much in research and development (R&D). The result is a track record of scientific breakthroughs, engineering successes and commercial progress. Our proud history of innovation We can trace our origins back to 1837, when Sir William Fothergill Cooke and Sir Charles Wheatstone filed a patent for the world’s first practical electric telegraph. From this they founded The Electric Telegraph Company, the seed business that eventually grew into BT. And we’ve kept innovating ever since – you can read more about our innovation story here: www.btplc.com/Innovation/Innovationstory/index.htm You can also see some of our past innovations in the Science Museum, including Cooke and Wheatstone’s electric telegraph and parts from Colossus, the world’s first programmable computer. This year we invested around £520m (2015/16: around £470m) in R&D. Over the last ten years we’ve been one of the largest investors in R&D both in the UK, and globally in the telecoms sectora. Our research activities keep producing new inventions. In 2016/17 we filed patent applications for 102 inventions (2015/16: 97), and as of 31 March 2017 had a worldwide portfolio of more than 4,900 patents and applications. Open innovation No-one has a monopoly on good ideas. That’s why we’re always keen to work with partners, universities and customers from around the world. We call it our open innovation model. We have eight global development centres including Adastral Park, our UK technology headquarters. It’s an innovation campus we share with over 90 high-tech companies, and is a workplace for around 3,800 people. This year we continued to grow our development centres in India. We’ve extensive, long-standing, joint-research programmes with Cambridge University (UK), Massachusetts Institute of Technology (US), Tsinghua University (China), Khalifa University (UAE) and over 30 other universities globally. 102 4,900 patent applications for inventions filed in 2016/17 patents and applications in our worldwide portfolio Innovation milestones 1926 1943 1968 We established the world’s first two-way, Trans-Atlantic conversation by radio telephone, from our wireless station near Rugby. Tommy Flowers, working in the telecoms division of the GPO, developed the world’s first programmable electronic computer, Colossus. The world’s first digital telephone exchange was installed by us in London. 1984 1980 We installed the world’s first 140Mbps commercial single- mode optical fibre link between Luton and Milton Keynes. We laid the world’s first, purpose-designed optical fibre submarine cable in Loch Fyne. 1999 2013 2016 Our live data call over a GPRS network was a world first. We conducted the world’s first G.fast trial in Ipswich, with our partner Huawei. G.fast is one of the technologies that underpins our ultrafast broadband vision. Our super-channel speed of 5.6Tbps in our core network set the record for the fastest data transmission over an operational fibre link. a Comparison based on total R&D spend 2006/07 to 2015/16. Source: EU Industrial R&D Investment Scoreboard, http://iri.jrc.ec.europa.eu/scoreboard.html 32 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 33 Tommy Flowers Institute This year we launched the Tommy Flowers Institute, a new Higher Education ICT training institute at Adastral Park. Working with partners from across the ICT sector, we’ve designed the Institute to create world-class research leaders who can collaborate across multiple academic disciplines. They’ll focus on solving some of the challenges facing UK businesses, exploring areas such as cyber- security, ‘Big Data’, autonomics and converged networks. Examples of our R&D activities this year include: Long-reach VDSL trial Building on last year’s lab tests, we’re trialling long-reach VDSL in Isfield, Sussex and on the Isle of Lewis. EAD Rapid Ethernet Access Direct (EAD) is Openreach’s Ethernet product, offering data rates from 100Mbps to 10Gbps on a single fibre (see page 86). We’ve developed EAD Rapid, a method to quickly provision a second EAD circuit where one already exists using the same fibre. This means that customers don’t have to wait for a second fibre to be installed before their new service will work. Exchange Filter Customer premises Filter Installed fibre Standard circuit EAD Rapid circuit Self-organising networks interworking Self-organising network (SON) technology automates the planning, set up, management and repair of mobile networks. We’ve established a test lab at Adastral Park to test SON equipment. This led to a world-first demonstration of SON interoperation between different vendors’ 4G products. Tommy Flowers was an engineer who joined the General Post Office research station at Dollis Hill in London in 1930. He had a particular interest in the use of electronics for telephone exchanges. In November 1943 Flowers developed ‘Colossus’ at the Ministry of Defence’s code-breaking facility in Bletchley Park. The world’s first programmable computer, Colossus was designed to counter the reputedly unbreakable Lorenz cipher. The thermionic valve-based, programmable Colossus successfully broke the Lorenz cipher and went on to provide information critical to the success of the D-Day landings and Allied war effort. After the war, Flowers went on to direct ground-breaking research in the field of telecommunications, including the development of the first all-electronic telephone exchange. Macrocells Macrocells Who was Tommy Flowers? 5G We’re working with a range of partners to deliver our 5G service ambitions, conducting trials of 5G-ready radio equipment at BT labs. 32 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 33 Small cells Interference coordination Interference coordination THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued Brand and reputation Our organisation is made up of three strong brands: BT, EE and Plusnet. Between them, they cover UK and global markets for consumers, businesses and the public sector. We’ve worked hard to position all three so they maximise their reach while minimising overlap with each other. This multi-brand approach gives us greater agility in the market and increases our overall consideration. Stakeholders As well as our own people, BT’s main stakeholders are our customers, communities, shareholders, lenders, pension schemes, suppliers, government and regulatory authorities. Our customers Our customers include individuals, households, businesses of all sizes and public sector organisations. You can read about our markets, customers and the services we offer them in our Lines of Business section, from page 56. BT BT is the biggest of our three brands in terms of overall brand value. It stretches across consumer, business and public sector markets and operates in 180 countries. This year, BT Sport continued to grow its viewership and win awards. These included the best TV or media innovation award for the BT Sport app at the Broadband World Forum. In the UK business market, BT has the highest awareness of any telecoms, networks and IT services brand. We kept up the pace with strong business wins such as network and ICT services for Royal Mail Group and network infrastructure for the Co- operative Group. BT was also positioned by Gartner, Inc, as a Leader in the Magic Quadrant for Network Services, Global for the 13th consecutive time (see page 72). Research company Millward Brown valued the BT brand at $18.6 billion in 2016. It’s possible that the impact of our Italian investigation may cause this to decline when the 2017 valuation is published. We describe what we’re doing to redress this on page 6. EE EE is the UK’s biggest mobile operator, positioned firmly at the cutting edge of technology. EE is also number one for spontaneous brand awareness, despite being almost a decade younger than any other major UK mobile brand. Plusnet Plusnet has a distinctive market position, offering UK consumers brilliant service at a great price. This year, Plusnet won 21 awards, including the uSwitch awards for Best Customer Service and Best Home Broadband, and a Silver at the IPA Effectiveness Awards for effective advertising and brand-building. Interestingly, some of our customers are also our competitors. That’s because we sell wholesale products and services to other communications providers in the UK and overseas. Communities and society Our purpose influences our decisions and actions. This year we invested £35.6m to help a number of initiatives that deliver social and environmental benefits, as well as stimulating economic growth. This investment is a mixture of cash, time volunteered, and in-kind contributions. Over the past five years we’ve invested over £157m, an average of 1.08% of our adjusted profit before tax. Total investment in society Year ended 31 March £m 1.12% 1.01% 1.15% 1.10% 1.03% . 1 7 2 . 2 7 2 . 5 2 3 . 0 5 3 . 6 5 3 40 30 20 10 0 2013 2014 2015 2016 2017 Percentage of previous year’s adjusted profit before taxation Investment – time, cash and in-kind support Connecting society Our 2020 ambitions More than 9 out of 10 people in the UK will have access to our fibre-based products and services We will help 10m people overcome social disadvantage, through the benefits our products and services can bring 9/10 10m 5m Working together We’re working on synergies and opportunities for our three big brands to support each other wherever possible. You can read more about this in the Consumer and EE sections on pages 56 and 62. We will help 5m children receive better teaching in computing and tech skills 34 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 35 in India that’s reached over 700,000 people. We’ve also delivered wi-fi connectivity and services to refugee centres in Serbia, reaching 317,000 people. Building a culture of tech literacy for the next generation Today the UK faces a major challenge. The next generation are great tech consumers, but few are active creators. In a world where so much of our life and work depends on technology, that may be the difference between getting ahead or being left behind. The answer is to build a culture of tech literacy, so that young people grow up with the tech know-how to step up to the jobs of the future and to shape a more inclusive society that works for them. We’re helping to do that by championing tech literacy as a new cornerstone of modern education in primary schools, and by connecting to popular culture to inspire young people about the relevance of tech. We believe that tech literacy is a fundamental skill for young minds, as important as reading and writing. That’s why the Barefoot Computing Project helps primary school teachers get confident with tech literacy concepts such as computational thinking which provides the building blocks of the digital world; like logic, sequencing, abstraction and programming. We’ve been providing a combination of free teaching materials and volunteer-led, face-to-face training. We’ve now reached more than 39,000 teachers, and through them more than a million children. And we know it’s having a positive impact: Teachers are more confident after using Barefoot resources: % 4 8 % 7 5 % 2 8 % 7 6 % 2 9 % 1 8 % 100 80 60 40 20 0 Confident with computing curriculum Understand computational thinking Use computational thinking in computing lessons All teachers Teachers who accessed Barefoot resources Teachers who use computational thinking in lessons see positive impacts on pupils’ learning: 99% say it helps pupils solve problems 96% say it improves pupils’ numeracy skills 82% say it helps pupils work together more collaboratively 69% say it improves pupils’ literacy skills Providing access to fast broadband We recognise how important it is for everyone to have access to fast broadband. We continue to progress towards our 2020 ambition, with 88% of UK premises now able to access our fibre-based products and services. The acquisition of EE gives us the opportunity to extend our reach even further through mobile broadband. Promoting digital inclusion Digital transformation has the power to improve our quality of life, boost the economy and protect the environment. Research we published last year suggests that access to e-health applications could provide better healthcare for nearly 20m more people in the UK by 2030a. It’s always been our aim to make sure no-one is left out, especially vulnerable groups like the elderly, disabled or financially disadvantaged. We continue to develop products and services to help people overcome barriers to inclusion, such as BT Basic + Broadband, 4GEE WiFi, and our social housing proposition. We also create awareness and collaboration through our presence on the UK Government’s Council for Digital Inclusion. Our partnership with Doteveryone is offering skills training to homeless people in the London Borough of Croydon. The ‘BT and Barclays Wi-Fi in our community’ programme now supports 100 libraries and community centres across the UK. The Tech4Good awards that we co-founded are now in their sixth year and still recognise organisations and individuals who use technology to improve the lives of others. Our EE stores run Techy Tea Parties to help boost people’s confidence in going online. And because we want to make sure children use the internet safely, we’re working with partners like Internet Matters and Unicef UK through our programme The Right Click: Internet Safety Matters. Outside the UK, we’ve completed the implementation of the healthcare management system within our Connecting Africa programme, winning the ‘Changing Lives’ award at the Broadband World Forum. Our insight is helping shape the World Economic Forum’s Internet4All initiative in Sub-Saharan Africa. As a partner in One Million Community Health Workers (1mCHW), we’re providing mobile health tools in Ghana. And we’ve helped provide IT training 34 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 35 a The role of ICT in Reducing Carbon Emissions in the UK, BT, 2016 – available at www.bt.com/deliveringourpurpose THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued We’re also focusing on the transition to work, so that the next generation can fulfil future job needs. Work Ready gives 16-24 year olds, particularly from disadvantaged backgrounds, skills development and hands-on work experience of what it takes to thrive in a world of work powered by tech. So far more than 2,000 young people have taken part in this initiative. Manchester Community Academy Research shows that interest drops off and career aspirations narrow in the early years of secondary school. Using the power of BT Sport, we delivered a pilot projecta at the Manchester Communication Academy to bring alive the tech behind the things young people love – using an Outside Broadcast truck to lift the lid on how much tech it takes to bring the best sporting action to their screens. We’re now working on plans for a national rollout to help more young people think again about how tech might show up in their futures. Supporting charities and communities Our 2020 ambition Use our skills and technology to help generate more than £1bn for good causes £1bn This year we helped generate £95m towards good causes, in support of our £1bn target. £62.6m of this was raised via MyDonate, our commission-free online fundraising and donations platform. That means we’ve now helped to generate £422m for good causes since we set ourselves this ambition in 2012. As well as creating scaleable opportunities to put something back into the community, this can also provide great content for our TV channels and improve public perception of our company. We again used MyDonate and our communications technology – with help from our volunteers – to support various large telethons. These included Stand Up To Cancer, Comic Relief and Children in Need. In the UK, we supported a number of smaller charities by providing discounted calls and line rental charges to members of The Charities Club, saving those charities almost £1.3m on their phone bills. We see sport as a positive vehicle for change in young people’s lives. This year we launched a new programme, in partnership with the Premier League, to help disabled people become more active in the sport of their choice, creating opportunities for them to develop the skills and build the confidence needed to realise their potential. Our shareholders We have more than 790,000 shareholders. As well as the Annual Report and Annual General Meeting, we keep our shareholders up to date with how we’re doing through regular mailings. These often include offers on our products and services that are only available to shareholders. Our website includes press releases, newsletters, presentations and webcasts that also keep our shareholders informed. Most of our shares are held by institutional investors. We have an extensive investor relations programme aimed at keeping existing investors informed and attracting new ones. This programme includes: – reporting quarterly results, accompanied by a conference call or presentation from senior management; – site visits and ‘teach-ins’ on key topics; and – meetings and conference calls with investors both in the UK and around the world. In 2016/17, we held 507 meetings or events with institutional investors. This compares with 353 in 2015/16. We were voted the best company for investor relations in England for the third year running in the Extel Survey 2016. We also maintained our second place in the European telecoms sector of the same survey. Our lenders Our lenders, mainly banking institutions and bondholders, play an important role in our treasury and funding strategy. These relationships are vital for funding our business and meeting our liquidity needs. You can find out more about this on page 97. Our pension schemes We operate defined benefit and defined contribution pension schemes. The largest by membership is the BT Pension Scheme (BTPS) which has around 300,000 members. You can read more about this on page 204. a www.techliteracy.co.uk 36 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 37 Our suppliers Our suppliers provide the products and services that are so important in executing our strategy. We source from across the world and currently have suppliers in over 150 countries. We spent around £14.1bn with our suppliers this year (2015/16: £10.2bn). Around 65% of our spend is with our top 100 suppliers. This year we consolidated the EE and BT supplier base. As part of the EE integration, we’ve combined the best practices and processes from both procurement teams to remove duplication and support synergies. Our approach to procurement We have around 360 BT people in 27 countries working with suppliers. As part of our cost transformation activities we aim to make the most of our relationships with our largest suppliers, demonstrating our commitment to them by establishing a specialist in-life contract management team. In-life contract management of our top 130 suppliers has helped us save around £10m. Our Central Business Services Centre reviewed around 80,000 purchase orders accounting for £3.8bn of spend, helping us save more than £15m. We’ve worked with other companies through our membership of an industry-recognised thought-leadership organisation. This gives us the peer benchmarking support, market insight and innovative techniques we need to optimise our procurement strategy. Choosing our suppliers We want to know who we’re doing business with and who’s acting on our behalf. So we: – choose suppliers using principles that make sure we act ethically and responsibly; – check that the goods and services we buy are made, delivered and disposed of in a socially and environmentally responsible way; and – measure things like suppliers’ energy use, environmental impact and labour standards, as well as working with them to improve these. You can find out more at: www.selling2bt.bt.com Ethical standards in our supply chain We want our suppliers’ employees to experience working conditions that are safe and fair. To help us assess the risks, we send an ethical standards questionnaire to suppliers of higher and medium-risk products and services. We follow up with suppliers identified as high or medium risk, based on their responses. This year we met our target of 100% follow-up within three months. We also visit supplier sites to make sure they meet our standards. This year we visited 63 sites (2015/16: 47 sites) around the world. We published our first Modern Slavery Act Statement this year. We conducted a detailed risk assessment of our categories of spend, and as a result, engaged with more than 500 suppliers to improve our understanding of forced labour and human trafficking in our supply chains. Number of on-site supplier assessments 7 4 7 4 3 6 70 60 50 40 30 20 10 0 2015 2016 2017 We continued our compliance with the Dodd-Frank Act and our Security and Exchange Commission (SEC) obligations by asking suppliers whether their products contained certain minerals that may have been sourced from conflict areas. In June 2016 we filed a report covering 2015 with the SEC, which described our conflict minerals approach and reflected the responses we got from our suppliers. Paying our suppliers This year the average time between invoice date and supplier payment was 67 days globally (2015/16: 62 days) with 50 days for UK invoices. Suppliers can choose to use the BT Supplier Finance scheme which offers contracted suppliers the chance to be paid early. This cuts financing costs for participating suppliers, large or small, and is particularly attractive for SMEs (who make up around 48% of our supply base). We remain a signatory of the UK Prompt Payment Code, and are supporting Government initiatives to encourage small business growth. Human rights We’re committed to respecting human rights. We’re steered by the UN Guiding Principles on Business and Human Rights (UN Guiding Principles). We believe our communications services have a positive impact on society, empowering people to exercise their rights and freedoms. At the same time we recognise that as a global company our work could adversely impact human rights, either directly or through our wider business relationships. The importance of privacy and free expression Privacy and free expression are still the rights most at risk from communication services. The Investigatory Powers Act 2016 (IPA) made significant changes to the investigatory powers regime in the UK, in a way that could have a considerable impact on the privacy of customer communications. We want our customers to know they can trust us with their information, which is why we played a central role in lobbying for changes to the IPA before it became law. To enhance our own processes, we’ve created a formal board committee (the Investigatory Powers Governance Committee), chaired by Sir Michael Rake, to oversee the role we play in the use of investigatory powers. 36 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 37 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued What we’ve been doing We’ve continued to champion free expression through our discussions with the Government on the Digital Economy Act. We’ve also reviewed our Acceptable Use Policya to make it easier for customers to understand how they should use our online services to express themselves. The directives include rules covering: – access and interconnection; – universal service obligations; and – a requirement for national regulators to review markets for significant market power (SMP) every three years and to put appropriate and proportionate SMP remedies in place. We continue to review our processes, including our approach to human rights in our global activities. We’ve launched our enhanced human rights due diligence tool. And we’re leading the broadcast element of an international initiative looking at the impact of large- scale sporting events on human rightsb. We’ve also joined The Global Network Initiative on privacy and free expression as an observer. Our first Modern Slavery Act statementc describes our approach to preventing modern slavery in our supply chain and our business. We want to play our part in tackling this so we’re proud to be partnering with the charity Unseen to set up and resource the Modern Slavery Helpline and Resource Centred. Our relationship with HM Government We’re one of the largest suppliers of networked IT services to the UK public sector. We work with almost 1,800 organisations across central, local and devolved government, supporting some of the UK’s most vital services including health and social care, police and defence. One of our most important contributions is helping organisations deliver better public services while keeping data secure. For example: – in Islington we’re linking up information systems to improve health and social care for the borough’s residents in a way that enables them to access their personal electronic health record. – in Essex, thanks to new smartphones supplied by BT, police are spending more time fighting crime and being visible in their communities. Another aspect of our relationship with government is that we can be required by law to do certain things and provide certain services. For example, under the Communications Act, we (and others) can be required to provide or restore services during disasters. The Civil Contingencies Act 2004 also states that the Government can impose obligations on us (and others) at times of emergency or in connection with civil contingency planning. The Secretary of State for the Home Department can also require us to take certain actions in the interests of national security. Regulation Communications and TV services are regulated in the UK and around the world. This is to make sure that CPs and broadcasters comply with common standards and rules, and that nobody is disadvantaged by providers with strong positions in their markets. European Union (EU) regulation In EU countries, electronic communications networks and services are governed by directives and regulations set by the European Commission (EC). These create a Europe-wide framework (known as the European Common Regulatory Framework) covering services such as fixed and mobile voice, broadband, cable and satellite transmission. Companies with SMP typically have a market share of 40% or more and could, without regulation, be able to do things such as increase prices without losing business to competitors (as would happen in a fully competitive market). Review of the European Common Regulatory Framework In September 2016, the EC published proposals for its review of the European Common Regulatory Framework. As part of this review, the EC will assess how to encourage investment in infrastructure and how to make current telecoms and media rules fit for new challenges and new types of service provider. The EC is also reviewing copyright and content policy. A directive embodying the new code is expected to be adopted in mid- 2018, taking effect mid- to late-2019. The UK’s exit from the EU When the UK leaves the EU, depending on the nature of any trade agreement reached, the UK may no longer be required to abide by the EU Regulatory Framework and other relevant EU rules. The existing regulations are widely recognised as having helped make the UK communications market one of the most competitive in the world, providing consumers with low prices and the best coverage of superfast broadband in the major EU countries. Therefore, while the existing regulations could be fine-tuned to suit specific UK market conditions, we do not expect fundamental changes. UK regulation The UK telecoms and broadcasting industries are regulated primarily by Ofcom (the UK’s independent regulator) within the framework set by the various European directives, the Communications Act 2003 (the Communications Act) and other UK and EU regulations and recommendations. The Communications Act and Ofcom The Communications Act gives Ofcom legal powers and sets out how electronic communications and broadcasting services should be regulated in the UK. It includes the conditions set by the European directives. Under the powers of the Communications Act, Ofcom sets conditions that CPs must comply with. Some conditions, known as General Conditions, apply to all CPs. These mainly deal with issues such as protecting consumers, access and interconnection, and allocating and transferring phone numbers. a www.productsandservices.bt.com/products/static/terms/ b www.ihrb.org/programmes/mega-sporting-events/white-paper-3.2-broadcasters c www.btplc.com/Thegroup/Ourcompany/Ourvalues/ModernSlaveryAct/ModernSlaverystatement.pdf d www.modernslaveryhelpline.org/ 38 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 39 Ofcom’s main duties – – To further the interests of citizens in relation to communications matters. To further the interests of consumers in relevant markets, where appropriate, by promoting competition. Other conditions apply to certain companies that are universal service providers or which Ofcom has decided have SMP in a particular market. We’re the designated universal service provider for the UK (except for the Hull area where that role is taken by KCOM Group) and so we have certain obligations. The main one is to make sure that basic fixed-line services are available at an affordable price to all consumers. We’re also obliged to provide public payphones. We have SMP in a number of markets including Business Connectivity (such as Ethernet and backhaul), Fixed Access (including LLU, GEA and WLR) and Wholesale Narrowband (such as Call Origination). That’s why Ofcom’s market reviews are so important for us. Following a market review, if Ofcom decides that a CP has SMP, it can put controls in place, typically on the prices which the CP can charge. CPs affected by Ofcom decisions can appeal them through a number of routes, including the Competition Appeal Tribunal (CAT) and the High Court. BT’s Undertakings In response to Ofcom’s 2005 Strategic Review of Telecommunications we gave some legally-binding undertakings under the Enterprise Act 2002. These Undertakings (which included the creation of Openreach) began in September 2005. They aim to give the UK telecoms industry clarity and certainty about the way we provide wholesale regulated products. This in turn supports effective and fair competition in related retail markets. Ofcom has published a consultation proposing to release BT from the Undertakings in light of the new Commitments we made to Ofcom on 10 March 2017. Overseas regulation The degree of regulation in international markets varies widely. This can hinder our ability to compete and provide the services our customers require. We keep pressing incumbent operators around the world, and their national regulatory authorities, for fairer, cost-related wholesale access to their networks. Ofcom’s Strategic review of Digital Communications In March 2015 Ofcom announced it would carry out a strategic review of the digital communications industry, looking at ways to improve investment, innovation and competition across fixed-line, broadband and mobile markets. In February 2016 Ofcom published its initial conclusions. These covered the wide range of issues originally flagged by Ofcom, as well as a conclusion that BT’s model of functional separation should be strengthened to allow Openreach to take its own decisions on budget, investment and strategy, in consultation with its communications provider customers. This became the focus of the review, with the other issues taken forward through separate Ofcom initiatives. In July 2016 Ofcom consulted on proposed reforms of Openreach, including Openreach becoming a distinct legal entity. Also in July 2016, we announced that we intended to implement changes to address Ofcom’s concerns, including: – a new Openreach board as a board committee of BT plc, with a majority of independent members including the chairman; greater delegation of strategic, operational and budgetary responsibilities to Openreach; and an enhanced process for industry consultation on large investment plans. – – On 29 November 2016 Ofcom announced it was planning to make a formal notification to the European Commission in 2017 seeking approval to mandate legal separation of Openreach, stating that the changes we announced in July would not fully address its concerns. At the same time, we announced that as the first step in the delivery of our changes, we had appointed Mike McTighe as the first chairman of the Openreach board. We said we were also continuing to seek to reach a voluntary agreement with Ofcom that would avoid the lengthy and complex processes involved in a notification to the Commission. Following further discussions, BT and Ofcom agreed a new settlement, announced on 10 March 2017. This agreement, based on voluntary commitments by BT, will see Openreach become a distinct, legally separate company within the BT Group. We will consult all Openreach employees on the transfer of their employment to Openreach Limited once all the necessary pensions’ protections and arrangements have been put in place. Once the agreement is implemented: – Openreach Limited will have its own branding, which will not feature the BT logo. The Openreach CEO will report to the Openreach chairman with accountability to the BT Group, as the CEO of a wholly-owned subsidiary. This includes accountability to the BT Group chief executive with regards to certain legal and fiduciary duties that are consistent with BT’s responsibilities as a listed company. – The agreement is intended to be comprehensive and enduring. It will provide BT and other companies with greater regulatory clarity and certainty which is vital for investment. This will help the UK retain its position as a leading digital economy, with the largest superfast network among major European nations. 38 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 39 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued speed GEA 40/10 service. Ofcom expects to publish its final decision in early 2018 with new measures taking effect from 1 April 2018. On 31 March 2017, Ofcom also published a consultation on a new fair and reasonable charge for MPF rental at service level 1 for the period 1 April 2017 to 31 March 2018. Wholesale broadband access (WBA) market review The current control set by Ofcom for the WBA market (ie IPStream) expired on 31 March 2017. Ofcom is expected to undertake a review of this market in calendar Q2 2017. Meanwhile we gave Ofcom a commitment to maintain a cap on the relevant price baskets of CPI-CPI until 31 December 2017, or the conclusion of Ofcom’s review if earlier. Narrowband market review Ofcom is currently reviewing the narrowband market that covers fixed call origination, call termination and WLR, and published a consultation in December 2016. This review was delayed and had not been completed by the time the existing charge control was due to end. We gave Ofcom a commitment to maintain a cap on the relevant price baskets of CPI-CPI until 31 December 2017, or the conclusion of Ofcom’s review if earlier. Mobile regulation The current charge control on mobile call termination applies until 31 March 2018 and Ofcom intends to review the market again in the coming year and will set new regulation, if required. We are also subject to regulation when our customers travel within the European Union, for the retail prices we charge our customers and the wholesale prices between operators. The EU regulations cover voice, text and data prices, with a cut to the retail price caps on 30 April 2016. From 15 June 2017, under EU regulations, customers will be able to ‘Roam like home’ within the EU, paying domestic prices when travelling with no extra fees. At the wholesale level, price caps will remain in place, on an agreed glide path, reducing to 1 January 2022. Standalone landline telephone services On 1 December 2016 Ofcom announced a review of the retail market for consumers who buy telephone services in a standalone contract and not part of a bundle with other services such as broadband or pay-TV. This affects around 2.9m UK households. Ofcom has provisionally concluded that this is a separate retail market in which BT has SMP. Ofcom has consulted on a number of possible remedies including requiring us to cut the line rental charge by between £5 and £7 per month for customers taking these services in a standalone contract. Price regulation of our main wholesale products The following table shows the main wholesale products provided to CPs which are subject to price controls in markets where we’ve been found to have SMP. Product Fixed call originationa Fixed call terminationa Mobile call termination Wholesale Line Rentala (WLR) Annual charge control Current charge control ends RPI–3.6% 30 September 2016 RPI–3.1% 30 September 2016 CPI–3.1% CPI–3.0% 31 March 2018 31 March 2017 IPStreama rental in Market Ab only CPI–10.7% 31 March 2017 Metallic Path Facility rentala (MPF) CPI+0.3% 31 March 2017 Shared Metallic Path Facility rentala (SMPF) Ethernetc CPI–33.4% 31 March 2017 CPI–13.5% 31 March 2019 Partial Private Circuits (PPCs)d CPI–3.5% 31 March 2019 a See WLA, WBA and Narrowband market reviews in the next section ‘Other regulatory decisions and activities’. b Wholesale broadband services are regulated in Market A which covers 9.5% of UK premises. Market B covers the remaining premises and is competitive and unregulated. c Outside central London and ≤1Gbps. d <8Mbps. Other regulatory decisions and activities Business connectivity market and cost attribution In April 2016 Ofcom published its Final Statement on its Business Connectivity Market Review, Leased Lines Charge Control and Cost Attribution Review. This broadly confirmed Ofcom’s proposals set out in its Draft Statement published in March, including: – the charge controls that apply from 1 May 2016 until 31 March 2019; – the introduction of minimum service levels for Openreach relating to the installation and repair of Ethernet services; and – a requirement for Openreach to provide access to its fibre network for providers of high-speed services to businesses (known as ‘dark fibre’) from 1 October 2017. We disagree with some aspects of Ofcom’s BCMR statement, including Ofcom’s proposals on Dark Fibre and have appealed these points to the Competition Appeal Tribunal (CAT). We expect Ofcom’s Cost Attribution Review assessment to also have an effect on other future price controls. Wholesale local access market review The current charge control set by Ofcom for the WLA market (ie MPF and SMPF) expired on 31 March 2017. Ofcom is currently undertaking a review of this market, but was not able to complete it by that date. As a result, we gave Ofcom a commitment to maintain a cap on the relevant price baskets of CPI-CPI until 31 December 2017, or the conclusion of Ofcom’s review if earlier. Generic Ethernet Access (GEA) rental has not previously been subject to price regulation but Ofcom’s consultation proposals, published on 31 March 2017, include introducing price regulation on the lower 40 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 41 Margin squeeze test In May 2015 we made an appeal to the CAT on Ofcom’s decision to introduce the VULA margin squeeze test. In March 2016 the CAT found that Ofcom was entitled to impose a regulatory margin squeeze test. In June 2016 the CMA published its determination on the remaining pricing grounds. It agreed with us that Ofcom had made an error in setting the relevant compliance period and determined that this should be extended to six months from the current one month. It dismissed our other grounds. On 25 July 2016 the CAT completed its appeals process by issuing directions to Ofcom to amend the VULA margin squeeze test in line with the CMA determination. Broadband USO The UK Government has continued with its plans for a broadband Universal Service Obligation (USO) that includes a minimum line speed. The Digital Economy Act – which includes the provisions for the USO – gained Royal Assent on 27 April 2017. We’ve proposed an alternative approach to achieving universal 10Mbps broadband coverage and continue to discuss this with the UK Government. Protecting the environment We believe that the Information and Communications Technology (ICT) industry plays a vital and ever-growing role in tackling climate changea. We continue to participate in UN climate negotiations (eg COP22 in Marrakech), sharing our research and highlighting that investment in ICT can cut carbon emissions while creating social and economic value. Our #go100percent campaign aims to inspire people to act more sustainably. In partnership with Sir Ben Ainslie and Land Rover BAR, we encouraged spectators at the America’s Cup World Series sailing event in Portsmouth to make pledges and to share their stories on sustainable ways of living, working and playing. Deemed Consent On 26 March 2017 Ofcom published the findings of its investigation into the historical use of Deemed Consent by Openreach. Deemed Consent is an agreed process between Openreach and its communications provider (CP) customers, which allows Openreach to halt the installation and reschedule the delivery date for providing dedicated business services (known as Ethernet) in a number of specific circumstances which are beyond its control. Ofcom found that Openreach had breached its contractual and regulatory obligations by inadequately and retrospectively applying Deemed Consent to reduce compensation payments to CPs between January 2013 and December 2014. As a result of the findings, Openreach has agreed to compensate CPs and Ofcom has imposed a fine of £42m, reflecting the seriousness of the failings. This includes a 30% maximum discount for BT admitting its liabilities and agreeing to compensate the affected CPs in full. The precise amount of these compensation payments will result from discussions with the affected parties and is currently estimated at £300m. The fine and associated compensation payments are treated as a specific item charge in this year’s income statement, with the cash expected to be paid in 2017/18. We take this matter very seriously and we’ve put in place additional controls to safeguard against this happening again and to make sure that we’re providing the highest standards in serving our customers. Our 2020 ambition Enable customers to reduce their carbon emissions by at least three times the end-to-end carbon impact of our business 3:1 3:1 ambition 2015/16 2016/17 Customer savings (Mt CO2e) Our impact (Mt CO2e) Ratio 7.6 4.8 1.6:1 10.0 5.5 1.8:1 Reducing our customers’ carbon footprint Adding EE to our carbon footprint has impacted progress towards our 2020 ambition (see below); nevertheless our underlying performance is still strong. Revenue from products contributing to carbon abatement totalled £5.3bn this year. This represents 22% of our total revenue. Reducing our own carbon footprint We report all the greenhouse gas (GHG) emission sources required under UK regulations. The following chart shows the increase this year in our total operational worldwide CO2 equivalent (CO2e) emissions due to the inclusion of EE. 40 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 41 a As a signatory to the Climate Disclosure Standards Board’s (CDSB) fiduciary duty and climate change disclosure, we summarise our response to climate change through this Annual Report with more details in our Delivering our Purpose report, available at www.bt.com/deliveringourpurpose THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Resources, relationships and sustainability continued Our worldwide energy usea Year ended 31 March 6 1 6 2 , 6 2 5 2 , GWh 2,700 2,600 2,500 2,400 2,300 ) 8 5 3 = E E ( 0 3 6 2 , 2 1 4 2 , 8 3 3 2 , 2013 2014 2015 2016 2017 Key: Addition due to EE Conserving natural resourcesa Reducing water usage Most of our direct water usage is for office and catering facilities, or to cool equipment (for example, in telephone exchanges). We ask all our suppliers what actions they’re taking to cut water usage, as one of the improvement areas we look for through the Better Future Supplier Forum. We continue to target and reduce leaks, using half-hourly meter readings through our automatic monitoring and reporting programme. This has reduced our water consumption by more than 5% compared to last year but, including EE, our overall consumption has risen by nearly 17% compared to last year. Managing waste products Supporting the principles of the circular economy, we work with our suppliers to minimise the materials we use, and we reuse or recycle equipment and materials wherever possible. We also offer take-back schemes, both for consumer products like our BT Hub, and for mobile handsets. We’ve achieved our UK target, to send zero qualifying waste directly to landfill by year-end. We use specialist contractors to manage hazardous waste responsibly, complying with relevant regulations. Last year we reported the early achievement of our science-based climate stabilisation intensity (CSI) target: that by 2020 we’d cut our operational worldwide carbon emissions per unit of value-added (our contribution to GDP) by 80% compared to 1996/97. We’re currently exploring a new target that includes EE. On our second intensity measure, our scope 1 & 2 emissions this year totalled 12.3 tonnes CO2e per £m revenue. This is a decrease of 1.5% from last year, and of 86% since our base year of 1996/97. Our worldwide greenhouse gas emissionsa Year ended 31 March CO2e Ktonnes 2,000 1,500 1,628 117 1,000 1,097 500 0 414 1997 (Base) 391 147 62 182 2014 387 148 65 174 2015 343 119 51 172 2016 428 132 121 175 2017 Scope 3: Other operational indirect emissions (eg air and rail travel) Scope 2 : Indirect emissions from the generation of our purchased energy (mainly electricity) Scope 1 : Direct emissions from our own operations (eg fuel combustion) Figures exclude third-party consumption. Scope 2 data uses market-based calculation. For full methodology, see www.bt.com/deliveringourpurpose Reducing our energy use We estimate that our energy savings programme has saved nearly £25m on our overall energy bill this year, contributing a total of £221m savings since 2009/10. This has helped us cut consumption by 2.7% this year, but is offset by the addition of EE’s energy use: overall, our consumption has risen by 12.5%. In Great Britain, we spent around £341m on energy and fuel (2015/16: £307m). We maintain our commitment to buy our electricity from 100% renewable sources, in the UK and globally, where markets allow. This year, our acquisition of EE has reduced the UK figure from 100% to 84% and our worldwide figure from 95% to 82%. We’ve plans in place to move over 98% of EE’s directly-billed electricity supply onto renewables during 2017 and have increased our renewable contracts outside of the UK. a We restate previous years’ data when subsequent information is deemed to be materially significant, such as replacing previous estimates with measured figures. 42 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 43 Our performance as a sustainable and responsible business The first table below demonstrates our performance against our six 2020 ambitions. Below that, we report progress against seven foundation measures. Next year, we aim to maintain or improve on each of our ambitions and measures. Our 2020 ambitions 2015/16 performance 2016/17 performance Status Page Target met Target failed Ongoing Supporting charities and communities Use our skills and technology to help generate more than £1bn for good causes £94m raised for good causes £95m raised for good causes Inspire 66% (two-thirds) of our people to volunteer Creating a connected society More than 9/10 people in the UK will have access to our fibre-based products and services Help 10m people overcome social disadvantage through the benefits our products and services can bring Help 5m children to receive better teaching in computer skills Creating a culture of tech literacy Delivering environmental benefits Enable customers to reduce their carbon emissions by at least three times the end-to-end carbon impact of our business 1.6:1 achieved 1.8:1 achieved Cumulative total: £327m since 2012 Cumulative total: £422m since 2012 27% of BT people volunteering 8.5 out of 10 UK premises passed 2.6m people reached 344,000 children reached 31% of BT people volunteering 8.8 out of 10 UK premises passed 3.9m people reached 1.1m children reached 36 29 34 34 35 41 Our foundation measures 2015/16 performance 2016/17 performance Status Page Our investment Investment to accelerate our purposeful business approach; to be more than 1% of adjusted profit before tax (PBT) 1.10% of PBT invested 1.03% of PBT invested Our customers Our employees Customer service: to consistently improve RFT across our entire customer base Employee engagement index: to maintain or improve our relationship with our employees 3.0% reduction 6.4% improvement 3.81/5 achieved 71% favourablea Sickness absence rate: to maintain or reduce % of calendar days lost to sickness 2.33% calendar days lost to sickness 2.32% calendar days lost to sickness Our suppliers Ethical performance: to maintain or improve our employees’ perception Ethical trading: across our supply chain, with focus on human rights. Achieve 100% follow-up within three months, for all suppliers identified as high or medium risk, through our ethical standards questionnaire 4.31/5 achieved 76% favourablea 100% follow-up within three months 100% follow-up within three months Our environmental impact CO2e emissions: a measure of our climate change impact. We’ll reduce our worldwide CO2e emission intensity by 80% by December 2020b 81% reduction in net CO2e emission intensity vs base levels (1996/97) n/a (new target being developed) 34 17 28 29 45 37 41 To find out more about our 2020 ambitions, our methodologies and how our results are calculated, take a look at www.bt.com/deliveringourpurpose a From our new employee survey (January 2017); not comparable with last year’s result. b After achieving our 2020 target last year, we’re currently developing a new target to include EE. 42 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 43 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our approach to risk management Like any business, we face a number of risks and uncertainties. Some come from outside our organisation, others from within. Some we can’t control, some we can. Many of our risks are similar to those felt by similar businesses. Principal risks and uncertainties The principal risks and uncertainties that affect us could have an impact on our business, brand, assets, revenue, profits, liquidity or capital resources. The principal risks we described last year have evolved, and so has our response to them. Our Enterprise Risk Management framework gives reasonable (but cannot give absolute) assurance that we’ve identified and addressed our biggest risks. However, there may be some risks that are either currently unknown, or currently seen as less important but with the potential to become more so in the future. Events outside BT present both risks and opportunities. We focus our efforts on predicting and reducing risks while aiming to take advantage of any opportunities that may emerge. We’ve also seen more interaction between our risks. For example increased costs of regulation, coupled with the risk of increased pension deficit payments, could impact our ability to invest to improve customer experience and drive revenue growth. We’ve also seen a growing interplay between our regulation and political risks. In the section below, we explain what we’re doing to prevent our main risks from materialising, or to limit their impact if they’re unavoidable. Our biggest risks and uncertainties should be considered alongside the risk management process, the forward-looking statements in this document and the associated cautionary statement (see page 260). How we manage risk To meet our objectives, build shareholder value and promote our stakeholders’ interests, it’s essential we manage risk. To help us we’ve developed a group-wide risk management process with four stages: Identification Monitoring Business activities Evaluation Response Changes over the year In 2015/16 we improved the way we manage risk through our response to the changes to the UK Corporate Governance Code, trialling the use of risk modelling software, and providing risk management training to colleagues. Specific improvements for 2016/17 included: Investment cases We’ve been helping our colleagues understand the risks linked to their investment cases. In doing so, we’re helping our investment committees make better decisions on where to invest and how we can keep any risks linked to those investments to a minimum. Root cause analysis This year we’ve trialled a new way of learning from incidents and ‘near misses’. We believe it will help us learn some important risk management lessons, which we can then use to stop other risks materialising in the future. Sharing good practice In May we held a conference for everybody involved in the BT risk management process, introduced by Gavin Patterson. We’re now exploring other ways of sharing good practice across our risk community. Enterprise risk framework Line of business and TSO audit and risk committees Line of business and TSO leadership teams Our lines of business and TSO follow our process for managing risk as part of our Enterprise Risk Management framework. That means identifying and responding to the key risks affecting their business. They record the risks for their leadership teams to review. Audit & risk committees in each line of business, TSO and our group functions, make sure this process is effective. Group Risk Panel The Group Risk Panel supports the Board and the Operating Committee. Every three months it reviews the Group Risk Register (which summarises those risks of greatest significance across our business), considers the inclusion of new or emerging risks, and recommends ways to tackle them. It also oversees the work of the group risk management function. Geo-political risks are reviewed by a sub-committee of the Panel. Operating Committee The Operating Committee identifies, evaluates, responds to and monitors risks. Significant risks are reported and monitored through the Group Risk Register. The Operating Committee assigns a management owner to take charge of monitoring and managing each risk. It monitors risks through regular, detailed reviews as well as six-monthly reviews of the Group Risk Register. Audit and Risk Committee Board The Board has overall responsibility for making sure we manage risks appropriately. It regularly reviews, either directly or through the Audit & Risk Committee, how we’re doing across the group, in our lines of business and in TSO. 44 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 45 Our principal risks Compliance risks Trend indicates our perception of pre-mitigation risk Increasing/worsening Lessening/improving At a similar level Ethical culture and controls Link to strategy – Deliver great customer experience – Transform our costs 1 2 Trend Link to business model – Financial capital – Human capital – Social capital It’s crucial that we maintain high ethical standards. We don’t tolerate fraud, bribery, any form of corruption or any illegal or unethical activity. We follow local and international law, including anti-corruption and bribery laws. The UK Bribery Act and US Foreign Corrupt Practices Act (FCPA) have extraterritorial reach, so cover our global operations. As we expand globally, we’re increasingly operating in countries seen as having a higher risk of bribery and corruption. We also have to make sure we follow trade sanctions and import and export controls. We also face the risks associated with inappropriate and unethical behaviour in local and other markets by our people or associates, such as suppliers or agents, which can be difficult to detect as well as facing the risks that our controls are designed to prevent, detect and correct such behaviour may be circumvented. Controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and there can be no assurance that any design will succeed in achieving its stated goals under all potential conditions, regardless of how remote. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Impact If our people, or associates like suppliers or agents, breach anti- corruption, bribery, sanctions or other legislation there could be significant penalties, criminal prosecution and damage to our brand. This could have an impact on future revenue and cash flow depending on the nature of the breach, the legislation concerned and any penalties. If we were accused of corruption, bribery, violating sanctions regulations or other laws, that could lead to reputational damage with investors, regulators and customers. If fraud is committed, there is a risk of financial misstatement which if undetected can have a material financial impact and potential litigation and regulatory consequences. Financial and other controls play an important part in our ability to prevent and detect inappropriate and unethical behaviour. This includes fraud, deliberate financial misstatement and improper accounting practices, as well as breaches of anti-corruption, bribery, or sanctions legislation. If the design, operation or the assurance over these controls is ineffective or they are circumvented, there is a greater risk that the impacts described above may materialise, as they did this year with respect to our Italian business. What’s changed over the last year? During the year we identified inappropriate behaviour in our Italian business. Our investigation identified collusion and override of controls within our Italian business and that our monitoring controls did not identify the circumvention and override, resulting in the misstatement of results going undetected for a number of years. As a result of our US listing we are required to make certain assessments of our controls as of 31 March 2017 for the purposes of Sarbanes- Oxley. Despite the remediation steps we took, the controls had not operated for sufficient time to allow assurance testing to confirm their effectiveness under Sarbanes-Oxley. We have therefore concluded for these purposes that our controls were ineffective as of 31 March 2017 due to a material control weakness with regard to our Italian business. For further details of what we found, how we’ve responded, and what our ongoing plans are, see page 6. Our acquisition of EE has grown our UK business, and we’ve made EE a part of our ACB compliance programme and financial and disclosure control environment. In terms of ACB enforcement generally, we’ve seen the first significant cases stemming from the UK Bribery Act, and in the US 27 companies paid about $2.5 billion to resolve FCPA cases. 2016 was the biggest enforcement year in FCPA history – both the number of enforcement actions and the overall amounts paid to resolve them. How we’re mitigating the risks We’ve put a number of controls in place to address risk in this area. These include the steps we have taken to improve our controls within Italy. We have also taken steps to enhance our wider controls that monitor our overseas operations in our shared service centres, Global Services and at a group level. While we have taken steps to improve our control environment, we recognise we have more to do. Further activities will include increasing and improving the capabilities of the controlling function and the audit function outside the UK, and further developing our integrated risk and assurance reporting processes. We are also enhancing our controls and compliance programme to strengthen awareness of the standards we expect, the capabilities of our people, and to reinforce the importance of doing business in an ethical, disciplined and standardised way. Our relevant controls include an anti-corruption and bribery programme and ‘The Way We Work’, our ethical code, available in 14 languages. We ask all our people to complete training and sign up to The Way We Work which includes our zero tolerance to bribery and corruption. We have policies covering gifts, hospitality, charitable donations and sponsorship. We run tailored training for people in higher-risk roles like procurement and sales. We regularly weigh up our business integrity risks to make sure we’ve got the right mitigation in place. All ‘Speak Up’ reports are passed to the director of ethics and compliance for action. Our confidential hotline is operated by a third party and is available to employees and third-party contractors who can remain anonymous if they choose to. Any reports received direct by BT are also dealt with in accordance with our Speak Up procedures. Our internal audit team regularly runs checks on our business. External providers also assess areas we think are higher risk (such as the use of agents), to make sure people understand our policies and that controls are working. We do due diligence checks on third parties like suppliers, agents, resellers and distributors. Our policy is that procurement contracts include anti-corruption and bribery clauses. 44 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 45 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our principal risks continued Compliance risks continued Our sanctions policy helps us keep track of trade sanctions and export controls that apply to us. That means all bids involving a country with sanctions imposed by the EU and/or the US need approval. The policy also mandates everyone in BT must use our internal shipping system to arrange international exports, as it runs compliance checks and flags any orders which need an export licence. BT Italy – our response In response to the inappropriate behaviours we identified in our Italian business, we suspended a number of BT Italy’s senior management team who have now left the business. The president of our European operations has also left the business. We have appointed a new president of our European operations and a new CEO and CFO of BT Italy, from outside the Italian executive management team. We appointed KPMG, with support and oversight from our Legal, Governance and Compliance function and Freshfields Bruckhaus Deringer, reporting directly to both the chair of the Audit & Risk Committee and BT Group chairman, to perform an independent investigation of the systems and controls relating to our Italian business. We also conducted a broader review of financial processes, systems and controls across the group. We are acting on both the recommendations of KPMG and our own observations and have taken steps to improve our controls within Italy. We have also taken steps to enhance our wider controls that monitor our overseas operations in our shared service centres, Global Services and at a group level. As a result of our US listing we are required to make certain assessments of our controls as of 31 March 2017 for the purposes of Sarbanes-Oxley. Despite the remediation steps we took, the controls had not operated for sufficient time to allow assurance testing to confirm their effectiveness under Sarbanes-Oxley. We have therefore concluded for these purposes that our controls were ineffective as of 31 March 2017 due to a material weakness with regards to our Italian business. Beyond Italy, we have completed detailed balance sheet reviews in seven selected country operations in Global Services outside of the UK. These thorough reviews were supported by EY, and did not identify any similar issues or areas of concern elsewhere giving us comfort that the inappropriate behaviours were isolated to Italy. While we have taken steps to improve our control environment, we recognise we have more to do. Further activities will include increasing the resources and improving the capabilities of the controlling function and the audit function outside the UK, and further developing our integrated risk and assurance reporting processes. We are also enhancing our controls and compliance programme to strengthen awareness of the standards we expect, the capabilities of our people, and to reinforce the importance of doing business in an ethical, disciplined and standardised way. The new CEO and CFO of BT Italy will continue to review the Italian management and finance teams and work with BT Group Ethics and Compliance to improve the governance, compliance and financial safeguards. Going forward, we will also continue to rotate senior management among countries to ensure an independently governed and rigorously controlled organisation throughout all parts of Global Services. Processing our customers’ data Link to strategy – Deliver great customer experience 1 Trend Link to business model – Financial capital – Social capital We control and process huge quantities of customer data around the world, so observing data privacy laws is something we take extremely seriously. It’s essential that individuals and businesses can trust us to do the right thing with their data. Firstly, we must make sure our customers’ data is secure, and protected against both internal and external threats (eg cyber attacks). Being trusted with our customers’ data goes further than that though. It means preserving the integrity of the personal data we process, and only keeping the things we need to provide customers with the services they’ve signed up for. It also means being transparent around how we use that data, making sure the way we process personal data is legal, fair and in line with customers’ rights and wishes. As a communications provider we operate under a stringent 24-hour reporting regime to tell the UK Information Commissioner’s Office (ICO) if we become aware of a personal data security breach. We must also tell any affected individuals as quickly as possible. Different parts of the world approach privacy and data protection differently. An individual’s fundamental right to privacy is reflected in the fact that data privacy laws are in force in over 100 countries. More and more we (and other multinationals) have to show that we’re handling personal data in line with a complex web of national data laws and society’s ethical expectations. Impact Failing to stick to data protection and privacy laws could result in regulatory enforcement action, fines, class-action, prison sentences and the regulator telling us to stop processing data. On top of that, we could see huge reputational damage and big financial losses. Those losses could come from fines and damages if we fail to meet our legal requirements, as well as costs resulting from having to close customer contracts and the subsequent customer churn. Companies who’ve had high profile ‘data incidents’ have seen their share price hit hard, and suffered ongoing costs from their non-compliance. What’s changed over the last year? National regulators are more aggressively protecting their citizens’ privacy and data protection rights. They’re especially targeting companies that fail to do due diligence, or who knowingly accept (or ignore) a related risk for too long. This has been brought into sharp focus by the growth of data threats, with several big organisations suffering incidents. There’s been a general trend toward bigger financial penalties and more frequent public shamings for organisations who break global privacy and data protection laws. 46 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 47 How we’re mitigating the risks We’ve introduced governance to clarify responsibilities for data activities across our whole business. People, processes and technology have been our core areas of focus. By embedding this governance, we’re reinforcing our expectations around personal data with our people, our partners and third parties. The cornerstone of our education and training programme is making sure our people understand our data governance culture and the impact of data risks on our business. Our mandatory data privacy training focuses on the individual’s role, and uses relevant scenarios to highlight the varying data risks of different BT job families. By educating our technical and commercial units we’ve made a step change in understanding data risks across BT Group. Impact Failure to implement and maintain effective health and safety management could have a huge impact on our people and our finances. It could lead to people getting injured, work-related sickness and service disruption for customers. It could also result in our people and third parties making compensation claims against us, and fines or other sanctions being issued by regulators. There could even be criminal prosecutions against us, our directors and our people – all of which would harm our brand and business. And of course an unhappy or unhealthy workforce also leads to higher work absence rates and lower performance levels. We want to give our people the tools they need to make everyday risk-based decisions around privacy and data protection without it being a burden or making their job more complicated. If we do that, there’s a much better chance of data compliance becoming ‘business as usual’. For example, using Privacy Impact Assessments when we develop new products and services makes sure everyone understands privacy issues from the start and builds in the right controls, without any operational impact. What’s changed over the last year? The range and complexity of risks has gone up as we’ve offered new services to our customers. Those risks include us doing more construction and electrical engineering work on our own network, as well as new contracts requiring us to maintain and extend the UK’s mobile network. We’ve taken a lot of steps to mitigate these risks – especially around how our people work with electricity or at height. Supporting the third-line assurance of our Internal Audit team, the Chief Privacy Officer and his team are a second line of defence. They undertake an annual cycle of audit and monitoring. The integration of EE has introduced new elements such as high street retail and an expansion of existing risks such as operating customer contact centres. Our mitigations against cyber attacks are described in our Security and resilience risk (page 52). Health and safety Link to strategy – Deliver great customer experience – Transform our costs 1 2 Trend Link to business model – Financial capital – Human capital – Social capital – Natural capital Our business – and in particular our UK engineering workforce – does a lot of work where our people could be injured or their health could be damaged. It’s essential we do all we can to keep our people safe; not only is it the law but it also means they’ll be better at their jobs. Acquiring EE has also raised the exposure of our customers and staff to radio frequency emissions from wireless mobile devices and mobile telecoms sites. Media reports have suggested these emissions may cause health issues, including cancer, and may interfere with some electronic medical devices, including hearing aids and pacemakers. Research and studies are ongoing. According to the World Health Organization’s Fact Sheet Number 193, last reviewed in October 2014, there are no known adverse effects on health from emissions at levels below internationally recognised health and safety standards. Even so, we can’t provide absolute assurance that research in the future won’t establish links between radio frequency emissions and health risks. We’re continuing to implement a strategy which embeds effective management of health and safety into all our operations and promotes health and wellbeing to help improve business performance. Two prosecutions against us for past incidents concluded in 2016 resulting in guilty verdicts and fines. Levels of sickness absence rose in the first part of the year but this trend reversed in the second half. Our workforce has also lost less time from injuries as a result of accidents. How we’re mitigating the risks We’re implementing the next stage of a Board-endorsed health, safety and wellbeing strategy. As part of this, each year every line of business produces its own health and safety plan with its own targets and programmes. Our people managers take responsibility for making sure their teams know how to comply with health and safety standards. We monitor compliance using annual licensing, scheduled refresher training, competency assessments and accreditation processes for higher risk groups. All our people undertake training in basic health and safety. Wherever we do business around the world, we put in place policies and programmes to make sure we adhere to our own standards and that those standards meet or exceed minimum legal requirements. We also work to make sure our products comply with safety regulations, including meeting industry standards for radio frequency emissions. We provide advice to help management teams understand and control health and safety risks and help everyone feel involved in health, safety and wellbeing. We’ve created interventions to help promote good mental health and physical wellbeing. We also provide support and rehabilitation services for people who have mental or physical health issues. And we complement these measures with strong attendance management processes. 46 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 47 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our principal risks continued Strategic and financial risks Growth in a competitive market Link to strategy – Invest for growth 3 Link to business model – Financial capital – Intellectual Capital Trend Our markets are characterised by: – constant, rapid change; – strong, new competition; – falling prices and (in some markets) falling revenues; – technology changes; – market and product convergence; – customers moving between providers; and – regulation to promote competition and cut wholesale prices. Potential impact It’s important we grow our revenue profitably and sustainably to protect our cash flow. Failure to do so could limit our ability to invest in the business or pay dividends. It’s also important that we manage our cost base to be able to invest in growth opportunities. What’s changed over the last year? We’ve been executing our strategy by: – – extending our 4G and fibre broadband coverage; making good progress on integrating EE and hitting our synergy targets; and investing to improve customer experience and the products we offer. – Our leading competitors have also been very active. Important developments included: – – – Virgin Media expanding its UK network; Sky and Gamma launching new mobile services; 21st Century Fox’s bidding for the share in Sky it didn’t already own; Sky launching a Now-TV branded triple-play bundle without a contract; and TalkTalk’s continued success at growing its data revenues. – – It also means transforming our costs. We take a forensic approach, supported by a team of specialists, to identifying opportunities to better manage our cost base and maximise our ability to invest in customer experience and growth. However, these opportunities are becoming more challenging to identify and deliver as our cost transformation programme matures. If we do all this, we’ll grow our revenue profitably and sustainably. We’ve been investing in five key areas: providing differentiated content, services and applications, making our UK network the best in the country, becoming a fully converged service provider, securing market leadership in all our UK segments and meeting the needs of multinational customers. Our transformation programmes continue to drive service and productivity improvement. We can also seek changes in regulation to make things fairer. Communications industry regulation Link to strategy – Deliver great customer experience – Transform our costs 1 2 Trend Link to business model – Financial capital – Manufactured capital Regulation affects much of what we do. In the UK, where Ofcom identifies concerns with the competitiveness of markets, it can set regulatory rules that require us to provide certain services on specified terms to our customers. The rules it imposes are assessed every three years via a series of market reviews focused on the supply of network access services to wholesale customers (for example, the supply of fixed access lines to support the provision of phone or broadband services, or the supply of business connectivity services). Ofcom can extend or remove rules as a result of its findings in a market review. Where controls are placed on our prices, these can be tightened or relaxed following a review of the expected costs of future supply. Ofcom will investigate our compliance with any regulatory rules in place and can impose fines and restitution on us if we don’t comply. The level of competitive risk facing the business has worsened over the last 12 months. Some of our leading telecoms competitors have taken important steps to grow their revenues. In addition the threat from new competitors, enabled by disruptive technologies, continues to increase. Leading players, operating in adjacent markets, still view telecoms services as an attractive growth opportunity. In particular OTT providers, who already dominate messaging, are now increasingly turning their attention to voice. Ofcom also has powers to regulate the terms on which we get supplied with certain services by others – for instance, mobile call termination and wholesale access to certain pay-TV channels. This can increase our costs and affect the scope of services we can provide to customers. Ofcom can also sort out disputes between us and other communications providers about the terms on which services are supplied. There are also economic risks that could threaten revenue growth: Downside risks to the UK and global economy are bigger than – they were 12 months ago. It’s unclear how much the UK economy will be impacted by the vote to leave the European Union, nor is it clear what trade arrangements will be agreed after the UK leaves. – How we’re mitigating the risks We stick to our strategy, which means: – – – broadening and deepening our customer relationships; providing a great customer experience; and investing for growth. Outside the UK, general licensing requirements can make it tough for us to enter markets and compete. Regulation will also define the terms on which we can buy wholesale services from others. Potential Impact Certain of our revenues come from supplying wholesale services to markets where Ofcom has found us to have significant market power. Most of these revenues relate to services where regulatory rules require us to cut average prices each year by a specific, real- term percentage for a three-year period. Where other telecoms providers ask Ofcom to resolve disputes with us, there’s a risk that Ofcom may set the prices at which we supply services, and/or make us provide additional services. In some circumstances, Ofcom can adjust past prices and make us pay back amounts to wholesale customers. 48 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 49 Regulation outside the UK can hit our revenue too. For example, overly-restrictive licensing requirements or ineffective regulation of access to other networks mean we might not be able to compete fairly. Regulation can also define and control the terms of access to necessary regulated inputs, which raises our costs. What’s changed over the last year? There’s been a lot of regulatory activity in different areas over the last year. Ofcom has started market reviews in relation to wholesale narrowband access, wholesale local access and wholesale broadband access. We’ve summarised this in the Regulation section on page 38. In March 2017 Ofcom found that Openreach had breached its contractual and regulatory obligations by inadequately and retrospectively applying Deemed Consent between January 2013 and December 2014; and that Openreach then failed to compensate communications providers fully. As a result of the findings, Ofcom imposed a fine on BT and Openreach agreed to compensate communications providers outside of BT in full. See page 41 for further information. Alongside the standard cycle of market reviews, in March 2015 Ofcom announced an overarching strategic review of the digital communications market. In March 2017 we reached agreement with Ofcom on the legal separation of Openreach, subject to consultation by Ofcom and changes to legislation to retain the Crown Guarantee on Openreach employees. Under this arrangement Openreach will have its own board and make its own investment decisions, within an overall budget set by BT. Although we believe that this is a good solution for BT and the UK communications market, we will face the risks and challenges that come with operating an independent business within BT. How we’re mitigating the risks Our team of regulatory specialists includes economists, accountants and lawyers. Together with legal experts and external advisers they check for potential disputes with other CPs and look for opportunities to change regulatory rules. They talk regularly with regulators and other key influencers to understand their outlook and to make our position clear. Their insight also helps us to forecast future regulatory outcomes. We can then build sensible expectations into our financial plans and investment decisions. We push for fair, proportionate, consistent and evidenced-based regulation everywhere we do business. Whenever there are market reviews, charge controls and disputes or investigations we put forward evidence and analysis. This helps us manage the risks around decisions in any particular year. We can appeal any regulatory decisions we think are wrong, albeit the basis upon which these appeals are judged in the UK has changed under the Digital Economy Act. We can also raise disputes or complain (under the relevant regulatory framework or competition law) where we have problems getting access to wholesale services – such as wholesale pay-TV channels or to other access networks. We’re also working hard to deliver a great customer experience, going beyond our minimum regulatory obligations. Pensions Link to strategy – Transform our costs 2 Link to business model – Financial capital – Human capital – Social capital Trend We have a large funding obligation to our defined benefit (‘DB’) pension schemes. The largest of these, the BT Pension Scheme (BTPS or Scheme), represents over 97% of our pension obligations. The BTPS faces similar risks to other UK DB schemes: things like future low investment returns, high inflation, longer life expectancy and regulatory changes may all mean the BTPS becomes more of a financial burden. Potential impact The last funding valuation of the BTPS, as at 30 June 2014, provides certainty over scheme funding until the forthcoming valuation, due to start in June 2017, is concluded. If there’s an increase in the pension deficit at the next valuation date, we may have to increase deficit payments into the Scheme. Higher deficit payments could mean less money available to invest, pay out as dividends or repay debt as it matures, which could in turn affect our share price and credit rating. We’re considering a number of options for funding the deficit after the next valuation, as at 30 June 2017. These options include considering whether there are alternative approaches to only making cash payments, including arrangements that would give the BTPS a prior claim over certain BT assets. What’s changed over the last year? The pension deficit of the BTPS is calculated as the value of the assets less the value of the liabilities. The deficit at the valuation date will influence the deficit payments we agree. A number of things affect the liabilities, including expected future investment returns at the valuation date. When considering expected future returns, we review different factors including yields (or returns) on government bonds, which have fallen in the year and have dropped significantly since 30 June 2014. If a lower future investment return is assumed at the next valuation our liabilities would likely go up. Asset returns have been positive over the year with strong returns from equities and government bonds. How we’re mitigating the risks The investment performance and liability experience are regularly reviewed by both us and the Trustee of the BTPS. We also consider the associated risks and possible mitigations. The investment strategy aims to mitigate the impact of increases in the liabilities, for example by investing in assets that will increase in value if future inflation expectations rise. The assets held are also well diversified, softening the impact of sharp drops in the value of individual asset classes. This helps us maintain a reasonable balance of risk and return. Our financial strength and cash generation provide a level of protection against the impact of changes in the funding position of the BTPS. The funding liabilities also include a buffer against future negative experience, as legislation requires that we calculate liabilities on a prudent basis. 48 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 49 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our principal risks continued Strategic and financial risks continued Political risk Link to strategy – Deliver great customer experience – Invest for growth 1 2 Trend Link to business model – Financial capital – Human capital – Social capital Across our operations we are exposed to the effects of political and geopolitical risks, in particular: – In the UK, internet access is increasingly seen as an essential part of people’s lives. As a result, the level of political debate and focus on issues such as quality and speed of service has increased. As well as providing a critical element of the UK’s national infrastructure, we are also engaged in supporting high profile programmes such as BDUK and the Emergency Services Network. The result of the UK referendum to leave the European Union (‘Brexit’) has significantly increased political uncertainty. This has been exacerbated by the possibility of further political change across the United Kingdom, most notably a second referendum that may be held on Scottish independence. Outside the UK, political and geopolitical risk can impact our business through changes in the regulatory and competitive landscape, but also as a direct threat to our people and assets as a result of social unrest or a break down in the rule of law. – – Potential impact Political uncertainty can have direct financial consequences across the economy, impacting for example foreign exchange rates, the availability and cost of capital, interest rates and also resulting in changes in the tax regime. For BT specifically, the most significant impact of political risk is its potential interaction with some of our other Principal Risks. In the UK, we are seeing an increasing overlap between political debate and the regulatory environment, with the potential that our Communications Industry Regulation risk increases as a result. The impacts of Brexit are still uncertain while the UK’s future relationship with the EU is determined. However, there is the potential for our costs to increase (for example through any changes required to our systems to reflect new taxes or customs duties); regulatory risk to increase as a result of any future divergence with the EU regime, including on data flows; supplier disruption to occur as a result of challenges in suppliers’ own organisations and supply chains; and for delivery of a great customer experience to become more challenging if it becomes harder for us to recruit and retain talent. Geopolitical risk outside the UK can most clearly impact our Communications Industry Regulation risk, but also our Security and Resilience risks where it poses a threat to the continuity of our operations. What’s changed over the last year? The most significant development was the referendum on 23 June 2016 by which the UK voted to leave the EU. That was immediately followed by political change, a fall in sterling, UK bond credit rating downgrades and uncertainty for business and foreign direct investment. On 29 March 2017, Article 50 was triggered initiating a two-year period of negotiation for the UK to leave the EU. In the same month, Scottish First Minister Nicola Sturgeon confirmed she would seek the approval of the Scottish Parliament to open discussions with the UK Government on legislating for a second Scottish independence referendum. UK Prime Minister Theresa May has said that permission would not be forthcoming during Brexit negotiations, potentially opening the possibility of a referendum in 2019 or 2020. Further change may also now follow as a result of the General Election called for 8 June 2017. From a telecoms perspective, this has been played out against the backdrop of the progression of the Digital Economy Act and in particular debate around Ofcom’s Digital Communications Review (see page 39), and of dialogue on the European Electronic Communications Code revisions. How we’re mitigating the risks We maintain strong engagement with the UK Government, key departments such as DCMS and BDUK, MPs, peers, the media and with consumer bodies; and with Governments and politicians in Brussels and in our key markets around the world. We seek to inform public debate around telecommunications through fact-based evidence concerning the market and BT’s role within it. As explained in the case study on page 51, we have set up a programme across the business to help us understand and manage the risks associated with Brexit. This will also consider other potential impacts such as those associated with a second Scottish Independence referendum, and is led by a steering group chaired by the group finance director. We’ve also offered our views to Government and business groups on related policy areas, including responding to Parliamentary inquiries. Outside the UK, our Public Affairs and regulatory teams work to help support governments and regulators in ensuring that markets work in an open and fair way for the benefit of customers and competition. Geopolitical risks are tracked by a committee, with our security and business continuity teams particularly focused on protecting our people and our assets. Financial risk Link to strategy – Transform our costs – Invest for growth 1 2 Link to business model – Financial capital – Social capital Trend In common with other major international businesses, we are exposed to a variety of financial risks. These include treasury risks, which arise principally from market risk (including interest rate risk and foreign exchange risk), credit risk, and liquidity risk. They also include tax risk, principally that we need to understand fully the current and future tax consequences of business decisions to comply with tax rules and avoid financial and reputational damage. 50 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 51 Potential impact If there is an adverse movement in foreign exchange and interest rates there could be a negative impact on the group’s profitability, cash flow, and balance sheet. Sensitivity in the income statement and shareholders’ equity arising from interest rate and foreign exchange volatility is shown in note 27 to the Consolidated Financial Statements. The failure of Treasury counterparties to honour financial obligations could have an adverse impact on the group’s liquidity (for example from the loss of cash deposits) and profitability (for example from increased finance expenses). A deterioration in liquidity could have an adverse impact on the Board’s assessment of going concern, particularly if combined with an inability to refinance maturing debt. If we fail to comply with tax rules then we could face financial penalties and reputational damage. Beyond compliance, if we don’t adequately reflect the current and future tax consequences in our business decisions, we might make bad decisions resulting in financial loss and potentially financial misstatements, as well as reputational damage. What’s changed over the last year? Following the UK referendum to leave the European Union, we saw increased volatility in foreign exchange rates. However, we continue to face the same treasury risks as in financial year 2015/16. From a taxation perspective, BT’s business continues to evolve rapidly, creating different tax consequences, for example the acquisition of EE and the DCR. Global tax rules also continue to evolve, for example the OECD’s Base Erosion and Profit Shifting project and the prospect of US tax reform, changing the current and future tax consequences of business decisions. How we’re mitigating the risks We have a centralised treasury function whose primary role is to manage liquidity and funding requirements as well as our exposure to associated financial and market risks, including credit risk, interest rate risk and foreign exchange risk in-line with Board approved policies. These risk management policies are described in detail in note 27 to the Consolidated Financial Statements. The Board reviews liquidity and funding requirements of the group on an ongoing basis. A strong governance framework is also at the heart of our mitigation approach to tax risk. We’ve a framework for managing taxes that is set centrally and agreed by the Board. We employ specialist teams to manage and assure the operation of this framework. We pay tax in accordance with the laws of the countries where we do business. However, in some areas these laws aren’t clear, and it can take many years to agree an outcome with a tax authority or through litigation. Nevertheless, we always seek to deal with tax authorities in an open and constructive manner, engaging specialist external advice where required. Brexit Once the Government decided to hold a referendum on the UK’s membership of the European Union, we realised this would create potential uncertainty for BT. The risk of this increased after Britain voted to leave the EU. How we managed the risk We decided early on that we needed to understand what risks and opportunities Brexit might create for us, so ahead of the vote we set up a programme bringing together functions across the business. The results of this work were reported to the Operating Committee. We then ramped up the activity after the vote, forming a steering group chaired by the group finance director. This continues to meet on a regular basis, overseeing work that is being done by our various sub-projects. These are looking at areas such as the tax, people, procurement, systems and commercial impacts of Brexit. We’ve also offered our views to Government on related policy areas, including responding to Parliamentary inquiries. The result, and what we learnt We had trialled similar approaches during previous events such as the Eurozone crisis and the Scottish independence referendum. This experience helped us make sure that senior leaders across BT understand how geopolitical events such as Brexit can impact us. We’ve also been able to explain to Government what we believe their priorities should be for our sector when negotiating with the EU. More broadly, we’ve recognised that we need to work together as a business to manage such risks. And we also appreciate that our customers can take confidence from us developing plans to get through uncertain times. 50 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 51 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our principal risks continued Operational risks Security and resilience Link to strategy – Deliver great customer experience 1 Trend Link to business model – Financial capital – Intellectual capital – Manufactured capital The security and continuity of our services are critical factors in our commercial success. Our networks and systems are constantly exposed to many different threats, and our customers expect the highest standards of protection and recovery planning to minimise any impact on our services. Cyber-attacks on our own IT systems and those of our customers are becoming more frequent and sophisticated, and we’re investing heavily to keep pace with this growing threat to steal data or equipment or damage our infrastructure. However, service interruption can result from many other sources. These include physical threats like fire, explosion, flooding, overheating, extreme cold or power failure; logical threats such as equipment failure or problems encountered with software upgrades or major changes; or disruptions in our supply chain. Potential impact In the event that our protective measures fail to prevent or contain a major security or continuity incident we might incur major financial loss, long-term damage to reputation and loss of market share. Regulatory sanctions, fines and contract penalties might be applied, contracts might be terminated, and costly concessions might be needed, together with unplanned and rapid improvements to retain business and rebuild trust. We might also miss opportunities to grow revenue and launch new services ahead of the competition. What’s changed over the last year? The acquisition of EE has substantially changed our security risk, adding large volumes of bank account and credit card data which are attractive to hackers. The rapidly escalating cyber threat is recognised as a major risk faced by organisations across the world, and we’re clearly seen as a legitimate target for cyber-incidents. We’re also exposed to collateral damage from attacks on our suppliers and customers by highly motivated and well-resourced nation state actors and criminal gangs. We responded to several potentially serious cyber-attacks during the year, and attempts to compromise our systems using known hacking tools have repeatedly failed. We’ve made real progress on improving risk controls, but more needs to be done to make sure we can keep up with the growing threat. The two major data breaches announced by Yahoo in September and December 2016 both included BT mail account records dating from 2013 and 2014. Some of these accounts are still vulnerable because their owners have never changed their passwords. The customers affected were quickly advised to reset their passwords, and forced resetting of passwords will be applied where necessary. Following the impacts of the winter storms of 2016/17, and the publication of the UK National Flood Resilience Review, it’s clear that the risk of extreme weather events is increasing. In response, our flood preparedness programme has seen major enhancements in our defence and response capabilities. How we’re mitigating the risks We’re investing in improvements across the full range of technology, processes and people for both security and continuity risks. Our cyber defence programme is focused on segmenting our IT estate to enhance access control and limit the spread of attacks. We’ve improved our strategic defences against Denial of Service (DoS) attacks in order to limit the disruption from high volumes of malicious traffic and from slower, more sophisticated attacks that mimic legitimate data flow. We’ve deployed more scanning, monitoring and logging tools to identify intrusions and to detect anomalous data traffic as early as possible. We’ve also invested in the development of cyber security skills that are deployed around the clock to apply threat intelligence to our defences and manage live incidents. We’ve completely revised the frequency and scope of our vulnerability testing using a risk-based approach to setting priorities, and we’ve increased resources for proactive penetration testing and ethical hacking. We’re adopting a more rigorous approach to auditing our suppliers’ security and are increasingly asking suppliers to substantiate their responses with evidence of compliance with our security policies and contract terms. Our flood preparedness programme has seen us double the size of our Emergency Response Team and their associated capabilities. We’ve enhanced our extreme weather monitoring processes and our ability to map warnings to specific assets. This, together with the production of specific flood defence plans for our critical sites, allows us to respond more rapidly and appropriately to fast-changing weather- related risks. We’ve also enhanced our ability to provide emergency communications support to local communities should these become isolated following storm damage. We continue to invest in resilience and recovery capabilities in response to a range of threats. Major contracts Link to strategy – Deliver great customer experience – Transform our costs – Invest for growth 1 2 3 Trend Link to business model – Financial capital We have a number of complex and high-value national and multinational customer contracts. The revenue and profitability of these contracts are affected by things like: variation in cost; achieving cost savings anticipated in contract pricing (both in terms of scale and time); delays in achieving agreed milestones owing to factors either in or out of our control; changes in customers’ needs, their budgets, strategies or businesses; and our suppliers’ performance. Any of these factors could make a contract less profitable or even loss-making. The degree of risk varies with the scope and life of the contract and is typically higher in the early stages. Some customer contracts need investment in the early stages, which we then expect to recover over the life of the contract. 52 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 53 Major contracts often involve implementing new systems and communications networks, transforming legacy networks and developing new technologies. Delays or missed milestones might have an impact on us recovering these upfront costs. There’s a substantial performance risk in some of these highly-complex contracts. Potential impact If we don’t manage to meet our commitments under these contracts – or if customers’ needs, budgets, strategies or businesses change – then our expected future revenue, profitability and cash generation may go down. Unexpectedly high costs associated with fulfilling particular transformational contracts could also hit profitability. Earnings may drop. Contracts may even become loss-making through loss of revenue, changes to customers’ businesses (due to, for example, mergers or acquisitions), business failure or contract termination. One of our largest and highest risk contracts is the delivery of a key element of the UK Emergency Services Network (ESN) on our EE mobile network. The complexities described above all apply to this programme. So far delivery has gone well, but there are still plenty of challenging parts of the programme to be delivered including aspects of the contract that are not in our control. We’re still delivering contracts with local authorities through regional fibre deployment programmes, including the Broadband Delivery UK programme (BDUK). As with our other major contracts, if we fail to deliver these contracts successfully it might lead to reduced future revenue, profitability and cash generation. As well as carrying a higher reputational risk, these contracts present specific risks around deployment, delivery and our ability to recover public funding. We also have an obligation to potentially either re- invest or repay grant funding depending on lots of different factors – including how many customers take up a new service. What’s changed over the last year? We’ve acquired EE and with it the Emergency Services Network (ESN) programme, which is a high-profile contract delivered with several partners and managed by the Home Office. To date we’ve delivered on our commitments but it’s still a high-risk programme and is being managed as such. Tough market conditions continue and the impact of the UK voting to leave the EU has meant some customer programmes have been delayed, which has had an impact on the business. Customers are requiring more flexibility in their contracts. The majority of our first phase of BDUK contracts have now completed deployment, with the remainder closing in 2017/18. We’re now mid-delivery of the second phase of contracts (SEP). Whilst these contracts are smaller in scale and coverage, the deployment challenges are significantly greater in terms of the geography encountered as we reach further into the final 5%. While our broadband contracts and ESN carry a different risk profile to other major corporate contracts, we apply our governance and reporting processes to make sure we identify risks and mitigation activities and report them to management. How we’re mitigating the risks At both group and line of business-level we have governance, risk management and reporting processes in place. Independent audits and the checks and balances in individual contracts provide assurance through an independent review programme. To track progress, we monitor how we’re doing on these risks and mitigation actions, and report the result to senior management. A separate, dedicated team provides assurance for our BDUK and ESN projects. The BT Academy helps support skills development and learning initiatives. These help our Contract Management Profession to better identify and manage risk. We also update new training collateral whenever we learn something new. The scope and availability of training options continues to improve through BT-wide learning and development initiatives. In fact we’ve invested in risk training, and assess the management of our contracts against a best practice framework we’ve developed based on our knowledge of running and managing major programmes. Contract management and automation Our ability to successfully manage major contracts is critical to maintaining performance and providing a great customer experience. How we managed the risk How we handle both contractual obligations and risk is key to success. To help our management community we’ve introduced a ‘contract lifecycle management’ system. This will centralise the storage, access and retention of all contract documents. The result, and what we learnt Our ‘contract lifecycle management’ system promises many benefits. Once it’s rolled out across the business, it’ll help us understand our contractual obligations and make sure every contract has a dedicated owner. It’ll also help with allocating work and by providing an online risk register, make sure risks are understood and agreed across the business. Finally, it should make it simpler to develop our expertise as we adopt a single way of working across contract management. 52 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 53 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Our principal risks continued Operational risks continued Supply chain Link to strategy – Deliver great customer experience – Transform our costs 1 2 Trend Link to business model – Financial capital – Social capital – Natural capital We operate in a global supply market, with a variety of supply chains ranging from simple to very complex. Guaranteeing their integrity and continuity is critical to our operations. Global markets expose us to global risks, including different standards in labour, environmental and climate change practices. We weigh up the impact and likelihood of external market forces on our suppliers’ ability to support us. A global supply market means better sourcing opportunities, but brings challenges if suppliers become more geographically and culturally remote from our customers – or if governments put barriers in the way of doing business to protect national economic interests. Our dealings with suppliers – from the way we choose them, to the contracts we sign and how we pay them – follow our trading and ethical policies. For more detail, see Our suppliers on page 37. Impact If something goes wrong in our supply chain, the speed and scale of impact can vary. We need to determine the potential damage to customer experience, the likelihood of higher costs and the potential damage to our brand. If losing an important supplier meant that we had to change technologies, it could cost us a lot of money. If we couldn’t find an alternative supplier, it might compromise the commitments we make to our customers, which could in turn lead to breach of contract, lost revenue or penalties. If any link in our supply chain falls foul of the law, or fails to meet our ethical expectations, that could damage our reputation – possibly leading to legal action and lost revenue. What’s changed over the last year? We dedicate time to assessing emerging geo-political threats and the impact they could have on our supply chain. These include the impacts of the UK leaving the EU; economic problems in countries like Venezuela; increasing regulation over the privacy of personal data; and the growing threat of cyber-attacks on networked ICT systems. We note the continuing trend of mergers and acquisitions in some of the global markets in which we source products and services. It highlights the risk of us becoming too dependent on single or monopolistic suppliers – particularly those less constrained by regulation and who might charge us more than their domestic customers. How we’re mitigating the risks We have a few really critical suppliers. We keep a close watch on their performance and ability to meet their obligations. We tell the business when to prepare for the risk of a supplier failing, and our senior leaders continually review how ready we are for such events. We make sure we exercise the right due diligence when it comes to introducing new suppliers and continuing to do business with existing ones. That includes checks on company finances, business systems, accreditations, media reputation and ethical practices. We manage our top suppliers according to the contracts they’ve signed. We work with them to find better ways of working, reducing our exposure to risks around poor supplier practices in the process. The increasing focus on human rights, following legislation like the Modern Slavery Act 2015, means that we must keep examining the potential risk of both modern slavery and human trafficking in our supply chain. We must also ensure that our products are free of components that could be sourced from areas of armed conflict, or sourced using methods that are unsustainable or ethically questionable. Employee engagement Link to strategy – Deliver great customer experience 1 Trend Link to business model – Human capital Our people are a vital part of our ambition to deliver a positive customer experience and sustainable, profitable revenue growth. Our people strategy supports this ambition by creating an environment where people can thrive as part of a dynamic business. Great employee engagement is necessary to ensure we meet our strategic aims. Potential impact If we fail to recruit, retain and engage our workforce it could impact our ability to deliver a great customer experience and continue to grow the business. Furthermore, a failure to develop and retain talent could result in a greater need for external recruitment, which would add cost to the business. Poor engagement also raises the risk of general industrial unrest and action. What’s changed over the last year? Following the acquisition of EE we’re working to bring these two businesses together into a truly integrated company. We’ve identified examples of best practice from both organisations that will act as building blocks for our ‘better than both’ ambition. We’ve launched a new set of values to reflect this. We’ve launched a new employee survey and approach which make it easier for managers and their teams to see the key things they need to do to improve levels of engagement and better serve our customers. How we’re mitigating the risks As we explain in the Our people section on page 26, we provide comprehensive support and training to help our people deliver to the best of their ability. We regularly review our pay and benefits to make sure our remuneration is competitive when compared to other companies of a similar size and complexity. We seek a positive and enduring relationship with our people and their representatives. We have a very comprehensive global engagement strategy in pursuit of that aim. This involves both our employees and their representatives (Unions, Works Councils and Employee Fora). We also have a comprehensive business continuity function. 54 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 55 Our viability statement Assessment of prospects An understanding of the group’s strategy and business model is central to assessing its prospects, and details can be found on pages 16 and 22. Viability statement In accordance with provision C2.2 of the 2014 revision of the UK Corporate Governance Code, the directors have assessed the prospects and viability of the group. Our business model provides resilience that is relevant to any consideration of our prospects and viability. In the UK, we benefit from diversification across a number of markets and products, which has increased as we moved into ‘quad play’ through the launch of BT Sport and the acquisition of EE. We also have a broad spread of customers and suppliers across different geographic areas and market sectors, serving the needs of customers in more than 180 countries worldwide. Our strategy of delivering great customer experience, transforming our cost base and investing for growth is designed to support long-term and sustainable cash flow growth. We assess our prospects on a regular basis through our financial planning process. Our three year Medium Term Plan forecasts the group’s profitability, cash flows and funding requirements, and is reviewed by the Board during the year. The Medium Term Plan is built from the bottom up forecasts of each of our Lines of Business, supplemented by items managed at a group level and assumptions such as macro-economic activity and exchange rates. The performance of the group and our Lines of Business against these forecasts is monitored monthly and this is supplemented each quarter through a series of deep-dive Business Unit Reviews performed by the Operating Committee. Beyond our core three-year planning horizon, the group also makes investments that have business cases covering a longer time period, such as our network investments. Significant capital expenditure investment cases are approved by the Design Council, a pan-BT investment board and, where appropriate, the Operating Committee and the Board after taking into account longer-term risks and opportunities such as the economy, technology and regulation. Finally, our business and financial planning also takes into account our longer-term obligations, including the funding of our defined benefit pension schemes. Although the directors have no reason to believe that the group will not be viable over a longer period, the Board has chosen to conduct this review for a period of three years to 31 March 2020. The Board believes this is an appropriate timeframe as it aligns with the group’s financial planning processes. In addition, a number of our principal risks share a natural three-yearly cycle: for example the BTPS funding valuation and Ofcom’s market review cycle. In support of this statement we have stress tested our forecast cash flows by assessing, through a probabilistic analysis, the range of potential combined impacts our most significant risks could have on these forecasts. This assessment was informed by our judgements as to the potential financial impact of these risks if they materialise, together with their likelihood of occurrence. Our stress testing confirmed that existing projected cash flows and cash management activities provide us with a buffer against the impact of our most likely risks. In the most extreme scenarios we tested, where all of our principal risks are assumed to materialise over the three-year period, we have considered the further actions we could take to mitigate the negative cash flow impact and ensure additional liquidity. These actions could include, for example, sale of assets, limiting or delaying discretionary capital expenditure and marketing activities, restricting share buyback programmes and reducing or ceasing dividend payments. In our viability assessment we have adopted a number of assumptions designed to stress test our resilience. For example, in making our assessments of the impact and likelihood of our risks, we have only taken into account the control activities that we have in place today. We have not factored in any of the extensive future mitigation activity that we are undertaking to address these risks, thereby assuming such activity proves ineffective. Whilst we do not expect this to happen, we have adopted these pessimistic assumptions to add greater stress to our viability testing. We have also assumed that, should the need arise, we would have both the ability to renew existing debt facilities which mature over the three-year period and be able to raise new debt. Based on the results of this analysis, the directors have a reasonable expectation that the group will be able to continue in operation and meet its liabilities as they fall due over the three-year period of their assessment. 54 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 55 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business Consumer We’re the largest provider of consumer fixed-line voice and broadband services in the UK. We’re also the second-largest pay-TV sports broadcaster in the UK and a leading innovator in broadcasting technology. Consumer and Plusnet (our award-winning second brand) connect our customers to information, entertainment, friends and family, both at home and on the move. We buy access to fixed-line and broadband infrastructure from Openreach, and we use EE’s mobile network to provide mobile phone services. Consumer, Plusnet and EE all provide home phone, broadband, TV and mobile services. Consumer brands Markets and customers Our broadband (copper and fibre) products are available to over 99% of UK premises, and our home phone and mobile services are available to all. Everyone who has a BT internet connection with a sufficient broadband speed can sign up to watch BT TV. The UK consumer telecoms market is highly competitive. In December 2016, Ofcom found that UK prices for telecoms and TV services compared well to international benchmarks. In 2016 the UK ranked second among six comparator countries (France, Germany, Italy, Spain, UK and the US) for a combination of standalone, bundled and ‘lowest-available’ prices. Home phone Home phone Home phone Broadband Broadband Broadband BT retail market share See page 62 Within the UK market, our three consumer brands mean we’re well placed to compete with the likes of Sky, Virgin Media, Talk Talk and Vodafone. BT TV BT Sport Mobile YouView TV on Plusnet EE TV BT Sport Mobile BT Sport app Mobile Our Consumer line of business offers products and services from both BT and Plusnet. Subscriber numbers and market share data for home phone, retail broadband and pay-TV are reported at group level and can be found in this section. Figures for mobile (also reported at group level) can be found in the EE section on page 62. Consumer sells a range of devices including telephones, baby monitors and wi-fi extenders via high street retailers, the online BT Shop and on our website, BT.com. We work closely with our suppliers to make our products and business operations as sustainable as possible, from the first link in the supply chain through to the end customer. We also sell services to commercial premises, such as pubs and hotels, so they can access BT Sport or BT Wi-fi. We employ over 11,000 full-time equivalent employees. Around 10,000 of these directly help our customers through our contact centres. % 40 30 20 10 0 % 9 3 % 7 3 % 9 Home phonea Retail broadbandb Pay-TVc Source: BT and Ofcom data. Home phone According to Ofcom, the number of home phone lines in the UK is 26.4m. The number of minutes of residential fixed line calls made in 2016 fell by 12.8% year on year to 43.5bn, as people increasingly prefer to use mobile phones, voice over IP or instant messaging services instead of landlines. Broadband There were 25.3m fixed broadband (residential and SME) connections in 2016, an increase of 2.2% from the previous year. Of these, 46% were fibre broadband connections. TV and content There are approximately 18m pay-TV subscriptions in the UK. a Home phone includes Consumer and EE analogue and ISDN channels (WLR), including customers in Northern Ireland and Plusnet. b Retail broadband – Consumer (including Plusnet and Northern Ireland), EE, B&Ps, and broadband lines sold by Global Services. c TV refers to the total number of customers either with a BT Vision, YouView or EE TV box registered and enabled to receive video on demand including YouView from Plusnet. 56 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Subscription video on demand (SVoD) content providers such as Netflix and Amazon Prime are becoming increasingly popular, although this is largely as a complement to traditional pay-TV rather than as a replacement. Broadband We offer an ADSL broadband service, delivered over copper lines; and BT Infinity, our superfast broadband service which uses fibre to deliver higher speeds and a more reliable service. Data published by Ofcom found that 75% of SVoD users also had a subscription to a pay-TV service. Mobile We describe the UK mobile market, including BT’s overall position, in the EE section of this report starting on page 62. Products and services One size rarely fits all. That’s why we sell home phone, broadband, TV and mobile services to our customers in a variety of packages. Home phone We sell a range of home phone products and calling plans which let our customers choose the right service for their particular household needs. We offer unlimited call packages and add-ons such as discounted international calls and calls to mobiles. 