BTPLC Annual Report 2006 - Consolidated financial statements

The total charge recognised in the income statement for the year in respect of share based payment plans was £76 million (2005: £50 million). The total value of share options and awards granted in the year ended 31 March 2006 was £64 million (2005: £77 million).
The company has an employee share investment plan and savings-related share option plans for its employees and those of participating subsidiaries, further share option plans for selected employees and an employee stock purchase plan for employees in the United States. It also has several share plans for executives. All share based payment plans are equity settled and details of these plans are provided below.

Share option plans

BT Group Employee Sharesave plans

There is an HM Revenue and Customs-approved savings related share option plan, under which 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. Options are granted annually, usually in June. Similar plans operate for BT’s overseas employees.
Employees may cancel sharesave options and remain employed by the group. In such cases the options so cancelled do not vest and the monthly savings contributions are returned to the employee, with interest if applicable. Such events are accounted for by ceasing to record a share based payments charge from the date of the employee’s withdrawal from the relevant plan. Previously recorded compensation expense is not reversed, and no charge is made for the accelerated vesting of future options that will not now vest.
For options outstanding at 31 March 2006 and 2005, the weighted average exercise prices are shown below.

			2006			2005

	Number of		Weighted	Number of		Weighted
	share		average	share		average
	options		exercise	options		exercise
	millions		price	millions		price

Outstanding at the beginning of the year	262		169p	233		180p
Granted during the year	59		179p	91		149p
Forfeited during the year	(20	)	173p	(59	)	176p
Exercised during the year	(2	)	215p	–		–
Expired during the year	(20	)	216p	(3	)	176p

Outstanding at the end of the year	279		166p	262		169p

Exercisable at the end of the year	–		–	16		218p

Options were exercised regularly throughout the year. The weighted average option price of options exercised during the year was 205p (2005: 183p).
The weighted average fair value of savings related share options granted during the year ended 31 March 2006 has been estimated on the date of grant using a binomial option pricing model. The following weighted average assumptions were used in that model: an expected life extending three months later than the first exercise date; share price at date of grant of 223p; estimated annualised dividend yield of approximately 5% (2005: 5%); risk free interest rates of approximately 4% (2005: 5%); and expected volatility of approximately 25% (2005: 25%). Volatility has been determined by reference to BT’s historical volatility over a three-year period, which is expected to reflect the share price of BT in the future. The exercise prices are 192p for Sharesave options exercisable three years after the date of grant and 171p for Sharesave options exercisable five years after the date of grant. The weighted average fair value of the share options granted in the year ended 31 March 2006 was 44p (2005: 41p) for Sharesave options exercisable three years after the date of grant and 55p (2005: 52p) for Sharesave options exercisable five years after the date of grant.
Options granted under BT’s international sharesave, which is a three-year plan, have been valued using the same assumptions. The weighted average fair value of these share options is 49p (2005: 52p). The exercise price is 171p, and the share price at date of grant was 214p.

Global Share Option Plan (GSOP)

There were no options granted under the GSOP in the 2006 financial year. The options granted in previous years will be exercisable subject to continued employment and meeting corporate performance targets. These options were valued using Monte Carlo Simulations. The weighted average fair value of options granted under the 2005 GSOP was estimated as 36p. The following weighted average assumptions were used in that model: dividend yield of 5%, expected volatility of 25% and risk free interest rates of 4%. Details of this plan are provided in the Report on directors’ remuneration.

