3i Group
Annual Report 2003

Plain-text annual report

3i Group plc Report and accounts 2003 3 i l G r o u p p c R e p o r t a n d a c c o u n t s 2 0 0 3 3i Group plc 91 Waterloo Road London SE1 8XP England Telephone +44 (0)20 7928 3131 Fax +44 (0)20 7928 0058 Website www.3igroup.com M38703 May 2003 Contents 02 Chairman’s statement 04 Chief Executive’s statement 06 Operating review 14 Financial review 20 Board of Directors 22 Corporate Social Responsibility report 25 Directors’ report 30 Remuneration report 38 Independent auditors’ report Financial statements 39 Consolidated statement of total return 39 Reconciliation of movement in shareholders’ funds 40 Consolidated revenue statement 41 Consolidated balance sheet 42 Parent company balance sheet 43 Consolidated cash flow statement 44 Accounting policies 46 Notes to the accounts 66 Principal subsidiary undertakings and joint ventures Additional financial information 67 Portfolio valuation methodology 68 Ten largest investments 69 New investment analysis 70 Portfolio analysis 72 Realisations analysis 72 Funds under management Inside back cover Information for shareholders Investor relations and general enquiries Five year record Net asset value per share (p) Dividend per share (p) Total return (£m) Return on opening shareholders’ funds (%) Revenue profit after tax (£m) Realisation proceeds (£m) Realised profits/(losses) on disposal of investments (£m) 2003 480 2002 2001 2000 1999 645 815 847 601 13.5 13.0 13.0 12.2 11.3 (935) (960) (142) 1,579 (23.7) (19.3) (2.7) 43.8 140 976 184 106 116 115 939 1,551 1,132 (39) 453 350 177 5.1 110 852 180 Unrealised value movement on revaluation of investments (£m) (1,165) (890) (676) 1,167 (90) Investment (£m) Share price at 31 March (p) 931 1,039 1,972 1,376 1,147 417 787 1,122 1,318 626 Comparison of 3i compound annual return v. FTSE All-Share (%) for the years ending 31 March 2003 (15.8) (15.4) (2.0) (6.6) 3 years 5 years 7 years 10 years 3i return FTSE All-Share 3.7 2.0 10.1 5.5 3i Report and accounts 2003 Information for shareholders Financial calendar Ex-dividend date Record date Annual General Meeting Final dividend to be paid Interim dividend expected to be paid Shareholder profile Location of investors at 31 March 2003 1 UK (including retail shareholders) 2 Continental Europe 3 US 4 Other international Share price Share price at 31 March 2003 High during the year (2 April 2002) Low during the year (9 October 2002) Balance analysis summary Range 1 – 1,000 1,001 – 10,000 10,001 – 100,000 100,001 – 1,000,000 1,000,001 – 10,000,000 10,000,001 – highest Total 18 June 2003 20 June 2003 11.00am 9 July 2003 18 July 2003 January 2004 83.46% 6.44% 6.73% 3.37% 417p 811p 407p Number of holdings Individuals 28,603 6,770 194 21 0 0 35,588 Number of holdings Corporate bodies 3,846 2,511 646 373 100 7 7,483 Balance as at 31 March 2003 16,559,435 21,168,608 30,214,167 131,242,917 290,082,185 121,650,941 610,918,253 % 2.71 3.47 4.95 21.48 47.48 19.91 100.00 The table above provides details of the number of shareholdings within each of the bands stated in the Register of Members at 31 March 2003. Registrars For shareholder administration enquiries, including changes of address, please contact: Lloyds TSB Registrars The Causeway Worthing West Sussex BN99 6DA Telephone +44 (0)870 600 3953 Investor relations and general enquiries For all investor relations and general enquiries about 3i Group plc, including requests for further copies of the Annual Report and accounts, please contact: Group Communications 3i Group plc 91 Waterloo Road London SE1 8XP Telephone +44 (0)20 7928 3131 Fax +44 (0)20 7928 0058 email ir@3igroup.com or visit our new investor relations website www.3igroup.com for full up-to-date investor relations information including the latest share price, recent annual and interim reports, results presentations and financial news. 3i Group plc is a deposit taker regulated by the Financial Services Authority. Designed and produced by Radley Yeldar (London). Printed by CTD Capita. The paper used for the production of this brochure is manufactured from 50% totally chlorine free pulps sourced from plantation forests, offcuts and forest thinnings. The further 50% is manufactured from recycled fibres. 01 3i Report and accounts 2003 An introduction to 3i 3i is Europe’s leading venture capital company. We focus on buy-outs, growth capital and early stage technology and invest across Europe, in the United States and in Asia Pacific. Our competitive advantage comes from our international network and the strength and breadth of our relationships in business. This network provides unrivalled market access, helps us to win the deals we want to do and is a source of added value in building and realising value for our shareholders. Financial results Net asset value per share Dividend per share Total return on opening shareholders’ funds Revenue profit after tax Realisation proceeds Realised profits on disposal of investments Unrealised value movement on revaluation of investments Investment 480p 13.5p (23.7)% £140m £976m £184m £(1,165)m £931m Investment amounts referred to in this report relate to investments made by 3i Group and third party unquoted funds unless otherwise stated. Portfolio amounts referred to in this report relate to assets owned by 3i Group and exclude assets managed on behalf of third parties unless otherwise stated. 3i’s performance for the year against the most commonly used indices Total return (%) for the year to 31 March 2003 3i FTSE 100 FTSE All-Share FTSE SmallCap MSCI Europe FTSE techMARK 100 (50.0) (23.7) (29.1) (29.8) (33.4) (37.7) 02 3i Report and accounts 2003 Chairman’s statement Baroness Hogg Chairman “The substantial changes we have made to the business in the past year to sharpen our competitive position, improve our investment processes and increase efficiency provide 3i with a much stronger base for growth.” This has been a year of challenge and change for 3i. Our mid-market buy-out business achieved a strong performance, despite the faltering economic recovery. But market conditions were particularly difficult for our technology portfolio. 3i has responded to the challenge by restructuring its organisation along product lines, giving clear leadership to all parts of the business, while using its international network to help the portfolio companies in which it invests to realise their potential for growth. The rigour with which we have reviewed the value of our technology portfolio has had an impact on our net asset value, contributing to a negative return on shareholders’ funds of 23.7% over the year to 31 March 2003. It may be small comfort to shareholders that this is still less than the drop in our benchmark, the FTSE All-Share, which fell 29.8%, or the FTSE SmallCap, which was down 33.4%. As the charts on page 1 show, we have also maintained our record of long term outperformance. But our share price, which proved volatile during the year, was 47% down in the year to 31 March. Despite the virtual closure of the market for new issues, we achieved a strong flow of realisations: a total of nearly £1 billion, at a healthy profit over the value at which these investments were held at the beginning of the year. Income, too, has held up well in a difficult environment, and costs have been reduced. The Board is recommending a final dividend of 8.6p, making a total dividend of 13.5p, an increase of 3.8% from 13.0p last year. A particular strength of 3i’s business in times like these is the balance of our three key product groups – buy-outs, growth capital and early stage technology. Our Chief Executive, Brian Larcombe, has carried out an extensive reorganisation of management and investment processes to provide each with international leadership and focus. The buy-out business, led by Jonathan Russell, achieved some strong realisations during the year such as Go, the low cost airline. The benefits of local origination of investment opportunities, sector focus and product expertise are also coming through with new investments by the buy-out team, such as De Telefoongids. 