82% of all call minutes are made to UK geographic numbers (ie excluding 03, 0845 and 0870 numbers). Of these, 89% are made without an additional charge as they form part of inclusive calling plans. Consumer home phone services include: – BT Basic – discounted line rental and inclusive calls to recipients of certain state benefits. We’re the only company to offer this sort of service in the UK. This year, we improved our BT Basic package by including more types of calls to the services and adding a cap on spend; – BT Call Protect – a new, free service, available to all customers, that diverts nuisance calls to a junk voicemail box; and – Home Phone Saver 2020 – a telephone-only package offering line rental, unlimited calls and calling features. The price is guaranteed until 2020. Plusnet and EE also offer a home phone service with a variety of different calling plans. Examples of our broadband services include BT Broadband Unlimited, which has speeds of up to 17Mbps, and our premium package, BT Infinity 2 Unlimited, which uses fibre broadband for speeds of up to 76Mbps. Where available, fibre-to-the-premises packages offer download speeds of up to 300Mbps. In July 2016 we launched the BT Smart Hub. Boasting the UK’s most powerful wi-fi signal versus major broadband providers, it uses the latest technology to help customers enjoy wi-fi in more places in the home. BT Smart Hub Our broadband packages also include the following products: – BT Wi-fi – free, unlimited wi-fi access at around 5.6m UK hotspots; – BT Cloud – secure online and on-the-go access to data and photos; and – BT Web Protect – a suite of security services which help to keep our customers and their families safe online. We offer targeted support to vulnerable customers and work with industry groups, such as Internet Matters, to promote internet safety. Plusnet broadband is sold in three packages – unlimited, with a download speed of up to 17Mbps; and two fibre broadband packages, fibre unlimited, with download speeds of up to 38Mbps, and unlimited fibre extra, with download speeds of up to 76Mbps. EE broadband offers three similar products. Annual Report 2017 BT Group plc 57 Lines of business continued Consumer continued TV BT TV is available exclusively to our broadband customers. TV content is delivered via a YouView box, which includes content from a number of third parties, including Netflix. Our ambition is to provide a selection of pay content at an attractive price. A good example of innovation in action was our coverage of the 2016 UEFA Champions League final. We made this the most social sports broadcast ever by live-streaming the match on BT Sport’s YouTube channel and breaking new ground across social media. BT TV comes in three different packages: Starter + BT Sport Over 70 Freeview channels, plus BT Sport channels; AMC; BoxNation and access to BT Store. This package comes with a YouView box which lets people pause and rewind live TV. Entertainment Plus Includes 110 channels, as well as a YouView+ box, which lets customers record up to 300 hours of programmes, pause and rewind live TV, and access seven days’ worth of catch-up TV. It also includes access to the BT TV app. Total Entertainment Offers 141 channels, including 21 in HD. Also includes additional recording space on the set-top box; BT Sport in 4K Ultra HD and BT Kids TV. Entertainment Plus and Total Entertainment are only available to BT Infinity broadband customers. YouView TV on Plusnet is available to Plusnet’s fibre customers. It includes over 70 Freeview channels, plus BT Sport 1, as well as pay-TV channels. EE TV provides more than 70 Freeview channels, as well as pay-TV channels. The EE TV app works seamlessly on up to four devices. BT Sport There are four main live BT Sport channels. The BT Sport channels are available on BT TV, the BT Sport app (to BT and EE customers), btsport.com. Sky, TalkTalk and Virgin Media TV customers can also purchase a BT Sport subscription. There’s a discount on BT Sport for existing broadband customers, and an even bigger discount for customers who take broadband and BT TV. BT Sport 4K UHD is the UK’s first Ultra HD TV channel. It has four times the detail of HD and is available exclusively to BT TV Total Entertainment customers with BT Infinity broadband. BT Sport is the exclusive live broadcaster of the UEFA Champions League and UEFA Europa League in the UK, with the rights secured until the end of the 2020/21 season. We also broadcast games from the Premier League and the FA Cup. As well as football, BT Sport offers coverage of a range of different sports including Aviva Premiership Rugby, MotoGP, Cricket Australia, WTA tennis and most recently, boxing. This year, we broadcast over 11,000 hours of live sport. Innovation is a key part of our strategy at BT Sport. Over the course of this year, we’ve run trials broadcasting content using virtual reality. We’ve also launched Dolby Atmos sound on our Ultra HD channel. Our BT Sport app and Ultra HD channel have won awards for innovation. BT Mobile BT Mobile is available as both SIM-only and a range of service plans with a choice of market-leading handsets. BT broadband customers get a £5/month discount on BT Mobile service plans. This year we launched BT Family SIM – a service plan which lets BT Mobile customers purchase two or more SIM cards at a discounted price. Plusnet entered the quad-play market in November 2016 with the launch of Plusnet Mobile. Performance in the year – strategic Customer experience remains our top priority. 1 Delivering great customer experience Last year we made an important investment in customer care. This year we’ve made real progress in this area. Even so, we continue to focus on making improvements. We’ve added more than 2,200 additional FTE call centre roles in the UK and Ireland. We’ve also made important gains by making sure we’re easy to deal with, a key part of our Net Promoter Score. Investing in online support 1.4m customers have the My BT app and can use it to get in touch with us, while the percentage of online contacts that reach us via chat has grown from 6% in 2015/16 to 20% today. Better systems and tools for our agents We’re in the process of deploying a new system to our frontline agents so they can help customers even more quickly and accurately. This system is now live for more than 4,500 agents. New diagnostics to help us detect and resolve faults Diagnostics are still progressing, while on-time repair performance improved by six percentage points over the course of the year. On average, our customers now have landline faults fixed 24 hours quicker than last year. Simplifying our organisation We’ve broadened the skillsets of our agents and empowered them to take ownership of customers’ needs. Even so, work continues in this area Although a lot of progress has been made in the year on customer experience, the criticism we’ve received from both the media and the regulatory authorities over the year reinforces the need to redouble our efforts. One specific issue we need to address is the growing number of customers contacting us to discuss their monthly package price. The increasing number of contacts offset the progress made in other areas (such as fault resolution and providing services on time) and lowered the Right First Time score achieved by Consumer. 58 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 2 3 Investing for growth This year we continued to focus on sustainable long-term growth, making several investments for the future. The table below summarises the progress made on the top priorities we set out in last year’s report. Transforming our costs Last year our costs went up by 10%, reflecting both our revenue growth and our investment in the mobile market and customer experience. Review of last year’s priorities WHAT WE SAID WHAT WE DID We said we’d transform customer services. We’ve invested in systems and process to improve customer experience, and we’ve employed more people to make sure that by spring of 2017, 90% of customer calls are answered in the UK or Ireland. We’re on track to meet this target, with over 86% of calls now answered in the UK and Ireland. We’ve also made it easier for customers to interact with us online. To partly offset this we cut costs by: – – consolidating suppliers shared by both Consumer and EE; encouraging customers to adopt a self-service approach – more than 1.4m of them now have the My BT app; and finding production and insourcing efficiencies in our TV business. – Performance in the year – operating We won several awards for our products and services over the course of the last year. Organisation/Publication Award BT product/service This year we provided over 800,000 hours of training to our contact centre agents. Mobile Industry Awards Hottest New MVNO BT Mobile We said we’d launch our new Premier League rights and Australian cricket on BT Sport. This football season we aired 42 Premier League matches and 130 live games from the UEFA Champions League. We also broadcast 16 international Australian cricket games exclusively in the UK. We said we’d trial and launch ultrafast broadband using Openreach G.fast products. We said we’d launch mobile handsets to create new market opportunities and synergies with EE. Following successful trials of G.fast- powered ultrafast broadband, with over 300 customers already connected across two locations in the UK (Gillingham and Cherry Hinton), we’re extending to another 15 sites in our plan prior to our launch. We launched handsets with BT Mobile and created synergies with EE by consolidating suppliers. We also launched BT Family SIM. In November 2016, we launched Plusnet Mobile. We said we’d introduce a new YouView user interface. In February 2017 we started to roll out the new BT TV YouView user interface to our customers, a process that’s now complete. Known as BT Call Protect, we launched this innovative new service in January 2017. We’re making good progress towards this aspiration, but we’re not there yet. We said we’d launch our new breakthrough service to help home phone customers avoid nuisance calls. We said we’d increase the number of ‘revenue generating units’ by 2.5m over the next three years. PC Pro Recommended BT Smart Hub Expert Reviews Recommended BT Smart Hub Tech Advisor Recommended BT Smart Hub Alphr Recommended BT Smart Hub Expert Reviews Recommended BT Halo phone Mobile Choice Awards Best Network BT Mobile Deal Under £25 Mother & Baby Silver Award BT 7500 Baby Monitor Expert Reviews Best Buy Whole Home Wi-Fi Alphr uSwitch Recommended Whole Home Wi-Fi Most Popular Broadband Provider BT Broadband Broadband World Forum Best TV or media innovation BT Sport App TV Connect Awards Best Content Discovery Service BT TV YouView interface The Connies The Connies Contribution to User Experience Best TV/Video Service Update (Silver) YouView on BT TV YouView on BT TV Sports Technology Awards Most innovative live event BT Sport D&AD Wood pencil Ultra HD Annual Report 2017 BT Group plc 59 Lines of business continued Consumer continued Plusnet also won several awards: Organisation/publication Award Home phone, broadband and TV are reported on a group-wide basis in the section below. Mobile performance is also reported on a group-wide basis and can be found in the EE section on page 62. Broadband Genie Survey Awards 2017 uSwitch Broadband and Mobile Awards 2017 Best broadband provider Best customer care Most recommended provider Best technical support Most trustworthy provider Best value provider Broadband provider of the year Best provider customer service Best value broadband provider Cable.co.uk Awards 2016 Best broadband provider Best reliability Best customer service Best value BT Sport is the only place to watch the Premier League, Champions League, Europa League and FA Cup all season long BT Sport channels 5 Home phone As of 31 March 2017, BT Group had a combined total of 10.3m home phone customers. This represents a market share of 39%. home phone customers 10.3m Broadband This year we maintained our position as the UK’s largest provider of retail fixed broadband services with 9.3m customers, representing a market share of 37%. Over half of our retail broadband customers have a fibre broadband connection and benefit from faster internet speeds than ever before. broadband customers 9.3m TV We have 1.7m TV customers, divided between BT TV, YouView TV on Plusnet and EE TV. 29,800 commercial premises have a BT Sport subscription, up from 27,000 last year. BT Sport’s average daily viewing figures went up by 12% in 2016. During this time, our BT Sport app was downloaded more than 2.2m times. BT Sport’s daily viewing figures +12% 60 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 61 Priorities for the year ahead Over the next 12 months we’ll carry on investing for the future and doing everything possible to ensure a great customer experience and sustainable business growth. Our top priorities for 2017/18 are: Keeping the household connected – we’ll carry on moving customers from copper to fibre broadband and grow our base through customer acquisitions; we’ll also launch an ultrafast broadband product in the form of G.fast and, where possible, via fibre-to-the-premises; and we’ll carry on promoting our BT Mobile proposition to give existing BT customers more for their money. Enhance sport and TV content – exclusive sport is a key point of differentiation, giving potential customers an excellent reason to choose BT; and at the same time we’ll improve the TV viewing experience for our customers. Transform customer experience – we’ll complete the deployment of our new frontline systems and operating structure to simplify the way we work; and we’ll make further investments to cut the time it takes to get through to a contact centre agent. – – – Performance in the year – financial In 2016/17, our revenue went up by 7%, with a particularly strong growth across broadband, TV and BT Mobile. EBITDA decreased 4%. Year ended 31 March Revenue Operating costs EBITDA Depreciation and amortisation Operating profit Capital expenditure Free cash flow 2017 £m 4,934 3,922 1,012 209 803 237 709 2016 £m 4,608 3,553 1,055 207 848 207 781 2015 £m 4,293 3,249 1,044 218 826 207 828 Broadband and TV revenue increased by 13% (2015/16: 17%), reflecting the growth in our customer bases. Our calls and lines revenue increased by 4% (2015/16: 2%), in part reflecting the growth of our BT Mobile business. Other revenue decreased by 6% (2015/16: 8%) reflecting the declining fixed handset market. Consumer 12-month rolling ARPU increased 8% to £39.9 per month driven by broadband, BT Sport and BT Mobile. We’ve also seen growth of 3% in the number of revenue generating units per customera, which is now at 1.95. Operating costs increased by 10% (2015/16: 9%) as a result of investment in our new mobile handset business and increases in sports rights costs in relation to our UEFA rights and our new Premier League contract, which commenced in August 2016. Our cost base also went up because of our investment in improving customer experience and contact centre onshoring. – Our EBITDA decreased 4% (2015/16: increased 1%) over the year, with a strong performance across voice, broadband and BT Sport more than offset by our investment in contact centre onshoring, increases in sports rights costs and our investment in mobile handsets. Capital expenditure increased by 14% (2015/16: flat). 60 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 61 a Revenue generating units are voice lines, broadband, TV and mobile. THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business EE We’re the UK’s largest mobile network operator, and we also offer fixed broadband and TV. At BT we report mobile customer numbers on a group-wide basis, including those from our other lines of business. We have over 30m connections, 18.6m of which are 4G. In EE, new mobile customers join the EE brand, though we still have a number of customers on legacy Orange and T-Mobile tariffs. We acquire and retain customers through our chain of around 570 shops, our website and contact centres, and through third parties, such as Dixons Carphone. To improve customer experience, all EE customer service calls have been handled in the UK and Ireland since the end of 2016. By September 2016, total UK mobile call volumes were steady at around 37bn minutes per quarter. SMS and MMS messages were down 4% to an average of 24bn messages per quarter. Mobile telephony services generated £3.9bn in retail revenue in the quarter to September 2016, up 1% compared to last year. According to Akamai’s latest State of the Internet report, the UK has the fastest mobile connection speed of the 61 countries it surveyed around the world. We have 9,000 people, with 67% directly helping our customers through our shops and contact centres. And we were named the third best employer in the Sunday Times Best Big Companies to Work For 2017 awards, up from seventh in 2016. The market is subject to a number of existing and potential structural changes: – rapid adoption of 4G devices as 4G networks are deployed. That means nearly all handsets sold are smartphones; Starting in September 2017 we’ll support the Emergency Services Network contract by providing a resilient 4G network for 300,000 emergency services workers. Our mobile network has been independently recognised as the fastest network by Ofcom in its Smartphone Cities 2016 report, and best overall network by RootMetrics in its report for the second half of 2016. From 1 April 2016 we changed how the former EE business was organised to manage it better within the group. Business mobile was transferred to Business and Public Sector, the wholesale operations were transferred to Wholesale and Ventures, and the mobile network was transferred as a distinct business unit into TSO. Markets and customers With four mobile network operators and numerous mobile virtual network operators (MVNOs), the UK mobile market is very competitive. Of the UK’s 91m mobile connections, 87% are consumer and 13% business. Our main competitors are O2, Vodafone, Three, Tesco Mobile, Virgin Media and TalkTalk. Sky also entered the market in January 2017 as an MVNO. Competition for customers is further increased by third-party distributors selling mobile services on behalf of mobile operators, from high street shops and online. Around 93% of adults in the UK use a mobile phone. Over 70% of adults in the UK use a smartphone, and 59% of homes also have a tablet. Smartphones are now the most widely-used device by UK adults for accessing the internet. Consequently, total mobile data use went up 64% in 2015. According to Ofcom, 63% of mobile connections are on postpaid tariffs. – growth of connected devices, including tablets; – significant growth in mobile data use; – continued decline in the prepaid market as customers move to postpaid tariffs; – blurring of postpaid and prepaid customer types with rolling postpaid tariffs and auto-renewing prepaid bundles; – popularity of SIM-only tariffs. Smartphones are evolving at a slower pace so people are keeping their mobile phones for longer; and – regulatory pressure on the prices charged to customers and other telecoms companies. BT has a 29% share of the UK mobile market, measured on a subscriber basis. Mobile subscriber UK market share by operator At 31 December 2016 29% BT including EE 1% TalkTalk 4% Virgin Mobile 6% Tesco Mobile 11% Three 22% Vodafone 27% O2 Source: EE and market data. The consumer fixed line voice and broadband market is discussed in the Consumer section of this report on page 56. 62 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Products and services We provide mobile services in the UK, now covering up to 99% of the population with 2G, 98% with 3G and over 99% with 4G, or 80% on a geographic basis. We also sell broadband services, fixed-voice and a TV service. The wholesale services previously provided by EE are now managed by Wholesale and Ventures. Postpaid New consumer customers, and those who renew their contracts with us, are put on 4G tariffs. If the tariff includes a handset, the contract is typically for 24 months. The tariff will include a bundle of monthly voice, SMS and data use. Prices vary with the size of the bundle, the device type and 4G speed. The tariffs are split into three main groups: – 4GEE Essentials plans give access to 4G speeds of up to 20Mbps, unlimited texts and tiered bundles of voice and data use; – 4GEE plans offer unlimited UK minutes and texts and 4G speeds of up to 60Mbps; and – 4GEE Max plans combine the largest data bundles, inclusive access to the BT Sport App and ‘roam like home’ voice, text and data usage when abroad in the EU. Prepaid Prepaid customers buy a phone and then add a ‘pay-as-you-go’ pack of 4G use. The packs are split into three groups: – Everything packs for unlimited texts and tiered bundles of voice and data use over a 30-day period; – Talk and text packs for tiered bundles of voice and text use over seven to 30-day periods; and – Data packs ranging from 100MB to 4GB over seven to 30-day periods. We also operate a loyalty programme where customers get extra data added to their packs in return for staying with us and topping up. Devices We offer a wide range of 4G mobile phones, tablets, connected devices and mobile broadband devices from leading manufacturers including Apple, Samsung and Google. Customers may also choose to use their own device and then connect via a SIM-only plan. Broadband and TV We sell fixed-voice, broadband (including superfast fibre broadband) and TV services. To reward loyalty, our postpaid customers get larger data allowances if they also buy EE broadband. EE TV provides more than 70 free channels simultaneously on up to four devices, as well as access to pay-TV channels. The EE TV set-top box comes with one terabyte of memory and can be controlled from a mobile phone or tablet using the EE TV app. One of EE’s Rapid Response Vehicles Emergency Services Network In December 2015 EE was awarded the network part of the Emergency Services Network (ESN). Some of the applications that our 4G network will enable include: – an ambulance crew sending vital data to a hospital to help staff prepare for a patient’s arrival; – a policeman recording an arrest on a body-worn camera and live- streaming to nearby officers for support; and – a fire and rescue crew assessing a burning building based on live helicopter camera footage and digital blueprints viewable via tablets. To deliver the ESN service we’re: – building a new, dedicated core network; – constructing up to 500 new sites to expand coverage; – switching on 800MHz on more than 3,500 sites to improve outdoor and indoor coverage; – using new 4G voice services, such as ‘push to talk’; – providing a fleet of Rapid Response Vehicles to ensure maximum service availability; and – using satellite backhaul for remote sites. Annual Report 2017 BT Group plc 63 Lines of business continued EE continued Performance in the year – strategic We’ve grown financially, improved customer experience and extended our mobile network while integrating with the group. Performance in the year – operating We report mobile customer numbers on a total BT Group basis, including those from other lines of business. 1 At 31 March 2017 we had over 30m connections. Here’s how they break down: Delivering great customer experience Improving customer service is one of our top priorities. While we’ve made strong progress on mobile services, we believe there’s always more we can do, particularly for our fixed broadband customers. During the year we worked on projects across four key areas: – Call centres – all EE customer service calls are now handled in UK and Ireland contact centres; – Self-service – we now have 9m customers using My EE; – Shops – we’re improving our service; and – IT – we’re enhancing our customer-facing IT systems. We’ve made real improvements across the business in the way we design, build and communicate our products and services to our customers. We’ve improved the way we engage with them, whether that’s by phone, in store or online, and upgraded the information and tools our advisers use to help them with customer queries. Together these steps have helped cut the number of customer calls to our contact centres, and cut the number of complaints our postpay customers make to Ofcom by 43%. At the same time our postpaid net promoter score has improved, with many more promoters than detractors. 2 Investing for growth We’ve built the UK’s best mobile network and we’re continuing to invest to keep our number one position. We’ve extended 4G geographic coverage to 80% and plan to increase this to 95% by the end of December 2020. As part of the ESN contract we’ll also increase the resilience of the network, benefiting all of our customers. We’ve also enabled new features like ‘4G calling’ (Voice Over LTE) and some parts of our network now let customers achieve download speeds of up to 360Mbps. 3 Transforming our costs Since becoming part of BT we’ve started a cost reduction programme to deliver planned synergies and identify other savings. We delivered savings this year by: – improving customer self-service to cut the volume of calls to our contact centres; – answering all EE customer calls in the UK and Ireland, rather than overseas, to resolve more queries first time and cut subsequent calls; – improving efficiency within our shops, through better staff planning and reduced facilities costs; and – reducing the number of head office employees. Customer base by type 000 2,439 3,760 6,921 M2M MVNO Prepay Postpay of which 4G 16,916 18,628 0 5,000 10,000 15,000 20,000 Our postpay base grew by 803,000 to 16.9m, supported by growth in the EE and BT brands. The prepay base continued to decline in line with industry trends, partly as a result of customers moving to postpay. The machine-to-machine base grew 78,000 to 2.4m as the Internet of Things market starts to grow. Our base of MVNO customers stood at 3.8m, up 40,000, as our MVNO partners continued to do well in the mobile market. Customer base movements 000 3 0 8 0 3 3 1 , y a p t s o P y a p e r P 31,500 31,000 30,500 30,000 29,500 29,000 5 4 4 0 3 , 6 1 0 2 l i r p A 1 t a s A 0 4 O N V M 8 7 M 2 M 6 3 0 0 3 , 7 1 0 2 h c r a M 1 3 t a s A 64 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 65 Revenue was £5,090m which includes postpaid mobile revenue of £4,140m, prepaid mobile revenue of £402m, fixed broadband revenue of £276m and equipment sales of £272m. Our performance for the year benefited from additional revenue from our ‘more for more’ pricing strategy. Monthly mobile ARPUs for the final quarter of the year were £26.3 for postpaid customers, £4.4 for prepaid and £19.8 on a combined basis. Operating costs were £3,934m giving EBITDA of £1,156m, a margin of 23%. Capital expenditure was £616m. Adjusted for the acquisition of EEc capital expenditure was up 22% as we extend 4G coverage and as our investment in ESN increased. Preparation for our part of the Emergency Services Network contract continued in line with agreed milestones. Operating cash flow, which excludes interest and tax, was £570m. Priorities for the year ahead Over the next 12 months we’ll continue to invest in the network and further improve the customer experience. Our top priorities for 2017/18 are: Maintain network leadership – we’ll further extend 4G geographic coverage to 95% of the UK by 2020. – Carry on improving customer experience – in the medium term we aim to become the mobile network operator with the best postpaid net promoter score. – Deliver the EE part of the Emergency Services Network contract – we’re aiming to finish building and testing by the end of September 2017. In last year’s report, we set out our top priorities for this year. In the table below we summarise the progress we’ve made. Review of last year’s priorities WHAT WE SAID WHAT WE DID We now answer 100% of EE calls in UK and Ireland contact centres. We’ve cut the rate of postpay complaints to Ofcom by 43%. We’ve now extended 4G geographic coverage to 80% of the UK. EE is still ranked as the best UK mobile network by RootMetrics. We remain on track to deliver our part of the ESN contract by September 2017. We said we’d improve the customer experience. We said we’d extend 4G coverage and retain our position as the UK’s best quality mobile network. We said we’d progress the build phase of the ESN contract, working closely with TSO. We said we’d launch a range of combined mobile, fixed-line and TV products. We’ve refreshed the EE mobile tariffs, offered BT Sport to EE customers and trialled the sale of Consumer broadband and TV products in EE shops. Performance in the year – financial Revenue for the year was £5,090m and EBITDA was £1,156m. Underlying revenuea and EBITDAa adjusted for the acquisition of EE went up by 1% and 6% respectively. Year ended 31 March Revenue Underlying revenue excluding transit adjusted for the acquisition of EE Operating costs EBITDA Depreciation and amortisation Operating profit Capital expenditure Free cash flow 2017 £m 5,090 1% 3,934 1,156 780 376 616 570 2016b £m 841 n/a 668 173 146 27 96 238 64 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 65 a Excludes specific items, foreign exchange movements and disposals. Calculated as though EE had been part of the group from 1 April 2015. b Includes EE results from acquisition on 29 January 2016. c Includes EE’s historical financial information as though it had been part of the group from 1 April 2015, under the new organisational structure. THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business Business and Public Sector We sell communications and IT services in the UK and the Republic of Ireland. We’ve around 1.2m business and public sector customers and lead the field in fixed voice, networking and broadband. We’re passionate about helping all our customers succeed – from large government departments, big household names and public sector organisations right through to small businesses and new start-ups. Markets and customers We have around 1.2m customers, including over half of the FTSE 350. We created our Business and Public Sector line of business on 1 April 2016 by combining three organisations into one: the original BT Business organisation, EE’s business division, and parts of Global Services’ UK corporate and public sector teams. Our 10,000 people provide local, regional and national coverage across the UK. We now have three customer-facing units focused on providing communication solutions and IT services to help create business outcomes for our customers: TRADING UNIT CUSTOMERS Small & Medium Enterprises Corporate Public Sector and Major Business – Businesses in the UK with up to 100 employees, ranging from sole traders through to more complex organisations (including schools and colleges). – Businesses in the UK with between 100 and 1,000 employees. – Public sector (central and local government, health, higher education, defence). – Businesses in the UK with over 1,000 employees. – Multinational corporates with majority of BT business in the UK. – – Corporates and public sector in Northern Ireland. Corporates, public sector and wholesale customers in the Republic of Ireland. Major customers include: – – – – – retailers like the Co-Operative Group; utilities like Northumbrian Water; public sector organisations like Norfolk County Council; financial organisations like eSure; and educational institutions like Kingston University. The telecoms market we serve has revenue of £8bn, and we estimate the adjacent IT services market has revenue of £14.5bn. Convergence of these markets to create more integrated services is already underway, a trend we expect to accelerate. At £10bn, the public sector market for IT and telecoms is a substantial part of our addressable market. Challenges in the public sector remain substantial as the market continues to change. For example, larger systems integration contracts are being disaggregated and replaced by smaller contracts, while the devolution agenda is increasingly shifting procurement decisions and spend to the regions. Overall we’re focused on four main product markets: Fixed voice; Mobility; Fibre and connectivity; and Networked IT services. Fixed voice For some time the market for fixed voice services has been transitioning from traditional voice to Future / IP Voice. Market analysts such as IDC believe that IP Voice will become the dominant business voice service by 2018. The fixed voice market is largely fragmented – as the market leader, we compete against more than 950 resellers and fixed network operators, including companies such as Azzurri, Colt Group, Daisy Group, Gamma, KCOM Group, O2 and Unicom. Mobility Mobility and mobile device usage continues to grow as a way for customers to cut costs, improve productivity and deliver a richer customer experience. This growth is taking place against a backdrop of increasing risks concerning security, privacy and compliance. Our main competitors in this area are O2 and Vodafone. Both offer fixed products as well as mobile and are increasingly selling converged services. 66 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 67 Mobility Our mobile portfolio offers a range of handsets and tablets and a choice of voice and data tariffs. BT One Phone is a converged proposition combining office switchboard and mobile needs into one cloud-based solution mainly delivered through the customer’s mobile phone. Fibre and connectivity We provide a range of internet access options including: BT Business Broadband (over copper connections); BT Business Infinity over fibre- to-the-cabinet (FTTC) and fibre-to-the-premises (FTTP); and BTnet dedicated internet access. Our networking solutions are ideal for customers who want to connect offices together or connect to the internet over dedicated leased lines. Products include Ethernet, IP Virtual Private Network services, SIP trunking (which transports voice calls over IP networks), leased lines, cabling infrastructure and local area networking solutions. Networked IT services Our specialist IT services team provide solution design, delivery, management and in-life support, built around five core product areas: – – – – – end-user computing; unified communications and collaboration; networking; security; and data centres, cloud and hosting. These services are supported by partnerships with the likes of Cisco, HP and Microsoft. Fibre and connectivity Broadband services are still migrating to fibre in order to meet the need for faster communication speeds. We’re the largest business broadband provider in the UK. Networking is moving from physical provision to software-based, virtual provision. It’s expanding into the wide area networking space through technologies such as Software Defined Networking (SDN). See page 71 for more details. Ethernet and dedicated internet access services are growing strongly, with businesses becoming increasingly reliant on connectivity. We’re the leading provider of fixed networking services in the UK. Networked IT services The IT services market is diverse, ranging from off-the-shelf hardware sales to large outsourced solutions. Areas of the market experiencing growth include cloud services, hosting, infrastructure and security, all of which offer attractive opportunities for us to expand our share of the overall market. Competition is fragmented, with providers often focused on specific customer-types, industries or technologies. Our main competitors are Computacenter, Dimension Data, CDW, Logicalis, SCC and Softcat. Security is increasingly important for companies as they face an evolving range of cyber security threats. Products and services We offer a wide choice of voice, connectivity and IT-related services. These range from standalone products and converged propositions to managed services and customised solutions. Together these meet the needs of our customer base that varies from small start-ups to large enterprises and public sector organisations. Fixed voice Our fixed-voice services range from calls and lines, to fully-managed office phone systems and contact centre solutions across both our traditional and IP Voice portfolio. We’ve a broad Future Voice portfolio of Cloud Unified Communications services, BT Cloud Phone and BT Cloud Voice, aimed at the full spectrum of customers we serve. BT Cloud Voice, a feature-rich, cloud-based phone system with the flexibility to meet the demands of the modern, agile business 66 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 67 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Business and Public Sector continued Performance in the year – strategic Our continued investments in our people and our portfolio has helped improve the customer experience we provide while positioning us to exploit the market move to convergence. 1 Delivering great customer experience We’ve made good progress on our journey to become the market leader for customer experience. Our Net Promoter Score has improved by 12.4 points and our Right First Time measure by 6.1%. We’re resolving complaints 11% more quickly than last year. This year we’ve: – followed up with 20,000 customers on specific ‘pain points’ to improve their end-to-end experience; launched our first Customer Experience Lab in Dundee to trial innovative customer service solutions and new ways of supporting our customers; invested in people with more than 200 new advisers joining our service teams, including new apprentices; and delivered over 30,000 hours of training to our customer service advisers to improve the customer experience. 2 Investing for growth We’re still investing to improve and future-proof our products and services. Whatever tomorrow brings, we aim to be ready. This year we’ve: – enriched our Future Voice portfolio by adding new features such as portal and app enhancements; upgraded our Infinity Broadband portfolio to address the demand for higher speeds, offering up to 76Mbps as standard; improved the wi-fi performance and reliability of our Business Hub and expanded our Smart Diagnostics capability to fix issues proactively; and expanded our range of cloud-based services for SME customers, for example Mozy Backup, our new flexible cloud back-up solution. – – – – – – Performance in the year – operating Our order intake of £3.4bn was up 7% with the inclusion of EE orders offsetting public sector decline. During the year weaker trading in the public sector, driven by a number of contracts coming to an end, contributed to our revised group outlook. Business & Public Sector 12-month rolling order intake Year ended 31 March 6 2 7 3 , 7 7 4 3 , 5 7 4 3 , £m 3,800 3,600 3,400 3,200 3,000 2,800 8 2 2 3 , 3 6 1 3 , 4 9 0 3 , 9 6 3 3 , 2 1 2 3 , Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2016 2017 Contracts we won or re-signed this year include: CUSTOMER CONTRACT Royal Mail. Glanbia. Ardagh Group. A four-year deal for wide-ranging network and ICT services, covering voice, data, and customer contact centres. Renewal of existing WAN and managed services deal by adapting our service model to meet Glanbia’s global expansion needs (particularly in the US). Extension of existing WAN contract, addition of global SIP, completion of a Cisco PBX replacement project and deployment of BT Microsoft One Cloud. Metropolitan Police. £100m networking and IT contract to deliver high-speed fixed and wireless networks, together with a range of Cloud and IT services, to help underpin its technology transformation programme. Our public services network contract was extended for a further two years, growing to 500 sites. 3 Transforming our costs We’ve achieved major cost synergies by integrating EE and Business and Public Sector. Surrey County Council. The creation of Business and Public Sector gave us the opportunity to align our customer service operations more effectively. The first stage of this reorganisation brought together around 2,000 of our people into a single centre of excellence for UK and Republic of Ireland managed services. We’ve brought around 800 engineers from across BT Group into Business and Public Sector. The result is a unified field service team focused on the provision and maintenance of equipment on customers’ premises. These changes will allow us to better serve our customers while driving efficiency and reducing costs. The number of business lines we provide fell by 9% as customers continue to migrate to VoIP. This has been partly offset by growth in the number of IP lines, up 78%. We’re seeing strong take-up of our BT Cloud Voice and BT Cloud Phone services with user numbers up 258% and 94% respectively. 68 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 69 SME revenue was up 37% due to growth in mobile from the addition of EE customers, while also benefiting from an increase in revenue from IP lines, partly offset by a decline in traditional switch revenue. Corporate revenue was up 37% with growth in mobile revenue driven by EE offset by a reduction in equipment sales. Public Sector and Major Business revenue was down 12%, with the inclusion of EE revenue more than offset by the decline in public sector revenue. Public sector still faces challenges as we have a small number of large contracts coming to an end. Foreign exchange movements had a £52m positive impact on Republic of Ireland revenue, where underlying revenuea excluding transit was down 2%. Operating costs were up 12% (2015/16: 0%) and EBITDA was up 8% (2015/16: 2%) as a result of EE. Underlying EBITDAa adjusted for the acquisition of EE was down 10%, reflecting the revenue decline in public sector. Depreciation and amortisation went up by 24% (2015/16: 21%) reflecting the impact of EE. Capital expenditure went up by £122m (2015/16: £7m decrease) and adjusted for the acquisition of EEb was up £81m. Operating cash flow went up 17% (2015/16: 3%) reflecting the higher EBITDA and the timing of working capital movements. Priorities for the year ahead Over the next 12 months we’ll continue to invest for the future to deliver a great customer experience and sustainable business growth. Our top priorities for 2017/18 are: – Drive growth from greater sales coverage, acquiring and cross-selling to customers – increase the average number of products sold per customer. Differentiate through an integrated experience and portfolio, delivered on the best network – growth in the strategic portfolio areas of IP Voice, Mobile, Networking and IT services. Continue to improve the customer experience we provide – further improvements in NPS. In last year’s report, we set out our top priorities for this year, the table below summarises the progress we’ve made against them. Review of last year’s priorities WHAT WE SAID WHAT WE DID We said we’d successfully launch our new Business and Public Sector organisation. We said we’d introduce our full portfolio of fixed, mobile and IT services to existing BT customers and those acquired with EE. We said we’d develop and integrate our portfolio of products and managed services. We said we’d carry on improving the customer experience we provide. We integrated 1,600 people within 60 days of concluding the EE acquisition and the new organisation went live on 1 April 2016. However, lower trading in Public Sector driven by the completion of a number of large contracts led to a decline in underlying profits and a revised performance outlook. We’ve made our full range of propositions available across BT and EE. We’ve upgraded Infinity Broadband to up to 76Mbps as standard, expanded our range of cloud-based services and introduced new features to BT Cloud Voice. Our Net Promoter Score has improved by 12.4 points and our Right First Time measure by 6.1%. Performance in the year – financial Revenue was up 11% (2015/16: 1%) while underlying revenue excluding transit adjusted for the acquisition of EE was down 6% (2015/16: 2%). Underlying profits declined in the year, impacted by a number of large public sector contracts coming to an end. The remaining business performed well, led by good growth in mobile. Year ended 31 March Revenue Underlyinga excluding transit adjusted for the acquisition of EE Operating costs EBITDA Depreciation and amortisation Operating profit Capital expenditure Free cash flow 2017 £m 2016 £m 2015 £m 4,758 4,294 4,247 (6)% (2)% 3,230 1,528 352 2,880 1,414 284 n/a 2,867 1,380 235 1,176 1,130 1,145 275 153 160 1,293 1,101 1,070 68 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 69 a Excludes specific items, foreign exchange movements and disposals and from 2016/17 is calculated as though EE had been part of the group from 1 April 2015. b Includes EE’s historical financial information as though it had been part of one group from 1 April 2015, under the new organisational structure. THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business Global Services We’re a leading global business communications provider, supplying ICT services to 5,500 multinational companies in 180 countries. By combining our global strengths in networks, ICT and innovation with our deep expertise and global delivery model we’ve become a trusted partner for our customers. We provide them with the services they need to create the digital transformation of their businesses. around 7,200 people across key European business hubs, and have an extensive network of more than 1,000 PoPs. In the UK, we serve multinational companies and financial services organisations. During the year, we identified inappropriate behaviour in our Italian business. This is an extremely serious matter and has no place in BT. For full details of what we found, how we responded and what we will do going forward see page 6. Global Services serves multinational companies headquartered around the world. We’ve been simplifying how we work to provide a sharper focus on our global customers. We’re structured around four regional operations providing expertise in key industry sectors. The Americas is important because 70% of our top customers have a presence in the region. We operate in 28 countries in Latin America and the Caribbean, as well as the US and Canada. In Asia, Middle East and Africa we’re helping multinationals expand into these areas, while supporting local companies as they grow internationally. We help our customers from 26 offices. Outside the UK, use of the incumbent’s access network under non-discriminatory terms and conditions is important to provide a competitive service to our customers. We still campaign for fair markets as we expand our business. Global Services revenue by region Year ended 31 March 2017 30% UK 12% AMEA 21% Americas Americas Continental Europe Key industry sectors: – Financial Services – Automotive – Energy and Resources – Manufacturing UK Asia, Middle East & Africa – Media and Business Services – Retail and Consumer Goods – Technology and Telecoms – Travel, Transport and Logistics Markets and customers Customers We work with 5,500 customers across 180 countries worldwide. Our focus is on our major accounts, which generated 78% of our revenue in 2016/17. 72% of revenue was from customers served in multiple geographies. We also keep focusing on growing our share of customer spend by cross- selling products and services in line with our Cloud of Clouds strategy. Regions We’ve over 17,000 people worldwide in 63 countries. Our 20 highest priority countries, including the UK and other key countries where our major customers are based, generate over 90% of our revenue. Continental Europe is our largest region by revenue. We employ 37% Continental Europe Global Services strategic review We have undertaken a strategic review of Global Services, with the objectives of improving its market and financial performance, its risk profile, and the long-term value that it delivers to BT. Global Services is most differentiated with large, multinational customers, who demand high quality, secure communications. Its product portfolio is industry-leading across a range of areas, including networking, security, cloud collaboration and contact centres. Technology trends mean that we are now less dependent on owning physical local network access assets around the world, creating the opportunity to reposition Global Services as a more focused digital business. We will prioritise innovation of cloud-based platforms that deliver our products and services, with BT’s global network at the core, to support the digital transformation of our customers. As we implement this strategy, we will ensure that we optimise the value of our global and our local network assets. 70 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 71 To enable this strategic repositioning, we are restructuring our Global Services organisation to a simpler operating model. This will involve a two-year restructuring of our operations, the costs of which will be treated as a specific item. Key market trends Our customers are globalising and transforming their businesses. They’re using services from the cloud to gain competitive advantage by increasing efficiencies and decreasing IT costs. They want: – – – – a greater choice of cloud service providers; high performance across their network and IT service; flexible, end-to-end secure service; and a trusted partner to provide ICT services. The network continues to be the critical infrastructure that connects our customers to their cloud services, their sites, their employees, customers and suppliers. As customers seek more flexible and agile models, they’re increasingly adopting software-based network technologies to achieve the right balance between performance, service, security and cost. In this market, our main competitors are global telecoms companies such as AT&T, NTT, Orange and Vodafone. We also compete against regional telecoms companies such as Singtel. Products and services Our portfolio strategy, known as Cloud of Clouds, brings together our six core product families and a network of partners to support the delivery of global network and IT infrastructure services. Our six core product families BT Compute BT Security BT Connect BT Contact BT One BT for Industries Service from B T BT Advise Innovation fro m B T BT Connect Network services are at the core of our Cloud of Clouds strategy. They connect our customers to their people, their own customers and the cloud. We offer a range of flexible, intelligent hybrid and secure IP, Ethernet and internet virtual private network services. These include direct connectivity to third-party cloud services providers and the latest Network Function Virtualisation (NFV) and Software Defined Networking (SDN) solutions – the new generation of networking technologies that are giving us a new way to build and manage corporate networks that are fit for the digital age. We use a range of access technologies to deliver our network services to over 180 countries. BT Security With cyber-attacks a daily event, cyber security is firmly on the boardroom agenda for many companies. We use the expertise we’ve gained from protecting BT to deliver managed security services, threat intelligence analysis and management, and consultancy services, helping our customers protect their organisations from this growing threat. BT One People communicate using technology in many different ways – by phone, instant messaging, email, audio and video conferencing and data-sharing, either at their desks or on mobile devices. Businesses want these channels to be integrated and to work together easily and reliably. Our collaboration services help customers improve productivity and cut costs by transforming the way they communicate with their customers, colleagues, partners and suppliers. BT Contact Our contact centre services help our customers build stronger relationships with their customers. We offer a number of ways for them to communicate, including email, web chat, video, social media and the phone – either via automated systems or dedicated advisers. Our cloud contact solutions give companies more control over their costs, allowing them to change capacity in response to demand. BT Compute Businesses want reliable but flexible ICT platforms and services for their applications, data storage and security. We provide ICT services across our global network from 48 data centres around the world, with 22 of them supporting our cloud services. Our services range from traditional telehousing and colocation to the latest public, private and hybrid cloud solutions. BT Advise Our global team of around 2,000 consultants work closely with customers to understand their business needs and current capabilities so we can create a set of recommendations based on our portfolio. We develop a plan to help customers achieve benefits such as cutting costs, increasing productivity or becoming more agile. 70 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 71 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Global Services continued BT for Industries Our industry-specific solutions help customers overcome particular challenges. For example: – – our Digital Consumer solution enables retailers to provide an online experience to shoppers in physical stores; our Field Force Automation solutions provide mobile workers with access to corporate applications regardless of their location; and – BT Radianz, the world’s largest secure, financial services cloud community, helps customers cut costs, get to market faster and perform the best trading options. Supporting our customers’ digital transformation Our footprint and product portfolio mean we can take the role of leader and trusted partner to our customers, helping them at every stage of their digital transformation journey. We support that journey in three areas: We’re also recognised as a Leader in the IDC ITMarketScape: Asia/ Pacific Managed Security Services 2016 Vendor Assessment. Our cloud collaboration portfolio is now being used by more than one million employees of global organisations. Performance in the year – strategic 1 Delivering great customer experience We’re using customer feedback and insight to inform our decisions and enhance our customers’ experience. – We implemented the Net Promoter Score (NPS) system in April 2016, so we conduct monthly online surveys to gauge customer loyalty and identify actionable insight. – We also use Customer Thermometer, our transactional survey programme, to regularly gauge customer experience at key points of interaction. Finally, we use Right First Time (RFT) measures and operational KPIs, such as speed of delivery and repair, billing and product quality to provide a snapshot of how we’re performing. – Digital customer – creating a richer experience for end customers. Digital business – increasing business agility and innovation through cloud-based solutions. During the year we improved: – – – – RFT measures by 3.4%. IP Connect Global on-time delivery by 18%; the performance of our complex contracts by 22%; baseline NPS by 13 percentage points: and Digital employee – creating a productive business environment through seamless employee collaboration. We do this by providing high-performance, integrated and secure network and IT infrastructure services to global customers – our Cloud of Clouds portfolio strategy. Performance in the year We’re a global leader for managed networked IT services. In the last year we’ve been named as: – a Leader in Gartner’s February 2017 Magic Quadrant for Network Services, Globala; a Leader in the August 2016 Gartner Global Magic Quadrant for Unified Communications as a Service, Worldwidea; a Leader in the October 2016 Gartner Magic Quadrant for Contact Center as a Service, Western Europea; and a Leader in the June 2016 Gartner Magic Quadrant for Managed Hybrid Cloud Hosting, Europe.a – – – At the same time we recognise there’s more to be done, so we’ve put a rigorous plan in place to help us continually improve. This plan addresses key areas of focus, such as lead times, on-time delivery, project management skills and service delivery communications. 2 Investing for growth We’ve invested in a new generation of networking technologies, giving us an innovative way to build and manage corporate networks. Our network We’re investing in dynamic network services to give our customers greater choice, security, resilience, service and agility in the rollout of high-performance networks. We’re using our expertise in SDN and NFV technology, as well as our global infrastructure, to further improve our portfolio of network services. We work with a range of organisations to deliver our dynamic network services, including Cisco and Nokia, who will contribute technology to our software-defined WAN service. a Gartner does not endorse any vendor, product or service depicted in its research publications, and does not advise technology users to select only those vendors with the highest ratings or other designation. Gartner research publications consist of the opinions of Gartner’s research organisation and should not be construed as statements of fact. Gartner disclaims all warranties, expressed or implied, with respect to this research, including any warranties of merchantability or fitness for a particular purpose. The Gartner Report(s) described herein, (the ‘Gartner Report(s)’) represent(s) research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc. (‘Gartner’), and are not representations of fact. Each Gartner Report speaks as of its original publication date (and not as of the date of this Annual Report) and the opinions expressed in the Gartner Report(s) are subject to change without notice. 72 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 73 Our products and services – We completed the acquisition of IP Trade SA, a provider of unified communications and collaboration solutions for trading floor environments. – We launched a mobile collaboration service in the UK as well as a new mobile roaming service for our global customers, building on our acquisition of EE. – We’re accelerating our efforts to be the world’s leading cloud services integrator, and expanded our network of partners to include Oracle, Microsoft and T-Systems. – We’re helping our customers understand what digital can mean for their organisation and how best to use it as an enabler for growth and change through an Advise two-day workshop. – We introduced Trend Micro’s Deep Security protection for physical, virtual, and cloud servers on our Cloud Compute platform. – We also integrated Zscaler cloud security access points into our global network, and Symantec’s latest technology into our managed security services. High-growth regions We’re continuing to invest for our customers across Latin America, helping them increase productivity and become more competitive. For example, we’ve opened a contract design hub in Brazil and added a unified communications service node in São Paulo. 3 Transforming our costs We’ve continued to focus on reducing our costs, with underlying operating costs excluding transit adjusted for the acquisition of EE down 1%. Our cost transformation programme uses our tried-and-tested approach to improve process efficiency, reduce the cost of failure, enhance the network and improve the value for money we get from our suppliers. For example: – Operating model review in AMEA. We’ve established a – – consistent and standardised set of principles to improve our performance in countries where we have a low number of resources. Service delivery. We’ve combined our design and delivery functions to enable faster, more consistent delivery of services at lower cost. Contract reviews. We’ve reviewed opportunities across shared services and third-party costs. We’ve also introduced improvements in the delivery and in-life support stages of contracts to improve their profitability. – Data centres. We’re evaluating our existing global data centre estate and consolidating our sites to lower our cost base while improving our service offering. Performance in the year – operating We achieved a total order intake of £4.6bn, down 10% reflecting challenging international corporate market conditions. The table below summarises the progress we’ve made on the top priorities we set out in last year’s report. Review of last year’s priorities WHAT WE SAID WHAT WE DID We’re on track to achieve this ambition. We’ve been focusing on deepening customer relationships and cross-selling our portfolio. We achieved double-digit growth across cloud unified communications and Cloud Compute. Excluding the delay of milestone-related revenue with a major customer, we also achieved double-digit growth across security. We raised our baseline net promoter score by 13 percentage points in 2016/17. We said we’d grow our share of spending with our Global Accounts by 10% over the next three years. We said we’d achieve double- digit percentage annual growth rates in the revenue we generate from security, cloud unified communications and Cloud Compute over the next three years. We said we’d increase our net promoter score by at least ten points over the next three years. Contracts we won this year include: CUSTOMER CONTRACT Alstom (BT One). Unified communications and collaboration services for 30,000 users at 300 locations. Bridgestone Europe (BT Connect, BT One, BT Contact). Network infrastructure and managed cloud services connecting more than 200 sites across 20 countries in Europe, Middle East and Africa. Grupo Santander (BT Connect). We consolidated our relationship with Grupo Santander. International Airlines Group (BT Connect). Network outsourcing contract to help the company simplify its IT systems and processes and improve efficiency. Komatsu (BT Connect, BT Compute). Michelin (BT Connect). Randstad (BT Connect, BT One). Global IT infrastructure covering 26 sites across 15 countries in Europe, Asia- Pacific and South-America. Comprehensive managed network services connecting 216 sites in 43 countries. Global IT infrastructure providing cloud connectivity to more than 3,500 sites across 37 countries. 72 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 73 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Global Services continued Performance in the year – financial Revenue went up by 8% (2015/16: decreased 3%) including a £470m positive impact from foreign exchange movements and a £17m decline in transit revenue. Our key revenue measure, underlying revenue excluding transit adjusted for the acquisition of EE, decreased by 2% (2015/16: was flat), and excluding the revenue of our Italian business was flat. EBITDA increased 3% (2015/16: 3%). Underlying EBITDAc adjusted for the acquisition of EE was down 11% and excluding the results of our Italian business was up 1%. We have described the issues in Italy on page 6. Depreciation and amortisation was up 4% (2015/16: down 5%). Operating profit decreased by £1m (2015/16: up £36m). Capital expenditure went up by 2% (2015/16: down 13%). EBITDA less capital expenditure increased by £10m to £134m compared with an increase of £65m last year. Our operating cash outflow of £245m was £396m worse than last year, as we have unwound the effects of improper working capital transactions in our Italian business. 2017 £m 2016a £m 2015a £m Priorities for the year ahead Over the next 12 months we’ll continue to focus on delivering improved operational efficiency and great customer experience. Our top priorities for 2017/18 are: – – – implement a leaner and more customer-focused operating model; grow our cloud-based services and our security portfolio at double-digit rates; and launch a new digital customer experience, leveraging automation and portfolio innovation eg NFV/SDN. Year ended 31 March Revenue Underlying revenue excluding transit adjusted for the acquisition of EE Operating costs EBITDA Depreciation and amortisation Operating profit Capital expenditure Free cash flow 5,479 5,074 5,218 (2)% 0% n/a 4,984 4,595 4,753 495 439 56 361 (245) 479 422 57 355 151 465 444 21 406 28 In AMEAb underlying revenuec decreased by 4% (2015/16: up 10%) due to milestone-related revenue in the prior year. In Continental Europe, underlying revenuec excluding transit decreased 5% (2015/16: down 1%) and, excluding the revenues of our Italian business, was up 3% (see page 6). Underlying revenue excluding transit adjusted for the acquisition of EE in the UK was up 5% (2015/16: 2%). The Americasd decreased 6% (2015/16: decreased 10%) due to the ongoing impact of a major customer insourcing services. Operating costsa went up by 8% (2015/16: down 3%) reflecting EE, the impact of foreign exchange movements and the impact of our investigation into our Italian business. Underlying net operating costs excluding transit adjusted for the acquisition of EE were down 1%. a Revised to reflect the outcome of the investigation into our Italian business and reorganisation of our segments, see note 1 to the consolidated financial statements. b Asia Pacific, the Middle East and Africa (AMEA). c Excludes specific items, foreign exchange movements and disposals and for 2016/17 is calculated as though EE had been part of the group from 1 April 2015. d United States & Canada and Latin America (Americas). 74 BT Group plc Annual Report 2017 Lines of business Wholesale and Ventures At Wholesale and Ventures (W&V) we help other companies provide fixed or mobile telephony services, as well as running a number of BT’s specialist business units. On 1 April 2016 we integrated BT Wholesale with EE’s wholesale team and some of BT’s specialist business units to form Wholesale and Ventures. We’ve 3,800 people, including 900 in BT Fleet and 700 in BT Supply Chain. Markets and customers Our wholesale business helps communications providers (CPs) and other organisations to provide fixed or mobile telephony services. Our ventures provide mass-market services such as directory enquiries and payphones, and enterprise services including BT Fleet and BT Redcare. Wholesale: Fixed network services We provide wholesale fixed network services to over 1,400 customers including Sky, TalkTalk, Telefonica O2, Three and Virgin Media, as well as overseas CPs operating in Great Britain. We also provide specialist media and broadcast services to organisations including the BBC, Channel 4, ITV, Sky, Premier League Productions and Viacom18. Ventures Our ventures provide a range of solutions to over 1,000 enterprise customers including law firms, energy providers and mobile payment companies. We also handle millions of directory enquiries and 999 calls, and deliver the Phone Book to over 21m homes and businesses. Market trends The key wholesale market trends this year were: – fewer calls, more IP voice services. This year people made 14% fewer calls. But takeup of business-grade IP voice services is accelerating; bandwidth in demand. 46% of all our wholesale broadband lines ordered this year were delivered over fibre, while average data usage over our fibre lines rose by 18%; and – – more mobile. The MVNO market is expanding as existing MVNOs add 4G and new MVNOs launch. 1,000 we provide a range of solutions to over 1,000 enterprise customers Wholesale: Mobile network services We help Mobile Virtual Network Operators (MVNOs) that want to offer own-brand mobile plans but don’t own a mobile network. We support 30 MVNO brands with 3.8m mobile customers between them. 21m We also use the EE network to provide machine-to-machine services, as explained on page 76. we deliver the Phone Book to over 21m homes and businesses 1,400 we provide wholesale fixed network services to over 1,400 customers 3.8m we support MVNOs with 3.8m mobile customers between them 46% wholesale broadband lines delivered over fibre +18% data usage over fibre lines rose by 18% PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 75 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Wholesale Ethernet: presence in BT exchanges Lines of business continued Wholesale and Ventures continued Products and services Broadband and Ethernet We provide CPs with broadband and Ethernet connections between their core network and their customers. Wholesale Broadband Connect can serve 96% of premises with copper-based broadband (2015/16: 95%) and more than 26.5m premises with fibre. Our older broadband network brings our total coverage to more than 99% of all premises. Wholesale Ethernet lets customers connect over 99% of business premises at speeds of up to 10Gbps. Wholesale Optical extends those speeds to 100Gbps. This year we extended our own fibre-based Ethernet to many more exchanges and third-party datacentres. Wholesale Ethernet: present in BT exchanges As at 31 March Virgin Mobile In December we announced a five- year deal to provide wholesale mobile network services to Virgin Media, whose Virgin Mobile service has more than 3m subscribers. This replaces an existing MVNO agreement between EE and Virgin Media and extends its exclusivity to 2021. Machine-to-machine Machine-to-machine services support the exchange of information between devices. Companies can securely communicate with their devices and improve their services’ features and reliability using our mobile and fixed networks. 2 3 2 1 , 6 0 3 1 , 2 8 4 1 , 2,000 1,500 1,000 500 0 1 1 9 1 , Media services Our media network connects major locations around the world where broadcast or film content is created or distributed. In the UK it carries all of the nation’s digital terrestrial TV, as well as TV broadcasts from more than 150 sports and news locations. Elsewhere, local partners help us link TV stations to major sports venues worldwide. We also offer media services such as cloud-based content playout and media file acceleration. 2014 2015 2016 2017 Our Managed Ethernet Access Service (MEAS) uses Ethernet technology to carry mobile voice and data traffic to and from mobile operators’ transmission masts. Voice CPs use our IP Exchange (IPX) platform to carry their customers’ voice calls beyond the reach of their own voice network. IPX is now used by over 170 CPs, including most of the UK’s biggest operators. CPs without their own voice network can use Wholesale Calls, which routes calls for them end to end. The CP maintains the customer relationship through its own sales, customer service and billing. Hosted communications Traditionally, businesses have made and received calls over phone lines via a switchboard. Wholesale SIP-Trunking delivers the calls over broadband or Ethernet while Wholesale Hosted Centrex moves the switchboard capability into BT’s network. Similarly, our Hosted Contact Centres replace the systems and services needed to handle large numbers of inbound or outbound customer calls. Mobile Virtual Network Operator We were named Best Wholesale Operator at MVNO World Congress 2016. Customers can use their brand, build their own retail propositions, sell mobile plans through their channels and own the relationship with the end customer, while we do the rest. Premier League Productions This year we installed the UK’s first uncompressed outside broadcast network for Premier League Productions (PLP), a partnership between the Premier League and international sports production company IMG. We now provide live HD video feeds between all 20 Premier League football stadiums and IMG’s studios in London. This means IMG can move its production facilities from the stadium to its studios; while PLP can eliminate the issues associated with distributing compressed video, such as delays and reduced image quality. 76 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 77 2,000 1,500 1,000 500 0 Voice Products and services Broadband and Ethernet We provide CPs with broadband and Ethernet connections between their core network and their customers. Wholesale Broadband Connect can serve 96% of premises with copper-based broadband (2015/16: 95%) and more than 26.5m premises with fibre. Our older broadband network brings our total coverage to more than 99% of all premises. Wholesale Ethernet lets customers connect over 99% of business premises at speeds of up to 10Gbps. Wholesale Optical extends those speeds to 100Gbps. This year we extended our own fibre-based Ethernet to many more exchanges and third-party datacentres. Wholesale Ethernet: present in BT exchanges As at 31 March 1 1 9 , 1 2 3 2 , 1 6 0 3 , 1 2 8 4 , 1 2014 2015 2016 2017 Our Managed Ethernet Access Service (MEAS) uses Ethernet technology to carry mobile voice and data traffic to and from mobile operators’ transmission masts. CPs use our IP Exchange (IPX) platform to carry their customers’ voice calls beyond the reach of their own voice network. IPX is now used by over 170 CPs, including most of the UK’s biggest operators. CPs without their own voice network can use Wholesale Calls, which routes calls for them end to end. The CP maintains the customer relationship through its own sales, customer service and billing. Hosted communications Traditionally, businesses have made and received calls over phone lines via a switchboard. Wholesale SIP-Trunking delivers the calls over broadband or Ethernet while Wholesale Hosted Centrex moves the switchboard capability into BT’s network. Similarly, our Hosted Contact Centres replace the systems and services needed to handle large numbers of inbound or outbound customer calls. Mobile Virtual Network Operator We were named Best Wholesale Operator at MVNO World Congress 2016. Customers can use their brand, build their own retail propositions, sell mobile plans through their channels and own the relationship with the end customer, while we do the rest. Ventures Several of our ventures provide well-known services nationwide: 999: we handle the nation’s 999 calls on behalf of BT and all other CPs. Directory Enquiries: calling 118 500 gives people easy access to all listed phone numbers. Payphones: we provide most of the UK’s payphones, whether in public places or on private premises. The Phone Book: we deliver this to over 21m UK homes and businesses. Other ventures are more enterprise-oriented: BT Cables: we manufacture, source and supply cabling for telcos, railways and other industries. BT Fleet: we source, manage and maintain BT’s fleet of 33,000 vehicles. We manage a further 58,000 vehicles for external customers including the AA and National Grid. BT Redcare: we provide secure signalling between on-site alarm systems and central alarm receiving centres. Pelipod Wholesale Ethernet: presence in BT exchanges This year we bought Pelipod, a data- driven secure storage company. Pelipod specialises in delivering items directly to a secure box that’s easy to access and close to an engineer’s place of work. BT Supply Chain: we hold and dispatch products such as mobile handsets and smart meters. If companies have a large field engineering team we can manage their vehicles, supply their engineers, return any surplus supplies to base and provide real-time data for route management. Tikit: we provide IT solutions to law and accountancy firms in the UK, where we supply more than two-thirds of the top 100 law firms, and across Europe, North America and Australia. Big data and messaging: our data scientists help companies’ and local authorities’ planning and decision-making. Managed solutions We combine our products with third-party components and our own professional services to create managed solutions that solve specific customer or industry problems. 33,000 vehicles sourced, managed and maintained for BT Fleet 58,000 vehicles managed for external customers Performance in the year – strategic 1 Delivering great customer experience Right First Time (RFT) tracks our ability to deliver orders and repair faults on time, every time. This year we achieved our best RFT result for many years, up 7.5%, including fulfilling 93% of broadband orders on time (up from 91% last year). We changed the way we measure customer satisfaction. We now measure customers’ Net Satisfaction, as the difference between those who score us very high (9+) and those who score us lower (six or less). Our score in the former BT Wholesale business was +36.6, up by 2.6. During the year we extended the measure to include three of our ventures. On this basis, our score overall was +44.8. 3D printing We’re using 3D printing to improve the customer experience in our Supply Chain business. 3D printing shortens the time it takes to get practical ideas off the drawing board and out into the field. Now Openreach, a Supply Chain customer, is trialling a range of 3D printed prototypes – for example, a cable-threading needle which makes it easier for engineers to add new circuits in a roadside cabinet without snagging other wires. 76 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 77 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Wholesale and Ventures continued 2 Investing for growth This year we’ve invested in both new connectivity options for wholesale networks and the services needed to run those networks. Looking further ahead, we’re developing a new strategy for the Internet of Things. Network services This year we’ve trialled two new access options from Openreach: G.fast and Single Order Generic Ethernet Access. We’re ready to offer them as soon as Openreach launches them. Meanwhile we’ve been developing the capability to run Ethernet services over 4G mobile networks so we can provide them more quickly and switch over to 4G if the fixed network fails. We’ve also invested in a range of new features for our Hosted Communications Services which we’ll launch during 2017/18. We have a long track record of running networks on our customers’ behalf. This year we created a new team to offer these services on a bigger scale. These range from taking over a single function like order management, through to outsourcing and transforming a customer’s entire network. Internet of Things (IoT) W&V leads strategy development for IoT across BT. IoT is a network of connected objects that exchange data to drive insight and action. We’re involved in major IoT projects including MKSmart in Milton Keynes and CityVerve in Manchester. In December we added 25 locations, including the BT Tower, to the London ‘Things Connected’ network, which local communities can use to transform their business or daily lives. 3 Transforming our costs Our many ongoing cost transformation projects continued to deliver savings through: – reduction in supplier cost by renegotiating better terms and changing or consolidating suppliers; lowering our network cost by re-engineering existing platforms and improving their utilisation; consolidation of legacy and end-of-life platforms; and better productivity, together with rationalisation of support functions and overheads. – – – Performance in the year – operating While usage of our more traditional products declined as expected, in other areas we were able to drive revenue growth as well as a healthy order book. New BT digital street units In October we announced a deal with two partners to replace hundreds of our phone boxes with new digital units which will offer free ultrafast wi-fi, free phone calls and free mobile phone charging. The first units will be deployed in London in 2017. We expect them to generate substantial advertising revenue while benefiting the communities in which they operate. This year we signed almost £2bn of orders. Deals included: – – extending our MVNO deals with Virgin Media and ASDA; supplying an Avaya Cloud Solution for thousands of contact centre staff at a major utility provider; re-signing a number of large Ethernet contracts, securing those circuits for the future; new IoT solutions for major corporate clients; and taking over management of the Environment Agency’s 1,350 vehicles. – – – 78 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 79 Our Ethernet base grew by 14% this year, well ahead of the market. Ethernet circuits are still replacing the shrinking number of Partial Private Circuits (PPCs). The number of broadband lines we provide over fibre grew by over 60,000; but our total broadband base fell by 25,000, mainly as a result of some customers’ own LLU network expansion. In last year’s report we set out our top priorities for this year. In the table below we report back on what we’ve achieved. Review of last year’s priorities WHAT WE SAID WHAT WE DID Ethernet installed base Year ended 31 March 0 0 4 1 3 , 0 0 7 4 2 , 50,000 40,000 30,000 20,000 10,000 0 0 0 9 6 1 , 0 0 8 3 4 , 0 0 5 8 3 , We said we’d integrate the various business units that now comprise W&V. We said we’d create revenue and cost synergies as a result of the new organisation. We launched the new W&V organisation on 1 April 2016. The many services provided by our new, digital street units (page 78) draw on a wide range of BT capabilities. These include payphone sites, BT Wi-fi, the fibre networks that connect the payphone to the internet and to the BT platform providing IP voice calls, BT’s Next Generation Text Service, and end-to-end service management. And we’ve made good progress in creating cost synergies in our Supply Chain operations. 2013 2014 2015 2016 2017 IPX carried 22bn voice minutes. This was up 9% on last year, excluding minutes carried for EE. IPX growth has slowed now that more of the UK’s major operators have completed their transition from Time-Division Multiplexing (TDM) to IP voice networks. Meanwhile the number of voice minutes that we carried over traditional TDM networks fell. Our SIP Trunks and Hosted Centrex users grew by 24% and 40% respectively. In BT Fleet the number of vehicles under management grew by 15%. We implemented round-the-clock working in some garages, recruited over a hundred extra technicians and appointed 47 Modern Apprentices. We provided professional services to help upgrade and/or install over 5,000 4G basestation sites for mobile network operators. 22bn voice minutes carried by IPX. Up 9% on 2016 5,000 we helped upgrade and/or install over 5,000 4G transmission sites We said we’d continue to improve customer experience, especially in Ethernet delivery. We achieved our best RFT result for many years. For Ethernet specifically we implemented a new and much improved ordering system. And we designed a new Ethernet service that will run over 4G; we’ll be trialling this with customers early in the new financial year. We said we’d further expand our Ethernet network. We said we’d increase the number of customers using fibre rather than copper broadband. We said we’d further strengthen our defences against attempted cyber attacks and fraud. We said we’d continue our cost transformation activities. We expanded our Ethernet network to another 429 exchanges. Our fibre broadband base rose by over 60,000 this year. We’ve upgraded many of our internet- facing systems with additional firewall protection. We further reduced our own network costs and overheads, as well as third- party supplier costs. 78 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 79 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION EBITDA grew quarter on quarter throughout the year. It was up on the prior year by 10% but down 6% adjusted for the acquisition of EE. This reflected lower revenues and the continuing migration to lower-margin IP services, offset by growth in Wholesale Mobile and Ventures. Depreciation and amortisation was up 21% (2015/16: 3%), primarily due to the inclusion of Ventures assets such as BT Fleet vehicles. Operating profit went up by 5% (2015/16: flat). Capital expenditure was up 8% because of investment in new MVNO platforms. Working capital was impacted by timing on managed solutions invoicing and VAT; this contributed to a 10% increase in free cash flow. Priorities for the year ahead Over the next 12 months we’ll carry on investing for the future and further enhancing our customer experience. Our top priorities for 2017/18 are: Roll out new services – – start to deploy our new digital street units; and expand our managed services capacity, to help customers run their networks and operations. Develop new solutions – helping mobile network operators prepare for the next generation of 5G mobile networks; adding 4G mobile access to our Hosted Communications Portfolio; and for the Internet of Things. – – Improve our customer experience – in particular our RFT delivery for Wholesale Ethernet and Hosted Communications Services. Lines of business continued Wholesale and Ventures continued Performance in the year – financial Revenue was down 7%, or 3% adjusted for the acquisition of EE, compared with a 4% decline last year. This included £30m or 37% less transit revenue than the year before. Last year our reported numbers included all revenues from EE as a customer until the end of January 2016. Where appropriate, we give yearly comparisons both including and excluding those revenues. Year ended 31 March Revenue Underlying revenuea excluding transit adjusted for the acquisition of EE Operating costs EBITDA Depreciation and amortisation Operating profit Capital expenditure Free cash flow 2017 £m 2016 £m 2015 £m 2,109 2,274 2,361 (3)% 0% n/a 1,275 1,519 1,615 834 306 528 226 587 755 253 502 209 536 746 245 501 294 416 Revenue was down 7% or 3% adjusted for the acquisition of EE. This reflects the market decline in legacy products offset by growth in Ventures. Managed Solutions revenue declined 33%. MEAS saw a 6% fall: mobile networks have now largely completed this phase of their network installation programme, so they added capacity at fewer sites and connected fewer new sites. This was partially offset by growth in other contracts. Data and Broadband revenue was down 5%, driven largely by Partial Private Circuits, though there was good growth in fibre broadband. Ethernet saw a 14% increase as the rental base grew to 43,800. Voice revenue was down 22% due to the market decline in call volumes and the inclusion of ladder revenues in last year’s numbers. Wholesale Mobile revenue was £223m, supported by growing data usage and more customers moving to 4G. Ventures revenue of £312m was up 7% compared to last year. This was driven by growth in BT Fleet, thanks to new strategic alliances, and in BT Supply Chain which enlarged its external customer base. These were offset by a £6m reduction in BT Cables because of lower demand for copper cabling, and another £6m reduction as our Phone Book, Payphones and BT Redcare businesses declined in line with their markets. Operating costs decreased 16%, while underlying operating costs excluding transit were down by 15%. a Excludes specific items, foreign exchange movements and disposals and from 2016/17 is calculated as though EE had been part of the group from 1 April 2015. 80 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Lines of business Technology, Service and Operations (TSO) TSO is our internal technology unit. It’s responsible for creating and operating our global networks, platforms and IT systems. We work closely with each of our lines of business, creating new products for them and making sure that services evolve to reflect the changing needs of their customers. And we make sure that BT’s networks and systems are reliable and resilient. We manage BT’s research and development and our worldwide patent portfolio. Find out more on page 32. There are more than 13,000 people in TSO, and this year we recruited over 220 graduates and apprentices. TSO people work on a wide variety of rapidly-changing technologies so we’ve developed comprehensive training and career pathways to attract and retain the best talent. For example, we now offer Degree Apprenticeships that allow apprentices to achieve a full bachelor’s degree while training on the job. Products and services We manage the infrastructure for BT’s products, services and internal systems, such as our IT systems and voice, data and TV networks. 2 Investing for growth This year we’ve completed the rollout of our new Ethernet switches. They’re now installed in 585 exchanges so even more businesses can access BT Ethernet services. We’re also embracing new technologies such as programmable networks. These deliver services faster and provide real-time visibility and control of a customer’s network. With the launch of Dynamic Network Services we’re offering these capabilities to Global Services’ customers. We’ve also completed the first voice calls on our single fixed and mobile infrastructure which enables us to offer new converged services such as high-definition voice calling. 3 Transforming our costs Following the acquisition of EE we’ve taken the opportunity to review and rationalise the number of applications we use. BT manages networks for many of the world’s top companies. Our people design and deliver the solutions that make this happen. We’re also migrating applications onto our Enterprise Cloud, making them easier to manage and lowering their running cost. Performance in the year – strategic 1 Delivering great customer experience To overcome wi-fi problems that people can encounter in the home, we developed and launched the BT Smart Hub. This uses smart technology such as improved antennas to improve wi-fi performance. We also developed the systems behind the new BT Call Protect service, designed to stop companies that regularly pester our customers with nuisance calls. Find out more on page 57. Performance in the year – operating We’re always looking for new ways to maintain and refresh the technology in our networks and service platforms. We’ve seen record levels of data traffic sustained throughout the year, and our investments have been focused to maintain high levels of performance. For example, we installed infrastructure that cuts congestion in the core network to improve the UK broadband experience. See page 30 for more on the improvements we’ve been making to our networks. We’ve improved the reliability of the IT systems we use to trade with our customers for the fourth year in a row. We’ve also continued to cut our costs and the group’s energy consumption. See page 42 for more details. PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 81 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Technology, Service and Operations (TSO) continued The table below summarises the progress we’ve made on the top priorities we set out in last year’s report. Priorities for the year ahead Review of last year’s priorities WHAT WE SAID WHAT WE DID We successfully trialled Long-Reach VDSL at Isfield, Sussex and North Tolsta on the Isle of Lewis. Over the next 12 months we’ll carry on improving our networks, platforms and IT systems, and doing everything possible to help deliver a great customer experience. Our top priorities for 2017/18 are: We said we’d develop technology solutions that increase the broadband speeds for homes at the end of long copper lines. We said we’d move from a technology trial to a live customer trial of an all-IP voice service. We said we’d investigate technology that could provide better picture quality on our TV platform. We said we’d enhance the cloud- based services that we offer to businesses. We said we’d continue our network rationalisation. We’ve started running wholesale and communications provider trials of IP voice. Enhance the UK broadband experience – deploy architectural and infrastructure improvements to cope with broadband traffic growth and improve the quality of the UK broadband experience. Extend 4G coverage – deliver upgrades to existing mobile cell sites and deploy new cell sites to increase 4G coverage in support of the Emergency Service Network contract. Improve systems reliability – continue to improve the reliability of our IT and network platforms, ensuring they’re as resilient as possible. We’ve performed perception tests to see what viewers think of the latest developments in TV technology. We added a new software-defined WAN service to Global Services’ dynamic network services portfolio. We turned off some of the equipment in our PSTN network that we no longer needed, saving over £1m in energy costs. By removing this older equipment, we’ve also released spares to avoid repair costs and help contribute to the best performance of the PSTN in eight years. 82 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Lines of business Openreach As the people responsible for building and maintaining much of the country’s digital infrastructure, we have continued to provide the foundation for Britain’s booming digital economy against a backdrop of profound changes to our business. member of the Equality of Access Board (EAB); and Liz Benison, chief executive, UK & Europe, Local & Regional Government at Serco. Our new board will work closely with Clive Selley and his executive team, and we’ll be responsible for setting the Openreach strategy whilst overseeing its performance. We’ll also make sure the business treats all customers equally and continues to invest in Britain’s digital future. Rising to the challenge We’re responsible for services that are hugely important to people and businesses throughout the country. The scale of what we manage is huge – overseeing 158m kilometres of telecommunications wires and fibre cables and more than 25,000 customer interactions every day. We recognise the importance and size of the challenge before us. We’re making progress in moving Openreach forwards and our renewed focus on service is starting to deliver improvements for our Communication Provider customers and their customers. Clive’s team halved the number of missed appointments Openreach is responsible for by the end of the financial year. And we’ve halted a historical rise in faults across our network. We’ve also continued to build our superfast broadband network for homes and businesses, and we’re increasingly upgrading the most remote and hard-to- reach areas of the country in partnership with both government – via the BDUK programme – and with individual communities and housebuilders. We made our fibre network available to over a million more premises this year and we won’t stop there. We’re also continuing with our ambitions to scale ultrafast technologies, to make speeds of over 100Mbps available to up to 12 million homes and businesses by 2020. In 2016 Ofcom reported that the UK already had the highest fibre broadband availability of all the major European economies and, thanks to our open wholesale network, we have one of the most competitive telecommunications markets anywhere in the world. I’m confident that continuing to invest in our broadband network and working more closely and collaboratively with our customers and the wider industry will provide the national telecommunications infrastructure necessary to support the future growth of the UK economy, something that will be particularly important as we leave the EU. Financial investment in our network alone will not deliver the change we need – we’ll invest in our people too. This year we’ll expand our engineering workforce by hiring 1,500 trainees and we’ll train more engineers to complete more tasks in a single visit. That will play a pivotal role in ensuring we meet our customers’ expectations. Finally, I want to address the issue of Deemed Consent. Ofcom’s investigation into Deemed Consent practices showed that in the past, Openreach made a number of mistakes when processing orders for high- speed business connections. This simply shouldn’t have happened and we apologise wholeheartedly to the communications providers affected. During my short time in Openreach, I’ve seen significant improvements being made to the way we deliver these connections and we are determined to make sure the same mistakes aren’t repeated in future. We’re committed to fixing the issues of the past, delivering better service, and investing in our network – and we recognise that to be successful in these goals, we need to work in closer partnerships with our customers, the wider industry, regulators and government. By working as a team, we can achieve success collectively and build the telecommunications infrastructure that will power Britain’s leading digital economy for years to come. Mike McTighe Chairman 11 May 2017 Annual Report 2017 BT Group plc 83 This has been a momentous year for Openreach Over the past 12 months, we’ve made big strides in our strategy to deliver better service, broader coverage and faster speeds for the UK. At the same time, how we operate and how the market should be regulated have been fiercely debated topics. The major theme in Ofcom’s once-in-a- decade Digital Communications Review became the extent to which we should operate more independently from BT – and in March 2017, a long-term regulatory settlement was agreed that will see us become a distinct, legally separate company within BT Group. Fundamental governance changes Under this agreement, we’re gaining more control of our strategy, investments and plans within a strategic and financial framework defined by BT. This means we can make more of our own decisions and be more autonomous, transparent, and accountable to everyone who has a stake in us. This will strengthen our ability to work in partnership with all our customers and deliver the communications infrastructure that is the foundation of the UK’s vibrant internet economy. Central to these changes are a first-class governance structure and a new board with a majority of independent members. I was delighted to be appointed as the first Openreach chair back in November 2016. I’m also pleased to have appointed three independent board members of the highest calibre: Sir Brendan Barber, former general secretary of the Trades Union Congress and current chair of Acas; Edward Astle, a former board member of National Grid and current THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Openreach continued We build the network that connects Britain’s homes and businesses to the future. We’re responsible for providing services over the local access network, sometimes referred to as ‘the last mile’, installing and maintaining the fibre and copper communications networks that connect homes and businesses. Communications Providers (CPs) access our network on equivalent terms, which means they have access to the same products, prices and levels of service. They use our network to deliver services ranging from home broadband, television and telephone to high-speed data connections for businesses of all sizes. Openreach local access network Exchange FTTC PCP G.fast DP c26.5m premises can access fibre Business FTTP Splitter DP c5,500 exchanges c97,800 PCPs c4.7m DPs c30m premises Fibre Copper FTTC PCP FTTP DP G.fast Fibre-to-the-cabinet Primary connection point Fibre-to-the-premises Distribution point G.fast side pod Delivering a more independent Openreach We’re pleased that the proposals to further enhance the organisational structure of our business have been accepted by Ofcom as a pragmatic solution to meeting its DCR concerns. We’re fully committed to implementing the requirements of the Commitments and Governance Protocol which includes a focus on compliance, increased transparency and improved customer engagement as quickly as possible. We’ve already started to introduce new governance and measures, where possible and appropriate, in advance of full implementation of the DCR agreement. For example, we’ve made a number of governance reforms to make Openreach a more transparent and autonomous business. In November 2016 we appointed our first chairman, Mike McTighe, who is leading our newly-formed board. The board has a majority of independent members and will be responsible for setting Openreach’s strategy and overseeing its performance. It will make sure we treat all customers equally while investing in better service, broader coverage and faster broadband speeds for the UK. Other activity underway includes the development of a new CP consultation process for major new strategic investments and the redesign of the Openreach brand to remove the reference to BT Group and the associated logo. We’re also preparing for the implementation of the remainder of the DCR agreement, including incorporation of Openreach Limited and the transfer of employees to it, once the preconditions have been met. Markets and customers The UK has the highest share of GDP generated by the digital economy of any country in the G20, and the highest superfast availability and take-up compared to our major European peersa. We’re playing our part in this success story by building and operating the largest superfast network in the country. At the end of December 2016 there were 25.3m broadband lines in the UK. 80% of these, excluding Hull, use the Openreach network with the rest mainly on Virgin Media’s cable network. Total UK broadband market As at 31 March . 9 1 2 . 9 2 2 . . 9 9 3 3 2 2 . 7 4 2 . 3 5 2 m 26 25 24 23 22 21 20 2013 2014 2015 2016 2017* * As at December 2016. Source: Company data. Our customers are the CPs who provide communications services to end customers, and property developers building new properties. a France, Germany, Italy and Spain. 84 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 85 There are more than 580 CPs using our network. They operate in three markets: – Consumer – made up of households using fixed-line broadband and telephone services. Our largest customers include BT’s Consumer division, Sky and TalkTalk; – Business – consisting of the 5.5m businesses in the UK. Most of our customers serve business clients; and – Infrastructure – including firms building network infrastructure to data centres and mobile cell sites, and property developers connecting new developments. We also have relationships with communities throughout the UK who co-fund investment in fibre networks with us through Community Fibre Partnerships. The market trends are: – ongoing demand for connectivity as total fixed broadband ownership steadily rises; – increasing data usage, propelled by video streaming driving demand for faster connections and major investment in backhaul capacity and network reach; – cloud computing increasing corporate demand for connectivity; – a fast-growing data centre market creating a new need for high- capacity circuits (1Gbps or more); and – strong demand for Ethernet and optical service products as businesses seek better speeds and reliability. Average monthly fixed data usage per residential connection As at 30 June 2 3 1 7 9 8 5 GB 140 120 100 80 60 40 20 0 3 2 0 3 2012 2013 2014 2015 2016 Source: Ofcom Connected Nations reports 2013-2016. Competitors Our main competitors are other network builders, the largest being Virgin Media. Its cable network covers around half of UK homes, with plans to reach around 17m premises by 2019. Other companies are building their own fibre access networks, reflecting the competitive nature of the market. CityFibre, Hyperoptic and Gigaclear are deploying fibre-to-the-premises across urban and rural areas, increasing the competition we face. Competitors in the business and infrastructure markets include Virgin Media, Colt Group and Vodafone. CityFibre’s prominence in this market continues to grow as it fulfils its plans to cover 50 ‘Gigabit cities’ by 2020. Pricing, service delivery and product innovation remain competitive themes. The ‘price per Gigabit’ is being pushed down by intense competition, particularly in urban areas. The introduction of a Dark Fibre product later in 2017 will increase price competition further. Products and services We provide network access and engineering services as well as four main products and services: copper access, fibre access, Ethernet and optical, and infrastructure solutions. Our network can carry broadcast and on-demand internet protocol television (IPTV). Our multicast service over fibre cuts the cost of broadcast TV. We also provide access to our network via our ducts and poles and will be launching a new Dark Fibre product in October 2017 (subject to CAT ruling). Copper access – Wholesale Line Rental (WLR) lets CPs offer phone services to their customers using our equipment and copper network. They pay to use the lines between our exchanges and the customer premises. – Local Loop Unbundling (LLU) provides CPs with a direct connection to the local network, or local loop. CPs can install their own equipment in, or near to, our exchanges, and use it to provide phone and broadband services to their customers. Fibre access Our wholesale fibre product is called Generic Ethernet Access. We offer a number of versions: – Fibre-to-the-cabinet (FTTC) uses fibre from the exchange to the street cabinet and the existing copper network for the final link to the customer. – Fibre-to-the-premises (FTTP) uses fibre all the way from the exchange to the property and offers ultrafast speeds from 100Mbps up to 1Gbps. We’ve launched 500Mbps and 1Gbps speed tiers for smaller businesses needing ultrafast speeds at lower price points than Ethernet. This allows us to offer superfast broadband (speeds over 24Mbps) via FTTC and FTTP and ultrafast broadband (speeds over 100Mbps) via G.fast and FTTP. 84 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 85 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Openreach continued Ethernet and Optical CPs use these high-speed fibre connections to build and extend their networks and provide high-quality, high-bandwidth services to businesses and the public sector. – Ethernet Access Direct (EAD) offers competitive services, from 10Mbps to 10Gbps, to all UK businesses and infrastructure markets. – Optical Spectrum Services (OSS) are scalable wavelength solutions offering up to 100Gbps at any distance. TBC Infrastructure solutions Our infrastructure solutions let CPs build their own networks. They allow third parties to request rearrangements of our network and for us to work on their networks. – Flexible Co-mingling allows CPs to place their equipment in our exchanges. – Physical Infrastructure Access (PIA) lets CPs use our ducts and telephone poles to deploy their own fibre networks. PIA has been available since 2011. – Mobile Infill Infrastructure Solution (MiiS) lets CPs install their radio equipment in special cabinets linked to antennas on telephone poles and use their spectrum to improve mobile coverage. – Network rearrangements help third parties to progress their projects by moving or removing our network. Performance in the year – strategic 1 Delivering great customer experience The internet is an essential part of modern life. Every year, customers expect more from the service we provide, and we’re committed to meeting their needs. The table on page 87 shows Openreach’s service performance on a number of key measures known as Minimum Service Levels (MSLs). These are quality of service standards for installation and repair which are set by Ofcom and increase annually. In May 2016, six Ethernet MSLs were added to the existing set of 60 copper MSLs. We publish this data quarterly with additional levels of detail. This year we exceeded all 40 of Ofcom’s copper MSLs that were due in the year, for the third year in a row. And we remain ahead on the other 20 which are measured to March 2018. We keep making progress with our Ethernet delivery, improving quality of service, providing more Ethernet circuits than ever before, and reducing the average age and number of jobs in our workstack. Even so, we’re disappointed that we’ve missed one of the Ethernet MSLs due to the impact of our most complex Ethernet orders, where we experience delays that aren’t fully within our control such as road traffic management. We launched the ‘Better service’ campaign to make real improvements in our customer service. We halved missed appointments by the end of the financial year. And we invested £32m to improve resilience and halt a historical rise in network faults. We also cut the number of customers waiting over 90 days for new orders by 60%a. Our Customer Satisfaction Score is provided by end customer surveys from our CP customers. The CPs’ sampling strategy has changed through the year making a like-for-like comparison difficult and has resulted in our performance being under reported. We’re working with the CPs to standardise sampling to enable future year-on-year comparisons. Right First Time, improved by 5.1% (down 6% in 2015/16), focusing particularly on time to repair. We completed 79% of repairs on timeb, a four percentage point increase compared with last year, and reduced the average time to restore service by five hours. We see the MSLs as a baseline and set ourselves a more challenging RFT target because we know there’s more to be done to deliver the service our customers expect. We’ve proactively improved our PIA processes by providing greater flexibility and self-service options. These include a digital map of our network which makes it quicker and easier for CPs to understand where our ducts and poles can help them to roll out fibre. a For copper-based services. b For LLU, WLR, PSTN and NGA services. 86 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 87  Improvement Steady performance – maintaining focus Further improvement needed – plans in place to get back on track Openreach performance against service responsibilities Home and smaller businesses Average time to install with an engineer (working days) Average time to install without an engineer (working days) Movement Q4 2016/17 Q4 2015/16 13.22 14.44 9.64 9.49 Installation requiring an engineer where wait is 22 days or longer for an appointment 0.37% 1.12% Average time for first available appointment date for new installation (working days) New lines requiring an engineer visit not installed 31 days past target date Average time to fix faults Maintenance level 1 (working days) Average time to fix faults Maintenance level 2 (working days) Faults not cleared after 31 days or more Maintenance level 1 Faults not cleared after 31 days or more Maintenance level 2 6.82 8.51 1.65% 1.34% 1.99 1.72 2.82 1.94 0.62% 1.60% 0.94% 1.79% Home and smaller businesses Minimum Service Levels New lines installed on time (WLR3) New lines installed on time (MPF) First available appointment date for new installation (working days) 12 days or less (WLR3) First available appointment date for new installation (working days) 12 days or less (MPF) Movement Ofcom minimum standard Q4 2016/17 Q4 2015/16 89% 94.55% 93.84% 89% 94.14% 93.02% 79% 92.91% 86.54% 79% 95.38% 89.65% Faults fixed within agreed time Maintenance level 1 77% 86.54% 74.53% Faults fixed within agreed time Maintenance level 2 77% 81.87% 76.14% Larger business Minimum Service Levels Average time to install (working days) Delivery date certainty Circuits provided in 30 working days Circuits provided in more than 159 working days Average time to initial CDDa (working days) Faults fixed within agreed time Notes: The homes and smaller businesses tables compare performance in the quarter and are not annual measures. The larger business measures have had an ‘adjustment’ applied to them in line with the Ofcom measurement methodology. a Contractual Delivery Date. Ofcom minimum standard 2016/17 full year 46 80% 40% 3% 61 41.4 85.4% 57.4% 3.2% 40.2 94% 94.2% 86 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 87 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Lines of business continued Openreach continued 2 3 Investing for growth We’ve invested £11bn in Britain’s digital infrastructure over the last ten years, committing over £3bn to create a fibre network that provides affordable high-speed broadband to the vast majority of the UK. Our ambition is to deliver ultrafast speeds to 12m homes and businesses by 2020 using FTTP and G.fast. Our G.fast technology can deliver ultrafast speeds of 300-500Mbps over existing copper wires with minimal disruption. This technological capability will allow us to offer speeds of over 100Mbps to 10m homes by 2020. After a successful trial we’re rolling out G.fast to 17 locations as part of our pilot deployment phase. We keep extending, upgrading and maintaining our copper network which underpins most of our services in the UK. We’ve raised preventative maintenance spend by 104% compared to last year and this will make our network more weather resilient in future. Our new Dark Fibre product will launch in October 2017 (subject to CAT rulinga). This will provide a dedicated, unmonitored, unlit optical fibre path between two sites up to 86km apart. CPs can use this to build connectivity solutions. Investing in our people We’ve a workforce of 30,400 people, including skilled network engineers and planners who maintain our access network. This year we invested in hiring over 1,500 people including around 250 apprentices and graduates. Our apprentices are trained on a wide range of skills relating to provision and repair activities to improve customer service. Our graduates complete a variety of project roles in order to learn the business, before taking on roles within our operational teams. Most of our new recruits, including 50 apprentices, have moved into front-line customer service engineering roles across the country. Another 75 will increase our in-house civil engineer capability. We’re training 100 apprentices on fibre jointing to improve Ethernet delivery and another 65 have been trained on connectorised fibre for our superfast broadband network build. We also launched our Fibre Academy and showcase to give our apprentices and engineers the training and hands-on experience they need. Transforming our costs We keep reviewing the way we work, simplifying our business to cut the cost of delivery while improving customer experience. This year we: – completed a ‘civils insourcing trial’. As a result we’re now insourcing certain civils activities to improve customer experience; – consolidated desk-based teams from over 400 locations down to 32 larger ‘centres of excellence’. This will better support the sharing of best practice and create better working environments; and – cut the number of Ethernet orders awaiting completion by improving our operational processes. Performance in the year – operating This year we made our fibre network available to a further 1.1m premises. We achieved 1.8m fibre broadband net additions, with a total of 7.7m homes and businesses in the UK choosing to take a fibre service. We grew our Ethernet base by 13% and exceeded all the increased copper MSLs set by Ofcom. External CPs accounted for 923,000 of the 1.8m fibre broadband net additions, an increase in share of 4% from last year, demonstrating the market-wide demand for fibre. The physical line base decreased by 153,000 following a 29,000 increase the year beforeb. Investing in fibre We keep investing heavily in our fibre network which now passes more than 26.5m premises nationwide. This year we launched new ultrafast products for SMEs and business parks. Our FTTP network is the largest in the UK and we delivered more FTTP this year than in any previous year. In May 2016 we launched our offer to connect fibre-to-the- premises for free to all developments of new sites with over 100 plots, then lowered the threshold to over 30 plotsc in November 2016. a This relates to our appeal to the Competition Appeal Tribunal of Ofcom’s BCMR market review decision – see page 40. ‘Other regulatory decisions and activities – Business connectivity market and cost attribution’. b Last year’s report stated a 2,000 line increase and this has been amended to include FTTP lines. c New sites with over 30 plots registered from 10 November 2016. 88 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 89 Ofcom investigation into historical use of Deemed Consent On 26 March 2017 Ofcom published the findings of its investigation into the historical use of Deemed Consent by Openreach. Deemed Consent is an agreed process between Openreach and its communications provider (CP) customers, which allows Openreach to halt the installation and reschedule the delivery date for providing dedicated business services (known as Ethernet) in a number of specific circumstances which are beyond its control. Ofcom found that Openreach had breached its contractual and regulatory obligations by inadequately and retrospectively applying Deemed Consent to reduce compensation payments to CPs between January 2013 and December 2014. As a result of the findings, Openreach has agreed to compensate CPs and Ofcom has imposed a fine of £42m, reflecting the seriousness of the failings. This includes a 30% maximum discount for BT admitting its liabilities and agreeing to compensate the affected CPs in full. The precise amount of these compensation payments will result from discussions with the affected parties and is currently estimated at £300m. The fine and associated compensation payments are treated as a specific item charge in this year’s income statement, with the cash expected to be paid in 2017/18. We take this matter very seriously and we’ve put in place additional controls to safeguard against this happening again and to make sure that we’re providing the highest standards in serving our customers. Extending our reach We’re still working in partnership with the BDUK programme to bring fibre broadband to communities who can’t currently access it, completing 39 of our 45 contracts this year. We’re also deploying our Superfast Extension Programme (SEP) in partnership with the Government. We’re committed to working with local communities to deploy co-funded solutions under our Community Fibre Partnerships programme. To date we’ve worked with over 200 communities, and have over 100 more in the pipeline for upgrades In last year’s report we set out our top priorities for this year. In the table below we report back on what we’ve achieved. Review of last year’s priorities WHAT WE SAID WHAT WE DID We said we’d achieve our goal of 95% on- time installations by the end of December 2017, ahead of Ofcom’s minimum service level. We said we’d work with Government to help take fibre broadband to 95% of the country by the end of December 2017. We said we’d get ultrafast broadband to 10m premises, with an ambition of 12m, by the end of 2020. We said we’d recruit 1,000 frontline engineers to deliver further improvements in service. We said we’d work to deploy FTTP using microfibre technology. We’re on track to hit this RFT goal. We’ve made our fibre network available to another 1.1m premises this year, bringing the total to 26.5m across the UK. We’ve built ultrafast broadband to 500,000 premises and have more than 98,000 customers, a 77% increase compared to last year. We recruited over 1,500 people, mostly engineers, to enable faster repairs and provide greater contingency. Around 250 of these new recruits were apprentices and graduates. We’ve introduced connectorised FTTP technology and halved the mean time to provide on our existing network this year. 88 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 89 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Priorities for the year ahead Over the next 12 months, we’ll continue to invest in our fibre network and ensuring a great customer experience. Our top priorities for 2017/18 are: Connecting Britain to the future – getting ultrafast broadband to 10m premises using G.fast and an ambition to reach a further 2m via FTTP, by the end of 2020; and – working to deploy FTTP using microfibre technology. Delivering a great customer experience – achieving our RFT goal of 95% on-time installations by the end of 2017, ahead of Ofcom’s minimum service level; – recruiting 1,500 frontline engineers to deliver further improvements in service; and – driving higher investment in fibre skills and growing our Fibre Academy. Working with Government and industry – working with the Government to support its objective for a Universal Broadband Commitment; and – launching a consultation with industry to inform on future FTTP planning. Lines of business continued Openreach continued Performance in the year – financial Despite around £230m of regulatory price changes, we held revenue flat thanks to strong demand for fibre products. Year ended 31 March Revenue Operating costs EBITDA Depreciation and amortisation Operating profit Capital expenditure Free cash flow 2017 £m 5,098 2,465 2,633 1,369 1,264 1,573 1,349 2016 £m 5,100 2,441 2,659 1,301 1,358 1,447 1,415 2015 £m 5,011 2,414 2,597 1,348 1,249 1,082 1,497 Revenue was flat (2015/16: 2% increase) with a 35% increase in fibre broadband revenue being offset by regulatory price drag which had an overall negative impact of around £230m, equivalent to 5% of our revenue. Operating costs were up 1% (2015/16: 1%) reflecting the investment we made to deliver our copper minimum service levels, halve missed appointments by the end of the financial year and upskill our workforce. We also saw higher service level guarantee costs associated with the delay in fulfilling a number of older and more complex Ethernet orders. EBITDA decreased 1% (2015/16: 2% increase). With depreciation and amortisation up 5% (2015/16: down 3%), operating profit was down 7% (2015/16: up 9%). Capital expenditure was £1,573m, up £126m or 9% (2015/16: up £365m or 34%) reflecting our ongoing investment in fibre coverage and speed, and the delivery of more complex Ethernet circuits. This was after gross grant income of £159m (2015/16: £320m) directly related to our activity on the BDUK programme build and offset by the deferral of £185m of the total grant income (2015/16: £227m) due to strong levels of fibre broadband take-up. This is primarily because we increased our base-case assumption for take- up to 39% in BDUK areas and under the terms of the programme, we have a potential obligation to either re-invest or repay grant funding depending on factors including the level of customer take-up achieved. Operating cash flow decreased 5% (2015/16: 5% decrease) largely due to the timing of BDUK funding receipts and other working capital movements. 90 90 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB BT Group plcAnnual Report 2017Group performance Group Finance Director’s introduction Our results this year have been significantly impacted by the findings from our investigation into our Italian business, Openreach’s historical practices on Deemed Consent and the headwinds we face in the UK public sector and international corporate markets. The performance of our UK consumer, business and wholesale activities have been in line with our expectations and the integration of EE into the group is going well. Our results for the year were below our expectations. We saw good performance from our UK consumer, business and wholesale activities but this was more than offset by what we found in our Italian business, Openreach’s historical practices on Deemed Consent and the headwinds we face in the UK public sector and international corporate markets. Reported revenue increased by 27% to £24.1bn. Our key measure of the group’s revenue trend, underlying revenuea excluding transit adjusted for the acquisition of EE, was down 0.2%. Our investigation into our Italian business identified £268m of prior year errors, for which we revised the prior periods, and a specific item charge of £260m in the current year for changes in accounting estimates and investigation costs. We’ve also recorded a specific item charge of £342m following Ofcom’s investigation into Openreach’s historical practices on Deemed Consent. Our reported operating profit, which includes specific items, was down 12%. Our adjustedb operating profit was up 8% reflecting a strong first year contribution from EE. Reported profit before tax was down 19% to £2.4bn and adjustedb profit before tax was £3.5bn, up 5%. Reported EPS of 19.2 pence was down 33% and adjusted EPS of 28.9 pence was down 9%. Net cash inflow from operating activities was £6.2bn, up 20%, whilst normalised free cash flowc was £2.8bn, down 10% which includes earlier than expected customer collections that will reverse next year. In addition, we are also expanding and accelerating areas of our cost transformation programme. We are simplifying our central Group Functions and our internal service unit, Technology, Service & Operations. We are also restructuring the Global Services organisation and accelerating ongoing transformation programmes in other lines of business. We anticipate that these transformation programmes will cost around £300m over the next two years, with most of this being incurred in 2017/18. This restructuring cost will be treated as a specific item and will payback in about 2 years. For 2017/18, we continue to expect underlying revenue excluding transit to be broadly flat year on year and adjusted EBITDA to be in the range £7.5bn to £7.6bn. Simon Lowth Group Finance Director 11 May 2017 Alternative Performance Measures We assess the performance of the group using a variety of performance measures. These measures are not defined under IFRS and therefore termed ‘non-GAAP’ measures. A reconciliation from these non-GAAP measures to the nearest prepared measure in accordance with IFRS is presented on pages 252 to 254. The alternative performance measures we use may not be directly comparable with similarly titled measures used by other companies. a Excludes specific items, foreign exchange movements and disposals and is calculated as though EE had been part of the group from 1 April 2015. b Before specific items, which are defined on page 252. c Before specific items, pension deficit payments and the cash tax benefit of pension deficit payments. 91 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group performance continued Summary financial performance for the year Performance against our outlook We did not achieve the financial guidance we set out at the beginning of the year. We were in line with the revised guidance we issued in January 2017. Adjusted EBITDA grew 18% to £7.6bn. This was below our original outlook of approximately £7.9bn and in line with the outlook we revised in January. 