Operating and Financial Review

Executive Summary

Analysis of Results

• Revenue growth ahead of goal ranges at 6.3% (5.4% including Europe Beverages)
• 6% confectionery growth: Trident +21%; Halls +9%; Cadbury Dairy Milk +7%
• 6% beverage growth: US carbonates outperforms the market, driven by Dr Pepper
• Underlying Operating margins +30bps in challenging cost environment
• Underlying profit before tax +12% at £873 million (+13% as reported)
• Underlying earnings per share +9% at 33.9 pence (+10% as reported)
• Significant increase in Free Cash Flow to £404 million
• Adams performance strong and growing ahead of the acquisition plan
• Successful sale of Europe Beverages for €1.85 billion (£1.26 billion)

1 Revenue

(i) Review of 2005 Group Income Statement

In 2005, acquisitions, net of disposals, resulted in an £11 million reduction in reported Revenue relative to the prior year. The reduction was driven principally by the disposal of Piasten, our German confectionery business, offset by additional revenues arising following our acquisition of Green & Black's. The absence of a 53rd week in 2005 reduced Revenues by an estimated £49 million, or 1%.

Base business Revenue grew £378 million or 6% driven by growth in all four of our business segments, led by the Americas Confectionery and Asia Pacific business segments. Growth was also broadly based across categories and brands. The growth rate was the highest growth rate for over a decade, as we began to see the benefits of our investments in our brands, capabilities and people.

(ii) Group Profit from Operations

Underlying Profit from Operations (Profit from Operations before restructuring costs, non-trading items, brand intangibles amortisation and the IAS 39 adjustment) was £1,033 million. This was £79 million or 8% higher than in 2004.

Currency movements had a £16 million (2%) favourable impact on Underlying Profit from Operations. The full-year impact of acquisitions, net of disposals, was minimal at £1 million as the Green & Black's profits more than offset the impact of the Piasten disposal. The lack of the 53rd week in 2005 gave rise to an estimated £11 million reduction in Underlying Profit from Operations.

Confectionery revenues grew by 6.3% reflecting a combination of healthy market growth and market share gains. We gained share in 16 out of our top 20 markets with innovation in all categories playing a key role.

All our major brands grew strongly during the year. The ex- Adams brands, including Halls, Trident, Dentyne and the Bubbas, continued to grow strongly with revenues up 11% (2004: +11%). Cadbury Dairy Milk revenues were 7% ahead as we rolled out the successful master-branding concept to Canada and South Africa. Trident grew by 21%, with sales growth boosted by the launch of Trident Splash, a centre-filled gum, in North America and a number of Continental European markets. Dentyne grew by 5% following the launch of Dentyne soft chew in the US and Canada, and the expansion of the brand into the Malaysian market. Halls revenues were ahead by 9%, benefiting from growth in the EMEA business segment where we continue to broaden Halls' distribution by using our existing route to market.

Emerging markets, which account for around 30% of our confectionery revenues, grew by 12% overall. All markets contributed to this performance with confectionery revenues ahead by 13% in Latin America; by 10% in Africa; by 32% in Russia and, by 11% in Asia Pacific. Developed market growth of 4% was driven by US, Canada, Australia and Japan. In the UK, a 2% rise in revenues was achieved in a year in which innovation activity was reduced to allow the business to focus on a major systems implementation programme. Green & Black's (acquired in May 2005) continued to perform strongly with year-on-year revenue growth of 49%.

Our beverage businesses in the Americas and Australia grew sales by 6.2% during the year with all markets performing strongly. Our business in North America continued to reap the benefits of consolidating three separately run businesses into one. In Australia, we are leveraging our increased scale following the integration of our full system beverage business with our confectionery operations.