03 3i Report and accounts 2003 Chairman’s statement The strength of 3i’s balance sheet and its leading positions in the key venture capital and private equity markets mean that the business has the robustness needed during the downturn in markets and economic conditions. This combination also means that 3i is well positioned to take advantage of an upturn. The substantial changes we have made to the business in the past year to sharpen our competitive position, improve our investment processes and increase efficiency provide 3i with a much stronger base for growth. Baroness Hogg Chairman 14 May 2003 Our growth capital investment business, for which there is a considerable market opportunity, has received fresh impetus under the leadership of Chris Rowlands, who has rejoined 3i as a member of the Executive Committee. Under the leadership of Rod Perry, our early stage technology business is now more narrowly targeted on the sectors which we believe will offer the best investment opportunities. It is also focused on achieving good realisations from our existing portfolio. As I indicated at the half-year, there have been a number of changes to the Board. Two executive Directors, Richard Summers and Peter Williams, retired from the Board at the end of 2002. I would like to thank them for the major part they played in the development of 3i right through the 1980s and 1990s. Christine Morin-Postel, who joined the Board in September as a non-executive Director, brings a wealth of international experience in financial services and industry and is already making an important contribution. I would also like to pay tribute to our staff, who have shown a high degree of energy and realism throughout the year, and are constantly alert to good opportunities to invest. 04 3i Report and accounts 2003 Chief Executive’s statement Brian Larcombe Chief Executive “Our priorities have been to pursue our core strategy, rebalance our investment activity, improve the quality of our processes and investment portfolio, and increase specialisation.” Overview For the second consecutive year, we are reporting a substantial fall in the value of the portfolio and shareholders’ funds. The market has undoubtedly been difficult and, particularly for early stage technology companies, the operating environment has been the toughest for a very long time. Our Operating review considers the performance of our product businesses – buy-outs, growth capital and early stage technology – in more detail. In summary, our mid-market buy-out business performed well and achieved a positive return. Our smaller buy-out business and our growth capital business both performed satisfactorily but produced negative returns, partly because of reduced valuations arising from falling stock markets. Our early stage technology business saw a substantial fall in the value of its portfolio and was the principal factor contributing to the Group’s negative total return. The return from our mid-market buy-out business of 5% and the negative return of 12% in our growth capital business compare strongly with the movements for the All-Share Index of minus 29.8% and the SmallCap Index of minus 33.4%. Our early stage technology business saw a decline of 51%, which is very similar to the fall in the techMARK Index of 50.0%. At the Group level, we generated about £1 billion of realisation proceeds, at good prices, and this has enabled us to retain our balance sheet strength. We have maintained our long term strategy but have taken significant actions to improve the quality of our processes. Market conditions The weakness in stock markets in the year clearly recognises the slowing down of world economies and the continuing pressure on corporate profits. This has had a major impact on the private equity industry which has seen falling returns and a difficult fundraising climate. For calendar year 2002, total investment in private equity and venture capital in the US and Europe is estimated to have increased by approximately 10% to $91 billion. However, within this total, buy-out investment was up 69% to $61 billion, whereas early stage investment was down 53% to $4.1 billion in the US and by 66% to $2.5 billion in Europe. We have continued to invest in line with our strategy of building a balanced portfolio. In our main European markets, we invested in about 10% of completed transactions, thereby maintaining our market leading position. Liquidity for the private equity and venture market has generally been difficult with significantly lower levels of mergers and acquisitions activity and virtually no IPOs. In this environment, it is very encouraging that we saw such a strong interest in many of our portfolio companies. Strategy and competitive advantage Our strategy is to: • develop the business internationally; • build a balanced investment business; • use the network as our key competitive advantage; and • invest primarily in growth companies. Our network enables us to use our local presence and established relationships to identify opportunities in which to invest. This, combined with our scale, gives us the ability to use specialist resources for winning deals, carrying out extensive referencing and adding value to our portfolio companies. A key element of our strategy is maintaining a balanced business with about 40% of our assets in buy-outs, 40% in growth capital and 20% of our portfolio in early stage technology based companies. The proportion of our portfolio in technology companies increased during the bubble in 05 3i Report and accounts 2003 Chief Executive’s statement Portfolio value by product (£m) as at 31 March 2003 Buy-outs* Growth capital* 1,927 1,206 Early stage technology 589 Quoted Total 217 £3,939m * Buy-outs and growth capital include a total of £544m in unquoted late stage technology companies. See page 71 for further information. Portfolio value by geography (£m) as at 31 March 2003 UK Continental Europe 1,175 US Asia Pacific Total 180 90 2,494 £3,939m Portfolio value by FTSE classification (£m) as at 31 March 2003 Resources Industrials Consumer goods Services and utilities Financials Information technology Total 186 274 944 873 1,018 644 £3,939m 2000 and 2001, which has damaged our short term performance, but we have now broadly restored the shape of the portfolio in line with our long term strategy. We seek to invest in companies with good growth potential rather than relying on financial engineering as the driver of value growth. Additionally, we look for growth markets, a strong and well-balanced management team and a business strategy that will deliver value to all shareholders. Strategy and management action We have adjusted our resources and organisation to meet the market challenges. The process of reorganising the business on to a product as well as geographical basis is now largely complete. We have also reduced staff numbers to align resources with market conditions. Our business is led on a product and sector basis. Jonathan Russell heads up our buy-out business and Rod Perry our technology business. Following the retirements of Peter Williams and Richard Summers, who had respectively run our UK and continental European networks, we were particularly pleased to recruit Chris Rowlands back to 3i. Chris is, in addition to responsibilities for the UK regional network and the northern European countries, driving forward our growth capital business across Europe. The drivers of change in our product approach have been specialist teams, focused marketing and using our resources on a pan European basis. This model, which we adopted in our buy-out business two years ago, is working well and delivering strong investment opportunities. Key elements of this approach include a refined investment process and a new performance management system for our staff. We closed our office in Tokyo and subsequently our office in Dublin, but made no other changes to our country network. In Japan, we had hoped to develop a mid-market buy-out business, but after three years it became clear that this market was not developing at a rate to support a local presence. Our decision to close our Dublin office reflected the slower than expected development of the Irish private equity market. In Germany, market conditions have been very tough, particularly for early stage companies, and we have carried through a major restructuring resulting in the closure of our offices in Hamburg and Berlin. Outlook In the short term, the outlook for corporate profits growth remains weak. Against this background, we are actively managing the portfolio and focusing investment on those companies that can thrive in this more difficult environment. Market weaknesses and imperfections also create great opportunities and we are mindful that the recession years of 1992-93 were excellent vintages in terms of investment returns. Although cautious about the short term outlook, I have every confidence in 3i’s business. Brian Larcombe Chief Executive 14 May 2003 06 3i Report and accounts 2003 Go Fly Limited The sale of Go Fly, the low cost airline, to easyJet in July 2002 crystallised a total return of £91 million (including £86 million of realised capital profits) on its investment (made in June 2001) of £56 million. 