2016/17 performance against our outlook Outlook provided in May 2016 Outlook provided in January 2017 Result Change in underlying revenue excluding transita Adjusted EBITDAa Growth Broadly flat (0.2)% c£7.9bn c£7.6bn £7.6bn Normalised free cash flowa £3.1bn – £3.2bn c£2.5bn £2.8bn Dividend per share ≥10% growth ≥10% growth 15.40p, +10% Share buyback c£200m c£206m £206m a Defined on pages 252 to 254. Reported revenue increased by 27% to £24.1bn. Underlying revenue excluding transit adjusted for the acquisition of EE was down 0.2%, below our original outlook of growth. This was in line with the outlook we revised in January of broadly flat. Normalised free cash flow was £2.8bn, down 10% and below our original outlook, but almost £300m above our revised outlook, due to early customer collections that will reverse in 2017/18. Outlook for 2017/18 Change in underlying revenue excluding transita Adjusted EBITDAa Normalised free cash flowa Dividend per share Share buyback a Defined on pages 252 to 254. Broadly flat £7.5bn – £7.6bn £2.7bn – £2.9bn Progressive c£100m Revenue Year ended 31 March Cash flow Year ended 31 March £m 30,000 25,000 20,000 15,000 10,000 5,000 0 7 7 6 3 2 , 8 6 9 7 1 , 0 4 8 7 1 , 2 9 6 3 2 , 2 1 0 9 1 , 9 7 8 8 1 , 2015 2016 a reported adjusteda,b adjusteda,b,c Profit Year ended 31 March 4 6 6 7 , 3 9 1 6 , 4 9 0 3 , 7 6 5 2 , £m 10,000 8,000 6,000 4,000 2,000 0 6% 6% 0% 6 2 8 7 , 9 5 4 6 , 1 5 3 3 , 7 0 9 2 , 2 6 0 4 2 , 2 8 0 4 2 , 2017 27% 28% 2% 5 4 6 7 , 2 3 5 3 , 4 5 3 2 , 8 8 7 4 , 2 8 7 2 , 0 3 8 2 , 1 5 1 5 , 9 6 0 3 , 8 9 0 3 , 4 7 1 6 , 7 8 6 2 , 2 8 7 2 , £m 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 2015 2016 2017 free cash flow normalised free cash flowd net cash inflow from operating activities 8 3 8 9 , 2 3 9 8 , Net debt At 31 March £m 10,000 8,000 6,000 4,000 2,000 3 1 1 5 , 2015 2016 2017 0 2015a,e 2016a,f 2017 adjusted EBITDA a,b a,b,c adjusted EBITDA profit before taxa adjusted profit before taxa,b 4% 2% 13% 0% 18% 2% 19% 5% a Certain prior year results have been revised to reflect the outcome of the investigation into our Italian business. See note 1 to the consolidated financial statements. b Items presented as adjusted are stated before specific items. See page 252 for further details. c Calculated as though EE had been part of the group from 1 April 2014. For 2016/17, no separate measure is shown as EE was part of the group for the full year and there is no difference to the adjusted measures. d See definition on page 254 and summarised cash flow statement on page 96. e Includes the impact of the £1.0bn equity placing we made in February 2015. f Reflects the impact from EE. 92 BT Group plcAnnual Report 2017For 2017/18, we continue to expect underlying revenue excluding transit to be broadly flat year on year. Adjusted EBITDA is expected to be £7.5bn - £7.6bn. Our outlook for normalised free cash flow over the cumulative two year period 2016/17 and 2017/18 remains broadly unchanged. However, normalised free cash flow in 2016/17 of £2,782m was almost £300m above our outlook of around £2.5bn, due to early customer collections that will reverse in 2017/18. As such, normalised free cash flow in 2017/18 is now expected to be £2.7bn - £2.9bn, from £3.0bn - £3.2bn previously. cash commitments. The Board believes that this dividend policy appropriately balances the interests of all stakeholders and provides a solid foundation for future growth, underpinned by an ongoing commitment to investment that delivers sustainable long-term value for customers and shareholders. We expect to buy back around £100m of shares in 2017/18 to help counteract the dilutive effect of all-employee share option plans maturing in the year. This is below the £206m buyback we completed in 2016/17 reflecting the lower number of shares that are expected to be required for our share option plans. This outlook is provided on the basis of our existing investment plans. However, we continue to evaluate a range of additional investment opportunities. Our decision on whether to move forward with these will be affected by a number of factors, including the outcome of Ofcom’s Wholesale Local Access Market Review, responses to Openreach’s consultations and the results of any future spectrum auctions. Our underlying dividend policy remains unchanged: to deliver progressive dividends while balancing the need to invest in the business, support the pension fund and maintain a strong balance sheet. The Board has concluded that a dividend increase of 10% in 2016/17 remains appropriate. However, given the importance of maintaining flexibility for additional investment and the range of potential outcomes, dividend growth in 2017/18 will be lower than the 10% previously anticipated. The rate of future dividend growth will reflect a number of factors, including underlying medium term earnings growth, the level of investment spending and other Earnings per share Year ended 31 March . 6 0 3 5 5 2 . . 8 1 3 . 5 8 2 . 9 8 2 . 2 9 1 . 3 6 2 . 8 4 2 . 2 8 2 . 7 5 2 pence 35 30 25 20 15 10 5 0 2013 2014 2015 2016 2017 a reported adjustedb Proposed full year dividend Year ended 31 March 15.4p +10% 2017 14.0p 2016 Transforming our costs Our integration of EE is going well. We’ve achieved around £150m of run-rate cost synergies in our first year, exceeding our target of £100m, as we’ve been able to realise synergies earlier than originally planned. We continue to expect cost synergies to reach a run-rate of around £400m in the fourth year. We’ve delivered savings this year through renegotiating supplier terms and reducing the number of head office employees. We’ve also insourced a number of activities where possible, including all roaming management, EE Facilities management and core mechanical and engineering field operations. We are also expanding and accelerating areas of our cost transformation programme. We are simplifying our central Group Functions and our internal service unit, Technology, Service & Operations to improve the effectiveness and efficiency of the services and infrastructure delivered to our lines of business. We are also restructuring the Global Services organisation and accelerating ongoing transformation programmes in other lines of business. We anticipate that these transformation programmes will save in total around £300m over two years, with a restructuring charge of around £300m over the next two years, with most of this being incurred in 2017/18. This restructuring cost will be treated as a specific item. These changes will clarify accountabilities, remove duplication and improve efficiencies, removing around 4,000 roles mainly from managerial and back office areas. The cost savings will provide headroom to offset market and regulatory pressures and support increased investment in delivering great customer experience and leading networks. Prior year revision and re-classifications Investigation into our Italian business Our investigations into our Italian business revealed inappropriate behaviour and improper accounting practices. We identified £268m of errors in relation to prior years and a specific items charge of £260m in the current year for changes in accounting estimates and investigation costs. Revised presentation of cash pooling arrangements We’ve also revised the presentation of our cash pooling arrangement following the release of an IFRIC clarification on IAS 32 ‘Financial instruments presentation offsetting and cash pooling arrangements’ in April 2016. This requirement resulted in us grossing up cash and cash equivalents and short-term loans and other borrowings by £499m at 31 March 2016 and £414m at 31 March 2015 with no impact on the income statement. EE purchase price accounting Subsequent to our 29 January 2016 acquisition of EE, we’ve finalised our purchase price accounting within the period allowed under IFRS 3 ‘Business Combinations’. We also received £20m from the previous owners of EE as a result of the finalisation of the audit of the completion balance sheet. The changes after considering taxation resulted in an increase in goodwill of £29m as of 31 March 2016 with no material impact on the income statement. The effect on prior years’ income statement, balance sheet and cash flow statements is set out in page 172 to 176 in note 1 to the financial statements. 93 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group performance continued Summarised income statement Year ended 31 March Before specific items Revenue Operating costsb EBITDA 2017 £m 2016a £m 2015a £m 24,082 18,879 17,840 (16,437) (12,420) (11,647) 7,645 6,459 6,193 Depreciation and amortisation (3,510) (2,631) (2,538) Operating profit Net finance expense 4,135 3,828 3,655 (594) (483) (560) Associates and joint ventures (9) 6 (1) Profit before taxation 3,532 3,351 3,094 Taxation Profit for the year (663) (607) (631) 2,869 2,744 2,463 a The comparative information of the current period results has been revised to reflect the outcome of the investigation into our Italian business. b Excluding depreciation and amortisation. Revenue Reported revenue, which includes specific items, was up 27%. Adjusted revenue was up 28% at £24,082m. Both of these increases were driven by the impact of EE being part of the group for the full year. We had a £522m positive impact from foreign exchange movements and a £64m reduction in transit revenue. Excluding these, underlying revenue excluding transit adjusted for the acquisition of EE was down 0.2% (2015/16: up 1.9%) which is consistent with our expectation of being broadly flat in the current year. This outlook was revised in our third quarter results following the challenging conditions in the UK public sector and international corporate markets and the impact of the issues in our Italian business. Consumer revenue was up 7% with a 13% increase in broadband and TV revenue and a 4% increase in calls and lines. EE underlying revenue adjusted for the acquisition of EE was up 1% mainly due to the success of our ‘more for more’ pricing strategy. Openreach revenue was flat with the impact of regulatory price reductions offsetting the continued growth in fibre. Underlying revenue excluding transit adjusted for the acquisition of EE was down 3% in Wholesale and Ventures as a result of the continuing decline in Partial Private Circuits and call volumes. Business and Public Sector underlying revenue excluding transit adjusted for the acquisition of EE was down 6% due to the decline in UK public sector revenue. Global Services underlying revenue excluding transit adjusted for the acquisition of EE was down 2% and excluding revenue from our Italian business was flat. You can see a full breakdown of reported revenue by major product and service category in note 4 to the consolidated financial statements. Operating costs Reported operating costs were up 36% while adjusted operating costs before depreciation and amortisation increased 32%. Our adjusted operating costs before depreciation and amortisation were £16,437m, up £4,017m (2015/16: £773m) driven by the acquisition of EE and adverse impact of foreign exchange. For the group, other operating costs were up £2,308m or 61%, primarily reflecting EE’s subscriber acquisition and retention costs, and adverse foreign exchange movements. 94 Underlying operating costs excluding transit adjusted for the acquisition of EE were up 1%. This reflects additional UEFA rights costs and the new Premier League rights contract, increased investment in mobile handsets and continued investment in improving customer experience, offset by the benefits of our cost transformation programme. Operating costs before depreciation, amortisation and specific items Year ended 31 March £m 17,000 16,000 15,000 14,000 13,000 12,000 11,000 0 2 4 2 1 , 6 1 0 2 2 5 5 s t s o c r u o b a l t e N 8 0 3 2 , 7 3 4 6 1 , 0 7 4 8 7 1 9 3 3 0 7 1 s O L O P y g r e n e & y t r e p o r P T I & k r o w t e N e m m a r g o r P s e g r a h c s t h g i r a r e h t O 7 1 0 2 a Includes all other movements in costs. Programme rights charges increased £170m to £714m, primarily reflecting our investment in BT Sport. Property and energy costs were up 17%, payments to telecommunications operators (POLOs) were up 22% and network, operating and IT costs were up 53%, with these all being impacted by EE. Net labour costs increased by 13% despite a reduction in leaver costs of £23m (2015/16: £109m) due to the impact of EE. 2016/17 operating costsa 29% Net labour costs 37% Other 5% Programme rights charges 6% Network operating and IT costs 7% Property & energy 16% POLOs a Excluding depreciation, amortisation and specific items. You can see a detailed breakdown of our operating costs in note 5 to the consolidated financial statements. BT Group plcAnnual Report 2017 EBITDA Adjusted EBITDA, which is before specific items, was £7.6bn which is in line with the 2016/17 outlook as revised in January. Underlying EBITDA adjusted for the acquisition of EE was down 3%. This is mainly as a result of declines in UK public sector and our investment in improving customer experience. You can see further details for EBITDA for the lines of business on pages 56 to 90. Specific items As we’ve explained on page 91, in this performance review we primarily explain our results before specific items. That’s because this is how we measure the sustainable performance of our business. The table below outlines items we’ve treated as specific items: 2017 £m 2016 £m 2015 £m 22 (2) – 20 481 238 215 30 (16) – – – 948 210 – (203) 70 (133) 203 – 116 – – 29 – – 348 229 – (128) – (128) 75 – 19 – (6) 45 315 (67) 381 299 Year to 31 March Specific revenue Italian business investigation (see page 6) Regulatory matters EE fair value adjustment Specific revenue Specific operating costs Regulatory matters (see page 7) Italian business investigation (see page 6) EE acquisition and integration costs Out of period irrecoverable VAT Profit on disposal of businesses Property rationalisation costs Restructuring charges Profit on disposal of property Specific operating costs Specific net finance expense Profit on disposal of interests in associates and joint ventures Tax credit Net specific items charged after tax We incurred £215m of EE integration costs (2015/16: EE acquisition-related costs £99m and integration costs of £17m). This includes a £62m (2015/16: £nil) specific amortisation charge relating to the write off of IT assets as we integrate the EE and BT IT infrastructure. We recognised an out of period irrecoverable VAT charge of £30m during the year (2015/16: £nil) and a £1m interest expense. In addition to the above, we also treated a number of other items as specific, such as the net interest expense on pensions of £209m (2015/16: £221m). The decrease from 2015/16 mainly reflects a fall in the IAS 19 discount rate between 31 March 2016 and 31 March 2017. We also recognised a tax credit of £63m (2015/16: £96m) for the re-measurement of deferred tax balances due to the upcoming changes in the UK corporation tax rate from 20% to 19% from 1 April 2017 and to 17% from 1 April 2020. The tax credit on specific items (excluding the re-measurement of deferred tax) was £154m (2015/16: £70m). In 2015/16, we recognised a fair value adjustment on the acquisition of EE which reduced the amount of revenue recognised between acquisition and 31 March 2016. You can see details of all revenue and costs that we have treated as specific items in the income statement in the last three years in note 8 to the consolidated financial statements. Profit before tax Reported profit before tax (which includes specific items) was down 19% to £2,354m while adjusted profit before tax was up 5% at £3,532m, due to the contribution from EE. We discuss depreciation, net finance expense and tax in later sections of this performance review. Earnings per share Reported earnings per share, which includes specific items, was 19.2p, down 33%, while adjusted earnings per share decreased 9% to 28.9p. – (217) 961 – (166) 278 (25) (121) 406 Adjusted earnings per share is one of our key performance indicators (see pages 20 and 21) and has decreased by 6% over the past two years. The graph below shows the key drivers of this decrease. This year, specific items resulted in a net charge after tax of £961m (2015/16: £278m). There was a net charge of £260m (2015/16: nil) arising from changes in accounting estimates regarding the carrying value of the assets and liabilities of our Italian business, including professional fees incurred. We’ve recognised a net cost of £479m (2015/16: £nil) in relation to regulatory matters. These are made up of the following: – Deemed Consent: A charge of £342m was recognised (2015/16: £nil) in relation to Ofcom’s March 2017 findings on our historical practices over the use of Deemed Consent. This includes a fine of £42m which has been imposed and we’ve also agreed to compensate Communication Providers, with the precise amount of the compensation to be determined but currently estimated at £300m. – Re-assessment of other regulatory risks: We’ve also re-assessed our regulatory risks in light of recent regulatory decisions by Ofcom and the Competitions Appeals Tribunal. As a result we’ve increased our net provision by £137m (2015/16: £nil) in the year. – Ladder pricing agreements: In 2016/17 we recognised revenue and costs of £8m (2015/16: £203m) being the prior year impacts of ladder pricing agreements with the other UK mobile operators. Adjusted earnings per share Year ended 31 March pence 50 . 8 3 1 45 40 35 30 25 . 6 0 3 5 1 0 2 3 3 . A D T I B E ) . 4 1 ( t s e r e t n I ) 2 1 . ( n o i t a s i t r o m a & n o i t a c e r p e D i 5 0 . . 8 1 3 r e h t O 6 1 0 2 A D T I B E . 9 8 2 7 1 0 2 ) 2 5 . ( a r e h t O ) 3 1 . ( t s e r e t n I ) . 2 0 1 ( n o i t a s i t r o m a & n o i t a c e r p e D i a Other primarily reflects the impact of the change in the weighted average number of shares. 95 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group performance continued Dividends The Board is proposing a final dividend to shareholders of 10.55p, up 10%. This brings the full year dividend to 15.40p, also up 10%, and compares with an increase in the 2015/16 full year dividend of 13%. This year’s dividend is in line with our outlook. It will be paid, subject to shareholder approval, on 4 September 2017 to shareholders on the register on 11 August 2017. Dividends per share Year ended 31 March pence 16 14 12 10 8 6 4 2 0 . 4 2 1 13% . 0 4 1 10% 5 8 . 9 3 . 2015 6 9 . 4 4 . 2016 Interim Final . 4 5 1 . 6 0 1 9 4 . 2017 The Board has reviewed the group’s dividend policy and continues to believe that a policy of paying progressive dividends is the most appropriate. The Board believes this best aligns with the group’s financial objectives of growing sustainable profitable revenue growth and transforming the cost base in order to drive long-term growth in cash flows. In reaching this decision, the Board took into account forecasts for future debt reduction as well as the level of dividend cover expected over the medium-term. BT Group plc has sufficient distributable reserves to support the dividend policy. We’ve set out our dividend expectations for 2017/18 in our Outlook on page 92. Cash flow We generated a net cash inflow from operating activities of £6,174m and normalised free cash flow of £2,782m, down £316m or 10%, which is above our outlook as revised in January of c£2.5bn for the year due to earlier than expected customer collections that we will now not receive next year. Free cash flow Normalised free cash flow decreased 10% to £2,782m, partly reflecting increased payments for the Premier League, UEFA Champions League and UEFA Europa League broadcast rights. The net cash cost of specific items was £205m (2015/16: £232m). This included: EE acquisition and integration related costs of £111m (2015/16: £114m); restructuring costs of £51m (2015/16: £85m); and ladder pricing payments of £1m (2015/16: £41m receipts). Summarised cash flow statement Year ended 31 March Before specific items EBITDA Capital expenditureb Net interest Taxationc Working capital movements Other non-cash and non-current liabilities movements 2017 £m 2016a £m 2015a £m 7,645 6,459 6,193 (3,119) (2,431) (2,403) (622) (661) (382) (541) (459) (12) (573) (415) (150) (79) 82 178 Normalised free cash flow 2,782 3,098 2,830 Cash tax benefit of pension deficit payments Specific items Free cash flow Pension deficit payments Dividends Disposals and acquisitions 110 (205) 203 (232) 106 (154) 2,687 3,069 2,782 (274) (880) (1,435) (1,075) 51 (3,379) (876) (924) 10 Share buyback programme (206) (315) (320) Proceeds from issue of own shares 70 90 1,201 Reduction (increase) in net debt from cash flows 893 (2,490) 1,873 Net debt at 1 April (9,838) (5,113) (7,023) Reduction (increase) in net debt from cash flows Non-cash movements Net debt at 31 March 893 13 (2,490) 1,873 (2,235) 37 (8,932) (9,838) (5,113) a Certain prior year results have been revised to reflect the outcome of the investigation into our Italian business. See note 1 to the consolidated financial statements. b Net of government grants. c Excluding cash tax benefit of pension deficit payments. Free cash flow, which includes specific item outflows of £205m (2015/16: £232m) and a £110m (2015/16: £203m) tax benefit from pension deficit payments, was £2,687m (2015/16: £3,069m). We made pension deficit payments of £274m (2015/16: £880m) and paid dividends to our shareholders of £1,435m (2015/16: £1,075m). We spent £206m (2015/16: £315m) on our share buyback programme to help counteract the dilutive effect of our all-employee share option plans maturing. Exercises of share options generated proceeds of £70m (2015/16: £90m). Non-cash movements within net debt in the prior year primarily reflect £2,107m of net debt acquired with EE. You can see a reconciliation to normalised free cash flow from the net cash inflow from operating activities, the most directly comparable IFRS measure, on page 254. 96 BT Group plcAnnual Report 2017 Capital expenditure We continue to make significant investments in line with our strategy including a focus on improving customer experience. Non-network infrastructure – Investment in our property estate, including integration of EE and BT people into the same locations. Capital expenditure was £3,454m (2015/16: £2,622m). This consists of gross expenditure of £3,426m (2015/16: £2,731m) which has been increased by net grant deferral of £28m (2015/16: £109m decreased by net grant funding) mainly relating to deferral of grant funding in the BDUK programme. This is driven by the base-case assumption for take-up in BDUK areas being increased to 39% of total homes passed following our review of the level of customer take-up. While we have recognised gross grant funding of £160m (2015/16: £338m) in line with network build in the year, we have also deferred £188m (2015/16: £229m) of the total grant funding to reflect higher take-up levels on a number of contracts. The increase in take-up assumption shows the high demand on our fibre network driven by customers taking advantage of faster speeds to consume more data. To date we have deferred £446m (2015/16: £258m). Of the total group capital expenditure £69m (2015/16: £5m) related to the integration of EE. Additionally, £272m, (2015/16: £248m, 2014/15: £231m) arose outside the UK. Capital expenditure contracted but not yet incurred was £889m at 31 March 2017 (2015/16: £922m, 2014/15: £507m). Depreciation and amortisation Depreciation and amortisation has increased by 33% to £3,510m (2015/16: £2,631m, 2014/15: £2,538m) due to the inclusion of EE depreciation and amortisation for the full financial year. Net debt Net debt decreased by £906m to £8,932m, reflecting strong cash generation by the business. We have achieved this while making investments for the future of our business including research and development, and sports and TV content, supporting our pension fund and funding our share buyback programme. We have also paid progressive dividends to our shareholders. Gross debt, translated at swap rates and excluding fair value adjustments, at 31 March 2017 was £10,980m. This comprises term debt of £9,680m, finance leases of £229m, bank loans of £350m, and other loans of £721m. Bond maturities in June 2016, December 2016 and February 2017 resulted in a total cash outflow of £1,787m. We have decreased our current investments and cash and cash equivalent by £1,866m, reflecting the funding of bond maturities and cash requirements of the business. The Design Council is accountable to the Operating Committee for delivering an efficient and optimised investment plan, aligning investment decisions across our networks, systems, platforms and products so that they are directed towards our strategic priorities. 2016/17 is the first full year including EE. Capital expenditure therefore includes the investment EE is making to expand coverage, improve network speed and performance while continuing to offer innovative products and excellent customer experience. We’re also investing in the integration of EE into the wider group to drive both revenue and cost synergies. For the year, our capital expenditure, inclusive of net grant deferral was £3,454m (2015/16: £2,622m, 2015/14: £2,317m). The table below shows the split of our investments by major category. Capital expenditure Year ended 31 March £m 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 151 451 943 772 2014/15 Capacity/Network Customer Driven 119 640 1,260 1,435 2016/17 97 463 1,076 986 2015/16 Systems/IT Infrastructure In recent years we’ve prioritised our capital expenditure to underpin our strategy to deliver sustainable revenue growth, and to expand coverage and capacity while enhancing speed and resilience of both our fixed access network and our mobile network. Key investments this year include: Capacity/network investments – increasing the footprint of our superfast fibre broadband network, including extending the reach of superfast broadband to rural areas under the BDUK programme. We’ve now passed more than 26.5m homes and businesses; – the launch of our Ultrafast broadband trial now with 500K premises passed; – enhancing and expanding our mobile network coverage, including the delivery of the ESN contract; and – continued investment in convergence of fixed and mobile services. Customer driven investments – continued development of customer contract-specific infrastructure for our global clients; and – deployment of Ethernet, including reduction in the existing workstack, and copper/fibre connections to homes and businesses. Systems/IT investments – improving customer experience by enhancing our online contact systems, order and repair journeys as well developing new products, such as our nuisance calls blocker. 97 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group performance continued The table below shows the key movements in net debt over the past two years. s d n e d v D i i k c a b y u b e r a h S e m m a r g o r p t n e m e v o m h s a c - n o N 5 3 2 2 , 6 1 0 2 h c r a M 1 3 t A 8 3 8 9 , e e r f d e s i l a m r o N w o fl h s a c 2 8 7 2 , f o t fi e n e b x a t h s a C t i c fi e d n o i s n e p s e r a h s n w o f o e u s s i m o r f s d e e c o r P d n a l a s o p s i D s n o i t i s i u q c a s m e t i i c fi c e p S t i c fi e d n o i s n e P s t n e m y a p 5 7 0 1 , 5 1 3 0 1 1 0 7 5 0 1 2 5 4 7 2 t n e m e v o m h s a c - n o N k c a b y u b e r a h S e m m a r g o r p s d n e d v D i i 5 3 4 1 , 6 0 2 3 1 7 1 0 2 h c r a M 1 3 t A 2 3 9 8 , Movements in net debt 5 1 0 2 l i r p A 1 t A e e r f d e s i l a m r o N w o fl h s a c f o t fi e n e b x a t h s a C t i c fi e d n o i s n e p s e r a h s n w o f o e u s s i m o r f s d e e c o r P d n a l a s o p s i D s n o i t i s i u q c a s m e t i i c fi c e p S t i c fi e d n o i s n e P s t n e m y a p £m 10,500 9,500 8,500 7,500 6,500 5,500 4,500 3,500 2,500 1,500 500 3 1 1 5 , 8 9 0 3 , 0 8 2 8 3 2 9 7 3 3 , 3 0 2 0 9 The table below shows the key components of our net debt and of the £906m decrease this year. £m Debt due within one yeara Debt due after one year Impact of cross-currency swapsb Removal of accrued interest and fair value adjustmentsc Gross debt Less: Cash and cash equivalents Current assets investments Net debt At 1 April 2016 Term debt issuance/ (maturities) Other cash flow Fair value move- ments Foreign exchange 3,736 (1,787) (1,038) 11,025 (652) (357) – – – 4 – – 13,752 (1,787) (1,034) (996) – (2,918) 1,787 9,838 – 505 (364) (893) – (29) – 29 – – – – 333 471 (767) – 37 (38) (29) (30) Transfer to within one year 1,399 (1,399) – – – – – – Other move- ments At 31 March 2017 (11) 2,632 9 – 14 12 1 4 10,081 (1,419) (314) 10,980 (528) (1,520) 17 8,932 a Including accrued interest and bank overdrafts. b Retranslation of debt balances at swap rates where hedged by cross-currency swaps. c Removal of accrued interest applied to reflect the effective interest rate method and removal of fair value adjustments. The impact of foreign exchange on net debt includes the impact of translation on finance leases, short-term borrowings, investments and cash balances. This also includes the benefit of translating our debt balances to Sterling at swap rates. 98 BT Group plcAnnual Report 2017 Financing and debt maturity The main source of our cash inflow in recent years has been the cash generated from our operations. We increased our undrawn revolving committed credit facility from £1.5bn to £2.1bn in June 2016. This facility has been extended by one year and will now mature in September 2021. In addition, we entered into a new 364-day revolving bridge facility of £1.5bn maturing in March 2018, with the option to renew to March 2019. The bridge facility contains mandatory prepayment and cancellation clauses in certain circumstances, such as the issuance of public debt securities. This facility was undrawn as at 31 March 2017. In July 2016 the remaining £181m of the EE acquisition facility was repaid. We have term debt of £1,399m, at swap rates, and other debt of £735m maturing in 2017/18. Maturity profile of term debt and average coupon rate At 31 March £m 1,800 1,500 1,200 900 600 300 0 % 7 5 . % 7 3 . % 3 4 . % 3 2 . % 7 2 . % 8 3 . % 2 9 . % 9 3 . % 4 6 . 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038 £ debt $ swapped to £ € swapped to £ Net finance expense Reported net finance expense has increased £92m to £804m. Adjusted net finance expense of £594m increased by £111m due to our average net debt being higher than last year as a result of our acquisition of EE. We’ve shown below an overview of our average gross debt, investments and cash balances, and net debt and the related weighted average interest rates over the past three years. The weighted average interest rate on net debt reduced from 7.4% to 5.9% as the new debt issuances and debt acquired from EE are at lower interest rates than the average rate of the existing debt. You can see a reconciliation of net finance expense to net interest cash outflow in note 26 to the consolidated financial statements. Taxation Our effective tax rate before specific items was 18.8% (2015/16: 18.1%). We paid income taxes of £551m (2015/16: £256m). Our tax contribution We are proud to be a major contributor of taxes to the UK economy. In 2016 we bore UK taxes of £893m and collected £2,985m of taxes. The One Hundred Group 2016 Total Tax Contribution Survey ranked us as the 5th highest contributor in the UK. We paid UK corporation tax of £471m. We benefited from £117m of EE’s historical tax losses (2015/16: £20m) and £110m from tax deductions associated with employee pension and share schemes (2015/16: £208m). Year ended 31 March Before specific items Average gross debt Weighted average interest rate on gross debt Average investments and cash balances Weighted average interest rate on investments Average net debt Weighted average interest rate on net debta 2017 £m 2016 £m 2015 £m 12,217 9,030 9,007 4.6% 5.4% 6.0% 2,817 2,616 2,446 0.3% 0.4% 0.4% 9,400 6,414 6,561 5.9% 7.4% 8.1% a Excludes interest relating to unwinding of discount on provisions and derivatives not in a designated hedge relationship. Our approach to tax We seek to ensure that our business develops in a tax-efficient manner that embodies our wider corporate purpose. In doing this we, comply with the tax rules of the countries where we do business and deal with their tax authorities in an open and constructive manner. We take the benefit of widely claimed tax incentives and apply OECD principles. Tax governance We maintain a limited appetite for tax risk by requiring a strong connection between tax planning and our business, and by requiring reasonably likely publicity to be neutral in nature. We seek out opportunities that meet these requirements where there is reasonable tax technical merit and we are confident that we can manage any organisational complexities. We have a framework for managing taxes that is set centrally and agreed by the Board. We employ suitably qualified professionals to manage the operation of this framework, who report to the group finance director. Compliance with this framework is tested by our internal audit function. 99 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group performance continued Tax expense Our tax expense recognised in the income statement before specific items was £663m (2015/16: £607m). In addition we recognised a £445m tax credit (2015/16: tax charge of £235m) in the statement of comprehensive income, principally in relation to our pension scheme. Summarised balance sheet Our balance sheet reflects our significant investment in the network infrastructure assets that are the foundation of our business, as well as the working capital with which we manage our business day by day. It also reflects the longer-term strategy with which we finance our investment, and our obligation to the pension fund. At 31 March 2017 £m 2016a £m Movement £m Property, plant & equipment, software and telecommunications licences 20,884 20,531 Goodwill and other intangible assets 10,643 10,890 Other non-current and current assets 3,067 2,288 Trade and other receivables 4,195 4,196 353 (247) 779 (1) Investments, cash and cash equivalents 2,048 3,914 (1,866) Total assetsb 40,837 41,819 (982) Loans and other borrowings (12,713) (14,761) 2,048 Trade and other payables (7,437) (7,418) Other current and non-current liabilities (2,398) (2,288) Provisions Deferred tax liability (1,161) (743) (1,240) (1,262) (19) (110) (418) 22 Pensions, net of deferred tax (7,553) (5,235) (2,318) Total liabilities Total equity (32,502) (31,707) (795) 8,335 10,112 (1,777) a Revised. See note 1 to the consolidated financial statements. b Excluding deferred tax asset relating to BT’s defined benefit pension schemes. Our core fixed and mobile network infrastructure is included within property, plant and equipment, software and telecommunications licences. These assets were held at a net book value of £20.9bn at 31 March 2017. The net increase of £353m in the year primarily reflects capital expenditure of £3,454m exceeding the related depreciation and amortisation charge of £3,189m, and a net foreign exchange gain of £87m. Goodwill and other acquisition-related intangible assets decreased by £247m, primarily reflecting the impact of foreign exchange translation of overseas non-current assets. This also reflects the outcome of our re-assessment of the provisional assets and liabilities fair values recognised in our 31 March 2016 financial statements as part of the acquisition of EE. We review the recoverable amounts of goodwill annually across our cash generating units which hold goodwill, which are Consumer, EE, Business and Public Sector, Global Services, and Wholesale and Ventures, and are satisfied that these support the carrying value of goodwill (see note 12 to the consolidated financial statements). We expect our income statement effective tax rate before specific items to be around the UK rate of corporation tax, as the majority of our business occurs in the UK. In the current year, our rate is lower than this because we recognised tax credits in respect of historical overseas tax losses and prior period tax items. The UK tax rate fell to 19% on 1 April 2017 and will fall to 17% on 1 April 2020, which should reduce our expected effective tax rate. Recognition of further deferred tax assets on historical overseas tax losses would also reduce our future rate. Changes to our estimates of uncertain tax positions may increase or reduce our future rate. Year ended 31 March Before specific items Tax at UK statutory rate Non-UK results taxed at different rates Net permanent differences Changes to prior year estimates Deferred tax accounting for non-UK losses Effective tax rate 2017 % 20.0 0.3 0.7 21.0 (1.1) (1.1) 18.8 2016 % 20.0 (0.2) 0.3 20.1 (2.5) 0.5 18.1 2015 % 21.0 0.6 – 21.6 (1.1) (0.1) 20.4 We have booked a tax benefit of £39m in respect of UK patent incentives (2015/16: £37m). We do not expect this to be affected materially by the OECD’s Base Erosion and Profit Shifting project. Key tax risks Our key uncertainties are whether EE’s tax losses will be available to us, whether our intra-group trading model will be accepted by a particular tax authority and whether intra-group payments are subject to withholding taxes. Additionally we have extensive and long standing UK operations that necessarily require the use of estimates. We routinely work with HMRC to validate these estimates. Tax losses We have an asset of £270m relating to tax losses on our balance sheet. This relates mainly to historical tax losses acquired with EE. We expect to be able to use this against future profits of EE. In addition we have £4.2bn of income tax losses that we’ve not given any value to on our balance sheet. We might be able to use these losses to offset future profits, however we currently do not consider this probable. We also have £17.0bn of UK capital losses, which we have no expectation of being able to use. We’ve given more details in note 9 to the consolidated financial statements. 100 BT Group plcAnnual Report 2017Other non-current and current assets and liabilities relate primarily to our financial instruments, which we’ve described in note 27 to the consolidated financial statements. It also includes inventories which have increased by £38m as outlined in note 16 to the consolidated financial statements. Trade and other receivables decreased by £1m to £4,195m while trade and other payables of £7,437m were £19m higher. Despite these movements, the unwinding of the effects of improper working capital transactions in our Italian business resulted in a working capital outflow of £382m. Investments, cash and cash equivalents, loans and other borrowings are reconciled to net debt of £8,932m in note 25 to the consolidated financial statements. We’ve discussed net debt on pages 97 to 98. Provisions increased by £418m to £1,161m mainly due to an increase in regulatory provisions which was treated as a specific item. We have a significant property portfolio which includes both office buildings and former telephone exchanges (see page 31). Property provisions, which mainly comprise onerous lease provisions, amounted to £292m. There are also asset retirement obligations of £83m relating to leased mobile sites forming part of the EE network. You can find more information about these provisions in note 19 to the consolidated financial statements. We’ve shown deferred tax movements in note 9 to the consolidated financial statements. Pensions, net of deferred tax, increased by £2.3bn to £7.6bn and are discussed below. Equity has deteriorated compared with the prior year due to the actuarial losses relating to retirement benefit obligations, being more than the profit for the year. Pensions Overview We provide a number of retirement plans for our employees: – The BT Pension Scheme (BTPS), a defined benefit plan in the UK, is the largest of these plans. Although closed to new members, the BTPS still has around 32,500 active members, 199,500 pensioners and 64,000 deferred members. – The BT Retirement Saving Scheme (BTRSS) is a contract-based, defined contribution arrangement operated by Standard Life. This is the current arrangement for UK employees who joined BT after 1 April 2001. It has around 32,500 active members. – EE operates the EE Pension Scheme (EEPS), which has a defined benefit section that is closed to future accrual and a defined contribution section which has around 11,000 active members. – We also maintain retirement arrangements around the world with a focus on these being appropriate for the local market and culture. The BTPS, BTRSS and EEPS are not controlled by the Board. The BTPS and EEPS are managed by separate and independent Trustee bodies while savings in the BTRSS are managed directly by members. Details of the governance of the BTPS, its financial position and the performance of its investments are available in the BTPS Annual Report published by the Trustee in December 2016, on the BTPS Trustee website (www.btpensions.net). We’ve given more information on our pension arrangements and on the funding and accounting valuations in note 20 to the consolidated financial statements. BTPS funding valuation and future funding obligations The funding of the BTPS is subject to legal agreement between BT and the Trustee of the BTPS and is determined at the conclusion of each triennial valuation. The most recent triennial funding valuation at 30 June 2014 and the associated deficit contribution plan was agreed with the Trustee in January 2015. At 30 June 2014, the market value of assets was £40.2bn and the funding deficit was £7.0bn. There is a wide range of assumptions that could be adopted for measuring pension liabilities. Legislation requires that this deficit is based on a prudent view – for example, assuming a lower future investment return than might be expected in practice. A 16-year deficit contribution plan was agreed reflecting BT’s long- term and sustainable cash flow generation. Under this plan, we made deficit payments of £875m in March 2015, £625m in April 2015 and £250m in March 2016 and March 2017. Accounting position under IAS 19 The accounting deficit, net of tax, rose over the year from £5.2bn to £7.6bn. The movements in the deficit for the group’s defined benefit plans are shown below. Movements in IAS 19 deficit t n e m e t a t s e m o c n I s n o i t u b i r t n o c h s a C s t n e m e r u s a e m e R ) . 3 0 1 ( 5 7 . Deficit (£bn) (20) (18) (16) (14) (12) (10) (8) (6) (4) (2) 0 ) 2 1 . ( ) 2 5 . ( 6 1 0 2 l i r p A 1 t a t i c fi e D Net of deferred tax asset Deferred tax asset ) 3 0 . ( ) 2 0 . ( 3 0 . 3 0 . e g r a h c g n i t a r e p O t s o c e c n a n fi t e N s n o i t u b i r t n o c l r a u g e R s n o i t u b i r t n o c t i c fi e D s e i t i l i b a i l n o s e s s o l l a i r a u t c A l s t e s s a n a p n o n r u t e R d n a e t a r t n u o c s i d e v o b a s t n e m e v o m e t a r e g n a h c x e ) . 5 1 ( ) 6 7 . ( 7 1 0 2 h c r a M 1 3 t a t i c fi e D 101 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Adoption of IFRS 15 ‘Revenue from Contracts with Customers’ IFRS 15 ‘Revenue from Contracts with Customers’ will be effective for BT on 1 April 2018. We are planning to adopt this new standard retrospectively, applying it to each prior reporting period presented in our 2018/19 financial statements, namely 2016/17 and 2017/18. On adoption in 2018/19, this will require a cumulative transitional adjustment at 1 April 2016. We are still in the process of quantifying the implications of this standard and the financial impact is not yet reasonably estimable, but we anticipate that the resulting accelerated revenues and deferred costs are likely to significantly exceed deferred revenues, and there will be a resulting cash tax impact in 2018/19 and 2019/20. More detail over our approach to this new standard as well as others is outlined in note 1 to the consolidated financial statements. Group performance continued The actual investment return in the year to 31 March 2017 of around 21% was higher than the discount rate assumption at 31 March 2016 of 3.30%, leading to a reduction in the deficit recognised as a remeasurement in other comprehensive income. The return reflects strong asset performance across all asset classes, in particular equities and government bonds which increased by c16% and c23% respectively. The actuarial losses on liabilities in 2016/17 primarily reflect a fall over the year in the real discount rate from 0.44% to 0.78%. Contractual obligations and commitments We’ve shown in the table below our principal contractual financial obligations and commitments at 31 March 2017. You can see further details on these items in notes 20, 25 and 30 to the consolidated financial statements. At 31 March 2017 Less than 1 year £m Between 1 and 3 years £m Between 3 and 5 years £m More than 5 years £m Total £m Loans and other borrowingsa 12,334 2,618 2,756 1,281 5,679 Finance lease obligations 229 14 24 26 165 Operating lease obligations 7,160 650 1,168 1,037 4,305 Capital commitments Other commitments Device purchase commitments Programme rights commitments Pension deficit obligations 889 367 423 2,644 7,686 811 231 423 77 127 – – 9 – 1 – – – 641 1,405 598 710 1,460 1,410 4,106 Total 31,732 5,457 6,253 5,168 14,854 a Excludes fair value adjustments. We have unused committed borrowing facilities totalling £3.6bn. We expect that these resources and our future cash generation will allow us to settle our obligations as they fall due. 102 BT Group plcAnnual Report 2017Governance Chairman’s governance report How we govern the group Board of directors The Board 104 105 106 108 Reports of the Board committees – Audit & Risk Committee chairman’s report 112 – Nominating & Governance Committee chairman’s report – BT Pensions Committee chair’s report – Committee for Sustainable and Responsible 116 118 Business chairman’s report 119 120 – Technology Committee chairman’s report 121 – Integration Committee chairman’s report 122 – Report on Directors’ Remuneration 146 Directors’ information General information 148 Shareholders and Annual General Meeting 152 Financial statements Additional information 153 251 Governance In this section we describe our governance structure. We talk about the people on the Board, how it works and what the Board focused on during the year. We also report on the work of our Board committees. Our directors Our directors’ skills and experience, together with their wide range of backgrounds, help them challenge constructively BT’s management and develop our effective strategy for the future. Our committees The Board gives certain responsibilities and authorities to a number of Board committees. Our governance framework Our governance and internal control framework helps the Board exercise proper oversight. The Board retains accountability. Our corporate governance statement Notwithstanding the very disappointing findings of issues in our Italian business, we remain committed to operating in accordance with best practice in business integrity and ethics and maintaining the highest standards of financial reporting and corporate governance. The directors consider that BT has complied throughout the year with the provisions of the UK Corporate Governance Code (the Code) as currently in effect. The directors also consider that BT has applied the main principles of the Code as described on pages 103 to 152 of this report. In particular, for details of our internal controls as affected by the issues identified in our Italian operations, see US Regulation on page 148. The directors submit their report and the audited financial statements of the company, BT Group plc, and the group, which includes its subsidiary undertakings, for 2016/17. BT Group plc is the listed holding company for the BT group of companies. Its shares are listed on the London Stock Exchange, and on the New York Stock Exchange in the form of American Depositary Shares. The Code and associated guidance are available on the Financial Reporting Council website at www.frc.org.uk PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 103 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Chairman’s governance report “ This has been a challenging year. The Board has focused on a number of key areas to ensure BT remains a strong company.” As I write my final chairman’s governance report, coming to the end of my tenth year at BT, I am delighted that Jan du Plessis will join the Board on 1 June 2017 as a non-executive director, before becoming chairman from 1 November 2017, when I retire. He brings great experience, having been chairman of British American Tobacco, SABMiller and Rio Tinto. I wish Jan every success as he leads BT at this important time. Simon Lowth joined the Board on 12 July 2016 as group finance director. Simon brings a wealth of knowledge to BT; having previously been CFO and served on the boards of BG Group, AstraZeneca and ScottishPower. Simon replaced Tony Chanmugam who stood down as group finance director in July 2016 and left the company on 31 March 2017. I am very disappointed by the findings in our Italian business and by the issues that arose in Openreach around Deemed Consent, which led to a considerable fine. We take these matters extremely seriously and we have taken immediate steps to strengthen our financial processes and controls. You can read more on these on pages 6 and 7. I continually review the membership of the Board and its range of skills. We look to appoint outstanding candidates with a diverse range of experience, as we recognise the importance of diversity in the widest sense to maximise Board effectiveness. We currently have 27% female representation on the Board. The Board has played an active role, particularly in relation to the key issues the company has faced this year, and the search for and appointment of my successor. Board members have also ensured they are available to support and engage with the management team. In addition to our forward programme of key items, updates from each line of business CEO and updates on customer experience, we also had in-depth discussions on BT Italy, the Digital Communications Review, Deemed Consent and BT Sport. You can read more about what we have done on pages 109 to 111. For 2016/17, the company secretary and I carried out a Board evaluation. We discussed the resulting report and noted that, overall, the results were positive. We also identified a number of areas of focus and you can find our actions in these areas on page 111. We have carried out the triennial external evaluation of the Board for 2017/18. This was conducted by ‘Independent Board Evaluation’. You will find further details on this evaluation process on page 117. We keep our governance framework under review to ensure it enhances the Board’s ability to exercise proper oversight. In accordance with our proposals to Ofcom on the DCR, we discussed the independent appointments to the Openreach board, and approved the appointment of Mike McTighe as the first Openreach chairman. We created the Investigatory Powers Governance Committee as a result of the new Investigatory Powers Act. You will find further details on this on page 37. We also reviewed our Board committee structure and approved changes to some of the committees’ terms of reference. As I leave BT, I would like to thank all members of the Board for their continued support in what has been a challenging year. I believe the Board has the right range of skills and experience to keep developing and delivering our strategy under Jan’s leadership. I look forward to following with interest BT’s progress in the coming years. Sir Michael Rake Chairman 11 May 2017 104 104 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 THE STRATEGIC REPORT THE STRATEGIC REPORT GOVERNANCE GOVERNANCE FINANCIAL STATEMENTS FINANCIAL STATEMENTS ADDITIONAL INFORMATION ADDITIONAL INFORMATION How we govern the group Our governance structure The Board The Board is responsible for managing the group, agreeing strategy, overseeing performance, and discharging certain legal responsibilities. The Board delegates day-to-day responsibility for running the group to BT’s executive management, with specialist tasks passed to various Board committees. PG106 and 107 For the Board biographies PG109To read about the Board activities for the year PG116 For Board diversity www.btplc.com for Board news Equality of Access Board Audit & Risk Committee The Equality of Access Board (EAB) monitors, reports and advises on BT's compliance with the Undertakings given by BT to Ofcom. The EAB reports regularly to the Board and publishes an annual report to Ofcom. The Audit & Risk Committee is responsible for financial and narrative reporting, internal controls and risk management, including core compliance programmes and non-financial assurance, internal audit and external audit. Nominating & Governance Committee The Nominating & Governance Committee makes sure the Board has the right balance of skills, experience, independence and knowledge. It also oversees BT’s governance framework. Remuneration Committee BT Pensions Committee The Remuneration Committee agrees the remuneration framework for our chairman, executive directors and certain senior executives. The BT Pensions Committee is responsible for overseeing the BT Pension Scheme (BTPS). Technology Committee The Technology Committee agrees the development and implementation of BT’s major technology strategies. Committee for Sustainable and Responsible Business The Committee for Sustainable and Responsible Business provides the strategic oversight necessary to make sure BT is a sustainable and responsible business. www.bt.com/eab PG112 PG116 PG122 PG118 PG119 PG120 Operating Committee The Operating Committee (OC) is our key management committee. It makes decisions on operational issues and other matters within the framework established by the Board. PG14 For the OC biographies Conflicted Matters Committee Integration Committee Investigatory Powers Governance Committee Following the appointment of Tim Höttges to the Board, we established the Conflicted Matters Committee to review all Board papers and agenda items that could give rise to a conflicted matter. The Integration Committee monitors and oversees the integration of EE and BT. This committee is responsible for overseeing BT’s role in the use of official investigatory powers. PG109 PG121 www.bt.com/privacyandfreeexpression Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 105 105 Board of Directors THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Key to membership of Board committees ARC IC PEN Audit & Risk Integration BT Pensions CSRB NAG REM Sustainable & Responsible Business Nominating & Governance Remuneration EAB OC TC Equality of Access Board Operating Technology Committee Chair CSRB NAG PEN IC OC TC CSRB IC OC PEN REM IC NAG TC ARC NAG TC Sir Michael Rake Chairman Appointed to the Board as chairman in September 2007. Age 69. Skills and experience Sir Michael has financial, risk, international business and professional services expertise gained during his time at KPMG (1974 to 2007) where he was senior partner in the UK from 1998 and international chairman from 2002. He was knighted in 2007 and is a former president of the Confederation of British Industry. Other appointments include Chairman of Worldpay Group, International Chamber of Commerce UK and Majid Al Futtaim Holdings and a director of S&P Global (formerly McGraw Hill Financial). Gavin Patterson Chief Executive Appointed chief executive in September 2013 and on the Board since June 2008. Age 49. Skills and experience Gavin has experience in sales, marketing, technology and operations. He was previously CEO, BT Retail and from 2004 to 2008 was managing director, BT Consumer (BT Retail). Before joining BT, Gavin was managing director of the consumer division of Telewest (now Virgin Media). Prior to that he spent nine years at Procter & Gamble, rising to become European marketing director. Other appointments include Non-executive director of British Airways and a member of the CBI President’s Committee. Simon Lowth Group Finance Director Appointed to the Board as group finance director in July 2016. Age 55. Skills and experience Simon has experience in finance, accounting, risk, corporate strategy and mergers and acquisitions. He was CFO and executive director of BG Group before the takeover by Royal Dutch Shell in February 2016. Simon was CFO and an executive director of AstraZeneca from 2007 to 2013, and an executive director of ScottishPower from 2003 to 2007, and was appointed finance director in 2005. Prior to that, Simon was a director of McKinsey & Company. Other appointments None outside BT. Tony Ball Independent non-executive director Appointed to the Board in July 2009. Age 61. Iain Conn Independent non-executive director Appointed to the Board in June 2014. Age 54. Skills and experience Tony brings international business expertise in addition to financial, operational, sales, marketing and media experience. From 1999 to 2003 Tony was chief executive of BSkyB and until 2013 chairman of Germany’s largest cable operator, Kabel Deutschland GmbH. He has held a number of senior executive positions in broadcasting and telecoms businesses in the UK, US and Continental Europe. Skills and experience Iain has significant international experience, and understanding of technology and energy markets. Iain joined Centrica as chief executive in January 2015 having been with BP since 1986. From 2004 to 2014 Iain was executive director of BP and chief executive downstream from 2007 to 2014. Until May 2014, Iain was a non-executive director of Rolls-Royce for nine years, and senior independent director. Other appointments include Senior adviser to Providence Equity Partners, chairman of the advisory council of Portland PR, Ambassadors Theatre Group and Bite Group. Other appointments include Member of the CBI President’s Committee, chairman of the advisory board of the Imperial College Business School and member of the Imperial College Council. Tim Höttges Non-independent, non-executive director Appointed to the Board in January 2016. Age 54. Skills and experience Tim has international telecoms experience having been CEO of Deutsche Telekom since January 2014, and with the company since 2000. From 2009 until his appointment as CEO, he was a member of the board of management responsible for finance and controlling. From 2006 to 2009 he was a member of the board of management responsible for the T-Home unit. In this position, he was in charge of fixed-network and broadband business, as well as integrated sales and service in Germany. Other appointments include Chairman of T-Mobile US and a supervisory board member of FC Bayern München AG and of Henkel AG & Co. KGaA. EAB PEN NAG REM REM TC ARC REM TC ARC IC NAG REM ARC CSRB Isabel Hudson Independent non-executive director Appointed to the Board in November 2014. Age 57. Mike Inglis Independent non-executive director Appointed to the Board in September 2015. Age 57. Karen Richardson Independent non-executive director Appointed to the Board in November 2011. Age 54. Skills and experience Isabel has experience in the financial sector as well as pensions, risk, control, governance and international business. Isabel was previously a non-executive director of The Pensions Regulator, MGM Advantage, QBE Insurance, Standard Life and an executive director of Prudential Assurance Company in the UK. Other appointments include Executive chair of National House Building Council and senior independent director of RSA Insurance. Isabel is also an ambassador for the disability charity, SCOPE. Skills and experience Mike’s technology experience includes serving on the board of ARM Holdings from 2002 to 2013, with roles including chief commercial officer, executive vice president and general manager of the processor division and executive vice president of sales and marketing. Prior to joining ARM, Mike worked in management consultancy with AT Kearney and held a number of senior operational and marketing positions at Motorola. Mike was previously a director at Pace. Other appointments include Non-executive chairman of Ilika and a director of Advanced Micro Devices. Skills and experience With a career over 30 years in the technology and software industry, Karen brings experience in technology having held a number of senior operating roles in both the public and private technology sector. She is a former adviser to Silver Lake Partners, was with NASDAQ-listed software company Epiphany Inc, latterly as chief executive and has served on a number of corporate boards including VirtuOz, Proofpoint, Hi5 Networks and Convercent. Other appointments include Director of AYASDI, Exponent, HackerRank, and Worldpay Group. Nick Rose Independent non-executive director Appointed to the Board in January 2011 and senior independent director since March 2014. Age 59. Jasmine Whitbread Independent non-executive director Appointed to the Board in January 2011. Age 53. Jan du Plessis Jan will join BT on 1 June 2017 as a non-executive director and will become chairman from 1 November 2017. Skills and experience Nick brings experience in finance, risk, control, governance and international business expertise. He was chief financial officer of Diageo prior to his retirement in December 2010, having joined the board in 1999. Other appointments include Chairman of Williams Grand Prix Holdings, senior independent director of BAE Systems and non-executive chairman of Loch Lomond Scotch Whisky. Adviser to CCMP Capital. Skills and experience Jasmine has experience in transforming large complex organisations in the UK and internationally and brings an understanding of corporate social responsibility and sustainable business. She was previously chief executive of Save the Children International and has a background in technology marketing. Other appointments include Chief executive of London First and non- executive director of Standard Chartered. Dan Fitz Company Secretary Dan is the group general counsel & company secretary. He joined BT in April 2010 as its group general counsel. 106 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 107 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Leadership The Board Who we are Gender diversity Read more about the Board directors and the skills and experience they bring to BT on pages 106 and 107. Balance of non-executive directors/executive directors Composition Tenure (years) (chairman and non-executive directors) 73% Male The Board consists of: the chairman, the chief executive, the group finance director, seven independent non-executive directors (including the senior independent director) and one non-independent, non- executive director. The Board is supported by the company secretary. 27% Female The roles of the chairman and the chief executive are separate. They are set out in written job descriptions which provide clear, distinct responsibilities for each role. Simon Lowth joined the Board on 12 July 2016. He’s also a member of the BT Pensions, Integration and Operating Committees. Following the Nominating & Governance Committee’s recommendation, we approved the re-appointments of Nick Rose and Jasmine Whitbread on the expiry of their second three-year terms. The majority of the Board is made up of independent non-executive directors. We judged the chairman to be independent at the time of his appointment, and consider all other non-executive directors to be independent under the terms of the Code, with the exception of Tim Höttges, a non-independent, non-executive. Read about the roles of the Board members and the company secretary below. The Chairman The chairman’s role is to: – lead the Board and create a culture of openness characterised by debate and appropriate challenge; – promote the highest standards of corporate governance; – ensure that the Board determines the nature and extent of the significant risks BT is willing to take to implement its strategy; – make sure that the Board receives accurate, timely and clear Composition information, and is consulted on all relevant matters; 12.5% – monitor the contribution and performance of Board members; – make sure that BT communicates clearly with shareholders, and discusses their views and concerns with the Board; and – acts as a key contact for important stakeholders, as well as 87.5% working with the chief executive and senior independent director to represent BT in key strategic and government relationships. The Chief Executive The chief executive’s role is to: – lead the group’s performance and management; – propose strategies, business plans and policies to the Board; – implement Board decisions, policies and strategies; – develop and promote compliance with BT’s policies on conducting business around the world; – maintain an effective framework of internal controls and risk management; – lead the Operating Committee in the day-to-day running of every part of the business; and – lead, motivate and monitor the performance of BT’s senior management team, as well as overseeing succession planning for roles on the Operating Committee. Gender diversity 73% Male 27% Female Balance of non-executive directors/executive directors 1 Chairman 2 Executive directors 1 Non-independent non-executive director 7 Independent non-executive directors 12.5% 87.5% Balance of non-executive directors/executive directors Composition Tenure (years) (chairman and non-executive directors) 1 Chairman 2 Executive directors 1 Non-independent non-executive director 7 Independent non-executive directors 45% 0-3 11% 3-6 33% 6-9 11% 9-12 45% 0-3 11% 3-6 33% 6-9 11% 9-12 12.5% 87.5% 1 Chairman 2 Executive directors 1 Non-independent non-executive director 7 Independent non-executive directors Gender diversity 73% Male 27% Female Tenure (years) (chairman and non-executive directors) 45% 0-3 11% 3-6 33% 6-9 11% 9-12 www.btplc.com for more information 108 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION The Independent Non-Executive Directors The independent non-executive director’s role is to: – bring experience and independent judgement to the Board; and – develop and constructively challenge strategy proposals. Each non-executive director is appointed for an initial three-year term but they are all subject to annual re-election by shareholders at the Annual General Meeting. Provided each director is re-elected by shareholders every year, their appointment may be extended. The Senior Independent Director The senior independent director is a non-executive director whose role is to: – meet with BT’s major institutional shareholders and shareholder representative bodies, to discuss matters that wouldn’t be appropriate for discussion with the chairman or chief executive; – act as a sounding board for the chairman and as an intermediary between the chairman and other directors; and – review the chairman’s performance during the year, taking account of feedback from other Board members. The Non-Independent Non-Executive Director After acquiring EE, we appointed Deutsche Telekom’s nominated director Tim Höttges to the Board. Tim owes a fiduciary duty to both BT and Deutsche Telekom. As a non-independent, non-executive director, Tim has the same responsibilities as the other directors; we’ve set up a Conflicted Matters Committee to identify potential or actual conflicts of interest. Read more about this committee below. The Company Secretary The company secretary’s role is to: – manage the flow of timely, accurate and well-considered information to the Board; – recommend corporate governance policies and practices to the chairman and the chief executive; – put in place and promote corporate governance policies across the group; – advise the Board and its committees on corporate governance and compliance across the group; and put in place the right procedures for managing their meetings and duties. The company secretary’s appointment and removal is a matter for the whole Board. What we’ve done The Board is responsible for deciding the group’s strategy and overseeing its performance, while passing the responsibility for day- to-day operations to executive management. The Board is directly involved with approving major acquisitions, providing oversight and control, growing shareholder value and promoting corporate governance. The chart below shows how the Board allocated its time. A number of these areas are also considered by the Board committees. Allocation of time 21% Strategy 20% Governance, risk and audit 4% People, health and safety 33% Business and CEO updates 22% Finance and investor relations The Board has a flexible forward programme of business that makes sure key areas get the time they need, and that items can be added to agendas as necessary. During 2016/17 we spent considerable time discussing our Italian business, the issues around Deemed Consent and Ofcom’s Strategic Review of Digital Communications. Read more about these matters on pages 6, 7 and 39. The Board’s annual programme included: – Chief executive’s reports – Financial reports – Strategy – Line of business updates – Risk management – Dividend policy – Investor relations – Health, safety and well-being – BT Sport – Succession planning – Customer experience – Regulation – Governance and compliance – Approach to tax – Annual Report & Form 20-F – Human rights – Board evaluation – Investing for the future We also received updates from the respective chairs on key matters discussed at the Board committees. The Board also sets time aside to hold a strategy offsite, giving directors the opportunity to focus solely on strategic issues and challenges and opportunities in the short and longer term areas of particular focus were Global Services, Business and Public Sector, the network and market developments. Conflicted Matters Committee (CMC) The CMC is chaired by the company secretary. It’s responsible for deciding to what extent Board meetings and papers are likely to consider or refer to a conflict of interest between BT and DT or their respective affiliates. The committee considers both actual and potential conflicts of interest including situations where BT and DT or their respective affiliates are considered competitors. The CMC helps the non-independent, non-executive director Tim Höttges comply with his fiduciary duties (although ultimate responsibility rests with him), supports good governance and protects the group’s competitively sensitive information. If a conflict arises the CMC makes sure the non-independent, non-executive director doesn’t receive related documents or information and that he absents himself from related Board discussions. During the year a number of Board papers were identified as containing conflicted material. Tim either didn’t receive these documents or he received a redacted version. Tim also didn’t receive any reports regarding Global Services which contained conflicted material and wasn’t present when these reports were discussed by the Board. Annual Report 2017 BT Group plc 109 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION The Leadership continued Investigatory Powers Governance Committee The Investigatory Powers Act 2016 made changes to the investigatory powers regime in the UK. To enhance our own processes we have created the Investigatory Powers Governance Committee, chaired by Sir Mike Rake, to help ensure we strike the right balance between complying with the law and respecting human rights, including the right to privacy. We reviewed our Board committee structure and approved changes to some committees’ terms of reference. Director election and re-election Jan du Plessis (appointed to the Board with effect from 1 June 2017) will be proposed for election. All other directors will be proposed for re-election by shareholders at the AGM in line with the Code. Length of appointment of chairman and non-executive directors Sep 2007 Jul 2009 Jan 2011 Jan 2011 Nov 2011 June 2014 Nov 2014 Sep 2015 Jan 2016 lain Conn Isabel Hudson Mike Inglis Tim Höttges 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Calendar year We include details of all directors’ contracts/letters of appointment in the Report on Directors’ Remuneration. Board members Member Sir Michael Rake (chairman) Gavin Patterson Tony Chanmugama Simon Lowthb Tony Ball Iain Conn Tim Höttges Isabel Hudson Mike Inglis Sir Michael Rake Tony Ball Jasmine Whitbread Nick Rose Karen Richardson Karen Richardson Nick Rose Attendance at Board meetings The following table shows each director’s attendance at Board meetings during the financial year. The chairman meets privately with independent non-executive directors before most scheduled Board meetings. We encourage directors who can’t attend a Board meeting to give the chairman their views in advance. Meetings Eligible to attend Attended 12 12 5 8 12 12 12 12 12 12 12 12 12 12 5 8 12 11 10 12 12 12 12 12 Jasmine Whitbread a Tony stepped down from the Board on 13 July 2016. b Simon was appointed to the Board from 12 July 2016. The chairman reviews the directors’ attendance, contribution and performance. He currently considers that each of them continues to make an effective contribution to the Board on a wide range of issues, as well as demonstrating commitment to their role. Nick Rose reviewed and discussed the chairman’s performance during the year, taking into account feedback from other Board members. Board induction On appointment, directors take part in an induction programme to increase their understanding of our business. Meetings are arranged with the chairman, chief executive, senior independent director and company secretary, as well as other Board members and senior members of management to ensure directors gain a thorough overview and understanding of the business. They receive information about BT including financial data and the key policies supporting BT’s business practices. We also give new directors details on: the role of the Board, its terms of reference, the membership of our main Board committees and matters reserved for decision by the Board, the Board committees or BT’s most senior executives. 110 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Training and information We encourage all directors to regularly update their skills and knowledge. As part of this the Board and individual directors receive ongoing training as required. The chairman works with individual directors to identify any specific training they need to perform their role. The chief executive regularly includes information on the business in his report to the Board. This can include updates on operational matters, the competitive and regulatory environment affecting the group and the wider communications industry, group and line of business performance, strategy, investor relations and corporate responsibility. The chairman also provides a weekly written update to the non-executive directors on key business activities, high level meetings, regulation and relevant sector highlights. Board evaluation The chairman and company secretary carried out a Board evaluation in 2016 through an electronic questionnaire. We discussed the resulting report and noted that the overall results were positive. Directors commented positively on the effective operation of the Board. They felt that Board members work well together as a unit, and that the non-executive directors strike a good balance between supporting and challenging management. Directors commented favourably on the Board strategy day, and they felt that the Board played an important and positive role in the EE transaction. The table below shows progress against the main actions: The company secretary provides briefings during the year on any significant developments in legal, governance and compliance areas. KEY AREAS ACTIONS Non-executive directors regularly meet with management and increase their understanding of the business through formal briefing sessions, breakfast meetings with senior staff and site visits which this year included a meeting at the BT Sport studios. In addition to the private session the chairman holds with the independent non-executive directors before Board meetings, Board dinners are held before most Board meetings which are also attended by the non-independent, non-executive director and the chief executive. The group finance director attends most dinners. At least once a year, a dinner is held for members of the Board and Operating Committee. Regulation Integration of EE Improving customer experience Succession planning and senior management The Board spent considerable time on the Digital Communications Review. The Board has received regular updates from the chair of the Integration Committee and have heard from the CEO, EE. The Board continued to focus on customer experience throughout the year. This has been an area of significant focus for the Board during the year. We have appointed a new chairman as well as the chair of the Openreach board. The chief executive has also given regular updates on senior management changes. We have commissioned the triennial external evaluation of the Board for 2017/18. This is being conducted by ‘Independent Board Evaluation’. You will find further details on this evaluation process on page 117. Annual Report 2017 BT Group plc 111 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Audit & Risk Committee Chairman’s report “ My report this year is dominated by the clear deficiencies in relation to the financial control of our Italian business. We have focused on the independent investigation led by KPMG and other advisers, and our internal investigations into the deficiencies, the subsequent accounting adjustments that the company has needed to make, and the actions which the company has already taken. We will continue to give these actions the highest priority in 2017/18 to ensure that issues such as these will never re-occur in BT.” Who we are I chair the Audit & Risk Committee and have recent and relevant financial experience as required by the provisions of the Code and am the designated financial expert for Sarbanes Oxley Act purposes. The committee acts independently of the executive and all its members are independent non-executive directors with diverse skills and experience. Although they aren’t members of the committee, the company secretary, group finance director, deputy finance director, group financial controller and director internal audit attend each meeting as does the lead audit partner and representatives from our external auditors. I meet with this group ahead of the meetings to discuss key areas for discussion with the committee. The external auditors are not present at meetings when we discuss their performance and/or remuneration. Committee members Member Nick Rose (chairman) Iain Conn Karen Richardson Jasmine Whitbread Meetings Eligible to attend Attended 9 9 9 9 9 6 9 9 What we’ve done We met nine times during the year and the chart below shows how we allocated our time. Meetings are scheduled in line with the financial reporting timetable and after each meeting, I report to the Board on the main issues that we discussed. During the year, we hold separate sessions with the internal and external auditors in the absence of management. Allocation of time 24% Risk and controls 27% Financial matters 13% Internal audit matters 13% External audit matters 23% Governance and compliance The committee has an annual work plan. This includes standing items that the committee considers regularly in addition to any specific mat- ters that require the committee’s attention and topical items on which we have chosen to focus. Activities during the year BT Italy Italy has been a major area of focus for the committee and the improper practices that came to light in our Italian business via a whistle-blower are extremely disappointing. A large part of our work in the second half of the year has been in relation to the financial irregularities that were discovered and which are detailed on page 6. In October, the committee instructed KPMG, with support and oversight from our Legal, Governance & Compliance function and Freshfields Bruckhaus Deringer, to commence an independent investigation. Throughout the investigation, KPMG reported directly to me and the BT Group chairman and the full committee has received regular reports from both KPMG and from the management team. This investigation is now complete. The investigation identified collusion, circumvention and override of controls within our Italian business that was not identified by our monitoring controls thereby resulting in the misstatement of results going undetected for a number of years. There are a number of recommendations arising from the KPMG work and our own observations that we are acting on. We are undertaking steps to improve the group’s systems, processes and controls, not only in Italy but also in our shared service centres, in Global Services and at a group level. This includes increasing the resources and improving the capabilities of the controlling function and the audit function outside the UK, and further developing our integrated risk and assurance reporting processes. We are also enhancing our controls and compliance programme to strengthen awareness of the standards we expect, the capabilities of our people, and to reinforce the importance of doing business in an ethical, disciplined and standardised way. The committee has specifically focused on: – understanding and investigating the override of controls and accounting processes in Italy; – understanding how the financial irregularities have accumulated over time. We considered management’s conclusions in determining the accounting treatment and disclosure of the prior year errors; 112 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 113 – reviewing management’s assessment of the nature of the specific items in the 2016/17 financial year and the judgements taken in determining these changes on estimates; – ensuring, in discussion with the chief executive, group finance director, the internal auditors, the external auditors, and other advisors that the remedial steps proposed are appropriate and sufficient to prevent a repetition of these issues; – satisfying itself that the issues in BT Italy are discrete and isolated and do not exist across our business more widely; and – examining the culture and behaviours that have come to light in the investigation into BT Italy and analysing the culture across BT more widely. In the course of and following the investigation into BT Italy, the business took immediate steps to strengthen the financial processes and controls in BT Italy and a number of BT Italy’s senior management team have now left the business. A new chief executive and chief finance officer of BT Italy are in place having moved from other parts of BT and they will report back to us on the improvements that have been made to the governance, compliance and financial safeguards in our Italian business. Other key matters considered by the committee A summary of key matters we considered and discussed at each meeting during the financial year are set out below: MEETING April 2016 April 2016 June 2016 July 2016 AREAS OF FOCUS – External audit & non-audit fees – Sarbanes Oxley update – Draft Annual Report & Form 20-F 2016 – Major contracts – External audit report – Internal audit plan of work – Ethics & Compliance & Speak up cases – Anti-corruption & bribery update – Full year results statement – Going concern and viability statement – Annual Report & Form 20-F 2016 including a review to ensure the report was fair, balanced and understandable – External and internal audit reports – Internal control requirements under the UK Corporate Governance Code including risk management processes – Internal audit performance report – Regional Governance Committee update – Review of the Regulatory Financial Statements – Security risk management – Regional Governance Committee update – External and internal audit reports – Sarbanes Oxley update – First quarter results – Ethics and Compliance & Speak Up cases September 2016 – Risk updates from the chief executive and the lines of business October 2016 December 2016 – BT Italy – Major contract review – Going concern assessment – Half year results – External and internal audit report – Internal controls – BT Italy – Major contracts – Data protection update – Regional Governance Committee effectiveness review January 2017 March 2017 – BT Italy – Third quarter results – Audit tender update – External and internal audit reports – Ethics and Compliance & Speak Up cases – Accounting policies and reporting developments – BT Italy – Regional Governance Committee update – External audit report Financial reporting We: – reviewed the Annual Report & Form 20-F, together with annual, half-year and quarterly results announcements for recommendation to the Board; – considered the appropriateness of the group’s accounting policies and critical accounting estimates and key judgements; and – considered the Annual Report in the context of advising the Board that the Annual Report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the group’s position and performance, business model and strategy. In addition to BT Italy, other significant issues we considered in relation to the financial statements for the year ended 31 March 2017 are set out below. We have discussed these with the external auditors during the year. Group accounting policies, critical accounting estimates and judgements We reviewed the accounting policies, including a paper from management and the disclosures in the consolidated financial statements that relate to critical accounting estimates and judgements, and re-confirmed they remained appropriate for the group. In particular we reviewed and challenged the judgements and assumptions in relation to provisions, including regulatory risks and litigation, and the assumed level of take-up in the BDUK programme which affects the value of the potential obligation to re-invest or repay grant funding. Going concern We considered management’s forecasts of group cash flows and net debt as well as the financing facilities available to the group. Following this review and a discussion of the sensitivities, we confirmed that it continues to be appropriate to follow the going concern basis of accounting in the financial statements. Further detail on the basis of the going concern assessment by the directors is set out on page 146. Viability statement We received a paper from management which summarised how we meet the requirement in the UK Corporate Governance Code to include a viability statement in the annual report. We were satisfied that the viability statement could be provided and endorsed the continued selection of a three year time horizon as a basis for the statement and the approach to its development. Further detail on the assessment of viability and the viability statement are set out on page 55. Regulatory reporting We reviewed and were supportive of the changes across people, processes and systems that were put in place to ensure that we met our 2016/17 regulatory financial obligations. Goodwill impairment We reviewed management’s process and methodology for assessing the carrying value of goodwill. This included the impact of the re- organisation of the group on 1 April 2016. We also considered the cash flow forecasts for the group’s cash generating units (CGUs) that hold goodwill, being Consumer, EE, Business and Public Sector, Global Services, and Wholesale and Ventures. We considered the key 112 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 113 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Chairman’s report continued assumptions, resulting headroom and the sensitivities applied by management in forming its assessment that no goodwill impairment charges were required. With regards to Global Services we reviewed the impact of the deterioration in international corporate markets and the outlook for our Italian business. We agreed management’s assessment that there was no impairment of goodwill this year. We also discussed and agreed with management’s disclosures in respect of the headroom in Global Services in note 12 to the financial statements. BT Pension Scheme (BTPS) We reviewed the assumptions underlying the valuation of the pension liabilities in the financial statements and considered the financial assumptions including the discount rate, future inflation, salary increase expectations and pension increases as summarised in note 20 to the financial statements. We also considered sensitivities around the assumptions and reviewed the accounting impacts, as well as the impact of the assumptions on the 2016/17 balance sheet statement and 2017/18 income statement and the related disclosures. We were satisfied that these were appropriate. Major contracts In addition to our review of the appropriateness of accounting policies, management provided regular updates on the performance of major contracts within Business and Public Sector and Global Services. This included an overview of the trading and operational performance of the contracts, the assessment of the recoverability of dedicated contract assets, the assessment of the future performance of the contracts and any requirement for loss provisions. Asset verification and asset lives We considered the results of management’s annual review of asset lives, verification of assets and fully depreciated assets. We considered the judgements taken in relation to asset lives and the methodology applied to consider asset verification. We were satisfied that the proposed adjustments were appropriate. Other matters Each quarter, as part of our review of the quarterly results, we are provided with a summary of specific items and management’s view of the quality of earnings and of the effective tax rate. We considered whether specific items are appropriately categorised. At the half-year and full-year, a detailed assessment of provisions is also provided and discussed. In each quarter and for the full year, the committee was satisfied with the information, analysis and explanations provided in relation to the results. External audit We: – considered and approved the auditors’ group audit plan – this followed discussion with the auditors on the scope of the work to be undertaken as well as their consideration of risk informing their plan; – reviewed reports on audit fees, external audit findings and the letter of engagement; and – considered and approved the letter of representation. The committee and the external auditors have discussed the issues addressed by the committee during the year and the areas of particular audit focus, as described in the Independent Auditors’ Report on pages 154 to 164. Audit tender PricewaterhouseCoopers (PwC) and its predecessor firms have been BT’s auditors since BT listed on the London Stock Exchange in 1984 and their reappointment has not been subject to a tender in that time. I reported to you last year that we proposed to tender the audit no later than 2019 but that the committee would keep the external audit arrangements under review annually. In our annual review, we recommended to the Board that the audit tender process be accelerated with a view to appointing new auditors for the financial year 2018/19. We expect the audit tender process to be completed by the company’s Annual General Meeting in July 2017, such that there can be an effective transition by the selected audit firm during the 2017/18 audit process. The company confirms that it complied with the provisions of the Competition and Markets Authority’s Order for the financial year under review. Auditor effectiveness We discussed the quality of the audit throughout the year and consider the performance of our external auditors, PricewaterhouseCoopers, annually, taking into account feedback from a survey targeted at various stakeholders across the business and the committee’s own assessment. The evaluation focused on: robustness of the audit process, quality of delivery, reporting and people and services. Based on the committee’s own view and the survey input, PwC have been informed of some specific “areas for improvement” which will ensure that they are able to deliver the very best outcomes for BT in the coming year. Independence and objectivity BT has agreed policies in place on what non-audit services can be provided by the external auditors. The external auditors are not permitted to perform any work which they may be later required to audit or which might affect their objectivity and independence or create a conflict of interest. There are internal procedures in place for the approval of work given to the external auditors. During the year we have considered independence matters and areas which could give rise to a conflict of interest. We noted the safeguards that the external auditors have in place to prevent compromising their independence and objectivity. We reviewed and approved changes to BT’s non-audit fee policy in light of the new FRC Revised Ethical Standard for auditors issued in June 2016 which applied to BT from 1 April 2017. We monitored compliance with the agreed policies and the level of non-audit fees paid to the auditors in order to satisfy ourselves that the types of services being provided and the fees incurred were appropriate. You can see details of non-audit services carried out by the external auditors in note 7 to the consolidated financial statements. In this context audit-related assurance services which included the audit of the Regulatory Financial Statements, are considered to pose a low threat to auditor independence and therefore the proportion of other non-audit services to total services is considered the most suitable measure of the non-audit services provided. These represented 20% of the total fees (2015/16: 26%). The most significant changes year on year relate to services performed on the EE acquisition prospectus in the prior year and advice in relation to Ofcom’s Digital Communications Review in the current year. Further details of the non-audit services that are prohibited and allowed under the policy can be found in the corporate governance section of the BT website. The committee is satisfied that when assessed against all relevant factors, the overall levels of audit and non-audit fees are not material relative to the income of the external auditors as a whole and therefore that the objectivity and independence of the external auditors was not compromised. 114 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 115 Internal audit We monitor and review the effectiveness of internal audit annually and endorse the internal audit plan of work. This integrates the assurance requirements for the internal financial controls testing programme, the group’s overseas footprint, and the group’s risk assurance mapping. It includes coverage of static and dynamic risks. Going forward the committee has asked for greater emphasis to be given to the audit of financial controls, and our overseas operations. We receive regular reports from the internal auditors and monitored management’s responsiveness to the findings and recommendations as well as discussing with them the action required to bring matters to resolution. As mentioned above, in light of the learnings arising from BT Italy, we are increasing the resources and improving the capabilities of the controlling function and audit function outside the UK and further developing our integrated risk and assurance reporting processes. Internal audit will also play a critical role as we move towards a more integrated risk and assurance reporting processes. Internal controls and risk management In accordance with the provisions of the UK Corporate Governance Code, BT has in place an internal control environment to protect the business from material risks which have been identified within the group. Management is responsible for establishing and maintaining adequate internal controls over financial reporting and we have responsibility for ensuring the effectiveness of these controls. To enable us to do this, each quarter the lines of business certify compliance with the Financial Reporting Council’s risk management guidance and Sarbanes-Oxley controls. The outcomes of these reviews are reported to us. As set out in the description of the committee’s activities during the year the investigations into the irregular practices in the Italian business identified a number of control deficiencies which were not identified by our monitoring controls thereby resulting in the misstatement of results going undetected for a number of years. Immediate steps were taken to strengthen the financial processes and controls in our business and control improvement plans have been instituted where appropriate. Steps will continue to be taken to improve further our control, governance and compliance environment. BT’s risk management processes which have been in place throughout the period under review identify and monitor the risks facing the group. The risks which are considered material are reviewed regularly by the Operating Committee and the Board. During the year we heard from the chief executive on the enterprise- wide risk management process and the key risks facing the group as a whole. Each line of business CEO presented the key risks in their part of the business as well as the actions they are taking to address them. The Board is ultimately responsible for the group’s systems of internal controls and risk management. You can find details of the Board’s and our review of the group’s systems of internal control and risk management on page 149 and for details of the assessment of internal controls, as affected by the issues identified in our Italian business for the purposes of the Sarbanes-Oxley Act, see US Regulation on page 148. Governance & Compliance We received and considered reports from management on: – ethics and compliance plan of work; – anti-corruption and bribery; – Speak Up arrangements, cases, outcomes statistics and trends (including the confidential, anonymous submission by employees regarding accounting, internal accounting controls or auditing matters). We ensure that arrangements are in place for the proportionate, independent investigation and follow up of these matters. We will review our whistleblowing arrangements in light of the issues found in our Italian business and consider if improvements are needed; – data protection; and – the effectiveness of our Regional Governance Committees which monitor governance and compliance in their respective regions. We were also updated on the work of several of these committees. Committee review We review our performance annually by inviting members and regular attendees at our meetings, including the external auditors, to complete online questionnaires. The results, as expected, reflect the disappointment concerning the issues found in our Italian business. We will ensure that we act upon the lessons learnt from this issue to enhance the role of the committee. Conclusion The events in 2016/17 surrounding BT Italy are a matter of substantial disappointment to the committee. We have undertaken a significant number of actions in response to these events and to thoroughly investigate and deal with the issues identified, including: – the commissioning and oversight of KPMG’s comprehensive investigation into the nature, extent and causes of the issues; – the oversight of multiple other related internal workstreams, including scrutiny of the accounting treatment of the issues identified, analysis of the controls framework in Italy and across Global Services, and testing and review to satisfy ourselves that the issues are isolated to BT Italy; – driving forward how we can learn from this issue, including to reflect the recommendations of the KPMG investigation and our own observations; and – the acceleration of the company’s audit tender. We believe that these actions will ensure that the events surrounding BT Italy will never be repeated in the company. We also continue and will continue to work on a number of specific areas to further strengthen our systems, controls and culture including: – analysis of the culture of the company in the context of the events in BT Italy and how this can be improved; and – an increased focus on integrated assurance across a range of functions, together with the development of a system to better integrate the range of financial and non-financial risk factors that exist across the group to enable a better understanding of them. Going forward, the committee will seek to ensure that all the lessons that need to be learnt from the events surrounding BT Italy have been learnt. Nick Rose Chairman of the Audit & Risk Committee 11 May 2017 114 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 115 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Nominating & Governance Committee Chairman’s report This chart shows how we allocated our time. Allocation of time 56% Succession 10% Committee governance 8% Board membership 26% Governance structure and effectiveness “ We have focused on succession, Board membership, and our governance structures for BT and Openreach. I believe the decisions we have made this year will have a meaningful impact in setting BT and Openreach up for long term future success.” Who we are I chair the Nominating & Governance Committee at the request of the Board. Our role is to ensure our Board and committee members have the right balance of skills, experience, independence and knowledge to effectively discharge their duties and responsibilities. We also oversee BT’s governance framework. Our members and their meeting attendance are set out below. The company secretary attends our meetings, as does the chief executive where appropriate. Committee members Member Sir Michael Rake (chairman) Tony Ball Iain Conn Isabel Hudson Nick Rose Meetings Eligible to attend Attended 5 5 5 5 5 5 5 5 5 5 What we’ve done We met five times this year. We spent a considerable amount of time discussing and agreeing the appointment of my successor. This process was led by Nick Rose as our senior independent director, who chaired the meetings when the appointment of my successor was discussed. In accordance with our proposals to Ofcom on the DCR, we discussed the independent appointments to the Openreach board, and approved the appointment of Mike McTighe as the first chairman of Openreach from January 2017. Mike is an experienced telecoms executive and brings a wealth of industry and regulatory knowledge to this role. Succession Our senior independent director, Nick Rose, led the process to find and appoint my successor. We engaged with external search consultants MWM Consulting to identify potential candidates. BT instructs MWM Consulting from time to time for search assignments, but they otherwise have no connection to the company. The committee discussed the process used to compile the candidate list, and agreed that MWM Consulting’s methodology and rationale were appropriate and that there was sufficient diversity in the proposed field of candidates. Nick Rose, Gavin Patterson and other Board members then met with potential candidates. MWM Consulting also commissioned an independent report from Montrose Associates, to provide a thorough profile on each candidate. Following this comprehensive process the committee was able to make a clear recommendation with which the Board agreed. As a result, I’m delighted to welcome Jan du Plessis as a non-executive director of the Board from 1 June 2017, before he becomes chairman on my retirement on 1 November 2017. Jan has led a number of high profile organisations, having been chairman of British American Tobacco, SABMiller and Rio Tinto. I wish Jan every success as he joins BT at this important time. Board membership We keep the composition of our Board under close review. In order to best serve all of our customers, we believe the composition of our Board should support diversity in its widest sense. As part of our gender diversity policy we aim to have at least 25% female representation on the Board. We currently have 27% female representation, with 3 female members out of 11. Gender diversity on our Board continues to be in line with the Davies Report target and we make sure that our external search consultants consider diversity as part of the candidate shortlisting process as we work towards Lord Davies’s new target of 33% female Board representation by 2020. Read more about BT’s approach to diversity on page 29. Our Board members each contribute individual knowledge, skills and experience, which we regularly review using a skills matrix. This covers the skills needed for running a listed company; knowledge and understanding of different customer sectors; industry specific knowledge; stakeholder engagement; and regional experience in different parts of the world. This year, we asked Board members to re-evaluate their own skills, and considered the skills we may wish to prioritise when evaluating potential new candidates. 116 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 117 We believe our Board currently has an appropriate composition and mix of skills and we continue to keep under review the retirement dates of our non-executive directors. The following table summarises our progress against the key areas of focus: This year, we recommended that Nick Rose’s appointment as senior independent director be extended for a further three-year term starting from 1 January 2017, and that Jasmine Whitbread’s appointment as a non-executive director should also be extended for a further three-year term starting on 19 January 2017. Nick did not participate in any discussions regarding his reappointment. The UK Corporate Governance Code states that any term beyond six years should be subject to a particularly rigorous review, therefore this recommendation followed a thorough appraisal of Nick’s and Jasmine’s performance. We concluded that both make a valuable and broad ranging contribution to the Board and the various committees of which they’re members, as well as to the business as a whole. We also reviewed Nick and Jasmine’s roles outside BT, and as a result we're confident that these don’t prevent either Nick or Jasmine from effectively discharging their Board responsibilities and making a full contribution in their roles. We were able to assure ourselves that Nick and Jasmine continue to be independent in character and judgement, and that there are no conflicts of interest that could affect their decision making. All non-executive appointments can be terminated on three months’ notice and are subject to automatic termination in the event of a director not being elected or re-elected by shareholders at the AGM. Governance structure and effectiveness We keep our governance structure and the membership of our Board committees under continuous review: – In light of the new Investigatory Powers Act passed in November 2016, we recommended that the Board approve the creation of an Investigatory Powers Governance Committee with immediate effect. This will help us to develop and refine our governance of investigatory powers requests so that we meet our new legal obligations and our human rights commitments. – After reviewing the terms of reference of this committee we recommended a change to allow any independent non-executive director to attend its meetings, unless the topic being discussed relates to their appointment. The Board approved this change in October 2016. – We also reviewed the terms of reference of our Regional Governance Committees (RGCs) which monitor governance and compliance in their respective regions. We approved a number of changes to help improve the effectiveness of the RGCs. Committee evaluation 2016/17 As part of our internal Board review in June 2016, we evaluated the committee’s effectiveness. Committee members, the chief executive and the group general counsel & company secretary completed an online questionnaire based on the committee’s terms of reference. We noted the results of the questionnaire in October 2016, and in March 2017 we reviewed our progress in addressing the various challenges and priorities it highlighted. KEY AREAS OF FOCUS ACTIONS Succession planning Chairman succession This has been a key focus of the committee this year; Nick Rose, our senior independent director has led the succession planning process. The impact of Ofcom’s DCR on Openreach and Group governance Openreach board In line with our proposals to Ofcom on the DCR, the committee received updates on the Openreach board appointment process. Mike McTighe’s appointment as chairman was approved by the committee and announced on 29 November 2016. The appointment of the remaining three independent non-executives was completed in January. Integrating BT’s and EE’s governance cultures post EE acquisition Integration Committee The Integration Committee oversees the integration of EE and BT, and has met four times this year. Governance arrangements for a non-independent non-executive director Conflicted Matters Committee The Conflicted Matters Committee reviews all Board papers and agenda items to make sure we don’t share any conflicted matters with the non- independent, non-executive director. The committee reviewed the role of the Conflicted Matters Committee at its meeting in March. Governance requirements for data privacy and data protection Investigatory Powers Governance Committee In December 2016, the committee recommended, and the Board subsequently approved, the formation of the Investigatory Powers Governance Committee. Its role is to make sure we balance our legal obligations under the new investigatory powers legislation, and our human rights commitments, particularly the right to privacy. Board evaluation 2017/18 In line with the UK Corporate Governance Code, we have commissioned an external evaluation of our Board effectiveness for 2017/18. We agreed that the company secretary would conduct the tender exercise and recommend an external facilitator to the chairman. Following the tender exercise, we chose ‘Independent Board Evaluation’ to conduct the evaluation, which comprised an interview with each Board member, and observations of the Board and certain committees. The review focused on Board accountability and composition, the Board’s role in setting strategy, risk management, succession planning, and the effectiveness of the Board committees. The evaluation took place in March and April 2017. The Board will receive a full report in June 2017, and will discuss the results at a future Board meeting. The chairman will also conduct one-to-one interviews with directors on their individual performance and the senior independent director, Nick Rose, will conduct the annual evaluation of the chairman. Sir Michael Rake Chairman of the Nominating & Governance Committee 11 May 2017 116 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 117 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION BT Pensions Committee Chair’s report “ During the year the committee focused on a number of areas, including how we’ll approach the 30 June 2017 valuation, and the potential implications of Ofcom’s Strategic Review of Digital Communications for our pension arrangements.” Who we are I chair the BT Pensions Committee. We’re responsible for BT’s interactions with the Trustee of the BT Pension Scheme (BTPS). The BTPS is a defined benefit pension scheme with around 300,000 members. It pays out over £2bn a year of pensions and has liabilities of around £60bn. I’d like to welcome Simon Lowth who joined the committee during the year. I’d also like to thank Tony Chanmugam, who stepped down on 13 July 2016, for his contribution to the committee’s work. Our membership and meeting attendance are set out below. Committee members Member Isabel Hudson (chair) Sir Michael Rake Simon Lowtha Alison Wilcox Tony Chanmugamb Meetings Eligible to attend Attended 6 6 4 6 2 6 5 4 6 2 a Simon Lowth was appointed to the committee from 12 July 2016. b Tony Chanmugam retired from the committee on 13 July 2016. Further information You can find out more about BT’s pension schemes in note 20 to the accounts. What we’ve done BT management provides regular updates on BT’s performance and strategy at BTPS Trustee meetings, and held extra sessions with the Trustee Board over the course of the year, including reporting on Ofcom’s Strategic Review of Digital Communications. We met six times during the year. The chart below shows how we allocated our time. Allocation of time 38% Risk management and investment performance 5% Other 8% BTPS administration 18% Governance, legal and regulatory 31% Funding Areas of work Key areas of work carried our in the year include: Risk management and investment strategy: At each meeting we reviewed the investment performance and risk associated with the BTPS. During the year we agreed enhancements to the Trustee’s reporting of investment performance and strategy to the committee. We received an improved information pack, updated each quarter, together with presentations from the BTPS management team every six months. Investment return was around 21% for the year to 31 March 2017. We reviewed the BTPS’s approach to reducing risk over the year, which included increasing its interest rate and inflation hedging levels. Over the course of the year we provided views to the Trustee on various elements of the investment strategy, including the Trustee’s approach to hedging. We also received a presentation from the CEO of Hermes – the investment management company wholly owned by the BTPS – on its financial performance and future strategy. Funding: We received regular updates on the development of the funding position throughout the year. We also started planning our approach to the next funding valuation that will take place as at an effective date no later than 30 June 2017, including how we might deal with an increased deficit given the continued low interest rate environment. Governance, legal and regulatory: We looked at the potential impact of Ofcom’s Strategic Review of Digital Communications on the BTPS. We also dealt with other governance matters, including reviewing trustee appointments. BTPS administration: We monitored BTPS Trustee progress on improving administration services to members. Isabel Hudson Chair of the BT Pensions Committee 11 May 2017 118 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 119 Committee for Sustainable and Responsible Business Chairman’s report 2020 ambitions. We’re focused in particular on the central role that we can play in shaping the world’s digital future, and how we can energise and inspire all of our people to help deliver our purpose, so that it becomes fully part of our culture at all levels. The chart below shows how we allocated our time. Allocation of time 33% Strategy and governance 9% Delivering environmental benefits 11% Volunteering 13% Supporting charities and communities 17% Creating a connected society 17% Engagement and advocacy The CSRB met twice this year and visited the EE contact centre in Merthyr Tydfil. As well as spending time with our employees, we saw how The Supporters Club is helping local schools by combining fun, action-packed rugby sessions with education pathways and mentoring sessions to drive social change. This year, we made an investment in society of £35.6m, made up of a mix of cash, time volunteered by BT people and in-kind contributions. 2020 Ambitions We’re making good progress toward our 2020 ambitions. We helped 3.9m people to overcome social disadvantage through our services in 2016/17, and since 2012, we’ve used our skills and technology to generate £422m for good causes. By 2020, we hope to have raised £1bn in total. To find out more about on our 2020 ambitions and our progress so far, please see BT’s Delivering Our Purpose Report 2016/17. Tech Literacy As part of our commitment to help build a culture of tech literacy in the UK, we’re on track to reach 5m kids by 2020. Through the Barefoot Computing Project, which brings computer science alive across the curriculum, we’ve already reached over 1m primary school children. This year we’ve helped over 2050 young people, many from disadvantaged backgrounds, get better prepared for the world of work through our Work Ready programme and partnership with the Rio Ferdinand Foundation. Volunteering Our people are essential to help us create a lasting positive impact on society and the environment; that’s why we offer them up to three volunteering days a year. To support this we’ve launched a new volunteering portal to make it easier for them to find opportunities and register their volunteering time. In 2016/17, over 31.8% of BT people volunteered over 39,000 days, worth over £11.5m to support charities and communities around the world. Find out more information about volunteering on page 29. Sir Michael Rake Chairman of the Committee for Sustainable and Responsible Business 11 May 2017 “ BT’s purpose is to use the power of communications to make a better world. This remains at the heart of everything we do and inspires our customers, partners and employees to make a lasting, positive impact on society and the environment.” Who we are I chair the Committee for Sustainable and Responsible Business (CSRB). Our membership and meeting attendance are set out below. Committee members Member Sir Michael Rake (chairman) Tony Chanmugama Niall Dunneb Phil Hodkinsonc Baroness Margaret Jayc,d Lisa MacCallumc,e Gavin Neathc,f Gavin Patterson Gunhild Stordalenc,g Jasmine Whitbread Alison Wilcoxb Meetings Eligible to attend Attended 2 1 2 2 2 2 2 2 2 2 2 2 0 2 2 2 2 2 2 0 2 2 a Tony stepped down from the CSRB from 13 July 2016. b BT employee. c Independent member. d Margaret stepped down from the CSRB from 14 April 2017. e Lisa was appointed to the CSRB from 6 July 2016. f Gavin stepped down from the CSRB from 31 December 2016. g Gunhild was unfortunately unable to attend meetings this year due to poor health. She receives the materials for the meetings and feeds back her comments to the chairman. I’m pleased to welcome Lisa to the CSRB, who brings a fresh new perspective. It is with regret that we say goodbye to Tony Chanmugam, Gavin Neath and Baroness Margaret Jay; on behalf of the CSRB I would like to thank all three for their contribution over the years. What we’ve done We’ve continued to bring our purpose to life through our Purposeful Business strategy, as well as monitoring our progress towards our 118 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 119 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Technology Committee Chairman’s report What we’ve done We met twice this year. The chart below shows how we allocated our time. Allocation of time 19% Governance 24% Future technology 37.61% 31.62% 17.95% “ We’re proud of the role BT plays in shaping the success of the UK’s digital economy. Our ambition is to be the first to build a truly converged fixed and mobile network. We want to give our customers a seamless service on a trusted network with the best connectivity.” Who we are I chair the Technology Committee. Our role is to agree the development and implementation of BT’s technology strategies, and oversee technology risk management across the group. This table shows our membership and meeting attendance. Committee members Member Gavin Patterson (chairman) Tony Ball Iain Conn Mike Inglis Karen Richardson Howard Watson Meetings Eligible to attend Attended 2 2 2 2 2 2 2 2 2 2 2 2 19% Technology risk 38% Technology strategy Technology strategy This year, we reviewed our ultrafast broadband programme, which is on track to deliver G.fast technology to 10m homes, with an ambition to deliver Fibre to the Premises (FTTP) to a further 2m locations by 2020. We looked at ways we will improve the capability and agility of our core IP network, and agreed our vision for 5G mobile services. Future technology It’s important we understand emerging future technologies, to identify potential opportunities for investment and growth. We spent time looking at the future of mobile, the Internet of Things and other emerging technologies such as transportation and finance technology. Cyber security The threat of cyber-attacks has continued to increase this year, as we see attacks growing in both scale and sophistication. We receive regular updates on cyber security to improve our understanding of the nature of these attacks, and how to prevent them. We’ve several major programmes underway to help us protect our systems, people and customers. Our focus is on prevention, so we’re working to detect pro-actively and repair vulnerabilities in our systems and networks. Gavin Patterson Chairman of the Technology Committee 11 May 2017 120 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 121 Integration Committee Chairman’s report “ I’m pleased with the progress we’ve made this year integrating EE and BT. We can now offer exciting converged propositions such as BT Sport to EE customers and Plusnet Mobile, and we’re realising the cost savings and efficiencies set out in our deal case.” Who we are I chair the Integration Committee. We oversee the integration of EE and BT, including monitoring progress towards financial synergy targets, creating a fit for future organisation, improving customer experience, and integrating the cultures of the two organisations. Our membership and meeting attendance are set out below. The group HR director and integration project director, although not members of the committee, attend meetings at my invitation. What we’ve done We met four times this year. This chart below shows how we allocated our time. Allocation of time 20% Financial performance and synergies 11% Governance 14% People and culture 17% Technology 19% Customers 19% Strategy The first year of our integration has gone well. We’ve delivered £152m of run rate cost synergies, which is higher than our public commitment of £100m in year 1. We’ve successfully launched converged propositions such as BT Sport for EE customers and Plusnet Mobile, which support our strategy of improving our entire customer experience. We want the combined EE and BT to remain a great place to work, with exciting opportunities for development. There are many things we can learn from each other, so we’re using a ‘best of both’ approach to integrate EE and BT’s cultures and policies. In 2017/18, our priorities are to: – continue to launch converged propositions to improve our customers’ experience; – deliver revenue and cost synergies; – continue to integrate the two organisations and cultures to create a brilliant place to work; and – preserve EE’s tax losses through the integration activities. Committee members Member Gavin Patterson (chairman) Tony Ball Thomas Dannenfeldta Simon Lowth Nick Rose a Deutsche Telekom member. Meetings Eligible to attend Attended Gavin Patterson Chairman of the Integration Committee 11 May 2017 4 4 4 4 4 4 4 4 4 4 120 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 121 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Report on Directors’ Remuneration Application of malus due to Italian issues: In January we published revised results for 2014/15 and 2015/16 after our investigations into accounting irregularities in our Italian business. The committee has recalculated the annual bonuses for the years in question and the outcome of vesting for the 2013 ISP to reflect the revised results. This clearly showed that the payouts based on the revised results would have been lower than those actually paid at the time. The committee has therefore decided to exercise its discretion and apply the malus provisions in the Deferred Bonus Plan to reduce the number of shares under award, for the executive directors, plus the Operating Committee members who received payments under the bonus arrangements and/or the ISP, and for the company secretary. This action ensures the restitution of overpayments to these recipients and places them in the same position they would otherwise have been in had the awards been based on the revised results. Further details are shown on page 133. The committee will keep under active review whether any additional employees’ awards should be adjusted. In addition, where employees have been dismissed or resigned as a result of our investigations into the issues in Italy, shares and incentives have been lapsed in full as a result. Looking ahead The committee considered the base salaries of the executive directors in the context of the UK employee population. We have agreed a 2.1% annualised pay settlement for our team members in the UK. However, the budget for increases for our managerial and professional team will be lower than this and any increases will be more targeted and discretionary. The executive directors’ salaries will remain unchanged. Good progress has been made on the integration of the EE business and the realisation of the associated cost synergies. As we move into the second year of integration, the committee is satisfied that EE is well embedded into the business, such that it is now business-as- usual, and has elected to remove the specific integration synergy target and increase the weighting of the earnings per share and free cash flow targets for the annual bonus for 2017/18. Finally, we agreed the remuneration package for the incoming chairman, Jan du Plessis, who joins the board on 1 June and becomes chairman on 1 November, the details of which are set out on page 135. This remuneration arrangement will remain fixed for five years. Renewal of Remuneration Policy Throughout the year we have continued to operate within the shareholder approved Remuneration Policy. We have conducted a comprehensive review of the Policy ahead of the 2017 AGM where shareholders will again have the opportunity to vote on it. The committee has concluded that the existing Policy (with some minor changes), remains aligned to the business strategy and current best market practice and therefore no material changes are proposed. The committee continues to maintain the link between pay and performance and remains committed to doing so in the future. Tony Ball Chairman of the Remuneration Committee 11 May 2017 Review of the year The past year has been challenging. Although good progress has been made in a number of areas unfortunately our performance has been significantly affected by the accounting irregularities in our Italian business, the issues that arose in Openreach around Deemed Consent and the significant challenges we faced in the UK public sector and international corporate markets. Our adjusted EBITDA was £7,645m compared with our initial outlook for the year of around £7.9bn and our normalised free cash flow was £2,782m compared with our initial outlook for the year of £3.1bn to £3.2bn. We have also seen a 28% fall in the share price over the last year. Outcomes for the year The committee has made a number of difficult decisions this year in light of these circumstances and these are summarised below. 