In the Americas, our US carbonates business significantly outperformed the market during the year with a 40 basis points increase in market share to 17.0%. Dr Pepper was the primary driver of performance with volumes ahead by 6% as Dr Pepper Cherry Vanilla (launched in late Q4 2004) moved into national distribution at the beginning of the year. Non-Carbonate volumes in the US were up 5% with the improved performance reflecting our focus on core brands and some sell-in to the trade ahead of a January price increase. In Mexico, we continued to generate strong profitable growth with revenues up 14% in a competitive market. In Australia, we had another good year with sales up 7% as we focused on a smaller range of brands.

Underlying Operating margins increased by 20 basis points to 15.9% from 15.7%. Exchange rate movements had an insignificant impact on margins.

After excluding the impact of the 53rd week in 2004 margins grew by 30 basis points with Fuel for Growth savings of £90 million (excluding Europe Beverages) more than offsetting sharply escalating raw material and oil related costs and higher investment behind growth initiatives. In 2005, we invested an additional £75 million in growth and capability related initiatives, including innovation, information technology, science and technology, commercial and sales force capabilities, and the understanding of our consumers.

Marketing

Restructuring Costs

In 2005, all of the business restructuring related to the continued execution of the Fuel for Growth cost reduction initiative.

Of this total charge of £72 million, £38 million was redundancy related and £18 million related to external consulting costs. The remaining costs consisted of asset write-offs, site closure costs, relocation costs and contract termination costs.

Business Segment analysis

The total Fuel for Growth restructuring spend undertaken to date amounts to £374 million, or 75% of the total expected Fuel for Growth restructuring spend of £500 million. In 2006, Restructuring spend is expected to be around £100 million, reflecting the restructuring activities associated with the ongoing Fuel for Growth cost reduction initiative and penalties under the Gumlink supply agreement. In 2005 we announced our intention to build a new green-field gum factory in Poland. Following commissioning of the factory in 2008, we will reduce our gum supply requirements from Gumlink A/S and incur penalties under the terms of the Gumlink supply agreement. We will recognise a restructuring cost, in 2006 and 2007 in respect of these costs. These charges are estimated to be £10 million and £20 million respectively.

Amortisation of Brand Intangibles

Non-trading items

• a £20 million profit from the disposal of Holland House Cooking Wines;
• a loss of £1 million on the disposal of Piasten, our German confectionery subsidiary;
• a net gain of £4 million on the sale of trade investments; and
• a net profit of £2 million through disposals of surplus properties.

IAS 39 Adjustment

(iii) Share of Result in Associates

(iv) Financing

• the incremental interest charges of £5 million resulting from the additional borrowing required to redeem the Group's $400 million Quarterly Income Preferred Stock ("QUIPS") in April 2005; offset by:
• a reduction in average net borrowing arising from positive operational cash flows in the year; and
• the impact of exchange rates and the absence of the additional week relative to 2004.

(v) Taxation

Reported Profit before Tax rose by 31% to £843 million reflecting the improved underlying performance of the business, lower restructuring costs and the favourable impact of fair value accounting under IAS 39. In 2005, we have concluded that recognition of a net deferred tax asset in the UK is now appropriate. This has resulted in a credit of £104 million to the current year tax charge which, given its size and one-off nature, has been excluded from the Group's underlying tax charge but is included in the reported tax charge of £140 million.

(vi) Discontinued Operations: Europe Beverages

The net profit from Europe Beverages of £73 million consists of Underlying profit from Operations of £112 million, Restructuring costs of £14 million, a Financing cost of £1 million, Taxation of £15 million and Disposal costs of £9 million.

The underlying tax charge for Europe Beverages is £31 million representing a rate of approximately 27.5%. In connection with the disposal, the Group has recorded a deferred tax credit of £11 million arising on the transfer of certain intellectual property assets out of the Europe Beverages companies prior to disposal. This has been excluded from the underlying tax rate of Europe Beverages.

We anticipate reporting a profit on disposal in 2006 of around £480 million after tax and expenses.