3i’s industry knowledge, experience and contacts from earlier investments were valuable in allowing it to evaluate the investment opportunity and in winning management’s support for a 3i-led deal. 3i’s previous contact with British Airways was also important in the 3i-led proposal being selected as the preferred bidder in June 2001. Featured: Barbara Cassani, CEO of Go Fly and Tom Sweet-Escott, 3i Director. Operating review Overview This review comments on the operations of our buy-out, growth capital and early stage technology businesses and covers the market conditions and our operating performance in Europe, the US and Asia Pacific. The review also comments on our third party fund management activities. We see the market through the local access that the 3i network provides, through our sector teams, through the relationships that we have built with large corporates and through the people programmes we run for chairmen, chief executives and independent directors. We aim to select the most attractive opportunities through harnessing our international network and experience and by assembling the best team for the job from our regional, sector and buy-out specialists. A transaction like De Telefoongids (profiled on page 7), involved our local office in Amsterdam, two of our sector teams, Media and Communications, as well as members of our pan European buy-out team. A panel of our most experienced buy-out investors ensures rigorous application of our investment process and provides additional guidance to try to ensure that we win the buy-outs that we want to do at an attractive price. Once we have made an investment, it is critical that we add value. We do this through the investee company board, through our knowledge and experience and through our network. Buy-outs 3i continues to lead the pan European mid-market for buy-outs and this part of the business, led by Jonathan Russell, has performed strongly through the year. 3i’s focus within this market is on transactions with a value from c25 million to c500 million. The vendors of these companies are typically large corporates disposing of non-core subsidiaries or private groups with succession issues. Market statistics for calendar year 2002 show that there were 153 transactions in this segment of which 3i invested in 18. 3i is also active in the smaller buy- out market (below c25 million). This is a more fragmented segment and one in which 3i’s local network provides ideal access to the private vendors, management teams and local advisers involved. During the year to 31 March 2003, 3i made 63 buy-out investments, with 3i and funds managed by 3i investing £482 million, of which 3i led 14 new mid-market deals investing £338 million including co-investment funds. Realisations from the buy-out portfolio were strong with total proceeds of £613 million, including £144 million from the sale of Go. These realisations were achieved at an aggregate equity uplift of 69%. Our buy-out performance is driven by a clear product strategy, which is rigorously applied. This strategy is to build competitive advantage from our scale and local knowledge so that we see the market, select the most attractive investment opportunities and drive value from our portfolio. De Telefoongids PaperPak In February 2003, 3i co-led the £345 million buy-out of the De Telefoongids telephone directories business from KPN (the Dutch telecommunications group), investing £22.6 million of its own capital. 3i’s local presence in Amsterdam, the use of sector and buy-out specialists within its investment team, its prior investment experience and knowledge of telephone directories businesses and its ability, through its network, to source a CEO and a number of key managers with highly relevant directories business experience combined to help create a winning bid. In September 2002, 3i led the £65 million buy-out of PaperPak, an international manufacturer and supplier of adult incontinence products. 3i’s investment totalled £15.3 million. The combination of 3i’s local presence in Stockholm, supported by buy-out specialists from London, and 3i’s knowledge of the sector both persuaded the incumbent management team to work with 3i and enabled 3i to appraise and execute the investment opportunity. 3i also introduced a chairman with relevant strengths from its Partnership Programme and a non-executive director, with a background in healthcare and turnaround situations, from its Independent Directors Programme. Featured: Alan Peterson (left), Chairman of PaperPak and Chris Williams, Director of 3i London Buy-out team. 07 3i Report and accounts 2003 Operating review Growth capital Growth capital has always been a core part of 3i’s business. It involves the provision of capital to accelerate the growth of established businesses and generally involves investing in a minority equity position. It is a product suited to a diverse range of growth opportunities, including acquisitions, increasing production capacity, market or product development, turnaround opportunities, shareholder succession and change of ownership situations. In the second half, we observed signs of increasing demand for growth capital, resulting from two main factors. Firstly, companies were unable to raise capital by achieving an IPO on European stock markets and, secondly, debt providers adopted a more cautious view on the level of finance they would advance. Both these factors are increasing demand for growth capital. Furthermore, as and when the economic outlook improves, we would expect deferred expansion and acquisition plans to be reactivated, giving rise to an increasing demand for growth capital. We believe that we are well placed to take advantage of these conditions. 3i’s investment in Go (profiled on page 6) was a good demonstration of our approach to this market. Access to the original investment was gained through strong corporate relationships with British Airways and its advisers. Past experience, track record and relationships in the sector enabled 3i to take an informed view and win the transaction at the right price, £110 million. Through the efforts of the management team and staff, led by CEO Barbara Cassani, both market share and profitability levels increased. They were supported with the introduction of Keith Hamill as Chairman and non-executive directors, including Paul Sternbetz, who was formerly Operations Director for Southwest Airlines in the US. easyJet, a natural strategic buyer for Go, made a successful bid in July 2002 of £374 million for the business. Our view is that the medium term outlook for buy-outs is improving. Economic conditions and depressed public markets are encouraging corporate restructuring and the selling off of non-core activities. Reduced levels of corporate mergers and acquisitions activity mean there is less competition from trade buyers. We believe that there is a significant amount of pent up demand, both in terms of corporates with subsidiaries to sell and of good management teams keen to gain their independence. Ten largest 3i-led buy-out investments in the year Transaction size £m 3i and funds total investment £m Company De Telefoongids Business description Country Telephone directories The Netherlands 345 Westminster Health Care Care homes operator UK SR Technics Esmalglass E2V technologies Extec PaperPak United Transport Tankcontainers Repair and maintenance of aeroplane engines and frames Switzerland Manufacturer of frites and glazes for ceramic tiles Spain Switching, sensing and imaging components Manufacturer of mobile crushing equipment Manufacturer of incontinence products Tank container operation moving hazardous chemicals UK UK US/Europe Partners for Finance/Legal Marketing Services Specialist financial services UK Ascent Technology IT software consultancy and supply UK 37 17 The Netherlands 65 301 293 159 77 68 65 45 55 70 48 21 15 24 12 9 10 08 3i Report and accounts 2003 Operating review Our strategy for this product targets investments from 3i of between £2 million and £30 million, across a range of sectors. This product is primarily focused on 3i’s European and Asia Pacific markets and has historically had a less competitive environment than buy-outs. Success in this market is determined by the ability to build long term relationships with local businesses and local intermediaries, as well as demonstrating the capability of helping these businesses to grow. This fits well with our strategy of local presence, sector specialisation, sharing knowledge and offering local businesses access to our international network of relationships. Chris Rowlands was appointed to lead growth capital investment in September 2002 and he has brought a more focused approach to deal origination and the key processes for this product. A Product Leadership Team, with representatives of each of the targeted regions in Europe, coordinates individual country activities, develops and implements strategy and operates as a forum for sharing ideas on a range of best practices. Certain sectors are ideally suited to the growth capital product. A good example is the oil and gas sector. The North Sea exploration and production sector is undergoing significant change and a number of new independent businesses are emerging as the next generation of North Sea oil companies. In the oil and gas services sector, the ability to provide services on an international basis is an important competitive advantage, and capital is required to enable the development and international distribution of products and services. 