2016/17 Bonus: The annual bonus is determined by a number of factors including profit, cash flow, revenue, customer experience and EE integration synergies. The threshold targets for revenue, customer experience and for the EE synergies were achieved. However the committee used its discretion to reduce the bonus payable to the group chief executive and outgoing group finance director to zero. In the case of the new group finance director, Simon Lowth, who joined the company in July 2016, the committee has calculated a bonus based on the formulaic outcome of the company performance measures and an assessment of his personal performance. This resulted in an annual bonus of 38.2% of maximum for Simon Lowth. Details of the outcome of performance against the targets for the 2016/17 annual bonuses for the group chief executive, the new group finance director and the outgoing group finance director are set out on page 126. 2014–2017 ISP vesting: The group returned below threshold performance against all of the performance measures for the 2014 ISP. This resulted in none of the shares under the award vesting. More information on the 2014 ISP is on pages 126 to 127. 2017–2020 ISP award: The level of ISP award for the chief executive was reduced from 400% of salary to 350% of salary for this year in light of the share price fall over the last year. 122 BT Group plcAnnual Report 2017THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Focus on Remuneration Fixed pay Base salary Pension Other benefits Annual bonus* 2016/17 maximum award 2016/17 performance measures No increases for executive directors in 2017/18. Base salaries during the year were Gavin Patterson £996,825, Simon Lowth £700,000 and Tony Chanmugam £646,000. Pension arrangements during the year were the same for all executive directors, each receiving a cash allowance of 30% of salary. There are no changes proposed to the pension arrangements for 2017/18. Benefits include company car, fuel or driver, personal telecommunication facilities and home security, medical and dental cover (for the directors and immediate family), life cover, professional subscriptions, personal tax advice and financial counselling. There are no changes proposed to the benefit framework for 2017/18. The maximum level of bonus opportunity was 240% for the chief executive, 210% for the outgoing group finance director (pro-rated for time) and 180% for the new group finance director (pro-rated for time). Group performance was based on: – 60% financial (adjusted earnings per share, normalised free cash flow, revenue (excluding transit) and integration synergies) – 40% non-financial (personal objectives and customer experience) Deferral One-third of the bonus is deferred into shares for three years. Award in respect of 2016/17 Changes for 2017/18 Despite some of the performance targets being met, the committee exercised discretion and determined that no bonus would be awarded to the chief executive and the outgoing group finance director and a bonus representing 38.2% of maximum would be awarded to the new group finance director. No changes are being proposed to the maximum bonus opportunities. Now that EE is well embedded into the business, the committee has elected to remove the integration synergy measure and increase the weightings of the earnings per share and free cash flow measures. Incentive Share Plan (ISP)* 2016/17 maximum award The Policy provides for a maximum annual ISP award of 500% for an executive director. The chief executive received an award of 400% of salary. The new group finance director received an award of 350% of salary. No award was made to the outgoing group finance director. 2016/17 performance measures Awards are subject to performance conditions: 40% based on relative TSR, 40% based on normalised free cash flow and 20% based on growth in underlying revenue excluding transit adjusted for the acquisition of EE over a three year period. Vesting of 2014 award The 2014 ISP lapsed in May 2017 as the threshold target was not met for any of the performance conditions. Changes for 2017/18 The award to the chief executive will be reduced from 400% of salary to 350% of salary as a result of the share price fall over the last year. It is expected that the award level will return to 400% in 2018. The award to the group finance director will remain at 350% of salary. No changes are proposed to the performance measures or operation of the ISP for awards to be granted in 2017/18. Shareholding Shareholding requirements The chief executive is required to build up a holding equal to 300% of salary and the new group finance director a holding of 250% of salary. Malus and clawback Application of malus and clawback In the context of the publication of revised results for 2014/15 and 2015/16, the committee has exercised its discretion and applied malus to outstanding deferred bonus awards to ensure restitution of overpayments of previous incentive awards. * Annual bonus and ISP awards are subject to malus and clawback provisions in certain circumstances. The ISP has an additional holding period of two years post vesting. More detail is available on page 145. Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 123 123 Remuneration Principles Our remuneration principles are to maintain a competitive remuneration package that promotes the long-term success of the business, avoids excessive or inappropriate risk taking and aligns managements’ interests with those of shareholders. We believe in pay for performance against challenging targets and stretching goals for the annual bonus (including deferred shares) and long-term incentive shares. A significant proportion of the total remuneration package is therefore variable and linked to corporate performance. The committee determines the remuneration policy for the executive directors and the chairman. The chairman is not currently a member of the committee. The committee reviews the performance targets regularly to ensure that they are both challenging and closely linked to the group’s strategic priorities. Furthermore, because a large part of the remuneration package is delivered in shares and senior executives are required to build up a significant shareholding themselves, they are directly exposed to the same gains or losses as all other shareholders. In setting directors’ remuneration, the committee takes account of the pay and employment conditions of all our employees, the performance of the group and the individual, the current views and guidelines of shareholders and their representatives, and general market conditions. Remuneration arrangements at other companies of a similar size and complexity are also reviewed for guidance. The committee continues to keep under review the relationship of risk to remuneration. The chair of the Audit & Risk Committee is currently a member of the Remuneration Committee. The committee is also satisfied that the incentive structure for senior executives does not raise environmental, social or governance risks by inadvertently motivating irresponsible behaviour. Part of the annual bonus depends upon an assessment of each senior executive’s personal contribution which typically includes the environmental, social, health and safety and governance agenda. The committee retains absolute discretion to reduce variable compensation in light of risk and the group’s overall performance. We would only use this in exceptional circumstances. 124 BT Group plc Annual Report 2017 Executive Directors G Pattersonf S Lowthg Non-executive directors T Ball I Conn T Höttgesh I Hudsoni M Inglisi K Richardsonj N Rosei J Whitbread Sub-total Former executive director T Chanmugamk Total Annual Remuneration Report This part of the Report summarises key elements of the directors’ remuneration in 2016/17. Single figure remuneration The following sets out the full review of directors’ emoluments, including bonus and deferred bonus, and long-term incentive plans and pension arrangements. Directors’ emoluments (audited) Directors’ emoluments for the financial years 2016/17 and 2015/16 are set out in the table below. Basic salary and fees (2016/17) £000 Basic salary and fees (2015/16) £000 Benefits excluding pension (2016/17) £000 Benefits excluding pension (2015/16) £000 Annual Bonusa,b (2016/17) £000 Annual Bonusa (2015/16) £000 ISPc (2016/17) £000 ISPd (2015/16) £000 Pension allowance net of pension contributionse (2016/17) £000 Pension allowance net of pension contributionse (2015/16) £000 Chairman Sir Michael Rake 675 675 Total 2016/17 £000 Total 2015/16 £000 710 706 31 57 – 16 35 54 17 1 1 18 2 993 499 124 121 – 179 86 126 159 102 969 – 112 103 – 99 47 114 152 97 – 343 1,057 – – – 2,906 – 298 151 291 – 1,345 1,010 5,280 – 124 121 – 180 87 144 161 102 112 103 – 99 47 130 152 97 3,064 2,368 128 104 343 1,057 184 643 3,248 3,011 19 147 32 136 – 587 343 1,644 – – – 2,906 449 291 3,984 6,726 1,351 4,257 55 504 193 484 258 4,242 2,806 9,532 a Annual bonus shown includes both the cash and deferred share element as reported in the 2015/16 Remuneration Report. The deferred element of the 2016/17 bonus includes the value of deferred shares to be granted in June 2017. Further details of the deferred element are set out below. b As a result of investigations into improper accounting practices in BT’s Italian business, the committee has exercised its discretion and applied the malus provisions under the Deferred Bonus Plan. This will be applied in 2017/18 and reflected in the single figure table in the Annual Report 2018. Further details can be found on page 133. c The ISP 2014 granted in June 2014 will lapse in full. Further details are provided on pages 126 to 127. d Vesting of ISP 2013 granted in June 2013 and vested in May 2016 at a share price of £4.45. The value shown last year of £3,022 for the chief executive and £1,405 for the then group finance director were based on an estimated share price of £4.63. Additional disclosures relating to the single figure table Salaries We reviewed Gavin Patterson’s salary and increased it to £996,825 in June 2016. This was an increase of 2.5% from the prior year. The salary increase was consistent with the approach taken for substantially all of our UK employees who received an average increase of 2.5%. No salary increase was made to Tony Chanmugam in light of his stepping down during the year. We agreed Simon Lowth’s salary (£700,000) at the time of his appointment in July 2016. Benefits Benefits provided to executive directors and the chairman include company car, fuel or driver, personal telecommunication facilities and home security, medical and dental cover (for the directors and immediate family), life cover, professional subscriptions, personal tax advice and financial counselling. e Pension allowance paid in cash for the financial year – see ‘Total pension entitlement’ on page 127. f The 2015/16 ISP figure reflects two awards granted in 2013. One as CEO BT Retail and one as chief executive. g Simon Lowth was appointed as a director on 12 July 2016. h Under the terms of the Relationship Agreement between BT and Deutsche Telekom and Tim’s letter of appointment, no remuneration is payable for this position. i Value shown relates to reimbursement of reasonable travelling and other expenses (including any relevant tax) incurred in carrying out their duties. j Includes an additional fee for regular travel to Board and Board Committee meetings. k Tony Chanmugam retired as a director on 13 July 2016. Under the terms of his service contract, he continued to receive his salary and contractual benefits until the end of his notice period, being 31 March 2017. Further details are provided on page 128. Annual bonus The annual bonus opportunities for the executive directors in 2016/17 were as follows: Level of 2016/17 bonus Chief executive New group finance director Outgoing group finance director Annual cash bonus Target 80% of salary Target 80% of salary Target 70% of salary Maximum 160% of salary Maximum 120% of salary Maximum 140% of salary Deferred bonus in shares Target 40% of salary Target 40% of salary Target 35% of salary Maximum 80% of salary Maximum 60% of salary Maximum 70% of salary Total bonus Target 120% of salary Target 120% of salary Target 105% of salary Maximum 240% of salary Maximum 180% of salary Maximum 210% of salary 125 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Annual Remuneration Report continued The bonus payment for the outgoing group finance director is pro- rated in respect of the period for which he was performing full-time duties. The bonus payment for the new group finance director is pro-rated in respect of the period for which he was in full-time employment. One third of any bonus paid is deferred into shares for three years with the remaining two-thirds paid in cash. The weighting of the annual bonus structure for 2016/17 is set out below. Simon Lowth achieved 80% of the maximum score for his personal contribution. The result for the personal contribution score was for significant contribution to commercially sensitive strategic programmes. As set out in the table opposite, the committee applied the EPS gateway and no payment was made in respect of the customer experience performance. This resulted in a total annual bonus, paid in both cash (two-thirds) and deferred shares (one-third) representing 68.8% of his salary (pro-rated to reflect the period he was in full-time employment during the year) and 38.2% of the maximum opportunity. The deferred shares will be granted in June 2017. Chief Executive and Group Finance Director % Weighting 20% Adjusted earnings per share 20% Personal objectives 20% Customer experience 10% Integration synergies 10% Revenue (excluding Transit) 20% Normalised free cash flow As a result of the accounting irregularities in our Italian business, the issues that arose in Openreach around Deemed Consent and the significant challenges we faced in the UK public sector and international corporate markets, the committee has exercised its discretion and moved not to award bonuses to the chief executive and the outgoing group finance director in respect of 2016/17 despite some of the performance targets being met. The table below provides an overview of performance against the targets for the 2016/17 annual bonus. Measure Adjusted EPS (p)b Normalised free cash flow (£m)c Revenue (£m)d Threshold Target Maximum Outcome Result % of maxa 30.9 32.5 34.9 28.9 0% 3,064 3,225 3,467 2,782 0% 23,661 23,900 24,259 23,678 26.7% 111 117 126 152 Integration synergies Customer experiencee 50 a Threshold represents 25% of maximum. Target represents 50% of maximum. b Adjusted EPS is defined on page 21. c Normalised free cash flow is defined on page 21. d Revenue is defined on page 20. e The committee applied the EPS gateway and no payment was made to executive directors in respect of Customer Experience performance. 100 200 124.33 62.2% 100% As described above, the committee moved not to award bonuses to the chief executive and the outgoing group finance director in respect of 2016/17. The chief executive and outgoing group finance director both understood the committee’s decision not to award a bonus and indicated that they would not have accepted a bonus should one have been approved. For Simon Lowth, the new group finance director who joined the company in July 2016, the committee calculated a bonus based on the formulaic outcome of the company performance measures and an assessment of his personal performance. 126 Bonus award and proportion of value Element of bonus EPS Normalised free cash flow Revenue growth Intergration synergies Customer experiencec Gavin Patterson Simon Lowtha Tony Chanmugamb 0% 0% 0% 0% 0% 0% 0% 9.25% 34.9% 0% 0% 0% 0% 0% 0% Personal contribution a New group finance director. b Outgoing group finance director. c The committee applied the EPS gateway and no payment was made to executive directors in respect of Customer Experience performance. 55.85% 0% 0% Incentive share plan 2014 The ISP is a conditional share award. The performance conditions are assessed to 31 March 2017 and the awards would ordinarily vest in May 2017. The performance conditions are based 40% on relative TSR, 40% on normalised free cash flow, and 20% on growth in underlying revenue excluding transit over a three-year performance period. The threshold performance target in respect of each measure was not met and therefore the awards will lapse in full. TSR The TSR element is measured against a comparator group containing other telecommunications companies and companies which are of a similar size or market capitalisation, have a similar business mix and spread as BT or operate in comparable markets. BT’s TSR comparator group for the 2014 ISP comprised the following companies: Accenture AT & T Belgacom IBM Telefónica National Grid Telekom Austria Pharol (formerly Portugal Telecom) Telenor Cap Gemini Royal KPN TeliaSonera Centrica Sky Deutsche Telekom Swisscom France Telecom TalkTalk Hellenic Telecom Telecom Italia Verizon Vodafone The TSR for a company is calculated by comparing the return index (RI) at the beginning of the performance period with the RI at the end of the period. The RI is the TSR value of a company measured on a daily basis, as tracked by independent analysts, Datastream. BT Group plcAnnual Report 2017 It uses the official closing price for a company’s shares, adjusted for all capital actions and dividends paid. The initial RI is determined by calculating the average RI value taken daily over the three months prior to the beginning of the performance period; and the end value is determined by calculating the average RI over the three months up to the end of the performance period. This mitigates the effects of share price volatility. A positive change between the initial and final values indicates growth in TSR. The following graph shows the vesting schedule for the TSR element of the 2014 ISP awards. TSR vesting schedule 2014 awards g n i t s e v d r a w a e r a h s f o % 40% 20% 0% 0 5 10 15 20 25 TSR ranking position The company’s TSR performance was -5.63%. This was 18th out of 23 companies during the three-year period and resulted in the threshold target for TSR not being met. Normalised free cash flow When we set the performance measures for the 2014 ISP, the threshold for the three-year cumulative normalised free cash flow was set above consensus market expectations at the time, with the upper part of the range considered to be stretching. Following completion of the EE acquisition in January 2016, the free cash flow measure was revised to reflect the enlarged group. We disclosed the adjustment in the 2016 Annual Report. We achieved a three-year cumulative normalised free cash flow outcome of £8.4bn. This resulted in the threshold target of £8.67bn for normalised free cash flow not being met. Underlying revenue excluding transit This measure reflects the group’s aim to drive sustainable profitable revenue growth. Following completion of the EE acquisition in January 2016, the revenue measure was revised to reflect the enlarged group. The measure excludes specific items, foreign exchange movements and disposals and is calculated as though EE has been part of the group from 1 April 2015. We disclosed the adjustment in the 2016 Annual Report. The measure was based on growth in underlying revenue excluding transit measured against the baseline of 2013/14, with the threshold set as growth of 2.35% cumulative over the three years. Over the three-year period we grew underlying revenue by 1.39%, resulting in the threshold target for revenue not being met. Total pension entitlements (audited) The BT Pension Scheme (BTPS) closed to new entrants on 31 March 2001. None of the executive directors participate in future service accrual in the BTPS. Tony Chanmugam has deferred benefits in the BTPS and benefitted from death in service cover which has now ceased. New UK employees are eligible to join a defined contribution scheme. These are typically personal pension plans. For executive directors, the company agrees to pay a fixed percentage of the executive’s salary each year which can be put towards the provision of retirement benefits. Executive directors who have never been members of the BTPS benefit from death in service cover that would provide a lump sum of four times salary and a dependant’s pension of 30% of capped salary. Gavin Patterson receives an annual allowance equal to 30% of salary in lieu of pension provision as set out in the table on page 125. Gavin has previously been a member of the BTRSS but neither he nor the company has made any contribution to the scheme during 2016/17. BT also provides death in service cover of a lump sum of four times his salary plus a dependant’s pension of 30% of his capped salary. Simon Lowth receives an annual allowance equal to 30% of salary in lieu of pension provision as set out in the table on page 125. Simon has not previously been a member of any of the company pension schemes. BT also provides death in service cover of a lump sum of four times his salary plus a dependant’s pension of 30% of his capped salary. Tony Chanmugam was not a contributing member of any of the company pension schemes; he did not accrue any BTPS pension over the financial year and no other contributions were made. Further information is provided in the table below. The company agreed to pay him an annual amount equal to 30% of salary in lieu of pension provision as set out in the table on page 125. Tony still had deferred payment of the BTPS benefit payable from his 60th birthday. BT provided death in service cover of a lump sum of four times his salary which would cease if his BTPS benefits were put into payment. Sir Michael Rake is not a member of any of the company pension schemes, and the company made no payments towards retirement provision for him. BT provides him with a lump sum death in service benefit of £1m. Deferred pension benefits at 31 March 2017 (audited) The table below shows Tony Chanmugam’s pension benefits at 31 March 2017. There was no pension accrued over the financial year and no contributions were made into the pension plans. Normal retirement age Accrued pension (£000) Additional scheme lump sum (£000) Tony Chanmugama 60 258 775 a Tony Chanmugam’s contributions in 2016/17 were £nil (2015/16: £nil). Figures represent total benefits accrued across two BT pension schemes. Tony is beyond the pension plans’ normal retirement age and is not drawing a pension. 127 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Annual Remuneration Report continued Awards granted during the year (audited) 2016 ISP awards The 2016 ISP awards were made in June and July 2016 as set out below and on page 131. The award to Gavin Patterson represented 400% of his salary and for Simon Lowth it was 350% of salary. No award was made to the outgoing group finance director. Director Gavin Patterson Simon Lowth Date of award ISP award (shares) Face value of awarda 20 June 2016 988,954 £3,987,297 Deferred shares A proportion of the 2015/16 annual bonus was awarded in deferred shares. The table below provides further details. No award was made to the new group finance director, having joined in July 2016. Director Date of award DBP award (shares) Face value of awarda Gavin Patterson 20 June 2016 87,412 £352,430 Tony Chanmugam 20 June 2016 48,564 £195,802 a Face value based on share price at grant of 403.18p. The grant price is calculated using the 29 July 2016 604,366 £2,449,978 average middle-market price of a BT share for the three days prior to grant. a Face value based on share price at the date of grant of 403.18p and 405.38p respectively. The grant price is calculated using the average middle-market price of a BT share for the three days prior to grant. The performance conditions are based 40% on relative TSR, 40% on normalised free cash flow, and 20% on growth in underlying revenue excluding transit over a three-year performance period from 1 April 2016 to 31 March 2019. The performance conditions are the same for each director. The target ranges for TSR; the normalised free cash flow and underlying revenue growth excluding transit for the three-year performance period 2016/17–2018/19 is set out in the table below. TSR vesting schedule 2016 awards 40% 20% g n i t s e v d r a w a e r a h s f o % 0% 0 5 10 15 20 25 TSR ranking position Measure 2016/17–2018/19 Threshold Level of vesting Maximum Level of vestinga Normalised free cash flow Revenueb growth £10.7bn 2.1% 25% 25% £11.7bn 7.6% 100% 100% a Vesting levels between threshold and maximum will be on a straight line basis. b Underlying revenue excluding transit. The committee believes that the free cash flow and revenue performance measures are challenging, and the financial performance necessary to achieve the upper end of the range for each target is stretching. Please see pages 126 to 127 for details of how TSR is calculated. With one change, the TSR comparator group for the 2016 ISP awards was the same for awards granted in June 2015. The committee agreed the removal of Pharol (formerly Portugal Telecom) on the basis of scale compared to others in the group. When ISP awards vest, additional shares representing the value of reinvested dividends on the underlying shares are added. 128 The deferred shares are not subject to further performance conditions and normally vest in three years if the individual is still employed by BT. Details of all interests in deferred shares are set out on page 130. When Deferred Bonus Plan (DBP) awards vest, additional shares representing the value of reinvested dividends on the underlying shares are added. Former directors (audited) Sir Peter Bonfield received, under pre-existing arrangements, a pension of £482,762 in 2016/17 (2015/16: £477,038). Baroness Jay retired as a non-executive director on 13 January 2008 and was a member of the Committee for Sustainable and Responsible Business until standing down on 14 April 2017. She received an annual fee of £10,000 as a member of the Committee for Sustainable and Responsible Business. Phil Hodkinson retired as a non-executive director on 31 January 2016 but continues to be a member of the Committee for Sustainable and Responsible Business, for which he receives an annual fee of £10,000. Payments for loss of office (audited) Tony Chanmugam retired as a director on 13 July 2016. Under the terms of his service contract, he continued to receive his salary and contractual benefits until the end of his notice period, being 31 March 2017. These payments totalled £462,000 basic salary and fees, £15,000 benefits (excluding pension) and £139,000 pension allowance. As outlined above, no payment will be made in respect of his 2016/17 annual bonus. All payments made to him as a director in respect of 2016/17 are reported in the single figure of remuneration on page 125. Directors’ share ownership The committee believes that the interests of the executive directors should be closely aligned with those of shareholders. The deferred shares and incentive shares provide considerable alignment. To increase the alignment between shareholders and executive directors, the chief executive is required to build up a shareholding equal to 300% of salary, and the new group finance director 250% of salary. The aim of this personal shareholding policy is to encourage the build up of a meaningful shareholding in the company over time by retaining shares which they have received under an executive share plan (other than shares sold to meet a National Insurance contribution or income tax liability) or from purchases in the market. The value of the BT shares to be used in determining whether the minimum shareholding requirement has been reached is the average BT share price over the preceding 12 months or, if higher, the share price at the acquisition date. BT Group plcAnnual Report 2017 At 31 March 2017, the chief executive met his shareholding requirement, as set out in the table below. Having joined the company in July 2016, the group finance director will build his shareholding over time. Executive director Gavin Patterson Simon Lowth Tony Chanmugama a As at 13 July 2016. Personal shareholding as a percentage of salary 1,103% 0% 216% The following table shows the total unvested interests held by the executive directors in the ISP and DBP. The numbers represent the maximum possible vesting levels. The ISP awards will only vest to the extent the performance conditions are met over a three-year period. Full details of all ISP and DBP awards, including performance periods and vesting conditions, are set out on pages 130 to 131. Unvested interests in shares (audited) ISP (subject to performance) DBP (not subject to performance) 1 April 2016 31 March 2017 1 April 2016 31 March 2017 – 376,092 3,046,654 2,734,526 Gavin Patterson Simon Lowtha Tony Chanmugamb a Simon Lowth was appointed to the Board on 12 July 2016. Details of Simon Lowth’s ISP and DBP awards are set out on pages 130 to 131. b Tony Chanmugam retired on 13 July 2016 and the number reflects his awards at that date. Details of Tony Chanmugam’s ISP and DBP awards are set out on pages 130 to 131. 1,270,600 900,663 337,943 628,928 245,143 334,944 – – The table below shows share options held by the directors under the company’s all employee sharesave plans as at 31 March 2017. None of the directors held share options with performance conditions. Share options held without performance conditions – saveshare (audited) Directors’ interests at 31 March 2017 or date of retirement, if earlier (audited) The beneficial interests of directors holding office at the end of the year (or at the point of leaving for directors who retired during the year), and their families, in the company’s shares at 31 March 2017 and 1 April 2016, or at date of appointment if later, are shown below: Beneficial holdings Sir Michael Rakea G Pattersona T Chanmugama,b S Lowthc T Ball I Conn T Höttges I Hudson M Inglis N Rose K Richardsond J Whitbread Number of shares 31 March 2017 1 April 2016 148,721 132,957 2,871,032 2,448,772 310,684 445,268 – 93,871 19,442 – 8,424 2,600 125,000 13,525 7,990 – 23,652 4,442 – 3,552 1,200 50,000 10,250 7,990 3,601,289 Total a Includes shares purchased under directshare and free shares awarded under UK allshare. Directshare is a HMRC approved plan that allows BT employees to buy shares out of gross pay. Prior to 2008 BT awarded free shares to UK employees (UK allshare). b Tony Chanmugam retired on 13 July 2016 and the number reflects his holding at that date. c Simon Lowth joined the Board on 12 July 2016. d Shares are held as 2,705 American Depositary Shares (ADS). One ADS equates to five BT ordinary shares. 3,128,083 During the period from 1 April 2017 to 11 May 2017, there were no movements in directors’ beneficial holdings. The directors, as a group, beneficially own less than 1% of the company’s shares. Share options at 1 April 2016 5,172 5,642 Options granted during year Options exercised during year Value at date of exercise (£) 31 March 2017 – – – – – – 5,172 5,642 The company encourages the chairman and independent non- executive directors to purchase, on a voluntary basis, BT shares with an aggregate value of £5,000 on average each year to further align the interests of non-executive directors with those of our shareholders. The directors are asked to hold these shares until they retire from the Board. This policy is not mandatory. Sir Michael Rake Gavin Patterson – Simon Lowtha Tony Chanmugamb a Simon Lowth joined the Board on 12 July 2016. b Tony Chanmugam retired on 13 July 2016 and the number reflects his options at that date. 6,525 – – – – – – – 6,525 No saveshare options were exercised by the directors during the year. There were no vested but unexercised options at the year end. This policy does not apply to Tim Höttges who was appointed to the Board as a non-independent non-executive director following completion of the EE acquisition in January 2016. This assists with avoiding any conflict of interest in relation to Tim’s ongoing employment as CEO of Deutsche Telekom. 129 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Annual Remuneration Report continued Deferred Bonus Plan awards at 31 March 2017 The following DBP awards have been granted to the directors. These shares will normally be transferred to participants at the end of the three-year deferred period if those participants are still employed by BT. Simon Lowth joined the Board on 12 July 2016 and is due to be granted his first DBP award in June 2017. 1 April 2016 Awardeda Dividends re-invested Vested Lapsed Total number of award shares 31 March 2017b Vesting date Price at grant Market price at vesting Monetary value of vested award £000 141,639 133,526 100,927 – – – – 87,412 – 141,639 5,426 4,101 3,552 – – – 141,364 142,055 54,524 – – – – 48,564 – 141,364 5,773 2,215 1,973 – – – – – – – – – – – – 01/08/2016 315.00p 413.01p 585 138,952 01/08/2017 384.20p 105,028 01/08/2018 449.50p 90,964 01/08/2019 403.18p – – – – – – – 01/08/2016 315.00p 413.01p 584 147,828 01/08/2017 384.20p 56,739 01/08/2018 449.50p 50,537 01/08/2019 403.18p – – – – – – Gavin Patterson DBP 2013 DBP 2014 DBP 2015 DBP 2016 Former Director Tony Chanmugam DBP 2013 DBP 2014 DBP 2015 DBP 2016 a Awards granted on 20 June 2016. The number of shares subject to awards was calculated using the average middle market price of a BT share for the three days prior to the grant. Awards of deferred shares in respect of 2017 will be calculated using the average middle market price of a BT share for the three days prior to grant. b As a result of investigations into improper accounting practices in BT’s Italian business, the committee has exercised discretion and applied the malus provisions under the Deferred Bonus Plan. This will be applied in 2017/18. Further details can be found on page 133. 130 BT Group plcAnnual Report 2017Share awards under long-term incentive schemes held at 31 March 2017 Details of the company’s ordinary shares under conditional share awards made to directors, as participants under the ISP are as follows: 1 April 2016 Awarded Dividends re-invested Vested Lapsed Total number of award shares 31 March 2017 Performance period end Price on grant Market price at vesting 394,139 401,669 1,047,567 891,151 – – – – – 988,954 42,574 36,216 40,192 – 604,366 24,562 – – 323,233 70,906 329,409 72,260 – 31/03/2016 315.00p 445.31p – 31/03/2016 372.00p 445.31p – – – – – – – – 1,090,141 31/03/2017 384.20p 927,367 31/03/2018 449.50p 1,029,146 31/03/2019 403.18p 628,928 31/03/2019 405.38p – – – – Monetary value of vested award £000 1,439 1,467 – – – – 369,937 486,290 414,373 – – – – 303,385 66,552 – 31/03/2016 315.00p 445.31p 1,351 19,763 16,840 – – – – 506,053 31/03/2017 384.20p 431,213 31/03/2018 449.50p – – – – Gavin Patterson ISP 2013a ISP 2013b ISP 2014c ISP 2015d ISP 2016e Simon Lowth ISP 2016f Former Director Tony Chanmugamg ISP 2013a ISP 2014c ISP 2015d a Awards granted on 20 June 2013. The number of shares subject to awards was calculated using the average middle market price of a BT share for the three days prior to grant of 315.00p. 40% of each award is linked to TSR compared with a group of 23 companies, 40% is linked to a three-year normalised free cash flow measure and 20% to a measure of growth in underlying revenue (excluding transit) over three years. The awards vested in May 2016. b Award granted on 12 November 2013 following appointment as chief executive. The number of shares subject to award was calculated using the average middle market price of a BT share for the three days prior to grant of 372p. 40% of each award is linked to TSR compared with a group of 23 companies, 40% is linked to a three-year normalised free cash flow measure and 20% to a measure of underlying revenue growth (excluding transit) over three years. The award vested in May 2016. c Awards granted on 19 June 2014. The number of shares subject to awards was calculated using the average middle market price of a BT share for the three days prior to grant of 384.20p. 40% of each award is linked to TSR compared with a group of 22 companies, 40% is linked to a three-year normalised free cash flow measure and 20% to a measure of underlying revenue growth (excluding transit) over three years. Performance against the TSR, normalised free cash flow and revenue targets resulted in the threshold targets not being met and none of the shares vesting under the 2014 ISP. The awards lapsed in May 2017. d Awards granted on 18 June 2015. The number of shares subject to awards was calculated using the average middle market price of a BT share for the three days prior to grant of 449.50p. 40% of each award is linked to TSR compared with a group of 22 companies, 40% is linked to a three-year normalised free cash flow measure and 20% to a measure of underlying revenue growth (excluding transit) over three years. e Award granted on 20 June 2016. The number of shares subject to award was calculated using the average middle market price of a BT share for the three days prior to grant of 403.18p. 40% of each award is linked to TSR compared with a group of 21 companies, 40% is linked to a three-year normalised free cash flow measure and 20% to a measure of underlying revenue growth (excluding transit) over three years. f Award granted on 29 July 2016. The number of shares subject to award was calculated using the average middle market price of a BT share for the three days prior to grant of 405.38p. 40% of each award is linked to TSR compared with a group of 21 companies, 40% is linked to a three-year normalised free cash flow measure and 20% to a measure of underlying revenue growth (excluding transit) over three years. g Tony Chanmugam retired from the Board on 13 July 2016 and details of the ISP 2013 award vesting are set out on page 125. Share options held at 31 March 2017 Number of shares under option: Sir Michael Rake Gavin Patterson Simon Lowth Former director Tony Chanmugam 1 April 2016 5,172a 5,642a – 6,024b 501a Granted Lapsed Exercised 31 March 2017 Option price per share Market price at date of exercise Usual date from which exercisable Usual expiry date – – – – - – – – – – – – – – – 5,172 5,642 – 6,024 501 319p 319p – 249p 359p – – – – – 01/08/2019 01/02/2020 01/08/2019 01/02/2020 – – 01/08/2018 01/02/2019 01/08/2017 01/02/2018 All of the above options were granted for nil consideration. a Option granted on 26 June 2014 under the employee saveshare scheme, in which all employees of the company are entitled to participate. b Option granted on 27 June 2013 under the employee sharesave scheme, in which all employees of the company are entitled to participate. 131 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Annual Remuneration Report continued Comparison of Chief Executive remuneration to Total Shareholder Return This graph illustrates the performance of BT Group plc measured by TSR relative to a broad equity market index over the past eight years. We consider the FTSE100 to be the most appropriate index against which to measure performance, as BT has been a constituent of the FTSE100 throughout the eight-year period, and the index is widely used. TSR is the measure of the returns that a company has provided for its shareholders, reflecting share price movements and assuming reinvestment of dividends. Percentage change in Chief Executive remuneration (comparing 2016/17 to 2015/16) The table below illustrates the increase in salary, benefits and annual bonus for the chief executive and that of a representative group of the company’s employees. For these purposes, we have used the UK management and technical employee population representing around 22,800 people. We believe this broad group provides the most meaningful comparison as they also participate in performance related pay arrangements on a similar basis as executive directors. % Change in chief executive remuneration Salary Benefitsa Bonusb 2.5% –5.26% –100% % Change in comparator groupc 2.5% a The decrease in benefits for the chief executive was around £3,000. b The bonus comparator is based on cash bonus only to give a better like for like comparison. c Comparator group is the UK management and technical employee population representing around 22,800 individuals. 0% -25.7% Relative importance of spend on pay The table below illustrates the change in total remuneration and dividends and share buyback paid. Area 2016/17 (£m) 2015/16 (£m) % Change Remuneration paid to all employees Dividends/share buybacks 5,189 1,642 4,639 1,390 11.9% 18% BT’s TSR performance vs the FTSE100 700 600 500 400 300 200 100 0 Mar 09 Mar 10 Mar 11 Mar 12 Mar 13 Mar 14 Mar 15 Mar 16 Mar 17 BT FTSE100 Source: Datastream The graph shows the relative TSR performance of BT and the FTSE100 over the past eight years. History of chief executive remuneration Year end 2017 2016a 2015 2014b 2013 2012 2011 2010 Chief Executive Gavin Patterson Gavin Patterson Gavin Patterson Gavin Patterson Ian Livingston Ian Livingston Ian Livingston Ian Livingston Ian Livingston Total rem £000 Annual bonus (% of max) ISP vesting (% of max) 1,345 5,396 4,562 2,901 4,236 9,402 8,520 4,009 3,556 0% 45% 58% 62% 35% 65% 73% 79% 71% 0% 82.01% 67.4% 78.7% 63.4% 100% 100% 0% 0% a The total remuneration figure includes the ISP award as CEO BT Retail and the first award as chief executive, granted in 2013. b Ian Livingston stepped down on 10 September 2013 and Gavin Patterson took over from that date. 132 BT Group plcAnnual Report 2017Implementation of Remuneration Policy in 2017/18 Base salary The committee decided not to increase salaries for the chief executive and group finance director which will remain at £996,825 and £700,000 respectively. Benefits The committee has set benefits in line with the Remuneration Policy set out on pages 139 to 145. There are no changes proposed to the benefit framework for 2017/18. Pension Current levels of pension provision for 2017/18 are the same as for 2016/17. Executive directors receive an annual amount equal to 30% of salary in lieu of pension provision. Clawback and malus The clawback provisions introduced in 2015/16 will continue for annual bonus payments relating to the 2017/18 financial year, and for the ISP awards that are expected to be made in June 2017. The annual bonus clawback will apply for one year following payment. The ISP clawback arrangements may be enforced by the committee in the two year period post-vesting of any awards. In January 2017 we published revised results for 2014/15 and 2015/16 as a result of our investigations into improper accounting practices in BT’s Italian business. The committee has recalculated the annual bonuses for the years in question and the outcome of the 2013 ISP award vesting to reflect the revised results. This showed that the payouts based on the revised results would have been lower than those actually paid at the time. The committee has therefore decided to exercise its discretion and apply the malus provisions in the Deferred Bonus Plan (DBP) to reduce the number of shares under award in recompense for payments and awards otherwise due under the annual bonus arrangements (for both cash and the deferred share element) and (where relevant) the ISP. These malus provisions will be applied in 2017/18 to previous awards made to the executive directors, plus the other Operating Committee members who received payments under the bonus arrangements and/or the ISP, and for the company secretary. This action ensures full restitution of the overpayments for the annual bonus (for the cash and the deferred share elements) and for the 2013 ISP award through the enforcement of the malus provisions in the DBP. This places the recipients in the same position they would otherwise have been in had the annual bonus and the ISP award been based on the revised results. The application of the malus provisions are calculated based on the share price at the original grant. For the cash element of the annual bonus, the calculation is based on the share price of the corresponding deferred share award. The committee will keep under active review whether any additional employees’ awards should be adjusted. In addition, where employees have been dismissed or resigned due to the outcome of our investigations into the issues in Italy, shares and incentives have lapsed in full as a result. The table below sets out the number of shares under the relevant DBP awards following the application of malus as explained above and as agreed by the committee. These shares will normally be transferred to participants at the end of the three-year deferred period if those participants are still employed by BT. Simon Lowth joined on 12 July 2016 and did not receive a bonus in 2016/17 for the 2015/16 financial year. Shares under award at 31 March 2017 Shares lapsed following application of malus Total number of award shares remaining Value of shares lapsed following application of malusa Vesting date Price at grantb Gavin Patterson DBP 2014 DBP 2015 DBP 2016 Total Former Director Tony Chanmugam DBP 2014 DBP 2015 DBP 2016 138,952 105,028 90,964 334,944 147,828 56,739 50,537 7,243 15,867 59,339 82,449 3,367 9,214 34,490 131,709 89,161 31,625 252,495 144,461 47,525 16,047 Total a The value of the shares lapsed following the application of malus has been calculated using the are price at the time of grant. b The grant price is calculated using the average middle market price of a BT share for the three days prior to grant. 208,033 255,104 47,071 £27,828 £71,327 £239,243 £338,398 £12,936 £41,420 £139,057 £193,412 01/08/17 01/08/18 01/08/19 01/08/17 01/08/18 01/08/19 384.20p 449.53p 403.18p 384.20p 449.53p 403.18p 133 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Annual Remuneration Report continued Annual bonus The level of bonus opportunity for the chief executive and group finance director is set out in the table below. One-third of any bonus will be deferred into shares for a period of three years. Level of 2017/18 bonus Chief executive Group finance director Annual cash bonus Target 80% of salary Target 80% of salary Maximum 160% of salary Maximum 120% of salary Incentive Share Plan Acknowledging the fall in the share price over the last year, the 2017 ISP award for the chief executive will be reduced from 400% to 350% of salary and for the group finance director will be 350% of salary. We expect to grant the awards in June 2017. The number of shares awarded is calculated using the average middle market price of a BT share for the three days prior to the grant. Any shares acquired on the vesting of the 2017 ISP awards will be subject to a holding period of two years, commencing from the end of the three- year performance period. Deferred bonus in shares Target 40% of salary Target 40% of salary Maximum 80% of salary Maximum 60% of salary Total bonus Target 120% of salary Target 120% of salary The holding period will apply to the number of shares received on vesting after tax and other statutory deductions. No further performance measures will apply during the holding period as performance will have already been assessed. The performance conditions will be the same as for the 2016 ISP: 40% based on relative TSR; 40% based on normalised free cash flow; and 20% growth in underlying revenue excluding transit over a three-year performance period. BT’s TSR comparator group for the 2017 ISP will be the same as for 2016 and comprise the companies listed below. Accenture KPN Telecom Italia AT & T National Grid Telefónica Cap Gemini Centrica Orange Proximus Telekom Austria Telenor Deutsche Telekom Sky Telia Company Hellenic Telecom Swisscom IBM TalkTalk Verizon Vodafone TSR vesting schedule 2017 awards For the 2017 ISP awards, 40% of the potential outcome is based on relative TSR. The following graph shows the potential vesting of awards based on the TSR element. TSR vesting schedule 2017 awards 40% 40% 20% 20% 0% 0% 0 5 10 15 20 25 TSR ranking position Maximum 240% of salary Maximum 180% of salary The 2017/18 annual bonus structure and weighting is set out below. Chief executive and group finance director % Weighting 25% Adjusted earnings per share 20% Personal objectives 20% Customer experience 10% Revenue (excluding Transit) 25% Normalised free cash flow Adjusted earnings per share; normalised free cash flow; and revenue excluding transit have a direct impact on shareholder value. Customer experience (measured through our RFT and the customer perception measure) is vital to the company’s long-term health and growth. All four of these measures are KPIs for BT and are defined on pages 20 to 21. Good progress has been made on the integration of the EE business and the realisation of associated cost synergies. The committee is satisfied that the EE is well embedded into the business, such that it is now business-as-usual, and elected to remove the specific integration synergy target and increase the weighting of the earnings per share and free cash flow targets for the annual bonus for 2017/18. g n i t s e v d r a w a e r a h s f o % We do not publish details of the financial targets in advance since these are commercially confidential. We will publish achievement against these targets at the same time as we disclose bonus payments in the Annual Report Form & 20-F 2018 so that shareholders can evaluate performance against those targets. The personal contribution measure is aligned to our strategy and is assessed by the chairman for the chief executive and by the chief executive for the group finance director and each senior executive. Performance against the personal contribution element is assessed individually and is based on achievement against individual objectives, organisational culture and growth measures. 134 BT Group plcAnnual Report 2017 The target ranges for the normalised free cash flow and underlying revenue growth excluding transit revenue are set out below: The senior independent director receives an additional fee of £27,000 for that position. An additional fee of £2,000 per trip is paid to those non-executive directors travelling on an inter-continental basis to Board and Board committee meetings. As outlined in the Remuneration Policy, we are proposing to increase this fee to up to £6,000. No element of non-executive director remuneration is performance- related. Non-executive directors do not participate in BT’s bonus or employee share plans and are not members of any of the company pension schemes. The Remuneration Committee This section describes the membership and role of the committee. Who we are Tony Ball chairs the Remuneration Committee, made up of independent non-executive directors, which met five times during the year. Our membership and meeting attendance are set out below. Isabel Hudson and Mike Inglis became members of the committee with effect from 1 April 2017. Committee members Member Tony Ball (chairman) Karen Richardson Nick Rose Meetings Eligible to attend Attended 5 5 5 5 5 4 Measure 2017/18–2019/20 Threshold Level of vesting Maximum Level of vestinga £7.92bn Normalised free cash flowb Revenue growthc 1.8% 4.0 % a Vesting level between threshold and maximum will be on a straight line basis. b Normalised free cash flow is defined on page 21. c Growth in underlying revenue excluding transit is defined on page 20. £8.92bn 25% 25% 100% 100% The committee continues to believe that the free cash flow and revenue performance measures are challenging, and the financial performance necessary to achieve awards is stretching. In setting these targets the committee took into account the revised outlook for the Group. Chairman and non-executive director remuneration The fees for non-executive directors, and for the chairman, were reviewed during the year. The last review of non-executive director fees was in January 2016. In accordance with the Articles of Association, the chairman and executive directors conducted the review, and considered the role and requirements of BT, together with the fees paid to non-executive directors at companies of a similar size and complexity. Following the review, it was agreed no increase should be applied. The chairman’s fee was reviewed by the committee (of which he is not a member) and it was agreed no increase should be applied. Jan du Plessis joins the company on 1 June 2017 as a non-executive director and will become chairman on 1 November 2017. On appointment, he will receive the basic fee per year for a non- executive director (£72,000). On becoming chairman, he will receive a fee of £700,000 per year, fixed for five years. The incoming chairman’s fee was reviewed and agreed by the committee. The basic fee for non-executive directors is £72,000 per year. There are additional fees for membership and chairing a Board committee, details of which are given in the table below: Committee Audit & Risk Integration Nominating & Governance Pensions Remuneration Sustainable & Responsible Business Technology Chairman’s fee Member’s fee £35,000 n/aa n/aa £25,000 £28,000 n/aa,b n/aa £25,000 £10,000 £10,000 £10,000 £15,000 £5,000 £14,000 Equality of Access Board a Where the chairman or chief executive acts as chair of a board committee, no additional committee £72,500 n/a chair fee is payable. b External members of the CSRB receive a fee of £10,000 a year. 135 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Voting at the 2016 Annual General Meeting The votes cast in respect of the Annual Remuneration Report at the Annual General Meeting held on 13 July 2016 were: Votes cast in favour % Votes cast against % Approve Annual Remuneration Report 6,638,116,690 98.52% 99,928,946 1.48% 246,127,946 votes were withheld. A vote withheld is not counted when calculating voting outcomes. Committee evaluation The committee reviews its performance with Board members and other participants, including through the annual Board evaluation. Independent non-executive directors’ letters of appointment Each independent non-executive director has an appointment letter setting out the terms of his or her appointment. They do not have service contracts. The letter includes membership of any Board committees, the fees to be paid and the time commitment expected. We ask each non-executive director to allow a minimum commitment of 22 days each year, subject to committee responsibilities, and to allow slightly more in the first year in order to take part in the induction programme. The actual time commitment required in any year may vary depending on business. We highlight that additional time may be required if the company is going through increased activity. Appointments are for an initial period of three years. During that period, either party can give the other at least three months’ notice of termination. All Board appointments automatically terminate in the event of a director not being elected or re-elected by shareholders at the Annual General Meeting. The appointment of a non-executive director is terminable on notice by the company without compensation. At the end of the period, the appointment may be continued by mutual agreement. Further details of appointment arrangements for independent non- executive directors are set out on page 137. The appointment letter also covers matters such as confidentiality, data protection and BT’s share dealing code. Tim Höttges was appointed as a non-independent non-executive director, following Deutsche Telekom’s nomination and his appointment letter reflects the terms of the Relationship Agreement between BT and Deutsche Telekom. Annual Remuneration Report continued Other Remuneration Matters In addition to the committee members, the chairman and chief executive are invited to attend meetings, except in instances where their own remuneration is discussed, or other circumstances where their attendance would not be appropriate. The committee regularly consults the chief executive, the group HR director, the HR director, reward and pensions, and the group general counsel & company secretary. Advisers During the year, the committee received independent advice on executive remuneration matters from Deloitte LLP. Deloitte received £103,450 in fees for these services. The fees are charged on a time spent basis in delivering advice that materially assisted the committee in their consideration of matters relating to executive remuneration. Deloitte is a founder member of the Remuneration Consultants Group and as such, voluntarily operates under the code of conduct in relation to executive remuneration consulting in the UK. The committee appointed Deloitte to the role of independent advisers to the committee in 2012 following a competitive tender exercise conducted by the committee. The committee is comfortable that the Deloitte engagement partner and team, who provide remuneration advice to the committee, do not have connections with BT that may impair their independence or objectivity. In addition, during 2016/17, Deloitte also provided the company with advice on corporate and indirect taxes, assistance with regulatory, risk and compliance issues and additional consultancy services. Dilution For a number of years we generally used treasury shares to satisfy the exercise of share options and the vesting of share awards under our employee share plans. We intend to use both treasury shares and shares purchased by the BT Group Employee Share Ownership Trust (the Trust) for share option exercises, and shares purchased by the Trust for the vesting of executive share awards in 2017/18. Shares held in the Trust do not have any voting rights. At the end of 2016/17, shares equivalent to 1.89% (2015/16: 1.98%) of the issued share capital (excluding treasury shares) would be required for all share options and awards outstanding. Of these, we estimate that for 2017/18, shares equivalent to approximately 0.45% (2016/17: 0.30%) of the issued share capital (excluding treasury shares) will be required for the all-employee share plans. Outside appointments The committee believes that there are significant benefits, to both the company and the individual, from executive directors accepting non-executive directorships of companies outside BT. The committee will consider up to two external appointments (of which only one may be to the board of a major company), for which a director may retain the fees. Gavin Patterson is a non-executive director of British Airways for which he receives an annual fee of £50,000 and the benefit of free BA flights. 136 BT Group plcAnnual Report 2017 Directors’ service agreements and letters of appointment The dates on which directors’ service agreements/initial letters of appointment commenced and the current expiry dates are as follows: Chairman and executive directors Commencement date Expiry date of current service agreement or letter of appointment Sir Michael Rake 26 September 2007 Gavin Patterson 10 September 2013 Simon Lowth 6 July 2016 Non-executive directors Tony Ball Nick Rose 16 July 2009 1 January 2011 Karen Richardson 1 November 2011 Jasmine Whitbread 19 January 2011 The agreement is terminable by the company on 12 months’ notice and by the director on six months’ notice. Initial term until 10 September 2014, and thereafter terminable by the company on 12 months’ notice and by the director on six months’ notice. Terminable by the company on 12 months’ notice and by the director on six months’ notice. Letter of appointment was for an initial period of three years. The appointment was extended for a further three years in June 2015 following extension in 2012. Letter of appointment was for an initial period of three years. The appointment was extended for a further three years in December 2013. Letter of appointment was for an initial period of three years. The appointment was extended for a further three years in October 2014. Letter of appointment was for an initial period of three years. The appointment was extended for a further three years in December 2013. Iain Conn Isabel Hudson Mike Inglis Tim Höttges 1 June 2014 Letters of appointment are for an initial period of three years. 1 November 2014 1 September 2015 29 January 2016 Appointed as a non-independent non-executive director under the terms of the Relationship Agreement between BT and Deutsche Telekom. The appointment is terminable immediately by either party. There are no other service agreements, letters of appointment or material contracts, existing or proposed, between the company and any of the directors. There are no arrangements or understandings between any director or executive officer and any other person pursuant to which any director or executive officer was selected to serve. Jan du Plessis joins the board as a non-executive director on 1 June 2017 and will become chairman with effect from 1 November 2017. There are no family relationships between the directors. Inspection by the public The service agreements and letters of appointment are available for inspection by the public at the registered office of the company. They will also be available for inspection commencing one hour prior to the start of our AGM, to be held in London on 12 July 2017. Tony Ball Chairman of the Remuneration Committee 11 May 2017 137 BT Group plcAnnual Report 2017THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Annual Remuneration Report continued Remuneration policy The following pages set out our directors’ remuneration policy (the ‘Policy’) which will be put forward for shareholder approval at the 2017 AGM on 12 July 2017 in accordance with section 439A of the Companies Act 2006. Subject to approval at the AGM, this Policy will apply from the date of the AGM. The Policy is divided into separate sections for the executive directors and the chairman and the non-executive directors. Minor changes have been made to the Policy to align it with the business strategy and evolving investor and HMRC guidance. The Policy was previously approved by shareholders at the AGM in 2014 and votes cast were: Votes cast in favour % Votes cast against % Approve Directors’ Remuneration policy 4,579,788,136 96.85% 148,973,373 3.15% 208,032,899 votes were withheld. A vote withheld is not counted when calculating voting outcomes. Legacy matters The committee reserves the right to make any remuneration payments and/or payments for loss of office (including exercising any discretions available to it in connection with such payments) notwithstanding that they are not in line with the Policy where the terms of the payment were agreed (i) before the AGM in 2014 (the date the company’s first shareholder-approved directors’ remuneration policy came into effect); (ii) before this Policy came into effect, provided that the terms of the payment were consistent with the shareholder-approved directors’ remuneration policy in force at the time they were agreed; or (iii) at a time when the relevant individual was not a director of the company and, in the opinion of the committee, the payment was not in consideration for the individual becoming a director of the company. For these purposes “payments” includes the committee satisfying awards of variable remuneration and, in relation to an award over shares, the terms of the payment are “agreed” at the time the award is granted. Any legacy payments would be disclosed in the Annual Remuneration Report for the relevant year Minor amendments The committee may make minor amendments to the arrangements for the directors as described in the Policy, for regulatory, exchange control, tax or administrative purposes, or to take account of a change in legislation. 138 BT Group plcAnnual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Remuneration Policy Executive Directors and Chairman Policy Element Operation and Opportunity Performance measures or basis of payment Salaries for the executive directors and the chairman are reviewed annually, although an out-of-cycle review may be conducted if the committee determines it appropriate. A review may not necessarily lead to an increase in salary. Salaries are paid monthly in cash. The pay and conditions for all UK employees are considered when setting salaries for executive directors and the chairman. Base salary Purpose - a core element of remuneration, used to attract and retain executive directors of the calibre required to develop and deliver our business strategy. Benefits Purpose – to support health and wellbeing and provide employees with a market competitive level of benefits. Executive directors and the chairman receive benefits which typically include (but are not limited to) company car (or monthly allowance in lieu of a car or part of such allowance not used for a car), fuel and/or driver, personal telecommunication facilities and home security, medical and dental cover for the directors and their immediate family, life cover, professional subscriptions, personal tax advice and financial counselling up to a maximum of £5,000 (excluding VAT) a year. Annual bonus Purpose – to incentivise and reward delivery of our business plan on an annual basis. Where executive directors are required to relocate, the committee may offer additional expatriate benefits, if considered appropriate. The company purchases directors’ and officers’ liability insurance to cover the directors, and has in place a directors’ and officers’ indemnity. The insurance operates to protect the directors in circumstances where, by law, BT cannot provide the indemnity. Further details of the directors’ and officers’ liability insurance and indemnity are set out on page 147. Executive directors are eligible for an annual bonus. The chairman is not eligible for an annual bonus. Awards are based on performance in the relevant financial year. The annual bonus is paid in two elements, a cash element, and a deferred element awarded in shares. Annual bonus amounts are not pensionable. The committee sets annual bonus performance targets each year, taking into account key strategic priorities and the approved budget for the year. The committee ensures that targets set are appropriately stretching in the context of the corporate plan and that there is an appropriate balance between incentivising executive directors to meet targets, while ensuring that they do not drive unacceptable levels of risk or inappropriate behaviours. At least one-third of the annual bonus will be granted in the form of deferred shares to strengthen further the alignment of management interests with the long-term interests of shareholders. The deferred element in shares must be held for a deferral period which will not be less than three years. If following the grant of an award, facts subsequently become known to the committee which would justify a reduction in the award, the committee may reduce the number of deferred shares, including to nil. Further information on the malus and clawback provisions is set out on page 145. The maximum annual bonus opportunity is 240% of base salary. Whilst there is no maximum salary level, any increase will typically be broadly in line with BT’s UK employee population. For the executive directors, higher increases may be made under certain circumstances, such as: – increase in the scope and/or responsibility of the individual’s role; – development of the individual within their role; and – where an executive director has been appointed to the Board at a lower than typical level of salary, for example to reflect less experience, larger increases may be awarded to move them closer to market practice as their experience develops. Individual and business performance are taken into account in deciding salary levels. While no maximum level of benefits is prescribed, they are generally set at an appropriate market competitive level determined by the committee, taking into account a number of factors including: – the jurisdiction in which the employee is based; – the level of benefits provided for other employees within the group; and – market practice for comparable roles within appropriate pay comparators in that jurisdiction. The committee keeps the benefit policy and benefit levels under regular review. The committee seeks to effectively reward performance against the key elements of our strategy. Measures used typically include, but are not limited to: – financial performance measures – these are chosen carefully to ensure alignment between reward and underlying financial performance. As an example, such measures may include free cash flow and earnings per share; and – non-financial performance measures – these reflect key company, strategic and individual goals. For example, such measures may include customer experience, purposeful company and personal objectives. In terms of weighting, non-financial measures will typically account for no more than 50% of the total annual bonus. A sliding scale between 0% and 100% of the maximum award applies for achievement between threshold and maximum performance under the bonus plan. Annual Report 2017 BT Group plc 139 Remuneration Policy continued Policy Element Operation and Opportunity Performance measures or basis of payment Incentive Share Plan (ISP) Purpose – to incentivise executive directors over the longer-term, by rewarding delivery of stretching targets linked to our strategy and long-term value creation. Executive directors are eligible to participate in the ISP. The chairman is not eligible to participate. The ISP forms the long- term variable element of executive remuneration. Awards are discretionary and normally vest subject to performance measured over a period of at least three years. Under the terms of the plan rules the current ISP has no maximum award level. The committee have determined that it will impose limits for executive directors to apply to future awards. The maximum normal ISP award that may be awarded to an executive director in respect of any financial year of the company will be 400% of basic salary. In exceptional circumstances, for example recruitment, this limit may be increased to 500% of basic salary. The proposed award levels for 2017/18 are set out on page 134. In respect of ISP awards made to executive directors there is normally a further holding period of two years, commencing from the end of the performance period applicable to the net number of shares received after tax and other statutory deductions. During the holding period, no further performance measures will apply. If following the grant of an award, facts subsequently become known to the committee which would justify a reduction in the award, the committee may reduce the number of shares, including to nil. Further information on the malus and clawback provisions is set out on page 145. The committee aligns the performance measures under the ISP with the long-term strategy of the company and considers that strong performance under the chosen measures should result in sustainable value creation: – financial measures – to reflect the financial performance of our business and a direct and focused measure of company success and, for example, may include free cash flow and revenue measures. We set targets to be appropriately stretching, with regard to a number of internal and external reference points including our business plan and consensus market expectations; and – share price performance measures, to reflect the ultimate delivery of shareholder returns which may, for example, include TSR. This promotes alignment between executive director reward and shareholder value creation. Targets are set with reference to wider market practice and positioned at a level which we consider represents stretching performance. Targets will be measured against a comparator group containing other telecommunication companies and/or companies which are either similar in size or market capitalisation and/or have a similar business mix and spread as BT or operate in comparable markets. In terms of weighting, share price performance measures will typically account for no more than 50% of the total award. Under each performance measure, performance below threshold levels would result in nil vesting for that element. For threshold levels of performance, no more than 25% of the maximum for that element would typically vest, rising to 100% for maximum performance. Pension Purpose – to attract and retain executive directors of the right calibre by providing market competitive post-retirement income. Executive directors currently receive a cash allowance in lieu of pension. The committee may determine that alternative pension provisions will operate for new appointments to the Board. When determining pension arrangements for new appointments, the committee will give regard to: – the cost of the arrangements; – pension arrangements received elsewhere in the group; and – relevant market practice. The chairman does not receive a pension benefit or payment in lieu of such benefit, but does receive a lump sum death in service benefit of £1m. For executive directors, the maximum cash allowance (or equivalent contribution to an executive director’s pension) may not exceed 30% of salary. Executive directors who are not members of the BT Pension Scheme benefit from a death in service cover of a lump sum of 4x salary and a dependant’s pension of 30% of capped salary. 140 BT Group plc Annual Report 2017 THE STRATEGIC REPORT THE STRATEGIC REPORT GOVERNANCE GOVERNANCE FINANCIAL STATEMENTS FINANCIAL STATEMENTS ADDITIONAL INFORMATION ADDITIONAL INFORMATION Policy Element Operation and Opportunity Performance measures or basis of payment Save As You Earn Saveshare Scheme Purpose – to encourage employee share ownership. ESIP (directshare) Purpose – to encourage employee share ownership. Executive directors and the chairman may participate in the all-employee saveshare (HMRC approved savings related share option plan) on the same basis as other eligible employees. All participants may invest up to the limits operated by the company at the time set in line with HMRC guidance. Executive directors and the chairman may participate in the Directshare (HMRC approved purchase of shares from gross salary) on the same basis as other eligible employees. All participants may invest up to the limits operated by the company at the time set in line with HMRC guidance. There are no performance measures attached to these awards. There are no performance measures attached to these awards. Notes to the policy table 1. For further information on the performance measures applicable to the annual bonus and ISP see pages 139 and 140. 2. No performance measures are applicable to salary, benefits, pension, BT saveshare and BT directshare in line with market practice. 3. Common award terms Awards under any of the company’s share plans referred to in this report may: – incorporate the right to receive the value of dividends that would have been paid on the shares subject to an award that vests, which may be calculated assuming the shares were reinvested in shares on a cumulative basis. This value will normally be delivered in the form of additional shares; – be granted as conditional share awards or in such other form that the committee determines has the same economic effect; – have any performance conditions applicable to them varied or substituted by the committee if an event occurs which causes the committee to determine that the performance conditions no longer achieve their original purpose, provided that the varied or substituted performance condition would be not be materially less difficult to satisfy; – be settled in cash at the committee’s discretion; and – be adjusted in the event of any variation of the company’s share capital or any demerger, special dividend or other event that may affect the current or future value of awards. Annual Report 2017 BT Group plc 141 Remuneration Policy continued Remuneration arrangements throughout the company BT operates in a number of different environments and has many employees who carry out diverse jobs across a number of countries: – all employees, including directors, are paid by reference to the market rate; – performance for managers is measured and rewarded through a number of performance-related bonus schemes across the group; – business unit performance measures are cascaded down through the organisation; – BT offers employment conditions that reflect our values and are commensurate with a large publicly listed company, including high standards of health and safety and equal opportunities; – BT operates all employee share plans in many countries. These are open to all employees where offered; and – BT offers a range of employee benefits many of which are available to everyone. Recruitment Our recruitment policy is based on a number of key principles: – we aim to provide a remuneration package which is sufficient to attract, retain and motivate key talent, while at all times ensuring that we pay no more than is necessary, with due regard to the best interests of the company and our shareholders; – the committee will take a number of factors into account in determining the appropriate remuneration package. For example, these may typically include the candidate’s experience and calibre, their circumstances, external market influences and arrangements for existing executive directors; – the ongoing remuneration package offered to new directors will only include those elements listed within the policy table; – the committee may also consider providing additional benefits to expatriate appointments, where appropriate; and – the committee will provide full details of the recruitment package for new executive directors in the next Annual Report on Directors’ Remuneration and will provide shareholders with the rationale for the decisions that were taken. The maximum level of variable pay (excluding buyouts for which see below) which may be awarded in respect of a recruitment event (internal or external), will not exceed 740% of base salary, representing the current maximum award under the annual bonus and ISP. In addition, to facilitate recruitment, the committee may make awards to buy-out variable incentives which the individual would forfeit at their current employer. The committee will give consideration to any relevant factors, typically including the form of the award (eg cash or shares), the proportion of the performance/ vesting period outstanding and the potential value of the forfeited remuneration, including performance conditions attached to the awards, the likelihood of those conditions being met, and the timing of any potential payments. In making buying-out awards, the committee may use the relevant provision in the Financial Conduct Authority Listing Rules. This allows for the granting of awards specifically to facilitate, in unusual circumstances, the recruitment of an executive director, without seeking prior shareholder approval. In doing so, the committee will comply with the relevant provisions in force at the date of this report. Where an executive director is appointed from within the organisation, the company will honour legacy arrangements in line with the original terms and conditions. In the event of the appointment of a new non-executive director, remuneration arrangements will be in line with those detailed on page 135. Payment for loss of office In a departure event, the committee will typically consider: – whether any element of annual bonus should be paid for the financial year. Any bonus paid will normally be limited to the period served during the financial year in which the departure occurs; – whether any of the share element of deferred bonus awarded in prior years should be preserved either in full or in part; and – whether any awards under the ISP should be preserved either in full or in part and, if relevant, whether the post vesting holding period should apply. The committee has historically maintained a discretionary approach to the treatment of leavers, on the basis that the facts and circumstances of each case are unique. In an exit situation, the committee will consider: the individual circumstances; any mitigating factors that might be relevant; the appropriate statutory and contractual position and the requirements of the business for speed of change. The default position is that an unvested ISP or DBP award or entitlement lapses on cessation of employment, unless the committee applies discretion to preserve some or all of the awards. This provides the committee with the maximum flexibility to review the facts and circumstances of each case, allowing differentiation between good and bad leavers and avoiding ‘payment for failure’. When considering a departure event, there are a number of factors which the committee takes into account in determining appropriate treatment for outstanding incentive awards. These include: – the position under the relevant plan documentation; – the individual circumstances of the departure; – the performance of the company/individual during the year to date; and – the nature of the handover process. In some cases, the treatment is formally prescribed under the rules of the relevant plan so that where there are ‘good leaver’ circumstances awards, which would otherwise lapse by default, vest either on the normal vesting date or on cessation of employment. These circumstances include death, injury, ill-health, disability, redundancy or sale of the company or business. If the director dies or leaves due to ill health, injury or disability, ISP awards which have less than 12 months of the performance period remaining or DBP awards which have less than 12 months of the deferred period to run, vest automatically on leaving. In other leaver circumstances the committee has discretion to determine whether, when, and to what extent, awards vest. Where a director leaves where some of his shares acquired under an ISP award are subject to a holding period, that holding period will continue to apply unless the committee determines otherwise. The committee considers the leaver circumstances along a continuum, ranging from ‘bad leaver’ scenarios such as termination of employment for gross misconduct or resignation, through to the ‘good leaver’ scenarios outlined above. Accordingly the committee may apply (or disapply) such performance conditions or time pro-rating to awards vesting in these circumstances as it considers appropriate. 142 BT Group plc Annual Report 2017 THE STRATEGIC REPORT THE STRATEGIC REPORT GOVERNANCE GOVERNANCE FINANCIAL STATEMENTS FINANCIAL STATEMENTS ADDITIONAL INFORMATION ADDITIONAL INFORMATION All-employee plans – leavers The treatment of saveshare options and directshare shares on leaving is as determined under the respective HMRC approved rules. For saveshare, someone who ceases to be an employee in special circumstances (for example injury, disability, death, or following sale of the company or business where they work) may exercise the option within six months after leaving (or 12 months in the case of death) or the relevant corporate event. If someone leaves for a reason not falling within special circumstances, the option lapses on the date the individual leaves. ISP/DBP – change of control In the event of a takeover or scheme of arrangement involving the company, ISP and DBP awards will vest, at a minimum, to the extent that any applicable performance measures have been satisfied at the time (subject to the committee’s discretion to determine the appropriate level of vesting, having regard to such relevant factors as it decides to take into account). If the acquiring company offers to exchange awards over BT shares for awards over its shares (or shares in another company), awards will normally be exchanged and continue under the rules of the relevant plan. If within 12 months of a change of control, a participant’s employment is terminated by his employer other than for misconduct or performance or he or she resigned as a result of a reduction of his or her duties or responsibilities constituting a material breach of the individual’s contract, the participant is entitled to receive an amount equal to the difference between the value he or she received on the change of control he would have received if the relevant performance condition had been met in full. In the event of a voluntary winding up of the company, awards may vest on the members’ resolution to voluntarily wind-up the company being passed. Employment conditions elsewhere in the group The committee considers the pay and conditions of employees throughout the company when determining the remuneration arrangements for executive directors although no direct comparison metrics are applied. In particular, the committee considers the relationship between general changes to UK employees’ remuneration and executive director reward. Whilst the committee does not directly consult with our employees as part of the process of determining executive pay, the Board does receive feedback from employee surveys that takes into account remuneration in general. The committee also receives updates from the group HR director. Executive director and chairman service contracts The other key terms of the service contracts for the current executive directors and the chairman are set out below. The termination provisions described above are without prejudice to BT’s ability in appropriate circumstances to terminate in breach of the notice period referred to above, and thereby be liable for damages to the executive director or chairman. In the event of termination by BT, each executive director and the chairman may have entitlement to compensation in respect of his or her statutory rights under employment protection legislation in the UK. Where appropriate, BT may also meet a director’s reasonable legal expenses in connection with either his or her appointment or termination of his or her appointment. There are no other service agreements, letters of appointment or material contracts, existing or proposed, between the company and any of the executive director Provision Notice period Termination payment Remuneration and benefits Policy – 12 months’ notice by the company, six months’ notice by the executive director or chairman (there is no fixed expiry date). – In lieu of giving an executive director or the chairman 12 months’ notice, BT may terminate the director’s contract and make a payment in lieu of notice to which the director was entitled if he or she had received salary and the value of contractual benefits for the period. – In respect of the executive directors, the payments in lieu will be payable in equal monthly instalments until the date on which the notice period would have expired or (if earlier) the date on which the director secures alternate employment with the same or higher basic salary or fee. In the event that the director secures alternate employment at a basic salary of £30,000 or higher, but lower than their salary, payment in lieu will be reduced by the amount of the new lower salary received. The Board retains the right to lower the payment in lieu of the directors new employment if it considers the new employment terms of the director are not appropriately balanced between basic salary and other elements, and may cease making payments entirely where the Board is not satisfied the director is making reasonable efforts to secure alternative employment. – In respect of the chairman, the payment in lieu will be payable in equal monthly instalments until the earlier of 12 months from the date of termination or the date the chairman secures alternate full-time employment. – Participation in the incentive plans, ISP, DBP and annual bonus, saveshare and directshare, is non- contractual. The chairman does not participate in the ISP, DBP or any annual bonus. – Other benefits include pension (including life cover), dental cover, company car, fuel or driver, private health care (including spouse and children under age of 18 or 21 if in full time education), telecommunication facilities, home security and professional subscriptions. The chairman does not receive pension benefits but is entitled to all other benefits. – The chairman receives an all-inclusive fee for the role. Annual Report 2017 BT Group plc 143 Remuneration Policy continued Illustration of executive director pay scenarios Our remuneration policy aims to ensure that a significant proportion of pay is dependent on the achievement of stretching performance targets. The committee has considered the level of total remuneration that would be payable under different performance scenarios and is satisfied that, as the graph below illustrates, executive pay is appropriate in the context of the performance required and is aligned with shareholders’ interests. The illustrative scenarios below set out the total remuneration that might be received by each executive director for different levels of performance, based on our remuneration policy. The minimum reflects base salary, pension and benefits only which are not performance related. Performance Assumptions Fixed pay All scenarios Consists of total fixed pay – base salary, benefits and pension: ISP awards have been shown at face value, with no share price growth or discount rate assumptions. All-employee share plans (saveshare and directshare) have been excluded, as have any legacy awards held by executive directors. Chief executive - performance scenario chart Minimum Minimum £1.3m On-Target On-Target Maximum Maximum £3.5m £7.7m 0 1 2 3 4 5 6 7 8 9 Fixed remuneration Variable remuneration Long-term incentives – Base salary – salary effective as Group finance director - performance scenario chart at June 2017 – Benefits – amount received by each director in 2016/17 – Pension – cash supplement in lieu of pension provision for 2016/17 Minimum Minimum £0.9m On-Target On-Target Maximum Maximum £2.4m £5.1m 0 1 2 3 4 5 6 Variable pay Minimum – No payout under the annual bonus – No vesting under the ISP Fixed remuneration Variable remuneration Long-term incentives On-target – On target payout under the Fixed pay is calculated as follows: Chief executive Group finance director Salary £000 997 700 Benefits £000 Pension £000 Total fixed pay 54 24 298 1,349 210 934 annual bonus – 25% of maximum vesting under the ISP Maximum – 100% of the maximum payout under the annual bonus – 100% of maximum vesting under the ISP For the purposes of the scenarios chart for the group finance director, we have increased the amount received in 2016/17 on a pro-rata basis to reflect a full financial year. The chief executive has a target bonus of 120% of salary, with a maximum bonus of 240% of salary. The group finance director has a target bonus of 120% of salary, with a maximum bonus of 180%.of salary. For these purposes, we have assumed a usual maximum ISP award of 400% of base salary for the chief executive and 350% of base salary for the group finance director. The absolute maximum ISP award under our remuneration policy is 500% of base salary 144 BT Group plc Annual Report 2017 THE STRATEGIC REPORT THE STRATEGIC REPORT GOVERNANCE GOVERNANCE FINANCIAL STATEMENTS FINANCIAL STATEMENTS ADDITIONAL INFORMATION ADDITIONAL INFORMATION Other Remuneration Policies Malus and clawback Under the terms of the DBP and ISP, if following the grant of an award, facts subsequently become known to the committee which would justify a reduction in the award, the committee may reduce the number of shares under award to take account of this, including to nil. In order to retain flexibility, the events under which this may apply are not formally stipulated in the rules. However, for illustration, such events may include, for example, mis-statement of the financial accounts, fraud or material failure of risk management. Clawback provisions are also in place for the cash part of the annual bonus and ISP awards granted from June 2015 onwards. Under the annual bonus, clawback will normally apply for one year following payment. The ISP clawback arrangements may be enforced by the committee in the two year period post-vesting of any awards. The circumstances in which the committee may consider it appropriate to apply clawback include, but are not limited to i) the behaviour of the participant which fails to reflect the company’s governance and business values; ii) material adverse change in the financial performance of the company or any division in which the participant Non-executive director fees works and/or worked; iii) a material misstatement of the company’s audited financial accounts (other than as a result of a change in accounting practices); iv) misconduct of a participant which results in or is likely to result in reputational damage to the company; v) a material failure in risk management; vi) negligence or gross misconduct of a participant; and/or vii) fraud effected by or with knowledge of a participant. Other elements of remuneration are not subject to recovery arrangements. Consideration of shareholder views The committee is strongly committed to an open and transparent dialogue with shareholders on remuneration matters. We believe that it is important to meet regularly with our key shareholders to understand their views on our remuneration arrangements and discuss our approach going forward. The committee will continue to engage with shareholders going forward and will aim to consult on any material changes to the Policy or other relevant matters. Element/purpose and link to strategy Operation Opportunity Purpose Core element of remuneration, paid for fulfilling the relevant role – NEDs receive a basic fee, paid monthly in – Current fee levels can be found in the Annual respect of their board duties. – Further fees may be paid for chairmanship or membership of Board committees or to the senior independent director. – Additional fees of up to £6,000 may also be payable to NEDs travelling regularly from overseas on an intercontinental basis to Board and committee meetings. – NEDs are not eligible for annual bonus, share incentives, pensions or other benefits. – Expenses incurred in the performance of non-executive duties for the company may be reimbursed (including any relevant tax) or paid directly by the company, as appropriate. Report on Remuneration on page 135. – Fees are set at a level which is considered appropriate to attract and retain NEDs of the necessary calibre. – Fee levels are normally set by reference to the level of fees paid to NEDs serving on boards of similarly-sized, UK-listed companies, taking into account the size, responsibility and time commitment required of the role. – The company’s Articles of Association provide the maximum fee level payable. The maximum is based on NED fees benchmarked as at 1 April 1999 with increases linked to the Retail Price Index. Annual Report 2017 BT Group plc 145 Directors’ information Statement of directors’ responsibilities The directors are responsible for preparing the Annual Report, the Report on Directors’ Remuneration and the financial statements in line with applicable law and regulations. Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have prepared the consolidated financial statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. They’ve also prepared parent company financial statements in accordance with UK Generally Accepted Accounting Practice (UK GAAP), including Financial Reporting Standard 101 Reduced Disclosure Framework (FRS 101), and applicable law. In preparing the consolidated financial statements, the directors have also elected to comply with IFRS, issued by the International Accounting Standards Board (IASB). Under company law, the directors must not approve the financial statements unless they’re satisfied that it gives a true and fair view of the group and the company and of the profit or loss of the group and the company for that period. To prepare these financial statements, the directors: – select suitable accounting policies and then apply them consistently; – make judgements and accounting estimates that are reasonable and prudent; – state whether IFRS, as adopted by the European Union, and IFRS issued by the IASB and applicable UK GAAP including FRS 101 have been followed, subject to any material departures disclosed and explained in the consolidated and parent company financial statements respectively; – notify the parent company’s shareholders in writing about the use of any disclosure exemptions of FRS 101 used in the preparation of financial statements; and – prepare financial statements on a ‘going concern’ basis unless it’s inappropriate to presume that the group and the company will continue in business. The directors are responsible for keeping adequate accounting records that show and explain the group and company’s transactions and disclose with reasonable accuracy at any time the financial position of the company and the group and enable them to ensure that the financial statements and the Report on Directors’ Remuneration comply with the Companies Act 2006 and, as regards the consolidated financial statements, Article 4 of the IAS Regulation. They’re also responsible for safeguarding the assets of the company and the group and for taking reasonable steps to prevent and detect fraud and other irregularities. The directors are responsible for the maintenance and integrity of the corporate and financial information included on the company’s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Each of the directors, whose names and functions are listed on pages 106 to 107 confirms that, to the best of their knowledge: – the company financial statements, which have been prepared in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards, comprising FRS 101 “Reduced Disclosure Framework”, and applicable law), give a true and fair view of the assets, liabilities, financial position and profit of the company; – the consolidated financial statements, which have been prepared in accordance with IFRS, and Article 4 of the IAS Regulation and International Accounting Standards, as adopted by the European Union, give a true and fair view of the assets, liabilities, financial position and profit of the group; and – the Strategic Report on pages 2 to 102 includes a fair review of the development and performance of the business and the position of the group, together with a description of the principal risks and uncertainties it faces. Fair, balanced and understandable In accordance with the principles of the UK Corporate Governance Code, we have processes and procedures in place to ensure that the information presented in the Annual Report is fair, balanced and understandable. We describe these processes and procedures on page 113. Based on the advice of the Audit & Risk Committee the Board considers that the Annual Report, as a whole, is fair, balanced and understandable, and provides the information necessary for shareholders to assess the group’s position, performance, business model and strategy. Critical accounting estimates and key judgements, and significant accounting policies Our critical accounting estimates, key judgements, and significant accounting policies conform with IFRS and are set out on page 176 of the consolidated financial statements. The directors have reviewed these policies and applicable estimation techniques and have confirmed them to be appropriate for the preparation of the 2016/17 consolidated financial statements. Disclosure of information to auditors As far as each of the directors is aware, there is no relevant information (as defined by section 418(3) of the Companies Act 2006) that has not been disclosed to the auditors and each of the directors believes that all steps have been taken that ought to have been taken to make them aware of any relevant audit information and to establish that the auditors have been made aware of that information. Going concern The Strategic Report on pages 2 to 102 includes information on the group structure, strategy and business model, the performance of each line of business, the impact of regulation and competition and principal risks and uncertainties. The Group Performance section on pages 91 to 102 includes information on our group financial results, financial outlook, cash flow and net debt and balance sheet position. Notes 23, 24, 25 and 27 of the consolidated financial statements include information on the group’s investments, cash and cash equivalents, borrowings, derivatives, financial risk management objectives, hedging policies and exposure to interest, foreign exchange, credit, liquidity and market risks. In line with IAS 1 ‘Presentation of financial statements’, and revised FRC guidance on ‘risk management, internal control and related financial and business reporting’, management has taken into account all available information about the future for a period of at least, but not limited to, 12 months from the date of approval of the financial statements when assessing the group’s ability to continue as a going concern. The directors carried out a robust assessment of the main risks affecting the group (including any that could threaten our business model, future performance, insolvency or liquidity). Details of those risks and how we manage and mitigate them are set out in Our Risks on pages 44 to 55. 146 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 147 Power to authorise conflicts All directors have a duty under the Companies Act 2006 (the 2006 Act) to avoid a situation in which he or she has, or can have a direct or indirect interest that conflicts, or possibly may conflict, with the interests of the company. The company’s Articles of Association include provisions for dealing with directors’ conflicts of interest in accordance with the 2006 Act. The company has procedures in place, which it follows, to deal with such situations. These require the Board to: – consider each conflict situation separately on its particular facts; – consider the conflict situation in conjunction with the rest of its duties under the 2006 Act; – keep records and Board minutes on any authorisations granted by directors and the scope of any approvals given; and – regularly review conflict authorisation. In addition, we have a Conflicted Matters Committee. Tim Höttges owes duties to both BT and Deutsche Telekom and the Conflicted Matters Committee helps him comply with his fiduciary duties (although ultimate responsibility rests with him). You can find more details about the Conflicted Matters Committee on page 109. Having assessed the main risks and other matters discussed in connection with the viability statement, in accordance with the UK Corporate Governance Code and the FRC guidance, the directors considered it appropriate to adopt the going concern basis of accounting when preparing the financial statements. This assessment covers the period to May 2018, which is consistent with the FRC guidance. Independent advice The Board has a procedure that allows directors to seek independent professional advice, at BT’s expense. All directors also have access to the advice and services of the company secretary. Directors’ and officers’ liability insurance and indemnity For some years, BT has bought insurance cover for the directors, officers and employees in positions of managerial supervision of BT Group plc and its subsidiaries. This is intended to protect against defence costs, civil damages and, in some circumstances, civil fines and penalties following an action brought against them in their personal capacity. The policy also covers individuals serving as directors of other companies or of joint ventures or on boards of trade associations or charitable organisations at BT’s request. The insurance protects the directors and officers directly in circumstances where, by law, BT cannot provide an indemnity. It also provides BT, subject to a retention, with cover against the cost of indemnifying a director or officer. One layer of insurance is ring-fenced for the directors of BT Group plc. As at 8 May 2017, and throughout 2016/17, the company’s wholly-owned subsidiary, British Telecommunications plc, has provided an indemnity for a similar group of people who would be covered by the above insurance. Neither the insurance nor the indemnity provides cover where the person has acted fraudulently or dishonestly. Interest of management in certain transactions During and at the end of 2016/17, none of BT’s directors was materially interested in any material transaction in relation to the group’s business and none is materially interested in any presently proposed material transactions. As explained below, Tim Höttges is a member of the Board as well as the CEO of Deutsche Telekom. 146 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 147 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION General information US Regulation New York Stock Exchange BT, as a foreign issuer with American Depositary Shares listed on the New York Stock Exchange (NYSE), is obliged to disclose any significant ways in which its corporate governance practices differ from the corporate governance listing standards of the NYSE. We have reviewed the NYSE’s listing standards and believe that our corporate governance practices are consistent with them, with the following exception where we do not meet the strict requirements in the standards. These state that companies must have a nominating/ corporate governance committee composed entirely of independent directors and with written terms of reference which, in addition to identifying individuals qualified to become board members, develops and recommends to the Board a set of corporate governance principles applicable to the company. We have a Nominating & Governance Committee whose terms of reference include governance and compliance issues (see Nominating & Governance Committee Chairman’s report on pages 116 to 117). The Nominating & Governance Committee’s terms of reference are in line with the requirements set out in the standards. However, the committee is chaired by the chairman, Sir Michael Rake, who is not considered independent under the NYSE’s listing standards. The Board and the Nominating & Governance Committee are made up of a majority of independent, non-executive directors. The US Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley Act), the US Securities and Exchange Commission (SEC) and NYSE listing standards require companies to comply with certain provisions relating to their audit committee. These include the independence of audit committee members and procedures for the treatment of complaints regarding accounting or auditing matters. We comply fully with these requirements. US Sarbanes-Oxley Act of 2002 BT has securities registered with the SEC. As a result, we must comply with those provisions of the Sarbanes-Oxley Act which apply to foreign issuers. We comply with the legal and regulatory requirements introduced under the Sarbanes-Oxley Act, in so far as they apply. The Audit & Risk Committee includes Nick Rose who, in the opinion of the Board, is an ‘audit committee financial expert’ and is independent (as defined for this purpose). The Board considers that the committee’s members have broad commercial knowledge and extensive business leadership experience, having held between them various prior roles in major business, financial management, and financial function supervision and that this constitutes a broad and suitable mix of business and financial experience on the committee. The code of ethics we have adopted for the purposes of the Sarbanes- Oxley Act applies to the chief executive, group finance director and senior finance managers. Controls and Procedures Background Our assessment of our controls and procedures for this year has been affected by the issues that have been identified in our Italian business. In October 2016 we reported that following an initial investigation we had identified improper accounting practices in our Italian business and had appointed KPMG, with support and oversight from our Legal, Governance and Compliance function and Freshfields Bruckhaus Deringer, reporting directly to both the chair of the Audit & Risk Committee and BT Group chairman, to perform an independent investigation, alongside our own detailed balance sheet review and continuing investigation. In January 2017 we reported that the investigations had revealed that the extent and complexity of the improper practices were greater than previously identified and that these had resulted in an overstatement of profits over a number of years. We concluded that the errors were not individually material to any of the group’s previously issued financial statements, but that the correction of £268m in the current year would materially misstate the current year. Therefore in our financial statements for and as of 31 March 2017, we have revised our prior year income statements, balance sheets and cash flow statements. As part of the investigation, we also commissioned KPMG, with support and oversight from our Legal, Governance and Compliance function and Freshfields Bruckhaus Deringer, reporting directly to both the chair of the Audit & Risk Committee and BT Group chairman, to conduct a detailed independent review to determine how the collusion and override of controls within our Italian business remained undetected, while management conducted its own review. These controls, investigations and reviews are now completed. Management had implemented a series of remedial and compensating actions after the issues were first identified in October 2016 and, informed by the results of their own review and the recently completed KPMG investigation, has since implemented, and plans to implement, further such actions. These actions include suspending the key members of the senior management team in Italy (who have now left the business) and appointing a new senior management team in Italy, strengthening the monitoring controls and escalation mechanisms in our finance shared services centres, transferring Italy customer billing activities to group billing services and performing detailed substantive reviews of the balance sheet of our Italian business and other large country operations outside the UK. As a result of the implementation of these remedial and compensating actions, management has made all necessary adjustments in our consolidated financial statements. Management has concluded that our consolidated financial statements for the year ended, and as of, 31 March 2017 fairly present, in all material respects, our financial condition and results of operations. Management also concluded that the impact of all facts known to management to date are reflected in the consolidated financial statements. Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934 (Exchange Act), and the rules and regulations thereunder, is recorded, processed, summarised and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive and group finance director to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognises that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgement and makes assumptions about the likelihood of future events. There can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. We have evaluated the effectiveness of our disclosure controls and procedures. Based upon that evaluation, our chief executive and group finance director concluded that as a result of the material weakness described below, as of 31 March 2017, our disclosure controls and procedures were not effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or furnish under the Exchange Act is recorded, processed, summarised 148 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 149 and reported, within the time periods specified in the applicable rules and forms. Management’s Report on Internal Control over Financial Reporting Management is responsible for establishing and maintaining adequate internal control over financial reporting for the group. Internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external reporting purposes in accordance with IFRS as issued by the IASB and IFRS as adopted by the EU. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management conducted an assessment of the effectiveness of our internal control over financial reporting as of 31 March 2017 based on the criteria established in “Internal Control – Integrated Framework” (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Following this assessment, management has concluded that our internal control over financial reporting was not effective as of 31 March 2017 due to the material weakness described below. Material Weakness in Internal Control over Financial Reporting A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of our consolidated financial statements will not be prevented or detected on a timely basis. Our Italian business is managed by a local management team within the Global Services line of business. Individuals in Italy colluded to override the period end financial close controls and overstate the results, and the monitoring controls which include the review of reconciliations, journals, results and financial position, did not operate effectively to identify the overstatement in a timely manner. The group did not maintain effective controls to prevent or detect the collusive circumvention or override of controls related to our Italian business. Specifically management has identified the following internal control deficiencies related to our Italian business and the failure to detect the circumvention or override of controls that together constitute a material weakness in the control environment (i) failure in the review of reconciliations (ii) failure in the review of journals and (iii) failure in our monitoring controls over the results and financial position of our Italian business. This material weakness could result in a misstatement of the account balances and disclosures relating to our Italian business that would represent material misstatements in our annual consolidated financial statements that would not be prevented or detected. Audit of the Effectiveness of Internal Control over Financial Reporting Our independent registered public accounting firm, PricewaterhouseCoopers LLP, has audited the effectiveness of our internal control over financial reporting, as stated in their report as of 31 March 2017, which is included herein. Remediation Since October 2016, and later informed by the results of the recently completed KPMG investigation and management’s own review, management has been actively engaged in the design and implementation of remediation efforts that are intended to address the identified material weakness. The design and implementation of these and other remedial efforts are the responsibility of management. The actions are intended to strengthen our internal control, governance and compliance environment and remediate the material weakness described above. These include the following: 1. We suspended a number of BT Italy’s senior management team (who have now left the business). The president of our European operations has also left the business. We have appointed a new president of our European operations and a new CEO and CFO of BT Italy from outside the Italian executive management team. 2. We strengthened our monitoring controls and escalation mechanisms as they relate to our Italian business, including in relation to the reviews of reconciliations and journals. 