(vii) Minority Interests

(viii) Dividends

(ix) Earnings per Share

Underlying Earnings per Share (earnings before Restructuring costs, Non-trading items, brand intangibles amortisation, the IAS 39 adjustment and the recognition of a deferred tax in the UK) at 33.9 pence were 10% ahead of last year. At constant exchange rates and excluding the impact of the additional week in 2004, Underlying Earnings per Share were up 9%.

(x) Acquisitions and Disposals

Disposal proceeds of £41 million arose principally from the disposal of the Gumlink investment (see page 72) and the Holland House Cooking Wines brands.

(xi) Effect of Exchange Rates and Inflation on 2005 Reported Results

The overall impact of exchange rate movements on the Group's Revenue and Profit growth is shown separately. In 2005, movements in exchange rates increased the Group's Revenue by 2%, underlying pre-tax profit by 2% and underlying Earnings per Share by 2%. The impact on Underlying Profit from Operations was consistent with the impact on Revenues.

General price inflation in countries where the Group has its most significant operations remained at a low level throughout the year and in general terms was within the 1% to 3% range. In certain developing markets, notably Venezuela, Turkey, Brazil, Russia and Argentina, the rate of inflation was significantly higher than this range, but the impact was not material to the Group results.

2. 2005 Compared to 2004 – Business segments performance

Americas Beverages

• Strong Revenue performance with Revenue growth of 6%.
• Margins adversely impacted by 40 basis points reflecting a challenging cost environment.
• Improved non-carbonated soft drinks performance in the US with revenue ahead 4%.
• Continued good growth in Mexican beverages where revenue grew by 14%.

In the USA, carbonated soft drink Revenues rose by 6%. We outperformed the carbonated soft drink market for the second year in a row, gaining 40 basis points of share to 17.0%. Performance was driven by a 6% volume growth in Dr Pepper which benefited from the national roll-out of Dr Pepper Cherry Vanilla, strong growth in diets and fountain. Performance of our flavour brands was impacted by 7 UP where volumes fell by 8%.

Non-carbonated soft drink performance in the USA improved through the year with Revenues ahead by 4% in the year and 8% in the second half reflecting a strong performance from the core four brands (Snapple, Mott's, Clamato and Hawaiian Punch) and some buy-in by our customers ahead of price increases scheduled for the first quarter of 2006. Revenues in Mexico were up by 14%.

Margins were slightly lower year-on-year mainly due to the sharp increase in oil, glass, PET and transport related input costs. Price increases on our non-carbonated soft drink portfolio were taken in late 2005 and early 2006 in order to recover these cost increases.

Americas Confectionery

• Excellent Revenue growth of 10%, driven by power brands.
• Market share gains reflecting strong innovation pipeline.
• Continued margin improvement – led by Canada.
• Strong growth in emerging markets with revenue growth of 13%.

In North America, Revenue growth in the US of 11% was led by gum. A strong innovation pipeline, including the launch of Trident Splash and Dentyne soft chew drove healthy market share gains particularly in the second half. We gained 80 basis points of gum share during the year with the latest four week period over 300 basis points up at 30%. In Canada, branded Revenue rose by 8% and total Revenue by 4% reflecting a focus on a smaller range of profitable brands. This focus on more profitable growth led to over 150 basis points increase in margins in Canada.

In emerging markets, Revenue grew by 13% with double-digit growth in all territories, including Mexico up 10% and Brazil up 15%.

Strong margin performance was due to the combination of Revenue growth, focus on profitable growth in Canada and the cost benefit arising from the successful execution of key Fuel for Growth projects including the consolidation of production in Brazil and the transfer of Halls production from Manchester into Canada and Colombia.

Outside underlying Profit from Operations were restructuring costs of £21 million. These costs reflect the completion of the Adams integration projects in the USA (£6 million), including the completion of the transition off the Pfizer shared services system. Restructuring costs in Canada (£9 million), reflected the costs of transition off the Pfizer shared services systems as well as the cost required to rationalise the Canadian brand range and packaging options. Further costs were incurred, mainly in Brazil, following the closure of the Cumbica site and transfer of production to Bauru.