3i’s sector knowledge, local presence and international network combine to position us as Parkdean Holidays plc Prosol Gestion 3i invested in Parkdean in November 1999 and achieved a full realisation, via a listing on AIM in May 2002, earning a total return of £3.8 million on its £7.0 million investment. Parkdean was set up to undertake a buy and build strategy in the UK caravan park business. 3i contributed to the successful implementation of this strategy through the provision of appropriate financial engineering, strategic support as the company made and integrated four acquisitions and through the introduction of Graham Wilson, an executive chairman who was well known to 3i, having worked on three previous 3i investments and who had a strong track record in the leisure industry and in making acquisitions. In January 2003, 3i invested c14 million in Prosol Gestion, a specialist retailer of fresh, chilled and ambient food based in Lyon, France, to help fund the rapid roll-out of 70 new stores over the following five years and thereby to secure Prosol’s leading position in this attractive product category. Three factors were key to 3i winning the deal against intense competition: 3i’s local presence in Lyon; its ability to fund potential further rounds of investment; and its retail sector contacts, which were instrumental in allowing senior Prosol management to have direct access to senior management at a leading UK food retailer. 3i has recently introduced a non-executive director with relevant sector and roll-out experience. 09 3i Report and accounts 2003 Operating review ultrafilter AG The sale in July 2002 of ultrafilter AG to US based Donaldson Corp. enabled 3i to crystallise its minority investment in the Haan (Germany) based specialist filter technology business. 3i´s initial growth investment in 1989 was followed by two further funding rounds, in 1996 and 2000, to support the expansion of ultrafilter’s export business and an acquisition in northern Germany respectively. 3i’s local presence in Dusseldorf enabled 3i to stay close to management throughout, providing strategic input during the earlier expansion and acquisition phases and at the latter exit stage. In addition, 3i was key in sourcing a new CFO when that position became vacant. However, following a restructuring under the leadership of Rod Perry, we now have a tightly focused business which is targeted at four key sub-sectors. We have also focused this activity on a smaller number of our locations and have refined the investment process. As a result, we now believe 3i is well positioned to take advantage of current market conditions and to seize the opportunity presented by an improved environment in the medium term. We continue to develop and nurture our relationships with key larger corporates in each sub- sector, since these corporates are potentially customers, partners or ultimate buyers of our individual portfolio companies, and to share these relationships with our portfolio companies. The events we hold for portfolio CEOs and key larger corporates are one way in which we do this. For example, the 3i eSecurity CEO Conference at the IESE business school in Barcelona in November 2002 was attended by over 20 3i-backed companies and 25 corporates, including IBM, Sun Microsystems and Microsoft. The year to 31 March 2003 saw total investment of £176 million, and realisation proceeds of £93 million, at an equity loss of 26% on the carrying value at 31 March 2002. The two biggest early stage technology markets, Europe and the US, both experienced significant falls in aggregate investment during 2002. According to market statistics, the total amount invested in Europe fell 66% to $2.5 billion. Most of this investment was in support of existing venture capital backed businesses rather than in completely new opportunities. 3i also saw this pattern, with 78% of early stage technology investment during the financial year being in our existing portfolio. The US market has shown a similar fall. According to market statistics, aggregate investment fell by 53% in 2002. Our US business is also now making a contribution to the rest of the Group, through the relationships we have been building with larger corporates such as IBM. a strong financial partner to such businesses. Major transactions by our Oil and Gas team in Aberdeen during the year included the investments in Petrofac Limited and Faroe Petroleum Limited, and the partial realisation, through an IPO on the London Stock Exchange, of our investment in John Wood Group plc. In addition, the sale of Orwell Group plc crystallised a total return for 3i of £35.0 million on our total investment of £2.9 million. During the year, we invested £273 million (2002: £258 million) in growth capital transactions, 46% (2002: 32%) of which was in companies new to our portfolio. However, despite difficult conditions for sales and IPOs, a good level of realisations was achieved, with proceeds of £270 million during the year and an equity uplift of 30%. Early stage technology The continuing depressed state of the technology and capital markets meant that 3i’s early stage technology business, which at 31 March 2003 represented 15% of our assets, had a difficult year. A negative return of £(671) million, arising principally from a reduction in the value of the portfolio to reflect these market weaknesses, severely impacted the performance of the Group as a whole. Balance and flexibility A key theme underpinning our business is “balance and flexibility”, which has a number of different aspects. Firstly, our ability to balance the strengths of our international network with our local presence gives us a strong and unique source of competitive advantage, enabling us to originate an attractive deal flow and to assemble the “best team for the job”. We can draw upon complementary skills and knowledge across international, sector and product boundaries. We invest across each of the three product categories within private equity and venture capital – buy-outs, growth capital and early stage technology – with product specialists in each. We strive for balance in our investment activity in terms of product, geography and industry sector. 