3. We transferred the Italy customer billing activities to our group billing services function. We also are in the process of evaluating additional actions to remediate the material weakness and strengthen our internal control, governance and compliance environment, including increasing the resources and improving the capabilities of the controlling function and the audit function outside the UK, and further developing our integrated risk and assurance reporting processes. We are also enhancing our controls and compliance programme to reinforce the importance of doing business in an ethical, disciplined and standardised way. Notwithstanding the identified material weakness, management has concluded that our consolidated financial statements for the year ended, and as of 31 March 2017 fairly present, in all material respects, our financial condition and results of operations. Management has also concluded that the impact of all facts known to management to date are reflected in the consolidated financial statements. Changes in Internal Control Over Financial Reporting Changes in our internal control over financial reporting that occurred during 2016/17, which have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting are described in points 2 and 3 above under “Remediation.” UK Internal control and risk management The Board is responsible for the group’s systems of internal control and risk management and for reviewing the effectiveness of those systems each year. These systems are designed to manage, rather than eliminate, the risk of failure to achieve business objectives; any system can provide only reasonable, and not absolute, assurance against material misstatement or loss. For details of our assessment of our internal controls, as affected by the issues identified in our Italian business, see US Regulation on page 148. The Board also takes account of significant social, environmental and ethical matters that relate to BT’s businesses and reviews BT’s corporate responsibility policy annually. The company’s workplace practices, specific environmental, social and ethical risks and opportunities and details of underlying governance processes are dealt with on pages 26 to 38 in the Delivering our strategy section. We have enterprise-wide risk management processes for identifying, evaluating and managing the principal risks faced by the group. These processes have been in place throughout the year and have continued 148 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 149 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION General information continued up to the date on which this document was approved. The processes are in accordance with the FRC guidance on risk management, internal control and related financial and business reporting. Risk assessment and evaluation take place as an integral part of BT’s annual strategic planning cycle. We have a detailed risk management process which identifies the key risks facing the group, each line of business and TSO. The key features of our enterprise-wide risk management and internal control process (covering financial, operational and compliance controls) are: – senior executives collectively review the group’s key risks and have created a Group Risk Register describing the risks, owners and mitigation strategies. The Group Risk Panel and the Operating Committee review this before it is reviewed and approved by the Board; – the lines of business and TSO carry out risk assessments of their operations, create risk registers relating to those operations and ensure that the key risks are addressed; – senior executives with responsibility for major group operations report quarterly their opinion on the effectiveness of the operation of internal controls in their areas of responsibility; – the group’s internal auditors carry out continuing assessments of the quality of risk management and control, report to management and the Audit & Risk Committee on the status of specific areas identified for improvement and promote effective risk management in the lines of business and TSO; – the Audit & Risk Committee, on behalf of the Board, considers the effectiveness of the group’s internal control procedures during the financial year. It reviews reports from the internal and external auditors and reports its conclusions to the Board. The Audit & Risk Committee has carried out these actions for 2016/17; and – the Audit & Risk Committee, on behalf of the Board, reviews the effectiveness of risk management arrangements across the group. In support of this, an annual review meeting is held with the group chief executive and the CEOs of each line of business. We have not dealt with joint ventures and associates, which BT does not control, as part of the group risk management process. They are responsible for their own internal control assessment. Our significant accounting policies are set out on pages 176 to 181. The consistent application of those policies is subject to ongoing verification through management review and independent review by internal and external auditors. The processes supporting the preparation and consolidation of the financial statements have been documented and are subject to annual verification through the programme of testing done by our internal auditors. This serves to confirm the operation of the internal controls over financial reporting and compliance with the Sarbanes-Oxley Act. The Audit & Risk Committee reviews BT’s published financial results, related disclosures and accounting judgements. The committee’s activities are set out on pages 112 to 115. The Board has approved the formal statement of matters which are reserved to it for consideration, approval or oversight. It has also approved the group’s corporate governance framework, which sets out the high level principles by which BT is managed and the responsibilities and powers of the Operating Committee and the group’s senior executives. As part of this framework, the development and implementation of certain powers relating to group-wide policies and practices are reserved to identified senior executives. Capital management and funding policy The objective of our capital management policy is to target an overall level of debt consistent with our credit rating objectives while investing in the business, supporting the pension fund and paying progressive dividends. The Board reviews the group’s capital structure regularly. Management proposes actions which reflect the group’s investment plans and risk characteristics as well as the macro-economic conditions in which we operate. Our funding policy is to raise and invest funds centrally to meet the group’s anticipated requirements. We use a combination of capital market bond issuance, commercial paper borrowing and committed borrowing facilities to fund the group. When issuing debt, group treasury will take into consideration the maturity profile of the group’s debt portfolio as well as forecast cash flows to avoid refinancing risk. Details of our treasury policy are included in note 27 to the consolidated financial statements. Financial instruments Details of the group’s financial risk management objectives and policies of the group and exposure to interest risk, credit risk, liquidity risk and foreign exchange are given in note 27 to the consolidated financial statements. Credit risk management policy We take proactive steps to minimise the impact of adverse market conditions on our financial instruments. In managing investments and derivative financial instruments, the group’s central treasury function monitors the credit quality across treasury counterparties and actively manages any exposures which arise. Management within the lines of business also actively monitors any exposures arising from trading balances. Off-balance sheet arrangements Other than the financial commitments and contingent liabilities disclosed in note 30 to the consolidated financial statements, there are no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on: our financial condition; changes in financial condition; revenues or expenses; results of operations; liquidity; capital expenditure; or capital resources. Legal proceedings The group is involved in various legal proceedings, including actual or threatened litigation, government or regulatory investigations. For further details of legal and regulatory proceedings to which the group is party please see note 30 to the consolidated financial statements on pages 229 to 231. Save as disclosed below and in note 30 to the consolidated financial statements, the group does not currently believe that there are any legal proceedings, government or regulatory investigations that may have a material adverse impact on the operations or financial condition of the group. In respect of each of the claims described in note 30 the nature and progression of such proceedings and investigations can make it difficult to predict the impact they will have on the group. There are many reasons why we cannot make these assessments with certainty, including, among others, that they are in early stages, no damages or remedies have been specified, and/or the often slow pace of litigation. Italian business Following the group’s announcement with respect to our investigation into our Italian business in January 2017, three purported securities class action complaints were filed against the company and certain current and former officers in United States courts. All three actions 150 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 151 The following disclosures aren’t covered elsewhere in this Annual Report: – BT has two employee share ownership trusts that hold BT shares for satisfying awards under the various employee share plans. The Trustee of the BT Group Employee Share Investment Plan may invite participants, on whose behalf it holds shares, to direct it how to vote in respect of those shares. If there is an offer for the shares or other transaction which would lead to a change of control of BT, participants may direct the Trustee to accept the offer or agree to the transaction. In respect of shares held in the BT Group Employee Share Ownership Trust, the Trustee abstains from voting those shares. – If there’s an offer for the shares, the Trustee doesn’t have to accept or reject the offer but will have regard to the interests of the participants, may consult them to obtain their views on the offer and may otherwise take the action with respect to the offer it thinks fair. – No person holds securities carrying special rights with regard to control of the company. – Proxy appointment and voting instructions must be received by the registrars not less than 48 hours before a general meeting (see also page 266). – Any amendment of BT’s Articles of Association requires shareholder approval in accordance with applicable legislation. – The powers of the directors are determined by UK legislation and the Articles of Association. The directors are authorised to issue and allot shares, and to undertake purchases of BT shares subject to shareholder approval at the AGM. – We have no agreements with directors providing for compensation for loss of office or employment as a result of a takeover. There is similarly no provision for this in standard contracts for employees. – We aren’t aware of any agreements between shareholders that may result in restrictions on the transfer of shares or on voting rights. Political donations Our policy is that no company in the group will make contributions in cash or kind to any political party, whether by gift or loan. However, the definition of political donations used in the 2006 Act is very much broader than the sense in which these words are ordinarily used. It could cover things like making members of parliament and others in the political world aware of key industry issues and matters affecting the company, enhancing their understanding of BT. The authority for political donations we are requesting at the AGM isn’t intended to change this policy. It will, however, ensure that the group continues to act within the provisions of the 2006 Act requiring companies to obtain shareholder authority before they can make donations to EU political parties and/or political organisations as defined in the 2006 Act. During 2016/17, the company’s wholly owned subsidiary, British Telecommunications plc, paid the costs of attending corporate days at (i) the Conservative party conference; (ii) the Labour party conference and (iii) costs associated with participating in an event as part of the EU referendum debate. These costs totalled £6,870 (2015/16: £4,192). No loans were made to any political party by any company in the BT group. are purportedly brought on behalf of purchasers of BT Group ADRs between May 2012 or May 2013 and January 2017. The actions allege that the company made materially false and/or misleading statements between 2012 and 2016 regarding its internal controls, ethics and corporate governance, and financial outlook in its submissions to and filings with the US Securities and Exchange Commission and other public disclosure. Plaintiffs’ counsel have filed motions to appoint lead plaintiff and lead counsel, and decisions on these motions have not yet been made. We intend to defend these claims vigorously. The issues in Italy have also resulted in engagement with certain of our regulators and other authorities in the UK and elsewhere. As would be expected, we are cooperating fully with these bodies including the Italian authorities. Other information – Listing Rules For the purposes of LR 9.8.4CR, the information required to be disclosed by LR 9.8.4R is on these pages: Section Information Interest capitalised Page Not material for the group (1) (2) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) Publication of unaudited financial information 20 to 21 Details of unusual long-term incentive schemes Not applicable Waiver of emoluments by a director Not applicable Waiver of future emoluments by a director Not applicable Non pre-emptive issues of equity for cash 92 and 234 Non pre-emptive issue by a major subsidiary undertaking Not applicable Parent participation in a placing by a listed subsidiary Not applicable Contracts of significance involving a director or controlling shareholder Not applicable Provision of services by a controlling shareholder Shareholder waiver of dividends Shareholder waiver of future dividends Not applicable See below See below Agreements with controlling shareholders Not applicable In respect of LR 9.8.4R (12) and (13) the trustee of the BT Group Employee Share Ownership Trust agrees to waive dividends payable on the BT shares it holds for satisfying awards under various BT executive share plans. Under the rules of these share plans, the dividends are re- invested in BT shares that are added to the relevant share awards. Other statutory information – Companies Act 2006 Certain provisions of the 2006 Act require us to make additional disclosures. These are described on the pages listed below: Information Page Structure of BT’s share capital (including the rights and obligations attaching to the shares) 168 and 266 to 268 Restrictions on the transfer of BT shares and voting rights 266 to 268 Significant direct or indirect shareholdings 152 Appointment and replacement of directors Significant agreements to which BT Group plc is a party that take effect, alter or terminate upon a change of control following a takeover 137 and 268 268 to 269 150 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 151 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Shareholders and Annual General Meeting Relations with shareholders The chief executive and group finance director, as well as other senior executives, hold meetings with BT’s institutional shareholders and prospective shareholders to discuss BT’s strategy and financial performance. In 2016/17 we held 507 meetings or events with institutional investors. This included a number of meetings held with investors by our chairman and senior independent director. This marks a significant increase on 353 in 2015/16. Following Simon Lowth joining as group finance director in July 2016, we saw an increased number of introductory meetings. The announcement of our updated outlook in January 2017 then also led to an increased number of requests for meetings. All non-executive directors have an invitation to attend investor meetings if they wish. We control contact with institutional investors (as well as financial analysts, brokers and the media) through written guidelines that ensure the protection of commercial and inside information that has not already been made generally available to the market. During the year, we surveyed 13,000 private shareholders selected at random to help us improve shareholder engagement. We’ve continued to include more information on BT’s financial performance, strategy, our purpose and future plans in our shareholder communications. We provide the directors with regular reports and other written briefings on shareholders’ and analysts’ views and the company secretary notifies directors of changes in the holdings of the principal shareholders. We’ve put procedures in place to ensure the timely release of inside information and for the publication of financial results and regulatory financial statements. The Disclosure Committee made up of the group chief executive, group finance director and other senior executives, is chaired by the company secretary and reviews all significant announcements for accuracy and compliance requirements. Substantial shareholdings At 11 May 2017, BT had received notice, under the Financial Conduct Authority’s Disclosure Guidance & Transparency Rules, in respect of the following holding of shares: BlackRock Inc 27 April 2017 497,222,381 4.99% Date Shares % of total voting rights At 31 March 2017, BlackRock’s interest was 547,375,427 shares representing 5.50% of total voting rights. No requirement to notify the company of any increase or decrease would have arisen unless the holding moved up or down a whole number percentage level. The percentage level may decrease on the transfer of treasury shares for any of the company’s share plans. In addition to the above, T-Mobile Holdings Limited holds 1,196,175,322 shares representing 12% of total voting rights and Orange SA and Orange Telecommunications Group Limited holds 399,070,327 shares representing 4% of total voting rights. No changes to these holdings were notified to BT in 2016/17. As partial consideration for our purchase of EE Limited in January 2016, we issued 1,594,900,429 new ordinary shares to T-Mobile Holdings Limited and Orange Telecommunications Group Limited. As part of our policy to involve shareholders fully in the affairs of the company, at our AGM we give them the opportunity to ask questions about BT’s activities. We also give shareholders the opportunity to vote on every important issue by proposing a separate resolution for each. Before the AGM, we count the proxy votes for and against each resolution, as well as votes withheld, and make the results available at the meeting. As with the 2016 AGM, we’ll take votes on all matters at the 2017 AGM on a poll, except procedural issues. We’ll count every vote cast, whether in person or by proxy at the meeting, and post the outcome of voting on the resolutions on our website as soon as possible after the meeting. It’s our policy for all directors to attend the AGM if possible. While, because of ill health or other pressing reasons, this may not always be possible, in normal circumstances this means that the chairs of the Audit & Risk, Nominating & Governance and Remuneration Committees are at the AGM and are available to answer questions. All directors attended the 2016 AGM. The separate Notice of meeting 2017 which we send to all shareholders who have requested shareholder documents by post contains the 23 resolutions we will propose at the 2017 AGM on 12 July, together with explanatory notes. We notify all shareholders of the publication of these documents, which we send out in the most cost-effective way. We aim to give as much notice of our AGM as possible and at least 21 clear days’ notice, as required by our Articles of Association. In practice, we send these documents to shareholders more than 20 working days before the AGM. (For other general meetings this should be at least 14 working days in advance). At the AGM we’ll propose resolutions to re-appoint PricewaterhouseCoopers as BT’s auditors and to authorise the directors to agree their remuneration. Authority to purchase shares The authority given at last year’s AGM, held on 13 July 2016, for BT to purchase in the market 996m of its shares, representing 10% of the issued share capital, expires on 12 July 2017. Shareholders will be asked to give a similar authority at the 2017 AGM. During 2016/17, 34m shares of 5p each were purchased under this authority (0.34% of the share capital) for a consideration of £150m, at an average price of £4.41 per share. During 2016/17, 34.5m treasury shares were transferred to meet BT’s obligations under our employee share plans. At 8 May 2017, we held a total of 7.6m shares as treasury shares. All of those shares were purchased in an on-market buyback programme from May 2016 to March 2017. In addition, the BT Group Employee Share Ownership Trust purchased 12.9m BT shares for a total consideration of £55m, of which 14.3m shares continued to be held in the Trust at 8 May 2017. Cross reference to the Strategic Report As permitted by the Companies Act, we have chosen to include in the Strategic Report the following information (required by law to be included in the Report of the Directors): – the final dividend proposed by the Board (page 96); – an indication of likely future developments in the business of the company (see the Strategic Report on pages 2 to 102); – an indication of our R&D activities (page 32); – information about our people (page 26); and – information about greenhouse gas emissions (page 42). Annual General Meeting Resolutions We’ll ask our shareholders to vote on both the Annual Report and the Report on Directors’ Remuneration at our AGM. Approval of the latter will be sought in two parts and will include the Remuneration Policy. By order of the Board Dan Fitz Group General Counsel & Company Secretary 11 May 2017 152 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Financial statements Financial statements Auditors’ reports – consolidated financial statements United Kingdom opinion United States opinion 154 164 Group income statement 165 Group statement of comprehensive income 166 167 Group balance sheet 168 Group statement of changes in equity 169 Group cash flow statement 170 Notes to the consolidated financial statements Basis of preparation Critical accounting estimates and key judgements Significant accounting policies Segment information Operating costs Employees Audit, audit related and other non-audit 176 176 182 186 187 188 services 189 Specific items 191 Taxation 194 Earnings per share 195 Dividends 195 Intangible assets 198 Property, plant and equipment 199 Business combinations 200 Programme rights 200 Inventories 200 Trade and other receivables 202 Trade and other payables 203 Provisions 204 Retirement benefit plans 214 Own shares 215 Share-based payments 216 Investments 218 Cash and cash equivalents 218 Loans and other borrowings 221 Finance expense Financial instruments and risk management 222 228 Other reserves Related party transactions 229 Financial commitments and contingent liabilities Auditors’ report – parent company financial statements Financial statements of  BT Group plc Related undertakings 229 232 234 238 Additional information 251 PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 153 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Independent auditors’ report Report on the group financial statements United Kingdom Our opinion In our opinion, BT Group plc’s group financial statements (the “financial statements”): – give a true and fair view of the state of the group’s affairs as at 31 March 2017 and of its profit and cash flows for the year then ended; – have been properly prepared in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the European Union; and – have been prepared in accordance with the requirements of the Companies Act 2006 and Article 4 of the IAS Regulation. Separate opinion in relation to IFRSs as issued by the IASB As explained in note 1 to the financial statements, the group, in addition to applying IFRSs as adopted by the European Union, has also applied IFRSs as issued by the International Accounting Standards Board (IASB). In our opinion, the financial statements comply with IFRSs as issued by the IASB. What we have audited The financial statements, included within the Annual Report & Form 20-F 2017 (the “Annual Report”), comprise: – the group balance sheet as at 31 March 2017; – the group income statement for the year then ended; – the group statement of comprehensive income for the year then ended; – the group cash flow statement for the year then ended; – the group statement of changes in equity for the year then ended; and – the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. Certain required disclosures have been presented elsewhere in the Annual Report, rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited. The financial reporting framework that has been applied in the preparation of the financial statements is IFRSs as adopted by the European Union, and applicable law. Our audit approach Context We took into consideration the ongoing integration of EE into the wider group and that 2016/17 was the first full year of EE’s results being consolidated into the group’s financial statements. EE was also included in the group’s internal control over financial reporting framework for the first time. In addition, in October 2016, the group announced that following allegations of inappropriate management behaviour in BT’s Italian business, it had conducted an initial internal investigation. This initial investigation included a review of accounting practices during which group management had identified certain historical accounting errors and reassessed certain areas of management judgement. In January 2017, the group announced that its investigations had revealed that the extent and complexity of inappropriate behaviour in the Italian business was greater than previously identified and had resulted in the overstatement of earnings in the Italian business over a number of years. We considered the impact of these matters on the group audit risk assessment, the scope of the audit (in determining which reporting units required audit work and the extent of the work to be performed in Italy specifically and in other reporting units) and the audit response to the issues identified. Overview – Overall group materiality: £130 million (2015/16: £130 million) which represents approximately 4% of profit before tax. – Full scope audits were performed in three reporting units – the main BT UK trading company (British Telecommunications plc), EE and the principal reporting unit in Italy. These units accounted for over 80% of the group’s revenue and group’s profit before tax. – Specific audit procedures were performed in four reporting units – Spain, Germany, Ireland and the US. These units accounted for 7% of the group’s revenue. – Specific audit procedures over certain operating costs were performed in one additional reporting unit in the UK. Our assessment of the risk of material misstatement also informed our views on the areas of particular focus for our work which are listed below: – Assessment of the carrying value of goodwill and acquired intangible assets in EE; – Assessment of the carrying value of goodwill in Global Services; – Major contracts in Global Services, Business & Public Sector and EE; – Accuracy of revenue due to complex billing systems; – Pension scheme obligations and unquoted investments in the BT Pension Scheme; – Litigation and regulatory provisions (including historical use of deemed consent); – Recognition and measurement of potential tax exposures and deferred tax assets; – Cost capitalisation and asset lives for property, plant and equipment and software intangible assets; and – Irregular accounting practices in BT Italia. The scope of our audit and our areas of focus We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (“ISAs (UK & Ireland)”). We designed our audit by determining materiality and assessing the risks of material misstatement in the financial statements. In particular, we looked at where the directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. As in all of our audits we also addressed the risk of management override of internal controls, including evaluating whether there was evidence of bias by the directors that represented a risk of material misstatement due to fraud. The risks of material misstatement that had the greatest effect on our audit, including the allocation of our resources and effort, are identified as “areas of focus” in the table below. We have also set out how we tailored our audit to address these specific areas in order to provide an opinion on the financial statements as a whole, and any comments we make on the results of our procedures should be read in this context. This is not a complete list of all risks identified by our audit. 154 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Area of focus How our audit addressed the area of focus Assessment of the carrying value of goodwill and acquired intangible assets in EE The group acquired EE on 29 January 2016 and finalised the purchase price accounting in the current year. The goodwill acquired was £6.5bn and other intangible assets with finite useful lives of £5.9bn were also recognised on acquisition. As a result of the group reorganisation effective 1 April 2016, the group allocated goodwill of £2.1bn relating to the acquisition of EE to other cash generating units (CGUs) on a relative fair value basis in accordance with IAS 36 ‘Impairment of assets’. The carrying value of goodwill and other intangible assets is generally considered to be at higher risk of impairment in the first year following any acquisition. Management prepared an impairment assessment, for both the goodwill and the intangible assets acquired, that was based on a value in use calculation. Management concluded that there was no impairment. The disclosures in respect of this are included in note 12. Assessment of the carrying value of goodwill in Global Services As at 31 March 2017, goodwill relating to the Global Services CGU amounted to £571m out of a total goodwill balance of £8bn. Management prepared an impairment assessment for the Global Services CGU, as required under accounting standards, which was based on a value in use calculation. Similar assessments were performed by the directors for the other goodwill balances. Management concluded that there was no impairment of goodwill in any CGU, including Global Services. We focused on the impairment assessment for Global Services as the headroom (of value in use over carrying value) was limited and the assessment is sensitive to changes in assumptions (in particular the long term growth rate, the discount rate and the assumptions underlying future operating cash flows). We evaluated the design and tested the operating effectiveness of management’s controls in assessing the carrying value of goodwill and other intangible assets. We determined that the controls were designed and operating effectively. We tested the allocation of EE goodwill to other CGUs. In testing this we assessed whether management’s approach was in compliance with IAS 36 and tested the calculation. We assessed and challenged management on the assumptions reflected in the future cash flows of the businesses transferred between CGUs as a result of the reorganisation. In testing the impairment assessment we agreed the cash flow forecasts used in the impairment model to Board approved forecasts. We considered management’s expectations in respect of developments in the business and corroborated certain information with third party sources where possible and tested internal data. We considered planned operational improvements and the reasonableness of these in generating future cash flows and whether these were appropriately reflected in the cash flow forecasts. We compared actual historical cash flows with previous forecasts. We used internal specialists to independently calculate an appropriate pre-tax discount rate by making reference to market data, and to verify the long-term growth rate used by management to observable market data. For the other intangible assets, we considered management’s assessment of whether there is any indication of an impairment trigger, considering both internal and external sources of information. We assessed the sufficiency of the sensitivity analyses performed by management, focusing on what we consider to be reasonably possible changes in key assumptions. Overall we considered the assumptions adopted by management to be within a reasonable range. We also considered the appropriateness of the disclosure in note 12. As a result of our work, we determined that the conclusions reached by management in the reallocation of goodwill between CGUs, and that there was no impairment of goodwill or the acquired finite-lived intangible assets, were supportable. We evaluated the design and tested the operating effectiveness of management’s controls in assessing the carrying value of goodwill. We determined that the controls were designed and operating effectively. We focused on the key assumptions included in the impairment assessment, being the cash flows for each year of management’s detailed forecast, the long-term growth rate and the discount rate. To determine the appropriateness of the future operating cash flows, we: – Agreed the cash flow forecasts used in the impairment model to Board approved forecasts; – Considered management’s expectations in respect of developments in the business and corroborated certain information with third party sources. We considered planned operational improvements and the reasonableness of these in generating future cash flows and whether these were appropriately reflected in the cash flow forecasts; and Annual Report 2017 BT Group plc 155 Independent auditors’ report continued Area of focus How our audit addressed the area of focus Assessment of the carrying value of goodwill in Global Services continued Major contracts in Global Services, Business & Public Sector and EE We focused on these contracts as they involve significant estimates in respect of: – the completeness and adequacy of provisions against contracts projected to be loss making; and – the recoverability of contract-specific assets, including deferred costs and property, plant and equipment. Consideration of the completeness and adequacy of provisions against contracts and the recoverability of contract-specific assets is dependent on the quantum and timing of recognition of contract profits and the assumptions underpinning the lifetime profitability forecasts for the contracts. The group has deferred costs in respect of major contracts totalling £163m at 31 March 2017. – Compared actual historical cash flow results for the Global Services CGU with previous forecasts to determine forecasting accuracy. We used internal specialists to independently verify the long term growth rate to market data and to independently calculate the pre-tax discount rate used by management by reference to market data. We assessed the sufficiency of the sensitivity analysis performed by management and performed further sensitivity analyses, focusing on what we considered to be reasonably possible changes in the key assumptions. As noted in note 12, the conclusion reached by management that no impairment has arisen is highly sensitive to relatively small changes in the assumptions. Overall we considered the assumptions made to be within a reasonable range. We also considered the appropriateness of the disclosures in note 12. We tested a sample of major contracts, focusing our work on those which were material by size, and then those which we regarded as higher risk because of the nature of the contract, its stage of delivery or the related assets on the balance sheet. In performing this sample testing we assessed the appropriateness of the assumptions and judgements underpinning the accounting for these major contracts as follows: – We evaluated the design and tested the operating effectiveness of controls in respect of the accounting for major contracts. – We obtained and read the relevant sections of the contracts agreed between BT and the customer, tested a sample of revenue transactions by tracing them to supporting evidence of delivery and acceptance and assessed the revenue recognised in the period by comparing it with the contractual terms and actual pattern of delivery of services. – We compared the forecast results of certain contracts in our scope with the actual results to assess the performance of the contract and the historical accuracy of forecasting. We assessed the recoverability of contract-specific assets dedicated to the sampled contracts by examining future forecast profitability of the related contract and the associated deferred revenue. We assessed the reasonableness of lifetime profitability forecasts by analysing historical contract performance relative to overall contractual commitments. We assessed management’s assumptions on future contract costs, including any forecast savings, by assessing the actions required to achieve these forecasts. We assessed whether the provisions for loss making contracts are adequate. Based on our work we did not identify any material misstatement in the related financial statement amounts and found them to be recorded in line with the group’s accounting policies as set out in note 3. 156 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Area of focus How our audit addressed the area of focus Accuracy of revenue due to complex billing systems The accuracy of revenue amounts recorded is an inherent industry risk. This is because telecom billing systems are complex and process large volumes of data with a combination of different products sold and price changes in the year, through a number of different systems. Pension scheme obligations and unquoted investments in the BT Pension Scheme We focused on the BT Pension Scheme (BTPS) because the valuation of the BTPS obligations (£58.6bn at 31 March 2017) and unquoted assets, comprised of unquoted equity investments and property assets, (£21.8bn at 31 March 2017) require the use of estimates and significant judgement, and a small change in the key assumptions can have a material impact on the financial statements. We evaluated the relevant IT systems and the design of controls, and tested the operating effectiveness of controls over the: – capture and recording of revenue transactions; – authorisation of rate changes and the input of this information into the billing systems; and – calculation of amounts billed to customers. We determined that the operation of the controls provided us with evidence over the accuracy of revenue recorded. We also tested a sample of customer bills and checked these to supporting evidence (e.g. customer orders, contracts or subsequent customer communications from the group confirming changes to prices) and cash received. Our testing included customer bills for consumers, corporate customers and wholesale customers. Based on our work, we noted no significant issues in the accuracy of revenue recorded in the year. We evaluated the design and tested the operating effectiveness of controls in respect of the determination of the BTPS net deficit. We determined that the operation of the controls provided us with evidence over the valuation of the obligations and the assets and thereby also the accuracy of the amounts recorded in Other Comprehensive Income. We used our actuarial experts to assess the reasonableness of the actuarial assumptions used in valuing the BTPS obligations. This included comparing the assumptions with our internally developed benchmarks. All the assumptions used by management fell within acceptable ranges. We tested the existence of the unquoted investments and the valuation of these investments on a sample basis. Specifically: – For property assets, we: – obtained and read valuation reports prepared by third party specialist valuers for management. We assessed the methods and assumptions used by the valuers and the competence and objectivity of those third party experts; – tested the carrying amount of other property assets by validating these to audited financial statements; – For direct investments held by the BTPS, the valuations of the investments are derived from discounted cash flow models. These models use assumptions including discount rates and cash flow forecasts. We assessed the assumptions used in the valuations by checking that the assumptions used were consistent with our internally developed range of discount rates (with the support of internal specialists), by comparing the cash flows with historical results and considering the impact of other external information. We tested the accuracy of the calculations and assessed whether the assumptions used were in line with other market participants and reflected the particular status of the investment shareholding; and – For other unquoted investments we tested internal controls, obtained confirmations of the valuation from the custodians and the investment managers, and tested the carrying amount by validating these to audited financial statements. We considered the estimates and judgements used by management for the obligations and the unquoted investments to be within an acceptable range. We also considered the appropriateness of the disclosure in note 20. Annual Report 2017 BT Group plc 157 Independent auditors’ report continued Area of focus How our audit addressed the area of focus Litigation and regulatory provisions (including historical use of deemed consent) The group has regulatory provisions of £479m relating to regulatory risks, including an additional £300m provision arising in the current year from the findings of the Ofcom investigation related to the historical use of deemed consent in the delivery of Ethernet services. Included within the group’s other provisions of £246m are provisions for litigation risks. These provisions are based on judgements and accounting estimates made by management in determining the likelihood and magnitude of claims, and consequently we focused on the judgements and estimates involved. In particular, the current telecommunications regulatory environment has seen an increased frequency and magnitude of matters brought to Ofcom and the Competition Appeal Tribunal (CAT) in the UK. We evaluated the design and tested the operating effectiveness of controls in respect of the determination of the provisions. We determined that the operation of the controls provided us with evidence over the completeness, accuracy and valuation of the provisions. For regulatory provisions, we read correspondence and pronouncements from the regulator Ofcom and the CAT and correspondence from other communication providers (CPs). We evaluated the regulatory risk exposures identified by management against observable data. We also assessed management’s regulatory risk likelihood assessment by comparing its assessment against historical disputes, open claims from CPs, current pronouncements issued by Ofcom and the CAT and by considering the nature of the identified regulatory risk exposure. In relation to the historical use of deemed consent in the delivery of Ethernet services, we assessed the provision calculation by comparison to the findings included in the correspondence with Ofcom, examining the methodology applied, testing inputs to source data and testing assumptions by comparison with supporting evidence. We engaged our statistical experts to review the findings of a third party expert appointed by management to determine an appropriate approach to sampling deemed consent orders. For litigation provisions, we read the summary of litigation matters provided by management and held discussions with the group’s general counsel and head of litigation. We held discussions with each of the group’s external legal advisors with respect to the matters included in the summary. Where appropriate we examined correspondence connected with the cases. For regulatory and litigation provisions, we tested the calculation of the provisions, assessed the assumptions against third party data, where available, and assessed the estimates against historical trends. We considered management’s judgements on the level of provisioning to be appropriate. We also considered the appropriateness of the disclosures in note 19. Recognition and measurement of potential tax exposures and deferred tax assets The group operates in a complex multinational tax environment and is subject to a range of tax risks. There is inherent judgement involved in determining provisions for uncertain tax positions. We evaluated the design and tested the operating effectiveness of controls in place for the determination and recognition of deferred tax balances and uncertain tax positions. We determined these controls provided us with evidence for the purposes of our audit. The group has material unrecognised deferred tax assets in respect of brought forward trading losses and other temporary differences, as set out in note 9. The recognition of deferred tax assets involves judgement regarding the likelihood of the realisation of these assets, in particular whether there will be taxable profits in future periods that support recognition of these assets. The group has deferred tax assets of £172m relating to EE. The recognition of these assets requires estimates to be applied in relation to the associated assessed future profitability of this legal entity, including the potential impact of the ongoing integration of the EE operations into the wider group. We tested the underlying data for the key deferred tax and uncertain tax provision calculations. In conjunction with our tax specialists, we evaluated management’s rationale in relation to the level of tax provisions. We considered the status of recent and current tax audits and enquiries, the results of previous claims and changes to the tax environments in the markets in which the group operates. We utilised our specialist tax knowledge and experience of similar situations elsewhere to examine tax planning arrangements and the global transfer pricing model and assess management’s judgements. We found that the level of provisioning overall was appropriate. 158 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Area of focus How our audit addressed the area of focus Recognition and measurement of potential tax exposures and deferred tax assets continued Cost capitalisation and asset lives for property, plant and equipment and software intangible assets Capitalisation of costs and the useful lives assigned to assets are areas of judgement by management. These manifest themselves in the following two audit risks: – the risk that amounts being capitalised do not meet capitalisation criteria, including the recognition and deferral of related grants; and – the risk that the useful economic lives assigned to assets are inappropriate. We focused on the recognition of capital grants associated with the Broadband Delivery UK (BDUK) and Superfast Extension (SEP) programmes, as the grants may be subject to re-investment or repayment depending on the level of take-up requiring calculation of grant income to be deferred. Irregular accounting practices in BT Italia As further explained on page 6 of the Annual Report, on 27 October 2016 BT announced that an initial internal investigation of accounting practices in its Italian business had identified certain historical accounting errors, and areas of management judgement that merited reassessment. At that time, management announced the write down of items on the Italian balance sheet by £145 million. In assessing management’s conclusions with respect to the recognition of deferred tax assets, we evaluated the amount of tax losses recognised in light of future projected profitability of the relevant subsidiary companies, by assessing the forecasts against past results and our expectations of future trading performance. In assessing the EE deferred tax asset we tested controls over the calculation of the asset and management’s assessment of its recoverability, using our tax specialists and our knowledge of the group as a whole. We considered management’s judgement on the recoverability of the EE deferred tax asset to be appropriate. We also considered the appropriateness of the disclosure in note 9. We evaluated the design and tested the operating effectiveness of controls around the property, plant and equipment cycle and software intangible assets cycle, including the controls over whether engineering (labour) activity is capital or operating in nature. We determined that the operation of the controls provided us with audit evidence in respect of the capitalisation of costs. We tested costs capitalised in the year and considered the ageing of assets in the course of construction. We assessed the nature of costs incurred in capital projects through testing of amounts recorded and considering whether the expenditure met the criteria for capitalisation under accounting standards. We found no material misstatements from our testing. We tested the controls over the annual review of asset lives. In addition, we tested whether management’s views on asset lives are supportable by considering our knowledge of the business and results of the wider telecoms industry. We also tested whether the prior year asset life review has been appropriately applied and assessed the judgements made by management in the current year review. We found that the asset lives were consistent with those commonly used in the industry and appropriately reflected technological developments. We tested the controls in place over the recording and reconciliation of grant income deferral. We assessed the key assumption of the forecast level of end user take-up applied by the management to calculate the deferral. In addition, we tested other key inputs to supporting evidence and the accuracy of the calculation. We considered the level of grant recognition to be appropriate. We incorporated our forensic specialists into our audit team to assess the structure, scope, approach and independence of the investigation commenced by the Board, and to satisfy ourselves that it considered the risk that the issues identified may be more pervasive across the BT Group, and that the conclusions reached were appropriate. We also used our forensics specialists to support us in considering the associated audit risks arising from each of the matters identified by the investigation and determining the impact on our audit risk assessment and developing an appropriate audit response. Annual Report 2017 BT Group plc 159 Independent auditors’ report continued Area of focus How our audit addressed the area of focus Irregular accounting practices in BT Italia continued In January 2017, management reported that the investigation into the financial position of the Italian business was substantially complete and further adjustments had been identified. The total impact amounted to £268m in relation to prior year errors, and £245m for changes in accounting estimates. The prior year errors were reflected in the relevant comparative periods and the impact is set out in note 1. The specific items are described in note 8. Further details of the investigation commissioned by the Board, which reported to the chairman of the Audit & Risk Committee and the BT Group chairman, are set out on pages 112 and 113. Management's response to the findings of the investigation, including the associated control deficiencies that were identified, is set out on pages 148 and 149. Our audit focussed on evaluating the impact on the financial statements and addressing the risk of similar issues in other reporting units. We considered the scope of the audit and, in particular, assessed which reporting units required additional audit procedures to be performed, including in Italy specifically. We also instructed our component teams to perform additional procedures to respond to the risk of fraud, including testing additional manual journals throughout the year. We considered the impact of the investigation on management’s internal control environment both in Italy and in other locations. Where deficiencies in controls were identified, we tested compensating controls where these existed and performed additional substantive testing where there were no appropriate compensating controls. Taking the above into account, consistent with our original audit plan, we instructed our component audit team in Italy to perform a full scope audit on the reporting unit’s complete financial information, and evaluated the component team’s work. In addition, we performed a significant level of oversight, with senior members of the group engagement team spending time in Italy during the planning, execution and completion phases of the component audit. As part of these oversight activities, we were involved in the component audit team’s risk assessment to identify significant risks of material misstatement, evaluated the appropriateness of the audit procedures to be performed by the component team to respond to the identified significant risks, reviewed certain working papers of the component audit team to evaluate the work performed and held regular meetings with our component audit team and with local, Global Services and Group management to consider the component team’s audit work and findings. Our component team in Italy also specifically tested the prior year revisions and the specific items recorded. As a result of our work, we satisfied ourselves that the adjustments posted by management following the investigation are materially appropriate. We also considered the appropriateness of the disclosures made by management in the financial statements, in particular in note 1 and determined that they provided an adequate explanation of the issue and the results of management’s investigation. How we tailored the audit scope We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, taking into account the geographic structure of the group, the accounting processes and controls including those performed at the group’s shared service centres, and the industry. The group comprises a number of reporting units, in both the UK and overseas, which relate to the geographic markets in which the group operates. The group’s accounting process is structured around a finance function in each of the reporting units who are supported by one of the group’s shared service centres. The reporting units are responsible for their own accounting records and controls and report to the head office finance team in London through an integrated consolidation system. In establishing the overall approach to the group audit, we determined the type of work that needed to be performed at reporting units by us, as the group engagement team, or component auditors from other PwC network firms operating under our instruction (including PwC UK for EE). Where the work was performed by component auditors, we determined the level of involvement we needed to have in the audit work at those reporting units to be able to conclude whether sufficient appropriate audit evidence had been obtained as a basis for our opinion on the financial statements as a whole. For three reporting units (the main BT UK trading company (British Telecommunications plc), EE and Italy) an audit of the complete financial information was performed. These accounted for over 80% of the group’s revenue and the group’s profit before tax. In four reporting units (Germany, Ireland, Spain and the US) specific audit procedures on revenue and related balance sheet accounts were performed. These accounted for 7% of the Group’s revenue. In one reporting unit (based in the UK) specific audit procedures on certain operating costs and related balance sheet accounts were performed. This, together with additional procedures performed on centralised functions and at the group level (on the consolidation and other areas of significant judgement including tax and goodwill), gave us the evidence we needed for our opinion on the financial statements as a whole. 160 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION The group engagement team performed the audit of British Telecommunications plc. The group engagement team also performed the work on the US reporting unit and the UK reporting unit. For EE, the group engagement team met regularly with the audit team, who are UK based, and attended meetings with management, including the year end clearance meeting. As explained in the area of focus “Irregular accounting practices in BT Italia” above, the group engagement team was heavily involved in oversight of the work performed on the Italy reporting unit. Senior members of the group engagement team also visited Spain, Germany and Ireland and communicated with our teams on a regular basis. We also reviewed certain component auditor working papers and participated in the audit clearance meetings for Spain, Germany and Ireland by conference call. In addition, the group engagement team visited the shared service centres relevant to those reporting units in scope for the group audit. Materiality The scope of our audit was influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures on the individual financial statement line items and disclosures and in evaluating the effect of misstatements, both individually and on the financial statements as a whole. Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: Overall group materiality £130m (2015/16: £130m) How we determined it Approximately 4% of profit before tax. Rationale for benchmark applied We consider that profit before tax is the primary measure used by the shareholders in assessing the performance of the group. In our view, using profit before tax ensures that where certain specific items are recurring in nature our audit work is performed to the lower materiality level that results from using a reported profit before tax measure rather than an adjusted profit before tax measure. In 2015/16 and previous years we used profit before tax as the benchmark, but used an average of profit before tax for the then current year and the previous 3 years. The acquisition of EE significantly changed the composition of the group and in light of this we changed the period from the historical approach of using a four year average of profit before tax to now using only the current year’s profit before tax. Component materiality For each reporting unit in our audit scope, we allocated a materiality that was less than overall Group materiality. For British Telecommunications plc and EE, the materiality allocated to these units was £110m and £100m respectively. For all other reporting units the materiality allocated was between £10m and £20m. We agreed with the Audit & Risk Committee that we would report to them misstatements identified during our audit above £10m (2015/16: £5m) as well as misstatements below that amount that, in our view, warranted reporting for qualitative reasons. Going concern Under the Listing Rules we are required to review the directors’ statement, set out on pages 146 and 147, in relation to going concern. We have nothing to report having performed our review. Under ISAs (UK & Ireland) we are required to report to you if we have anything material to add or to draw attention to in relation to the directors’ statement about whether they considered it appropriate to adopt the going concern basis in preparing the financial statements. We have nothing material to add or to draw attention to. As noted in the directors’ statement, the directors have concluded that it is appropriate to adopt the going concern basis in preparing the financial statements. The going concern basis presumes that the group has adequate resources to remain in operation, and that the directors intend it to do so, for at least one year from the date the financial statements were signed. As part of our audit we have concluded that the directors’ use of the going concern basis is appropriate. However, because not all future events or conditions can be predicted, these state- ments are not a guarantee as to the group’s ability to continue as a going concern. Other required reporting Consistency of other information and compliance with applicable requirements Companies Act 2006 reporting In our opinion, based on the work undertaken in the course of the audit: the information given in the Strategic Report and the Report of the Directors for the financial year for which the financial statements are prepared is consistent with the financial statements; and the Strategic Report and the Report of the Directors have been prepared in accordance with applicable legal requirements. In addition, in light of the knowledge and understanding of the group and its environment obtained in the course of the audit, we are required to report if we have identified any material misstatements in the Strategic Report and the Report of the Directors. We have nothing to report in this respect. Annual Report 2017 BT Group plc 161 Independent auditors’ report continued Under ISAs (UK & Ireland) we are required to report to you if, in our opinion: information in the Annual Report is: – materially inconsistent with the information in the audited financial statements; or – apparently materially incorrect based on, or materially inconsistent with, our knowledge of the group acquired in the course of performing our audit; or – otherwise misleading. – the statement given by the directors on page 146, in accordance with provision C.1.1 of the UK Corporate Governance Code (the “Code”), that they consider the Annual Report taken as a whole to be fair, balanced and understandable and provides the information necessary for members to assess the group’s position and performance, business model and strategy is materially inconsistent with our knowledge of the group acquired in the course of performing our audit. We have no exceptions to report. We have no exceptions to report. – the section of the Annual Report on pages 112 to 114, as required by provision C.3.8 of the Code, describing the work of the Audit & Risk Committee does not appropriately address matters communicated by us to the Audit & Risk Committee. We have no exceptions to report. The directors’ assessment of the prospects of the group and of the principal risks that would threaten the solvency or liquidity of the group Under ISAs (UK & Ireland) we are required to report to you if we have anything material to add or to draw attention to in relation to: – the directors’ confirmation on page 146 of the Annual Report, in accordance with provision C.2.1 of the Code, that they have carried out a robust assessment of the principal risks facing the group, including those that would threaten its business model, future performance, solvency or liquidity. – the disclosures in the Annual Report that describe those risks and explain how they are being managed or mitigated. – the directors’ explanation on page 55 of the Annual Report, in accordance with provision C.2.2 of the Code, as to how they have assessed the prospects of the group, over what period they have done so and why they consider that period to be appropriate, and their statement as to whether they have a reasonable expectation that the group will be able to continue in operation and meet its liabilities as they fall due over the period of their assessment, including any related disclosures drawing attention to any necessary qualifications or assumptions. We have nothing material to add or to draw attention to. We have nothing material to add or to draw attention to. We have nothing material to add or to draw attention to. Under the Lisg Rules we are required to review the directors’ statement that they have carried out a robust assessment of the principal risks facing the group and the directors’ statement in relation to the longer-term viability of the group. Our review was substantially less in scope than an audit and only consisted of making inquiries and considering the directors’ process supporting their statements; checking that the statements are in alignment with the relevant provisions of the Code; and considering whether the statements are consistent with the knowledge acquired by us in the course of performing our audit. We have nothing to report having performed our review. Adequacy of information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion, we have not received all the information and explanations we require for our audit. We have no exceptions to report arising from this responsibility. Directors’ remuneration Under the Companies Act 2006 we are required to report to you if, in our opinion, certain disclosures of directors’ remuneration specified by law are not made. We have no exceptions to report arising from this responsibility. Corporate governance statement Under the Listing Rules we are required to review the part of the Corporate governance statement relating to ten further provisions of the Code. We have nothing to report having performed our review. 162 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Responsibilities for the financial statements and the audit Our responsibilities and those of the directors As explained more fully in the Statement of Directors’ Responsibilities set out on page 146, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and ISAs (UK & Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the parent company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. What an audit of financial statements involves An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: – whether the accounting policies are appropriate to the group’s circumstances and have been consistently applied and adequately disclosed; – the reasonableness of significant accounting estimates made by the directors; and – the overall presentation of the financial statements. We primarily focus our work in these areas by assessing the directors’ judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements. We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. With respect to the Strategic Report and the Report of the Directors, we consider whether those reports include the disclosures required by applicable legal requirements. Other matter We have reported separately on the parent company financial statements of BT Group plc for the year ended 31 March 2017 and on the information in the Report on Directors’ Remuneration that is described as having been audited. Richard Hughes (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 11 May 2017 Annual Report 2017 BT Group plc 163 Independent auditors’ report continued United States opinion Report of Independent Registered Public Accounting Firm to the Board of Directors and Shareholders of BT Group plc (the ‘company’) In our opinion, the accompanying group balance sheets and the related group income statements, group statements of comprehensive income, group statements of changes in equity and group cash flow statements present fairly, in all material respects, the financial position of BT Group plc and its subsidiaries at 31 March 2017 and 31 March 2016, and the results of their operations and their cash flows for each of the three years in the period ended 31 March 2017 in conformity with International Financial Reporting Standards as issued by the International Accounting Standards Board and International Financial Reporting Standards as adopted by the European Union. Also in our opinion, the company did not maintain, in all material respects, effective internal control over financial reporting as of 31 March 2017, based on criteria established in Internal Control – Integrated Framework 2013 issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) because a material weakness in internal control related to the Group’s failure to maintain effective controls to prevent or detect the collusive circumvention or override of controls related to the group’s Italian business existed as of that date. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness referred to above is described in Management’s Report on Internal Control over Financial Reporting on page 149 of the Report of the Directors, General Information of the BT Group plc Annual Report & Form 20-F 2017. We considered this material weakness in determining the nature, timing, and extent of audit tests applied in our audit of the 31 March 2017 group financial statements, and our opinion regarding the effectiveness of the company’s internal control over financial reporting does not affect our opinion on those group financial statements. The company's management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in management’s report referred to above. Our responsibility is to express opinions on these financial statements and on the company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorisations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorised acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. As set out in note 1, the group has adopted the IFRS Interpretations Committee agenda decision on IAS 32 para 42(a) with effect from 1 April 2016. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. PricewaterhouseCoopers LLP London, United Kingdom 11 May 2017 164 BT Group plc Annual Report 2017 Group income statement Year ended 31 March 2017 Revenue Operating costs Operating profit (loss) Finance expense Finance income Net finance expense Share of post tax loss of associates and joint ventures Profit (loss) before taxation Taxation Profit (loss) for the year Earnings per share Basic Diluted Year ended 31 March 2016 Revenue Operating costs Operating profit (loss) Finance expense Finance income Net finance expense Share of post tax profit of associates and joint ventures Profit (loss) before taxation Taxation Profit (loss) for the year Earnings per share Basic Diluted a For a definition of specific items, see page 252. An analysis of specific items is provided in note 8. b See note 1. Notes 4 5 4 26 9 10 Notes 4 5 4 26 9 10 Before specific items £m 24,082 (19,947) 4,135 (607) 13 (594) (9) 3,532 (663) 2,869 Specific a items £m Total £m (20) (948) (968) (210) – (210) – (1,178) 217 24,062 (20,895) 3,167 (817) 13 (804) (9) 2,354 (446) (961) 1,908 19.2p 19.1p Before specific items b Revised £m Specific a items £m Total b Revised £m 18,879 (15,051) 3,828 (520) 37 (483) 6 3,351 (607) 2,744 133 (348) (215) (229) – (229) – (444) 166 (278) 19,012 (15,399) 3,613 (749) 37 (712) 6 2,907 (441) 2,466 28.5p 28.2p PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 165 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group income statement Year ended 31 March 2015 Revenue Operating costs Operating profit (loss) Finance expense Finance income Net finance expense Share of post tax loss of associates and joint ventures Profit on disposal of interest in associates and joint ventures Profit (loss) before taxation Taxation Profit (loss) for the year Earnings per share Basic Diluted a See note 1. b For a definition of specific items, see page 252. An analysis of specific items is provided in note 8. Group statement of comprehensive income Year ended 31 March Profit for the year Other comprehensive (loss) income Items that will not be reclassified to the income statement Remeasurements of the net pension obligation Tax on pension remeasurements Items that have been or may be reclassified to the income statement Exchange differences on translation of foreign operations Fair value movements on available-for-sale assets Fair value movements on cash flow hedges: – net fair value gains – recognised in income and expense Tax on components of other comprehensive income that have been or may be reclassified Other comprehensive (loss) income for the year, net of tax Total comprehensive (loss) income for the year a See note 1. Before specific items a Revised £m Notes Specific b items £m Total a Revised £m 4 5 4 26 8 9 10 Notes 20 9 28 28 28 28 9, 28 17,840 (14,185) 3,655 (577) 17 (560) (1) – 3,094 (631) 2,463 128 (381) (253) (299) – (299) – 25 (527) 121 (406) 17,968 (14,566) 3,402 (876) 17 (859) (1) 25 2,567 (510) 2,057 25.5p 25.1p 2017 £m 2016 a Revised £m 2015 a Revised £m 1,908 2,466 2,057 (2,789) 416 755 (240) (1,051) 208 237 (3) 884 (938) 29 (2,164) 29 (2) 381 (230) 5 698 16 7 207 (218) 37 (794) (256) 3,164 1,263 166 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 167 Group balance sheet At 31 March Non-current assets Intangible assets Property, plant and equipment Derivative financial instruments Investments Associates and joint ventures Trade and other receivables Deferred tax assets Current assets Programme rights Inventories Trade and other receivables Current tax receivable Derivative financial instruments Investments Cash and cash equivalents Current liabilities Loans and other borrowings Derivative financial instruments Trade and other payables Current tax liabilities Provisions Total assets less current liabilities Non-current liabilities Loans and other borrowings Derivative financial instruments Retirement benefit obligations Other payables Deferred tax liabilities Provisions Equity Ordinary shares Share premium Own shares Merger reserve Other reserves Retained loss Total equity a See note 1. Notes 2017 £m 2016 a Revised £m 2015 a Revised £m 12 13 27 23 17 9 15 16 17 27 23 24 25 27 18 19 25 27 20 18 9 19 21 28 15,029 16,498 1,818 44 31 360 1,717 15,450 15,971 1,462 46 24 218 1,247 3,170 13,498 1,232 44 26 179 1,559 35,497 34,418 19,708 264 227 3,835 73 428 1,520 528 225 189 3,978 65 177 2,918 996 118 94 3,093 65 97 3,523 848 6,875 8,548 7,838 2,632 34 7,437 197 625 3,736 48 7,418 271 178 10,925 11,651 2,314 168 5,348 222 142 8,194 31,447 31,315 19,352 10,081 869 9,088 1,298 1,240 536 11,025 863 6,382 1,106 1,262 565 7,862 927 7,583 929 948 422 23,112 21,203 18,671 499 1,051 (96) 6,647 884 (650) 499 1,051 (115) 8,422 685 (430) 419 1,051 (165) 998 502 (2,124) 8,335 10,112 681 31,447 31,315 19,352 166 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 167 The consolidated financial statements on pages 165 to 231 and 234 to 249 were approved by the Board of Directors on 11 May 2017 and were signed on its behalf by: Sir Michael Rake Chairman Gavin Patterson Chief Executive Simon Lowth Group Finance Director THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group statement of changes in equity Notes Share a capital £m Share b premium £m Own c shares £m Merger d reserve £m Other e reserves £m At 1 April 2014 – previously reported Revisions At 1 April 2014 – revised Profit for the yearf Other comprehensive gain (loss) – before taxf Tax on other comprehensive gain (loss) Transferred to the income statement Total comprehensive income for the yearf Issue of new sharesg Dividends to shareholders Share-based payments Tax on share-based payments Net buyback of own shares Other movements At 1 April 2015f Profit for the yearf Other comprehensive gain – before taxf Tax on other comprehensive gain Transferred to the income statement Total comprehensive income for the yearf Issue of new sharesh Dividends to shareholders Share-based payments Tax on share-based payments Net buyback of own shares Other movementsf At 1 April 2016f Profit for the year Other comprehensive gain (loss) – before tax Tax on other comprehensive gain (loss) Transferred to the income statement Total comprehensive income (loss) for the year Transfers to realised profit Dividends to shareholders Share-based payments Tax on share-based payments Net buyback of own shares 9 11 22 9 21 9 11 22 9 21 9 11 22 9 21 408 – 408 – – – – – 11 – – – – – 62 – 62 – – – – – 989 – – – – – (829) – (829) – – – – – – – – – 664 – 998 – 998 – – – – – – – – – – – 449 4 453 – 230 37 (218) 49 – – – – – – Retained (loss) earnings £m (1,680) (64) (1,744) 2,057 (1,051) 208 – 1,214 – (925) 70 54 (783) (10) Total equity (deficit) £m (592) (60) (652) 2,057 (821) 245 (218) 1,263 1,000 (925) 70 54 (119) (10) 419 1,051 (165) 998 502 (2,124) 681 – – – – – 80 – – – – – – – – – – – – – – – – – – – – – – – – – 50 – – – – – – 7,424 – – – – – 499 1,051 (115) 8,422 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 19 – – – – – (1,775) – – – – – 408 5 (230) 183 – – – – – – 685 – 1,108 29 (938) 199 – – – – – 884 2,466 755 (240) – 2,981 – (1,078) 58 12 (275) (4) 2,466 1,163 (235) (230) 3,164 7,504 (1,078) 58 12 (225) (4) (430) 10,112 1,908 (2,779) 416 – (455) 1,775 (1,436) 57 (6) (155) 1,908 (1,671) 445 (938) (256) – (1,436) 57 (6) (136) (650) 8,335 At 31 March 2017 499 1,051 (96) 6,647 a The allotted, called up, and fully paid ordinary share capital of BT Group plc at 31 March 2017 was £499m comprising 9,968,127,681 ordinary shares of 5p each (2016: £499m comprising 9,968,127,681) ordinary shares of 5p each. b The share premium account, comprising the premium on allotment of shares, is not available for distribution. c For further analysis of own shares, see note 21. d The merger reserve balance at 1 April 2015 arose on the group reorganisation that occurred in November 2001 and represented the difference between the nominal value of shares in the new parent company, BT Group plc, and the aggregate of the share capital, share premium account and capital redemption reserve of prior parent company, British Telecommunications plc. On 29 January 2016, the company issued 1,594,900,429 ordinary shares of 5p at 470.7p per share. These shares were used as part consideration for the acquisition of EE. As a result of this transaction the merger reserve was credited with £7,424m net of £3m issue costs. In 2016/17, there was a transfer of £1,775m of merger reserve to realised profit following the settlement of an intercompany loan by qualifying consideration. e For further analysis of other reserves, see note 28. f Revised, see note 1. g On 12 February 2015, the company issued 222,000,223 ordinary shares of 5p at 455p per share, raising £1,000m net of issue costs. Share capital increased by £11m and share premium by £989m. h On 29 January 2016, the company issued 1,594,900,429 ordinary shares of 5p at 470.7p per share, raising £7,504m net of issue costs. Share capital increased by £80m and merger reserve by £7,424m. 168 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 169 Group cash flow statement Year ended 31 March Cash flow from operating activities Profit before taxation Profit on disposal of interest in associates and joint ventures Share of post tax loss (profit) of associates and joint ventures Net finance expense Operating profit Other non-cash charges (credits) (Profit) loss on disposal of businesses Depreciation and amortisation Increase in inventories Increase in programme rights Decrease (increase) in trade and other receivables (Decrease) increase in trade and other payables Decrease in other liabilitiesb Increase (decrease) in provisions Cash generated from operations Income taxes paid Net cash inflow from operating activities Cash flow from investing activities Interest received Dividends received from associates and joint ventures Acquisition of subsidiariesc Proceeds on disposal of subsidiariesc, associates and joint ventures Acquisition of joint ventures Proceeds on disposal of current financial assetsd Purchases of current financial assetsd Proceeds on disposal of non-current asset investments Purchases of non-current asset investments Proceeds on disposal of property, plant and equipment Purchases of property, plant and equipment and software Net cash outflow from investing activities Cash flow from financing activities Equity dividends paid Interest paid Repayment of borrowingse Net repayment of commercial paper Proceeds from bank loans and bonds Cash flows from derivatives related to net debt Drawdown on acquisition facility Repayment of acquisition facility Repayment of EE revolving credit facility Proceeds from issue of own shares Repurchase of ordinary share capital Net cash (outflow) inflow from financing activities Net increase (decrease) in cash and cash equivalents Opening cash and cash equivalentsf Net increase (decrease) in cash and cash equivalents Effect of exchange rate changes Closing cash and cash equivalentsf Note 2017 £m 2016 a Revised £m 2015 a Revised £m 2,354 – 9 804 3,167 20 (16) 3,572 (33) (95) 168 (152) (307) 401 2,907 – (6) 712 3,613 39 – 2,631 – (44) (83) 124 (810) (63) 2,567 (25) 1 859 3,402 (19) 1 2,538 (13) (40) (263) 199 (727) 19 6,725 5,407 5,097 (551) (256) (309) 6,174 5,151 4,788 7 2 18 46 (13) 10,834 (9,411) – (22) 26 (3,145) 10 17 (3,371) – (8) 8,918 (8,252) – – 7 (2,438) 10 – (6) 26 (10) 8,124 (9,898) 8 – 100 (2,410) (1,658) (5,117) (4,056) (1,435) (629) (1,805) – 3 119 – (181) (438) 70 (206) (4,502) 14 459 14 38 511 (1,075) (558) (1,283) – 3,023 79 3,200 (3,019) (100) 90 (315) 42 76 407 76 (24) 459 (924) (590) (1,166) (338) 812 297 – – – 1,201 (320) (1,028) (296) 684 (296) 19 407 19 14 24 168 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 169 a See note 1. b Includes pension deficit payments of £274m (2015/16: £880m, 2014/15: £876m). c Acquisitions and disposals of subsidiaries are shown net of cash acquired or disposed of and includes £20m true-up of consideration following the audit of the completion balance sheet relating to the acquisition of EE. d Primarily consists of investment in and redemption of amounts held in liquidity funds. e Repayment of borrowings includes the impact of hedging and repayment of lease liabilities. f Net of bank overdrafts of £17m (2015/16: £537m, 2014/15: £441m). THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 1. Basis of preparation Preparation of the financial statements These consolidated financial statements have been prepared in accordance with the Companies Act 2006, Article 4 of the IAS Regulation and International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) and related interpretations, as adopted by the European Union. The consolidated financial statements are also in compliance with IFRS as issued by the International Accounting Standards Board (the IASB). The consolidated financial statements are prepared on a going concern basis. The consolidated financial statements are prepared on the historical cost basis, except for certain financial and equity instruments that have been measured at fair value. The consolidated financial statements are presented in Sterling, the functional currency of BT Group plc, the parent company. New and amended accounting standards effective during the year During the year we revised the presentation of cash pooling arrangements under IAS 32, refer to the prior year revision and re- classifications below. There are no other new or amended standards of interpretations adopted during the year that have a significant impact on the financial statements. New and amended accounting standards that have been issued but are not yet effective The following standards have been issued and are effective for accounting periods ending on or after 1 April 2017 and are expected to have an impact on the group financial statements. IFRS 15 ‘Revenue from Contracts with Customers’ Background In May 2014, IFRS 15 ‘Revenue from Contracts with Customers’ was issued. It was subsequently amended in September 2015 and April 2016. It will be effective for periods beginning on or after 1 January 2018. Transition to IFRS 15 for BT Group plc will take place on 1 April 2018. Results in the 2018/19 financial year will comply with IFRS 15, with the first Annual Report and Form 20-F published in accordance with IFRS 15 being that for the year ended 31 March 2019. IFRS 15 sets out the requirements for recognising revenue and costs from contracts with customers and includes extensive disclosure requirements. The standard requires entities to apportion revenue earned from contracts to individual promises, or performance obligations, on a relative stand-alone selling price basis, based on a five-step model. Transition BT is planning to adopt IFRS 15 retrospectively and apply the new standard to each prior reporting period presented, ie 2016/17 and 2017/18, in accordance with IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’. In the year of adoption, the group will record a cumulative transitional adjustment at 1 April 2016 to revise historical financial data. All customer contracts in progress but not completed or starting after this date will need to be revised. Our decision to adopt retrospectively depends on a number of factors considering the time, effort and cost involved in doing so when compared to the benefits to users of the financial statements. The group intends to use the following practical expedients on transition, because in the view of the group, the costs of providing the information significantly outweigh any benefits: (a) completed contracts that begin and end within the same annual reporting period will not be revised; (b) for completed contracts that have variable consideration, the transaction price at the date the contract was completed will be used rather than estimating variable consideration amounts in the comparative reporting periods; and (c) for all reporting periods presented before the date of initial application, BT will not disclose the amount of the transaction price allocated to the remaining performance obligations or identify when it expects to recognise that amount as revenue. IFRS 15 Project The group has determined its planned revenue and cost accounting policies under IFRS 15. Following the acquisition of EE in January 2016, the group has extended its future IFRS 15 accounting policies to cover EE. The group has deployed a cross-functional project team dedicated to the implementation of IFRS 15. This team has been engaged in determining accounting policies under the new standard, quantifying the transitional adjustments and selecting and implementing suitable systems solutions. The team is also reviewing the impact on tax, intragroup trading, forecasting, the bid and tender process and HR and remuneration plans. There will be a significant impact on the group’s billing data and accounting platforms. An IT-based solution is in development for certain areas and lines of business. New processes and controls are being designed in addition to complement this solution. Performance obligations IFRS 15 requires that at contract inception, we assess the goods or services promised in a contract with a customer and identify as a performance obligation each promise to transfer to the customer. Promises in a contract can be explicit, or implicit if the promises create a valid expectation to provide a good or service based on the customary business practices, published policies, or specific statements. IFRS 15 will require disclosures relating to the group's performance obligations. We continue to review our disclosure of revenue by products and services in the segment disclosure note in the light of the requirements of IFRS 15. The stand-alone selling prices of the group’s products and services are being determined. These may be regulated prices, list prices, a cost- plus derived price, the price of similar products when sold on a stand- alone basis by BT or a competitor or in some cases the contract price where the price contracted represents a bespoke price that would be the same for a similar customer in a similar circumstance. Financial Impact The group is in the process of quantifying the implications of the standard and the financial impact is not yet reasonably estimable. Based on our analysis to date we expect the acceleration of revenues (notably handset revenues) and deferral of costs (notably third party contract acquisition costs associated with handset revenues) will significantly exceed deferred connection revenues on the adoption date. This will: – pull forward profits in the periods being restated; – lead to the recognition of a contract asset; and increase equity reserves at 1 April 2016. This will give rise to a one-off additional cash tax charge payable split between 2018/19 and 2019/20. 170 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 171 Notes to the consolidated financial statements1. Basis of preparation continued An update on the financial impact of each business area is as follows: – Under our current accounting policy, mobile handset revenue is recognised based on the amount the customer pays for the handset when it is delivered to the customer. Generally mobile handsets are either provided for free or for a small upfront charge. Under IFRS 15, additional revenue will be allocated to the mobile handset at the start of the contract. This is calculated with reference to its relative standalone value within the contract, regardless of the contract pricing. For each mobile handset contract the revenue recognition profile will change with greater day one recognition of revenue for the handset and a corresponding reduction in ongoing mobile service revenue over the contract period. The difference between the mobile handset revenue recognised and the amounts charged to the customer will be recognised as a contract asset. On adoption of IFRS 15, this change will pull forward profits in the periods being restated, and we will recognise a contract asset for all open contracts at 1 April 2016. Over time, the contract asset generated is expected to remain at similar levels as old contracts expire and new ones are signed. However we will see short term volatility, for example around key handset launches. This will be the most significant impact of the IFRS 15 adoption on the group and will primarily impact EE. To a lesser extent this will also impact mobile handset revenues in Business and Public Sector, in respect of the legacy EE business division, and Consumer. The impact in these lines of businesses is less significant due to the lower handset base. We expect to see a similar trend in respect of subsidised equipment although we expect this to have a less significant impact due to the lower relative standalone value for this equipment. – Currently, sales commissions and other third party acquisition costs resulting directly from securing contracts with customers are expensed when incurred. Under IFRS 15 sales commissions and other third party contract acquisition costs will be recognised as an asset, and amortised over the period in which the corresponding benefit is received, resulting in earlier profit recognition. The impact is greatest in EE in respect of third-party acquisition costs associated with handset revenues. – Currently, the group recognises connections revenue upon performance of the connection activity. Under IFRS 15 connections revenue will be deferred and recognised on a straight-line basis over the associated line/circuit contractual period. This will mean that revenue and profits will be recognised later and on transition leads to the recognition of a contract liability as revenue and profits are deferred to future periods. Wholesale and Ventures and Openreach deliver the majority of this service and therefore will experience the majority of the impact. Over time, this liability is expected to remain at similar levels as old contracts expire and new ones are signed. On the adoption date we expect the impact of this deferral to be significantly less than the impact of handset revenue and third party acquisition costs for handsets noted above. – We recognised a customer relationship intangible asset during our acquisition of EE. This represents our expectation of future revenue from customers existing on acquisition. Upon adoption of IFRS 15, we would need to identify how much of the customer relationship intangible asset needs to be reclassified as contract assets. This is to avoid double counting. The reduction in customer relationship intangible asset will result in a lower amortisation charge. – Recognised contract assets will be subject to impairment under IFRS 9 as set out below. – There will be a corresponding effect on tax in relation to the above impacts. The group anticipates a higher tax charge in 2018/19 and 2019/20 as a result of our expectation that accelerated revenues and deferred costs are likely to significantly exceed deferred revenues, thus increasing taxable profit in the periods being restated. IFRS 15 will impact other areas but we do not expect them to be material. These include certain contract fulfilment costs which will be recognised as an asset and amortised over the period in which benefit is received and certain expenses will be recognised as a deduction from revenue. IFRS 15 also provides more detailed guidance on how to account for contract modifications than the current revenue standards IAS 18 and IAS 11. Changes must be accounted for either as a retrospective change (creating either a catch up or deferral of previously recorded revenues), prospectively with a reallocation of revenues amongst identified performance obligations, or prospectively as separate contracts which will not require any reallocation. We expect contract modifications would primarily relate to changes in the agreed products and services to be provided to customers for long-term IT and networking solution contracts. IFRS 9 ‘Financial instruments’ IFRS 9 will be effective for BT from 1 April 2018. It is applicable to financial assets and financial liabilities and covers the classification, measurement, impairment and de-recognition of financial assets and liabilities together with a new hedge accounting model. With the exception of the impact on IFRS 15 contract assets we do not expect the standard to have a material impact on our results, with the key issues for BT being around documentation of policies, hedging strategy and new hedge documentation. Providing for loss allowances on our existing financial assets is not expected to have a material impact. However, we have not yet quantified the impact on contract assets which will be recognised under IFRS 15. This is being considered as part of the wider IFRS 15 project. IFRS 16 ‘Leases’ IFRS 16 was published in January 2016 and will be effective for BT from 1 April 2019, replacing IAS 17 ‘Leases’. We do not expect to early-adopt the standard and so transition to IFRS 16 will take place on 1 April 2019. Results in the 2019/20 financial year will be IFRS 16 compliant, with the first Annual Report and 20-F published in accordance with IFRS 16 being the 31 March 2020 report. The standard requires lessees to recognise assets and liabilities for all leases unless the lease term is 12 months or less, or the underlying asset is of low value. The group is still in the process of quantifying the implications of this standard. However, we expect the following indicative impacts: – There is expected to be an increase in total assets, as leased assets which are currently accounted for off balance sheet (ie classified as operating leases under IAS 17) will be recognised on balance sheet. The biggest asset category impacted for the group is expected to be land and buildings. – There is expected to be an increase in debt, as liabilities relating to existing operating leases are recognised. This is still under review. The increase in total debt will have an impact on gearing ratios. – Operating lease expenditure will be reclassified and split between depreciation and finance costs. Therefore EBITDA will increase. Future depreciation and finance costs for our historic leases are also affected by our choice of transition method, which is still under review. 170 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 171 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 1. Basis of preparation continued – There may be a corresponding effect on tax balances in relation to all of the above impacts. We also made changes in estimates resulting from the reassessment of the financial position and outlook for the Italian business amounting to £245m. This is presented within specific items in the year given its size and one-off nature. See note 8. Revised presentation of cash pooling arrangements An IFRIC clarification on IAS 32 ‘Financial Instruments presentation Offsetting and cash pooling arrangements’ was released in April 2016. This confirmed a requirement to gross up cash and overdraft balances associated with notional cash pooling arrangements when there is no intention to settle the period end balance. As a result we revised the comparative balance sheet at 31 March 2016. The impact is to increase cash and cash equivalents and short-term loans and other borrowings by £499m at 31 March 2016 and £414m at 31 March 2015. EE purchase price accounting IFRS 3 ‘Business Combinations’ allows us to recognise provisional fair values if the initial accounting for the business combination is incomplete. In the period ended 31 March 2016, we reported that the fair vales recognised for our 29 January 2016 acquisition of EE were provisional. The fair values were to be finalised over a period not exceeding one year from the acquisition date. During the year, we’ve finalised our assessment within the measurement period. This resulted in a revision to previously recognised brand, customer relationships and prepaid assets. Our reassessment also resulted in a net decrease in trade and other receivables and an increase in provisions related to unfavourable contracts. We also received a £20m refund from the previous owners of EE following the finalisation of the audit of the completion balance sheet. The net impact of the adjustments including the deferred tax effect resulted in an increase in goodwill of £29m as of 31 March 2016 with no material impact on the income statement. See note 14. Revision of segment results From 1 April 2016, the group has been reorganised and the reporting segments have changed. The group has six customer- facing lines of business: – BT Consumer remains a separate segment, renamed Consumer; – EE’s consumer division is a separate segment; – BT Business has become Business and Public Sector and includes the UK corporate and public sector operations from BT Global Services as well as EE’s business division; – BT Global Services has been renamed Global Services and is focused on multinational customers; – BT Wholesale has become Wholesale and Ventures and includes EE’s MVNO operations and certain specialist businesses that were previously in the BT Business segment; and – Openreach, remains unchanged. In addition, EE’s technology team is now the mobile technology unit of our internal service unit, Technology, Service and Operations. The comparative results for all six customer facing lines of business in the segment information note have been revised to be presented on a consistent basis. See note 4. Presentation of specific items Our income statement and segmental analysis separately identify trading results before specific items. The directors believe that presentation of our results in this way is relevant to an understanding of our financial performance, as specific items are identified by virtue of their size, nature or incidence. This presentation is consistent with the way that financial performance is measured by management and reported to the Board and the Operating Committee and assists in providing a meaningful analysis of our trading results. In determining whether an event or transaction is specific, management considers quantitative as well as qualitative factors such as the frequency or predictability of occurrence. Furthermore, we consider a columnar presentation to be appropriate, as it improves the clarity of the presentation and is consistent with the way that financial performance is measured by management and reported to the Board and the Operating Committee. Specific items may not be comparable to similarly titled measures used by other companies. Examples of charges or credits meeting the above definition and which have been presented as specific items in the current and/or prior years include acquisitions/disposals of businesses and investments, regulatory settlements, historical insurance or litigation claims, business restructuring programmes, asset impairment charges, property rationalisation programmes, net interest on pensions and the settlement of multiple tax years. In the event that other items meet the criteria, which are applied consistently from year to year, they are also treated as specific items. Specific items for the current and prior years are disclosed in note 8. Prior year revision and re-classifications Investigation into our Italian business During the year our investigations into our Italian business have revealed inappropriate behaviour and improper accounting practices. The improper practices included a complex set of improper sales, purchase, factoring and leasing transactions. The effect of the prior years’ errors on the income statement, balance sheet and cash flow statements for the prior periods is set out in the Summary on pages 173 to 176. In total we identified prior period errors that amounted to a £268m reduction in total equity in our 31 March 2016 balance sheet. The prior years’ errors have resulted from profits, and therefore equity, being overstated for a number of years. These errors affected the Consolidated Group Balance Sheets and Consolidated Group Income Statements included in the Annual Report and Form 20-F for a number of years including the years ended 31 March 2016 and 31 March 2015, and in each of the quarterly results announcements of those years. We have concluded that errors were not material to these or any other of the group’s previously issued financial statements. We have also assessed whether the correction of the cumulative effect of these errors in the current year would be material to the current year and concluded that correcting these in the current year would be material. Therefore we consider it appropriate to correct the errors by revising the prior years to avoid mis-stating the current year. 172 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 173 Notes to the consolidated financial statements continued1. Basis of preparation continued Summary of adjustments The following tables reconcile the 31 March 2016 and 31 March 2015 financial years from previously published to the revised position reflecting the three prior year revisions. All subsequent comparative information has been revised accordingly. Group income statement For the year ended 31 March 2016 As publisheda £m Revenue Operating costs Operating profit Profit before tax Profit for the period Earnings per share – basic Earnings per share – diluted 19,042 (15,307) 3,735 3,029 2,588 29.9p 29.6p Italian business adjustment £m (30) (92) (122) (122) (122) (1.4)p (1.4)p For the year ended 31 March 2015 Revenue Operating costs Operating profit Profit before tax Profit for the period Earnings per share – basic Earnings per share – diluted As publisheda £m Italian business adjustment £m 17,979 (14,499) 3,480 2,645 2,135 26.5p 26.1p (11) (67) (78) (78) (78) (1.0)p (1.0)p a After specific items, which are defined on page 252. Revised £m 19, 012 (15,399) 3,613 2,907 2,466 28.5p 28.2p Revised £m 17,968 (14,566) 3,402 2,567 2,057 25.5p 25.1p 172 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 173 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 1. Basis of preparation continued Group balance sheet As at 31 March 2016 Non-current assets Intangible assets Property, plant and equipment Trade and other receivables Other non-current assets Current assets Trade and other receivables Cash and cash equivalents Other current assets Current liabilities Loans and other borrowings Trade and other payables Other current borrowings Total assets less current liabilities Non-current liabilities Loans and other borrowings Retirement benefit obligations Other non-current liabilities Equity Ordinary shares Retained loss Other components of equity Total equity As published £m Italian business adjustment £m Cash pooling adjustment £m EE purchase price accounting adjustment £m Revised £m 15,436 16,010 233 2,779 34,458 4,063 497 3,574 8,134 3,237 7,289 490 11,016 31,576 11,032 6,382 3,782 21,196 499 (167) 10,048 10,380 31,576 – (39) (15) – (54) (91) – – (91) – 129 – 129 (274) (7) – 1 (6) – (263) (5) (268) (274) – – – – – – 499 – 499 499 – – 499 – – – – – – – – – – 14 – – – 14 6 – – 6 – – 7 7 13 – – 13 13 – – – – 13 15,450 15,971 218 2,779 34,418 3,978 996 3,574 8,548 3,736 7,418 497 11,651 31,315 11,025 6,382 3,796 21,203 499 (430) 10,043 10,112 31,315 174 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 175 Notes to the consolidated financial statements continued 1. Basis of preparation continued Group balance sheet As at 31 March 2015 Non-current assets Intangible assets Property, plant and equipment Trade and other receivables Other non-current assets Current assets Trade and other receivables Cash and cash equivalents Other current assets Current liabilities Loans and other borrowings Trade and other payables Other current borrowings Total assets less current liabilities Non-current liabilities Loans and other borrowings Retirement benefit obligations Other non-current liabilities Equity Ordinary shares Retained loss Other components of equity Total equity As published £m Italian business adjustment £m Cash pooling adjustment £m Revised £m 3,170 13,505 184 2,861 19,720 3,140 434 3,897 7,471 1,900 5,276 532 7,708 – (7) (5) – (12) (47) – – (47) – 72 – 72 19,483 (131) 7,868 7,583 3,224 18,675 419 (1,982) 2,371 808 19,483 (6) – 2 (4) – (142) 15 (127) (131) – – – – – – 414 – 414 414 – – 414 – – – – – – – – – – 3,170 13,498 179 2,861 19,708 3,093 848 3,897 7,838 2,314 5,348 532 8,194 19,352 7,862 7,583 3,226 18,671 419 (2,124) 2,386 681 19,352 174 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 175 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 1. Basis of preparation continued Group cash flow statement For the year ended 31 March Net cash flow from operating activities Net cash flow from investing activities Net cash flow from financing activities Net increase in cash and cash equivalents Opening cash and cash equivalents Effect of exchange rate changes Closing cash and cash equivalents As published £m Italian business adjustment £m 5,179 (5,145) 42 76 407 (24) 459 (28) 28 – – – – – 2016 Revised £m 5,151 (5,117) 42 76 407 (24) 459 As published £m Italian business adjustment £m 4,796 (4,064) (1,028) (296) 684 19 407 (8) 8 – – – – – 2015 Revised £m 4,788 (4,056) (1,028) (296) 684 19 407 2. Critical accounting estimates and key judgements The preparation of financial statements in conformity with IFRS requires the use of accounting estimates and assumptions. It also requires management to exercise its judgement in the process of applying our accounting policies. We continually evaluate our estimates, assumptions and judgements based on available information and experience. As the use of estimates is inherent in financial reporting, actual results could differ from these estimates. Management has discussed its critical accounting estimates and associated disclosures with the Audit and Risk Committee. The areas involving a higher degree of judgement or complexity are described in the applicable notes to the financial statements. Critical accounting estimates and key judgements can be identified throughout the notes by the following symbol. We have the following critical accounting estimates and key judgements: – Revenue from multiple element arrangements, see note 4 – Subscriber acquisition and retention costs, see note 5 – Current and deferred income tax, see note 9 – Goodwill, see note 12 – Useful lives for property, plant and equipment and software, see note 13 – Government grants relating to Broadband Delivery UK (BDUK) contracts, see note 13 – Business combinations, see note 14 – Long-term customer contracts, see note 17 – Providing for doubtful debts, see note 17 – Provisions and contingent liabilities, see note 19 – Pension obligations, see note 20 3. Significant accounting policies The significant accounting policies applied in the preparation of our consolidated financial statements are set out below. These policies have been consistently applied to all the years presented, unless otherwise stated. Basis of consolidation The group financial statements consolidate the financial statements of BT Group plc and its subsidiaries, and include its share of the results of associates and joint ventures using the equity method of accounting. The group recognises its direct rights to (and its share of) jointly held assets, liabilities, revenues and expenses of joint operations under the appropriate headings in the consolidated financial statements. A subsidiary is an entity that is controlled by another entity, known as the parent or investor. An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee. Non-controlling interests in the net assets of consolidated subsidiaries, which consist of the amounts of those interests at the date of the original business combination and non-controlling share of changes in equity since the date of the combination, are not material to the group’s financial statements. The results of subsidiaries acquired or disposed of during the year are consolidated from and up to the date of change of control. Where necessary, accounting policies of subsidiaries have been aligned with the policies adopted by the group. All intra-group transactions including any gains or losses, balances, income or expenses are eliminated in full on consolidation. When the group loses control of a subsidiary, the profit or loss on disposal is calculated as the difference between (i) the aggregate of the fair value of the consideration received and the fair value of any retained interest and (ii) the previous carrying amount of the assets (including goodwill), and liabilities of the subsidiary and any non-controlling interests. The profit or loss on disposal is recognised as a specific item. 176 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 177 Notes to the consolidated financial statements continued 3. Significant accounting policies continued Revenue Revenue represents the fair value of the consideration received or receivable for communications services and equipment sales, net of discounts and sales taxes. Revenue is recognised when it is probable that the economic benefits associated with a transaction will flow to the group and the amount of revenue and associated costs can be measured reliably. The accounting for revenue sharing arrangements depends on the analysis of the facts and circumstances surrounding these transactions. Where we act as an agent in a transaction, we recognise revenue net of directly attributable costs. The percentage of completion method relies on estimates of total expected contract revenues and costs, as well as reliable measurement of the progress made towards completion. Unless the financial outcome of a contract can be estimated with reasonable certainty, no attributable profit is recognised. In such circumstances, revenue is recognised equal to the costs incurred to date, to the extent that such revenue is expected to be recoverable, or costs are accrued to bring the margin to nil. Recognised revenue and profits are subject to revisions during the contract if the assumptions regarding the overall contract outcome are changed. The cumulative impact of a revision in estimates is recorded in the period in which such revisions become likely and can be estimated. Where the actual and estimated costs to completion exceed the estimated revenue for a contract, the full contract life loss is recognised immediately. Services Revenue arising from separable installation and connection services is recognised when it is earned, upon activation. Revenue from the rental of analogue and digital lines and private circuits is recognised on a straight line basis over the period to which it relates. Revenue from calls is recognised at the time the call is made over our network. Subscription fees, consisting primarily of monthly charges for access to broadband and other internet access or voice services, are recognised as revenue as the service is provided. Revenue from the interconnection of voice and data traffic between other telecommunications operators is recognised at the time of transit across our network. Revenues from telephone service and internet access subscription fees as well as those from wholesale access revenues are recognised on a straight line basis over the period to which they relate. Revenue from calls is recognised at the time the call is made over the group’s network. Revenue from the interconnection of voice and data traffic between other telecommunications operators is recognised at the time of transit across the group’s network. Equipment sales Revenue from the sale of equipment is recognised when all the significant risks and rewards of ownership are transferred to the customer, which is normally the date the equipment is delivered and accepted by the customer. Long-term contractual arrangements Revenue from long-term contractual arrangements, including fixed price contracts to design and build software solutions, is recognised based on the percentage of completion method. The stage of completion is estimated using an appropriate measure according to the nature of the contract such as the proportion of costs incurred relative to the estimated total contract costs, or other measures of completion such as the achievement of contract milestones and customer acceptance. In the case of time and materials contracts, revenue is recognised as the service is rendered. Costs related to delivering services under long-term contractual arrangements are expensed as incurred except for an element of costs incurred in the initial contract set-up, transition or transformation phase, which is deferred and recorded within non-current assets. These costs are then recognised in the income statement on a straight line basis over the remaining contract term, unless the pattern of service delivery indicates a different profile is more appropriate. These costs are directly attributable to specific contracts, relate to future activity, will generate future economic benefits and are assessed for recoverability on a regular basis. Multiple element arrangements and bundles Revenue from multiple element arrangements and bundles is described in note 4. Operating and reportable segments Our operating segments are reported based on financial information provided to the Operating Committee, as detailed on page 14, which is the key management committee and represents the ‘chief operating decision maker’. Our organisational structure reflects the different customer groups to which we provide communications products and services via our customer-facing lines of business: Consumer, EE, Business and Public Sector, Global Services, Wholesale and Ventures and Openreach. The customer-facing lines of business are supported by an internal service unit: Technology, Service & Operations (TSO). The customer-facing lines of business are our reportable segments and generate substantially all of our revenue. We aggregate the remaining operations and include within the ‘Other’ category to reconcile to the consolidated results of the group. The ‘Other’ category includes TSO and our centralised functions including procurement and property management. Provisions for the settlement of significant legal, commercial and regulatory disputes, which are negotiated at a group level, are initially recorded in the ‘Other’ segment. On resolution of the dispute, the full impact is recognised in the results of the relevant line of business and offset in the group results through the utilisation of the provision previously charged to the ‘Other’ segment. Settlements which are particularly significant or cover more than one financial year may fall within the definition of specific items as detailed on page 252. The costs incurred by TSO are recharged to the customer-facing lines of business to reflect the services it provides to them. Depreciation and amortisation incurred by TSO in relation to the networks and systems it manages and operates on behalf of the customer- facing lines of business is allocated to the lines of business based on their respective utilisation. Capital expenditure incurred by TSO for specific projects undertaken on behalf of the customer-facing lines of business is allocated based on the value of the directly attributable expenditure incurred. Where projects are not directly attributable to a particular line of business, capital expenditure is allocated between them based on the proportion of estimated future economic benefits. TSO and the group’s centralised functions are not reportable segments as they did not meet the quantitative thresholds as set out in IFRS 8 ‘Operating Segments’ for any of the years presented. 176 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 177 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 3. Significant accounting policies continued The estimated useful lives assigned to principal categories of assets are as follows: Land and buildings – Freehold buildings – Short-term leasehold improvements – Leasehold land and buildings 14 to 50 years Shorter of 10 years or lease term Unexpired portion of lease or 40 years, whichever is the shorter Performance of each reportable segment is measured based on adjusted EBITDA, defined as EBITDA before specific items, as included in the internal financial reports reviewed by the Operating Committee. EBITDA is defined as the operating profit or loss before depreciation, amortisation, net finance expense and taxation. Adjusted EBITDA is considered to be a useful measure of the operating performance of the lines of business because it approximates the underlying operating cash flow by eliminating depreciation and amortisation and also provides a meaningful analysis of trading performance by excluding specific items, which are disclosed separately by virtue of their size, nature or incidence. Specific items are detailed in note 8 and are not allocated to the reportable segments as this reflects how they are reported to the Operating Committee. Finance expense and income are not allocated to the reportable segments, as the central treasury function manages this activity, together with the overall net debt position of the group. Network infrastructure Transmission equipment – Duct – Cable – Fibre Exchange equipment Other network equipment The comparative results for all six customer facing lines of business have been revised to reflect the 1 April 2016 reorganisation of the reporting segments, see note 1. Other assets – Motor vehicles – Computers and office equipment 40 years 3 to 25 years 5 to 20 years 2 to 13 years 2 to 20 years 2 to 9 years 3 to 7 years Retirement benefits The group’s net obligation in respect of defined benefit pension plans is the present value of the defined benefit obligation less the fair value of the plan assets. The calculation of the obligation is performed by a qualified actuary using the projected unit credit method and key actuarial assumptions at the balance sheet date. The income statement expense is allocated between an operating charge and net finance income or expense. The operating charge reflects the increase in the defined benefit obligation resulting from the pension benefit earned by active employees in the current period, the costs of administering the plans and any past service costs/credits such as those arising from curtailments or settlements. The net finance income or expense reflects the interest on the net retirement benefit obligations recognised in the group balance sheet, based on the discount rate at the start of the year. Actuarial gains and losses are recognised in full in the period in which they occur and are presented in the group statement of comprehensive income. The group also operates defined contribution pension plans and the income statement expense represents the contributions payable for the year. Property, plant and equipment Property, plant and equipment are included at historical cost, net of accumulated depreciation, government grants and any impairment charges. Property, plant and equipment acquired through business combinations are initially recorded at fair value and subsequently accounted for on the same basis as the group’s existing assets. An item of property, plant and equipment is derecognised on disposal or when no future economic benefits are expected to arise from the continued use of the asset. The difference between the sale proceeds and the net book value at the date of disposal is recognised in operating costs in the income statement. Included within the cost of network infrastructure and equipment are direct and indirect labour costs, materials and directly attributable overheads. Depreciation is provided on property, plant and equipment on a straight line basis from the time the asset is available for use, to write off the asset’s cost over the estimated useful life taking into account any expected residual value. Freehold land is not depreciated. Assets held under finance leases are depreciated over the shorter of the lease term or their useful economic life. Residual values and useful lives are reassessed annually and, if necessary, changes are recognised prospectively. Network share assets Certain assets have been contributed to a network share arrangement by both EE and Hutchison 3G UK Limited, with legal title remaining with the contributor. This is considered to be a reciprocal arrangement. The group’s share of the assets on acquisition of EE was recognised at fair value within tangible assets, and depreciated in line with the group’s policy. Subsequent additions are recorded at cost. For further information see note 13. Intangible assets Identifiable intangible assets are recognised when the group controls the asset, it is probable that future economic benefits attributable to the asset will flow to the group and the cost of the asset can be reliably measured. All intangible assets, other than goodwill, are amortised over their useful economic life. The method of amortisation reflects the pattern in which the assets are expected to be consumed. If the pattern cannot be determined reliably, the straight line method is used. Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the group’s share of the identifiable net assets (including intangible assets) of the acquired business. For the purpose of impairment testing, goodwill acquired in a business combination is allocated to each of the Cash Generating Units (CGUs) that is expected to benefit from the business combination. Each CGU to which goodwill is allocated represents the lowest level within the group at which the goodwill is monitored for internal management purposes. Acquired intangible assets – customer relationships and brands Intangible assets such as customer relationships or brands acquired through business combinations are recorded at fair value at the date of acquisition and subsequently carried at amortised cost. Assumptions are used in estimating the fair values of these relationships or brands and include management’s estimates of revenue and profits to be generated by them. 178 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 179 Notes to the consolidated financial statements continued 3. Significant accounting policies continued Telecommunications licences Licence fees paid to governments, which permit telecommunications activities to be operated for defined periods, are initially recorded at cost and amortised from the time the network is available for use to the end of the licence period or where our usage can extend beyond the licence period, over the period we expect to benefit from the use of the licences, which is typically 20 years. Licences acquired through business combinations are recorded at fair value at the date of acquisition and subsequently carried at amortised cost. The fair value is based on management’s assumption of future cash flows using market expectations at acquisition date. Computer software Computer software comprises computer software licences purchased from third parties, and also the cost of internally developed software. Computer software licences purchased from third parties are initially recorded at cost. Costs directly associated with the production of internally developed software, including direct and indirect labour costs of development, are capitalised only where it is probable that the software will generate future economic benefits, the cost of the asset can be reliably measured and technical feasibility can be demonstrated, in which case it is capitalised as an intangible asset on the balance sheet. Costs which do not meet these criteria and research costs are expensed as incurred. The group’s development costs which give rise to internally developed software include upgrading the network architecture or functionality and developing service platforms aimed at offering new services to the group’s customers. See research and development on page 32. Other Other intangible assets include website development costs and other licences. Items are capitalised at cost and amortised on a straight line basis over their useful economic life or the term of the contract. Estimated useful economic lives The estimated useful economic lives assigned to the principal categories of intangible assets are as follows: – Computer software – Telecommunications licences – Customer relationships and brands 2 to 10 years 2 to 20 years 1 to 15 years Programme rights Programme rights are recognised on the balance sheet from the point at which the legally enforceable licence period begins. Rights for which the licence period has not started are disclosed as contractual commitments in note 30. Payments made to receive commissioned or acquired programming in advance of the legal right to broadcast the programmes are classified as prepayments. Programme rights are initially recognised at cost and are amortised from the point at which they are available for use, on a straight line basis over the programming period, or the remaining licence term, as appropriate, this is generally 12 months. The amortisation charge is recorded within operating costs in the income statement. Programmes produced internally are recognised within current assets at production cost, which includes labour costs and an appropriate portion of relevant overheads, and charged to the income statement over the period of the related broadcast. Programme rights are tested for impairment in accordance with the group’s policy for impairment of non-financial assets set out below. Related cash outflows are classified as operating cash flows in the cash flow statement. Inventories Network maintenance equipment and equipment to be sold to customers are stated at the lower of cost or net realisable value, taking into account expected revenues from the sale of packages comprising a mobile handset and a subscription. Cost corresponds to purchase or production cost determined by either the first in first out (FIFO) cost or average cost method. Provisions Provisions are recognised when the group has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources will be required to settle the obligation and the amount can be reliably estimated. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and the risks specific to the liability. Financial liabilities within provisions are initially recognised at fair value and subsequently carried at amortised cost using the effective interest method. Onerous lease provisions are measured at the lower of the cost to fulfil or to exit the contract. Current and deferred income tax Current income tax is calculated on the basis of the tax laws enacted or substantively enacted at the balance sheet date in the countries where the group’s subsidiaries, associates and joint ventures operate and generate taxable income. The group periodically evaluates positions taken in tax returns with respect to situations in which applicable tax regulation is subject to interpretation, and the group establishes provisions where appropriate on the basis of the amounts expected to be paid to tax authorities. Deferred tax is recognised, using the liability method, in respect of temporary differences between the carrying amount of the group’s assets and liabilities and their tax base. Deferred income tax assets and liabilities are offset when there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income tax assets and liabilities relate to income taxes levied by the same taxation authority on either the taxable entity or different taxable entities where there is an intention to settle the balances on a net basis. Any remaining deferred tax asset is recognised only when, on the basis of all available evidence, it can be regarded as probable that there will be suitable taxable profits, within the same jurisdiction, in the foreseeable future against which the deductible temporary difference can be utilised. Deferred tax is determined using tax rates that are expected to apply in the periods in which the asset is realised or liability settled, based on tax rates and laws that have been enacted or substantively enacted by the balance sheet date. Impairment of non-financial assets Intangible assets with finite useful lives and property, plant and equipment are tested for impairment if events or changes in circumstances (assessed at each reporting date) indicate that the carrying amount may not be recoverable. When an impairment test is performed, the recoverable amount is assessed by reference to the higher of the net present value of the expected future cash flows (value in use) of the relevant cash generating unit and the fair value less costs to dispose. 