BT Group Legacy Option Plan

On the demerger of O2, BT’s share option plans ceased to operate and were replaced by similar BT Group Employee Sharesave plans and the BT Group Global Share Option Plan.
The BT Group Legacy Option Plan was launched on 17 December 2001 following the scheme of arrangement and demerger of O2 in November 2001, and is therefore outside the scope of IFRS 2. Replacement unapproved options over BT Group shares were granted to all participants in the executive option plans who had released their options over British Telecommunications plc shares. The value of the replacement options was determined by averaging the combined prices of BT Group plc and O2 plc shares over the 20 dealing days following the demerger on 19 November 2001. This resulted in a factor of 1.3198 being applied to the former option over British Telecommunications plc shares in order to give the number of BT Group shares under the new option. The option prices of the original options were also adjusted to take account of the different number of shares under option. The options are exercisable subject to continued employment and meeting corporate performance targets, on the third anniversary of the date of grant.
For options outstanding at 31 March 2006 and 2005 in respect of the BT Global Share Option Plan and the BT Group Legacy Option Plan, the weighted average exercise prices are shown below.

			2006			2005

	Number of		Weighted	Number of		Weighted
	share		average	share		average
	options		exercise	options		exercise
	millions		price	millions		price

Outstanding at the beginning of the year	206		213p	194		216p
Granted during the year	–		–	31		193p
Forfeited during the year	(16	)	205p	(18	)	193p
Exercised during the year	(3	)	199p	–		–
Expired during the year	–		–	(1	)	353p

Outstanding at the end of the year	187		213p	206		213p

Exercisable at the end of the year	57		280p	34		206p

Outstanding options
Options outstanding under all share option plans at 31 March 2006 and 2005, together with their exercise prices and dates, were as follows:

	2006 Option price	2006	2005 Option price	2005
Normal dates of exercise	per share	millions	per share	millions

BT Group Employee Sharesave plans
2005	–	–	218p-255p	20
2006	154p-173p	20	154p-173p	22
2007	146p-227p	50	146p-227p	57
2008	154p-192p	103	154p	92
2009	146p	66	146p	71
2010	171p	40	–	–

Total		279		262

BT Group Legacy Option Plan
2001-2011	318p-602p	14	318p-602p	15

Total		14		15

BT Group Global Share Option Plan
2005-2012	163p-263p	45	163p-263p	51
2004-2014	176p-199.5p	100	176p-199.5p	110
2007-2015	179p-215p	28	179p-215p	30

Total		173		191

Total outstanding options		466		468

The options outstanding under all share option plans at 31 March 2006 and 2005 have weighted average remaining contractual lives as follows:

Executive plans

			2006				2005

Range of exercise prices	Weighted average exercise price	Number of outstanding share options (millions)	Weighted average contractual remaining life	Range of exercise prices	Weighted average exercise price	Number of outstanding share options (millions)	Weighted average contractual remaining life

150p - 249p	195p	171	89 months	150p - 249p	195p	190	100 months
250p - 349p	302p	8	65 months	250p - 349p	304p	8	77 months
350p - 650p	552p	8	53 months	350p - 650p	554p	8	65 months

Total		187				206

All-employee plans

			2006				2005

Range of exercise prices	Weighted average exercise price	Number of outstanding options (millions)	Weighted average contractual remaining life	Range of exercise prices	Weighted average exercise price	Number of outstanding options (millions)	Weighted average contractual remaining life

100p - 199p	158p	243	39 months	100p - 199p	154p	203	47 months
200p - 300p	220p	36	18 months	200p - 300p	222p	59	22 months