3i’s balance sheet enables us to take a view of the relative attractiveness of the new investment and realisations markets. In an uncertain environment, we have sought to achieve a balance between these two key aspects of our business, but we are able to flex their respective levels in line with our view of market conditions. We are also able to take a balanced and flexible view with regard to the period we hold individual investments. We aim for balance as regards our people. Our culture embraces a balanced lifestyle between work and family; and in our people we seek a rounded set of qualities – we recognise the need for strong technical and task-oriented skills and the benefits of competitive behavioural instincts, but equally emphasise other qualities such as sound judgement, the ability to work in a team, as well as communication, motivational and influencing skills. Finally, we aim to take a balanced outlook in planning our business activity, recognising the risks that face us and our need to manage them, but also having an eye for opportunity and ensuring we are well placed to exploit it. 10 3i Report and accounts 2003 3i Report and accounts 2003 Operating review The key factor in the weak investment performance of early stage technology companies has been the depressed state of the markets for their products and services. The most important cause of this has been the significantly reduced levels of expenditure by corporates on information technology and related applications. A number of 3i’s investments have underperformed as their business models have been undermined by significantly lower levels of demand than expected. A number of technology companies have also experienced difficulty in translating a strong product into a commercial success. An example is Weston Medical, a 3i investment that achieved an IPO in 2001. Weston’s needle-free injection product was technically respected but the company was unable to translate that into commercial success, and recently went into receivership. In the context of the reported performance of 3i’s early stage technology investments made in the period 1999 through 2001, the “J-Curve” phenomenon (so named because the reported performance of a portfolio or vintage of technology investments tends to dip in the early years before rising again, as poor and failing investments become apparent before the successful ones) is interesting. While the continuing depressed markets and the difficulty of commercialising newly developed products have adversely affected the reported performance of that portfolio, the J-Curve phenomenon would hold that the performance of the remaining portfolio should improve as more of the underlying businesses achieve success and the investments are realised. The financial performance of the early stage technology portfolio was also adversely affected by falls in value. Valuation of technology companies usually involves reference to valuation ratios of listed companies or the price at which similar companies have been acquired. However, the absence of an active market for IPOs and a low level of mergers and acquisitions activity have diminished the usefulness of these traditional benchmarks. Another benchmark involves reference to the value at which private companies in the early stage technology sector are currently raising capital. During the year, capital has generally been raised through funding rounds at lower capitalisations than previous rounds, even when a company is meeting its milestones, and they have therefore become known as “down rounds”. Our valuations reflect the impact of actual down rounds undertaken by our portfolio companies, and also at 31 March 2003 the application of this benchmark to companies with no imminent plans to seek funding. The combined down round effect during the year was a £361 million reduction in value of which £269 million was in respect of early stage technology investments. In conclusion, the early stage technology business has seen a significant loss of value this year but the portfolio has been valued using prudent assumptions regarding the outlook for market conditions, and the business has been reshaped for the market we now face. Europe Economic conditions across Europe weakened during the year. In general, manufacturing sectors experienced difficult conditions but the downturn has spread to all sectors, including retail and services, largely driven by weakening consumer demand. The prevailing economic uncertainty continues adversely to affect the levels of private equity investment, as institutional investors, banks and equity providers have become more cautious and vendors of businesses have become increasingly unwilling to sell in the face of falling prices. Additionally, expansion and acquisition plans have been deferred and spending on information technology by corporates has reduced. Offsetting 11 3i Report and accounts 2003 3i Report and accounts 2003 Operating review Adaytum Software Inc PlaceWare Inc The sale of Adaytum Software, Inc. a provider of financial planning software products to businesses, in January 2003 crystallised a total profit for 3i of £6.5 million on its total investment of £6.1 million, made over six investment rounds since January 1997. A key element in the successful development of the business was the expansion into and establishment of a strong base in the US, both of which were facilitated through 3i’s contacts there, with venture capital firms and others. Featured: Guy Haddleton, former CEO, Adaytum Software, Inc. In January 2003, PlaceWare Inc, a provider of web conferencing services that enable businesses to conduct real-time, interactive presentations and meetings over the internet, announced that it had entered into an agreement to be acquired by Microsoft Corp, providing 3i with realisation proceeds of $14 million on its November 2001 investment of $7 million. 3i led the private placement financing round in 2001 and subsequently helped PlaceWare build its European business by facilitating approaches to 3i’s network of portfolio companies. 3i’s board representative at PlaceWare established the initial contact with Microsoft that ultimately led to the sale and also played a lead role in the sale negotiations. these negative factors, economic conditions have encouraged corporate restructuring and the selling off of non-core assets, which has created opportunities for buy-outs. Against this background, market statistics show that the total amount of private equity monies invested in Europe in 2002 increased to c27.2 billion from c24.3 billion in 2001, but was still below the c35.0 billion invested in 2000. Across Europe, £835 million (2002: £889 million) was invested by 3i (including co-investment funds) in 357 companies during the year. In the UK, investment amounted to £399 million, compared with £443 million the previous year. Despite difficult conditions, we achieved a strong level of realisations at good prices, comfortably in excess of the valuations we placed on those businesses at March 2002. In total, realisation proceeds across Europe during the year amounted to £965 million, compared with £927 million the previous year. There has been a significant reduction in the valuation of our portfolio, caused by increased provisions and value reductions as a result of down rounds and weaker business performance. At 31 March 2003, our portfolio in Europe amounted to £3,669 million, of which £2,494 million was in the UK. During the year, we announced the closure of three of our offices in Europe (Hamburg, Berlin and Dublin) and we reduced the number of staff in our European business. These changes were made to align resources with the market and to reflect changes in our investment processes. 3i now has 27 offices across Europe. US The US venture market has continued to be depressed throughout the year. 3i continues to develop its business in the US and to focus on managing the existing portfolio with a view to achieving realisations in the next few years. During the year, £74 million (down from £119 million in 2002) was invested in 33 companies, of which £56 million was in new investments. Our people programmes continue to deliver Our people programmes continue to deliver At 3i, we believe that a strong board significantly improves a company’s performance and that strong boards have clarity of purpose, the right people and good process. Our people programmes focus on sourcing and developing people for four key board roles: Chairmen, Chief Executives, Finance Directors and Independent Directors. The Independent Directors Programme (“IDP”) is a pool of successful business people who are available to become a chairman or an independent director of 3i-backed businesses. IDP members come from a wide range of industries and company backgrounds. Today, the programme has over 600 members in Europe, Asia Pacific and North America and they hold board positions in over 1,000 3i-backed situations. The CEO programme provides 3i with access to talented and ambitious CEOs. These programmes, which operate as a centre of excellence on people issues across 3i, deliver real value through deal origination, assessing opportunities, and building and realising value from our portfolio. They have also enabled us to develop innovative training materials and approaches to board best practice for the people with whom we work. Events for members, such as “How do you know a good Finance Director when you see one?” are highly participative and draw on the combined experience of those attending and our 3i teams. 