178 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 179 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 3. Significant accounting policies continued Goodwill is reviewed for impairment at least annually. Impairment losses are recognised in the income statement, as a specific item. If a cash generating unit is impaired, impairment losses are allocated firstly against goodwill, and secondly on a pro-rata basis against intangible and other assets. Government grants Government grants are recognised when there is reasonable assurance that the conditions associated with the grants have been complied with and the grants will be received. Grants for the purchase or production of property, plant and equipment are deducted from the cost of the related assets and reduce future depreciation expense accordingly. Grants for the reimbursement of operating expenditure are deducted from the related category of costs in the income statement. Government grants received relating to the BDUK programme and other rural superfast broadband contracts are accounted for as described under ‘Critical accounting estimates and key judgements’. Once a government grant is recognised, any related contingent liability or contingent asset is treated in accordance with IAS 37 ‘Provisions, Contingent Liabilities and Contingent Assets’. Foreign currencies Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the date of the transaction. Foreign exchange gains and losses resulting from the settlement of transactions and the translation of monetary assets and liabilities denominated in foreign currencies at period end exchange rates are recognised in the income statement line which most appropriately reflects the nature of the item or transaction. On consolidation, assets and liabilities of foreign undertakings are translated into Sterling at year end exchange rates. The results of foreign undertakings are translated into Sterling at average rates of exchange for the year (unless this average is not a reasonable approximation of the cumulative effects of the rates prevailing on the transaction dates, in which case income and expenses are translated at the dates of the transactions). Foreign exchange differences arising on retranslation are recognised directly in a separate component of equity, the translation reserve. In the event of the disposal of an undertaking with assets and liabilities denominated in a foreign currency, the cumulative translation difference associated with the undertaking in the translation reserve is charged or credited to the gain or loss on disposal recognised in the income statement. Research and development Research expenditure is recognised in the income statement in the period in which it is incurred. Development expenditure, including the cost of internally developed software, is recognised in the income statement in the period in which it is incurred unless it is probable that economic benefits will flow to the group from the asset being developed, the cost of the asset can be reliably measured and technical feasibility can be demonstrated, in which case it is capitalised as an intangible asset on the balance sheet. Capitalisation ceases when the asset being developed is ready for use. Research and development costs include direct and indirect labour, materials and directly attributable overheads. Leases The determination of whether an arrangement is, or contains, a lease is based on the substance of the arrangement and requires an assessment of whether the fulfilment of the arrangement is dependent on the use of a specific asset or assets and whether the arrangement conveys the right to use the asset. Leases of property, plant and equipment where the group holds substantially all the risks and rewards of ownership are classified as finance leases. Finance lease assets are capitalised at the commencement of the lease term at the lower of the present value of the minimum lease payments or the fair value of the leased asset. The obligations relating to finance leases, net of finance charges in respect of future periods, are recognised as liabilities. Leases are subsequently measured at amortised cost using the effective interest method. Leases where a significant portion of the risks and rewards are held by the lessor are classified as operating leases. Rentals are charged to the income statement on a straight line basis over the period of the lease. Own shares Own shares represent the shares of the parent company BT Group plc that are held in treasury or by employee share ownership trusts. Own shares are recorded at cost and deducted from equity. When shares vest unconditionally or are cancelled they are transferred from the own shares reserve to retained earnings at their weighted average cost. Share-based payments The group operates a number of equity settled share-based payment arrangements, under which the group receives services from employees in consideration for equity instruments (share options and shares) of the group. Equity settled share-based payments are measured at fair value at the date of grant. Market- based performance criteria and non-vesting conditions (for example, the requirement for employees to make contributions to the share purchase programme) are reflected in this measurement of fair value. The fair value determined at the grant date is recognised as an expense on a straight line basis over the vesting period, based on the group’s estimate of the options or shares that will eventually vest and adjusted for the effect of non market-based vesting conditions. Fair value is measured using either the Binomial options pricing model or Monte Carlo simulations, whichever is more appropriate to the share-based payment arrangement. Service and performance conditions are vesting conditions. Any other conditions are non-vesting conditions which have to be taken into account to determine the fair value of equity instruments granted. In the case that an award or option does not vest as a result of a failure to meet a non-vesting condition that is within the control of either counterparty, this is accounted for as a cancellation. Cancellations are treated as accelerated vesting and all remaining future charges are immediately recognised in the income statement. As the requirement to save under an employee saveshare arrangement is a non-vesting condition, employee cancellations are treated as an accelerated vesting. No adjustment is made to total equity for awards that lapse or are forfeited after the vesting date. Termination benefits Termination benefits (leaver costs) are payable when employment is terminated before the normal retirement date, or when an employee accepts voluntary redundancy in exchange for these benefits. The group recognises termination benefits when it is demonstrably committed to the affected employees leaving the group. 180 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 181 Notes to the consolidated financial statements continued3. Significant accounting policies continued Financial instruments Financial liabilities at amortised cost Trade and other payables Financial liabilities within trade and other payables are initially recognised at fair value, which is usually the original invoiced amount, and subsequently carried at amortised cost using the effective interest method. Loans and other borrowings Loans and other borrowings are initially recognised at the fair value of amounts received net of transaction costs. Loans and other borrowings are subsequently measured at amortised cost using the effective interest method and, if included in a fair value hedge relationship, are re-valued to reflect the fair value movements on the hedged risk associated with the loans and other borrowings. The resulting amortisation of fair value movements, on de-designation of the hedge, is recognised in the income statement.  Available-for-sale investments Liquid and other investments are classified as available-for-sale investments and are initially recognised at fair value plus direct transaction costs and then re-measured at subsequent reporting dates to fair value, with unrealised gains and losses (except for changes in exchange rates for monetary items, interest, dividends and impairment losses, which are recognised in the income statement) recognised in equity until the financial asset is derecognised, at which time the cumulative gain or loss previously recognised in equity is taken to the income statement, in the line that most appropriately reflects the nature of the item or transaction. On disposal or impairment of the investments, any gains and losses that have been deferred in other comprehensive income are re-classified to the income statement. Dividends on equity investments are recognised in the income statement when the group’s right to receive payment is established. Equity investments are recorded in non-current assets unless they are expected to be sold within one year.  Loans and receivables Trade and other receivables Trade and other receivables are initially recognised at fair value, which is usually the original invoiced amount, and are subsequently carried at amortised cost, using the effective interest method, less provisions made for doubtful receivables. Provisions are made specifically where there is evidence of a risk of non-payment, taking into account ageing, previous losses experienced and general economic conditions. Cash and cash equivalents Cash and cash equivalents comprise cash in hand and current balances with banks and similar institutions, which are readily convertible to cash and are subject to insignificant risk of changes in value and have an original maturity of three months or less. For the purpose of the consolidated cash flow statement, cash and cash equivalents are as defined above net of outstanding bank overdrafts. Bank overdrafts are included within loans and other borrowings, in current liabilities on the balance sheet.  Financial assets and liabilities at fair value through profit or loss All of the group’s derivative financial instruments are held for trading and classified as fair value through profit or loss. Derivative financial instruments The group uses derivative financial instruments mainly to reduce exposure to foreign exchange and interest rate risks. The group’s policy is not to use derivatives for trading purposes. However, derivatives that do not qualify for hedge accounting or are specifically not designated as a hedge where natural offset is more appropriate are initially recognised and subsequently measured at fair value through profit and loss. Any direct transaction costs are recognised immediately in the income statement. Gains and losses on re- measurement are recognised in the income statement in the line that most appropriately reflects the nature of the item or transaction to which they relate. Derivative financial instruments are classified as current assets or current liabilities where they have a maturity period within 12 months. Where derivative financial instruments have a maturity period greater than 12 months, they are classified within either non-current assets or non-current liabilities. Where the fair value of a derivative contract at initial recognition is not supported by observable market data and differs from the transaction price, a day one gain or loss will arise which is not recognised in the income statement. Such gains and losses are deferred and amortised to the income statement based on the remaining contractual term and as observable market data becomes available. Hedge accounting Where derivatives qualify for hedge accounting, recognition of any resultant gain or loss depends on the nature of the hedge. To qualify for hedge accounting, hedge documentation must be prepared at inception and the hedge must be expected to be highly effective both prospectively and retrospectively. The hedge is tested for effectiveness at inception and in subsequent periods in which the hedge remains in operation. Hedge accounting is discontinued when the hedging instrument expires, or is sold, terminated or no longer qualifies for hedge accounting or the group chooses to end the hedge relationship. The group designates certain derivatives as either cash flow hedges or fair value hedges. Cash flow hedges When a derivative financial instrument is designated as a hedge of the variability in cash flows of a recognised asset or liability, or a highly probable transaction, the effective part of any gain or loss on the derivative financial instrument is recognised directly in equity, in the cash flow reserve. For cash flow hedges of recognised assets or liabilities, the associated cumulative gain or loss is removed from equity and recognised in the same line of the income statement and in the same period or periods that the hedged transaction affects the income statement. Any ineffectiveness arising on a cash flow hedge of a recognised asset or liability is recognised immediately in the same income statement line as the hedged item. Where ineffectiveness arises on highly probable transactions, it is recognised in the income statement line which most appropriately reflects the nature of the item or transaction. Fair value hedges When a derivative financial instrument is designated as a hedge of the variability in fair value of a recognised asset or liability, or unrecognised firm commitment, the change in fair value of the derivative that is designated as a fair value hedge is recorded in the income statement at each reporting date, together with any changes in fair value of the hedged asset or liability that is attributable to the hedged risk.  180 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 181 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 4. Segment information The definition of our operating and reportable segments is provided on page 177. What has changed in our segment information? From 1 April 2016, the group has been reorganised and the reporting segments have been changed. This was in addition to the revision disclosed in note 1 for our Italian business. The comparative results for 2015/16 and 2014/15 for all six customer facing lines of business have been revised and presented on a consistent basis. The impact on line of business results in 2015/16 was to increase revenue, EBITDA and operating profit in Consumer by £10m, £18m and £17m (2014/15: £8m, £13m and £13m), to reduce revenue, EBITDA and operating profit in EE by £204m, £88m and £58m (2014/15: £nil, £nil and £nil), to increase revenue, EBITDA and operating profit in Business and Public Sector by £1,442m, £338m and £252m (2014/15: £1,402m, £339m and £284m), to reduce revenue, EBITDA and operating profit in Global Services by £1,427m, £569m and £473m (2014/15: £1,532m, £582m and £507m), to increase revenue, EBITDA and operating profit in Wholesale and Ventures by £162m, £213m and £172m (2014/15: £124m, £185m and £164m), to reduce EBITDA and operating profit in Openreach by £5m (2014/15: £3m) and to reduce revenue, EBITDA and operating profit in Other by £13m, £28m and £27m (2014/15: £13m, £30m and £29m). Intra group revenues were decreased by £342m in 2015/16 (2014/15: £295m). We have set out below information regarding the results of each reportable segment. Segment revenue and profit Year ended 31 March 2017 Segment revenue Internal revenue Revenue from external customersa EBITDAb Depreciation and amortisation Operating profit (loss)a Specific items (note 8) Consumer £m EE £m 4,934 (63) 4,871 1,012 (209) 803 5,090 (37) 5,053 1,156 (780) 376 Business and Public Sector £m 4,758 (122) 4,636 1,528 (352) 1,176 Global Services £m Wholesale and Ventures £m Openreach £m 5,479 – 5,479 495 (439) 56 2,109 (138) 1,971 834 (306) 528 5,098 (3,036) 2,062 2,633 (1,369) 1,264 Operating profit Net finance expensec Share of post tax loss of associates and joint ventures Profit before tax Year ended 31 March 2016 Segment revenue Internal revenue Revenue from external customersa EBITDAb Depreciation and amortisation Operating profit (loss)a Specific items (note 8) Consumer £m 4,608 (65) 4,543 1,055 (207) 848 Business and Public Sector £m d EE £m Global Services £m Wholesale and Ventures £m Openreach £m 841 (7) 834 173 (146) 27 4,294 (99) 4,195 1,414 (284) 1,130 5,074 – 5,074 479 (422) 57 2,274 (94) 2,180 755 (253) 502 5,100 (3,058) 2,042 2,659 (1,301) 1,358 Operating profit Net finance expensec Share of post tax profit of associates and joint ventures Profit before tax a Before specific items. b EBITDA is stated before specific items and is the group’s profitability measure for segments. c Net finance expense includes specific item expense of £210m (2015/16: £229m, 2014/15: £299m). See note 8. d EE reflects results for the period from acquisition on 29 January to 31 March 2016. Other £m 10 – 10 (13) (55) (68) Other £m 11 – 11 (76) (18) (94) Total £m 27,478 (3,396) 24,082 7,645 (3,510) 4,135 (968) 3,167 (804) (9) 2,354 Total £m 22,202 (3,323) 18,879 6,459 (2,631) 3,828 (215) 3,613 (712) 6 2,907 182 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 183 Notes to the consolidated financial statements continued 4. Segment information continued Year ended 31 March 2015 Segment revenue Internal revenue Revenue from external customersa EBITDAb Depreciation and amortisation Operating profit (loss)a Specific items (note 8) Consumer £m 4,293 (62) 4,231 1,044 (218) 826 Business and Public Sector £m 4,247 (99) 4,148 1,380 (235) 1,145 Global Services £m 5,218 – 5,218 465 (444) 21 Wholesale and Ventures £m 2,361 (80) 2,281 746 (245) 501 Openreach £m 5,011 (3,064) 1,947 2,597 (1,348) 1,249 Other £m 15 – 15 (39) (48) (87) Operating profit Net finance expensec Share of post tax loss of associates and joint ventures Profit on disposal of interest in associates and joint ventures Profit before tax a Before specific items. b EBITDA is stated before specific items and is the group’s profitability measure for segments. c Net finance expense includes specific item finance expense of £210m (2015/16: £229m, 2014/15: £299m). See note 8. Total £m 21,145 (3,305) 17,840 6,193 (2,538) 3,655 (253) 3,402 (859) (1) 25 2,567 What are our internal revenue and costs? Most of our internal trading relates to Openreach and arises on rentals, and any associated connection or migration charges, of the UK access lines and other network products to the customer-facing lines of business. This occurs both directly, and also indirectly, through TSO which is included within the ‘Other’ segment. Wholesale and Ventures internal revenue arises from EE for mobile ethernet access and TSO for transmission planning services. Internal revenue in Business and Public Sector relates primarily to the use of BT Ireland’s network by other lines of business. Internal revenue arising in Consumer relates primarily to employee broadband and wi-fi services, while internal revenue in Global Services relates primarily to conferencing services. Intra-group revenue generated from the sale of regulated products and services is based on market price. Intra-group revenue from the sale of other products and services is agreed between the relevant lines of business and therefore line of business profitability may be impacted by transfer pricing levels. The tables below show internal revenue and costs recorded by each line of line of business. Year ended 31 March 2017 Internal revenue recorded by Consumer EE Business and Public Sector Global Services Wholesale and Ventures Openreach Total Consumer £m EE £m Internal cost recorded by Business and Public Sector £m Global Services £m Wholesale and Ventures £m Openreach £m Other £m Total £m – – 60 – – 910 970 – – 3 – – – 3 21 – – – 2 236 259 20 – 39 – 23 158 240 4 37 20 – – 260 321 – – – – 39 – 39 18 – – – 74 1,472 1,564 63 37 122 – 138 3,036 3,396 182 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 183 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 4. Segment information continued Year ended 31 March 2016 Internal revenue recorded by Consumer EEa Business and Public Sector Global Services Wholesale and Ventures Openreach Total Consumer £m – – 60 – – 905 965 a EE £m – – 1 – 12 – 13 Internal cost recorded by Business and Public Sector £m Global Services £m Wholesale and Ventures £m Openreach £m Other £m Total £m 20 – – – 5 262 287 23 – 18 – 22 173 236 4 7 19 – – 264 294 – – 1 – 55 – 56 18 – – – – 1,454 1,472 65 7 99 – 94 3,058 3,323 a EE reflects results for the period from acquisition on 29 January 2016 to 31 March 2016. Year ended 31 March 2015 Internal revenue recorded by Consumer Business and Public Sector Global Services Wholesale and Ventures Openreach Total Revenue by products and services Internal cost recorded by Consumer £m Business and Public Sector £m Global Services £m Wholesale and Ventures £m Openreach £m Other £m Total £m – 61 – 1 939 1,001 20 – – 4 282 306 20 18 – 28 187 253 3 19 – – 266 288 – 1 – 46 – 47 19 – – 1 1,390 1,410 62 99 – 80 3,064 3,305 What critical accounting judgements do we make when we have revenue from multiple element arrangements? Where a contractual arrangement consists of two or more separate elements that have value to a customer on a standalone basis, revenue is recognised for each element as if it were an individual contract. Total contract consideration is allocated between the separate elements based on their fair value. We apply judgement in both identifying separate elements and allocating consideration between them. Sales of bundled offers in our mobile businesses frequently include a handset and a telecommunications service contract. There is objective and reliable evidence of fair value for the telecommunications service to be delivered and this represents the revenue recognised in respect of the services delivered. The residual value of the bundled offer therefore represents the revenue in respect of the handset. For offers that cannot be separated into identifiable elements, revenues are recognised in full over the life of the contract. The main example is connection to a service where this does not represent a separately identifiable transaction from the subscription. Year ended 31 March ICT and managed networks Broadband and TV Mobile Calls, lines and connections Transit Other products and services Revenuea a Before specific items. 2017 £m 2016 £m 2015 £m 5,927 4,477 6,358 5,069 404 1,847 6,193 3,535 1,326 5,920 419 1,486 6,493 3,112 314 5,881 555 1,485 24,082 18,879 17,840 184 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 185 Notes to the consolidated financial statements continued 4. Segment information continued Capital expenditure Year ended 31 March 2017 Intangible assets Property, plant and equipment Capital expenditurea Year ended 31 March 2016 Intangible assets Property, plant and equipment Capital expenditurea Year ended 31 March 2015 Intangible assets Property, plant and equipment Capital expenditurea Consumer £m 92 145 237 EE £m 133 483 616 Consumer £m 88 119 207 b EE £m 29 67 96 Consumer £m 85 122 207 Business and Public Sector £m 64 211 275 Business and Public Sector £m 36 117 153 Business and Public Sector £m 35 125 160 Global Services £m Wholesale and Ventures £m Openreach £m 126 235 361 77 149 226 74 1,499 1,573 Global Services £m Wholesale and Ventures £m Openreach £m 62 293 355 70 139 209 62 1,385 1,447 Global Services £m Wholesale and Ventures £m Openreach £m 209 197 406 84 210 294 55 1,027 1,082 Other £m 55 111 166 Other £m 65 90 155 Other £m 93 75 168 Total £m 621 2,833 3,454 Total £m 412 2,210 2,622 Total £m 561 1,756 2,317 a Net of government grants. b EE reflects results for the period from acquisition on 29 January to 31 March 2016. How do we determine our geographic information? The UK is our country of domicile and we generate the majority of our revenue from external customers in the UK. The geographic analysis of revenue is based on the country of origin in which the customer is invoiced. The geographic analysis of non-current assets, which exclude derivative financial instruments, investments and deferred tax assets, is based on the location of the assets. Revenue from external customers Year ended 31 March UK Europe, Middle East and Africa, excluding the UK Americas Asia Pacific Revenuea a Before specific items. Non-current assets At 31 March UKa Europe, Middle East and Africa, excluding the UK Americas Asia Pacific Non-current assets a The increase in non-current assets in the UK from 2015 to 2016 is primarily due to the acquisition of EE. 2017 £m 2016 £m 2015 £m 19,421 2,841 1,148 672 14,814 2,442 1,011 612 13,827 2,383 1,049 581 24,082 18,879 17,840 2017 £m 2016 £m 2015 £m 28,810 2,535 424 149 28,575 2,349 548 191 13,977 2,172 555 169 31,918 31,663 16,873 184 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 185 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 5. Operating costs Year ended 31 March Operating costs by nature Staff costs: Wages and salaries Social security costs Other pension costs Share-based payment expense Total staff costs Own work capitalised Net staff costs Net indirect labour costsb Net labour costs Payments to telecommunications operators Property and energy costs Network operating and IT costs TV programme rights charges Other operating costs Other operating income Depreciation of property, plant and equipment Owned assets Held under finance leases Amortisation of intangible assetsc Total operating costs before specific items Specific items Total operating costs Operating costs before specific items include the following: Leaver costsd Research and development expendituree Operating lease charges Foreign currency gains Government grants Notes 2017 £m a 2016 £m 2015 £m 20 22 13 13 12 8 4,134 477 521 57 5,189 (813) 4,376 399 4,775 2,653 1,202 983 714 6,297 (187) 2,382 10 1,118 3,689 398 494 58 4,639 (720) 3,919 304 4,223 2,183 1,024 644 544 4,017 (215) 2,000 10 621 3,574 440 467 70 4,551 (691) 3,860 324 4,184 2,144 968 605 330 3,640 (224) 1,997 11 530 19,947 15,051 14,185 948 348 381 20,895 15,399 14,566 86 638 692 (12) (5) 109 574 441 (1) (6) 8 580 388 (1) (7) a Certain cost items have been represented following the acquisition of EE and the reorganisation of the reporting segments as set out in note 1. b Net of capitalised indirect labour costs of £463m (2015/16: £430m, 2014/15: £451m). c Excludes £62m (2015/16: £nil, 2014/15: £nil) of amortisation presented as specific items which relate to a write off of software costs as a result of the integration of EE. Refer to note 8. d Leaver costs are included within wages and salaries and social security costs, except for leaver costs of £37m (2015/16: £nil, 2014/15: £237m) associated with restructuring in prior years and leaver costs associated with the EE Integration costs in 2017, which have been recorded as specific items. e Research and development expenditure reported in the income statement, includes amortisation of £577m (2015/16: £501m, 2014/15: £493m) in respect of internally developed computer software and operating expenses of £61m (2015/16: £73m, 2014/15: £87m). In addition, the group capitalised software development costs of £457m (2015/16: £399m, 2014/15: £421m). Why is the treatment of our subscriber and retention costs a critical judgement? Subscriber acquisition and retention costs are recognised as an expense within other operating costs for the period in which they are incurred. If subscriber acquisition and retention costs are paid in advance they are recognised as prepayments provided the amounts are able to be measured reliably and are expected to be recoverable. In some cases, contractual clauses with retailers provide for profit-sharing based on the recognised and paid revenue. In these cases we recognise an expense when the revenue is earned from the customer and a corresponding liability to pay that retailer. In some cases we need to exercise judgement in assessing whether we have an upfront obligation based on the contractual terms. 186 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 187 Notes to the consolidated financial statements continued 5. Operating costs continued Who are our key management personnel and how are they compensated? Key management personnel comprise executive and non-executive directors and members of the Operating Committee. Compensation of key management personnel is shown in the table below: Year ended 31 March Short-term employee benefits Post employment benefits Share-based payments Termination benefits 2017 £m 10.5 1.3 5.6 – 17.4 2016 £m 2015 £m 9.4 1.1 5.5 0.6 9.7 1.1 5.7 0.5 16.6 17.0 More detailed information concerning directors’ remuneration, shareholdings, pension entitlements, share options and other long-term incentive plans is shown in the audited part of the Report on Directors’ Remuneration (see page 122), which forms part of these consolidated financial statements. 6. Employees Number of employees in the groupa UK Non-UK Total employees Number of employees in the groupa Consumer EE Business and Public Sector Global Services Wholesale and Ventures Openreach Other Total employees Year end 000 82.8 23.6 2017 Average 000 82.2 22.8 Year end 000 81.4 21.1 106.4 105.0 102.5 Year end 000 2017 Average 000 Year end 000 8.7 9.2 10.3 17.5 3.8 30.2 26.7 7.7 9.1 10.2 17.4 3.7 30.9 26.0 6.7 9.0 10.3 16.8 3.7 31.5 24.5 106.4 105.0 102.5 2016 Average 000 71.8 19.2 91.0 2016b Average 000 6.3 1.3 9.3 16.5 3.8 32.1 21.7 91.0 Year end 000 70.9 17.6 88.5 Year end 000 6.2 – 9.2 16.3 3.9 32.7 20.2 88.5 2015 Average 000 72.2 16.5 88.7 2015b Average 000 6.0 – 9.9 17.2 4.2 32.4 19.0 88.7 a These reflect the full-time equivalent of full and part-time employees. b Prior year numbers have been revised to reflect the reorganisation of our reporting segments as set out in note 1. 186 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 187 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 7. Audit, audit related and other non-audit services The following fees were paid or are payable to the company’s auditors, PricewaterhouseCoopers LLP. Year ended 31 March Fees payable to the company’s auditors and its associates for: Audit servicesa The audit of parent company and consolidated financial statements The audit of the company’s subsidiaries Audit related assurance servicesb Other non-audit services Taxation compliance servicesc Taxation advisory servicesd All other assurance servicese All other servicesf Total services 2017 £000 2016 £000 2015 £000 4,316 5,675 9,991 3,915 5,084 8,999 2,925 4,809 7,734 1,865 2,210 1,639 366 111 200 2,332 3,009 412 156 1,611 1,665 3,844 350 401 3,199 570 4,520 14,865 15,053 13,893 a Services in relation to the audit of the parent company and the consolidated financial statements, including fees for reports under section 404 of the Sarbanes-Oxley Act. This also includes fees payable for the statutory audits of the financial statements of subsidiary companies. b Services in relation to other statutory filings or engagements that are required by law or regulation to be carried out by an appointed auditor. This includes fees for the audit of the group’s regulatory financial statements and reporting associated with the group’s US debt shelf registration. c Services relating to tax returns, tax audits, monitoring and enquiries. d Fees payable for all taxation advisory services not falling within taxation compliance. e All other assurance services include fees payable to PricewaterhouseCoopers LLP as Reporting Accountants in 2015/16 in relation to the Listing Prospectus, which was issued on 26 January 2016 for the issue of new shares and in 2014/15 in relation to the Circular to shareholders, which was issued on 1 April 2015, both in connection with the acquisition of EE. f Fees payable for all non-audit services not covered above, principally comprising other advisory services. The BT Pension Scheme is an associated pension fund as defined in the Companies (Disclosure of Auditor Remuneration and Liability Limitation Agreements) (Amendment) Regulations 2011. In the year ended 31 March 2017 PricewaterhouseCoopers LLP received total fees from the BT Pension Scheme of £2.1m (2015/16: £1.7m, 2014/15: £2.5m) in respect of the following services: Year ended 31 March Audit of financial statements of associates Audit-related assurance services Taxation compliance services Taxation advisory services Other non-audit services Total services 2017 £000 2016 £000 2015 £000 251 – 210 493 1,168 2,122 213 10 198 681 603 1,705 265 10 374 227 1,605 2,481 188 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 189 Notes to the consolidated financial statements continued 8. Specific items Year ended 31 March Revenue Italian business investigation Regulatory matters EE fair value adjustment Operating costs Regulatory matters Italian business investigation EE acquisition and integration costs Out of period irrecoverable VAT Profit on disposal of businesses Property rationalisation costs Restructuring charges Profit on disposal of property Operating loss Net finance expense Interest expense on retirement benefit obligation EE related finance cost Interest on out of period irrecoverable VAT Share of results of associates and joint ventures Profit on disposal of interest in associates and joint ventures Net specific items charge before tax Taxation Tax credit on specific items above Tax credit on re-measurement of deferred tax Net specific items charge after tax 2017 £m 2016 £m 2015 £m 22 (2) – 20 481 238 215 30 (16) – – – 948 968 209 – 1 210 – 1,178 (154) (63) (217) 961 – (203) 70 (133) 203 – 116 – – 29 – – 348 215 221 8 – 229 – 444 (70) (96) (166) 278 – (128) – (128) 75 – 19 – (6) 45 315 (67) 381 253 292 7 – 299 (25) 527 (121) – (121) 406 Italian business investigation Our investigation into our Italian business revealed prior-period errors from inappropriate behaviour and improper accounting practices as set out in note 1. During the year, we also reviewed the carrying value of the assets and liabilities on the balance sheet of our Italian business including reassessing the recoverability of trade and other receivables and reconsidering other exposures, principally sales taxes. We took into account any changes in facts or circumstances since 31 March 2016 in determining whether there was a need to change an estimate and whether additional exposures had arisen in the current year. This exercise required a level of judgement, in many cases taking a more cautious view based on our current understanding of circumstances in the business. We have set out in note 17 details of estimates we make in accounting for the recoverability of trade and other receivables. We have made estimates for the potential other exposures, principally sales taxes, which represent the group’s best estimate of the amount that may be required to settle the obligation and are included within other payables as set out in note 18. The total impact of £245m is presented within specific items given the size and one-off nature. We have also incurred fees in relation to the investigation of £15m which have been included in specific items. Regulatory matters We’ve recognised £479m (2015/16: £nil, 2014/15: revenue of £53m) of net costs in relation to regulatory matters. These are made up of the following: Deemed Consent A charge of £342m was recognised (2015/16: £nil, 2014/15: £nil) in relation to Ofcom’s March 2017 findings of its investigation into our historical practices on Deemed Consent by Openreach. A fine of £42m has been imposed and we’ve also agreed to compensate Communication Providers. The precise amount of these compensation payments will be determined from discussion with the affected parties and is currently estimated at £300m. 188 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 189 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 8. Specific items continued Ladder pricing agreements In 2016/17 we recognised revenue and costs of £8m (2015/16: £203m and in 2014/15: £128m revenue) being the prior year impacts of ladder pricing agreements with the other UK mobile operators. This was following a Supreme Court judgment in July 2014 which overturned a Court of Appeal judgment made in July 2012. The Court of Appeal’s ruling had disallowed our ladder pricing policy relating to 0800, 0845 and 0870 calls from mobile phones terminating on our network. Other regulatory matters We’ve also re-assessed our regulatory risk provision in light of recent regulatory decisions by Ofcom and by the Competition Appeal Tribunal (CAT). As a result we’ve increased our net provision by £137m (2015/16: £nil) for the year. In 2014/15 the CAT handed down judgment on various appeals brought against a December 2012 Ofcom determination on the pricing of certain Ethernet products. Ofcom had determined that BT had overcharged for certain services between 1 April 2006 and 31 March 2011 and required BT to make repayments. The CAT judged that BT should also pay interest on these amounts. Together with a review of our regulatory risk position in relation to other historical matters, we recognised a specific item charge of £75m in 2014/15. EE fair value adjustment In 2015/16 we recognised a fair value adjustment on the acquisition of EE which reduced the amount of deferred income in relation to its prepaid subscriber base by £70m with no cash impact. The step down reflects the difference between the amount recorded by EE on acquisition and the fair value calculated based on the incremental cost that a market participant would incur to take on the liability plus a reasonable profit margin. This amount was released as a reduction to revenue in the period between acquisition and 31 March 2016, reflecting the period over which EE provided the related service. EE acquisition and integration costs We incurred £215m (2015/16: £116m, 2014/15: £19m) of acquisition and integration related costs for EE. This includes a £62m (2015/16: £nil, 2014/15: £nil) amortisation charge relating to the write-off of IT assets as we integrate the EE and BT IT infrastructure. Integration costs include EE related restructuring and leaver costs in year. Out of period irrecoverable VAT We recognised a £30m charge (2015/16: £nil, 2014/15: £nil) for out of period irrecoverable VAT and a further £1m (2015/16: £nil, 2014/15: £nil) related interest charge. Profit on disposal of businesses During the year we disposed of non-core businesses with a gain on disposal of £16m (2015/16: £nil, 2014/15: £6m). Property rationalisation costs In 2015/16 we recognised a £29m charge (2014/15: £45m) relating to the rationalisation of the group’s property portfolio. Restructuring charges There were no restructuring charges for the current year or in 2015/16. The components of the restructuring charges recognised in 2014/15 were: people and property charges of £294m, principally comprising leaver costs of £237m, and property exit costs and networks, products and procurement channels rationalisation charges of £21m. Profit on disposal of property In 2014/15 we disposed of a surplus building in London, Keybridge House, for a consideration of £93m resulting in a profit of £67m. Interest expense on retirement benefit obligation See note 20 for more details. Profit on disposal of interest in associates and joint ventures In 2014/15 we recognised a £25m profit on the disposal of an associate, which was held at £nil cost. Tax credit on re-measurement of deferred tax See note 9 for more details. 190 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Notes to the consolidated financial statements continued9. Taxation Current and deferred income tax What critical judgements and estimates do we make in accounting for taxation? We pay tax in accordance with the laws of the countries where we do business. In some areas these laws aren’t clear, and it can take many years to agree an outcome with a tax authority or through litigation. We estimate our tax on country-by-country and issue-by-issue bases. Our key uncertainties are whether EE’s tax losses will be available to us, whether our intra-group trading model will be accepted by a particular tax authority and whether intra-group payments are subject to withholding taxes. We provide for the most likely outcome where an outflow is probable, but the agreed amount can differ materially from our estimates. Approximately 80% by value of the provisions are under active tax authority examination and are therefore likely to be re-estimated or resolved in the coming 12 months. £281m (2015/16: £278m) is included in current tax liabilities in relation to these uncertainties. Under a downside case an additional amount of £372m could be required, of which £273m would relate to EE losses. This amount is not provided as we don’t consider this outcome to be probable. Deciding whether to recognise deferred tax assets is judgemental. We only recognise them when we believe it is probable that they can be recovered. In making this judgement we consider evidence such as historical financial performance, future financial plans and trends, the duration of existing customer contracts and whether our intra-group pricing model has been agreed by the relevant tax authority. The value of the group’s income tax assets and liabilities is disclosed on the Group balance sheet on page 167. The value of the group’s deferred tax assets and liabilities, including the deferred tax asset recognised in respect of EE Limited’s historical tax losses, is disclosed below. Analysis of our taxation expense for the year Year ended 31 March United Kingdom Corporation tax at 20% (2015/16: 20%, 2014/15: 21%) Adjustments in respect of earlier years Non-UK taxation Current Adjustments in respect of earlier years Total current tax expense Deferred taxation Origination and reversal of temporary differences Adjustments in respect of prior periods Impact of change in UK corporation tax rate to 17% (2015/16: 19%, 2014/15: 20%) Total deferred taxation credit Total taxation expense 2017 £m 2016 £m 2015 £m (555) 33 (109) – (631) 96 26 63 185 (446) (617) 59 (80) 29 (655) 35 (60) 18 (609) (662) 70 2 96 168 (441) 170 (18) – 152 (510) PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 191 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 9. Taxation continued Factors affecting our taxation expense for the year The taxation expense on the profit for the year differs from the amount computed by applying the UK corporation tax rate to the profit before taxation as a result of the following factors: Year ended 31 March Profit before taxation Expected taxation expense at UK rate of 20% (2015/16: 20%, 2014/15: 21%) Effects of: (Higher) lower taxes on non-UK profitsa Net permanent differences between tax and accountingb Adjustments in respect of earlier yearsc Non-UK losses used against current year profitsa Non-UK losses not recogniseda,d Other deferred tax assets not recognised Lower taxes on profit on disposal of business Re-measurement of deferred tax balances Other non-recurring items Total taxation expense Exclude specific items (note 8) 2017 £m 2016 £m 2015 £m 2,354 2,907 2,567 (471) (581) (539) (29) (183) 59 120 (8) – 3 63 – (446) (217) 4 (12) 90 9 (34) 6 – 96 (19) (4) (4) 35 28 (50) 9 7 – 8 (441) (166) (510) (121) Total taxation expense before specific items a Earlier years re-presented to reflect adjustments for BT Italia. b Includes income that is not taxable or UK income taxable at a different rate, and expenses for which no tax relief is received. Examples include some types of depreciation and amortisation and the benefit of R&D tax incentives. c Reflects the differences between initial accounting estimates and tax returns submitted to tax authorities, including the release and establishment of provisions for uncertain tax positions. d Reflects losses made in countries where it has not been considered appropriate to recognise a deferred tax asset, as future taxable profits are not probable. (631) (607) (663) Tax components of other comprehensive income Year ended 31 March Tax on items that will not be reclassified to the income statement Pension remeasurements Tax on items that have been or may be reclassified subsequently to the income statement Exchange differences on translation of foreign operations Fair value movements on cash flow hedges – net fair value gains or losses – recognised in income and expense Current tax credita Deferred tax expense a Includes £110m (2015/16: £217m, 2014/15: £220m) relating to cash contributions made to reduce retirement benefit obligations. 2017 Tax credit (expense) £m 2016 Tax credit (expense) £m 2015 Tax credit (expense) £m 416 (240) 208 21 (131) 139 445 122 323 445 38 (72) 39 (235) 231 (466) (235) 13 (28) 52 245 268 (23) 245 192 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 193 Notes to the consolidated financial statements continued 9. Taxation continued Tax (expense) credit recognised directly in equity Year ended 31 March Tax (expense) credit relating to share-based payments Deferred taxation At 1 April 2015 (Credit) expense recognised in income statement Expense (credit) recognised in other comprehensive income Expense recognised in equity Acquisition At 31 March 2016 Non-current Deferred tax asset Deferred tax liability At 1 April 2016 (Credit) expense recognised in the income statement (Credit) expense recognised in other comprehensive income Expense recognised in equity Exchange differences At 31 March 2017 Non-current Deferred tax asset Deferred tax liability At 31 March 2017 2015 £m 54 Total £m (611) (168) 466 30 298 15 2017 £m (6) 2016 £m 12 Fixed asset temporary differences £m Retirement benefit a obligations £m Share- based payments £m Tax losses £m Other £m Jurisdictional offset £m 1,041 (63) (4) – 644 (1,483) (107) 457 – (16) 1,618 (1,149) (81) 1,699 1,618 (181) (5) – – (1,149) – (1,149) (82) (306) – – 1,432 (1,537) (117) 1,549 (1,537) – 1,432 (1,537) (86) 2 – 30 – (54) (54) – (54) 14 – 23 – (17) (17) – (17) (44) 34 (2) – (313) (325) (325) – (325) 65 (3) – (7) (270) (270) – (270) (39) (34) 15 – (17) (75) – – – – – – (102) 27 464 (464) (1,247) 1,262 (75) (1) (9) – – (85) (96) 11 (85) – – – – – – 15 (185) (323) 23 (7) (477) 320 (320) (1,717) 1,240 – (477) a Includes a deferred tax asset of £2m (2015/16: £2m) arising on contributions payable to defined contribution pension plans. The majority of the deferred tax assets and liabilities noted above are anticipated to be realised after more than 12 months. We’ve recognised a deferred tax asset at 31 March 2017 of £172m in respect of EE Limited’s historical tax losses. We expect to be able to utilise these against future taxable profits in EE Limited. If EE Limited’s business were subject to a major change in the nature or conduct of trade on or before 5 February 2018, these losses would be forfeited and a current tax liability of £273m would be created. Based on our current plans, we do not expect a major change to arise. Deferred tax balances for which there is a right of offset within the same jurisdiction are presented net on the face of the group balance sheet as permitted by IAS 12, with the exception of deferred tax related to our pension schemes which is disclosed within deferred tax assets. What factors affect our future tax charges? The rate of UK corporation tax changed from 20% to 19% on 1 April 2017 and will change to 17% on 1 April 2020. As deferred tax assets and liabilities are measured at the rates that are expected to apply in the periods of the reversal, deferred tax balances at 31 March 2017 have been calculated at the rate at which the relevant balance is expected to be recovered or settled. This reduction in rate has been recognised as a deferred tax credit specific item of £63m in the income statement (note 8) and as a deferred tax expense in reserves. 192 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 193 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 9. Taxation continued What are our unrecognised tax losses and other temporary differences? At 31 March 2017 we had operating losses and other temporary differences carried forward in respect of which no deferred tax assets were recognised amounting to £4.5bn (2015/16: £4.1bn). Our other temporary differences have no expiry date restrictions. The expiry date of operating losses carried forward is dependent upon the tax law of the various territories in which the losses arose. A summary of expiry dates for losses in respect of which restrictions apply is set out below: At 31 March 2017 Restricted losses Europe Americas Total restricted losses Unrestricted operating losses Other temporary differences Total £m Expiry 2018–2026 2021–2036 19 220 239 3,961 No expiry 173 No expiry 4,373 At 31 March 2017 we had UK capital losses carried forward in respect of which no deferred tax assets were recognised amounting to £17.0bn (2015/16: £17.0bn). These losses have no expiry date, but we consider the future utilisation of these losses to be remote. At 31 March 2017 the undistributed earnings of non-UK subsidiaries were £3.5bn (2015/16: £3.3bn). No deferred tax liabilities have been recognised in respect of these unremitted earnings because the group is in a position to control the timing of any dividends from subsidiaries and hence any tax consequences that may arise. Under current tax rules, tax of £26.2m (2015/16: £23.1m) would arise if these earnings were to be repatriated to the UK. On 29 March 2017, the UK Government notified the EU of its intention to withdraw membership from the EU. Depending on the outcome of negotiations we could cease to benefit from the EU Parent Subsidiary directive on dividends paid by our EU subsidiaries. In this event, additional tax of up to £17.7m could arise if the undistributed earnings of EU subsidiaries of £619m were to be repatriated to the UK. 10. Earnings per share How are earnings per share calculated? Basic earnings per share is calculated by dividing the profit after tax attributable to equity shareholders by the weighted average number of shares in issue after deducting the own shares held by employee share ownership trusts and treasury shares. In calculating the diluted earnings per share, share options outstanding and other potential shares have been taken into account where the impact of these is dilutive. Options over 27m shares (2015/16: 15m shares, 2014/15: 13m shares) were excluded from the calculation of the total diluted number of shares as the impact of these is antidilutive. Year ended 31 March Basic weighted average number of shares (millions) Dilutive shares from share options (millions) Dilutive shares from executive share awards (millions) Diluted weighted average number of shares (millions) Basic earnings per share Diluted earnings per share 2017 2016 2015 9,938 27 29 9,994 19.2p 19.1p 8,619 58 37 8,714 28.5p 28.2p 8,056 80 55 8,191 25.5p 25.1p The earnings per share calculations are based on profit after tax attributable to equity shareholders of the parent company which excludes non-controlling interests. Profit after tax attributable to equity shareholders of the parent company was £1,908m (2015/16: £2,466m, 2014/15: £2,057m) and profit after tax attributable to non-controlling interests was £1m (2015/16: £7m, 2014/15: £nil). Profit attributable to non-controlling interests is not presented separately in the financial statements as it is not material. 194 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 195 Notes to the consolidated financial statements continued 11. Dividends What dividends have been paid and proposed for the year? The Board recommends that a final dividend in respect of the year ended 31 March 2017 of 10.55p per share will be paid to shareholders on 4 September 2017, taking the full year proposed dividend in respect of 2016/17 to 15.4p (2015/16: 14.0p, 2014/15: 12.4p) which amounts to approximately £1,532m (2015/16: £1,324m, 2014/15: £1,028m). This final dividend is subject to approval by shareholders at the Annual General Meeting and therefore the liability of approximately £1,050m (2015/16: £954m, 2014/15: £712m) has not been included in these financial statements. The proposed dividend will be payable to all shareholders on the Register of Members on 11 August 2017 . The value of £1,436m (2015/16: £1,078m, 2014/15: £925m) for the final and interim dividends is disclosed in our statement of changes in equity. This value may differ from the amount shown for equity dividends paid in the group cash flow statement, which represents the actual cash paid in relation to dividend cheques that have been presented over the course of the financial year. Year ended 31 March Final dividend in respect of the prior year Interim dividend in respect of the current year 12. Intangible assets pence per share 9.60 4.85 2017 £m 954 482 pence per share 8.50 4.40 2016 £m 710 368 pence per share 7.50 3.90 14.45 1,436 12.90 1,078 11.40 2015 £m 609 316 925 Cost At 1 April 2015 Acquisitionsa Additions Disposals and adjustments Transfers Exchange differences At 31 March 2016 Additions Acquisitions Disposals and adjustments Transfers Exchange differences At 31 March 2017 Accumulated amortisation At 1 April 2015 Charge for the year Disposals and adjustments Exchange differences At 31 March 2016 Charge for the yearb Disposals and adjustments Exchange differences At 31 March 2017 Carrying amount At 31 March 2017 At 31 March 2016 Customer relationships and brands £m Telecoms licences and other £m Internally developed software £m Goodwill £m Purchased software £m 390 2,524 1 – – 15 2,930 – – – – 15 3,680 129 331 (63) (4) – 4,073 483 – (131) (66) 4 1,230 286 80 (27) 4 37 1,610 138 – 2 62 41 Total £m 7,095 12,395 412 (90) – 109 19,921 621 5 (152) (4) 226 2,945 4,363 1,853 20,617 96 27 – 8 131 140 – 9 280 2,401 437 (91) – 2,747 556 (114) 4 1,092 79 (28) 32 1,175 101 (7) 33 3,925 621 (119) 44 4,471 1,180 (121) 58 3,193 1,302 5,588 1,396 6,459 – – – 52 7,907 – 5 (23) – 145 8,034 399 2,997 – – – 5 3,401 – – – – 21 3,422 336 78 – 4 418 383 – 12 813 8,034 7,907 2,609 2,983 2,665 2,799 1,170 1,326 551 435 15,029 15,450 194 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 195 a Relates to the fair value of intangible assets identified on acquisition of EE on 29 January 2016. See note 14. b Includes a £62m (2015/16: £nil) specific item amortisation charge relating to the write-off of internally developed software as we integrate the EE and BT IT infrastructure. THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 12. Intangible assets continued Goodwill Goodwill recognised in a business combination does not generate cash flows independently of other assets or groups of assets. As a result, the recoverable amount, being the value in use, is determined at a cash generating unit (CGU) level. How do we determine our CGUs? The determination of our CGUs is judgemental. The identification of CGUs involves an assessment of whether the asset or group of assets generate largely independent cash inflows. This involves consideration of how our core assets are operated and whether these generate independent revenue streams. Our CGUs are deemed to be Consumer, EE, Business and Public Sector, Global Services and Wholesale and Ventures which are the same units we report in our segmental reporting. For impairment purposes goodwill is tested at the lowest level within the entity at which the goodwill is monitored for internal management purposes, and cannot be larger than our operating segments. We test goodwill at the CGU level. What other critical estimates and assumptions have we made? During the year we re-allocated goodwill among our CGUs based on the relative fair value of the business transferred to reflect our new line of business structure effective as of 1 April 2016. We estimated the relative fair values on a discounted cash flow basis using the three-year financial plans effective at the time of the re-organisation. The assumptions used were set in the same way as those used in our value in use calculations as set out below. Our value in use calculations require estimates in relation to uncertain items, including management’s expectations of future revenue growth, operating costs, profit margins, operating cash flows, and the discount rate for each CGU. Future cash flows used in the value in use calculations are based on our latest Board approved three-year financial plans. Expectations about future growth reflect the expectations of growth in the markets to which the CGU relates. The future cash flows are discounted using a pre- tax discount rate that reflects current market assessments of the time value of money. The discount rate used in each CGU is adjusted for the risk specific to the asset, including the countries in which cash flow will be generated, for which the future cash flow estimates have not been adjusted. The group is required to test goodwill acquired in a business combination annually for impairment. This was carried out as at 31 March 2017. The carrying value of goodwill and the key assumptions used in performing the annual impairment assessment and sensitivities are disclosed below. How have we carried out our goodwill impairment review? We perform an annual goodwill impairment review, based on our CGUs. From 1 April 2016, we re-organised our lines of business resulting in the change of the CGUs that have associated goodwill. We’ve now allocated goodwill to Consumer, EE, Business and Public Sector, Global Services and Wholesale and Ventures. Previously no goodwill was allocated to Wholesale and Ventures. In addition to this new CGU, to which goodwill has been allocated, there have been changes to the amount allocated to the other CGUs as a result of the re-organisation. These CGUs represent the smallest identifiable groups of assets that generate cash inflows that are largely independent of the cash inflows from other groups of assets, and to which goodwill is allocated. Goodwill is allocated to these CGUs as follows: At 31 March 2015 Acquisitions (note 14) Exchange differences At 31 March 2016 Re-organisation Exchange differences Acquisitions and disposals At 31 March 2017 Consumer £m EE £m 80 1,103 – 1,183 – – – 1,183 – 4,917 – 4,917 (2,149) – – 2,768 Business and Public Sector £m 220 439 3 662 1,921 10 (23) 2,570 Global Services £m Wholesale and Ventures £m 1,096 – 49 1,145 (709) 135 – 571 – – – – 937 – 5 942 Total £m 1,396 6,459 52 7,907 – 145 (18) 8,034 How do we calculate the recoverable amount? The value in use of each CGU is determined using cash flow projections derived from financial plans approved by the Board covering a three-year period. They reflect management’s expectations of revenue, EBITDA growth, capital expenditure, working capital and operating cash flows, based on past experience and future expectations of business performance. The value in use calculation includes a fourth year estimate of cash flows which is held flat from the last year assumed in the financial plans approved by the Board. Cash flows beyond the fourth-year period have been extrapolated using perpetuity growth rates. 196 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 197 Notes to the consolidated financial statements continued 12. Intangible assets continued What discount rate have we used? The pre-tax discount rates applied to the cash flow forecasts are derived from our post-tax weighted average cost of capital. The assumptions used in the calculation of the group’s weighted average cost of capital are benchmarked to externally available data. The pre-tax discount rate used in performing the value in use calculation in 2016/17 was 8.6% (2015/16: 8.8%). We’ve used the same discount rate for all CGUs except Global Services where we have used 9.0% reflecting higher risk in some of the countries in which Global Services operates. What growth rates have we used? The perpetuity growth rates are determined based on the forecast market growth rates of the regions in which the CGU operates, and they reflect an assessment of the long-term growth prospects of that market. The growth rates have been benchmarked against external data for the relevant markets. None of the growth rates applied exceed the expected long-term average growth rates for those markets or sectors. The perpetuity growth rate for Global Services was 2.4% (2015/16: 2.3%) and 2.0% (2015/16: 2.0%) for Business and Public Sector, Consumer and EE and 2.0% (2015/16: nil) for Wholesale and Ventures. What sensitivities have we applied? There is significant headroom in Business and Public Sector, Consumer, Wholesale and Ventures and EE. No reasonably possible changes in the key assumptions would cause the carrying amount of the CGUs to exceed the recoverable amount. For Global Services, the value in use exceeds the carrying value of the CGU by approximately £594m (2015/16: £6,900m). Any of the following changes in assumptions would cause the recoverable amount for the CGU to equal its carrying amount: – reduction in the perpetuity growth rate from the 2.4% assumption applied to a revised assumption of no growth; – an increase in the discount rate from the 9.0% assumption applied to a revised assumption of 11%; and – shortfalls in trading performance against forecast resulting in operating cash flows decreasing by 27% each year and in perpetuity. 196 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 197 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 13. Property, plant and equipment What critical estimates have we made for property plant and equipment? The plant and equipment in our networks is long-lived with cables and switching equipment operating for over ten years and underground ducts being used for decades. We also develop software for use in IT systems and platforms that support the products and services provided to our customers. Our annual depreciation and amortisation charge is sensitive to the estimated service life we allocate to each type of asset. If an asset life is extended this would reduce the annual depreciation or amortisation charge; reducing a life would increase the charge. Asset lives are assessed annually and changed when necessary to reflect our current thinking on technological change, network investment plans (including the group’s fibre rollout programme), prospective economic utilisation and the physical condition of the assets concerned. Changes to the service lives of assets implemented in the year had no significant impact on our results for the year ended 31 March 2017. The carrying values of software, property, plant and equipment are disclosed below and in note 12. The useful lives applied to the principal categories of assets are disclosed on pages 178 and 179. Cost At 1 April 2015 Acquisitions Additionsc Transfers Disposals and adjustmentsd Exchange differences At 31 March 2016 Additionsc Transfers Disposals and adjustmentsd Exchange differences At 31 March 2017 Accumulated depreciation At 1 April 2015 Charge for the year Disposals and adjustmentsd Exchange differences At 31 March 2016 Charge for the year Disposals and adjustmentsd Exchange differences At 31 March 2017 Carrying amount At 31 March 2017 Engineering stores Total at 31 March 2017 At 31 March 2016 Engineering stores Total at 31 March 2016 Land and a buildings £m Network a infrastructure £m Assets in course of b construction £m Other £m Total £m 48,626 2,270 2,213 – (948) 289 45,179 1,772 78 1,810 (879) 234 1,788 43 67 9 (60) 23 527 357 2,055 (1,841) 8 2 48,194 1,870 1,108 52,450 40 2,393 (1,637) 382 128 (1) (106) 47 2,672 (2,402) 30 5 2,846 4 (1,758) 483 1,132 98 13 22 (17) 30 1,278 6 14 (45) 49 1,302 49,372 1,938 1,413 54,025 687 53 (17) 27 750 64 (36) 39 817 485 – 485 528 – 528 33,069 1,856 (848) 210 1,446 101 (56) 22 34,287 1,513 2,224 (1,627) 330 104 (104) 41 35,214 1,554 – – – – – – – – – 14,158 – 14,158 13,907 – 13,907 384 – 384 357 – 357 1,413 58 1,471 1,108 71 1,179 35,202 2,010 (921) 259 36,550 2,392 (1,767) 410 37,585 16,440 58 16,498 15,900 71 15,971 a The carrying amount of the group’s property, plant and equipment includes an amount of £73m (2015/16: £83m) in respect of assets held under finance leases, comprising land and buildings of £45m (2015/16: £52m) and network infrastructure of £28m (2015/16: £31m). The depreciation expense on those assets in 2016/17 was £10m (2015/16: £10m), comprising land and buildings of £3m (2015/16: £4m) and network infrastructure of £7m (2015/16: £6m). b Other mainly comprises motor vehicles, computers and fixtures and fittings. c Net of grant deferral of £28m (2015/16: £109m net grant funding). d Fully depreciated assets in the group’s fixed asset registers were reviewed during the year, as part of the group’s annual asset verification exercise, and certain assets that were no longer in use have been written off, reducing cost and accumulated depreciation by £1.1bn (2015/16: £0.7bn). 198 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 199 Notes to the consolidated financial statements continued 13. Property, plant and equipment continued At 31 March The carrying amount of land and buildings, including leasehold improvements, comprised: Freehold Leasehold Total land and buildings 2017 £m 2016 £m 269 216 485 296 232 528 Network infrastructure Some of our network assets are jointly controlled by EE Limited with Hutchison 3G UK Limited. These relate to shared 3G network and certain elements of network for 4G rural sites. The net book value of the group’s investment in this shared operation is £591m (2015/16: £519m) and is recorded within network infrastructure. Included within this is £179m (2015/16: £128m), being the group’s share of assets owned by its joint operation MBNL. Within network infrastructure are assets with a net book value of £8.0bn which have useful economic lives of more than 18 years. Government grants relating to Broadband Delivery UK (BDUK) contracts The group receives government grants in relation to the BDUK programme and other rural superfast broadband contracts. Where we’ve achieved certain service levels, or delivered the network more efficiently than anticipated, we’ve an obligation to either re-invest or repay grant funding. Where this is the case, we assess and defer the income with a corresponding increase in capital expenditure. What estimates and critical judgements have we made in accounting for our BDUK contracts? Assessing the timing of whether and when we change the estimated take-up assumption is judgemental as it involves considering information which is not always observable. Our consideration on whether and when to change the base case assumption is dependent on our expectation of the long term take-up trend. Our assessment of how much grant income to defer includes consideration of the difference between the take-up percentage agreed with the local authority and the likelihood of actual take-up. The value of the government grants deferred is disclosed in note 18. We receive grant funding mainly under the BDUK programme which reduces the capital expenditure incurred by Openreach. Under the terms of the programme, we have a potential obligation to either re-invest or repay grant funding depending on factors including the level of take-up achieved. In the current year we had a net grant deferral of £28m (2015/16: £109m net grant funding) mainly related to our activity on the BDUK programme. Our base case assumption for take-up in BDUK areas has been increased to 39% following our review of the level of customer take-up. To date we have deferred £446m (2015/16: £258m). 14. Business combinations All business combinations are accounted for using the acquisition method regardless of whether equity instruments or other assets are acquired. What critical judgements do we apply in accounting for business combinations? We exercise judgement in allocating the purchase consideration to acquired assets and liabilities. We also take into account future integration and our plan on how goodwill will be monitored post acquisition. Assessing how much of the estimated synergies are buyer or market specific is also judgemental as it requires us to determine what a market participant could reasonably achieve, which is inherently judgemental. Buyer specific synergies support the goodwill amount recognised while market specific synergies are factored into the fair value measurement of the acquired assets and liabilities. We also exercise judgement in identifying all of the intangible assets we have acquired. What other critical estimates and assumptions have we made? We initially measure identifiable assets acquired and liabilities and contingent liabilities assumed in a business combination, with limited exceptions, at their fair values at the acquisition date. The fair value of an asset or liability represents the price that would be received to sell an asset or the price paid to transfer a liability in an orderly transaction between market participants. In determining the fair value of the intangible assets acquired for EE we generally used risk-adjusted future cash flows discounted using discount rates specific to the asset. In determining the cash flows, we have used a combination of historical data and estimates regarding revenue growth, profit margins and operating cash flows. Tangible assets were valued by estimating current cost to purchase or replace the assets. We used independent valuers to assist in the valuation for EE. We didn’t make any material acquisitions in the year ended 31 March 2017. We have however revisited the provisional fair values ascribed to our acquisition of EE which took place on 29 January 2016. This acquisition resulted in us acquiring the entire share capital of EE Limited (EE) from Deutsche Telekom and Orange. The total purchase consideration amounted to £10,971m with a goodwill value of £6,430m after considering the provisional fair values of the identifiable net assets acquired of £4,541m. During the year, we’ve received a purchase consideration refund from the previous owners of £20m following the finalisation of the audit of the completion balance sheet and have also finalised our reassessment of the provisional fair values within the measurement period. This resulted in a revision to previously recognised brand, customer relationship and prepaid assets which decreased by £15m. Our reassessment also led to a £14m decrease in receivables and an 198 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 199 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 14. Business combinations continued increase in provisions related to unfavourable contracts in the amount of £20m. The net impact of the adjustment including the deferred tax effect resulted in an increase of £29m in goodwill with no material impact on the income statement for the period ended 31 March 2016. In the prior year, we provisionally paid £3,464m of cash and issued 1,595m of new shares valued at £7,507m (using the opening share price of 470.7p per share on 29 January 2016, being the date of acquisition of EE and the date when the shares were admitted to trading). The excess of the consideration transferred over the fair value of the net identifiable assets acquired is recorded as goodwill. For the acquisition of EE this amounted to £6,430m. The fair values ascribed and the resulting goodwill were recognised on a provisional basis which the group had one year from the acquisition date to re-measure. As discussed above we completed this in 2016/17 resulting in an increase of £29m in goodwill. 15. Programme rights At 1 April 2015 Additions Amortisation At 1 April 2016 Additions Amortisation At 31 March 2017 Total £m 118 651 (544) 225 753 (714) 264 Additions reflect TV programme rights for which the legally enforceable licence period has started during the year. Payments made for programme rights for which the legally enforceable licence period has not yet started are included within prepayments (see note 17). TV programme rights commitments are disclosed in note 30. 16. Inventories At 31 March Consumables Work in progress Finished goods 2017 £m 24 23 180 227 2016 £m 2015 £m 26 11 152 189 25 10 59 94 Inventories recognised as an expense during the year ended 31 March 2017 amounted to £2,680m (2015/16: £1,369ma). These were included in ‘Operating costs’ in our income statement. a We have revised prior year information to be on a consistent basis. 17. Trade and other receivables We’ve made various judgements in accounting for trade and other receivables. These include long-term contracts and bad debt provisions. Long-term customer contracts Long-term customer contracts can extend over a number of financial years. During the contractual period recognition of costs and profits may be impacted by judgements and estimates made. What critical judgements have we made? We’ve exercised judgement in assessing when the transition or transformation phase of a contract ends. This influences the timing of recognition of revenue and costs which are deferred until the transition or transformation phase ends unless these elements of a contract have standalone value. Judgements are also required in assessing the lifetime profitability of a contract when determining whether we have an onerous contract liability. Where we have an onerous contract liability this would be classified in provisions. 200 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 201 Notes to the consolidated financial statements continued 17. Trade and other receivables continued How do we estimate and recognise contract losses? We estimate and recognise immediately the entire estimated loss for a contract when we have evidence that the contract is unprofitable. Also if these estimates indicate that any contract will be less profitable than previously forecast, contract assets may have to be written down to the extent they are no longer considered to be fully recoverable. We perform ongoing profitability reviews of our contracts in order to determine whether the latest estimates are appropriate. Key factors reviewed include: – Transaction volumes or other inputs affecting future revenues which can vary depending on customer requirements, plans, market position and other factors such as general economic conditions. – Our ability to achieve key contract milestones connected with the transition, development, transformation and deployment phases for customer contracts. – The status of commercial relations with customers and the implication for future revenue and cost projections. – Our estimates of future staff and third-party costs and the degree to which cost savings and efficiencies are deliverable. The carrying value of assets comprising the costs of the initial set-up, transition or transformation phase of long-term networked IT services contracts is disclosed below. At 31 March Non-current Other assetsa 2017 £m 2016 £m 2015 £m 360 218 179 a Other assets includes costs relating to the initial set-up, transition or transformation phase of long-term networked IT services contracts of £163m (2015/16: £111m, 2014/15: £89m), and prepayments and leasing debtors of £197m (2015/16: £107m, 2014/15: £90m). At 31 March Current Trade receivables Prepayments Accrued income Other receivablesa a Other receivables includes assets held for sale of £22m (2015/16: £nil, 2014/15: £nil). Trade receivables are stated after deducting allowances for doubtful debts, as follows: At 1 April Expense Utilised Exchange differences At 31 March 2017 £m 2016 £m 2015 £m 1,774 733 955 373 3,835 1,803 702 1,072 401 3,978 1,410 502 810 371 3,093 2017 £m 195 211 (114) 11 303 2016 £m 196 77 (89) 11 195 2015 £m 192 78 (58) (16) 196 Included within the expense above are amounts for exposures relating to the Italian business investigation, as set out in note 8. How do we assess recoverability of our receivables? We provide services to consumer and business customers, mainly on credit terms. We know that certain debts due to us will not be paid through the default of a small number of our customers. Judgements are required in assessing the recoverability of trade receivables and whether a provision for doubtful debts may be required. In estimating a provision for doubtful debts we consider historical experience alongside other factors such as the current state of the economy and particular industry issues. The value of the provision for doubtful debts is disclosed above. Trade receivables are continuously monitored and allowances applied against trade receivables consist of both specific impairments and collective impairments based on our historical loss experiences for the relevant aged c ategory as well as taking into account general economic conditions. Historical loss experience allowances are calculated by line of busine ss in order to reflect the specific nature of the customers relevant to that line of business. 200 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 201 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 17. Trade and other receivables continued Trade and other receivables are classified as loans and receivables and are held at amortised cost. The carrying amount of these balances approximates to fair value due to the short maturity of amounts receivable. Note 27 provides further disclosure regarding the credit quality of our gross trade receivables. Trade receivables are due as follows: At 31 March 2017 2016 2015 Past due and not specifically impaired Trade receivables specifically impaired net of provision £m Between 0 and 3 months £m Between 3 and 6 months £m Between 6 and 12 months £m 146 98 1 292 368 305 17 51 50 41 44 127 Not past due £m 1,184 1,152 817 Over 12 months £m 94 90 110 Total £m 1,774 1,803 1,410 Gross trade receivables which have been specifically impaired amounted to £238m (2015/16: £192m, 2014/15: £159m). Trade receivables not past due and accrued income are analysed below by line of business. At 31 March Consumer EE Business and Public Sector Global Services Wholesale and Ventures Openreach Other Total Trade receivables not past due Accrued income 2017 £m 2016 £m 2015 £m 2017 £m 2016 £m 2015 £m 128 335 200 444 75 1 1 138 267 115 555 76 1 – 1,184 1,152 119 – 134 460 87 15 2 817 90 170 151 297 167 78 2 955 83 312 146 351 99 79 2 1,072 85 – 160 333 155 75 2 810 Given the broad and varied nature of our customer base, the analysis of trade receivables not past due and accrued income by line of business is considered the most appropriate disclosure of credit concentrations. Cash collateral held against trade and other receivables amounted to £4m (2015/16: £4m, 2014/15: £4m). 18. Trade and other payables At 31 March Current Trade payables Other taxation and social security Other payables Accrued expenses Deferred incomea At 31 March Non-current Other payablesb Deferred incomea 2017 £m 2016 £m 2015 £m 4,205 704 672 382 1,474 7,437 4,331 682 552 418 1,435 7,418 2,875 416 565 414 1,078 5,348 2017 £m 2016 £m 2015 £m 885 413 876 230 1,298 1,106 855 74 929 a Includes £71m (2015/16: £71m, 2014/15: £nil) current and £375m (2015/16: £187m, 2014/15: £29m) non-current liabilities relating to the Broadband Delivery UK programme, for which grants received by the group may be subject to re-investment or repayment depending on the level of take-up. b Other payables relate to operating lease liabilities and deferred gains on a 2001 sale and finance leaseback transaction. Included within other payables are amounts for exposures relating to the Italian business investigation, principally sales taxes, as set out in note 8. 202 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 203 Notes to the consolidated financial statements continued 19. Provisions Provisions and contingent liabilities As disclosed below, our provisions principally relate to obligations arising from property rationalisation programmes, restructuring programmes, asset retirement obligations, network assets, insurance claims, litigation and regulatory risks. What critical judgements have we made in accounting for provisions? We exercise judgement in determining the timing and quantum of all provisions to be recognised. Our assessment includes consideration of whether we have a present obligation, whether payment is probable and if so whether the amount can be estimated reliably. As part of this assessment, we also assess the likelihood of contingent liabilities occurring in the future which are not recognised as liabilities on our balance sheet. By their nature, contingencies will be resolved only when one or more uncertain future events occur or fail to occur. We assess the likelihood that a potential claim or liability will arise and also quantify the possible range of financial outcomes. We’ve disclosed our assessment of contingent liabilities in note 30. What other critical estimates and assumptions have we made? Under our property rationalisation programmes we’ve identified a number of surplus properties. Although efforts are being made to sub- let this space, this is not always possible. Estimates have been made of the cost of vacant possession and of any shortfall arising from any potential sub-lease income being lower than the lease costs. Any such shortfall is recognised as a provision. Restructuring programmes involve estimation of the direct cost necessary for the restructuring and exclude items that are associated with ongoing activities. Asset retirement obligations involve an estimate of the cost to dismantle equipment and restore sites upon vacation and the timing of the event. The provision represents the group’s best estimate of the amount that may be required to settle the obligation. Network asset provisions represent our future operational costs and vacant site rentals arising from obligations relating to network share agreements. Costs are expected to be incurred over a period of up to 20 years. Our regulatory provision represents our best estimate of the cost to settle our present obligation in relation to historical regulatory matters. Included within the increase for the year is a £300m charge in relation to estimated compensation payments to other Communication Providers as a result of Ofcom’s March 2017 findings on historical practices on Deemed Consent by Openreach. The precise amount of the compensation payments will result from discussions with the affected parties. A related fine of £42m has been imposed and is recognised as a payable rather than as a provision. The fine and associated compensation payments totalling £342m are treated as a specific item charge in this year’s income statement. The remaining provision reflects management’s estimates of regulatory risks across a range of issues, including price and service issues. These increased by £126m, also treated as specific items, resulting from our re-assessment of these other regulatory risks and in light of the regulatory decisions by Ofcom and by the Competition Appeal Tribunal. Refer to note 8 for further information on specific items. In respect of claims, litigation and regulatory risks, the group provides for anticipated costs where an outflow of resources is considered probable and a reasonable estimate can be made of the likely outcome. The prices at which certain services are charged are regulated and may be subject to retrospective adjustment by regulators. Estimates are used in assessing the likely value of the regulatory risk. For all risks, the ultimate liability may vary from the amounts provided and will be dependent upon the eventual outcome of any settlement. The estimates are discounted using a rate that reflects the passage of time and risk specific to the liability. An estimate is also required in assessing the timing of when a provision is recognised. The outcome of our estimate of the provisions is disclosed below. At 31 March 2015 Acquisitions Income statement expense Unwind of discount Utilised or released Transfers Exchange differences At 31 March 2016 Income statement expense Unwind of discount Utilised or released Transfers Exchange differences At 31 March 2017 Restructuring £m Property £m Network ARO £m Network share £m Regulatory £m a Other £m Total £m 45 – – – (25) – – 20 – – (10) – 1 11 217 72 28 8 (29) – – 296 38 12 (54) – – 292 – 81 2 – (5) – – 78 27 2 (24) – – 83 – 63 - – (3) – – 60 5 2 (17) – – 50 84 – – – (20) – – 64 426 – (11) – – 479 218 23 15 – (26) (7) 2 225 40 – (19) (3) 3 246 564 239 45 8 (108) (7) 2 743 536 16 (135) (3) 4 1,161 a Other provisions include amounts provided for legal or constructive obligations arising from insurance claims and litigation which will be utilised as the obligations are settled. 202 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 203 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Notes to the consolidated financial statements continued 19. Provisions continued At 31 March Analysed as: Current Non-current 2017 £m 2016 £m 2015 £m 625 536 1,161 178 565 743 142 422 564 20. Retirement benefit plans Background to BT’s pension plans The group has both defined benefit and defined contribution retirement benefit plans. The group’s main plans are in the UK and the largest by membership is the BT Pension Scheme (BTPS) which is a defined benefit plan that was closed to new entrants on 31 March 2001. After that date new entrants to BT in the UK have been able to join a defined contribution plan, currently the BT Retirement Saving Scheme (BTRSS), a contract-based arrangement. EE operates the EE Pension Scheme (EEPS), which has a defined benefit section that was closed to future benefit accrual in 2014 and a defined contribution section which is open to new joiners. What are they? How do they impact BT’s financial statements? Defined contribution plans Defined benefit plans Benefits in a defined contribution plan are linked to: – – contributions paid; the performance of each individual’s chosen investments; and the form in which individuals choose to take their benefits. – The income statement charge in respect of defined contribution plans represents the contribution payable by the group based upon a fixed percentage of employees’ pay. The group has no exposure to investment and other experience risks. Contributions are paid into an independently administered fund. Benefits in a defined benefit plan are: determined by the plan rules, – dependent on factors such as age, years of service and pensionable pay; and not dependent upon actual contributions made by the company or members. – The income statement service cost in respect of defined benefit plans represents the increase in the defined benefit liability arising from pension benefits earned by active members in the current period. The group is exposed to investment and other experience risks and may need to make additional contributions where it is estimated that the benefits will not be met from regular contributions, expected investment income and assets held. Amounts in the financial statements Group income statement The expense or income arising from all group retirement benefit arrangements recognised in the group income statement is shown below. Year ended 31 March Recognised in the income statement before specific items Service cost (including administration expenses & PPF levy): – defined benefit plans – defined contribution plans Past service credita Total operating expense Net interest expense on net pensions deficit included in specific items (note 8) Total recognised in the income statement a Past service credit relates to various pension plans operating outside the UK. 2017 £m 2016 £m 2015 £m 281 240 – 521 209 730 301 193 – 494 221 715 296 176 (5) 467 292 759 Group statement of comprehensive income Remeasurements of the net pension obligation are recognised in full in the group statement of comprehensive income in the year in which they arise. These comprise the impact on the defined benefit liability of changes in demographic and financial assumptions compared with the start of the year, actual experience being different to those assumptions and the return on plan assets above the amount included in the net pension interest expense. 204 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 20. Retirement benefit plans continued Group balance sheet The net pension obligation in respect of defined benefit plans reported in the group balance sheet is set out below. At 31 March BTPS EEPS Other plansa Retirement benefit obligation Adjustments due to effect of asset ceilingb Deferred tax asset Net pension obligation Present value of liabilities £m Assets £m 50,090 748 274 (58,649) (973) (578) 51,112 (60,200) Assets £m Present value of liabilities £m 43,121 596 251 (49,119) (710) (521) 43,968 (50,350) 2017 Deficit £m (8,559) (225) (304) (9,088) – 1,535 (7,553) 2016 Deficit £m (5,998) (114) (270) (6,382) – 1,147 (5,235) a Included in the present value of liabilities of other plans is £104m (2015/16: £90m) related to unfunded pension arrangements. b There is no limiting effect of the asset ceiling as any accounting surplus arising in individual plans is deemed to be recoverable due to the economic benefits available in the form of future refunds or reductions to future contributions. Included within trade and other payables in the group balance sheet is £15m (2015/16: £10m) in respect of contributions payable to defined contribution plans. What is IFRIC 14 and how does it impact BT? For some pension schemes, IFRIC 14 potentially: – limits the surplus in a pension scheme that can be recognised on the balance sheet; and/or – requires additional pension liabilities to be recognised where scheduled future deficit contributions are greater than the unadjusted accounting deficit. BT is not required to limit any pensions surplus or recognise additional pensions liabilities in individual plans as economic benefits are available in the form of either future refunds or reductions to future contributions. In any event, for both the BTPS and the EEPS, the net present value (using the IAS 19 discount rate) of scheduled future deficit contributions agreed with the schemes’ trustee are less than the accounting deficit at 31 March 2017, and therefore IFRIC 14 would have no effect on the figures disclosed. In 2015, the International Accounting Standards Board (IASB) published an Exposure Draft setting out proposed changes to IFRIC 14. We understand there have been subsequent discussions around further changes by the IFRS Interpretations Committee and a revised version of IFRIC 14 is expected to be published in 2017. Annual Report 2017 BT Group plc 205 Notes to the consolidated financial statements continued 20. Retirement benefit plans continued Movements in defined benefit plan assets and liabilities The table below shows the movements on the pension assets and liabilities and shows where they are reflected in the financial statements. At 31 March 2015 Service cost (including administration expenses and PPF levy) Interest on pension deficit Included in the group income statement Return on plan assets below the amount included in the group income statement Actuarial gain arising from changes in financial assumptionsa Actuarial gain arising from changes in demographic assumptionsa Actuarial gain arising from experience adjustmentsb Included in the group statement of comprehensive income Regular contributions by employer Deficit contributions by employer Included in the group cash flow statement EEPS position at acquisition Contributions by employees Benefits paid Foreign exchange Other movements At 31 March 2016 Service cost (including administration expenses and PPF levy) Interest on pension deficit Included in the group income statement Return on plan assets above the amount included in the group income statement Actuarial loss arising from changes in financial assumptionsa Actuarial loss arising from changes in demographic assumptionsa Actuarial gain arising from experience adjustmentsb Included in the group statement of comprehensive income Regular contributions by employer Deficit contributions by employer Included in the group cash flow statement Contributions by employees Benefits paid Foreign exchange Other movements At 31 March 2017 Assets £m Liabilities £m Deficit £m 43,627 (51,210) (7,583) (40) 1,406 (261) (1,627) (423) – – – 226 880 – 255 2 921 – – 585 10 (2,321) 18 (698) (10) 2,321 (43) (301) (221) (522) (423) 255 2 921 755 226 880 1,106 (113) – – (25) (138) 43,968 (50,350) (6,382) (44) 1,413 (237) (1,622) 7,475 – – – 313 274 – (10,221) (206) 163 – – 8 (2,315) 20 (8) 2,315 (34) (281) (209) (490) 7,475 (10,221) (206) 163 (2,789) 313 274 587 – – (14) (14) 51,112 (60,200) (9,088) a The actuarial gain or loss arises from changes in the assumptions used to value the defined benefit liabilities at the end of the year compared with the assumptions used at the start of the year. This includes both financial assumptions, which are based on market conditions at the year end, and demographic assumptions such as life expectancy. b The actuarial loss or gain arising from experience adjustments on defined benefit liabilities represents the impact on the liabilities of differences between actual experience during the year compared with the assumptions made at the start of the year. Such differences might arise, for example, from members choosing different benefit options at retirement, actual salary increases being different from those assumed or actual benefit increases being different to the pension increase assumption. 206 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 20. Retirement benefit plans continued How do we value our retirement benefit plans? Valuation methodology The IAS 19 liabilities are measured as the present value of the estimated future benefit cash flows to be paid by each scheme, calculated using the projected unit credit method. These calculations are performed for the group by professionally qualified independent actuaries. The expected future benefit payments are based on a number of assumptions including future inflation, retirement ages, benefit options chosen and life expectancy and are therefore inherently uncertain. Actual benefit payments in a given year may be higher or lower, for example if members retire sooner or later than assumed, or take a greater or lesser cash lump sum at retirement than assumed. What are our critical judgements, estimates and assumptions? The accounting cost of these benefits and the present value of our pension liabilities involve judgements about uncertain events including the life expectancy of the members, the salary progression of our current employees, price inflation and the discount rate used to calculate the net present value of the future pension payments. We use estimates for all of these uncertain events in determining the pension costs and liabilities in our financial statements. Our assumptions reflect historical experience and our judgement regarding future expectations. We also estimate the fair value of some of our pension assets which are made up of quoted and unquoted investments. The latter require more judgement as their values are not directly observable. The assumptions used in valuing unquoted investments are affected by current market conditions and trends which could result in changes in fair value after the measurement date. How do we value the assets? Under IAS 19, plan assets must be valued at the bid market value at the balance sheet date. For the main asset categories: – Securities listed on recognised stock exchanges are valued at closing bid prices. – Properties are valued on the basis of open market value. – Bonds are measured using a combination of broker quotes and pricing models making assumptions for credit risk, market risk and market yield curves. – Pooled investment vehicles are valued at fair value which is typically the Net Asset Value provided by the investment manager. – Certain unlisted investments are valued using a model based valuation such as a discounted cash flow. – The value of the longevity insurance contract held by the BTPS is measured by discounting the projected cash flows payable under the contract (projected by an actuary, consistent with the terms of the contract). Overview and governance of the BTPS What is the profile of the BTPS? At 31 March 2017 there were 296,000 members of the BTPS. Members belong to one of three sections depending upon the date they first joined the BTPS. The membership is analysed below. Analysis of BTPS Sections A and B liabilities (£bn)a Section C liabilities (£bn) Total IAS 19 liabilities (£bn) Total number of members a Sections A and B have been aggregated in this table as Section A members have typically elected to take Section B benefits at retirement. Active members Deferred members Pensioners Total 5.5 7.2 12.7 4.9 5.3 10.2 32.2 3.5 35.7 42.6 16.0 58.6 32,500 64,000 199,500 296,000 Annual Report 2017 BT Group plc 207 Notes to the consolidated financial statements continued 20. Retirement benefit plans continued The estimated duration of the BTPS liabilities, which is an indicator of the weighted average term of the liabilities, is around 16.5 years although the benefits payable by the BTPS are expected to be paid over more than 70 years. Whilst benefit payments are expected to increase over the earlier years, the value of the liabilities is expected to reduce. The chart below illustrates the estimated benefits payable from the BTPS forecast using the IAS 19 assumptions. Forecast benefits payable by the BTPS at 31 March 2017 (unaudited) £m 3,000 2,500 2,000 1,500 1,000 500 0 a s t n e m y a p t fi e n e B £m 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 a n o i t a g i l b o t fi e n e b d e n fi e d e h t f o e u a v l t n e s e r P 2017 2037 2057 2077 2097 Forecast benefit payments (Left axis) Liabilities (Right axis) a Based on accrued benefits to date. What are the benefits under the BTPS? Benefits earned for pensionable service prior to 1 April 2009 are based upon a member’s final salary and a normal pensionable age of 60. Since 1 April 2009, when changes to member benefits and contribution rates were introduced, Section B and C active members have accrued benefits based upon a career average re-valued earnings (CARE) basis and a normal pensionable age of 65. On a CARE basis benefits are built up based upon earnings in each year and the benefit accrued for each year is increased by the lower of inflation or the individual’s actual pay increase in each year to retirement. Under the Scheme rules the determination of the rate of inflation for statutory minimum rates of revaluation and indexation for the majority of benefits is based upon either the Retail Prices Index (RPI) or the Consumer Prices Index (CPI) which apply to each category of member as shown below. Active members Deferred members Pensioners Section Ba Section C Benefits accrue on a CARE basis increasing at the lower of RPI or the individual’s actual pensionable pay increase a Section A members have typically elected to take Section B benefits at retirement. Preserved benefits are revalued before retirement based upon CPI Increases in benefits in payment are currently based upon CPI Increases in benefits in payment are currently based upon RPI up to a maximum of 5% 208 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 20. Retirement benefit plans continued How is the BTPS governed and managed? BT Pension Scheme Trustees Limited (the Trustee) has been appointed by BT as an independent trustee to administer and manage the BTPS on behalf of the members in accordance with the terms of the BTPS Trust Deed and Rules and relevant legislation (principally the Pension Schemes Act 1993, the Pensions Act 1995 and the Pensions Act 2004). Under the terms of the Trust Deed there are nine Trustee directors, all of whom are appointed by BT, as illustrated below. Trustee directors are usually appointed for a three-year term but are then eligible for re-appointment. Chairman of the Trustees Appointed by BT after consultation with, and with the agreement of, the relevant trade unions. Member nominated Trustees Appointed by BT based on nominations by trade unions. Employer nominated Trustees Appointed by BT. Two normally hold senior positions within the group and two normally hold (or have held) senior positions in commerce or industry. BTPS assets Asset allocation The allocation of assets between different classes of investment is reviewed regularly and is a key factor in the Trustee’s investment policy. The allocations set reflect the Trustee’s views on the appropriate balance to be struck between seeking returns and incurring risk, and on the extent to which the assets should be distributed to match liabilities. Current market conditions and trends are regularly assessed which may lead to adjustments in the asset allocation. The fair value of the assets of the BTPS analysed by asset category are shown below. These are subdivided by assets that have a quoted market price in an active market and those that do not (such as investment funds). Growth Equities Property Other growth assets Liability matching Active Passive Private Equity UK Property Overseas Property Absolute Return Non Core Credit Mature Infrastructure Government bondsc Corporate bonds Cash, derivatives and other Total 2017a Total assets £bn of which b quoted £bn Total % Total assets £bn of which b quoted £bn 2.9 7.4 1.9 4.1 1.7 2.3 3.5 1.7 12.3 7.6 4.7d 50.1 2.1 7.2 – – – – 1.1 – 12.0 5.9 n/a 28.3 6 15 4 8 3 5 7 3 25 15 9 100 6.5 6.7 1.5 4.2 1.4 1.8 3.5 1.1 10.0 7.1 (0.7) 43.1 5.0 6.3 – – – – 1.3 – 9.9 5.6 n/a 28.1 2016a Total % 15 15 4 10 3 4 8 3 23 17 (2) 100 a At 31 March 2017 and 31 March 2016, the Scheme’s assets did not include any directly held ordinary shares of the company. The Scheme held £10m (2015/16: £9m) of index-linked bonds issued by the group. b Assets with a quoted price in an active market. c Comprises primarily of UK index-linked government bonds. d Comprises primarily of collateral relating to derivatives held by the Scheme and physical cash of £1.6bn. Annual Report 2017 BT Group plc 209 Notes to the consolidated financial statements continued 20. Retirement benefit plans continued IAS 19 assumptions The table below summarises the approach used to set the key IAS 19 assumptions for the BTPS. Approach to set the assumption Discount rate IAS 19 requires that the discount rate is determined by reference to market yields at the reporting date on high quality corporate bonds. The currency and term of these should be consistent with the currency and estimated term of the pension obligations. RPI inflation CPI inflation Salary increases Pension increases Longevity The assumption is calculated by applying the projected BTPS benefit cash flows to a corporate bond yield curve constructed based on the yield on AA-rated corporate bonds. In setting the yield curve, judgement is required on the selection of appropriate bonds to be included in the universe and the approach used to then derive the yield curve. The approach to set the RPI inflation assumption has been revised at 31 March 2017 to use the entire inflation curve, weighted by projected BTPS benefit cash flows, and making an adjustment for an inflation risk premium (to reflect the extra premium paid by investors for inflation protection), currently 20bps. CPI is assessed at a margin below RPI taking into account market forecasts and independent estimates of the expected difference. Long-term salary increases for BTPS members are assumed to be equal to CPI inflation. Benefits are assumed to increase in line with the RPI or CPI inflation assumptions, based on the relevant index for increasing benefits, as prescribed by the rules of the BTPS and summarised above. The longevity assumption takes into account: – the actual mortality experience of the BTPS pensioners, based on a formal review conducted at the last triennial valuation; and – future improvements in longevity based on a model published by UK actuarial profession’s Continuous Mortality Investigation (using the CMI 2013 Mortality Projections model with a 1.25% per year long- term improvement parameter). The key financial assumptions used to measure the liabilities of the BTPS are shown below. At 31 March Rate used to discount liabilities Inflation – increase in RPI Inflation – increase in CPI a The real rate is calculated relative to RPI inflation. b Assumed to be 0.5% higher until 31 March 2019. c Assumed to be 0.2% higher until 31 March 2017. Nominal rates (per year) Real rates (per year)a 2017 % 2.40 3.20 2.00b 2016 % 3.30 2.85 1.65c 2015 % 3.25 2.85 1.65c 2017 % (0.78) – (1.2)b 2016 % 0.44 – (1.2)c 2015 % 0.39 – (1.2)c The BTPS represents over 97% of the group’s retirement benefit obligation. While the financial assumptions may vary for each plan, the nominal financial assumptions weighted by liabilities across all plans are equal to the figures shown in the table above (to the nearest 0.05%). Based on the IAS 19 longevity assumptions, the forecast life expectancies for BTPS members aged 60 are as follows: At 31 March Male in lower pay bracket Male in medium pay bracket Male in higher pay bracket Female in lower pay bracket Female in higher pay bracket Average improvement for a member retiring at age 60 in 10 years’ time 210 BT Group plc Annual Report 2017 2017 Number of years 2016 Number of years 26.2 27.5 28.9 28.9 29.2 1.0 26.1 27.4 28.8 28.8 29.1 1.0 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 20. Retirement benefit plans continued Risks underlying the assumptions The BTPS faces similar risks to other UK DB schemes: things like future low investment returns, high inflation, longer life expectancy and regulatory changes may all mean the BTPS becomes more of a financial burden. Further details are set out on page 49. Changes in external factors, such as interest rates, can have an impact on the IAS 19 assumptions, impacting the measurement of BTPS liabilities. These factors can also impact the Scheme assets. The BTPS hedges some of these risks, including longevity and currency using financial instruments and insurance contracts. Some of the key financial risks, and mitigations, for the BTPS are set out in the table below. Changes in bond yields A fall in yields on AA-rated corporate bonds, used to set the IAS 19 discount rate, will lead to an increase in the IAS 19 liabilities. The BTPS’s assets include corporate bonds, government bonds and interest rate derivatives which are expected to partly offset the impact of movements in the discount rate. However, yields on these assets may diverge compared to the discount rate in some scenarios. Changes in inflation expectations A significant proportion of the benefits paid to members are currently increased in line with RPI or CPI inflation. An increase in long-term inflation expectations will lead to an increase in the IAS 19 liabilities. Changes in life expectancy The BTPS’s assets include index-linked government bonds and inflation derivatives which are expected to partly offset the impact of movements in inflation expectations. An increase in the life expectancy of members will result in benefits being paid out for longer, leading to an increase in the BTPS liabilities. The BTPS holds a longevity insurance contract which covers around 25% of the BTPS’s total exposure to improvements in longevity, providing long-term protection and income to the BTPS in the event that members live longer than currently expected. Other risks include volatile asset returns (ie where asset returns differ from the discount rate) and changes in regulation which impact the measurement of the liabilities or value of the assets. BT’s independent actuary has assessed the potential negative impact of the key risks that might occur no more than once in every 20 years. The impact shown under each scenario assumes this is the only change in assumptions – in practice a combination of changes to assumptions could arise. Sensitivity analysis of the principal assumptions used to measure BTPS liabilities £bn 10 6 9 . 8 6 4 2 0 . 9 2 9 6 . . 2 2 . 9 22 2 . 1 percentage point a fall in discount rate 0.9 percentage point increase to inflation rate b 1.35 year increase to life expectancy Increase in liabilities Increase in deficit a Scenario assumes a 1 percentage point fall in the yields on both government and corporate bonds. b Assuming RPI, CPI, pension increases and salary increases all increase by 0.9 percentage points. The sensitivity of the deficit allows for both the change in the liabilities and the assumed change in the assets. For example, the increase in the deficit under the life expectancy scenario incorporates the expected movement in the value of the insurance contract held to hedge longevity risk. The sensitivities have been prepared using a similar approach as 2015/16 which involves calculating the liabilities and deficit using the alternative assumptions stated. Annual Report 2017 BT Group plc 211 Notes to the consolidated financial statements continued 20. Retirement benefit plans continued BTPS funding Triennial funding valuation The triennial valuation is carried out for the Trustee by a professionally qualified independent actuary. The purpose of the valuation is to design a funding plan to ensure that the BTPS has sufficient funds available to meet future benefit payments. The latest funding valuation was performed as at 30 June 2014. The next funding valuation will have an effective date of no later than 30 June 2017. The valuation methodology for funding purposes, which is based on prudent assumptions, is broadly as follows: – assets are valued at market value at the valuation date; and – liabilities are measured on an actuarial funding basis using the projected unit credit method and discounted to their present value. The results of the two most recent triennial valuations are shown below. BTPS liabilities Market value of BTPS assets Funding deficit Percentage of accrued benefits covered by BTPS assets at valuation date Percentage of accrued benefits on a solvency basis covered by the BTPS assets at the valuation date June 2014 valuation £bn (47.2) 40.2 (7.0) 85.2% 63.0% June 2011 valuation £bn (40.8) 36.9 (3.9) 90.4% 66.0% The funding deficit increased to £7.0bn at 30 June 2014. While deficit contribution payments totalling £2.65bn and investment returns of 5.8% per year since the 2011 valuation contributed to higher assets at the 2014 valuation date, the low interest rate environment resulted in a higher value being placed on the BTPS’s liabilities which more than offset the increase in the BTPS’s assets. Key assumptions – funding valuation These valuations were determined using the following prudent long-term assumptions. Average single equivalent discount rate Average long-term increase in RPI Average long-term increase in CPI a The real rate is calculated relative to RPI inflation and is shown as a comparator. Nominal rates (per year) Real rates (per year)a June 2014 valuation % June 2011 valuation % June 2014 valuation % June 2011 valuation % 4.5 3.5 2.5 5.2 3.2 2.2 1.0 – (1.0) 2.0 – (1.0) The discount rate at 30 June 2014 was derived from prudent return expectations above a yield curve based on gilt and swap rates. The discount rate reflects views of future returns at the valuation date. This gives a prudent discount rate of 2.1% per year above the yield curve initially, trending down to 0.6% per year above the curve in the long-term. The assumption is equivalent to using a flat discount rate of 4.5% per year. The average life expectancy assumptions at the 2014 valuation date, for members 60 years of age, are as follows. Number of years from 30 June 2014 Male in lower pay bracket Male in medium pay bracket Male in high pay bracket Female in lower pay bracket Female in high pay bracket Average improvement for a member retiring at age 60 in 10 years’ time June 2014 assumptions June 2011 assumptions 26.1 27.5 29.0 28.9 29.2 1.3 26.3 28.1 28.7 1.2 212 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 20. Retirement benefit plans continued Payments made to the BTPS Year ended 31 March Ordinary contributions Deficit contributions Total contributions in the year Future funding obligations and recovery plan 2017 £m 303 250 553 2016 £m 215 875 1,090 Under the terms of the Trust Deed, the group is required to have a funding plan, determined at the conclusion of the triennial funding valuation, which is a legal agreement between BT and the Trustee and should address the deficit over a maximum period of 20 years. In January 2015, the 2014 triennial funding valuation was finalised, agreed with the Trustee and certified by the Scheme Actuary. The funding deficit at 30 June 2014 was £7.0bn. Under the associated recovery plan BT made payments of £875m in March 2015, £625m in April 2015 and £250m in March 2016. BT is scheduled to make future deficit payments in line with the table below. Year to 31 March 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030 Deficit contribution (£m) 688 699 711 724 670 670 670 495 495 495 495 495 289 The ordinary contribution rate to meet the benefits of current employed members is: – 16.0% of pensionable salaries (including employee contributions) from 1 April 2015 through to 30 June 2017; and – 16.9% of pensionable salaries from 1 July 2017. This will be reviewed as part of the 2017 triennial valuation. Based on the 2014 funding valuation agreement, the group expects to make contributions of approximately £850m to the BTPS in 2017/18, comprising ordinary contributions of approximately £162m and deficit contributions of £688m. This will be reviewed as part of the 2017 funding valuation. Other protections The 2014 funding agreement with the Trustee included additional features for BT to provide support to the BTPS. These include: Feature Detail Shareholder distributions In the event that shareholder distributions exceed an agreed threshold, BT will provide matching payments to the BTPS. The threshold allows for 15% per year dividend per share growth plus £300m per year of share buybacks on a cumulative basis. BT will consult with the Trustee if it considers share buybacks in excess of £300m per year or making a special dividend. These provisions apply from 29 January 2015 until 31 March 2019, or until the finalisation of the next valuation if earlier. Material corporate events In the event that BT generates net cash proceeds greater than £1bn from disposals (net of acquisitions) in any 12-month period ending 30 June, BT will make additional contributions to the BTPS equal to one third of those net cash proceeds. BT will consult with the Trustee if: – it considers making acquisitions with a total cost of more than £1bn in any 12-month period; or – it considers making disposals of more than £1bn; or – it considers making a Class 1 transaction (acquisition or disposal) which will have a material impact on the BTPS; or – it becomes aware it is likely to be subject to a takeover offer. BT will advise the Trustee should there be other material corporate events which would materially impact BT’s covenant to the BTPS. These provisions apply from 29 January 2015 until 31 March 2019, or until the finalisation of the next valuation if earlier. Negative pledge A negative pledge that future creditors will not be granted superior security to the BTPS in excess of a £1.5bn threshold, to cover both British Telecommunications plc and BT Group plc. This provision applies until the deficit reduces to below £2.0bn at any subsequent funding valuation. Annual Report 2017 BT Group plc 213 Notes to the consolidated financial statements continued 20. Retirement benefit plans continued In the highly unlikely event that the group were to become insolvent there are additional protections of BTPS members’ benefits: Feature Detail Crown Guarantee The Crown Guarantee was granted by the Government when the group was privatised in 1984 and would only come into effect upon the insolvency of BT. The Trustee brought court proceedings to clarify the scope and extent of the Crown Guarantee. The Court of Appeal judgment on 16 July 2014 established that: – the Crown Guarantee covers BT’s funding obligation in relation to the benefits of members of the BTPS who joined post-privatisation as well as those who joined pre-privatisation (subject to certain exceptions); – the funding obligation to which the Crown Guarantee relates is measured with reference to BT’s obligation to pay deficit contributions under the rules of the BTPS. The Crown Guarantee is not taken into account for the purposes of the actuarial valuation of the BTPS and is an entirely separate matter, only being relevant in the highly unlikely event that BT became insolvent. The Pension Protection Fund (PPF) may take over the BTPS and pay benefits not covered by the Crown Guarantee to members. There are limits on the amounts paid by the PPF and the PPF would not provide exactly the same benefits as those provided under the BTPS Rules. Pension Protection Fund (PPF) Other benefit plans In addition to the BTPS, the group maintains benefit plans around the world with a focus on these being appropriate for the local market and culture. EE Pension Scheme (EEPS) The EEPS is the second largest defined benefit plan sponsored by the group with defined benefit liabilities of around £1bn. The EEPS also has a defined contribution section with around 11,000 active members. The defined benefit section’s assets are invested across a number of asset classes including global equities (27%), property (19%), an absolute return portfolio (27%) and a liability driven investment portfolio (27%). The triennial valuation of the defined benefit section was performed as at 31 December 2015, and agreed in March 2017. This showed a funding deficit of £141m. To meet the deficit, the group will contribute: – c£1.667m each month until March 2018 (inclusive); and – £1.875m each month thereafter until November 2020. The next funding valuation will have an effective date of no later than 31 December 2018. Other schemes The BT Retirement Saving Scheme (BTRSS) is the largest defined contribution scheme maintained by the group with around 32,500 active members. In the year to 31 March 2017, the group contributed £139m to the BTRSS. 21. Own shares At 31 March 2015 Own shares purchasedb Share options exercisedb,c Executive share awards vested At 31 March 2016 Own shares purchasedb Share options exercisedb,c Executive share awards vested At 31 March 2017 Treasury sharesa millions Employee share ownership trusta Total £m millions £m millions £m 1 46 (39) – 8 35 (35) – 8 (4) (211) 176 – (39) (151) 155 – (35) 41 22 (24) (22) 17 12 – (15) 14 (161) (104) 102 87 (76) (55) – 70 (61) 42 68 (63) (22) 25 47 (35) (15) 22 (165) (315) 278 87 (115) (206) 155 70 (96) a At 31 March 2017, 7,690,097 shares (2015/16: 8,170,876) with an aggregate nominal value of £nil (2015/16: £nil) were held at cost as treasury shares and 14,303,068 shares (2015/16: 16,600,756) with an aggregate nominal value of £1m (2015/16: £1m) were held in the Trust. b See group cash flow statement on page 169. In 2016/17 the cash paid for the repurchase of ordinary share capital was £206m (2015/16: £315m). The cash received for proceeds on the issue of treasury shares was £70m (2015/16: £90m). c Includes share option exercises of £1m (2015/16: £nil) relating to other plans. The treasury shares reserve represents BT Group plc shares purchased directly by the group. The BT Group Employee Share Ownership Trust (the Trust) also purchases BT Group plc shares. The treasury shares and the shares in the Trust are being used to satisfy our obligations under employee share plans. Further details on Employee Saveshare Plans and Executive share plans are provided in note 22. 214 BT Group plc Annual Report 2017 THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 22. Share-based payments What share incentive arrangements do we have? Our plans include savings-related share option plans for employees and those of participating subsidiaries, further share option plans for selected employees and a stock purchase plan for employees in the US. We also have several share plans for executives. All share-based payment plans are equity-settled. Details of these plans and an analysis of the total charge by type of award is set out below. Year ended 31 March Employee Saveshare Plans Executive Share Plans: Incentive Share Plan (ISP) Deferred Bonus Plan (DBP) Other plans 2017 £m 2016 £m 2015 £m 40 – 9 8 57 27 21 4 6 58 25 32 9 4 70 Employee Saveshare Plans Under an HMRC-approved savings-related share option plan, employees save on a monthly basis, over a three or five-year period, towards the purchase of shares at a fixed price determined when the option is granted. This price is usually set at a 20% discount to the market price for five-year plans and 10% for three-year plans. The options must be exercised within six months of maturity of the savings contract, otherwise they lapse. Similar plans operate for our overseas employees. Incentive Share Plan (ISP) Under the ISP, participants are only entitled to these shares in full at the end of a three-year period if the company has met the relevant pre- determined corporate performance measures and if the participants are still employed by the group. For ISP awards granted in 2016/17, 2015/16 and 2014/15: 40% of each award is linked to a total shareholder return (TSR) target for a comparator group of companies from the beginning of the relevant performance period; 40% is linked to a three-year cumulative free cash flow measure, and 20% to growth in underlying revenue excluding transit. Deferred Bonus Plan (DBP) Under the DBP, awards are granted annually to selected employees. Shares in the company are transferred to participants at the end of three years if they continue to be employed by the group throughout that period. Under the terms of the ISP and DBP, dividends or dividend equivalents earned on shares during the conditional periods are reinvested in company shares for the potential benefit of the participants. Employee Saveshare Plans Movements in Employee Saveshare options are shown below. Year ended 31 March Outstanding at 1 April Granted Forfeited Exercised Expired Outstanding at 31 March Exercisable at 31 March Movement in the number of share options Weighted average exercise price 2017 millions 2016 millions 2015 millions 2017 pence 2016 pence 2015 pence 197 44 (18) (33) (1) 189 – 226 47 (12) (63) (1) 197 – 459 81 (9) (304) (1) 226 – 287 362 345 208 345 313 237 226 385 306 139 247 287 140 102 326 239 65 163 226 74 The weighted average share price for all options exercised during 2016/17 was 357p (2015/16: 463p, 2014/15: 382p). The following table summarises information relating to options outstanding and exercisable under Employee Saveshare plans at 31 March 2017. Normal dates of vesting and exercise (based on calendar years) 2017 2018 2019 2020 2021 Total Exercise price per share 168p – 359p 249p – 423p 319p – 397p 376p 353p Weighted average exercise price Number of outstanding options millions Weighted average remaining contractual life 228p 310p 236p 376p 353p 313p 45 8 months 31 21 months 66 33 months 25 44 months 22 56 months 189 29 months Annual Report 2017 BT Group plc 215 22. Share-based payments continued Executive share plans Movements in executive share plan awards during 2016/17 are shown below: At 1 April 2016 Awards granted Awards vested Awards lapsed Dividend shares reinvested At 31 March 2017 ISP 43 18 (12) (5) 1 45 Number of shares (millions) DBP Other 8 2 (3) – – 7 – 4 – – – 4 Total 51 24 (15) (5) 1 56 Fair values The following table summarises the fair values and key assumptions used for valuing grants made under the Employee Saveshare plans and ISP in 2016/17, 2015/16 and 2014/15. Year ended 31 March Weighted average fair value Weighted average share price Weighted average exercise price Expected dividend yield Risk free rates Expected volatility Employee Saveshare 2017 ISP Employee Saveshare 2016 ISP Employee Saveshare 72p 422p 362p 2.9% – 3.4% 0.5% – 0.8% 19.0% – 21.5% 328p 426p n/a n/a 0.6% 81p 454p 385p 3.2% – 3.7% 0.7% – 1.6% 21.8% 19.7% – 22.7% 364p 451p n/a n/a 0.7% 82p 387p 326p 3.5% – 3.8% 1.2% – 2.0% 22.0% 22.2% – 24.9% 2015 ISP 309p 393p n/a n/a 1.2% 24.3% Employee Saveshare grants are valued using a Binomial options pricing model. Awards under the ISP are valued using Monte Carlo simulations. TSRs are generated for BT and the comparator group at the end of the three-year performance period, using each company’s volatility and the cross correlation between pairs of stocks. Volatility has been determined by reference to BT’s historical volatility which is expected to reflect the BT share price in the future. An expected life of three months after vesting date is assumed for Employee Saveshare options. For all other awards the expected life is equal to the vesting period. The risk-free interest rate is based on the UK gilt curve in effect at the time of the grant, for the expected life of the option or award. The fair values for the DBP were determined using the market price of the shares at the grant date. The weighted average share price for DBP awards granted in 2016/17 was 421p (2015/16: 451p, 2014/15: 393p). 23. Investments At 31 March Non-current assets Available-for-sale Fair value through profit or loss Current assets Available-for-sale Loans and receivables 2017 £m 2016 £m 2015 £m 37 7 44 39 7 46 36 8 44 1,437 83 1,520 2,878 40 2,918 3,133 390 3,523 Loans and receivables are held on the balance sheet at amortised cost and this approximates fair value. Loans and receivables consist of investments in term deposits denominated in Sterling of £35m (2015/16: £10m, 2014/15: £360m), in US Dollars of £30m (2015/16: £30m, 2014/15: £30m) and in other currencies £18m (2015/16: £nil, 2014/15: £nil). 