Europe, Middle East and Africa (EMEA)

• Revenue growth of 4%, driven by our emerging markets in Africa and Russia.
• Developed market revenue growth was modest, reflecting the difficult retail environment in Continental Europe.
• UK revenue ahead 2%, reflecting a planned reduction in innovation at the time of a major new IT implementation.
• Margins were flat year-on-year, with Fuel for Growth savings offset by IT implementation costs of £20 million in the UK.

In the UK, Revenue was ahead by 2%. Our overall market share rose by 10 basis points due to a focus on the Maynard and Bassett master-brands in sugar and growth in premium chocolate. The Green & Black's organic chocolate range grew year-on-year by 49%.

While Western European markets remain difficult, our focus on the growing gum and value-added sugar categories enabled our businesses in the region to register modest growth overall.

We grew our gum share in most countries, with share boosted by the highly successful launch of centre-filled gum under local brand names: such as Trident Splash in Greece; Hollywood Sweet Gum in France; and Stimorol Fusion in Sweden, Switzerland and Benelux.

Revenue in Russia rose by 32% benefiting from investments in upgrading the quality of our Dirol and Stimorol brands using Adams product technology and in sales force capabilities. Strong growth in South Africa was driven by the re-launch of Cadbury Dairy Milk.

Margins were flat year-on-year largely reflecting the £20 million cost of IT implementation in the UK. Fuel for Growth cost reduction projects included the final closures of the Manchester and Chesterfield plants in the UK, and our Adams Cape Town facility in South Africa.

Outside Underlying Profit from Operations were Restructuring costs of £22 million. These costs include the expenses associated with the relocation our Irish gum production facilities from the existing Pfizer site (£5 million), headcount reductions in our South African (£4 million) and French (£3 million) supply chain operations, the completion of the closure of the Manchester and Chesterfield plants in the UK (£2 million) and the integration of our Spanish and Portuguese businesses (£2 million).

Asia Pacific

• Strong Revenue growth of 8%.
• Developed market revenue growth of 7% and emerging markets ahead 11%.
• Good margin growth reflecting the benefits of cost reduction projects and a focus on profitable growth.

Our confectionery operations in Australia and New Zealand grew revenues by 7% following a number of highly successful new product launches in Australia (Cadbury Caramel Whip, Boost and Brunch Bar) and share recovery in New Zealand. Our beverage business in Australia grew revenues by 7% despite discontinuing a number of its smaller less profitable brands.

In Japan, innovation in gum, particularly in the Clorets and Whiteen brands, led to a 140 basis point increase in share to 16.8% and a further improvement in margins.

In emerging markets, India grew strongly with Revenue up 14% and chocolate share ahead by 120 basis points to 70.5%. Performance was also boosted by a resurgence in our business in Pakistan. In South East Asia, we continued to extend our share leadership in gum in Thailand (by 80 basis points to 58.9%), driven by the focus on sugar-free gum. The successful launch of Dentyne in Malaysia, using product sourced from our Thailand operations, saw our gum share increase by nearly 10 percentage points to 17.0%. In China, where we have been refocusing the business, Revenue was 11% ahead as we relaunched our Cadbury Dairy Milk range of products.

Margins in the region were 80 basis points ahead due to the benefits of cost reduction projects and a focus on profitable growth. Key efficiency projects during the year included supply chain optimisation in Australia and New Zealand; manufacturing consolidation in China; and automation of Bournvita production in India.

Outside underlying Profit from Operations were restructuring costs of £15 million. The main costs arose from headcount reductions in the Australian and New Zealand supply chain operations (£6 million), in the Indian supply chain operations (£5 million) and the reorganisation of the Chinese route-to-market (£2 million).

Central

Central Revenue arises on the rendering of research and development services to third parties. Central costs have increased from £149 million to £156 million, principally reflecting incremental investments in innovation and capabilities, notably the Building Commercial Capabilities programme.