12 3i Report and accounts 2003 Operating review Asia Pacific The Japanese market has not developed as rapidly as we had expected, and the flow of quality deals has not been sufficient to justify the resourcing of our Tokyo office, which was closed in February 2003. The Japanese market will continue to be serviced out of the Hong Kong and Singapore offices, as will other markets in the region. The Asia Pacific business invested £22 million during the year, including the first investment by the Hong Kong office, which was in a Korean multiplex cinema operator. Conditions for realisations in the region were depressed during the year. Despite this, £9 million of realisation proceeds were generated. Private equity fund management 3i manages third party co- investment funds primarily in our mid-market buy-out business, where capital raised is co-invested alongside our capital, enabling us to invest in companies without 3i itself holding a majority interest in the underlying business. Since 1994, 3i has raised funds with total third party commitments of £2.3 billion. Funds are usually raised from institutional investors, typically pension funds and insurance companies seeking exposure to private equity and who are attracted by 3i’s market leading position, business model and track record. The funds raised are typically invested on a 50:50 basis alongside 3i’s capital. During the year, we earned fee income of £34 million (2002: £35 million) from the management of funds and, in addition, received £7.3 million (2002: £1.6 million) in respect of carried interest on realisations. At 31 March 2003, the invested portfolio managed on behalf of third party investors was valued at £1,158 million (2002: £1,264 million), excluding undrawn commitments. Since the balance sheet date, 3i has announced the successful first closing of its pan European mid- market buy-out fund, Eurofund IV. Third party investors have committed c0.4 billion and intend to invest a further c0.2 billion over the life of the fund and 3i intends to invest up to c1.5 billion. It is expected that further closings will take place over the coming months and the final closing of Eurofund IV will take place by the end of the year. The network brings it all together 13 3i Report and accounts 2003 Operating review Third party unquoted co-investment funds under management (£bn) at 31 March 1999 2000 2001 2002 2003 1.5 1.6 2.3 2.1 2.0 Third party quoted funds under management (£bn) at 31 March 1999 2000 2001 2002 2003 0.5 0.5 0.8 0.8 0.9 Summary Despite a tough year, we have focused the business on the three product areas of buy- outs, growth capital and early stage technology. We believe we have the right structures and processes in place to gain access to and select the most profitable opportunities and then to enhance value and generate profit from the investments that we make. In an environment of low growth and low inflation, this strategy will enable 3i to provide superior returns for our shareholders. Quoted fund management 3i’s Asset Management team manages the Group’s portfolio of quoted investments (comprising principally our holdings in investments that have achieved an IPO) as well as the portfolios of the 3i Group Pension Plan and of three quoted specialist investment companies – 3i Smaller Quoted Companies Trust plc, which invests in smaller UK companies, 3i Bioscience Investment Trust plc, which invests internationally in life science and healthcare companies, and 3i European Technology Trust plc, which invests in quoted companies across Europe whose focus is on technology. At the balance sheet date, total third party funds under management by 3i Asset Management were £452 million. Fees earned from quoted fund management amounted to £4 million for the year, a reduction from £7 million last year, mainly due to the fall in capital markets. 3i’s relationships deliver tangible benefits every day. Investments such as De Telefoongids in The Netherlands or Fonecta in Finland demonstrate that, without our teams on the ground in local business communities and our sector network and credibility, our pan European buy-out business would not have developed so quickly. Relationships with large corporates and key corporate finance houses enable exits like the sale of Bristan to Masco Corporation to maximise value. Our people programmes enable us to take informed views of businesses at an early stage in the bidding process, assemble the best board for the job and increase our chances of winning the deals we want to do. They also help us reduce costs and avoid weak investments through earlier withdrawal. When it comes to adding value to investments, relationships like those with IBM, which enabled a small software company deNovis to link up with IBM in winning a substantial contract with a large insurance company in the US, can propel an exciting business with potential into a commercial success. The leadership and sector insights that our Portfolio Chief Executives gain from our regular sector focused CEO summits at the IESE business school in Barcelona and INSEAD in Fontainbleau add a different kind of value. They learn, and they partner and forge new commercial relationships as a result. As the attendee from PlaceWare, one of our US investments, put it: “The conference was the most interesting portfolio event that I have ever attended. The concept of bringing your companies together in a beautiful location, to educate them with top academia, introduce them to peer group, industry leaders and target customers is truly superb networking”. Our network comprises many important groups of people. For example, management teams, larger corporates, our people programmes, intermediaries such as corporate finance advisers and search consultants, academic institutions, government and last, but not least, our staff. Why does it deliver? Put simply, because we add value to the people in it. We have the systems in place to make it work in terms of IT knowledge management. More importantly, we ensure through our performance management systems and individual objectives that there is the right attitude. But above all, the network delivers because it is built on thousands of good relationships. 14 3i Report and accounts 2003 Financial review Michael Queen Finance Director “3i has the financial capacity to increase investment when economic and market opportunities improve.” Total return Total return for the year was a negative 23.7% on opening shareholders’ funds, a return of £(935) million. High levels of investment in early stage technology companies in the three years to 31 March 2002, combined with the current exceptionally difficult conditions, have resulted in a total return of £(671) million for our early stage technology business. The downturn in other sectors and the fall in stock markets have resulted in negative returns for our smaller buy-outs and growth capital businesses, although our mid-market buy-out business produced a positive return. Overall, the effect of falling stock markets on total return was £(453) million. 3i’s return of (23.7)% represents an outperformance against our benchmark indices, the FTSE All-Share (29.8)%, the FTSE 100 (29.1)% and the FTSE SmallCap (33.4)%. Over the medium and longer term, 3i has maintained its record of outperformance against stock market indices, except that over a cumulative three year period to 31 March 2003, the FTSE All-Share and FTSE 100 had marginally smaller negative returns by 0.4% and 0.2% respectively. For all longer cumulative periods up to 10 years, 3i has continued to outperform, and overall has maintained its margin of outperformance. There was a strong performance on realisations, with realised capital profits of £184 million. The negative total return arose from the unrealised valuation movement on the portfolio of £1,165 million, due mainly to reductions in the valuation of the technology portfolio. Given the difficult economic conditions, the mid-market buy- out business performed well, delivering a positive total return of £61 million, through a strong level of profitable realisations and a good income yield. The smaller buy-outs and growth capital portfolios have produced negative total returns of £(188) million and £(137) million respectively. This is largely as a result of unrealised losses on the revaluation of the portfolio, caused mainly by a fall in price-earnings ratios used to value a large proportion of the portfolio and provisions for companies that may fail. Realisations were, however, strong, producing a satisfactory level of realised profits and there were also continued good levels of dividend and interest income. In the early stage technology business, provisions continued at the high levels experienced in the previous year and the impact of the worsening conditions necessitated additional valuation reductions. Geographically, the return from our UK investments was £(400) million and the return on our continental Europe investments was £(379) million. UK investments have earned a good income yield, mainly in the form of dividends and interest, and also strong realised profits, which partially offset reductions in the valuation of the portfolio. In continental Europe, the portfolio is weighted more towards early stage technology but the valuation reductions were partly offset by a currency gain of £95 million. Our Asia Pacific business produced a return of £(16) million, and our US business, mainly in early stage technology, a return of £(140) million, which includes a currency loss of £26 million arising from the weakening of the US dollar against sterling. 