216 BT Group plcAnnual Report 2017Notes to the consolidated financial statements continued THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION 23. Investments continued Fair value hierarchy At 31 March 2017 Non-current and current investments Available-for-sale investments Fair value through profit or loss Total At 31 March 2016 Non-current and current investments Available-for-sale investments Fair value through profit or loss Total At 31 March 2015 Non-current and current investments Available-for-sale investments Fair value through profit or loss Total Level 1 £m Level 2 £m Level 3 £m Total held at fair value £m 21 7 28 1,437 – 1,437 16 – 16 1,474 7 1,481 Level 1 £m Level 2 £m Level 3 £m Total held at fair value £m 24 7 31 2,878 – 2,878 15 – 15 2,917 7 2,924 Level 1 £m Level 2 £m Level 3 £m Total held at fair value £m 26 8 34 3,133 – 3,133 10 – 10 3,169 8 3,177 The three levels of valuation methodology used are: Level 1 – uses quoted prices in active markets for identical assets or liabilities Level 2 – uses inputs for the asset or liability other than quoted prices, that are observable either directly or indirectly Level 3 – uses inputs for the asset or liability that are not based on observable market data, such as internal models or other valuation method. Level 2 balances classified as available-for-sale consist of investments in liquidity funds denominated in Sterling of £900m (2015/16: £2,430m 2014/15: £2,784m) and in Euros of £537m (2015/16: £448m 2014/15: £349m). Level 3 balances consist of available-for-sale investments of £16m (2015/16: £15m 2014/15: £10m) which represent investments in a number of private companies. In the absence of specific market data, these investments are held at cost, adjusted as necessary for impairments, which approximates to fair value. Annual Report 2017 BT Group plc 217 Notes to the consolidated financial statements continued 24. Cash and cash equivalents At 31 March Cash at bank and in hand Cash equivalents Loans and receivables US deposits UK deposits Other deposits Total cash equivalents Total cash and cash equivalents Bank overdrafts (note 25) Cash and cash equivalents per the cash flow statement 2017 £m 469 32 1 26 59 528 (17) 511 2016 £m 900 44 20 32 96 996 (537) 459 2015 £m 749 28 28 43 99 848 (441) 407 The group’s cash and cash equivalents include restricted cash of £43m (2015/16: £51m, 2014/15: £82m), of which £41m (2015/16: £44m, 2014/15: £73m) was held in countries where local capital or exchange controls currently prevent us from accessing cash balances. The remaining balance of £2m (2015/16: £7m, 2014/15: £9m) was held in escrow accounts, or in commercial arrangements akin to escrow. The classification of the items noted above represents a change in our definition of restricted cash. We previously included in our definition cash held in countries where capital or exchange controls imposed local compliance obligations upon the group. Upon further review, we have concluded these controls do not necessarily restrict access providing these obligations are satisfied. We now also include cash balances held in arrangements akin to escrow as well as balances physically held in escrow accounts. We have updated the comparative balances to reflect this change by reducing reported restricted cash by £50m in 2015/16 and £61m in 2014/15. Cash equivalents are classified as loans and receivables and are held on the group balance sheet at amortised cost which equates to fair value. 25. Loans and other borrowings What’s our capital management policy? The objective of our capital management policy is to target an overall level of debt consistent with our credit rating target while investing in the business, supporting the pension scheme and paying progressive dividends. In order to meet this objective, we may issue or repay debt, issue new shares, repurchase shares, or adjust the amount of dividends paid to shareholders. We manage the capital structure and make adjustments to it in the light of changes in economic conditions and the risk characteristics of the group. The Board regularly reviews the capital structure. No changes were made to these objectives and processes during 2016/17, 2015/16 or 2014/15. For details of share issues and repurchases in the year see note 21. Our capital structure consists of net debt and shareholders’ equity. The analysis below summarises the components which we manage as capital. 2016 £m 2015 £m 2017 £m 8,932 8,305 9,838 10,090 17,237 19,928 5,113 669 5,782 At 31 March Net debt Total parent shareholders’ equitya a Excludes non-controlling interests of £30m (2015/16: £22m, 2014/15: £12m). 218 BT Group plc Annual Report 2017 25. Loans and other borrowings continued Net debt Net debt consists of loans and other borrowings (both current and non-current), less current asset investments and cash and cash equivalents. Loans and other borrowings are measured at the net proceeds raised, adjusted to amortise any discount over the term of the debt. For the purpose of this measure, current asset investments and cash and cash equivalents are measured at the lower of cost and net realisable value. Currency denominated balances within net debt are translated to Sterling at swapped rates where hedged. Net debt is considered to be an alternative performance measure as it is not defined in IFRS. The most directly comparable IFRS measure is the aggregate of loans and other borrowings (current and non-current), current asset investments and cash and cash equivalents. A reconciliation from the most directly comparable IFRS measure to net debt is given below. At 31 March Loans and other borrowings Less: Cash and cash equivalents Current asset investments Adjustments: To retranslate debt balances at swap rates where hedged by currency swaps To remove accrued interest applied to reflect the effective interest method and fair value adjustments Net debt At 31 March 2.00% US$750m bond due June 2015a 6.50% €1,000m bond due July 2015a 1.625% US$600m bond due June 2016a 8.50% £683m bond due December 2016 (minimum 7.50%b) 3.5% €500m bond due February 2017a 1.25% US$500m bond due February 2017a 6.625% £500m bond due June 2017a 5.95% US$1,100m bond due January 2018a 3.25% €600m bond due August 2018a 2.35% US$800m bond due February 2019a 4.38% £450m bond due March 2019 1.125% €1,000m bond due June 2019a 8.625% £300m bond due March 2020 0.625% €1,500m bond due March 2021a 1.125% €1,100m bond due March 2023a 3.50% £250m index linked bond due April 2025 1.75% €1,300 bond due March 2026a 5.75% £600m bond due December 2028 9.125% US$2,670m bond due December 2030a (minimum 8.625%b) 6.375% £500m bond due June 2037a Total listed bonds Finance leases LIBOR + 0.95% £438m Syndicated loan facilities due April 2016 2.21% £350m bank loan due December 2017 Acquisition facility Other loans Bank overdrafts (note 24) Total other loans and borrowings Total loans and borrowings 2017 £m 2016 £m 2015 £m 12,713 14,761 10,176 (528) (1,520) (996) (2,918) (848) (3,523) 10,665 10,847 5,805 (1,419) (314) (652) (357) (357) (335) 8,932 9,838 5,113 2017 £m 2016 £m 2015 £m – – – – – – 526 891 539 642 460 863 300 1,282 942 403 1,113 731 2,191 522 – – 419 696 398 348 525 775 510 558 464 800 300 1,190 873 396 1,032 741 1,910 522 508 758 406 695 – 337 525 750 – 541 – 730 299 – – 392 – 751 1,850 522 11,405 12,457 9,064 229 – 352 – 710 17 233 438 354 181 561 537 1,079 2,071 232 – – – 439 441 880 12,713 14,761 10,176 a Designated in a cash flow hedge relationship. b The interest rate payable on this bond attracts an additional 0.25% for a downgrade by one credit rating by either Moody’s or S&P to the group’s senior unsecured debt below A3/A– respectively. In addition, if Moody’s or S&P subsequently increase the ratings then the interest rate will be decreased by 0.25% for each rating category upgrade by each rating agency. In no event will the interest rate be reduced below the minimum rate reflected in the above table. Annual Report 2017 BT Group plc 219 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Notes to the consolidated financial statements continued 25. Loans and other borrowings continued Unless previously designated in a fair value hedge relationship, all loans and other borrowings are carried on our balance sheet at amortised cost and in the table on page 219. The fair value of listed bonds and other long-term borrowings is £13,496m (2015/16: £14,500m, 2014/15: £10,919m) and the fair value of finance leases is £273m (2015/16: £284m, 2014/15: £268m). The fair value of our bonds and other long-term borrowings is estimated on the basis of quoted market prices, based on the same or similar issues where they exist. Where the same or similar issues do not exist, the fair value is estimated based on the calculation of future cash flows using blended discount rates in effect at the balance sheet date. The carrying amount of other loans and bank overdrafts equates to fair value due to the short maturity of these items. The interest rates payable on loans and borrowings disclosed above reflect the coupons on the underlying issued loans and borrowings and not the interest rates achieved through applying associated cross-currency and interest rate swaps in hedge arrangements. Loans and other borrowings are analysed as follows: At 31 March Current liabilities Listed bonds Finance leases Bank loans Syndicated loan facilities Other loans and bank overdraftsa Total current liabilities Non-current liabilities Listed bonds Finance leases Bank loans Other loans Total non-current liabilities Total 2017 £m 2016 £m 2015 £m 1,539 15 352 – 726 2,632 9,866 214 – 1 2,013 8 – 619 1,096 3,736 10,444 225 354 2 10,081 11,025 1,422 13 – – 879 2,314 7,642 219 – 1 7,862 12,713 14,761 10,176 a Includes collateral received on swaps of £702m (2015/16: £553m, 2014/15: £437m). The carrying values disclosed in the above table reflect balances at amortised cost adjusted for accrued interest and fair value adjustments to the relevant loans or borrowings. These do not reflect the final principal repayments that will arise after taking account of the relevant derivatives in hedging relationships which are reflected in the table below. Apart from finance leases, all borrowings as at 31 March 2017, 2016 and 2015 were unsecured. The principal repayments of loans and borrowings at hedged rates amounted to £10,980m (2015/16: £13,752m, 2014/15: £9,482m) and repayments fall due as follows: At 31 March Within one year, or on demand Between one and two years Between two and three years Between three and four years Between four and five years After five years Total due for repayment after more than one year Effect of hedging and interest £m (498) (197) (43) (121) – (724) 2017 Principal repayments at hedged rates £m 2,134 1,417 1,123 1,174 12 5,120 Carrying amount £m 2,632 1,614 1,166 1,295 12 5,844 Effect of hedging and interest £m 2016 Principal repayments at hedged rates £m (232) 3,504 (216) (72) 18 (26) (302) 1,416 1,416 1,121 1,173 5,122 Carrying amount £m 3,736 1,632 1,488 1,103 1,199 5,424 Carrying amount £m 2,314 1,431 1,251 549 1,031 3,457 9,931 (1,085) 8,846 10,846 (598) 10,248 7,719 Total repayments Fair value adjustments 12,563 150 Total loans and other borrowings 12,713 (1,583) 10,980 14,582 179 14,761 (830) 13,752 10,033 143 10,176 Effect of hedging and interest £m 2015 Principal repayments at hedged rates £m (152) 2,162 (48) (191) (51) 89 (198) (399) (551) 1,383 1,060 498 1,120 3,259 7,320 9,482 220 BT Group plc Annual Report 2017 25. Loans and other borrowings continued Obligations under finance leases are analysed as follows: At 31 March Amounts payable under finance leases: Due within one year Between two to five years After five years Less: future finance charges Total finance lease obligations 2017 2016 2015 2017 2016 2015 Minimum lease payments £m £m £m Repayment of outstanding lease obligations £m £m £m 29 102 237 368 (139) 229 13 105 265 383 (150) 233 29 100 264 393 (161) 232 14 50 165 229 – 229 8 51 174 233 – 233 13 45 174 232 – 232 Assets held under finance leases mainly consist of buildings and network assets. Our obligations under finance leases are secured by the lessors’ title to the leased assets. 26. Finance expense Year ended 31 March Finance expense Interest on: Financial liabilities at amortised cost and associated derivatives Finance leases Derivatives Fair value movements: Bonds designated as hedged items in fair value hedges Derivatives designated as hedging instruments in fair value hedges Derivatives not in a designated hedge relationship Reclassification of cash flow hedge from other comprehensive income Unwinding of discount on provisions Finance expense Less: interest capitaliseda Total finance expense before specific items Specific items (note 8) Total finance expense 2017 £m 2016 £m 2015 £m 567 15 12 – – (2) (1) 16 607 – 607 210 817 489 14 11 – – (5) 3 8 520 – 520 229 749 516 15 7 82 (82) 7 26 8 579 (2) 577 299 876 a No interest was capitalised in 2016/17 or 2015/16. Interest was capitalised at a weighted average rate of 6.0% in 2014/15. Reconciliation of net finance expense to net interest cash outflow Net interest cash outflow of £622m (2015/16: £548m, 2014/15: £580m) is £28m higher (2015/16: £65m, 2014/15: £20m) than the net finance expense in the income statement. This is mostly due to certain interest cash outflows and inflows being spread over a number of years in the income statement. Year ended 31 March Net finance expense before specific items Timing differences: – Derivative restructuring costs – Timing of coupon payments on bonds – Timing of interest receipts – Deferred income Specific item – EE-related financing costs (note 8) Net interest cash outflow 2017 £m 594 1 19 – 8 – 2016 £m 483 (1) 27 22 9 8 2015 £m 560 – 4 – 9 7 622 548 580 Annual Report 2017 BT Group plc 221 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 27. Financial instruments and risk management We issue or hold financial instruments mainly to finance our operations; to finance corporate transactions such as dividends, share buybacks and acquisitions; for the temporary investment of short-term funds; and to manage currency and interest rate risks. In addition, various financial instruments, for example trade receivables and payables arise directly from operations. How do we manage financial risk? Our activities expose us to a variety of financial risks: market risk (including interest rate risk and foreign exchange risk), credit risk and liquidity risk. Treasury operation We have a centralised treasury operation whose primary role is to manage liquidity and funding requirements as well as our exposure to associated financial and market risks, including credit risk, interest rate risk and foreign exchange risk. Treasury policy Treasury policy is set by the Board. Group treasury activities are subject to a set of controls appropriate for the magnitude of borrowing, investments and group-wide exposures. The Board has delegated authority to operate these policies to a series of panels responsible for the management of key treasury risks and operations. Appointment to and removal from the key panels requires approval from two of the following: the chairman, the chief executive or the group finance director. There has been no change in the nature of our risk profile between 31 March 2017 and the date of approval of these financial statements. How do we manage interest rate risk? Management policy Interest rate risk arises primarily from our long-term borrowings. Interest cash flow risk arises from borrowings issued at variable rates, partially offset by cash held at variable rates. Fair value interest rate risk arises from borrowings issued at fixed rates. Our policy, as set by the Board, is to ensure that at least 70% of ongoing net debt is at fixed rates. Short-term interest rate management is delegated to the treasury operation while long-term interest rate management decisions require further approval by the group finance director, director of treasury and risk management or the group treasurer who each have been delegated such authority from the Board. Hedging strategy In order to manage our interest rate profile, we have entered into cross-currency and interest rate swap agreements to vary the amounts and periods for which interest rates on borrowings are fixed. The duration of the swap agreements matches the duration of the debt instruments. The majority of the group’s long-term borrowings are subject to fixed Sterling interest rates after applying the impact of these hedging instruments. How do we manage foreign exchange risk? Management policy Foreign currency hedging activities protect the group from the risk that changes in exchange rates will adversely affect future net cash flows. The Board’s policy for foreign exchange risk management defines the types of transactions typically covered, including significant operational, funding and currency interest exposures, and the period over which cover should extend for each type of transaction. The Board has delegated short-term foreign exchange management to the treasury operation and long-term foreign exchange management decisions require further approval from the group finance director, director of treasury and risk management or the group treasurer. Hedging strategy A significant proportion of our external revenue and costs arise within the UK and are denominated in Sterling. Our non-UK operations generally trade and are funded in their functional currency which limits their exposure to foreign exchange volatility. We enter into forward currency contracts to hedge foreign currency, capital purchases, purchase and sale commitments, interest expense and foreign currency investments. The commitments hedged are principally denominated in US Dollar, Euro and Asia Pacific region currencies. As a result, our exposure to foreign currency arises mainly on non-UK subsidiary investments and on residual currency trading flows. We use cross-currency swaps to swap foreign currency borrowings into Sterling. 222 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 223 Notes to the consolidated financial statements continued27. Financial instruments and risk management continued The table below reflects the currency and interest rate profile of our loans and borrowings after the impact of hedging. At 31 March Sterling Euro Total Ratio of fixed to floating Weighted average effective fixed interest rate – Sterling 2017 Floating rate interest £m 706 641 1,347 12% Fixed rate interest £m 9,633 – 9,633 88% 4.9% Total £m Fixed rate interest £m 10,339 641 10,980 100% 11,417 – 11,417 83% 6.0% 2016 Floating rate interest £m 1,748 587 2,335 17% Total £m Fixed rate interest £m 13,165 587 13,752 100% 7,601 – 7,601 80% 6.3% 2015 Floating rate interest £m 1,405 476 1,881 20% Total £m 9,006 476 9,482 100% The floating rate loans and borrowings bear interest rates fixed in advance for periods ranging from one day to one year, primarily by reference to LIBOR quoted rates. Sensitivity analysis The income statement and shareholders’ equity are exposed to volatility arising from changes in interest rates and foreign exchange rates. To demonstrate this volatility, management have concluded that the following are reasonable benchmarks for performing sensitivity analysis: – for interest, a 1% increase in interest rates and parallel shift in yield curves across Sterling, US Dollar and Euro currencies; and – for foreign exchange, a 10% strengthening/weakening in Sterling against other currencies. The impact of a 1% change in interest rates on the group’s annual net finance expense was insignificant in 2016/17, 2015/16 and 2014/15. The impact on equity, before tax, of a 1% increase in interest rates is as detailed below: At 31 March Sterling interest rates US Dollar interest rates Euro interest rates 2017 £m Increase (reduce) 554 (348) (229) 2016 £m Increase (reduce) 626 (374) (263) 2015 £m Increase (reduce) 428 (400) (34) A 1% decrease in interest rates would have broadly the same impact in the opposite direction. Our exposure to foreign exchange volatility in the income statement, after hedging, and within shareholders’ equity (excluding translation exposures) was insignificant in 2016/17, 2015/16 and 2014/15. Credit ratings We continue to target a BBB+/Baa1 credit rating over the medium term. We regularly review the liquidity of the group and our funding strategy takes account of medium-term requirements. These include the pension deficit and shareholder distribution. Our December 2030 bond contains covenants which require us to pay higher rates of interest since our credit ratings fell below A3 in the case of Moody’s or A– in the case of Standard & Poor’s (S&P). Additional interest of 0.25% per year accrues for each ratings category downgrade by each agency below those levels effective from the next coupon date following a downgrade. Based on the total notional value of debt outstanding of £2.1bn at 31 March 2017, our finance expense would increase/decrease by approximately £11m a year if the group’s credit rating were to be downgraded/upgraded, respectively, by one credit rating category by both agencies. Our credit ratings were as detailed below: At 31 March Rating agency Moody’s Standard & Poor’s 2017 2016 2015 Rating Outlook Rating Outlook Rating Outlook Baa1 BBB+ Negative Negative Baa2 BBB Positive Positive Baa2 BBB Positive Stable How do we manage liquidity risk? Management policy We maintain liquidity by entering into short and long-term financial instruments to support operational and other funding requirements, determined using short and long-term cash forecasts. These forecasts are supplemented by a financial headroom analysis which is used to assess funding adequacy for at least a 12-month period. On at least an annual basis the Board reviews and approves the long-term funding requirements of the group and on an ongoing basis considers any related matters. We manage refinancing risk by limiting the amount of borrowing that matures within any specified period and having appropriate strategies in place to manage refinancing needs as they arise. The maturity profile of our loans and borrowings at 31 March 2017 is disclosed in note 25. We have term debt maturities of £1.8bn in 2017/18. 222 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 223 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 27. Financial instruments and risk management continued Our treasury operation reviews and manages our short-term requirements within the parameters of the policies set by the Board. We hold cash, cash equivalents and current investments in order to manage short-term liquidity requirements. At 31 March 2017 we had undrawn committed borrowing facilities of £2.1bn (2015/16: £1.5bn, 2014/15: £1.5bn) maturing in September 2021. We also have an undrawn 364-day revolving bridge facility of £1.5bn maturing in March 2018, with the option to renew to March 2019. The bridge facility contains mandatory prepayment and cancellation clauses in certain circumstances, such as the issuance of public debt securities. Maturity analysis The following table provides an analysis of the remaining contractually-agreed cash flows including interest payable for our non-derivative financial liabilities on an undiscounted basis, which therefore differs from both the carrying value and fair value. Non-derivative financial liabilities At 31 March 2017 Due within one year Between one and two years Between two and three years Between three and four years Between four and five years After five years Interest payments not yet accrued Fair value adjustment Impact of discounting Carrying value on the balance sheeta At 31 March 2016 Due within one year Between one and two years Between two and three years Between three and four years Between four and five years After five years Interest payments not yet accrued Fair value adjustment Impact of discounting Carrying value on the balance sheeta At 31 March 2015 Due within one year Between one and two years Between two and three years Between three and four years Between four and five years After five years Interest payments not yet accrued Fair value adjustment Impact of discounting Carrying value on the balance sheeta Loans and other borrowings £m Interest on loans and other borrowings £m Trade and other payables £m Provisions £m Total £m 2,468 1,614 1,166 1,295 12 5,844 12,399 – 150 – 507 415 364 327 319 2,726 4,658 (4,494) – – 5,259 – – – – – 5,259 – – – 12,549 164 5,259 Loans and other borrowings £m Interest on loans and other borrowings £m Trade and other payables £m 3,558 1,632 1,488 1,103 1,199 5,424 14,404 – 179 – 491 435 357 343 308 2,885 4,819 (4,641) – – 5,301 – – – – – 5,301 – – – 62 41 21 18 17 310 469 – – (177) 292 8,296 2,070 1,551 1,640 348 8,880 22,785 (4,494) 150 (177) 18,264 Provisions £m Total £m 50 30 25 15 16 326 462 – – (166) 9,400 2,097 1,870 1,461 1,523 8,635 24,986 (4,641) 179 (166) 14,583 178 5,301 296 20,358 Loans and other borrowings £m Interest on loans and other borrowings £m Trade and other payables £m Provisions £m Total £m 2,120 1,431 1,251 549 1,031 3,457 9,839 – 143 – 513 458 392 315 302 2,973 4,953 (4,759) – – 3,854 – – – – – 3,854 – – – 32 19 15 15 13 218 312 – – (104) 6,519 1,908 1,658 879 1,346 6,648 18,958 (4,759) 143 (104) 9,982 194 3,854 208 14,238 a Foreign currency-related cash flows were translated at closing rates as at the relevant reporting date. Future variable interest rate cash flows were calculated using the most recent rate applied at the relevant balance sheet date. Trade and other payables are held at amortised cost. The carrying amount of these balances approximates to fair value due to the short maturity of amounts payable. 224 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 225 Notes to the consolidated financial statements continued 27. Financial instruments and risk management continued The following table provides an analysis of the contractually agreed cash flows in respect of the group’s derivative financial instruments. Cash flows are presented on a net or gross basis in accordance with the settlement arrangements of the instruments. Derivatives – Analysed by earliest payment datea Derivatives – Analysed based on holding instrument to maturity Derivative financial liabilities At 31 March 2017 Net settled £m Gross settled outflows £m Gross settled inflows £m Total £m Net settled £m Gross settled outflows £m Gross settled inflows £m Due within one year Between one and two years Between two and three years Between three and four years Between four and five years After five years Totalb At 31 March 2016 Due within one year Between one and two years Between two and three years Between three and four years Between four and five years After five years Totalb At 31 March 2015 Due within one year Between one and two years Between two and three years Between three and four years Between four and five years After five years Totalb Total £m 98 134 92 88 83 679 291 296 198 114 104 123 582 1,139 – – – – (576) (1,097) – – – – 297 338 198 114 104 123 92 92 92 88 83 679 582 1,139 – – – – (576) (1,097) – – – – 1,126 1,721 (1,673) 1,174 1,126 1,721 (1,673) 1,174 Derivatives – Analysed by earliest payment datea Derivatives – Analysed based on holding instrument to maturity Net settled £m Gross settled outflows £m Gross settled inflows £m 268 386 371 60 81 – 263 38 38 838 17 165 (250) (27) (27) (836) (18) (180) Total £m 281 397 382 62 80 (15) Net settled £m Gross settled outflows £m Gross settled inflows £m 91 88 88 90 84 725 263 38 38 838 17 165 (250) (27) (27) (836) (18) (180) Total £m 104 99 99 92 83 710 1,166 1,359 (1,338) 1,187 1,166 1,359 (1,338) 1,187 Derivatives – Analysed by earliest payment datea Derivatives – Analysed based on holding instrument to maturity Net settled £m Gross settled outflows £m Gross settled inflows £m Total £m Net settled £m Gross settled outflows £m Gross settled inflows £m 215 471 273 177 48 – 1,421 39 38 38 838 390 (1,292) (26) (26) (26) (749) (394) 344 484 285 189 137 (4) 88 109 92 94 111 690 1,320 42 42 42 842 476 (1,179) (30) (30) (30) (753) (491) Total £m 229 121 104 106 200 675 1,184 2,764 (2,513) 1,435 1,184 2,764 (2,513) 1,435 a Certain derivative financial instruments contain break clauses whereby either the group or bank counterparty can terminate the swap on certain dates and the mark to market position is settled in cash. b Foreign currency-related cash flows were translated at closing rates as at the relevant reporting date. Future variable interest rate cash flows were calculated using the most recent rate applied at the relevant balance sheet date. How do we manage credit risk? Management policy Our exposure to credit risk arises from financial assets transacted by the treasury operation (primarily derivatives, investments, cash and cash equivalents) and from trading-related receivables. For treasury-related balances, the Board’s defined policy restricts exposure to any one counterparty by setting credit limits based on the credit quality as defined by Moody’s and S&P. The minimum credit ratings permitted with counterparties in respect of new transactions are A3/A– for long-term and P1/A1 for short-term investments. If counterparties in respect of existing transactions fall below the permitted criteria we will take action where appropriate. The treasury operation continuously reviews the limits applied to counterparties and will adjust the limit according to the nature and credit standing of the counterparty, and in response to market conditions, up to the maximum allowable limit set by the Board. Operational management policy Our credit policy for trading-related financial assets is applied and managed by each of the lines of business to ensure compliance. The policy requires that the creditworthiness and financial strength of customers are assessed at inception and on an ongoing basis. Payment terms are set in accordance with industry standards. Where appropriate, we may minimise risks by requesting securities such as deposits, guarantees and letters of credit. We take proactive steps including constantly reviewing credit ratings of counterparties to minimise the impact of adverse market conditions on trading-related financial assets. 224 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 225 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 27. Financial instruments and risk management continued Exposures The maximum credit risk exposure of the group’s financial assets at the balance sheet date is as follows: At 31 March Derivative financial assets Investments Trade and other receivablesa Cash and cash equivalents Notes 23 17 24 2017 £m 2016 £m 2015 £m 2,246 1,564 2,729 528 7,067 1,639 2,964 2,875 996 8,474 1,329 3,567 2,220 848 7,964 a The carrying amount excludes £360m (2015/16: £218m, 2014/15: £179m) of non-current trade and other receivables which relate to non-financial assets, and £1,106m (2015/16: £1,103m, 2014/15: £873m) of prepayments and other receivables. The credit quality and credit concentration of cash equivalents, current asset investments and derivative financial assets are detailed in the tables below. Where the opinion of Moody’s and S&P differ, the lower rating is used. Moody’s/S&P credit rating of counterparty Aa2/AA and above Aa3/AA– A1/A+a A2/Aa A3/A–a Baa1/BBB+a Baa2/BBB and below 2017 £m 2016 £m 2015 £m 1,444 208 952 370 204 561 86 3,825 2,878 120 64 939 160 492 – 4,653 3,133 206 248 793 121 439 11 4,951 a We hold cash collateral of £702m (2015/16: £553m, 2014/15: £437m) in respect of derivative financial assets with certain counterparties. The concentration of credit risk for our trading balances is provided in note 17, which analyses outstanding balances by line of business. Where multiple transactions are undertaken with a single financial counterparty or group of related counterparties, we enter into netting arrangements to reduce our exposure to credit risk by making use of standard International Swaps and Derivatives Association (ISDA) documentation. We have also entered into credit support agreements with certain swap counterparties whereby, on a daily and weekly basis, the fair value position on notional £1,742m of long dated cross-currency swaps and interest rate swaps is collateralised. The related net cash inflow during the year was £100m (2015/16: £79m, 2014/15: £297m). The collateral paid and received is recognised within current asset investments and loans and other borrowings, respectively. 226 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 227 Notes to the consolidated financial statements continued 27. Financial instruments and risk management continued Offsetting of financial instruments The table below shows our financial assets and liabilities that are subject to offset in the group’s balance sheet and the impact of enforceable master netting or similar agreements. Financial assets and liabilities At 31 March 2017 Derivative financial assets Derivative financial liabilities Total At 31 March 2016 Derivative financial assets Derivative financial liabilities Total At 31 March 2015 Derivative financial assets Derivative financial liabilities Total Related amounts not set off in the balance sheet Amounts presented in the balance sheet £m Right of set off with derivative counterparties £m 2,246 (903) 1,343 (693) 693 – Cash collateral £m (702) 64 (638) Net amount £m 851 (146) 705 Related amounts not set off in the balance sheet Amounts presented in the balance sheet £m Right of set off with derivative counterparties £m 1,639 (911) 728 (456) 456 – Cash collateral £m (553) 40 (513) Net amount £m 630 (415) 215 Related amounts not set off in the balance sheet Amounts presented in the balance sheet £m Right of set off with derivative counterparties £m 1,329 (1,095) 234 (603) 603 – Cash collateral £m (437) 30 (407) Net amount £m 289 (462) (173) Derivatives All of our derivative financial instruments are held at fair value on the balance sheet. The fair values of outstanding swaps and foreign exchange contracts are estimated using discounted cash flow models and market rates of interest and foreign exchange at the balance sheet date. At 31 March 2017 Designated in a cash flow hedge Other Total derivatives At 31 March 2016 Designated in a cash flow hedge Other Total derivatives At 31 March 2015 Designated in a cash flow hedge Designated in a fair value hedge Other Total derivatives Current asset £m Non-current asset £m Current liability £m Non-current liability £m 417 11 428 1,508 310 1,818 25 9 34 616 253 869 Current asset £m Non-current asset £m Current liability £m Non-current liability £m 166 11 177 1,158 304 1,462 40 8 48 618 245 863 Current asset £m Non-current asset £m Current liability £m Non-current liability £m 86 6 5 97 941 143 148 1,232 161 – 7 168 698 – 229 927 226 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 227 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 27. Financial instruments and risk management continued All derivative financial instruments are categorised at Level 2 of the fair value hierarchy as defined in note 23, with the exception of a derivative energy contract which is classified at Level 3. The energy derivative was renegotiated during the year and has been designated as a cash flow hedge. On initial recognition of this contract a loss of £8m was deferred. The fair value of the energy derivative at 31 March 2017 was a liability of £8m (31 March 2016: £nil, 2014/15: asset of £14m). It has been valued using assumptions on volumes, inflation and energy prices. Hedging activities Derivatives may qualify as hedges for accounting purposes if they meet the criteria for designation as fair value hedges or cash flow hedges in accordance with IAS 39. Cash flow hedges Instruments designated in a cash flow hedge include interest rate swaps and cross-currency swaps hedging Euro- and US Dollar-denominated borrowings. Forward currency contracts are taken out to hedge step-up interest on currency denominated borrowings relating to the group’s 2030 US Dollar bond. The hedged cash flows will affect the group’s income statement as interest and principal amounts are repaid over the remaining term of the borrowings (see note 25). We hedge forecast foreign currency purchases, principally denominated in US Dollar, Euro and Asia Pacific currencies 12 months forward, with certain specific transactions hedged further forward. The related cash flows are recognised in the income statement over this period. All cash flow hedges were effective in the period. See note 28 for details of the movements in the cash flow reserve. Fair value hedges Gains and losses arising on fair value hedges are disclosed in note 26. Other derivatives Our policy is not to use derivatives for speculative purposes. However, due to the complex nature of hedge accounting under IAS 39, some derivatives may not qualify for hedge accounting, or are specifically not designated as a hedge where natural offset is more appropriate. Derivative instruments that do not qualify for hedge accounting are classified as held for trading and held at fair value through profit or loss under IAS 39. 28. Other reserves At 1 April 2014 Revisionsd At 1 April 2014 – Revised Exchange differencese Net fair value gain on cash flow hedges Recognised in income and expense Fair value movement on available-for-sale assets Tax recognised in other comprehensive income At 1 April 2015d Exchange differencese Net fair value gain on cash flow hedges Recognised in income and expense Fair value movement on available-for-sale assets Tax recognised in other comprehensive income At 1 April 2016d Exchange differencese Net fair value gain on cash flow hedges Recognised in income and expense Fair value movement on available-for-sale assets Tax recognised in other comprehensive income At 31 March 2017 Other comprehensive income Capital redemption reserve £m Cash flow a reserve £m Available- for-sale b reserve £m Translation c reserve £m 27 – 27 – – – – – 27 – – – – – 27 – – – – – 27 42 – 42 – 207 (218) – 24 55 – 381 (230) – (33) 173 – 884 (938) – 8 127 11 – 11 – – – 7 – 18 – – – (2) – 16 – – – (3) – 13 369 4 373 16 – – – 13 402 29 – – – 38 469 227 – – – 21 717 Total £m 449 4 453 16 207 (218) 7 37 502 29 381 (230) (2) 5 685 227 884 (938) (3) 29 884 a The cash flow reserve is used to record the effective portion of the cumulative net change in the fair value of cash flow hedging instruments related to hedged transactions that have not yet occurred. Amounts ‘recognised in income and expense’ include a net charge to the cash flow reserve of £941m (2015/16: £255m, 2014/15: £244m) relating to fair value movements on derivatives. The items generating these foreign exchange movements are in designated cash flow hedge relationships. b The available-for-sale reserve is used to record the cumulative fair value gains and losses on available-for-sale financial assets. The cumulative gains and losses are recycled to the income statement on disposal of the assets. c The translation reserve is used to record cumulative translation differences on the assets and liabilities of foreign operations. The cumulative translation differences are recycled to the income statement on disposal of the foreign operation. d Revised, see note 1. e Excludes £10m (2015/16: £nil, 2014/15: £nil) of exchange differences in relation to retained earnings attributed to non-controlling interests. 228 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 229 Notes to the consolidated financial statements continued 29. Related party transactions Key management personnel comprise executive and non-executive directors and members of the Operating Committee. Compensation of key management personnel is disclosed in note 5. Amounts paid to the group’s retirement benefit plans are set out in note 20. 30. Financial commitments and contingent liabilities Financial commitments were as follows: At 31 March Capital commitments Other commitments Device purchase commitments TV programme rights commitments Total 2017 £m 2016 £m 889 367 423 2,644 4,323 922 481 260 2,026 3,689 TV programme rights commitments, mainly relating to football broadcast rights, are those for which the licence period has not yet started. Future minimum operating lease payments were as follows: Payable in the year ending 31 March: 2017 2018 2019 2020 2021 2022 Thereafter Total future minimum operating lease payments a We have revised prior year information to be on a consistent basis. 2017 £m a 2016 £m – 650 610 558 532 505 4,305 7,160 642 614 564 517 493 453 4,188 7,471 Operating lease commitments were mainly in respect of land and buildings which arose from a sale and operating leaseback transaction in 2001. Leases have an average term of 15 years (2015/16: 16 years) and rentals are fixed for an average of 15 years (2015/16: 16 years). Other than as disclosed below, there were no contingent liabilities or guarantees at 31 March 2017 other than those arising in the ordinary course of the group’s business and on these no material losses are anticipated. We’ve insurance cover to certain limits for major risks on property and major claims in connection with legal liabilities arising in the course of our operations. Otherwise, the group generally carries its own risks. Commitments and guarantees BDUK Under the Broadband Delivery UK programme, grants received by the group may be subject to reinvestment or repayment to the customer depending on the level of take-up. Telefónica UK Limited leases We’ve provided guarantees relating to certain leases entered into by Telefónica UK Limited (formerly O2 UK Limited) prior to the demerger of mmO2 from BT on 19 November 2001. mmO2 plc (now part of the Telefónica Group) has given BT a counter indemnity for these guarantees. There is no exposure in the event of credit default in respect of amounts used to defease future lease obligations. The guarantee lasts until Telefónica UK Limited has discharged all its obligations. Legal proceedings The group is involved in various legal proceedings, including actual or threatened litigation, government or regulatory investigations. However, save as disclosed below, the group does not currently believe that there are any legal proceedings, government or regulatory investigations that may have a material adverse impact on the operations or financial condition of the group. In respect of each of the claims below, the nature and progression of such proceedings and investigations can make it difficult to predict the impact they will have on the group. There are many reasons why we cannot make these assessments with certainty, including, among others, that they are in early stages, no damages or remedies have been specified, and/or the often slow pace of litigation. 228 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 229 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 30. Financial commitments and contingent liabilities continued Italian business Following the group’s announcement with respect to our investigation into our Italian business in January 2017, three purported securities class action complaints were filed against the company and certain current and former officers in United States courts. All three actions are purportedly brought on behalf of purchasers of BT Group ADRs between May 2012 or May 2013 and January 2017. The actions allege that the company made materially false and/or misleading statements between 2012 and 2016 regarding its internal controls, ethics and corporate governance, and financial outlook in its submissions to and filings with the US Securities and Exchange Commission and other public disclosure. Plaintiffs’ counsel have filed motions to appoint lead plaintiff and lead counsel, and decisions on these motions have not yet been made. We intend to defend these claims vigorously. The issues in Italy have also resulted in engagement with certain of our regulators and other authorities in the UK and elsewhere. As would be expected, we are cooperating fully with these bodies including the Italian authorities. Phones 4U In December 2016, the administrators of Phones 4U Limited (P4U) started legal proceedings in the High Court in the United Kingdom against EE, claiming £66m in payments under a retail trading agreement, which relate to a revenue share for certain customers prior to P4U’s insolvency. We are contesting these claims and have brought counter-claims against P4U, including damages arising from P4U ceasing trading. The administrators have also indicated an intention to start separate High Court proceedings, alleging that EE and other mobile network operators colluded to procure P4U’s insolvency. We also dispute these allegations vigorously. Hutchison 3G Limited In May 2016, Hutchison 3G Limited (H3G) brought legal proceedings in the High Court in the United Kingdom against EE, alleging breach of contract relating to alleged delays in the roll out of certain free carrier coverage to H3G. H3G is entitled to this free carrier coverage under arrangements agreed following the merger of Orange and T-Mobile, predecessors of EE. The litigation is also at a relatively early stage and we are contesting the claims. H3G claims damages relating to loss of business of £167m, although we dispute that there is a basis for the claim and the substantiation of the claimed damages. Brazilian tax claims The Brazilian state tax authorities have made tax demands against certain Brazilian subsidiaries relating to the Tax on Distribution of Goods and Services (ICMS), an indirect tax imposed on the provision of telecommunications services in Brazil. The state tax authorities are seeking to impose ICMS on revenues earned on activities that the company does not consider as being part of the provision of telecommunications services, such as equipment rental and managed services. We have disputed the basis on which ICMS is imposed and the rate which the tax authorities are seeking to apply. We are currently contesting 35 cases, eight of which are pending appeal to the Sao Paulo Court of Appeal; and the judicial process is likely to take many years. The current potential total of the claims is £232m. We are vigorously contesting these tax demands. Regulatory matters In respect of regulatory risks, the group provides for anticipated costs where an outflow of resources is considered probable and a reasonable estimate can be made of the likely outcome. Estimates are used in assessing the likely value of the regulatory risk. The ultimate liability may vary from the amounts provided and will be dependent upon the eventual outcome of any settlement. We hold provisions for regulatory risks of £479m at 31 March 2017. These provisions cover the following issues: Deemed Consent Deemed Consent is an agreed process between Openreach and its Communications Provider (CP) customers, which allows Openreach to halt the installation and reschedule the delivery date for providing dedicated business services (known as Ethernet) in a number of specific circumstances where it is beyond its control. Ofcom found that Openreach had breached its contractual and regulatory obligations by inadequately and retrospectively applying Deemed Consent to reduce compensation payments to CPs between January 2013 and December 2014. We hold a provision of £300m for Deemed Consent relating to estimated compensation payments to CPs resulting from Ofcom’s deemed consent investigation. The precise amount will result from discussions with affected parties, and could result in lower or higher payments than the £300m provided. We also hold £42m within trade payables being the Ofcom fine in relation to their investigation into Ethernet deemed consent, and is therefore certain. Court of Appeal judgment on Ethernet Dispute On 20 December 2012, Ofcom made determinations resolving disputes between BT and five communications providers (C&W Worldwide, Sky, TalkTalk, Virgin Media, and Verizon) concerning BT’s charges for certain Ethernet services. The Determinations found that BT had overcharged C&W Worldwide, Sky, TalkTalk, Virgin Media, and Verizon for certain Ethernet services for varying periods from April 2006 to March 2011. All parties appealed the determinations to the Competition Appeal Tribunal (CAT), which largely confirmed Ofcom’s assessment of overcharging, and ordered BT to pay interest on the amounts overcharged. BT and TalkTalk appealed the CAT’s judgment to the Court of Appeal, the hearing took place in March 2017. 230 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 231 Notes to the consolidated financial statements continued30. Financial commitments and contingent liabilities continued On 4 May 2017, the Court of Appeal handed down its judgment, dismissing TalkTalk’s appeal that Ofcom should have used a different cost standard in assessing cost orientation, which would have resulted in higher repayments to CPs. The Court of Appeal also dismissed BT’s appeal (which would have reduced the repayments). This confirmed our view that no additional amounts were payable in relation to TalkTalk’s appeal. Both BT and TalkTalk may appeal the Court of Appeal judgment to the Supreme Court. Other regulatory matters The remaining provision reflects management’s estimates of regulatory risks across a range of issues, including price and service issues. The precise outcome of each matter depends on whether it becomes an active issue, and the extent to which negotiation or regulatory decision will result in financial settlement. 230 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 231 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Independent auditors’ report to the members of BT Group plc United Kingdom opinion Independent auditors’ report to the members of BT Group plc Report on the parent company financial statements Our opinion In our opinion, BT Group plc’s parent company financial statements (the financial statements): – give a true and fair view of the state of the parent company’s affairs as at 31 March 2017; – have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and – have been prepared in accordance with the requirements of the Companies Act 2006. What we have audited The financial statements, included within the Annual Report & Form 20-F 2017 (the Annual Report), comprise: – the BT Group plc company balance sheet as at 31 March 2017; – the BT Group plc company statement of changes in equity for the year then ended; and – the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. The financial reporting framework that has been applied in the preparation of the financial statements is United Kingdom Accounting Standards, comprising FRS 101 “Reduced Disclosure Framework”, and applicable law (United Kingdom Generally Accepted Accounting Practice). Other required reporting Consistency of other information and compliance with applicable requirements Companies Act 2006 reporting In our opinion, based on the work undertaken in the course of the audit: – the information given in the Strategic Report and the Report of the Directors for the financial year for which the financial statements are prepared is consistent with the financial statements; and – the Strategic Report and the Report of the Directors have been prepared in accordance with applicable legal requirements. In addition, in light of the knowledge and understanding of the parent company and its environment obtained in the course of the audit, we are required to report if we have identified any material misstatements in the Strategic Report and the Report of the Directors. We have nothing to report in this respect. ISAs (UK & Ireland) reporting Under International Standards on Auditing (UK and Ireland) (“ISAs (UK & Ireland)”) we are required to report to you if, in our opinion, information in the Annual Report is: – materially inconsistent with the information in the audited financial statements; or – apparently materially incorrect based on, or materially inconsistent with, our knowledge of the parent company acquired in the course of performing our audit; or – otherwise misleading. We have no exceptions to report arising from this responsibility. Adequacy of accounting records and information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion: – we have not received all the information and explanations we require for our audit; or – adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or – the financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns. We have no exceptions to report arising from this responsibility. Directors’ remuneration Directors’ remuneration report - Companies Act 2006 opinion In our opinion, the part of the Directors’ Remuneration Report to be audited has been properly prepared in accordance with the Companies Act 2006. Other Companies Act 2006 reporting Under the Companies Act 2006 we are required to report to you if, in our opinion, certain disclosures of directors’ remuneration specified by law are not made. We have no exceptions to report arising from this responsibility. Responsibilities for the financial statements and the audit Our responsibilities and those of the directors As explained more fully in the Statement of Directors’ Responsibilities set out on page 146, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and ISAs (UK & Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the parent company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. What an audit of financial statements involves We conducted our audit in accordance with ISAs (UK & Ireland). An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: – whether the accounting policies are appropriate to the parent company’s circumstances and have been consistently applied and adequately disclosed; – the reasonableness of significant accounting estimates made by the directors; and – the overall presentation of the financial statements. We primarily focus our work in these areas by assessing the directors’ judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements. 232 232 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 233 233 We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. With respect to the Strategic Report and Report of the Directors, we consider whether those reports include the disclosures required by applicable legal requirements. Other matter We have reported separately on the group financial statements of BT Group plc for the year ended 31 March 2017. Richard Hughes (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 11 May 2017 232 232 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 233 233 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Financial Statements of BT Group plc BT Group plc company balance sheet Registered number 04190816 At 31 March Investments Trade and other receivablesa Current assets Trade and other receivablesa Cash and cash equivalents Current liabilities Trade and other payablesb Total assets less current liabilities Non-current liabilities Loans and other borrowingsc Equity Ordinary shares Share premium Capital redemption reserve Merger reserve Own shares Retained profit Total equity Notes 2 3 2017 £m 2016 £m 10,801 6,783 10,744 8,511 17,584 19,255 283 2 285 78 78 46 7 53 61 61 17,791 19,247 1,371 1,371 499 1,051 27 5,649 (96) 9,290 1,409 1,409 499 1,051 27 7,424 (115) 8,952 16,420 17,838 17,791 19,247 a Trade and other receivables primarily relate to a £1,010m equity placing raised in February 2015 and net proceeds of £7,507m, before £3m of issue costs relating to the sale of EE to British Telecommunications plc on 29 January 2016. During the year £1,775m of the loan receivable relating to the sale of EE was repaid. The balance consists of two loans to group undertakings of £1,024m (2015/16: £1,004m) repayable on 31 January 2058 and £5,578m (2015/16: £7,507m) repayable on 21 December 2064. The loans attract interest of LIBOR plus 90 basis points (2015/16: Libor plus 102.5 basis points). b Trade and other payables consists of loans from group undertakings of £32m (2015/16: £32m) and other creditors of £46m (2015/16: £29m). c Loans and other borrowings consist of a loan from group undertakings of £1,371m (2015/16: £1,409m). The loan is repayable on 31 January 2058 and attracts interest of LIBOR plus 90 basis points (2015/16: LIBOR plus 102.5 basis points). The financial statements of the company on pages 234 to 237 were approved by the Board of Directors on 11 May 2017 and were signed on its behalf by: Sir Michael Rake Chairman Gavin Patterson Chief Executive Simon Lowth Group Finance Director 234 234 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 235 235 BT Group plc company statement of changes in equity Called up share a capital £m Notes Share premium account £m Capital redemption reserve £m Merger reserve £m b Own shares £m Profit and loss account £m b,c At 1 April 2015 Profit for the financial year Dividends paid Capital contribution in respect of share-based payments Issue of new shares Net buyback of own shares At 1 April 2016 Profit for the financial year Transfer to realised profit Dividends paid Capital contribution in respect of share-based payments Net buyback of own shares At 31 March 2017 3 3 419 – – – 80 – 499 – – – – – 1,051 – – – – – 1,051 – – – – – 499 1,051 27 – – – – – 27 – – – – – 27 – – – – 7,424 – 7,424 – (1,775) – – – 5,649 (165) – – – – 50 (115) – – – – 19 (96) 9,034 1,213 (1,078) 58 – (275) 8,952 97 1,775 (1,436) 57 (155) Total £m 10,366 1,213 (1,078) 58 7,504 (225) 17,838 97 – (1,436) 57 (136) 9,290 16,420 a The allotted, called up and fully paid ordinary share capital of the company at 31 March 2017 was £499m (31 March 2016: £499m), representing 9,968,127,681 (31 March 2016: 9,968,127,681) ordinary shares of 5p each. b In 2016/17, 49,758,963 shares (2015/16: 84,760,494) were issued from Own shares to satisfy obligations under employee share schemes and executive share awards at a cost of £225m (2015/16: £365m). At 31 March 2017, 21,993,165 shares (31 March 2016: 24,771,632) with an aggregate nominal value of £1m (31 March 2016: £1m) were held as part of Own shares at cost. c As permitted by Section 408(3) of the Companies Act 2006, no profit and loss account of the company is presented. The profit for the financial year, dealt with in the profit and loss account of the company was £97m (2015/16: £1,213m). 234 234 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 235 235 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Notes to the company financial statements 1. BT Group plc accounting policies Principal activity The principal activity of the company is to act as ultimate holding company of the BT group. The BT Group plc consolidated financial statements for the year ended 31 March 2017 contain financial instrument disclosures which comply with IFRS 7, ‘Financial Instruments: Disclosures’. Consequently, the company is exempt from the disclosure requirements of IFRS 7 in respect of its financial instruments. Accounting basis As used in these financial statements and associated notes, the term ‘company’ refers to BT Group plc. These separate financial statements of the company are prepared in accordance with, and presented as required by, the Companies Act 2006. These financial statements have been prepared in accordance with Financial Reporting Standard 101 (FRS 101). FRS 101 incorporates, with limited amendments, International Financial Reporting Standards (IFRS). As permitted by FRS 101, the company has taken advantage of the disclosure exemptions available under that standard in relation to business combinations, share-based payments, non-current assets held for sale, financial instruments, capital management, and presentation of comparative information in respect of certain assets, presentation of a cash flow statement, standards not yet effective, impairment of assets and related party transactions. The company intends to continue to take advantage of these exemptions in future years. Further detail is provided below. Where required, equivalent disclosures have been given in the consolidated financial statements of BT Group plc. Financial statements The financial statements are prepared on a going concern basis and under the historical cost convention as modified by the revaluation of certain financial instruments at fair value. As permitted by section 408(3) of the Companies Act 2006, the company’s profit and loss account has not been presented. Exemptions The BT Group plc consolidated financial statements for the year ended 31 March 2017 contain a consolidated cash flow statement. Consequently, as permitted by IAS 7 ‘Statement of Cash flow’, the company has not presented its own cash flow statement. The BT Group plc consolidated financial statements for the year ended 31 March 2017 contain related party disclosures. Consequently, the company has taken advantage of the exemption in IAS 24, ‘Related Party Disclosures’ not to disclose transactions with other members of the BT Group. Investments Investments are stated at cost and reviewed for impairment if there are indicators that the carrying value may not be recoverable. An impairment loss is recognised to the extent that the carrying amount can not be recovered either by selling the asset or by continuing to hold the asset and benefiting the net present value of the future cash flows of the investment. Taxation Full provision is made for deferred taxation on all temporary differences which have arisen but not reversed at the balance sheet date. Deferred tax assets are recognised to the extent that it is regarded as more likely than not that there will be sufficient taxable profits from which the underlying timing differences can be deducted. The deferred tax balances are not discounted. Dividends Dividend distributions are recognised as a liability in the year in which the dividends are approved by the company’s shareholders. Interim dividends are recognised when they are paid; final dividends when authorised in general meetings by shareholders. Dividend income is recognised on receipt. Share capital Ordinary shares are classified as equity. Repurchased shares of the company are recorded in the balance sheet as part of Own shares and presented as a deduction from shareholders’ equity at cost. Cash Cash includes cash on hand and bank deposits repayable on demand. Share-based payments The company does not incur a charge for share-based payments. However, the issuance by the company of share options and awards to employees of its subsidiaries represents additional capital contributions to its subsidiaries. An addition to the company’s investment in subsidiaries is recorded with a corresponding increase in equity shareholders’ funds. The additional capital contribution is determined based on the fair value of options and awards at the date of grant and is recognised over the vesting period. 236 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 237 2. Investments Cost At 1 April 2015 Additions Disposals At 31 March 2016 Additions At 31 March 2017 Total £m 10,686 11,029 (10,971) 10,744 57 10,801 On 29 January 2016, the company acquired the entire share capital of EE Limited (EE) from T-Mobile Holdings Ltd, which is owned by Deutsche Telekom A.G. (DT), and Orange Telecommunications Group Ltd (Orange), in exchange for the issue of 1,595m Consideration Shares and £3,464m cash. The value of the Consideration Shares and cash allotted to DT and Orange at Completion was £10,971m. Subsequently on 29 January 2016 the company sold its entire investment in EE to its wholly owned subsidiary, British Telecommunications plc, at fair value in exchange for an intercompany loan. Included within additions is £57m (2015/16: £58m) of capital contributions in respect of share-based payments. The company held a 100% investment in BT Group Investments Limited, a company registered in England and Wales, throughout 2016/17 and 2015/16. 3. Merger reserve On 29 January 2016, the company issued 1,594,900,429 ordinary shares of 5p at 470.7p per share resulting in a total of £80m being credited to Share capital. These shares were used as part consideration for the acquisition of EE, which completed on 29 January 2016 (note 2 above and note 14 to the consolidated financial statements). As a result of this transaction, a merger reserve was created of £7,424m, net of £3m issue costs. The acquisition of EE was structured by way of a share-for-share exchange and cash. This transaction fell within the provisions of section 612 of the Companies Act 2006 (merger relief) such that no share premium was recorded in respect of the shares issued. The company chose to record its investment in EE at fair value and therefore recorded a merger reserve equal to the value of the share premium which would have been recorded had section 612 of the Companies Act 2006 not been applicable (ie equal to the difference between the fair value of EE and the aggregate nominal value of the shares issued). This merger reserve was initially considered unrealised on the basis that it was represented by the investment in EE which is not considered to be qualifying consideration (in accordance with Tech 02/10 (Guidance on the determination of realised profits and losses in the context of distributions under the Companies Act 2006)). Immediately following the acquisition of EE, the company transferred its investment in EE to its wholly owned subsidiary British Telecommunications plc in exchange for an intercompany loan. To the extent the loan is settled in qualifying consideration, the related proportion of the merger reserve is considered realised. Hence the merger reserve is an unrealised profit until it is realised by the settlement of the intercompany loan by qualifying consideration. During 2016/17 £1,775m (2015/16: £nil) of merger reserve was transferred to realised profit following the settlement of an intercompany loan by qualifying consideration. 4. Other information Dividends The Board recommends that a final dividend in respect of the year ended 31 March 2017 of 10.55p per share will be paid to shareholders on 4 September 2017, taking the full year proposed dividend in respect of 2016/17 to 15.4p (2015/16: 14.0p, 2014/15: 12.4p) which amounts to approximately £1,532m (2015/16: £1,324m, 2014/15: £1,028m). This final dividend is subject to approval by shareholders at the Annual General Meeting and therefore the liability of approximately £1,050m (2015/16: £954m, 2014/15: £712m) has not been included in these financial statements. The proposed dividend will be payable to all shareholders on the Register of Members on 11 August 2017. Employees The chairman, the executive directors and the group general counsel & company secretary of BT Group plc were the only employees of the company during 2016/17 and 2015/16. The costs relating to qualifying services provided to the company’s principal subsidiary, British Telecommunications plc, are recharged to that company. 236 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 237 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Related undertakings Subsidiaries Company name Activity Group interest in allotted capitala Registered Address and Country of incorporation Held directly BT Group Investments Limited Held via other group companies British Telecommunications plc Albacom Holdings América Inalámbrica S.A. Atlanet SpA Autumnwindow Limited Autumnwindow No.2 Limited Autumnwindow No.3 Limited B. Telecomunicações, Cabo Verde, Sociedade Unipessoal, SA B.T. Communication Israel Ltd Basictel SpA Basilica Computing Limited Basilica Distribution Limited Belmullet Limited Brightview Group Limited Brightview Internet Services Limited Bruning Limited BT (Barbados) Limited BT (CBP) Limited BT (Germany) GmbH & Co. oHG BT (Gibraltar) Limited BT (India) Private Limited BT (India) Private Limited Singapore Branchb BT (International) Holdings Limited BT (International) Holdings Limited (Jordan) BT (Netherlands) Holdings B.V. BT (Nigeria) Limited BT (RRS LP) Limited BT (SL) Limited BT (Vietnam) Co. Ltd. BT Albania Limited SH.P.K BT Algeria Communications SARL BT Americas Holdings Inc. BT Americas Inc. BT Argentina S.R.L. BT Australasia Pty Limited Holding company 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom Communications related services and products provider In liquidation Communications related services, systems integration and products provider Communications related services, systems integration and products provider Property company Finance company Property company In liquidation Communications related services, systems integration and products provider Communications related services, systems integration and products provider In liquidation In liquidation Investment company In liquidation In liquidation Finance company Communications related services, systems integration and products provider In liquidation Communications related services and products provider Communications related services and products provider Communications related services and products provider Communications related services and products provider Investment/holding company Communications related services, systems integration and products provider Holding company Communications related services and products provider Investment/holding company Communications related services and products provider Communications related services and products provider Communications related services and products provider Communications related services and products provider Holding company Communications related services, systems integration and products provider Communications related services and products provider Communications related services and products provider 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% common BDO LLP, 55 Baker Street, London, W1U 7EU Calle 113, 7 - 21 Piso 11, Bogota, Torre A. Oficina, Colombia 99% ordinary Via Pianezza n° 123, Torino, Italy 100% ordinary 100% ordinary 100% ordinary 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Avenida Andrade Corvo, 30, Praia, CP63, Cabo Verde 100% ordinary 99% ordinary Beit Oz, 14 Abba Hillel Silver Rd, Ramat Gan, 52506, Israel Via Tucidide 56, Torre 7, 20134, Milano, Italy 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 1 More London Place, London, SE1 2AF 1 More London Place, London, SE1 2AF Third Floor, St Georges Court, Upper Church Street, Douglas, IM1 1EE, Isle of Man 1 More London Place, London, SE1 2AF 1 More London Place, London, SE1 2AF 81 Newgate Street, London, EC1A 7AJ, United Kingdom The Gabbles, Haggatt Hall, St Michael, BB11063, Barbados 1 More London Place, London, SE1 2AF Barthstraße 4, 80339, Munich, Germany 100% ordinary Montagu Pavilion, 8-10 Queensway, Gibraltar 100% ordinary 100% – 100% ordinary 100% ordinary 11th Floor, Eros Corporate Tower, Opp. International Trade Tower, Nehru Place, New Delhi, 110019, India 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore 81 Newgate Street, London, EC1A 7AJ, United Kingdom Al Mirad Building – Second Floor, Wadi Saqra Street Amman – P.O.Box 962178 Amman 11196, Jordan 100% ordinary Minerva & Mercurius building, Herikerbergweg 2, 100% ordinary 100% ordinary 100% ordinary 1101CM, Amsterdam Zuidoost, Netherlands ADOL House, 15 CIPM Avenue, Central Business District, Alausa, Ikeja, Lagos, Nigeria 81 Newgate Street, London, EC1A 7AJ, United Kingdom 84 Dundas Street, Freetown, Sierra Leone 100% ordinary 100% ordinary 16th Floor, Saigon Tower, 29 Le Duan Road, District 1 Ho Chi Minh City, Socialist Republic of Vietnam Rr. Murat Toptani, Eurocol Center, Kati 8, Tirana, Albania 100% ordinary 100% common 100% common 100% ordinary 100% 100% ordinary preference 20 Micro zone d'Activités Dar El Madina, Bloc B, Loc N01 Hydra, Alger, 16000, Algeria c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States Lola Mora 421, 15th Floor, Puerto Madero, Buenos Aires, Buenos Aires, C1107DDA, Argentina Level 1, 76 Berry Street, North Sydney NSW 2060, Australia 238 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 239 Company name BT Australasia Pty Limited – New Zealand Branchb BT Austria GmbH BT Azerbaijan Limited, Limited Liability Company BT Belgrade d.o.o BT BELRUS Foreign Limited Liability Company BT Bilisim Hizmetleri Anonim Şirketi BT Brasil Serviços de Telecomunicações Ltda Activity Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider BT Broadband Luxembourg Sàrl BT Bulgaria EOOD BT Business Direct Limited Holding company Communications related services, systems integration and products provider Technology equipment retailer BT Cables Limited BT Cables MEA FZE BT Canada Inc. Manufacture of telecommunications and rail signalling cables Sale of telecommunications and rail signalling cables Holding company BT Centre Nominee 2 Limited BT China Communications Limited Property company Trading company BT China Limited BT China Limited – Shanghai Branch Officeb Communications related services, systems integration and products provider Communications related services, systems integration and products provider Group interest in allotted capitala 100% – 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% quotas 100% ordinary 100% ordinary Registered Address and Country of incorporation c/- BDO Auckland, 8th Floor 120 Albert St, Auckland, New Zealand Handelskai. 94-96, Millennium Tower 32. OG, Top 324, 1200, Wien, Austria The Landmark III Building, 8th Floor, c/o Deloitte & Touche, 96 Nizami Street, Baku, AZ 1010, Azerbaijan Dimitrija Georgijevica Starike 20, Belgrade, 11070, Serbia, Republic of Office 13, ul. M. Bogdanovicha 1, Minsk, 220029, Belarus Yenisahra Mahallesi, Yavuz Selim Caddesi No 19/A, Atasehir, Istanbul, Turkey Rodovia SP 101, KM 9,5, Trecho Campinas- Monte Mor, Unidade 27, Bloco Beta, Distrito Industrial, Hortolandia - SP- CEP, Sao Paolo, 13185-900, Brazil 12 rue Eugene Ruppert, L 2453, Luxembourg 51B Bulgaria Blvd., fl. 4, Sofia, 1404, Bulgaria 100% ordinary 100% ordinary Alpha & Beta House, Enterprise Park, Horwich, Bolton, Lancs, BL6 6PE 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% common 100% ordinary 50% ordinary Office No. TPOFCB0505, Jabal Ali, Dubai, United Arab Emirates 200 King St W, Suite 1904, Toronto ON M5H 3T4, Canada 81 Newgate Street, London, EC1A 7AJ, United Kingdom Unit 1537B, Floor 15th, No. 55, Xili Road, Shanghai Free Trade Zone, Shanghai, China 100% registered Room 702A, Tower W3, Oriental Plaza, 1 East Chang An 100% – BT Colombia Limitada BT Commerce L.L.C. Communications related services, systems integration and products provider Dormant 100% quotas 100% units BT Communications Bangladesh Limited BT Communications do Brasil Limitada Communications related services, Communications related services, systems integration and products provider 100% ordinary 100% quotas BT Communications Ireland Group Limited BT Communications Ireland Group Limited – UK Branchb BT Communications Ireland Holdings Limited BT Communications Ireland Limited technology consulting and products provider Holding company 100% ordinary Communications related services, systems integration and products provider Holding company 100% – 100% ordinary Telecommunications service provider 100% ordinary BT Communications Kenya Limited BT Communications Lanka (Private) Limited BT Communications Philippines Incorporated BT Communications Sales LLC Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services 100% ordinary 100% ordinary 100% ordinary 100% units BT Communications Sales of Virginia LLC Communications related services 100% units Avenue, Dongcheng, Beijing, 100738, China Room 2101-2103, 21/F, International Capital Plaza, No. 1318 North Sichuan Road, Hong Kou District, Shanghai, 200080, China Calle 113 #7 - 21, Torre A, Of. 1112, Bogota, Colombia c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States House 51 (3rd Floor), Road 9, Block F, Banani, Dhaka, 1213, Bangladesh Avenida das Nações Unidas, nº 4777, 14° Andar, Sao Paulo, SP, 05477-000, Brazil 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Republic of Ireland 81 Newgate Street, London, EC1A 7AJ, United Kingdom 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Republic of Ireland 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Republic of Ireland 6th Floor, Virtual Offices, Morningside Office Park,Ngong Road, Nairobi, Kenya 65/2, Sir Chittampalam A., Gardiner Mawatha, Colombo, 2, Sri Lanka 27th Floor, BPI Buendia Center,, 372 Sen. Gil Puyat Avenue, Makati City, 1226, Philippines c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States c/o Corporation Service Company, 1111 East Main Street, Richmond, VA 23219, United States 238 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 239 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Company name BT Communications Sales, LLC Puerto Rico branchb Activity Communications related services BT Communications Services South Africa (Pty) Limited BT Conferencing Video Inc. BT Conferencing Video Limited BT Cornwall Limited BT Corporate Trustee Limited BT Cote D’Ivoire BT de Panama, S.R.L. BT Denmark ApS BT Deutschland GmbH BT Directories Limited BT Dominican Republic, S. A. BT e-Serv (India) Private Limited BT Eighty-Four Limited BT El Salvador, Limitada de Capital Variable BT Enìa Telecomunicazioni S.P.A. BT ESPAÑA, Compañia de Servicios Globales de Telecommunicaciones, S.A BT European Investments Limited BT Facilities Services Limited BT Federal Inc. BT Fifty BT Fifty-One BT Fifty-Three Limited BT Fleet Limited BT Forty-Nine BT France S.A.S. BT Frontline Outsourcing Sdn Bhd Communications related services, systems integration and products provider Audio, video and web collaboration service provider In liquidation Employment company Finance company Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider In liquidation Communications related services, systems integration and products provider Communications related services, systems integration and products provider In liquidation Communications related services, systems integration and products provider Communications related services Communications related services and products provider Investment/holding company Provision of facilities management services Communications related services for US federal government Finance company Finance company Holding company Fleet management Holding company Communications related services, systems integration and products provider In liquidation BT Gabon Limited Dormant BT Garrick GmbH BT Georgia Limited LLC BT Ghana Limited BT Global (Venezuela) S.A. Holding company Communications related services, systems integration and products provider Provision of IT network services and IT solutions Communications related services, systems integration and products provider Group interest in allotted capitala 100% – 70% ordinary 100% common 100% ordinary 100% ordinary 100% limited by guarantee 100% ordinary 100% ordinary 100% ordinary Registered Address and Country of incorporation The Prentice-Hall Corporation System of Puerto Rico, Inc., c/o FGR Corporate Services Inc., Oriental Center, Suite P1 -, 254 Munoz Rivera Ave, San Juan, PUERTO RICO, 00918, Puerto Rico BT Building North Office Park, 54 Maxwell Drive, Woodmead, 2191, South Africa c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States BDO LLP, 55 Baker Street, London, W1U 7EU 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 29 Boulevard Clozel, 01 BP 3586, Abidjan 01, Cote d’Ivoire Edificio Credicorp Bank, Piso 3, Oficina 301, Cuidad de Panama, Panama Havnegade 39, 1058, Kobenhavn K, Denmark 100% ordinary Barthstraße 4, 80339, Munich, Germany 100% ordinary 100% ordinary 100% equity 100% ordinary 100% ordinary 87% ordinary 100% ordinary BDO LLP, 55 Baker Street, London, W1U 7EU Calle Jose Amado Soler, Esquina Abraham Lincoln, Edificio Progresus, Suite No. 3A, Ensanche Seraller, Santo Domingo, Dominican Republic 11th Floor, Eros Corporate Tower, Opp. International Trade Tower, Nehru Place, New Delhi, 110019, India 1 More London Place, London, SE1 2AF Edificio Centro Profesional Madre Tierra, Local 10, Piso 1, Santa Elena, Antiguo Cuscatlan, El Salvador Strada S. Margherita n° 6/a, Parma, Italy C/ Isabel Colbrand 6-8, 28050, Madrid, Spain 100% ordinary 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% common 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Tour Ariane, 5 place de la Pyramide, La Defense Cedex, 92088 PARIS, France 100% ordinary Menara BT, Level 8, Tower 3, Avenue 7, Bangsar South, No.8, Jalan Kerinchi, 59200, Kuala Lumpur, Malaysia 100% Franc CFA Centre Ville Avenue Alfred, Marche Imm. 2 AG BP 3927, 100% ordinary 100% – Libreville, Gabon Barthstraße 4, 80339, Munich, Germany 74 Ilia Chavchavadze Avenue, Tbilisi, Georgia 100% ordinary 11 Adaman Loop, Tesano, Accra, Ghana 100% ordinary Edificio Parque Cristal, Torre Este, Piso 1, Ofic. 06, Av. Francisco de Miranda, Los Palos Grandes, Caracas, Venezuela 11th Floor, Eros Corporate Tower, Opp. International Trade Tower, Nehru Place, New Delhi, 110019, India 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Republic of Ireland 10 Frere Felix De Valois Street, Port Louis, Mauritius Av. das Nações Unidas, 4777 - 17th floor, São Paulo / SP, Brazil BT Global Business Services Private Limited BT Global Communications (Ireland) Limited BT Global Communications (Mauritius) Limited BT Global Communications do Brasil Limitadaa Communications related services 100% ordinary Property company 100% ordinary Communications related services, systems integration and products provider Communications related services, systems integration and products provider 100% ordinary 100% quotas 240 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 241 Related undertakings continuedCompany name BT Global Communications India Private Limited  BT Global Costa Rica SRL BT Global Japan Corporation BT Global Services (Dalian) Co. Ltd. Activity Communications related services Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider BT Global Services (M) Sdn Bhd BT Global Services Botswana (Proprietary) Limited BT Global Services Korea Limited. BT Global Services Limitedb BT Global Services Limited Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider BT Global Services Limited Londra Sucursala Bucurestib BT Global Services Luxembourg SARL Communications related services, systems Group interest in allotted capitala 74% ordinary 100% ordinary 100% ordinary Registered Address and Country of incorporation 11th Floor, Eros Corporate Tower, Opp. International Trade Tower, Nehru Place, New Delhi, 110019, India Centro Corporativo Internacional, Piso 1, Avenida 6 y 8, Calle 26 y 28, Barrio Don Bosco, Costa Rica ARK Mori Building, 12-32 Akasaka, 1-Chome, Minato-Ku, Tokyo, 107 - 6024, Japan 100% registered No. 31 Software Park Road, Tower A, Science & Technology Building, Dalian Software Park, Dalian, 116023, China 100% ordinary Menara BT, Level 8, Tower 3, Avenue 7, Bangsar South, 100% ordinary 100% common 100% – No.8, Jalan Kerinchi, 59200, Kuala Lumpur, Malaysia Plot 113, Unit 28 Kgale Mews, Gaborone International Finance Park, Gaborone, PO BOX 1839, Botswana 8th Floor, KTB Building, 66 Yeoui-daero, Yeongdeungpo-gu, Seoul, 07325, Korea, Republic of Via Mario Bianchini 15, 00142 Roma, Italy 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% – 100% ordinary 35-37 Oltenitei Str., Cladirea A1, Biroul Nr. 52, Bucharest, Sector 4, Romania 12 rue Eugene Ruppert, L 2453, Luxembourg BT Global Services Solutions Sdn Bhd Communications related services, systems 100% ordinary Menara BT, Level 8, Tower 3, Avenue 7, Bangsar South, integration and products provider BT Global Services Technologies Pte. Ltd. BT Global Solutions Pte. Ltd. BT Global Technology (M) Sdn. Bhd. BT GLOBALNE STORITVE, telekomunikacijske storitve, obdelava podatkov, podatkovnih baz; d.o.o. BT Group Nominees Limited BT Guatemala S.A. BT Holdings Limited BT Hong Kong Limited integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Dormant Communications related services, systems integration and products provider Investment holding company Communications related services and products provider BT Hong Kong Ltd. – Macau Branchb Communications related services, systems BT International Holdings Limited & Co. LLC BT IT Services Limitedc BT Italia S.p.A. BT Jamaica Limited BT Japan Corporation BT Jersey Limited BT Kazakhstan LLP BT Lancashire Services Limited BT LatAm (BVI) Corporation BT LatAm (Nevada) Corp. BT Latam Argentina S.A integration and products provider Communications related services, systems integration and products provider Dormant Communications related services and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services Communications related services and products provider Communications related services and products provider Communications related services, systems integration and products provider Communications related services Communications related services and products provider 100% ordinary 100% ordinary No.8, Jalan Kerinchi, 59200, Kuala Lumpur, Malaysia 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore 100% ordinary Menara BT, Level 8, Tower 3, Avenue 7, Bangsar South, 100% ordinary No.8, Jalan Kerinchi, 59200, Kuala Lumpur, Malaysia CESTA V MESTNI LOG 1, 1000 LJUBLJANA, Slovenia 100% ordinary 100% unique 100% ordinary ordinary preference 39% 61% 100% – 100% ordinary 100% ordinary 99% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom 3ra Avenida 13-78, Zona 10 Torre Citibank, Nivel 2, Oficina No. 206, Guatemala 81 Newgate Street, London, EC1A 7AJ, United Kingdom 38 Floor Dorset House, Taikoo Place, 979 King’s Road, Quarry Bay, Hong Kong Av.Praia Grande,No. 369,, Keng Ou Commercial Building,17 flr, Macau, Macao 413, 4th Floor, Maktabi Building, Wattayah, PC 112, Muscat, 2188, Oman 3 Midland Way, Barlborough Links, Barlborough, Chesterfield, S43 4XA, United Kingdom Via Tucidide 56, Torre 7, 20134, Milano, Italy 100% ordinary 26 Beechwood Avenue, PO Box 351, Kingston 5, Jamaica 100% ordinary 100% ordinary 100% – 100% ordinary 100% common 100% common 100% common ARK Mori Building, 12-32 Akasaka, 1-Chome, Minato-Ku, Tokyo, 107 - 6024, Japan PO Box 264, Forum 4, Grenville Street, St Helier, JE4 8TQ, Jersey 36 Al Farabi Ave., Bldg. B, Almaty Financial District, Almaty, Republic of Kazakhstan, 050059, Kazakhstan 81 Newgate Street, London, EC1A 7AJ, United Kingdom Sea Meadow House, Blackburne Highway (P.O. Box 116), Road Town, Tortola, Virgin Islands, British c/o Corporation Service Company, 2215-B Renaissance Drive, Las Vegas, NV 89119, United States Lola Mora 421, 15th Floor, Puerto Madero, Buenos Aires, Buenos Aires, C1107DDA, Argentina 240 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 241 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Company name BT LatAm Brasil Ltda. BT LatAm Colombia S.A. BT LatAm Costa Rica, S.A. BT LatAm Dominicana, S.A. Activity Communications related services, systems integration and products provider Group interest in allotted capitala 100% quotas Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider 100% common 100% common 100% common BT LatAm El Salvador, S.A. de CV BT LatAm Guatemala, S.A. Communications related services, systems integration and products provider Communications related services, systems integration and products provider 100% common 100% common BT LatAm Holdings (Colombia) S. A. Holding company 100% common BT LatAm Holdings Brasil Ltda Holding company 100% common BT LatAm Holdings One, Inc. Holding company 100% common BT LatAm Holdings Three, Inc. Holding company 100% common BT LatAm Holdings Two, Inc. Holding company 100% common BT LatAm Honduras, S.A. Communications related services, systems integration and products provider 100% common BT LatAm México, S.A. de C.V. BT LatAm Nicaragua, S.A. BT LatAm Panama, Inc. BT LatAm Peru S.A.C. BT LatAm Services, Inc. BT LatAm Venezuela, S.A. Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Holding company 100% common 100% common 100% common 100% common 100% common Communications related services, systems integration and products provider 100% ordinary BT LatAm, Inc. Communications related services 100% common Registered Address and Country of incorporation Rodvia SP 101, KM 9,5, Trecho Campinas - MonteMor, Unidade 27, Bloco Alfa, Distrito Industrial, Hortolandia- SP- CEP, 13185-900 Calle 113 #7 - 21, Torre A, Of. 1112, Bogota, Colombia Centro Corporativo Internacional, Piso 1, Avenida 6 y 8, Calle 26 y 28, Barrio Don Bosco, Costa Rica Calle Jose Amado Soler, Esquina Abraham Lincoln, Edificio Progresus, Suite No. 3A, Ensanche Seraller, Santo Domingo, Dominican Republic Edificio Centro Profesional Madre Tierra, Local 10, Piso 1, Santa Elena, Antiguo Cuscatlan, El Salvador Edificio Torre Citibank en Intercontinental Plaza, 3 Avenida, 13-78, Zona 10, Nivel 2, Oficina 203, Guatemala Calle 113, 7 - 21 Piso 11, Bogota, Torre A. Oficina, Colombia Avenida Das Nações Unidas, 4777 - 14, andar- parte- Jardim Universidade - São Paulo- SP- CEP, 05477-000 c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States Edificio Plaza Azul, Piso 2 do Nivel, Local No. 26, Colonia Lomas del Guijarro Sur, Avenida Paris, Calle Viena, Tegucigalpa, Honduras Av. Renato Leduc 321, Col. Toriello Guerra, 14050 Mexico D.F. Edificio Invercasa, 5to Piso, Suite 505, Via Fontana, frente al colegio La Salle, Managua, Nicaragua Edificio Credicorp Bank, Piso 3, Oficina 301, Cuidad de Panama, Panama Calle Martir Olaya, 129 of 1901, Miraflores, Lima, Peru c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States Av. Francisco de Miranda, Edificio Parque Cristal, Torre Este, Mezz 2, Local 28, Los Palos Grandes, Caracas 1060, Venezuela c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States BT Latvia Limited, Sabiedriba ar ierobezotu atbildibu BT Law Limited BT Lease Holdings Limited BT Leasing Limited BT Lebanon S.A.L. BT LGS Limited BT Limitedb BT Limited BT Limitedb Communications related services, systems integration and products provider Provision of third party claims handling services Investment/holding company Finance company Communications related services, systems integration and products provider Employment company Communications related services, systems integration and products provider International telecommunications network systems provider Dormant 100% – 100% ordinary Muitas iela 1A, Riga, LV-1010, Latvia 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% – 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Abou Hamad, Merheb, Nohra & Chedid Law Firm, Chbaro Street, 22nd Achrafieh Warde Building, 1st Floor, Beirut, P.O.BOX 165126, Lebanon 81 Newgate Street, London, EC1A 7AJ, United Kingdom Telecomlaan 9, 1831 Diegem, Belgium 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom BT Limited Hungarian Branch Officeb Communications related services, systems 100% – BT Limited Taiwan Branchb BT Limited, Beijing Officeb integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider 100% – 100% – First Floor, Culross Court North, 16 Culross Road, Bryanston 2021, 2021, South Africa Budafoki U. 91-93, Budapest, 1117, Hungary Shin Kong Manhattan Building, 14F, No. 8, Sec. 5, Xinyi Road, Taipei, 11049, Taiwan No. 3 Dong San Huan Bei Lu, Chao Yang District, Beijing, 100027, China 242 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 243 Related undertakings continuedCompany name BT Limited, organizacni slozkab BT Luxembourg Investment Holdings Sarl BT Malawi Limited Activity Communications related services, systems integration and products provider Holding company Group interest in allotted capitala 100% – Registered Address and Country of incorporation V Celnici 1031/4, 110 00 Prague 1, Czech Republic 100% ordinary 12 rue Eugene Ruppert, L 2453, Luxembourg BT Managed Services (No.2) Limited Dormant BT Managed Services Limited Communications related services, systems integration and products provider 100% ordinary 100% ordinary 100% ordinary BDO Tax & Advisory Services (Pvt) Ltd, 6th Floor Unit House, 12 Victoria Street PO BOX 3038, Blantyre, Malawi 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom BT Manx Investments Limited BT MDV Limited BT MEA FZ-LLC BT Montenegro DOO BT Moorgate LLC Communications related services and products provider In liquidation Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services 100% units BT Moorgate LLC – UK Branchb BT Moorgate One Limited BT Moorgate Two Limited BT Mozambique, Limitada BT Multimedia (Malaysia) Sdn Bhd Communications related services Finance company Finance company Communications related services, systems integration and products provider In liquidation 100% – 100% ordinary 100% ordinary 100% quotas 100% ordinary 100% ordinary Equiom (Isle of Man) Limited, Jubilee Buildings, Victoria Street, Douglas, Isle of Man, IM1 2SH 100% ordinary MD-2001, 65 Stefan cel Mare si Sfant Boulevard, office 806, Chisinau, Moldova, Republic of Office No G03, Ground Floor, EIB Building No 04, Dubai, United Arab Emirates Bulevar revolucije 7, Podgorica, 81000, Montenegro 100% ordinary 100% – c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Av. 25 de Setembro, 1230, 3º, Bloco 5, Caixa Postal 4200, Maputo, 4200, Mozambique Level 1 to 8, Tower 3,, Avenue 7, Bangsar South, No. 8 Jalan Kerinchi, 59200 Kuala Lumpur, Malaysia BT Nederland N.V. BT Nederland N.V.b BT Netherlands Investments B.V. Communications related services and products provider Communications related services, systems integration and products provider Holding company 100% ordinary Minerva & Mercurius building, Herikerbergweg 2, 100% – 1101CM, Amsterdam Zuidoost, Netherlands Via Tucidide 56, Torre 7, 20134, Milano, Italy 100% ordinary Minerva & Mercurius building, Herikerbergweg 2, BT Newgate LLC Communications related services 100% units BT Newgate LLC – UK Branchb BT Nicaragua S.A. BT Niger BT Nominees Limited BT Nordics Finland Oy BT Nordics Sweden AB BT Pakistan (Private) Limited BT Paraguay S.R.L. BT Payment Services Limited BT Peru S.R.L. BT Poland Spólka Z Ograniczoną Odpowiedzialnością BT Portugal – Telecomunicações, Unipessoal, Lda. BT Professional Services (Germany) GmbH BT Professional Services (Holdings) N.V. BT Professional Services (India) Private Limited Communications related services Communications related services, systems integration and products provider Dormant Dormant Communications related services Communications related services Communications related services, systems integration and products provider Communications related services, systems integration and products provider In liquidation Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Holding company In liquidation BT Professional Services (Luxembourg) S.A. BT Professional Services Nederland B.V. Communications related services, systems integration and products provider Communications related services, systems integration and products provider 100% quotas 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% – 100% ordinary 100% ordinary 100% ordinary 100% – 100% capital 1101CM, Amsterdam Zuidoost, Netherlands c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 81 Newgate Street, London, EC1A 7AJ, United Kingdom Edificio Invercasa, 5to Piso, Suite 505, Via Fontana, frente al colegio La Salle, Managua, Nicaragua 57, Rue des Sorkhos, BP 616, Niamey-Niger 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% ordinary 100% ordinary Mannerheimvägen 12 B 6, 00100 Helsinki, Finland 100% ordinary 100% ordinary Box 30005, 104 25, Stockholm, Sweden 2nd Floor, Block C, Lakson Square, Building No. 1, Sarwar Shaheed Road, Karachi, 74200, Pakistan Humaita 145, Planeta I Building, 9th Floor, Asuncion, 1245, Paraguay BDO LLP, 55 Baker Street, London, W1U 7EU Calle Martir Olaya, 129 of 1901, Miraflores, Lima, Peru International Business Center, Al. Armii Ludowej, 14,00-638 Warszawa Rua D. Francisco Manuel de Melo 21-1, 1070-085 Lisboa, Portugal Unterster Zwerchweg 61, 60599 Frankfurt am Main, Germany Telecomlaan 9, 1831 Diegem, Belgium 602, Tower B, RMZ Infinity, Municipal No. 3, Old Madras Road, Benninganahalli, Bengaluru, Karnataka, 560016, India 12 rue Eugene Ruppert, L 2453, Luxembourg 100% ordinary Minerva & Mercurius building, Herikerbergweg 2, 1101CM, Amsterdam Zuidoost, Netherlands 242 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 243 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Activity Property/holding company Company name BT Property Holdings (Aberdeen) Limited BT Property Holdings (Oxford) Limited Property/holding company BT Property Limited BT ROC Kft BT Services S.A.S. BT Seventy-Four Limited BT Seventy-Three BT Siam Limited BT Singapore Pte. Ltd. BT Sixty-Four Limited BT Sle Euro Limited BT Sle USD Limited BT Slovakia s.r.o. BT Sociedad De Responsabilidad Limitada BT Solutions Limitedb BT Solutions Limitedb BT Solutions Limitedb BT Solutions Limitedb BT Solutions Limitedb BT Solutions Limitedb BT Solutions Limited BT Solutions Limitedb BT Solutions Limited (Bahrain Branch)b BT Solutions Limited – Kuwait Branchb BT Solutions Limited – Morocco Branchb BT Solutions Limited – Tanzania Branchb BT Solutions Limited Branch Office in Skopjeb BT Solutions Limited Eesti Filiaalb Dormant Communications related services, systems integration and products provider Technology consulting and engineering services In liquidation Investment/holding company Communications related services, systems integration and products provider Communications related services and products provider Finance company Finance company Finance company Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider BT Solutions Limited Liability Company BT Solutions Limited Podruznica Hrvatskab BT Solutions Limited Sucursal Boliviab Communications related services, systems BT Solutions Limited Sucursal Uruguayb BT Solutions Limited Útibú á Íslandib BT Solutions Limited-Greek Branchb BT Solutions Norway AS integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Group interest in allotted capitala 100% ordinary Registered Address and Country of incorporation 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% ordinary 100% business 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Budafoki út 91-13, 1117 Budapest, Hungary 100% ordinary Tour Ariane, 5 place de la Pyramide, La Defense Cedex, 92088 PARIS, France BDO LLP, 55 Baker Street, London, W1U 7EU 81 Newgate Street, London, EC1A 7AJ, United Kingdom 69% preference Athenee Tower, 23rd Floor, (CEO Suite, Suite 38 & 40), 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 63 Wireless Road, Lumpini, Pathumwan, Bangkok, 10330, Thailand 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Laurinská 18, 811 01 Bratislava, Slovakia 100% – 100% – 100% – 100% – 100% – 100% – 100% – 100% ordinary 100% 100% – 100% – 100% – 100% – 100% – 100% – Colonia Lomas Del Guijarro sur, edificio Plaza azul, 2do. Nivel, local #26, Tegucigalpa, Honduras 236 Strovolos Avenue, Strovolos 2048, Nicosia, Cyprus Av. Amazonas N21-252 y Carrión, Edificio Londres, 4° Piso, Quito, Ecuador Tower Gate Place, Tal-Qroqq Street, Msida MSD 1703, Malta PO Box 2184, 61 Bismarck Street, Windhoek, Namibia 9 Warner Street, Port of Spain, 0000, Trinidad and Tobago c/o BDO East Africa, Plot 22 Mbuya Road, Bugolobi, Kampala,, P.O. BOX 9113, Uganda 81 Newgate Street, London, EC1A 7AJ, United Kingdom C/O BDO Zambia Limited Services, Unit B, Counting House Square, Thabo Mbeki Road, Lusaka, Zambia Suite #650, 6th floor, Building No. 247, Road 1704, Diplomatic Area 317, Bahrain Block 2-A, 9th Floor, Ahmad Al Jaber Street, Sharq, Kuwait 193, Avenue HASSAN II, Casablanca, MAROC s/c Domicilia services, Morocco BDO East Africa, 1st Floor-Wing B, Infotech Place, Mwai Kibaki Road, Dar es Salaam, Tanzania Str. Dame Gruev no.8, 5th floor, Building “Dom na voenite invalidi”, SKOPJE 1000, Macedonia A.H. Tammsaare tee 47, Tallinn, 11316, Estonia 100% – 26 Pravdy Street, Moscow, 127137, Russia 100% – Savska 64, 10 000 Zagreb, Croatia 100% – 100% – 100% – Avenida Arce esquina Rosendo Gutierrez, Edifico Multicentre Torre B, Piso 12, La Paz, Bolivia Rincón 487 Piso 11, Montevideo, ZIP CODE 11.000, Uruguay Co. Deloitte, Smáratorg 3, 201, Kopavogur, Iceland 100% – 75 Patision Street, Athens, 10434, Greece 100% ordinary Munkedamsveien 45, c/o BDO AS, 0121 Oslo, Norway 244 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 245 Related undertakings continuedGroup interest in allotted capitala 100% ordinary 100% ordinary Registered Address and Country of incorporation 81 Newgate Street, London, EC1A 7AJ, United Kingdom Richtistrasse 5, 8304 Wallisellen, Switzerland 100% ordinary Menara BT, Level 8, Tower 3, Avenue 7, Bangsar South, No.8, Jalan Kerinchi, 59200, Kuala Lumpur, Malaysia 100% registered Building 16, 6th Floor, Room 602-B, No. 269 Wuyi Company name BT South Tyneside Limited BT Switzerland AG BT Systems (Malaysia) Sdn Bhd BT Technology (Dalian) Company Limited. BT Telconsult Limited BT Telecom Egypt LLC BT Telecom India Private Limited Activity Employment company Communications related services and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider In liquidation Communications related services, systems integration and products provider Communications related services, systems integration and products provider Dormant integration and products provider Communications related services, systems integration and products provider 100% ordinary 100% stakes 74% ordinary 100% ordinary 100% common 100% ordinary BT Telecommunications Kenya Limited BT Telekom Hizmetleri Anonim Şirketi Communications related services, systems BT Tunisia S.A.R.L BT UAE Limited Communications related services, systems integration and products provider 100% ordinary BT UAE Limited – Abu Dhabi Branchb Communications related services, systems 100% – integration and products provider BT UAE Limited – Dubai Branch (1)b Communications related services, systems integration and products provider 100% – BT UAE Limited – Dubai Branch (2)b Communications related services, systems integration and products provider 100% – BT Ukraine Limited Liability Company Communications related services, systems 100% stakes BT US Investments Limited BT US Investments Limited – UK branchb BT U.S. Government Services L.L.C. integration and products provider Investment/holding company 100% ordinary Investment company 100% – Dormant 100% units BT United States L.L.C. Holding company 100% units BTexact Technologies Limited BTexact Venturing Limited BTGS Mexico S.A. de C.V. Finance company Investment/holding company Communications related services, systems integration and products provider 100% ordinary 100% ordinary 2% 98% fixed variable Road, Hi-tech Park, Dalian, 116023, China BDO LLP, 55 Baker Street, London, W1U 7EU 1 Wadi El Nile St., Mohandessin, Giza, Cairo, Egypt 11th Floor, Eros Corporate Tower, Opp. International Trade Tower, Nehru Place, New Delhi, 110019, India P.O. BOX 10032-00100, Nairobi, Kenya Barbaros Mahallesi, Yavuz Selim Caddesi No: 17/1 Ataşehir, İstanbul, Turkey BT chez BDO Tunisie, Immeuble, ENNOUR BUILDING 3ème étage, Centre Urbain Nord 1082, Mahrajène Tunis, Tunisia 81 Newgate Street, London, EC1A 7AJ, United Kingdom Office No. (F6) International Business Center, Building No. (27W10), Three Sails Tower, Cornish, Abu Dhabi, United Arab Emirates Office no.206 BLOCK B, Diamond Business Center 1, Al Barsha South Third, Dubai, P.O.BOX 25205, United Arab Emirates Office no.206 BLOCK B, Diamond Business Center 1, Al Barsha South Third, Dubai, P.O.BOX 25205, United Arab Emirates Office 615; 26 Lesi Ukrayinky Boulevard, Kyiv, 01133, Ukraine Ogier House, The Esplanade, Parish, St Helier, Jersey, JE4 9WG, Jersey 81 Newgate Street, London, EC1A 7AJ, United Kingdom c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 100% owned by BT America Holdings Inc. c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom Blvd. Manuel Avila Camacho #1-6, Col. Lomas de Chapultepec, Deleg. Miguel Hidalgo, Mexico D.F., 11009, Mexico BTGS USVI Limited Dormant 100% ordinary Waterfront Center - Suite A, St. Thomas 00803, BTIH Teleconsult Drustvo sa organicenom odgovornoscu za posredovanje i zastupanje d.o.o. Sarajevo Canal Capital Investment Limited Cegetel Holdings I B.V.e Cegetel Holdings I Sarl Cegetel Holdings II B.V.e Cegetel Holdings II Sarl Comms Factory Limited Communications Global Network Services Limited Communications Global Network Services Limited – UK Branchb Architectural and engineering activities and technical consulting 100% – US Virgin Islands ul. Despiceva broj 3/II, Sarajevo, Sarajevo-Stari Grad, 71000, Bosnia and Herzegovina Investment company 100% ordinary 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Holding company Holding company Holding company Holding company In liquidation Communications related services and products provider Communications related services and products provider 100% ordinary 100% – 100% ordinary 100% – 100% ordinary 100% ordinary 100% – Republic of Ireland 12 rue Eugene Ruppert, L 2453, Luxembourg 12 rue Eugene Ruppert, L 2453, Luxembourg 12 rue Eugene Ruppert, L 2453, Luxembourg 12 rue Eugene Ruppert, L 2453, Luxembourg BDO LLP, 55 Baker Street, London, W1U 7EU Century House, 16 Par-la-Ville Road, Hamilton, HM08, Bermuda 81 Newgate Street, London, EC1A 7AJ, United Kingdom 244 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 245 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Group interest in allotted capitala 100% ordinary Registered Address and Country of incorporation 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% - 81 Newgate Street, London, EC1A 7AJ, United Kingdom Company name Communications Networking Services (UK) Communicator (IOM) Limited - UK Branchb Communicator Insurance Company Limited Communicator Limited Activity Communications related services and products provider Insurance Investment company Investment company Comsat de Guatemala S.A. Dormant 99% 1% ordinary preference 100% ordinary 100% common dabs.com plc Technology equipment retailer 100% ordinary Deleteway Limited Dublin London Network Limited EE (Group) Limited In liquidation Communications related services, systems integration and products provider Dormant 100% ordinary 55% ordinary 100% ordinary EE Communications (South Africa) Proprietary Limited EE Finance plc Dormant 100% ordinary Finance company 100% ordinary EE Limited Telecommunications 100% ordinary EE Pension Trustee Limited Pension trustee company 100% ordinary EE Services Limited Dormant ERPTech S.p.A. ESAT Telecommunications (UK) Limited Everything Everywhere Limited Communications related services, systems integration and products provider Dormant Dormant Extraclick Limited Frontline Solutions Pte Ltd Investment/holding company In liquidation Green House Group Pte Ltd In liquidation 100% ordinary 99% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary Third Floor, St Georges Court, Upper Church Street, Douglas, IM1 1EE, Isle of Man Third Floor, St Georges Court, Upper Church Street, Douglas, IM1 1EE, Isle of Man 6a avenida, 7-39 de la zona 10 Edificio las Brisas, 3er nivel, ciudad de Guatemala, Guatemala Alpha & Beta House, Enterprise Park, Horwich, Bolton, Lancs, BL6 6PE 1 More London Place, London, SE1 2AF 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Republic of Ireland Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom 24-18th Street, Menlo Park, Pretoria, 0081, South Africa Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Via Charles Robert Darwin, no 85, 20019, Settimo Milanese, Italy 81 Newgate Street, London, EC1A 7AJ, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 600 North Bridge Road, #23-01 Parkview Square, 188778, Singapore 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore Green House Solution Sdn Bhd In liquidation 100% ordinary Menara BT, Level 8, Tower 3, Avenue 7, Bangsar South, groupBT Limited Holland House (Northern) Limited iASPire.Net Pte Ltd Communications related services, systems integration and products provider Property/holding company Dormant 100% ordinary 100% ordinary 95% ordinary IINS, Inc. Communications related services 100% common Ilford Trustees (Jersey) Limited Infocom Telecom LLC Infonet Broadband Services Corporation Infonet China Limited Infonet China Limited Beijing Representative Officeb Infonet China Limited Shanghai Representative Officeb Infonet Italia S.p.A Infonet Primalliance Beijing Co. Ltd. Infonet Primalliance Co., Limited Investment company Communications related services, systems integration and products provider Communications related services Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Dormant Communications related services, systems integration and products provider Communications related services, systems integration and products provider 100% ordinary 100% charter 100% common 100% ordinary 100% – 100% – 100% ordinary 66% ordinary 100% ordinary Infonet Primalliance Holding Co. Ltd. Holding company 100% ordinary No.8, Jalan Kerinchi, 59200, Kuala Lumpur, Malaysia 81 Newgate Street, London, EC1A 7AJ, United Kingdom Alexander Bain House, 15 York Street, Glasgow, G2 8LA 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 26 New Street, St Helier, JE2 3RA, Jersey Miusskaya Square 7, 125811, Moscow, Russia c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 38th floor, Dorset House, Taikoo Place, 979 King’s Road, Island East, Hong Kong Room 4C, 7/F, Tower W3, Oriental Plaza, 1 East Chang An Avenue, Dong Cheng District, Beijing, P. R. China Room B, 28/F, Cross Region Plaza, 899 Ling Ling Road, Xu Hui District, Shanghai, P. R. China Via Tucidide 56, Torre 7, 20134, Milano, Italy Room 4B, 7/F, Tower W3, Oriental Plaza, 1 East Chang An Avenue, Dong Cheng District, Beijing, P. R. China 38 Floor Dorset House, Taikoo Place, 979 King's Road, Quarry Bay, Hong Kong Room 635-3, No. 2 BLDG, 351 Guo Shou Jing Road, Zhang Jiang High Technology Park, Shanghai, P. R. China 246 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 247 Related undertakings continuedCompany name Infonet Services (Hong Kong) Limited Communications related services, systems Activity Infonet Services Corporation integration and products provider Communications related services Group interest in allotted capitala 100% ordinary 100% common Infonet USA Corporation Communications related services 100% common IT Holdings, Inc Dormant 100% ordinary Holding company 100% ordinary Mainline Communications Group Limited Mainline Digital Communications Limited Mainline Limited Distribution of mobile telephones and services Dormant Mobilise Telecoms Limited Dormant M-Viron Limited Dormant Newgate Communication (Sudan) Co. Ltd Newgate Leasing Limited Newgate Street Secretaries Limited Numberrapid Limited Numberrapid Limitedb Nuova Societa di Telecomunicazioni SpA Openreach Limited Opimus S.A. de C.V. Orange FURBS Trustees Limited In liquidation Investment/holding company Dormant Communications related services, systems integration and products provider Communications related services, systems integration and products provider Communications related services, systems integration and products provider Dormant Communications related services, systems integration and products provider Pension trustee company Orange Home UK Limited Dormant Orange Personal Communications Services Limited Orange Services India Private Limited Provision of call centre services Pelipod Ltd Holding company Supplier of delivery pods for supply chain solution Broadband service provider Plusnet plc Postgate Holding Company Priestgate Limited In liquidation Holding company PSPI-Subic, Inc Dormant Registered Address and Country of incorporation 38 Floor Dorset House, Taikoo Place, 979 King's Road, Quarry Bay, Hong Kong c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States 12th Floor, Multinational Bancorporation Centre, 6805 Ayala Ave., Makati City, Philippines Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Alskheikh Mustafa Building, Parlman Street, Khartoum, Sudan 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% – 3 Baines Avenue, Box 334, Harare, Zimbabwe 99% ordinary Via Tucidide 56, Torre 7, 20134, Milano, Italy 100% ordinary 100% common 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 51% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom Av. Renato Leduc 321, Col. Toriello Guerra, 14050 Mexico D.F. Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom Trident Place, Mosquito Way, Hatfield, Hertfordshire, AL10 9BW, United Kingdom A-47, Hauz Khas, New Delhi, Delhi-DL, 110016, India 81 Newgate Street, London, EC1A 7AJ, United Kingdom The Balance, 2 Pinfold Street, Sheffield, S1 2GU, United Kingdom BDO LLP, 55 Baker Street, London, W1U 7EU Third Floor, St Georges Court, Upper Church Street, Douglas, IM1 1EE, Isle of Man c/o Sun Microsystems Phil Inc., 8767 Paseo de Roxas, Makati City, Philippines PT BT Communications Indonesia PT BT Indonesia PT Sun Microsystems Indonesia Communications related services, systems integration and products provider Communications related services, systems integration and products provider Dormant 100% ordinary World Trade Centre 5, 13th Floor, Jl. Jend. Sudirman Kav. 29-31, Jakarta, Jakarta, 12920, Indonesia 100% ordinary World Trade Center 5, 13th Floor, Jl.Jend Sudirman, Kav. 29-31, Jakarta, Jakarta, 12920, Indonesia 60% ordinary World Trade Centre 5, 13th Floor, Jl. Jend. Sudirman Kav. Radianz Americas Inc. Communications related services 100% common Radianz Italia S.r.l. Radianz Limited Radianz Spain S.L. RDZ Netherlands BV Sama Empreedimentos e Participações Limitada Communications related services, systems integration and products provider Investment/holding company Communications related services, systems integration and products provider Communications related services, systems integration and products provider Dormant 29-31, Jakarta, Jakarta, 12920, Indonesia c/o Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE 19808, United States Via Correggio 5, 20097, San Donato Milanese, Milan, Italy 81 Newgate Street, London, EC1A 7AJ, United Kingdom C/ Isabel Colbrand 6-8, 28050, Madrid, Spain 100% ordinary 100% ordinary 100% ordinary 100% ordinary Minerva & Mercurius building, Herikerbergweg 2, 100% common 1101CM, Amsterdam Zuidoost, Netherlands Rua Arnaldo Quintela - 96, 1 Andar - Botafogo, CEP 22.280-070, Rio de Janeiro, Brazil 246 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 247 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Company name Servicios de Telecomunicaciones BT Global Networks Chile Limitada SEV Automotive and Plant Limited Skeegle App Limited Skeegle Holdings Limited Skeegle Operations Limited Southgate Developments Limited Stemmer GmbH Sun Microsystems Philippines, Inc Activity Communications related services, systems integration and products provider Maintenance and repair of motor vehicles In liquidation In liquidation In liquidation Investment/holding company Communications related services, systems integration and products provider Dormant Sun Vietnam Co., Ltd. Sun Vietnam Pte. Ltd. Syntone S.A.R.L. Tikit Group Limited Tikit Limited Tikit TFB Limited Tikit, Inc. Transcomm UK Limited Tudor Minstrel UAB BTH Vilnius Whitestream Industries Limited Dormant Dormant Dormant In liquidation Software services products provider In liquidation Software services products provider Communications related services and products provider Finance company Communications related services, systems integration and products provider Investment/holding company Group interest in allotted capitala 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 51% common 60% ordinary 60% ordinary 99% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary 100% ordinary Registered Address and Country of incorporation Avenida Américo Vespucio Sur 951, Piso 1 y 2, Las Condes, Santiago de Chile, Chile, 7550371, Chile Future Technology Centre, Barmston Court, Nissan Way, Sunderland, Tyne and Wear, SR5 3NY, United Kingdom BDO LLP, 55 Baker Street, London, W1U 7EU BDO LLP, 55 Baker Street, London, W1U 7EU BDO LLP, 55 Baker Street, London, W1U 7EU 81 Newgate Street, London, EC1A 7AJ, United Kingdom Peter Henlein Straße 2, 82140 Olching, Germany 18th Floor, Philamlife Tower, 8767 Paseo de Roxas, Makati City, Philippines 7th Floor, ESTAR Building, 147-149 Vo Van Tan Street, Ward 6, District 3, HCM City, Viet Nam 8 Changi Business Park Ave (South Tower), #08-51 UE Bizhub East, Singapore, 486018, Singapore Espace Jet Business Class, 16/18 Lot Attoufik Sidi Maarouf, Casablanca, 20190, Morocco BDO LLP, 55 Baker Street, London, W1U 7EU 81 Newgate Street, London, EC1A 7AJ, United Kingdom BDO LLP, 55 Baker Street, London, W1U 7EU 200 King Street W, Suite 1904, Toronto ON M5H 3TA, Canada 81 Newgate Street, London, EC1A 7AJ, United Kingdom 100% ordinary 100% ordinary 81 Newgate Street, London, EC1A 7AJ, United Kingdom Aludariu str 2-33, LT-01113 Vilnius, Lithuania 100% ordinary 2 Grand Canal Plaza, Upper Grand Canal Street, Dublin 4, Republic of Ireland Joint ventures and joint operationsd Company name Activity Group interest in allotted capitala Country of incorporation Financial year end Address Held via other group companies BT OnePhone Limited Communications related services and products provider 70% ordinary UK 31 March Mobile Broadband Network Limited Joint venture between EE and Hutchison 3G UK Limited to manage network 50% ordinary UK 31 December Rugby Radio Station (General Partner) Limited Property investment 50% ordinary UK 31 December Rugby Radio Station (Nominee) Limited Property company 50% ordinary UK 31 December Rugby Radio Station LP Property company 50% – UK 31 December 81 Newgate Street, London, EC1A 7AJ, United Kingdom 6 Anglo Office Park, 67 White Lion Road, Amersham, Buckinghamshire, HP7 9FB, United Kingdom St Helen’s 1 Undershaft, London, EC3P 3DQ, United Kingdom St Helen’s 1 Undershaft, London, EC3P 3DQ, United Kingdom 1 Poultry, London, EC2R 8EJ, United Kingdom 248 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 249 Related undertakings continued Interests in joint operations EE Limited and Hutchison 3G UK Limited (together ‘the Companies’) each have a 50% share in the joint operation Mobile Broadband Network Limited (‘MBNL’). MBNL’s ongoing purpose is the operation and maintenance of mobile networks through a sharing arrangement. This includes the efficient management of shared infrastructure and networks on behalf of the Companies, acquiring certain network elements for shared use, and coordinating the deployment of new infrastructure and networks on either a shared or a unilateral basis (unilateral elements being network assets or services specific to one company only). The group is committed to incurring 50% of costs in respect of restructuring the Shared Network, a similar proportion of the operating costs (which varies in line with usage), and 100% of any unilateral elements. Guarantees for the joint operation are given by Deutsche Telekom AG and Hutchison Whampoa Limited. Deutsche Telekom, Orange and BT have agreed between them to manage any potential liability by arrangements between themselves. The principal place of business of the joint operation is in the UK. Activity Group interest in allotted capitala Country of incorporation Associates Company name Held via other group companies British Telecom Al-Saudia Limited Communications related services, systems integration and products provider 49% other BT Global Services (North Gulf) LLC BT Siam Communications Co. Ltd. Communications related services, systems integration and products provider Communications related services, systems integration and products provider Collectively Limited In liquidation Digital Mobile Spectrum Limited Ecquaria Limited Mitigation of interference to digital terrestrial television Communications related services, systems integration and products provider ePLDTSunphilcox JV, Inc Dormant I2 S.r.l Infonet Primalliance Shanghai Co. Ltd. Communications related services, systems integration and products provider Communications related services, systems integration and products provider 49% ordinary 49% class B 20% – 25% ordinary 50% ordinary 20% ordinary 23% – 28% ordinary Infonet Primalliance Shenzhen Co. Ltd. Communications related services, systems integration and products provider 35% ordinary Internet Matters Limited Not for profit venture 25% – Mahindra – BT Investment Company (Mauritius) Limited Midland Communications Distribution Limited Distribution and retailing of mobile telephones, associated equipment and airtime connections Investment/holding company 43% ordinary 35% ordinary QXN S.c.p.A. Real Time Content, Inc. Communications related services and products provider Provision of Cloud based video services 25% ordinary 21% common SunPhilcox JV, Inc Dormant Youview TV Limited Not for profit venture – Development of software to provide TV platform services 20% ordinary 14% voting a The proportion of voting rights held corresponds to the aggregate interest in percentage held by the holding company and subsidiary undertakings. b No shares issued for a branch. c On 1 April 2016 BT IT Services Limited transferred its business operations to British Telecommunications plc. d All joint ventures are governed by a joint venture agreement or shareholder agreement. MBNL is accounted for as a joint operation. See above. e Cegetel Holdings I B.V. and Gegetel Holdings II B.V. were incorporated in the Netherlands rather than the country of their registered address. New Acaria Commercial Complex, Al-Siteen Street, Malaz, Riyadh, Saudi Arabia 1413, 14th Floor, Al Fardan Office Tower, Doha, 31316, Qatar Athenee Tower, 23rd Floor, (CEO Suite, Suite 38 & 40), 63 Wireless Road, Lumpini, Pathumwan, Bangkok, 10330, Thailand Kings Orchard, 1 Queen Street, Bristol, BS2 0HQ, United Kingdom 83 Baker Street, London, W1U 6AG, United Kingdom c/o Offshore Incorporations Limited, P.O. Box 957, Road Town, Tortola, Virgin Islands, British 32F Philam Life Tower, 8767 Paseo de Roxas, Makati City, Philippines Via XII Ottobre 2N, 16121, Genova, Liguria, Italy Room 601, No. 2 BLDG, 750 West Zhong Shan Rd., Shanghai, 200051, P R China Room 1206, Tower A, United Plaza, 5022 Bin He Avenue, Fu Tian District, Shenzhen, P. R. China Ambassador House 2nd Floor, St Michaels Street, London, W2 1QS, United Kingdom c/o IFS, IFS Court, TwentyEight, Cybercity, Ebene, Mauritius Unit 1, Colwick Quays Business Park, Colwick, Nottingham, Nottinghamshire, NG4 2JY, United Kingdom Piazzale Luigi Sturzo, 23, 00144, Roma, Italy Corporation Trust Center, 1209 Orange Street, City of Wilmington, County of New Castle 19801, United States of America 32F Philam Life Tower, 8767 Paseo de Roxas, Makati City, Philippines 10 Lower Thames Street, Third Floor, London, EC3R 6YT, United Kingdom 248 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 249 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION 250 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Additional information In this section you will find more financial and operational statistics. We also provide information for shareholders on subjects such as dividends and location. We have also included a glossary of terms we use in this report. Additional information Alternative performance measures Selected financial data Financial and operational statistics Information for shareholders Cross reference to Form 20-F Glossary of terms 252 255 257 260 276 280 PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 251 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Alternative performance measures Introduction We assess the performance of the group using a variety of alternative performance measures. We principally discuss the group’s results on an ‘adjusted’ basis. The rationale for using adjusted measures is explained below. Results on an adjusted basis are presented before specific items. Certain comparatives have been revised, see note 1 to the consolidated financial statements. We also explain financial performance using measures that are not defined under IFRS and are therefore termed ‘non-GAAP’ measures. The non-GAAP measures we use are: the trend in underlying revenue excluding transit adjusted for the acquisition of EE, and in underlying operating costs excluding transit adjusted for the acquisition of EE, as well as in EBITDA, adjusted EBITDA and underlying EBITDA adjusted for the acquisition of EE; normalised free cash flow; and net debt. A reconciliation from these non-GAAP measures to the nearest measure prepared in accordance with IFRS is presented below. The alternative performance measures we use may not be directly comparable with similarly titled measures used by other companies. Specific items The group’s income statement and segmental analysis separately identify trading results before specific items. The directors believe that presentation of the group’s results in this way is relevant to an understanding of the group’s financial performance, as specific items are identified by virtue of their size, nature or incidence. This presentation is consistent with the way that financial performance is measured by management and reported to the Board and the Operating Committee and assists in providing a meaningful analysis of the trading results of the group. In determining whether an event or transaction is specific, management considers quantitative as well as qualitative factors such as the frequency or predictability of occurrence. Examples of charges or credits meeting the above definition and which have been presented as specific items in the current and/or prior years include acquisitions/disposals of businesses and investments, regulatory settlements, historical insurance or litigation claims, business restructuring programmes, asset impairment charges, property rationalisation programmes, net interest on pensions and the settlement of multiple tax years. In the event that other items meet the criteria, which are applied consistently from year to year, they are also treated as specific items. Specific items are disclosed in note 8 to the consolidated financial statements. Trends in underlying revenue and underlying operating costs excluding transit adjusted for the acquisition of EE Underlying revenue and underlying operating costs excluding transit adjusted for the acquisition of EE are measures which seek to reflect the underlying performance of the group that will contribute to long-term sustainable profitable growth. As such they exclude the impact of acquisitions or disposals, foreign exchange movements and specific items. We exclude transit from the trends as transit traffic is low-margin and is affected by reductions in mobile termination rates. Given the significance of the EE acquisition to the group, in 2016/17 we are calculating underlying revenue excluding transit adjusted for the acquisition of EE and underlying operating costs excluding transit adjusted for the acquisition of EE, as though EE had been part of the group from 1 April 2015. This is different from how we usually adjust for acquisitions. A reconciliation from the increase in reported revenue and in reported operating costs, the most directly comparable IFRS measures, to the movement in underlying revenue and increase in underlying operating costs excluding transit adjusted for the acquisition of EE, are set out below. a 2016 % Year ended 31 March 2017 % Increase in reported revenue Specific items Increase in adjusted revenue Adjusted for the acquisition of EEb Increase in adjusted revenue adjusted for the acquisition of EE Transit revenue Acquisitions and disposals Foreign exchange movements (Decrease) increase in underlying revenue excluding transit adjusted for the acquisition of EE Year ended 31 March Increase in reported operating costs Depreciation and amortisation Increase in reported operating costsc Specific items Increase in adjusted operating costsc Adjusted for the acquisition of EEb Increase in adjusted operating costs adjusted for the acquisition of EEc Transit costs Acquisitions and disposals Foreign exchange movements Increase in underlying operating costsc excluding transit adjusted for the acquisition of EE a b c 2015/16 calculation excludes specific items, foreign exchange movements and the effect of acquisitions and disposals. Includes EE’s historical financial information as though it had been part of the group from 1 April 2015. Before depreciation and amortisation. 