Total		279				262

Other share based payment plans

Incentive Share Plan, Deferred Bonus Plan and Retention Share Plan

The BT Group Incentive Share Plan (ISP) and the BT Group Retention Share Plan (RSP) were introduced for employees of the group in 2001. Under the plans, company shares are conditionally awarded to participants.
     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 measure and if the participants are still employed by the group. The corporate performance measure is BT’s total shareholder return (TSR) measured against a group of companies from the European Telecom Sector at the beginning of the relevant performance period. The ISP was operated in the 2006 financial year with 1,382 participants receiving awards over 23,183,408 shares (2005: 1,406 participants received awards over 12,654,013 shares). Awards under the ISP have been valued using Monte Carlo Simulations. TSRs were generated for BT and the comparator group at the end of the three-year performance period, using each company’s volatility and dividend yield, as well as the cross correlations between pairs of stocks. Simulations were run using averaged one and three-year volatility and dividend yield for BT and the comparator group. The weighted average fair value of awards of shares granted under the ISP has been estimated at 124p (2005: 98p).
     Historical dividend yields of 4.8% and 4.1% and volatility of 18% and 24% were used in the one-year and three-year models respectively.
     Under the RSP, the length of retention period before awards vest is flexible. Awards may vest in annual tranches. The shares are transferred at the end of a specified period, only if the participant is still employed by the group. During the 2006 financial year 1,107,330 shares vested in 16 participants in the RSP (2005: 1,340,256 shares vested in 11 participants).
     The BT Deferred Bonus Plan (DBP) was established in 1998 and awards are granted annually to selected employees of the group. Under this plan, shares in the company are transferred to participants at the end of three years if they continued to be employed by the group throughout that period. On 1 August 2005, 1,966,496 shares (2 August 2004: 1,280,934 shares) were transferred to 193 participants (2 August 2004: 219 participants) at the end of the three-year deferred period. At 31 March 2006, 24.7 million shares (2005: 27.8 million shares) in the company were held in trust for employee share plans, of which 12.4 million shares (2005: 12.7 million shares) were held for the ISP, 2.9 million shares (2005: 2.8 million shares) were held for the RSP and 5.9 million shares (2005: 7.9 million shares) were held for the DBP. In accordance with the terms of the plans, dividends or dividend equivalents earned on the shares during the conditional periods are reinvested in company shares for the potential benefit of the participants.
     Awards under the DBP and RSP were valued by reference to the weighted average market price of the shares on the date of grant of 223p and 216p respectively.

Employee Share Investment Plan

The BT Group Employee Share Investment Plan (ESIP) has been in operation since December 2001. The ESIP, which has been approved by HM Revenue & Customs, comprises ‘directshare’ and ‘allshare’. Under directshare, UK employees are given an opportunity to purchase shares (partnership shares) out of pre-tax salary up to a maximum value of £1,500 per year. During the 2006 financial year, 6.4 million shares (2005: 6.1 million shares), including 0.8 million shares (2005: 0.2 million shares) purchased by dividend reinvestment, were purchased by the Trustee of the ESIP on behalf of 14,443 (2005: 13,017) employees at a total cost of £13.7 million (2005: £11.7 million). Allshare, the free shares element of the ESIP allows BT to provide free shares to UK employees which are held in trust for at least three years. Employees outside the UK receive cash awards equivalent to the value of the free shares. In 2006, 1% (2005: 0.5%) of pre-tax profits, amounting to £22 million, was allocated to allshare (2005: £11 million). Up to 2% of pre-tax profits would have been available subject to meeting two corporate performance targets; one of these to maintain earnings per share at the same level as in the 2005 financial year, and the other to have five percent more customers very or extremely satisfied with BT (provided the percentage of customers who are dissatisfied did not increase compared with the 2005 financial year). The earnings per share target was met but not the one for customer satisfaction. The ESIP replaced the BT Employee Share Ownership Scheme which operated for employee profit sharing until 2001.

Employee Stock Purchase Plan

The BT Group Employee Stock Purchase Plan (ESPP), for employees in the US, enables participants to purchase American Depositary Shares (ADS) quarterly at a price (the Initial Base Option Price) which is 85% of the fair market price of an ADS at the start of the Initial Enrolment Period (or, in the case of employees who enrol in the ESPP after the Initial Enrolment Period, 85% of the fair market price of an ADS on the last business day of the calendar quarter immediately following enrolment). From 15 May 2005 to 15 May 2006, 1,750,560 shares (175,056 ADSs) have been transferred to participants out of treasury under the ESPP (from 15 May 2004 to 15 May 2005, 934,782 shares (93,478 ADSs)). The third offer, with an Initial Base Option Price of US$31.52 ended in December 2005. A fourth offer was launched in December 2005 with an Initial Base Option Price of US$32.53 and will expire in December 2006.

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