15 3i Report and accounts 2003 Financial review Total return (£m) Total operating income before interest payable Interest payable Management expenses Realised profits/(losses) on disposal of investments Unrealised value movement on revaluation of investments Other (changes to organisational structure, goodwill, tax and currency) – Revenue return – Capital return Total return 2003 308 (110) (153) 2002 355 (120) (171) 184 (39) (1,165) (890) 1 146 (95) 102 (1,081) (1,062) (935) (960) Total return by product (£m) Mid-market buy-outs Smaller buy-outs Growth capital Early stage technology Goodwill amortisation Total return Total return by geography (£m) UK Continental Europe US Asia Pacific Goodwill amortisation Total return 61 (188) (137) (671) – (935) (400) (379) (140) (16) – (935) (48) (38) 14 (815) (73) (960) (298) (481) (74) (34) (73) (960) Statement of Recommended Practice: Financial Statements of Investment Trust Companies (SORP) The recommendations of the revised SORP issued by the Association of Investment Trust Companies in February 2003 have been adopted in these accounts. Fee income earned and costs incurred on the acquisition or intended acquisition or disposal of investments are included in the capital return. The revenue account includes a tax charge of £30 million and the capital account a corresponding tax credit in respect of expenses charged to the capital return which are being utilised in reducing taxable revenue profits. Adoption of these recommendations has had no effect on total return and, as a result, as required by the SORP, comparatives for the previous year have not been restated. In addition to implementing the revised SORP recommendations, the methodology used to identify management expenses and interest costs available for allocation between the revenue and capital accounts has been revised, resulting in a higher level of costs being available for allocation. All finance costs, less interest income on short term funds, are now available for allocation, as borrowings are now considered to finance investment packages, comprising equity shares and loans, rather than primarily loans as previously. The proportion of available management expenses and interest charged to the capital reserve has been reduced from 80% to 70% to reflect the expected future balance of returns from capital and revenue. This proportion had been increased from 70% to 80% in the year to 31 March 2001. The effect of adopting the revised SORP recommendations and changes in the allocation methodology for management expenses and interest payable has been to increase revenue profits after tax this year by £50 million and to reduce the capital return by a corresponding amount, compared with the previous methodology. 16 3i Report and accounts 2003 Financial review Income, costs and revenue profit Total operating income was £308 million, a reduction from the previous year, £355 million. Interest receivable on loan investments of £96 million (2002: £113 million) has fallen due to lower interest rates (and the prior year benefited from some exceptional high yields on certain investments). Dividend income of £123 million (2002: £130 million) includes £46 million of dividends received on the sale and restructuring of investments (2002: £44 million). Fee income, comprising mainly unquoted fund management fees and investment negotiation fees, amounted to £56 million, the same as last year. Interest receivable on treasury assets has fallen to £34 million from £46 million, mainly due to a fall in interest rates. Management expenses were £18 million or 11% lower than in the previous year, as the number of staff employed reduced from 943 to 858 at 31 March 2003. The cost of organisational changes in the year was £10 million (March 2002: £18 million). Costs less fee income amount to £97 million compared with £115 million last year. Interest payable on borrowings, which are mainly fixed rate, has reduced by £10 million but this is offset by the fall of £12 million in interest receivable on treasury assets, included in total operating income. Revenue profit after tax was £140 million, which is higher than last year (£106 million), because of changes in accounting treatment arising from the SORP and in the allocation of costs. Realised profits on disposal of investments Realised profits on disposal of investments were £184 million which compares to a loss of £39 million in the previous year. Proceeds amounted to £976 million, of which £110 million were realised from the quoted portfolio. Despite corporate mergers and acquisitions markets remaining weak throughout the year, realisations from the unquoted portfolio were strong, generating proceeds of £829 million, significantly higher than £514 million in the previous year. Realisations included the sale of Go, the low cost airline, which generated £144 million of proceeds and contributed £86 million to realised profits. Unquoted equity investments were realised, after taking account of write-offs, at a good uplift of 40% over their March 2002 valuations. Sales of holdings in our quoted portfolio generated an uplift of 6% despite falling stock markets. The uplift achieved on the total equity realisations was 34%. Overall, 14% of the total equity portfolio at 31 March 2002 was realised and, including loan and fixed income share repayments, 16% of 3i’s total portfolio was realised. Realised profits also include £50 million in respect of the write- off of subordinated borrowings, which are no longer repayable in full. These borrowings, where some of the risk was assumed by the finance provider, funded the acquisition of German technology investments, which have failed or been provided for this year and in previous years. Realised profits are stated net of write-offs, which amounted to £79 million (2002: £151 million). Realisations – five year record 1999 2000 2001 2002 2003 687 165 781 351 569 1,015 370 866 110 536 Unquoted realisations Quoted realisations Excludes realisations of non-venture capital investments in FTSE 350 companies of £156m in 2002 and £49m in 2001. Realisation proceeds (£m) Quoted equity investments and on IPO Unquoted equity investments Loan and fixed income shares Total Net realised profit/(loss) – over opening valuation (£m) Equity proceeds (£m)* Uplift over opening equity valuation (%)* Percentage of opening equity portfolio sold (%)* 2003 147 493 336 976 184 640 34 14 * Excludes the disposal in 2002 of non-venture capital investments made in FTSE 350 companies. Unrealised value movement on revaluation of investments (£m) Provisions Down rounds and reductions to fair value Price-earnings ratios Earnings growth Other movements on unquoted investments Quoted portfolio Total 2003 (379) (361) (244) 48 (20) (209) (1,165) 2002 425 303 211 939 (39) 728 1 19 2002 (400) (181) – 130 (136) (303) (890) 17 3i Report and accounts 2003 Financial review Investment by product (£m) year to 31 March Buy-outs Growth capital Early stage technology 2003 2002 2003 2002 2003 2002 312 170 226 135 234 39 209 49 170 6 399 21 3i total Co-investment funds total Investment by geography (£m) year to 31 March UK Continental Europe US Asia Pacific 2003 2002 2003 2002 2003 2002 74 119 2003 20 2 2002 26 5 3i total Co-investment funds total 318 81 377 66 304 312 132 134 First and subsequent investment (£m) New first investments Further funding or drawdown on existing arrangements Total 2003 585 346 931 2002 560 479 1,039 Unrealised value movement on revaluation of investments There has been a net unrealised value movement of £(1,165) million. The main drivers have been provisions for companies which may fail of £379 million, down rounds and reductions to fair value of £361 million and the effect of falling