252 BT Group plc Annual Report 2017 26.6 1.0 27.6 (25.9) 1.7 0.1 0.1 (2.1) (0.2) 2017 % 35.7 0.5 36.2 (3.9) 32.3 (28.7) 3.6 0.2 0.1 (2.7) 1.2 5.8 – 5.8 n/a 5.8 0.8 (5.6) 0.9 1.9 a 2016 % 5.7 0.4 6.1 0.5 6.6 n/a 6.6 1.0 (6.4) 1.4 2.6 Annual Report 2017 BT Group plc 253 EBITDA In addition to measuring financial performance of the group and lines of business based on operating profit, we also measure performance based on EBITDA, adjusted EBITDA and underlying EBITDA adjusted for the acquisition of EE. EBITDA is defined as the group profit or loss before depreciation, amortisation, net finance expense and taxation. Adjusted EBITDA is defined as EBITDA before specific items. EBITDA is a common measure used by investors and analysts to evaluate the operating financial performance of companies, particularly in the telecommunications sector. We consider EBITDA, adjusted EBITDA and underlying EBITDA adjusted for the acquisition of EE to be useful measures of our operating performance because they approximate the underlying operating cash flow by eliminating depreciation and amortisation. EBITDA and adjusted EBITDA are not direct measures of our liquidity, which is shown by our cash flow statement, and need to be considered in the context of our financial commitments. Trends in underlying EBITDA adjusted for the acquisition of EE is a measure which seeks to reflect the underlying performance of the group that will contribute to long-term sustainable profitable growth. As such they exclude the impact of acquisitions or disposals, foreign exchange movements and specific items. Given the significance of the EE acquisition to the group in 2016/17 we are calculating underlying EBITDA adjusted for the acquisition of EE, as though EE had been part of the group from 1 April 2015. This is different from how we usually adjust for acquisitions. A reconciliation from group operating profit, the most directly comparable IFRS measure, to group EBITDA and adjusted group EBITDA and a reconciliation of the trends in EBITDA adjusted for the acquisition of EE is provided below. A reconciliation between operating profit and adjusted EBITDA for our lines of business is set out in note 4 to the consolidated financial statements. Year ended 31 March Operating profit Depreciation and amortisation EBITDA Specific itemsa Adjusted EBITDA Year ended 31 March Increase in EBITDA Specific items Increase in adjusted EBITDA Adjusted for the acquisition of EEc (Decrease) increase in adjusted EBITDA adjusted for the acquisition of EE Acquisitions and disposals Foreign exchange movements (Decrease) increase in underlying EBITDA adjusted for the acquisition of EE 2017 £m 2016 £m 2015 £m 3,167 3,572 6,739 906 7,645 3,613 2,631 6,244 215 6,459 2017 % 7.9 10.5 18.4 (20.7) (2.3) – (0.6) (2.9) 3,402 2,538 5,940 253 6,193 b 2016 % 5.1 (0.8) 4.3 n/a 4.3 (4.2) 0.0 0.1 a Excludes amortisation specifics of £62m (2015/16: £nil, 2014/15: £nil). Specific items are set out in note 8 to the consolidated financial statements. b 2015/16 calculation excludes specific items, foreign exchange movements and the effect of acquisitions and disposals. c Includes EE’s historical financial information as though it had been part of the group from 1 April 2015. Earnings per share We also measure financial performance based on adjusted earnings per share, which excludes specific items. Basic and adjusted earnings per share, and the per share impact of specific items, are as follows: Year ended 31 March Basic earnings per share/profita Specific itemsb Adjusted basic earnings per share/profit Pence per share 19.2 9.7 28.9 2017 £m 1,908 961 2,869 Pence per share 28.5 3.3 31.8 2016 £m 2,466 278 2,744 Pence per share 25.5 5.1 30.6 2015 £m 2,057 406 2,463 a The stated profit is the component of total profit which is attributable to equity shareholders excluding non-controlling interests. b Specific items are set out in note 8 to the consolidated financial statements. We disclose reported earnings per share, both basic and diluted, in note 10 to the consolidated financial statements. 252 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 253 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Alternative performance measures continued Free cash flow Normalised free cash flow is one of the group’s key performance indicators by which our financial performance is measured. Normalised free cash flow is defined as the net increase in cash and cash equivalents less: cash flows from financing activities (except net interest paid), the acquisition or disposal of group undertakings and the net sale of short-term investments and excluding: the cash impact of specific items, purchases of telecommunications licences, and the cash tax benefit of pension deficit payments. For non-tax related items the adjustments are made on a pre-tax basis. Normalised free cash flow is primarily a liquidity measure. However, we also believe it is an important indicator of our overall operational performance as it reflects the cash we generate from operations after capital expenditure and financing costs, both of which are significant ongoing cash outflows associated with investing in our infrastructure and financing our operations. In addition, normalised free cash flow excludes cash flows that are determined at a corporate level independently of ongoing trading operations such as dividends, share buybacks, acquisitions and disposals, and repayment and raising of debt. Normalised free cash flow is not a measure of the funds that are available for distribution to shareholders. A reconciliation from net cash inflow from operating activities, the most directly comparable IFRS measure, to free cash flow and normalised free cash flow, is set out below. Year ended 31 March Net cash inflow from operating activities Add back pension deficit payments Included in cash flows from investing activities Net capital expenditure Interest received Net (purchases) sales of non-current asset investments and dividends received from associates and joint ventures Included in cash flows from financing activities Interest paid Free cash flow Net cash outflow from specific items Cash tax benefit of pension deficit payments Normalised free cash flow 2017 £m 2016 £m 2015 £m 6,174 274 (3,119) 7 (20) (629) 2,687 205 (110) 2,782 5,151 880 (2,431) 10 17 (558) 3,069 232 (203) 3,098 4,788 876 (2,310) 10 8 (590) 2,782 154 (106) 2,830 Net debt Net debt consists of loans and other borrowings (both current and non-current), less current asset investments and cash and cash equivalents. Loans and other borrowings are measured as the net proceeds raised, adjusted to amortise any discount over the term of the debt. For the purpose of this measure, current asset investments and cash and cash equivalents are measured at the lower of cost and net realisable value. Our net debt calculation starts from the expected future undiscounted cash flows that should arise when our financial instruments mature. We adjust these cash flows to reflect hedged risks that are re-measured under fair value hedges, as well as for the impact of the effective interest method. Currency-denominated balances within net debt are translated to Sterling at swap rates where hedged. Net debt is a measure of the group’s net indebtedness that provides an indicator of the overall balance sheet strength. It is also a single measure that can be used to assess both the group’s cash position and its indebtedness. The use of the term ‘net debt’ does not necessarily mean that the cash included in the net debt calculation is available to settle the liabilities included in this measure. Net debt is considered to be an alternative performance measure as it is not defined in IFRS. A reconciliation from loans and other borrowings, cash and cash equivalents, and current asset investments, the most directly comparable IFRS measures to net debt, is set out below. At 31 March Loans and other borrowingsa Cash and cash equivalents Current investments Adjustments: To retranslate currency denominated balances at swapped rates where hedgedb To remove fair value adjustments and accrued interest applied to reflect the effective interest methodc Net debt a Includes overdrafts of £17m at 31 March 2017 (31 March 2016: £537m, 31 March 2015: £441m). b The translation difference between spot rate and hedged rate of loans and borrowings denominated in foreign currency. c Includes remaining fair value adjustments made on certain loans and other borrowings and accrued interest at the balance sheet date. 2017 £m 2016 £m 2015 £m 12,713 (528) (1,520) 14,761 (996) (2,918) 10,176 (848) (3,523) 10,665 10,847 5,805 (1,419) (314) (652) (357) (357) (335) 8,932 9,838 5,113 254 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Selected financial data Summary group income statement Year ended 31 March Revenue Adjusted Specific items Operating costs Adjusted Specific items Operating profit Adjusted Specific items Net finance expense Adjusted Specific items Share of post tax (loss) profit of associates and joint ventures Adjusted Profit (loss) on disposal of interest in associates and joint ventures – specific items Profit before taxation Adjusted Specific items Taxation expense Adjusted Specific items Profit for the year Adjusted Specific items Basic earnings per share Adjusted Specific items Average number of shares used in basic earnings per share (millions) Average number of shares used in diluted earnings per share (millions) Diluted earnings per share Dividends per sharec Dividends per share, US centsc,d 2017 £m a 2016 £m a 2015 £m b 2014 £m b 2013 £m 24,082 (20) 18,879 133 17,840 128 18,287 – 18,339 (236) 24,062 19,012 17,968 18,287 18,103 (19,947) (948) (15,051) (348) (14,185) (381) (14,866) (276) (15,039) (116) (20,895) (15,399) (14,566) (15,142) (15,155) 4,135 (968) 3,167 (594) (210) (804) (9) – 3,532 (1,178) 2,354 (663) 217 (446) 3,828 (215) 3,613 (483) (229) (712) 6 – 3,351 (444) 2,907 (607) 166 (441) 3,655 (253) 3,402 (560) (299) (859) (1) 25 3,094 (527) 2,567 (631) 121 (510) 3,421 (276) 3,145 (591) (235) (826) (3) (4) 2,827 (515) 2,312 (613) 319 (294) 3,300 (352) 2,948 (653) (119) (772) 9 130 2,656 (341) 2,315 (597) 230 (367) 2,869 (961) 2,744 (278) 2,463 (406) 2,214 (196) 2,059 (111) 1,908 2,466 2,057 2,018 1,948 28.9p (9.7)p 19.2p 9,938 9,994 19.1p 15.4p 19.3c 31.8p (3.3)p 28.5p 8,619 8,714 28.2p 14.0p 20.1c 30.6p (5.1)p 25.5p 8,056 8,191 25.1p 12.4p 18.4c 28.2p (2.5)p 25.7p 7,857 8,231 24.5p 10.9p 18.2c 26.3p (1.5)p 24.8p 7,832 8,203 23.7p 9.5p 14.4c a Revised, see note 1. b As previously reported. c Dividends per share represents the dividend paid and proposed in respect of the relevant financial year. Under IFRS, interim dividends are recognised as a deduction from shareholders’ equity when they are paid, final dividends when they are approved. d Based on actual dividends paid and/or year end exchange rate on proposed dividends. PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 255 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Selected financial data continued Summary group balance sheet At 31 March Intangible assets Property, plant and equipment Other non-current assets Total non-current assets Current assets less current liabilities Total assets less current liabilities Non-current loans and other borrowings Retirement benefit obligations Other non-current liabilities Total assets less liabilities Ordinary shares Share premium account Own shares Merger reserve Other reserves Retained loss Total equity (deficit) a Revised, see note 1. b As previously reported. 2017 £m a 2016 £m a 2015 £m b 2014 £m b 2013 £m 15,029 16,498 3,970 35,497 (4,050) 31,447 (10,081) (9,088) (3,943) 15,450 15,971 2,997 34,418 (3,103) 31,315 (11,025) (6,382) (3,796) 3,170 13,498 3,040 19,708 (356) 19,352 (7,862) (7,583) (3,226) 3,087 13,840 2,265 19,192 (1,981) 17,211 (7,941) (7,022) (2,840) 3,258 14,153 2,794 20,205 (2,930) 17,275 (8,277) (5,856) (3,404) 8,335 10,112 681 (592) (262) 499 1,051 (96) 6,647 884 (650) 499 1,051 (115) 8,422 685 (430) 419 1,051 (165) 998 502 (2,124) 408 62 (829) 998 449 (1,680) 408 62 (832) 998 792 (1,690) 8,335 10,112 681 (592) (262) 256 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc PB Financial and operational statistics Financial statistics Year ended 31 March (Decrease) increase in underlying revenue excluding transitd,e Adjusted EBITDAd,e Cash flowd – Free cash flow – Normalised free cash flow Net debt at 31 Marchd Operating costs excluding depreciation and amortisatione Expenditure on research and development Research and development operating expense Capitalised software development costs Total expenditure on research and development Capital expenditure Additions to property, plant and equipment comprised: Land and buildings Network infrastructure Transmission equipment Exchange equipment Other network equipment Other Computers and office equipment Motor vehicles and other Total additions to property, plant and equipment (Increase) decrease in engineering stores Software additions Total capital expenditure before government grants Government grants Total capital expenditure net of government grants (Decrease) increase in net payables and receivables Cash outflow from capital expenditure before purchases of telecommunications licences Purchases of telecommunications licences Cash outflow from total capital expenditure 2017 £m (0.2)% 7,645 2,687 2,782 8,932 a 2016 £m b 2015 £m c 2014 £m c 2013 £m 1.9% 6,459 3,069 3,098 9,838 (0.4)% 6,193 2,782 2,830 5,113 0.5% 6,116 2,171 2,450 7,028 (3.1)% 6,143 2,292 2,300 7,797 16,437 12,420 11,647 12,171 12,196 61 457 518 73 399 472 87 421 508 170 365 535 279 265 544 42 31 31 44 42 1,592 126 917 119 22 2,818 (13) 2,805 621 3,426 28 3,454 (309) 3,145 – 3,145 1,531 41 652 48 19 2,322 (3) 2,319 412 2,731 (109) 2,622 (184) 2,438 – 2,438 1,463 33 455 85 75 2,142 6 2,148 561 2,709 (392) 2,317 93 2,410 – 2,410 1,126 24 657 112 8 1,971 (5) 1,966 506 2,472 (126) 2,346 10 2,356 – 2,356 1,170 32 660 80 24 2,008 (9) 1,999 454 2,453 (15) 2,438 43 2,481 202 2,683 a Revised, see note 1. b Other than the decrease in underlying revenue excluding transit adjusted for the acquisition of EE 2014/15 has been revised. c As previously reported. d Defined on pages 252 to 254. e Before specific items. PB BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 257 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Financial and operational statistics continued Financial ratios Year ended 31 March Return on capital employed – %c Adjustedd – % Interest cover – timese Adjustedd – times Net debt to adjusted EBITDAd – times Capital expenditure as a percentage of revenued – % 2017 11.2 14.6 3.9 7.0 1.2 14.3 2016a 2015a 2014b 2013b 12.7 13.5 5.1 7.9 1.5 13.9 23.3 24.9 4.0 6.5 0.8 13.0 21.1 22.9 3.8 5.8 1.1 12.8 20.6 22.1 3.8 5.1 1.3 13.3 a Revised, see note 1. b As previously reported. c The ratio is based on profit before taxation and net finance expense to capital employed. Capital employed is represented by total assets less current liabilities (excluding corporation tax, current borrowings, derivative financial liabilities and finance lease creditors) less deferred and current tax assets, retirement benefit asset, cash and cash equivalents, derivative financial assets and investments. d Before specific items. e The number of times net finance expense is covered by operating profit. 258 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 259 Operational statisticsa All values in thousands unless otherwise stated. Year ended 31 March Consumer Average revenue per user (ARPU)b (£) Business and Public Sector Order intake (£m) Global Services Order intake (£m) Wholesale and Ventures Order intake (£m) Ethernet circuits Openreach Physical lines Internal External Fully unbundled Total physical lines BT Group TV customers Broadband lines Total retail Wholesale and Ventures (external) Openreach Total broadband lines Broadband market share Total retail share of net asset additionsc Total retail share of installed base Lines sold through BT lines of businessd Consumer/EE Business/corporate Total exchange lines Mobile base Mobile churn (%) Total Postpaid Mobile ARPU (£) Postpaid Prepaid Total 2017 2016 2015 2014 2013 39.9 37.1 34.6 32.6 30.4 3,369 3,163 3,781 2,098 2,202 4,604 5,124 5,000 6,963 6,348 1,956 43.8 1,421 38.5 1,887 31.7 1,910 – 2,031 – 12,567 3,541 9,047 12,915 3,563 8,921 12,274 4,509 8,586 12,700 4,580 7,846 13,217 5,125 6,702 25,245 25,398 25,370 25,126 25,044 1,747 1,561 1,142 1,002 810 9,276 886 10,162 9,041 906 9,947 7,713 1,831 9,544 7,281 1,872 9,302 6,704 2,066 8,859 20,324 19,894 19,088 18,455 17,629 55% 46% 65% 45% 51% 40% 69% 39% 51% 38% 10,313 2,937 10,411 3,228 9,633 3,481 9,908 3,784 10,207 4,165 13,250 13,639 13,114 13,692 14,372 30,036 30,445 2.1 1.1 26.3 4.4 19.8 n/a n/a 26.0 4.0 18.3 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a a We have re-presented certain prior year information to be on a consistent basis. These are aligned with our operational performance measures that we publish on a quarterly basis. b Consumer revenue per-month, less mobile POLOs, less BT Sport revenue from: satellite customers paying for the channels, our wholesale deals and from commercial premises. This is divided by the average number of primary lines. c DSL and fibre excluding cable. d Lines sold through BT lines of business include analogue lines and digital channels sold through Global Services, Business and Public Sector, Consumer, EE and Wholesale and Ventures. 258 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 259 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders Cautionary statement regarding forward-looking statements This Annual Report contains certain forward-looking statements which are made in reliance on the safe harbour provisions of the US Private Securities Litigation Reform Act of 1995. These statements relate to analyses and other information which are based on forecasts of future results and estimates of amounts not yet determinable. These statements include, without limitation, those concerning: current and future years’ outlook; revenue and revenue trends; EBITDA; free cash flow; capital expenditure; shareholder returns including progressive dividends and share buyback; net debt; credit ratings; our group-wide restructuring programme, cost transformation plans and restructuring costs; investment in and roll out of our fibre network, and its reach, innovations, increased speeds and speed availability; our broadband-based service and strategy; our investment in TV, enhancing our TV service and BT Sport; the recovery plan, operating charge, regular cash contributions and interest expense for our defined benefit pension schemes; effective tax rate; growth opportunities in networked IT services, the pay-TV services market, broadband, and mobility and future voice; growth of, and opportunities available in, the communications industry and BT’s positioning to take advantage of those opportunities; anticipated financial and other benefits to be realised from the EE acquisition; expectations regarding competition, market shares, prices and growth; expectations regarding the convergence of technologies; plans for the launch of new products and services; network performance and quality; the impact of regulatory initiatives, decisions and outcomes on operations, including the regulation of the UK fixed wholesale and retail businesses and the impact of Ofcom’s Wholesale Local Access Market Review; BT’s possible or assumed future results of operations and/or those of its associates and joint ventures; investment plans; adequacy of capital; financing plans and refinancing requirements; demand for and access to broadband and the promotion of broadband by third-party service providers; improvements to the control environment; and those statements preceded by, followed by, or that include the words ‘aims’, ‘believes’, ‘expects’, ‘anticipates’, ‘intends’, ‘will’, ‘should’ ‘plans’, ‘strategy’, ‘future’, ‘likely’, ‘seeks’, ‘projects’, ‘estimates’ or similar expressions. Although BT believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to have been correct. Because these statements involve risks and uncertainties, actual results may differ materially from those expressed or implied by these forward- looking statements. Factors that could cause differences between actual results and those implied by the forward-looking statements include, but are not limited to: material adverse changes in economic conditions in the markets served by BT whether as a result of the uncertainties arising from the UK’s exit from the EU or otherwise; future regulatory and legal actions, decisions, outcomes of appeal and conditions or requirements in BT’s operating areas, including the outcome of Ofcom’s strategic review of digital communications in the UK, as well as competition from others; the outcome of Ofcom’s Wholesale Local Access Market Review; responses to Openreach consultations and the results of any future spectrum auctions; selection by BT and its lines of business of the appropriate trading and marketing models for its products and services; technological innovations, including the cost of developing new products, networks and solutions and the need to increase expenditures for improving the quality of service; the anticipated benefits and advantages of new technologies, products and services not being realised; developments in the convergence of technologies; external threats to cyber security, data or resilience; political and geo-political risks; prolonged adverse weather conditions resulting in a material increase in overtime, staff or other costs or impact on customer service; the timing of entry and profitability of BT in certain markets; significant changes in market shares for BT or its principal products and services; fluctuations in foreign currency exchange rates or interest rates; the underlying assumptions and estimates made in respect of major customer contracts proving unreliable; the aims of the anticipated savings from our restructuring programmes not being delivered; the aims of the group-wide restructuring programme not being achieved; the anticipated benefits and synergies of the EE integration not being delivered; the improvements to the control environment proposed following the investigations into BT’s Italian business not being implemented successfully or effectively; and general financial market conditions affecting BT’s performance and ability to raise finance. Certain of these factors are discussed in more detail elsewhere in this Annual Report including, without limitation, in Our risks on pages 44 to 55. BT undertakes no obligation to update any forward- looking statements whether written or oral that may be made from time to time, whether as a result of new information, future events or otherwise. 260 260 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 261 261 Stock exchange listings The principal listing of BT Group’s ordinary shares is on the London Stock Exchange. Trading on the London Stock Exchange is under the symbol ‘BT.A’. American Depositary Shares (ADSs), have been issued by JPMorgan Chase & Co, as Depositary for the American Depositary Receipts (ADRs) evidencing the ADSs, and are listed on the New York Stock Exchange. Trading on the New York Stock Exchange is under the symbol ‘BT’. In December 2015 BT changed the ratio of its NYSE-listed American Depositary Receipt (ADR) programme from the previous ratio of one ADR per ten ordinary shares to one ADR per five ordinary shares. These changes to the ADR ratio have brought the ADR price broadly in line with the market average. To implement the change, ADR holders on the record at the close of business on 30 November 2015 received two ADRs for every one ADR held. There was no change to the underlying ordinary shares. Share and ADS prices Financial years ended 31 March 2013 2014 2015 2016a 2017a Financial year ended 31 March 2016a 1 April – 30 June 2015 1 July – 30 September 2015 1 October – 31 December 2015 1 January – 31 March 2016 Financial year ended 31 March 2017a 1 April – 30 June 2016 1 July – 30 September 2016 1 October – 31 December 2016 1 January – 31 March 2017 Monthsa November 2016 December 2016 January 2017 February 2017 March 2017 April 2017 8 May 2017 Pence per ordinary share US$ per ADS High pence Low pence High US$ Low US$ 281.00 418.10 470.55 499.80 454.90 470.00 479.15 499.80 496.00 454.90 414.35 389.20 396.85 373.40 371.40 396.85 332.90 342.45 316.00 306.60 200.70 265.70 356.20 404.00 302.10 438.80 404.00 417.20 432.95 375.85 375.30 346.70 302.10 350.30 346.70 302.10 304.70 317.00 304.75 – 42.76 69.75 70.18 37.49 33.46 36.92 37.35 37.49 35.87 33.46 27.66 24.89 24.57 23.52 23.35 24.57 20.82 20.88 20.25 20.14 31.02 40.70 57.99 31.18 19.29 32.82 31.30 31.91 31.18 25.21 24.93 22.05 19.29 22.05 22.34 19.33 19.29 19.88 19.42 – a The ADS prices stated for 2015/16 and 2016/17 reflect the change in ADR ratio. The prices are the highest and lowest closing middle market prices for BT ordinary shares, as derived from the Daily Official List of the London Stock Exchange and the highest and lowest closing sales prices of ADSs, as reported on the New York Stock Exchange. Fluctuations in the exchange rate between Sterling and the US Dollar affect the US Dollar equivalent of the Sterling price of the company’s ordinary shares on the London Stock Exchange and, as a result, are likely to affect the market price of the ADSs on the New York Stock Exchange. Background BT Group plc is a public limited company registered in England and Wales and listed on the London and New York Stock Exchanges. It was incorporated in England and Wales on 30 March 2001 as Newgate Telecommunications Limited with the registered number 4190816. Its registered office address is 81 Newgate Street, London EC1A 7AJ. The company changed its name to BT Group plc on 11 September 2001. Following the demerger of mmO2 from BT in November 2001, the continuing activities of BT were transferred to BT Group plc. British Telecommunications plc is a wholly-owned subsidiary of BT Group plc and encompasses virtually all the businesses and assets of the group. The successor to the statutory corporation British Telecommunications, it was incorporated in England and Wales as a public limited company, wholly owned by the Government, as a result of the Telecommunications Act 1984. Between November 1984 and July 1993, the Government sold all of its shareholding in British Telecommunications plc in three public offerings. 260 260 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 261 261 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued Analysis of shareholdings at 31 March 2017 Range 1 – 399 400 – 799 800 – 1,599 1,600 – 9,999 10,000 – 99,999 100,000 – 999,999 1,000,000 – 4,999,999 5,000,000 and abovea,b,c,d Totale Ordinary shares of 5p each Number of holdings Percentage of total % Number of shares held millions Percentage of total % 310,908 208,657 151,917 113,725 4,309 621 310 204 39.31 26.40 19.22 14.39 0.55 0.08 0.04 0.03 65 116 170 349 80 229 734 8,224 0.66 1.16 1.71 3.50 0.81 2.30 7.37 82.50 790,651 100.00 9,967 100.00 a 14.3m shares were held in trust by Ilford Trustees (Jersey) Limited for allocation to employees under the employee share plans. b Under the BT Group Employee Share Investment Plan, 55.7m shares were held in trust on behalf of 42,854 participants who were beneficially entitled to the shares. 381.3m shares were held in the corporate nominee BT Group EasyShare on behalf of 92,115 beneficial owners. c 154.1m shares were represented by ADSs. An analysis by size of holding is not available for these. d 7.6m shares were held as treasury shares. e 7.45% of the shares were in 781,899 individual holdings, of which 50,855 were joint holdings, and 92.55% of the shares were in 8,752 institutional holdings. As far as the company is aware, the company is not directly or indirectly owned or controlled by another corporation or by the UK Government or any other foreign government or by any other natural or legal person severally or jointly. There are no arrangements known to the company, the operation of which may at a subsequent date result in a change in control of the company. The company’s major shareholders do not have different voting rights to those of other shareholders. At 8 May 2017, there were 9,968,127,681 ordinary shares outstanding, including 7,635,015 shares held as treasury shares. At the same date, approximately 30.8m ADSs (equivalent to 153.9m ordinary shares, or approximately 1.54% of the total number of ordinary shares outstanding on that date) were outstanding and were held by 1,477 record holders of ADRs. At 31 March 2017, there were 3,465 shareholders with a US address on the register of shareholders who in total hold 0.02% of the ordinary shares of the company. 262 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 263 Dividends A final dividend in respect of the year ended 31 March 2016 was paid on 5 September 2016 to shareholders on the register on 12 August 2016, and an interim dividend in respect of the year ended 31 March 2017 was paid on 6 February 2017 to shareholders on the register on 30 December 2016. The final proposed dividend in respect of the year ended 31 March 2017, if approved by shareholders, will be paid on 4 September 2017 to shareholders on the register on 11 August 2017. The dividends paid or payable on BT shares and ADSs for the last five financial years are shown in the following table. The dividends on the ordinary shares exclude the associated tax credit. The amounts shown are not those that were actually paid to holders of ADSs. For the tax treatment of dividends paid, see Taxation of dividends on page 272. Dividends have been translated from Sterling into US Dollars using exchange rates prevailing on the date the ordinary dividends were paid. Financial years ended 31 March 2013 2014 2015 2016 2017 Interim pence 3.00 3.40 3.90 4.40 4.85 Per ordinary share Total pence Final pence 6.50 7.50 8.50 9.60 10.55 9.50 10.90 12.40 14.00 15.40 Interim £ 0.300 0.340 0.390 0.220a 0.2425 Final £ 0.650 0.750 0.850 0.480a 0.5275 Per ADS Total £ 0.950 1.090 1.240 0.700a 0.770 Interim US$ 0.451 0.534 0.573 0.296a 0.281 Final US$ 0.994 1.187 1.285 0.623 –b Per ADS Total US$ 1.445 1.721 1.858 0.919 –b a The reduction in the dividend payment is to reflect the ratio change to BT ADRs. b Qualifying holders of ADSs on record as of 11 August 2017 are entitled to receive the final dividend which will be paid to ADS holders on 12 September 2017, subject to approval at the AGM. The US Dollar amount of the final dividend of 52.75 pence per ADS to be paid to holders of ADSs will be based on the exchange rate in effect on 4 September 2017, the date of payment to holders of ordinary shares. As dividends paid by the company are in Sterling, exchange rate fluctuations will affect the US Dollar amounts received by holders of ADSs on conversion by the Depositary of such cash dividends. Dividend mandate Any shareholder wishing dividends to be paid directly into a bank or building society account should contact the Shareholder Helpline (see page 275), or go to the Shareholder information page of our website. Dividends paid in this way will be paid through the Bankers Automated Clearing System (BACS). Share buyback Calendar montha April 2016 May June July August September October November December January 2017 February March Total number of shares purchased Average price paid per share (pence – net of dealing costs) Total number of shares purchased as part of publicly announced plans or programmes Maximum number of shares yet to be purchased under the AGM authorityb nil 39,710,091 nil 1,130,000 6,140,405 nil nil nil nil nil nil nil 46,980,496 n/a 442 n/a 413 408 n/a n/a n/a n/a n/a n/a n/a 437 nil 39,710,091 nil 1,130,000 6,140,405 nil nil nil nil nil nil nil 811,964,400 772,254,309 772,254,309 994,870,000 988,729,595 988,729,595 988,729,595 988,729,595 988,729,595 988,729,595 988,729,595 988,729,595 46,980,496 988,729,595 a Purchases made from 1 April 2015 to 15 July 2015 were made in accordance with a resolution passed at the AGM held on 16 July 2014. Own share purchases by BT from 16 July 2015 to 31 March 2016 were made in accordance with a resolution passed at the AGM on 15 July 2015. b Authority was given to purchase up to 792m shares on 16 July 2014 and 837m shares on 15 July 2015. These authorities expire at the close of the following AGM. A total of 34m own shares were purchased during 2016/17. Of these, 34m shares were purchased for a total consideration of £150m (under the authority given at the 2015 AGM), and 12.9m shares were purchased by the BT Group Employee Share Ownership Trust for a consideration of £55m. Please see note 21 to the consolidated financial statements for further details. 262 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 263 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued Dividend investment plan Under the Dividend investment plan, cash from participants’ dividends is used to buy further BT shares in the market. Shareholders could elect to receive additional shares in lieu of a cash dividend for the following dividends: 2011/12 interim 2011/12 final 2012/13 interim 2012/13 final 2013/14 interim 2013/14 final 2014/15 interim 2014/15 final 2015/16 interim 2015/16 final 2016/17 interim Date paid 6 February 2012 3 September 2012 4 February 2013 2 September 2013 3 February 2014 8 September 2014 9 February 2015 7 September 2015 8 February 2016 5 September 2016 6 February 2017 Price per share pence 216.39 223.15 265.01 339.38 385.76 387.00 436.92 428.17 469.41 394.44 309.41 Global Invest Direct Details of the direct purchase plan run by the ADR Depositary, JPMorgan Chase & Co, Global Invest Direct, including reinvestment of dividends, are available from JPMorgan Chase & Co on +1 800 428 4237 (toll free within the US), or on written request to the ADR Depositary. Total shareholder return Total Shareholder Return (TSR) is the measure of the returns that a company has generated for its shareholders, reflecting both movement in the share price and dividends, which are assumed to be reinvested. We compare this against indexes for the UK market (FTSE100) and the European telecommunications sector (FTSEurofirst 300 Telco Index). BT’s TSR for 2016/17 was negative 25.1%, compared with the market which was positive 23.3% and the sector which was negative 3.1%. Over the last five financial years BT’s TSR was positive 65.1%, compared with the market’s TSR of positive 53.0% and the sector’s TSR of positive 54.1%. BT’s TSR performance vs the FTSE100 and the Sector over the last 8 years 31 March 2009=100 850 750 650 550 450 350 250 150 100 Mar 09 Mar 10 Mar 11 Mar 12 Mar 13 Mar 14 Mar 15 Mar 16 Mar 17 BT FTSE100 Sector Index € Source: Datastream. NB: Sector index is shown in Euro terms. The performance in Sterling is 17% worse than the TSR performance in the graph shown above. 264 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 265 Results announcements Expected announcements of results: Results for the 2017/18 financial year 1st quarter 2nd quarter and half year 3rd quarter and nine months 4th quarter and full year Annual Report 2017 published a Dates may be subject to change. Datea 28 July 2017 November 2017 February 2018 May 2018 May 2018 ShareGift Small parcels of shares, which may be uneconomic to sell on their own, can be donated to ShareGift – the share donation charity (Registered Charity number 1052686). ShareGift transfers these holdings into their name, aggregates them, and uses the proceeds to support a wide range of UK registered charities based on donor suggestion. They can also accept larger donations of shares. If you would like further details about ShareGift, please visit www.sharegift.org, email help@sharegift.org or telephone them on 020 7930 3737. Exchange rates BT publishes its consolidated financial statements expressed in Sterling. The following tables provide certain information concerning the exchange rates between Sterling and US Dollars based on the noon buying rate in New York City for cable transfers in Sterling as certified for customs purposes by the Federal Reserve Bank of New York (the Noon Buying Rate). Year ended 31 March Period end Averagea High Low a The average of the Noon Buying Rates in effect on the last day of each month during the relevant period. High Low 2017 1.25 1.31 1.47 1.21 April 2017 1.29 1.23 2016 1.44 1.50 1.59 1.39 March 2017 1.25 1.21 2015 1.49 1.61 1.72 1.47 2014 1.67 1.60 1.68 1.48 2013 1.52 1.58 1.63 1.49 February 2017 January 2017 Month December 2016 1.26 1.24 1.26 1.21 1.27 1.22 On 8 May 2017, the latest practicable date for this Annual Report, the Noon Buying Rate was US$1.294 to £1.00. 264 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 265 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued Articles of Association (Articles) The following is a summary of the principal provisions of BT’s Articles, a copy of which has been filed with the Registrar of Companies. A ‘holder of shares’ and a ’shareholder’ is, in either case, the person entered on the company’s register of members as the holder of the relevant shares. Shareholders can choose whether their shares are to be evidenced by share certificates (ie in certificated form) or held in electronic (ie uncertificated) form in CREST (the electronic settlement system in the UK). BT adopted new Articles of Association with effect from July 2015, to provide additional flexibility for BT when trying to trace shareholders and to amend the provisions in line with the UK Corporate Governance code by providing for automatic retirement of all the directors at each AGM. (a) Voting rights Subject to the restrictions described below, on a show of hands, every shareholder present in person or by proxy at any general meeting has one vote and, on a poll, every shareholder present in person or by proxy has one vote for each share which they hold. Voting at any meeting of shareholders is by a show of hands unless a poll is demanded by the chairman of the meeting or by at least five shareholders at the meeting who are entitled to vote (or their proxies), or by one or more shareholders at the meeting who are entitled to vote (or their proxies) and who have, between them, at least 10% of the total votes of all shareholders who have the right to vote at the meeting. No person is, unless the Board decides otherwise, entitled to attend or vote at any general meeting or to exercise any other right conferred by being a shareholder if they or any person appearing to be interested in those shares has been sent a notice under section 793 of the Companies Act 2006 (which confers upon public companies the power to require information with respect to interests in their voting shares) and they or any interested person has failed to supply to the company the information requested within 14 days after delivery of that notice. These restrictions end seven days after the earlier of the date the shareholder complies with the request satisfactorily or the company receives notice that there has been an approved transfer of the shares. (b) Variation of rights Whenever the share capital of the company is split into different classes of shares, the special rights attached to any of those classes can be varied or withdrawn either: (i) (ii) with the sanction of a special resolution passed at a separate meeting of the holders of the shares of that class; or with the consent in writing of the holders of at least 75% in nominal value of the issued shares of that class. At any separate meeting, the necessary quorum is two persons holding or representing by proxy not less than one-third in nominal amount of the issued shares of the class in question (but at any adjourned meeting, any person holding shares of the class or his proxy is a quorum). The company can issue new shares and attach any rights and restrictions to them, as long as this is not restricted by special rights previously given to holders of any existing shares. Subject to this, the rights of new shares can take priority over the rights of existing shares, or existing shares can take priority over them, or the new shares and the existing shares can rank equally. (c) Changes in capital The company may by ordinary resolution: (i) (ii) divide all or any of its share capital into shares with a smaller nominal value; and consolidate and divide all or part of its share capital into shares of a larger nominal value. The company may also: (i) (ii) buy back its own shares; and by special resolution reduce its share capital, any capital redemption reserve and any share premium account. (d) Dividends The company’s shareholders can declare dividends by passing an ordinary resolution provided that no dividend can exceed the amount recommended by the directors. Dividends must be paid out of profits available for distribution. If the Board considers that the profits of the company justify such payments, they can pay interim dividends on any class of shares of the amounts and on the dates and for the periods they decide. Fixed dividends will be paid on any class of shares on the dates stated for the payments of those dividends. The directors can offer ordinary shareholders the right to choose to receive new ordinary shares, which are credited as fully paid, instead of some or all of their cash dividend. Before they can do this, the company’s shareholders must have passed an ordinary resolution authorising the directors to make this offer. Any dividend which has not been claimed for ten years after it was declared or became due for payment will be forfeited and will belong to the company. (e) Distribution of assets on winding up If the company is wound up (whether the liquidation is voluntary, under supervision of the court or by the court) the liquidator can, with the authority of a special resolution passed by the shareholders, divide among the shareholders all or any part of the assets of the company. This applies whether the assets consist of property of one kind or different kinds. For this purpose, the liquidator can place whatever value the liquidator considers fair on any property and decide how the division is carried out between shareholders or different groups of shareholders. The liquidator can also, with the same authority, transfer any assets to trustees upon any trusts for the benefit of shareholders which the liquidator decides. The liquidation of the company can then be finalised and the company dissolved. No past or present shareholder can be compelled to accept any shares or other property under the Articles which could give that shareholder a liability. (f) Transfer of shares Certificated shares of the company may be transferred in writing either by an instrument of transfer in the usual standard form or in another form approved by the Board. The transfer form must be signed or made effective by or on behalf of the person making the transfer. The person making the transfer will be treated as continuing to be the holder of the shares transferred until the name of the person to whom the shares are being transferred is entered in the register of members of the company. The Board may refuse to register any transfer of any share held in certificated form: (i) which is in favour of more than four joint holders; or (ii) unless the transfer form to be registered is properly stamped to show payment of any applicable stamp duty and delivered to the company’s registered office or any other place the Board 266 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 267 decide. The transfer must have with it: the share certificate for the shares to be transferred; any other evidence which the Board ask for to prove that the person wanting to make the transfer is entitled to do this; and if the transfer form is executed by another person on behalf of the person making the transfer, evidence of the authority of that person to do so. Transfers of uncertificated shares must be carried out using a relevant system (as defined in the Uncertificated Securities Regulations 2001 (the Regulations)). The Board can refuse to register a transfer of an uncertificated share in the circumstances stated in the Regulations. If the Board decide not to register a transfer of a share, the Board must notify the person to whom that share was to be transferred giving reasons for its decision. This must be done as soon as possible and no later than two months after the company receives the transfer or instruction from the operator of the relevant system. (g) Untraced shareholders The company may sell any shares if the shares have been in issue for at least ten years, during that period at least three dividends have become payable on them and have not been cashed and BT has not heard from the shareholder or any person entitled to the dividends by transmission. BT must take all reasonable steps in the circumstances, to trace shareholders. This can include engaging an asset reunification company or other tracing agent to search for shareholders who have not kept their details up-to date, or taking any other steps the company considers appropriate. Shareholders whose shares are sold following this process will not be able to claim the proceeds of the sale. BT will be able to use the proceeds in any way the Board from time to time thinks fit. (h) General meetings of shareholders Every year the company must hold an annual general meeting. The Board can call a general meeting at any time and, under general law, must call one on a shareholders’ requisition. At least 21 clear days’ written notice must be given for every annual general meeting. For every other general meeting, at least 14 clear days’ written notice must be given. The Board can specify in the notice of meeting a time by which a person must be entered on the register of shareholders in order to have the right to attend or vote at the meeting. The time specified must not be more than 48 hours before the time fixed for the meeting. (i) Limitations on rights of non-resident or foreign shareholders The only limitation imposed by the Articles on the rights of non-resident or foreign shareholders is that a shareholder whose registered address is outside the UK and who wishes to receive notices of meetings of shareholders or documents from BT must give the company an address within the UK to which they may be sent. (j) Directors Directors’ remuneration Excluding remuneration referred to below, each director will be paid such fee for his services as the Board decide, not exceeding £65,000 a year and increasing by the percentage increase of the retail prices index (as defined by section 833(2) Income and Corporation Taxes Act 1988) for any 12-month period beginning 1 April 1999 or an anniversary of that date. The company may by ordinary resolution decide on a higher sum. This resolution can increase the fee paid to all or any directors either permanently or for a particular period. The directors may be paid their expenses properly incurred in connection with the business of the company. The Board can award extra fees to a director who: holds an executive position; acts as chairman or deputy chairman; serves on a Board committee at the request of the Board; or performs any other services which the Board consider extend beyond the ordinary duties of a director. The directors may grant pensions or other benefits to, among others, any director or former director or persons connected with them. However, BT can only provide these benefits to any director or former director who has not been an employee or held any other office or executive position in the company or any of its subsidiary undertakings, or to relations or dependants of, or people connected to, those directors or former directors, if the shareholders approve this by passing an ordinary resolution. Directors’ votes A director need not be a shareholder, but a director who is not a shareholder can still attend and speak at shareholders’ meetings. Unless the Articles say otherwise, a director cannot vote on a resolution about a contract in which the director has an interest (this will also apply to interests of a person connected with the director). If the legislation allows, a director can vote and be counted in the quorum on a resolution concerning a contract: (i) (ii) (iii) (iv) (v) (vi) in which the director has an interest of which the director is not aware; or which cannot reasonably be regarded as likely to give rise to a conflict of interest; in which the director has an interest only because the director is a holder of shares, debentures or other securities of BT, or by reason of any other interest in or through BT; which involves: the giving of any security, guarantee or indemnity to the director or any other person for money lent or obligations incurred by the director or by any other person at the request of or for the benefit of BT or the benefit of any of its subsidiary undertakings; or a debt or other obligation which is owed by BT or any of its subsidiary undertakings to that other person if the director has taken responsibility for all or any part of that debt or obligation by giving a guarantee, security or indemnity; where BT or any of its subsidiary undertakings is offering any shares, debentures or other securities for subscription or purchase to which the director is or may be entitled to participate as a holder of BT securities; or where the director will be involved in the underwriting or sub-underwriting; relating to any other company in which the director has an interest, directly or indirectly (including holding a position in that company) or is a shareholder, creditor, employee or otherwise involved in that company – these rights do not apply if the director owns 1% or more of that company or of the voting rights in that company; relating to an arrangement for the benefit of BT employees or former BT employees or any of BT’s subsidiary undertakings which only gives the directors the same benefits that are generally given to the employees or former employees to whom the arrangement relates; (vii) relating to BT buying or renewing insurance for any liability for the benefit of directors or for the benefit of persons who include directors; (viii) relating to the giving of indemnities in favour of directors; relating to the funding of expenditure by any director or (ix) directors: on defending criminal, civil or regulatory proceedings or actions against the director or the directors; in connection with an application to the court for relief; or on defending the director or the directors in any regulatory investigations; or which enables any director or directors to avoid incurring expenditure as described in this paragraph; and in which the director’s interest, or the interest of directors generally, has been authorised by an ordinary resolution. (x) 266 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 267 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued Subject to the relevant legislation, the shareholders can, by passing an ordinary resolution, ratify any particular contract carried out in breach of those provisions. a provision under which a member of the group has an obligation or entitlement which is, or may be, material to BT or such other member of the group. Directors’ appointment and retirement Under BT’s Articles there must be at least two directors, who manage the business of the company. The shareholders can vary this minimum and/or decide a maximum by ordinary resolution. The Board and the shareholders (by ordinary resolution) may appoint a person who is willing to be elected as a director, either to fill a vacancy or as an additional director. Definitions The definitions apply to the following section titled: Acquisition of EE – summary of the principal terms. Acquisition: the acquisition by BT of EE Articles: the articles of association of BT in force from time to time At every annual general meeting, all directors must automatically retire. A retiring director is eligible for re-election. Board: the Directors of the Company from time to time In addition to any power of removal under the 2006 Act, the shareholders can pass an ordinary resolution to remove a director, even though his or her time in office has not ended. They can elect a person to replace that director subject to the Articles, by passing an ordinary resolution. A person so appointed is subject to retirement by rotation when the director replaced would have been due to retire. Directors’ borrowing powers To the extent that the legislation and the Articles allow, the Board can exercise all the powers of the company to borrow money, to mortgage or charge its business, property and assets (present and future) and to issue debentures and other securities, and give security either outright or as collateral security for any debt, liability or obligation of the company or another person. The Board must limit the borrowings of the company and exercise all the company’s voting and other rights or powers of control exercisable by the company in relation to its subsidiary undertakings so as to ensure that the aggregate amount of all borrowings by the group outstanding, net of amounts borrowed intragroup among other things, at any time does not exceed £35bn. These borrowing powers may only be varied by amending the Articles. (k) Sinking fund, liability to further calls and change of control BT’s shares are not subject to any sinking fund provision under the Articles or as a matter of the laws of England and Wales. No shareholder is currently liable to make additional contributions of capital in respect of BT’s ordinary shares in the future. There are no provisions in the Articles or of corporate legislation in England and Wales that would delay, defer or prevent a change of control. (l) Disclosure of interests in shares Under the Financial Services and Markets Act 2000 and the UK Disclosure and Transparency Rules there is a statutory obligation on a person who acquires or ceases to have a notifiable interest in the relevant share capital of a public company like BT to notify the company of that fact. The disclosure threshold is 3%. These Rules also deal with the disclosure by persons of interests in shares or debentures of companies in which they are directors and certain associated companies. Under section 793 of the 2006 Act (referred to in (a) above), BT may ascertain the persons who are or have within the last three years been interested in its shares and the nature of those interests. The UK City Code on Takeovers and Mergers also imposes strict disclosure requirements with regard to dealings in the securities of an offeror or offeree company on all parties to a takeover and also on their respective associates during the course of an offer period. Material contracts The contracts summarised below (not being entered into in the ordinary course of business) have been entered into in the two years preceding the date of this document by BT or another member of the group and are, or may be, material to the group or have been entered into by BT or another member of the group and contain BT Pension Scheme: BT’s main defined benefit pension scheme Buy-Back Resolution: the resolution to approve the buy-back of Ordinary Shares from Deutsche Telekom and/or Orange pursuant to the CP Contracts CP Contracts: the DT CP Contract and Orange CP Contract Company: BT Group plc Completion: completion of the Acquisition pursuant to the terms of the Share Purchase Agreement which occurred on 29 January 2016 Consideration Shares: the Ordinary Shares to be issued by the Company to the Sellers pursuant to the Share Purchase Agreement Directors or Board of Directors: the directors of the Company whose names appear in the section in the shareholder circular entitled Directors, Company Secretary, Registered Office and Advisers Financial Investor: a Qualified Institutional Buyer as defined in Rule 144A under the US Securities Act 1933 or a Qualified Investor as described in Section I(1) of Annex II to Directive 2004/39/EC, other than any activist fund, or any company licensed as a telecommunications operator (or its affiliates) Ordinary Shares: the ordinary shares of nominal value 5 pence each in the capital of the Company, including, if the context requires, the Consideration Shares Sellers: Deutsche Telekom and Orange Shareholder: a holder of Ordinary Shares and “Shareholders” shall be construed accordingly Sponsor: JP Morgan Cazenove Transaction Documents: the Share Purchase Agreement, the Relationship Agreement, the Standstill and Lock-up Agreement and the CP Contracts Acquisition of EE – summary of the principal terms Share Purchase Agreement On 5 February 2015, the Share Purchase Agreement was entered into between the Company, the Sellers, who held 100% of the issued share capital of EE on a combined basis, Deutsche Telekom AG as guarantor of Deutsche Telekom and Orange SA as guarantor of Orange. Pursuant to the Share Purchase Agreement, the Sellers agreed to sell, and the Company agreed to acquire, the entire issued share capital of EE. The Acquisition completed on 29 January 2016. 268 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 269 1. Seller Warranties, Indemnities and Covenants 1.1 Warranties The Share Purchase Agreement contains customary warranties given by the Sellers, including in relation to authorisations, valid obligations, filings and consents for the entry of the Sellers into the Transaction Documents, and including in relation to the EE Group, its share capital, accounts and financial condition, material licences and approvals, compliance with laws, condition and sufficiency of its network and assets, tax, material contracts, related party arrangements, litigation, IP and IT systems, employees and benefit arrangements, pension schemes, real estate and ownership and conduct of the MBNL joint venture arrangement. 1.2 Indemnities The Sellers agreed, amongst other things, to indemnify BT in the event that BT suffers loss as a result of certain regulatory fines being levied against BT or the EE Group, and against losses suffered by BT or the EE Group as a result of certain other investigations and disputes. The warranties and indemnities given by the Sellers are subject to customary financial and other limitations. 1.3 Covenants The Share Purchase Agreement contains customary covenants restricting the Sellers from competing with EE’s business for a period of three years following Completion (subject to customary exceptions for existing businesses and financial investments) and from soliciting employees of the EE Group for a period of two years following Completion (subject to customary exceptions). The Share Purchase Agreement also contains a customary tax covenant in respect of liability for taxes due pre and post-Completion. 2. Company Warranties and Indemnity The Share Purchase Agreement contains warranties given by the Company as to, amongst other things, its capacity and authority to enter into and perform its obligations under the Transaction Documents, compliance by the Company in all material respects with certain laws and regulations, the availability of financing for the cash element of the consideration for the Acquisition, the accuracy of its public filings, and there having been no material adverse change to its financial position since its last accounts date. BT also agreed that it will indemnify the Sellers in the event that they suffer loss as a result of BT having taken certain actions in respect of the EE defined benefit pension scheme or the BT defined benefit pension scheme (but in relation to the BT Pension Scheme, only where Deutsche Telekom is identified as being connected to BT by virtue of the appointment of a Director to the Board by the Deutsche Telekom Group). The Sellers (or the relevant members of their groups), BT, and EE agreed appropriate conditions for the continued use of the Orange or T-Mobile (as applicable) brands by EE. Such agreement included appropriate modifications to the existing brand licences to reflect the change in ownership of EE, and continued use of the brands will be for the purpose of an orderly wind-down and extraction of the Orange and T-Mobile brands from EE’s business and subject to the continued payment of royalties. BT has also undertaken to Deutsche Telekom AG to provide, from Completion, a back-to-back guarantee of Deutsche Telekom AG’s guarantee to Hutchison, to a maximum value of £750 million. Deutsche Telekom AG’s existing arrangement guarantees EE’s obligations in respect of any liability incurred by EE under the MBNL joint operation. 4. Guarantee Deutsche Telekom AG agreed to guarantee the performance by Deutsche Telekom, and Orange S.A. agreed to guarantee the performance by Orange, of their respective obligations under the Share Purchase Agreement. Relationship Agreement 1. Relationship Agreement with Deutsche Telekom AG and Deutsche Telekom At Completion, BT entered into the Relationship Agreement with Deutsche Telekom AG and Deutsche Telekom, which regulates aspects of the ongoing relationship between BT, Deutsche Telekom AG and the Deutsche Telekom Group. The Relationship Agreement will terminate if (a) the Ordinary Shares are no longer listed on the premium listing segment of the Official List and traded on the London Stock Exchange’s main market for listed securities or (b) the Deutsche Telekom Group ceases to be interested in more than 3% of the issued ordinary share capital of BT. The Relationship Agreement contains, among other things, undertakings from Deutsche Telekom AG that for such period as the Deutsche Telekom Group holds 10% or more of the issued share capital of BT: (i) (ii) (iii) transactions and arrangements between BT and the Deutsche Telekom Group will be entered into on an arm’s length basis and on normal commercial terms; neither it nor any member of the Deutsche Telekom Group will take any action that would have the effect of preventing BT from complying with its obligations under the Listing Rules; and neither it nor any member of the Deutsche Telekom Group will propose or procure the proposal of a shareholder resolution which is intended or appears to be intended to circumvent the proper application of the Listing Rules (the “Independence Provisions”). The warranties and indemnity given by BT are subject to customary financial and other limitations. Deutsche Telekom AG undertakes to procure the compliance of its group members with the Independence Provisions. 3. Other undertakings The Sellers and BT agreed the scope and terms of certain transitional services arrangements required after Completion. The purpose of these transitional services agreements is to document any services that are currently provided by a party (or a member of its group) and that the recipient of those services wishes to continue to receive for a transitional period from Completion. Any services that a service recipient elects to continue to receive from Completion will be provided on the current terms or agreement applicable to the provision and receipt of those services. Unless otherwise agreed, the maximum term of each service is between six and 18 months depending on the type of service. 2. Standstill Provisions The Relationship Agreement contains standstill provisions pursuant to which Deutsche Telekom AG undertakes on behalf of itself and the Deutsche Telekom Group for a period of three years from the date of the Relationship Agreement (the “Initial Standstill Period”), subject to certain exceptions, not to: (i) (ii) acquire or offer to acquire any interest in any shares or other securities of BT as a result of which the aggregate interest of the Deutsche Telekom Group and any of its concert parties increases above 12% of Ordinary Shares in issue at any time; act in concert with any person with respect to the holding, voting or disposition of any shares or other securities of BT; 268 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 269 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued (iii) (iv) solicit or participate in any solicitation of Shareholders to vote in a particular manner at any meeting of Shareholders; or actively or publicly make any proposals for any merger, consolidation or share exchange involving shares or other securities of BT (for the purposes of this Part only, the “Standstill Provisions”). The exceptions to the Standstill Provisions include circumstances: (i) (ii) (iii) (iv) where the Deutsche Telekom Group acquires an interest in any shares or other securities of BT from the Orange Group provided that such acquisition does not increase the aggregate interest of the Deutsche Telekom Group and its concert parties above 15% of the Ordinary Shares in issue; where the Deutsche Telekom Group announces an offer under Rule 2.7 of the City Code on Takeovers and Mergers (the “Code”) or takes any action requiring it to make an offer under Rule 9 of the Code, in each case if such offer is recommended by the Directors of BT; where any third party makes or announces under Rule 2.7 of the Code an offer to acquire the issued ordinary share capital of BT, whether such offer is recommended by the Directors of BT or not; and where BT makes any offering or issue of shares or other securities and the Deutsche Telekom Group takes up its rights to subscribe for or acquire the shares or other securities offered to it by BT. Under the Relationship Agreement, Deutsche Telekom AG undertakes, among other things, that for a period of two years from the expiry of the Initial Standstill Period, in the event that the Deutsche Telekom Group acquires (other than as a result of a reduction or re-organisation of share capital or re-purchase of shares or other securities of BT) any Shares in excess of 15% of the Ordinary Shares in issue (the “Excess Shares”), it shall procure that the votes attaching to such Excess Shares shall be exercised (subject to the provisions of the Code and applicable law or regulation) in accordance with the recommendation of the Board of Directors of BT on all shareholder resolutions which relate to a transfer of an interest in Ordinary Shares carrying in aggregate 30% or more of the voting rights of BT and on all special resolutions of BT. After expiry of the Initial Standstill Period, the Deutsche Telekom Group will otherwise be free to increase its shareholding in BT. 3. Lock-up Provisions The Relationship Agreement contains lock-up provisions pursuant to which Deutsche Telekom AG and Deutsche Telekom undertake for a period of 18 months from the date of the Relationship Agreement, subject to certain exceptions, that neither they nor any of their group members will, directly or indirectly, offer, sell, contract to sell, grant or sell options over, purchase any option or contract to sell, transfer, charge, pledge, grant any right or warrant or otherwise transfer, lend or dispose of any shares in BT or any securities convertible into or exercisable or exchangeable for such shares, or announce or otherwise publish an intention to do any of the foregoing (each of the above activities being a “Disposal”). The exceptions include: (i) (ii) (iii) where Deutsche Telekom AG or Deutsche Telekom accepts any offer by a third party for the whole of the ordinary share capital of BT, whether by tender offer or scheme of arrangement, or provides an irrevocable undertaking or letter of intent to accept or vote in favour of any such offer; any Disposal to any member of the Deutsche Telekom Group, provided that the transferee agrees to be bound by the restrictions of the Relationship Agreement; and any sale of shares via any single off-market trade to a Financial Investor of no more than 5% each of the Ordinary Shares in issue of BT (or, on one occasion only, the sale of two stakes of not more than 5% each at the same time to two different Financial Investors), provided that any transferee enters into a lock-up agreement on substantially similar terms to the lock-up provisions of the Relationship Agreement. 4. DT CP Contract Prior to any Disposal by Deutsche Telekom AG, Deutsche Telekom or any of their group members in accordance with paragraph 3(iii) above, BT has a right of first offer in relation to the relevant shares (subject to the passing of the Buy-Back Resolution), and such right is set out in the DT CP Contract. Pursuant to the DT CP Contract, prior to an intended Disposal to Financial Investors, the relevant selling entity is obliged to issue a notice to BT specifying the number of Ordinary Shares proposed to be sold or transferred. BT has nine Business Days within which to make an offer for all of the Ordinary Shares detailed in the notice, or else its right to make an offer will lapse. If the offer is not accepted, the selling entity may make the sale or transfer within three months of the delivery of the notice to BT at a price equal to or greater than the price offered by BT. If BT does not make an offer within the allotted time, the selling entity may sell the Ordinary Shares within three months of the delivery of the notice to BT at any price. The DT CP Contract will terminate 18 months from Completion. The notice from the selling entity may be issued to BT during a close period or prohibited period (as such terms are defined in the Model Code of Chapter 9 of the Listing Rules) of BT. If any such period does not expire prior to the end of the nine Business Day period within which BT may elect to make an offer to buy-back the shares, BT will not be able to exercise its right of first offer. When exercised in conjunction with BT’s right of first offer in relation to Ordinary Shares held by Orange and Orange SA, the maximum amount of Ordinary Shares BT can acquire by exercise of its rights of first offer is approximately 14% of BT’s share capital on an enlarged basis post-Acquisition. The price at which Ordinary Shares can be bought back shall be no more than the higher of the closing price of the Ordinary Shares on (i) the date on which BT makes an offer to buy-back the Ordinary Shares and (ii) the last trading day before the buy-back takes place. In addition, BT has separately undertaken to give the Sponsor prior notice of its intention to make an offer for Ordinary Shares under the DT CP Contract, to consult with the Sponsor regarding such offer and not to make such offer unless at the relevant time the Board, having been so advised by the Sponsor, considers such offer to be fair and reasonable as far as Shareholders are concerned. After expiry of the lock-up period described above, the Deutsche Telekom Group will be free to dispose of its shareholding in BT without further restriction. 5. Rights of Deutsche Telekom AG Under the Relationship Agreement, subject to compliance with any applicable regulatory requirements, Deutsche Telekom AG is able to appoint one Non-Executive Director (the “Deutsche Telekom Representative Director”) to the Board for so long as the Deutsche Telekom Group holds 10% or more of the issued share capital of BT (provided that, if the shareholding is reduced below 10% as a result of a non-pre-emptive share issuance by BT, the board appointment right shall continue for as long as the Deutsche Telekom Group holds at least 8% of BT’s shares but provided further that such reduced shareholding shall not have occurred as a result of the Deutsche Telekom Group selling Ordinary Shares, and also provided that the Deutsche Telekom Group must top up to 10% within 12 months or the right will lapse). Any such appointment shall be made in consultation with the BT Nominating & Governance Committee and the appointee must be approved by the BT Chairman (such approval not to be unreasonably withheld or delayed). 270 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 271 The Relationship Agreement provides for the establishment of a new committee of BT (the “Conflicted Matters Committee”) which shall assess whether and to what extent the Board papers and Board meetings of BT are likely to consider or refer to any matter in respect of which the Conflicted Matters Committee believes that either: (ii) (iii) (i) (ii) BT and the Deutsche Telekom Group are competitors; or there is an actual or potential conflict of interest between BT and the Deutsche Telekom Group (a “Conflicted Matter”). The Conflicted Matters Committee shall comprise of at least three members including at all times the Secretary to the Board, the Head of Competition and Regulatory Law and the Director of Governance. The Deutsche Telekom Representative Director shall not be a member of the Conflicted Matters Committee. The Deutsche Telekom Representative Director shall not attend any Board meeting of BT unless a senior compliance officer of Deutsche Telekom AG has received prior confirmation that the Conflicted Matters Committee has considered whether such attendance raises any concerns in relation to a Conflicted Matter. In the event that the Conflicted Matters Committee has a serious or immediate concern in relation to a Conflicted Matter, the Deutsche Telekom Representative Director shall not attend any Board meetings in relation to the Conflicted Matter and shall not receive any information in relation to the Conflicted Matter. Deutsche Telekom AG is also entitled to receive, subject to compliance by BT with its legal and regulatory obligations, such financial or other information in relation to the BT Group as is necessary or reasonably required by Deutsche Telekom AG in order to comply with its reporting requirements and legal, regulatory or tax obligations. Standstill and Lock-up Agreement with Orange SA and Orange 1. Standstill and Lock-up Agreement BT entered into a Standstill and Lock-up Agreement with Orange SA and Orange on Completion, which regulates the ability of the Orange Group to deal in shares and other securities of BT. The Standstill and Lock-up Agreement terminates if (a) the Ordinary Shares are no longer listed on the premium listing segment of the Official List and admitted to trading on the London Stock Exchange’s main market for listed securities or (b) the Orange Group ceases to be interested in more than 3% of the issued ordinary share capital of BT. 2. Standstill Provisions The Standstill and Lock-up Agreement contains standstill provisions pursuant to which Orange SA undertakes on behalf of itself and its group for a period of three years from the date of the Standstill and Lock-up Agreement, subject to certain exceptions, not to: (i) (ii) (iii) (iv) acquire or offer to acquire any interest in any shares or other securities of BT as a result of which the aggregate interest of the Orange Group and its concert parties increases above 4% of Ordinary Shares in issue at any time; act in concert with any person in respect of the holding, voting or disposition of any shares or other securities of BT; solicit or participate in any solicitation of Shareholders to vote in a particular manner at any meeting of the Shareholders; or actively or publicly make any proposals for any merger, consolidation or share exchange involving shares or other securities of BT (for the purposes of this Part only, the “Standstill Provisions”). The exceptions to the Standstill Provisions include: (i) where the Orange Group announces an offer under Rule 2.7 of the Code or takes any action requiring it to make an offer under Rule 9 of the Code, in each case if such offer is recommended by the Directors of BT; where any third party makes or announces under Rule 2.7 of the Code an offer to acquire the issued ordinary share capital of BT, whether such offer is recommended by the Directors of BT or not; and where BT makes any offering or issue of shares or other securities and the Orange Group takes up its rights to subscribe for or acquire the shares or other securities offered to it by BT. After expiry of the standstill period, the Orange Group will otherwise be free to increase its shareholding in BT. 3. Lock-up Provisions The Standstill and Lock-up Agreement contains lock-up provisions pursuant to which Orange SA and Orange undertake for a period of 12 months from the date of the Standstill and Lock-up Agreement, subject to certain exceptions, that neither they nor any of their group members will, directly or indirectly, effect any Disposal. The exceptions include: (i) (ii) (iii) (iv) (v) any Disposal to the Deutsche Telekom Group; where Orange SA or Orange accepts any offer by a third party for the whole of the ordinary share capital of BT, whether by tender offer or scheme of arrangement, or provides an irrevocable undertaking or letter of intent to accept or vote in favour of any such offer; any Disposal to any member of the Orange Group, provided that the transferee agrees to be bound by the restrictions of the Standstill and Lock-up Agreement; any sale of shares via any single off-market trade to a Financial Investor of up to all the shares of BT in which the Orange Group has an interest, provided that the transferee enters into a lock-up agreement on substantially similar terms to the lock-up provisions of the Standstill and Lock-up Agreement; and if the Orange Group owns 2% or less of the issued ordinary share capital of the Company, any Disposal which is by way of a swap or other agreement to transfer the economic ownership of the shares. 4. Orange CP Contract Prior to any Disposal by Orange SA, Orange or any of their group members, in accordance with paragraph 3(iv) above, BT has a right of first offer in relation to the relevant shares (subject to the passing of the Buy-Back Resolution), and such right is set out in the Orange CP Contract. Pursuant to the Orange CP Contract, prior to an intended Disposal to Financial Investors, the relevant selling entity is obliged to issue a notice to BT specifying the number of Ordinary Shares proposed to be sold or transferred. BT has nine Business Days within which to make an offer for all of the shares detailed in the notice, or else its right to make an offer will lapse. If the offer is not accepted, the selling entity may make the sale or transfer within three months of the delivery of the notice to BT at a price equal to or greater than the price offered by BT. If BT does not make an offer within the allotted time, the selling entity may sell the Ordinary Shares within three months of the delivery of the notice to BT at any price. The Orange CP Contract will terminate 12 months from Completion. The notice from the selling entity may be issued to BT during a close period or prohibited period (as such terms are defined in the Model Code of Chapter 9 of the Listing Rules) of BT. If any such period does not expire prior to the end of the nine Business Day period within which BT may elect to make an offer to buy-back the shares, BT will not be able to exercise its right of first offer. When exercised in conjunction with BT’s right of first offer in relation to Ordinary Shares held by Deutsche Telekom AG and Deutsche Telekom, the maximum amount of Ordinary Shares BT can acquire 270 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 271 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued by exercise of its rights of first offer is approximately 14% of BT’s share capital on an enlarged basis post-Acquisition. The price at which Ordinary Shares can be bought back shall be no more than the higher of the closing price of the Ordinary Shares on (i) the date on which BT makes an offer to buy-back the Ordinary Shares and (ii) the last trading day before the buy-back takes place. After expiry of the lock-up period described above, the Orange Group will be free to dispose of its shareholding in BT without further restriction. Taxation (US Holders) This is a summary only of the principal US federal income tax and UK tax consequences of the ownership and disposition of ordinary shares or ADSs by US Holders (as defined below) who hold their ordinary shares or ADSs as capital assets. It does not address all aspects of US federal income taxation and does not address aspects that may be relevant to persons who are subject to special provisions of US federal income tax law, including: US expatriates; insurance companies; tax-exempt organisations; banks; regulated investment companies; financial institutions; securities broker-dealers; traders in securities who elect a mark-to-market method of accounting; persons subject to alternative minimum tax; investors that directly, indirectly or by attribution own 10% or more of the outstanding share capital or voting power of BT; persons holding their ordinary shares or ADSs as part of a straddle, hedging transaction or conversion transaction; persons who acquired their ordinary shares or ADSs pursuant to the exercise of options or otherwise as compensation; or persons whose functional currency is not the US Dollar, amongst others. Those holders may be subject to US federal income tax consequences different from those set forth below. For the purposes of this summary, a US Holder is a beneficial owner of ordinary shares or ADSs that, for US federal income tax purposes, is: a citizen or individual resident of the United States; a corporation (or other entity taxable as a corporation for US federal income tax purposes) created or organised in or under the laws of the United States or any political subdivision thereof; an estate the income of which is subject to US federal income taxation regardless of its sources, or a trust if a US court can exercise primary supervision over the administration of the trust and one or more US persons are authorised to control all substantial decisions of the trust. If a partnership holds ordinary shares or ADSs, the US tax treatment of a partner generally will depend upon the status of the partner and the activities of the partnership. A partner in a partnership that holds ordinary shares or ADSs is urged to consult its own tax adviser regarding the specific tax consequences of owning and disposing of the ordinary shares or ADSs. In particular, this summary is based on (i) current UK tax law and the practice of Her Majesty’s Revenue & Customs (HMRC) and US law and US Internal Revenue Service (IRS) practice, including the Internal Revenue Code of 1986, as amended, existing and proposed Treasury regulations, rulings, judicial decisions and administrative practice, all as currently in effect and available, (ii) the United Kingdom-United States Convention relating to estate and gift taxes, and (iii) the United Kingdom-United States Tax Convention that entered into force on 31 March 2003 and the protocol thereto (the Convention), all as in effect on the date of this Annual Report, all of which are subject to change or changes in interpretation, possibly with retroactive effect. US Holders should consult their own tax advisers as to the applicability of the Convention and the consequences under UK, US federal, state and local, and other laws, of the ownership and disposition of ordinary shares or ADSs. Taxation of dividends Under current UK tax law, BT will not be required to withhold tax at source from dividend payments it makes. Unless a US Holder of ordinary shares or ADSs is resident for UK tax purposes in the UK or unless a US Holder of ordinary shares or ADSs carries on a trade, profession or vocation in the UK through a branch or agency, or, in the case of a company, a permanent establishment in the UK, the holder should not be liable for UK tax on dividends received in respect of ordinary shares and/or ADSs. For US federal income tax purposes, a distribution will be treated as ordinary dividend income. The amount of the distribution includible in gross income of a US Holder will be the US Dollar value of the distribution calculated by reference to the spot rate in effect on the date the distribution is actually or constructively received by a US Holder of ordinary shares, or by the Depositary. In the case of ADSs, a US Holder who converts Sterling into US Dollars on the date of receipt generally should not recognise any exchange gain or loss. A US Holder who does not convert Sterling into US Dollars on the date of receipt generally will have a tax basis in Sterling equal to their US Dollar value on such date. Foreign currency gain or loss, if any, recognised by the US Holder on a subsequent conversion or other disposition of Sterling generally will be US source ordinary income or loss. In addition, in a situation where US holders receive distributions of previously taxed earnings and profits, foreign currency gain or loss will generally be recognised as the same source as the associated income included under Subpart F rules for US federal income tax purposes. Dividends paid by BT to a US Holder will not be eligible for the US dividends received deduction that may otherwise be available to corporate shareholders. For purposes of calculating the foreign tax credit limitation, dividends paid on the ordinary shares or ADSs will be treated as income from sources outside the US and generally will constitute ‘passive income’. US Holders who do not elect to claim a credit with respect to any foreign taxes paid in a given taxable year may instead claim a deduction for foreign taxes paid. A deduction does not reduce US federal income tax on a Dollar for Dollar basis like a tax credit. The deduction, however, is not subject to the limitations applicable to foreign credits. Following recent changes in UK tax law (effective from 6 April 2016), UK tax credits no longer attach to any dividends paid on the ordinary shares or ADSs, irrespective of the domicile or residence of the shareholder. No question therefore arises as to the entitlement of any US Holder to any UK tax credit. Certain US Holders (including individuals) are eligible for reduced rates of US federal income tax (currently at a maximum of 20%) in respect of qualified dividend income. There could also be a 3.8% net investment income tax on dividends to individuals and other non- corporate holders with income above a certain amount. For these purposes, qualified dividend income generally includes dividends paid by a non-US corporation if, among other things, the US Holders meet certain minimum holding periods and the non-US corporation satisfies certain requirements, including that either (i) the shares or ADSs with respect to which the dividend has been paid are readily tradable on an established securities market in the US, or (ii) the non-US corporation is eligible for the benefits of a comprehensive US income tax treaty (such as the Convention) which provides for the exchange of information. BT currently believes that dividends paid with respect to its ordinary shares and ADSs should constitute qualified dividend income for US federal income tax purposes. Each individual US Holder of ordinary shares or ADSs is urged to consult his own tax adviser regarding the availability to him of the reduced dividend tax rate in light of his own particular situation and regarding the computations of his foreign tax credit limitation with respect to any qualified dividend income paid by BT to him, as applicable. 272 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 273 Taxation of capital gains Unless a US Holder of ordinary shares or ADSs is resident for UK tax purposes in the UK or unless a US Holder of ordinary shares or ADSs carries on a trade, profession, or vocation in the UK through a branch, agency, or in the case of a company, a permanent establishment in the UK, and the ordinary shares and/or ADSs have been used, held, or acquired for the purposes of that trade, profession or vocation, the holder should not be liable for UK tax on capital gains on a disposal of ordinary shares and/or ADSs. A US Holder who is an individual and who has ceased to be resident for tax purposes in the UK on or after 17 March 1998 or who falls to be regarded as resident outside the UK for the purposes of any double tax treaty (Treaty non-resident) on or after 16 March 2005 and continues to not be resident in the UK or continues to be Treaty non-resident for a period of less than five years of assessment and who disposes of his ordinary shares or ADSs during that period may also be liable on his return to the UK to UK tax on capital gains, subject to any available exemption or relief, even though he is not resident in the UK or is Treaty non-resident at the time of disposal. For US federal income tax purposes, a US Holder generally will recognise capital gain or loss on the sale, exchange or other disposition of ordinary shares or ADSs in an amount equal to the difference between the US Dollar value of the amount realised on the disposition and the US Holder’s adjusted tax basis (determined in US Dollars) in the ordinary shares or ADSs. Such gain or loss generally will be US source gain or loss, and will be treated as long-term capital gain or loss if the ordinary shares have been held for more than one year at the time of disposition. Long-term capital gains recognised by an individual US Holder generally are subject to US federal income tax at preferential rates. The deductibility of capital losses is subject to significant limitations. Non-corporate US Holders may also be subject to a 3.8% tax on net investment income in respect of any gains. A US Holder’s tax basis in an ordinary share or ADS will generally be its US Dollar cost. The US Dollar cost of an ordinary share or ADS purchased with foreign currency will generally be the US Dollar value of the purchase price on the date of purchase, or the settlement date for the purchase, in the case of ordinary shares or ADSs traded on an established securities market, as defined in the applicable Treasury Regulations, that are purchased by a cash basis US Holder (or an accrual basis US Holder that so elects). Such an election by an accrual basis US Holder must be applied consistently from year to year and cannot be revoked without the consent of the IRS. The amount realised on a sale or other disposition of ordinary shares or ADSs for an amount in foreign currency will be the US Dollar value of this amount on the date of sale or disposition. On the settlement date, the US Holder will recognise US source foreign currency gain or loss (taxable as ordinary income or loss) equal to the difference (if any) between the US Dollar value of the amount received based on the exchange rates in effect on the date of sale or other disposition and the settlement date. However, in the case of ordinary shares or ADS traded on an established securities market that are sold by a cash basis US Holder (or an accrual basis US Holder that so elects), the amount realised will be based on the exchange rate in effect on the settlement date for the sale, and no exchange gain or loss will be recognised at that time. Passive foreign investment company status A non-US corporation will be classified as a passive foreign investment company (a PFIC) for US federal income tax purposes for any taxable year if at least 75% of its gross income consists of passive income or at least 50% of the average value of its assets consist of assets that produce, or are held for the production of, passive income. BT currently believes that it did not qualify as a PFIC for the tax year ended 31 March 2017. If BT were to become a PFIC for any tax year, US Holders would suffer adverse tax consequences. These consequences may include having gains realised on the disposition of ordinary shares or ADSs treated as ordinary income rather than capital gains and being subject to punitive interest charges on certain dividends and on the proceeds of the sale or other disposition of the ordinary shares or ADSs. Furthermore, dividends paid by BT would not be ‘qualified dividend income’ which may be eligible for reduced rates of taxation as described above. US Holders should consult their own tax advisers regarding the potential application of the PFIC rules to BT. US information reporting and backup withholding Dividends paid on and proceeds received from the sale, exchange or other disposition of ordinary shares or ADSs may be subject to information reporting to the IRS and backup withholding at a current rate of 28% (which rate may be subject to change). Certain exempt recipients (such as corporations) are not subject to these information reporting requirements. In addition, non-corporate US Holders may be required to report their investment on a Form 8938. Backup withholding will not apply, however, to a US Holder who provides a correct taxpayer identification number or certificate of foreign status and makes any other required certification or who is otherwise exempt. Persons that are US persons for US federal income tax purposes who are required to establish their exempt status generally must furnish IRS Form W-9 (Request for Taxpayer Identification Number and Certification). Holders that are not US persons for US federal income tax purposes generally will not be subject to US information reporting or backup withholding. However, such holders may be required to provide certification of non-US status in connection with payments received in the US or through certain US-related financial intermediaries. Backup withholding is not an additional tax. Amounts withheld as backup withholding may be credited against a holder’s US federal income tax liability. A holder may obtain a refund of any excess amounts withheld under the backup withholding rules by timely filing the appropriate claim for refund with the IRS and furnishing any required information. UK stamp duty A transfer of or an agreement to transfer an ordinary share will generally be subject to UK stamp duty or UK stamp duty reserve tax (SDRT) at 0.5% of the amount or value of any consideration provided rounded up (in the case of stamp duty) to the nearest £5. SDRT is generally the liability of the purchaser. It is customarily also the purchaser who pays UK stamp duty. A transfer of an ordinary share to, or to a nominee for, a person whose business is or includes the provision of clearance services or to, or to a nominee or agent of, a person whose business is or includes issuing depositary receipts gives rise to a 1.5% charge to stamp duty or SDRT of either the amount of the consideration provided or the value of the share issued rounded up (in the case of stamp duty) to the nearest £5. No UK stamp duty will be payable on the transfer of an ADS (assuming it is not registered in the UK), provided that the transfer documents are executed and always retained outside the UK. Transfers of ordinary shares into CREST will generally not be subject to stamp duty or SDRT unless such a transfer is made for a consideration in money or money’s worth, in which case a liability to SDRT will arise, usually at the rate of 0.5% of the value of the consideration. Paperless transfers of ordinary shares within CREST are generally liable to SDRT at the rate of 0.5% of the value of the consideration. CREST is obliged to collect SDRT from the purchaser of the shares on relevant transactions settled within the system. 272 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 273 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Information for shareholders continued In addition, during our integration of the EE business, we discovered a roaming agreement between EE and Syriatel Mobile Telecom, an entity designated under UK/EU sanctions. Following an internal investigation, we ceased providing services under the agreement and made a voluntary disclosure to HM Treasury. We are also investigating whether there are additional implications under other sanctions regimes. EE is now fully subject to BT’s sanctions compliance policies and procedures. Limitations affecting security holders There are no government laws, decrees, regulations, or other UK legislation which have a material effect on the import or export of capital, including the availability of cash and cash equivalents for use by the company except as otherwise described in Taxation (US Holders). There are no limitations under UK law restricting the right of non- residents to hold or to vote shares in the company. The above statements are intended as a general guide to the current position. Certain categories of person (including recognised market makers, brokers and dealers) may not be liable to stamp duty or SDRT or may, although not liable for the tax, be required to notify and account for it under the Stamp Duty Reserve Tax Regulations 1986. UK inheritance and gift taxes in connection with ordinary shares and/or ADSs The rules and scope of domicile are complex and action should not be taken without advice specific to the individual’s circumstances. A lifetime gift or a transfer on death of ordinary shares and/or ADSs by an individual holder, who is US domiciled (for the purposes of the UK/US Estate and Gift Tax Convention) and who is not a UK national (as defined in the Convention) will not generally be subject to UK inheritance tax if the gift is subject to US federal gift or US estate tax unless the tax is not paid (otherwise than as a result of a specific exemption, deduction, exclusion, credit or allowance). Further note on certain activities In addition, under Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13 (r) to the Securities Exchange Act of 1934, we are required to disclose whether BT or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or certain designated individuals or entities. Disclosure is required even when the activities were conducted outside the US by non-US entities and even when they were conducted in compliance with applicable law. During 2016/17, certain of the group’s non-US subsidiaries or other non-US entities conducted limited activities in, or with persons from, certain countries identified by the US Department of State as State Sponsors of Terrorism or otherwise subject to US sanctions. These activities, which generally relate to the provision of communications services to embassies and diplomatic missions of US-allied governments, other Communication Providers, news organisations, multinational corporations and other customers that require global communications connectivity, are insignificant to the group’s financial condition and results of operations. BT has a contract in place with Telecommunication Infrastructure Company (TIC), to make and receive voice calls from Iran to the UK. BT entered into a Framework Agreement with Rafsanjan Industrial Complex (RIC) for business consultancy services in May 2010 and provided an initial consultancy engagement under phase 1 of the agreement. In February 2011, phase 2 was agreed with RIC however BT stopped work in December 2011 due to the geopolitical situation. RIC made an advance payment to BT of €384,120 to carry out the phase 2 work. We continue to explore whether the amount can be refunded. BT’s subsidiary, EE (the acquisition of which was completed on 29 January 2016), has in place roaming partner agreements with Mobile Company of Iran (MCI), and Taliya Company (also known as Rafsanjan Industrial Complex). These bilateral agreements allow the transmission of mobile calls. There has been no traffic with Taliya in 2016/17. The amounts received by EE under these contracts were less than £405,000. In addition, EE also exchanges SMS traffic with MCI, Mobile Telecommunications Company of Esfahan and Telecommunication Kish Company. The amounts received by EE under these contracts were less than £6,500. 274 274 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc PB THE STRATEGIC REPORT GOVERNANCE FINANCIAL STATEMENTS ADDITIONAL INFORMATION Documents on display All reports and other information that BT files with the US Securities and Exchange Commission (SEC) may be inspected at the SEC’s public reference facilities at Room 1580, 100 F Street NE, Washington, DC 20549, US. Shareholder Helpline Tel: Freefone 0808 100 4141 Fax: 01903 833371 Textphone: Freefone 0800 169 6907 These reports may be accessed via the SEC’s website at www.sec.gov Publications BT produces a series of reports on the company’s financial, compliance, and social and environmental performance. Document Notice of meeting Annual Report & Form 20-F Delivering our purpose report EAB Annual Report Publication date May May May May Expected quarterly results releases July, October, January and May Current Cost Financial Statements The Way We Work, a statement of business practice July July For printed copies, when available, contact the Shareholder Helpline on Freefone 0808 100 4141 or contact our Registrars in the UK, at the address opposite. Most of these reports (as well as the EAB Annual Report on BT’s compliance with the Undertakings) can be accessed online at www.bt.com/aboutbt More detailed disclosures on BT’s implementation of social, ethical and environmental policies and procedures are available online through our independently verified sustainability report at www.bt.com/deliveringourpurpose Electronic communication Shareholders can choose to receive their shareholder documents electronically rather than by post. Shareholders may elect to receive documents in this way by going to www.bt.com/signup and following the online instructions, or by calling the Shareholder Helpline. Shareholder communication BT is committed to communicating openly with each of its stakeholder audiences in the manner most appropriate to their requirements. All investors can visit our website at www.bt.com/investorcentre for more information about BT. There are direct links from this page to sites providing information particularly tailored for shareholders, institutional investors, financial analysts, industry analysts and journalists. Private shareholders If private shareholders have any enquiries about their shareholding, they should contact our Registrars, Equiniti, at the address below. Equiniti maintain BT Group’s share register and the separate BT Group EasyShare register. They also provide a Shareholder Helpline service on Freefone 0808 100 4141. From outside the UK: Tel: +44 121 415 7178 Fax: +44 1903 833371 Textphone: +44 121 415 7028 https://help.shareview.co.uk The Registrar Equiniti Aspect House Spencer Road Lancing West Sussex BN99 6DA www.equiniti.com ADR Depositary JPMorgan Chase & Co PO Box 64504 St Paul, MN 55164-0854, US Tel: +1 800 990 1135 (General) or +1 651 453 2128 (From outside the US) or +1 800 428 4237 (Global Invest Direct) email: jpmorgan.adr@wellsfargo.com www.adr.com General enquiries BT Group plc BT Centre 81 Newgate Street London EC1A 7AJ United Kingdom Tel: 020 7356 5000 Tel: +44 1793 596 931 (from outside the UK) Institutional investors, financial and industry analysts Institutional investors and financial analysts may contact BT Investor Relations on: Tel: 020 7356 4909 email: ir@bt.com Industry analysts and consultants may contact BT Analyst Relations on: Tel: 020 7356 4909 email: industryenquiry@bt.com Find out more about the BT Supplier Finance scheme at: www.selling2bt.bt.com You can find out more about the Better Payment Practice Code at: www.payontime.co.uk www.btplc.com/TheWayWeWork Annual Report 2017 BT Group plc 275 Cross reference to Form 20-F The information in this document that is referred to in the following table shall be deemed to be filed with the Securities and Exchange Commission for all purposes. None of the websites referred to in this Annual Report 2017, including where a link is provided, nor any of the information contained on such websites is incorporated by reference in the Form 20-F. Required item in Form 20-F Item 3 3A Key information Selected financial data 4 4A Information on the company History and development of the company 4B Business overview 4C Organisational structure 4D Property, plants and equipment Where information can be found in this Annual Report Section Selected financial data Information for shareholders Exchange rates Lines of business Information for shareholders Background Group performance Capital expenditure General information Capital management and funding policy Review of the yeara How we’re organised How we’re doing What we do Our networks and physical assets Research and development Brand and reputation Stakeholders Protecting the environment Our performance as a sustainable and responsible business Lines of business Consolidated financial statements Notes to the consolidated financial statements Segment information Financial and operational statistics Operational statistics Information for shareholders Cautionary statement regarding forward-looking statements Information for shareholders Further note on certain activities Operating Committee Our business model Lines of business Related undertakings Our networks and physical assets Properties Protecting the environment Our performance as a sustainable and responsible business Consolidated financial statements Notes to the consolidated financial statements Property, plant and equipment Financial and operational statistics Financial statistics Page 255 265 56 261 97 150 3 8 17 24 30 32 34 34 41 43 56 182 259 260 274 14 22 56 238 30 31 41 43 198 257 276 276 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc 277 277 Required item in Form 20-F Item 5 Operating and financial review and prospects Operating results 5A 5B Liquidity and capital resources 5C Research and development, patents and licences 5D Trend information 5E 5F 6 6A 6B Off-balance sheet arrangements Tabular disclosure of contractual obligations Directors, senior management and employees Directors and senior management Compensation 6C Board practices 6D Employees 6E Share ownership Where information can be found in this Annual Report Section Lines of business Group performanceb c Our relationship with HM Government Regulation Protecting the environment Our performance as a sustainable and responsible business Alternative performance measures Information for shareholders Cautionary statement regarding forward-looking statements Group performanceb c Information for shareholders Cautionary statement regarding forward-looking statements Consolidated financial statements Notes to the consolidated financial statements Loans and other borrowings Financial instruments and risk management Financial commitments and contingent liabilities Research and development Financial and operational statistics Financial statistics Group performanceb c Selected financial data Information for shareholders Cautionary statement regarding forward-looking statements General information Off-balance sheet arrangements Group performance Contractual obligations and commitments Board of Directors The Board Reports of the Board committees Report on Directors’ Remuneration Focus on Remuneration Annual Remuneration Report Consolidated financial statements Notes to the consolidated financial statements Retirement benefit plans Share-based payments Board of Directors The Board Reports of the Board committees Report on Directors’ Remuneration Focus on Remuneration Remuneration Principles Annual Remuneration Report Remuneration Policy Our people Group performance Income statement Operating costs Consolidated financial statements Notes to the consolidated financial statements Employees Reports of the Board committees Report on Directors’ Remuneration Focus on Remuneration 276 276 BT Group plc BT Group plc Annual Report 2017 Annual Report 2017 Annual Report 2017 Annual Report 2017 BT Group plc BT Group plc Page 56 91 38 38 41 43 252 260 91 260 218 222 229 32 257 91 255 260 150 102 106 108 122 123 125 204 215 106 108 122 123 124 125 139 26 94 187 122 123 277 277 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Cross reference to Form 20-F continued Required item in Form 20-F Item 7 7A Major shareholders and related party transactions Major shareholders 7B Related party transactions 8 8A Financial information Consolidated statements and other financial information 8B 9 9A Significant changes The offer and listing Offer and listing details 9C Markets 10 10B Additional information Memorandum and articles of association 10C Material contracts 10D Exchange controls 10E Taxation 10H Documents on display 11 Quantitative and qualitative disclosures about market risk Where information can be found in this Annual Report Section Annual Remuneration Report Remuneration Policy Consolidated financial statements Notes to the consolidated financial statements Share-based payments Shareholders and Annual General Meeting Relations with shareholders Substantial shareholdings Information for shareholders Analysis of shareholdings at 31 March 2017 Directors’ information Interest of management in certain transactions Consolidated financial statements Notes to the consolidated financial statements Related party transactions See Item 18 below General information Legal proceedings Group performance Dividendsc Consolidated financial statements Notes to the consolidated financial statements Financial commitments and contingent liabilities Information for shareholders Dividends Articles of Association (Articles) Dividends Directors’ information Going concern Information for shareholders Stock exchange listings Share and ADS prices Information for shareholders Stock exchange listings Information for shareholders Articles of Association (Articles) Information for shareholders Material contracts Information for shareholders Limitations affecting security holders Information for shareholders Taxation (US Holders) Information for shareholders Documents on display Consolidated financial statements Notes to the consolidated financial statements Significant accounting policies Financial instruments Notes to the consolidated financial statements Financial instruments and risk management Page 125 139 215 152 262 147 229 150 96 229 263 266 146 261 261 266 268 274 272 275 181 222 278 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 279 Required item in Form 20-F Item 15 Controls and procedures Where information can be found in this Annual Report Section General information 16A Audit committee financial expert 16B Code of ethics 16C Principal accountants’ fees and services 16E 16G Purchases of equity securities by the issuer and affiliated purchasers Corporate Governance 18 Financial statements US Regulation UK Internal control and risk management Report of the independent auditors – Consolidated financial statements United States opinion General information US Regulation US Sarbanes-Oxley Act of 2002 General information US Regulation US Sarbanes-Oxley Act of 2002 Consolidated financial statements Notes to the consolidated financial statements Audit, audit related and other non-audit services Reports of the Board Committees Audit & Risk Committee Chairman’s report Information for shareholders Share buyback General information US Regulation New York Stock Exchange Report of the independent auditors – Consolidated financial statements United States opinion Financial statements Page 148 149 164 148 148 188 112 263 148 164 153 a Excluding the information under the heading “Outlook” on page 7. b Excluding the paragraph beginning “For 2017/18” on page 91, the information under the sub-heading “Outlook for 2017/18” on page 92 and the paragraph beginning “Our outlook for normalised free cash flow...” on page 93. c Excluding the last sentence ending in “... in our Outlook on page 92.” under the sub-heading “Dividends” on page 96. 278 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 279 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Glossary of terms 2G: the second generation of mobile telephony systems. It uses digital transmission to support voice, low-speed data communications and short messaging services. 3G: the third generation of mobile systems. It provides high-speed data transmission and supports multimedia applications like video, audio and internet access as well as conventional voice services. 4G: the fourth generation of mobile systems. It is designed to provide faster data download and upload speeds on mobile networks. 5G: the coming fifth generation wireless broadband technology which will provide better speeds and coverage than the current 4G. ADSL: asymmetric digital subscriber line – a digital technology that allows the use of a standard telephone line to provide high-speed data communications. Dark fibre: an ‘unlit’ fibre-only connection provided with no associated electronics. DP: distribution point. DSL: digital subscriber line – a broadband service where existing wires between the local telephone exchange and a customer’s telephone sockets are transformed into a high-speed digital line. EAD: Ethernet access direct – a point-to-point access product in the Openreach Ethernet portfolio offering high bandwidth connectivity, linking end-user sites, communications provider networks and BT exchanges. Ethernet: high-capacity, high-speed digital connections available throughout the UK. They tend to be used by businesses and offices for which a domestic connection is inadequate when large numbers of devices have to be online. ARPU: average revenue per user. ESN: Emergency Services Network. BDUK: Broadband Delivery UK – the UK Government body charged with helping to oversee the use of public money for rolling out fibre broadband in harder-to-reach parts of the country. BTPS: BT Pension Scheme – the defined benefit pension scheme which was closed to new members on 31 March 2001. BTRSS: BT Retirement Saving Scheme – the scheme set up on 1 April 2009 as a successor to the BT Retirement Plan. It is a contract-based, defined contribution arrangement. CI: continuous improvement – a complementary ‘bottom-up’ approach, empowering our people to make small but significant changes to improve customer service and employee engagement while reducing the cost of failure. Cloud of Clouds: Global Services’ portfolio strategy which brings together its six core product families and a network of partners to support the delivery of global network and IT infrastructure services. CP: communications provider – a provider of communications services – telephony, broadband, video on demand and other services. Flexible Co-mingling: allows CPs to place their equipment in our exchanges. FTTC: fibre-to-the-cabinet – a variant of GEA which uses fibre to provide high connection speeds from the exchange to a street cabinet near to a customer premises, and a copper line for the final connection to the premises. FTTP: fibre-to-the-premises – a variant of GEA which uses fibre to provide high connection speeds for the whole route from the exchange to the customer. G.Fast: an innovative technology that uses higher frequencies than FTTC to provide faster broadband speeds over copper. GEA: generic Ethernet access – Openreach’s wholesale fibre broadband product. IoT: internet of things – the interconnection via the internet of computing devices embedded in everyday objects, enabling them to send and receive data. IP: internet protocol – a packet-based protocol for delivering data – including voice and video – across networks. IPTV: internet protocol television – the combination of broadcast content with broadband content, delivering both through the television. IPX: IP exchange – a telecommunications interconnection model for the exchange of IP-based traffic between customers of separate mobile and fixed operators. 280 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 281 Ladder pricing: Ladder pricing links the amounts that BT charges mobile operators for mobile calls to 0800, 0845 and 0870 numbers terminating on our network to the retail price charged by mobile operators to their customers. LLU: local loop unbundling – the process by which CPs can rent the copper lines between BT’s exchanges and customer premises from Openreach to provide voice and broadband services using their own equipment. M2M: machine-to-machine – M2M communications refers to connecting electronic devices to one another. This can streamline processes and enable tasks to be automated. Managed Ethernet Access Service: a product that uses pseudo-wire technology to carry Ethernet traffic between the mobile operators’ cell and core sites in a single converged packet network. MBNL: Mobile Broadband Network Limited is a joint venture arrangement between EE Limited and Hutchison 3G UK Limited with each company owning a 50% share. MiiS: mobile infill infrastructure solution – lets CPs install their radio equipment in special cabinets linked to antennas on telephone poles and use their spectrum to improve mobile coverage. MPF: metallic path facility – a circuit comprising a pair of twisted metal wires between an end-user’s premises and a main distribution frame. MPLS: multi-protocol label switching – supports the rapid transmission of data across network routers, enabling modern networks to achieve high quality of service. MSL: minimum service level – set by Ofcom in relation to the quality of service that Openreach offers. MVNO: mobile virtual network operator – an arrangement where a retailer sells mobile services under its own brand but uses a mobile network owned by another operator to do so. NFV: network function virtualisation. Ofcom: the independent regulator and competition authority in the UK communications industries, with responsibilities across television, radio, telecommunications and wireless communications services. PCP: primary connection point. PIA: passive infrastructure access – this occurs when one company accesses ducts owned by another and installs its own fibre optic or other cables. POLOs: payments to other licensed operators – typically refers to payments by one CP to another CP when terminating voice traffic on their network to carry the call to the customer receiving the call. PoPs: points of presence – this refers to a location in a city where we have the ability to connect customers to one of our networks. PPC: partial private circuit – a generic term used to describe a category of private circuits that terminate at a point of connection between two operators’ networks. RFT: Right First Time – the internal measure of whether we are keeping our promises to our customers and meeting or exceeding their expectations. SDN: software defined networking – one of the new generation of networking technologies that are giving us a new way to build and manage corporate networks that are fit for the digital age. SEP: superfast extension programme. SIP: session initiation protocol – a method for creating, modifying and terminating sessions with one or more participants. These include internet telephone calls, multimedia distribution and multimedia conferences. SIP Trunk: this replaces the need for traditional analogue, T1-based Public Switched Telephone Network connections with termination instead provided over a company’s public or private internet connection through a SIP provider. SMPF: shared metallic path facility – access to the non-voiceband frequencies of the metallic path facility. SON: self-organising network. SVoD: subscription video on demand. TDM: time-division multiplexing. Undertakings: legally-binding commitments BT made to Ofcom, designed to bring greater transparency and certainty to the regulation of the telecommunications industry in the UK. They led to the formation of Openreach. UHD: ultra high definition. 280 BT Group plc Annual Report 2017 Annual Report 2017 BT Group plc 281 THE STRATEGIC REPORTGOVERNANCEFINANCIAL STATEMENTSADDITIONAL INFORMATION Glossary of terms continued VDSL: very high speed DSL – a high-speed variant of DSL technology. It provides a high headline speed by reducing the length of the access line copper by connecting to fibre at the cabinet. VoIP: voice over internet protocol – a method of transporting speech over the internet. VPN: virtual private network – a secure way to create an apparent dedicated network between nodes over a network infrastructure, which is in reality shared with other services. WAN: wide area network – a computer network that exists over a relatively large geographical area that connects two or more smaller networks. This enables computers and users in one location to communicate with computers and users in other locations. WLR: wholesale line rental – a product supplied by Openreach which is used by other CPs to offer telephony services using their own brand, pricing structure and billing, but using BT’s network. 282 BT Group plc Annual Report 2017 Notes Notes Notes Notes Notes Notes In this document, references to ‘BT Group’, ‘BT’, ‘the group’, ‘the company’, ‘we’ or ‘our’ are to BT Group plc (which includes the activities of British Telecommunications plc) and its subsidiaries and lines of business, internal service unit, or any of them as the context may require. A reference to a year expressed as 2016/17 is to the financial year ended 31 March 2017 and a reference to a year expressed as 2017 is to the calendar year. This convention applies similarly to any reference to a previous or subsequent year. References to ‘this year’, ‘the year’ and ‘the current year’ are to the financial year ended 31 March 2017. References to ‘last year’ and ‘prior year’ are to the financial year ended 31 March 2016. BT Group plc Registered office: 81 Newgate Street, London EC1A 7AJ Registered in England and Wales No. 4190816 Produced by BT Group PHME 80256 Printed in England by Pindar Scarborough Ltd Design by emperor.works Typeset by Donnelley Financial Solutions Printed on Amadeus 50 Silk which is made from 50% de-inked, post-consumer waste and 50% virgin fibre www.bt.com Please recycle 

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