stock markets which amounted to £453 million. Reductions in the valuation of the early stage technology portfolio make up 62% of provisions and 75% of down round and fair value adjustments. Our approach to the valuation of early stage technology investments has changed over the last year. At 31 March 2002, the valuations of early stage investments were reduced where a down round or further financing had taken place at a lower value. At 30 September 2002, valuations were reduced for down rounds that had already taken place and also for those that were anticipated to take place within the next six months. At the balance sheet date, 31 March 2003, valuations of early stage investments were reduced for down rounds that have occurred or are anticipated, and were also reduced to an estimated down round value or to a fair value, even where no further financing is anticipated, based on the most appropriate valuation criteria available. The continued fall in stock markets has led to a decrease in the value of the quoted portfolio of £209 million and has also reduced the weighted average price- earnings ratio used to value the unquoted equity portfolio valued on an earnings basis from 10.0 at March 2002 to 8.1. This has resulted in a further value reduction of £244 million. There has been an increase in investee companies’ earnings, where these are used as a valuation basis at the start and end of the year, which has generated a valuation movement of £48 million; earnings of these portfolio companies have increased by 2%. Unrealised value movement includes a net currency gain of £60 million (2002: £(1) million), mainly arising from the weakening of sterling resulting in an increase in the valuation of European investments partially offset by losses on related borrowings. Investment During the year, we invested a total of £931 million (£716 million invested by 3i and £215 million of co-investment funds). This is lower than last year (March 2002: £1,039 million) but there was a 37% increase in the second half of the year reflecting improved investment opportunities in the market. Investment has been balanced and aligned more closely with our portfolio objectives with investment in buy- outs representing 52% of total investment in the year, growth capital 29% and early stage technology 19%. The majority of the technology investment, 78%, has been made in supporting our existing portfolio where those companies continue to look likely to deliver good returns over the medium term. Investment across Europe was balanced with 43% of total investment being made in the UK and 47% in continental Europe. The US invested £74 million, 8% of total investment, reflecting the reduction in technology investment across the Group. Asia Pacific invested £22 million. 18 3i Report and accounts 2003 Financial review Balance sheet (£m) at 31 March 2003 Portfolio and other net assets 3,949 Net borrowings Shareholders’ funds 1,013 2,936 Balance sheet (£m) at 31 March 2002 Portfolio and other net assets Net borrowings Shareholders’ funds 1,187 5,132 3,945 Cash flow and balance sheet Strong net realisation proceeds of £975 million and relatively low cash investment of £673 million were the main factors contributing to a cash inflow of £219 million, before a refinancing investment of £49 million in a joint venture, resulting in a net cash inflow of £170 million, reducing net borrowings to £1,013 million. This compares with a net cash outflow last year, after acquisitions, of £102 million. The value of the portfolio (excluding co-investment funds) has fallen during the year from £5,109 million to £3,939 million largely because of unrealised losses on the revaluation of investments. Early stage technology investments amount to £589 million,15% of the total portfolio. Buy-out and growth capital investments amount to 51% and 34% of the portfolio respectively. At the balance sheet date, 63% of the portfolio by value was located in the UK, 30% in continental Europe, 5% in the US and 2% in Asia Pacific. By sector, the portfolio continues to be well diversified. Of the total portfolio, 5% is represented by quoted investments, 40% by loans and fixed income shares and 55% by unquoted equity investments, of which 28% have been valued at cost and 44% on an earnings basis. The capital and funding structure of the Group is strong. At the balance sheet date, shareholders’ funds amounted to £2.9 billion, net debt to £1.0 billion and private equity co-investment funds under management were £1.6 billion. The net effect of the reduction during the year in both shareholders’ funds and net borrowings has increased gearing to 35% (March 2002: 30%). The Group’s net borrowing comprises long term borrowing, short term borrowing and liquid treasury assets and cash. Original long term borrowing of £1.6 billion, which is unsecured and primarily raised from the public issue of debt under the notes issuance programme, has been swapped to give a predominantly fixed rate position. Of the original long term borrowing, £197 million is repayable in 2003, with £754 million in 2006 and 2007 and £600 million in 2023 or later. Short term borrowing of £196 million is outweighed by cash and liquid treasury assets of £811 million. At the balance sheet date, the Group had committed and undrawn borrowing facilities amounting to £634 million. The Group continues to meet very comfortably the capital adequacy ratios set by the Financial Services Authority, in its role as supervisor of 3i Group plc’s status as a deposit taker. Pension Pension costs have been accounted for on the basis of SSAP 24. The charge for the year to 31 March 2003 to Group profits in respect of the main defined benefit scheme, the 3i Group Pension Plan (“the Plan”) was £12 million (March 2002: £13 million), based on the triennial actuarial valuation at 30 June 2001. If the SSAP 24 charge continues to be based on the 30 June 2001 valuation, the charge for the year to 31 March 2004 would be £12 million. Details are included in note 11. The progressive implementation of FRS17 “Accounting for Retirement Benefits” has been accompanied by considerable debate about its suitability as a measure of present and future pension liabilities. Mandatory implementation of FRS 17 in full has been deferred by the Accounting Standards Board. FRS 17 has not been fully implemented in these accounts, but the full effects had it been are disclosed in note 11 on page 48. This is supported by a framework of core values, Group standards and controls, a code of business conduct and delegated authorities. The ability to recruit, develop and retain capable people is of fundamental importance to achieving our strategic objectives. We operate in a competitive industry and aim to remunerate our staff in line with market practice and to provide superior development opportunities. A group-wide business continuity strategy is in place. This strategy has been assessed against a detailed business impact analysis and independently benchmarked against best practice. Summary Net asset value per share has fallen, mainly due to the fall in stock markets and the reduction in the valuation of the early stage technology portfolio which at the balance sheet date represented 15% of the total portfolio. 3i did, however, experience a smaller fall in net asset value than its stock market benchmarks. 3i continues to have the financial capacity to increase investment should economic and market opportunities improve. Michael Queen Finance Director 14 May 2003 19 3i Report and accounts 2003 Financial review Due to substantial falls in stock markets and declines in interest rates used to calculate the present value of liabilities, the FRS17 figures show a significant deterioration during the year to a deficit on the Plan of £90 million (2002: deficit of £14 million). Recognising that in the short term at least, some of the deficit is unlikely to be made up simply by the recovery in asset values, the Group has contributed lump sums over the last two years of £13 million during the year to 31 March 2003 and £22 million during the year to 31 March 2002. It has also recommenced making monthly contributions with effect from 1 April 2002 which have amounted to £12 million in the current year. Total contributions in the year to 31 March 2003 were £25 million (2002: £22 million). Changes have been made to the Plan which require existing members to contribute 1% of salary from 1 January 2003, increasing by 1% each year to 5% by 1 January 2007. New employees joining 3i and the Plan after 1 September 2002 are required to contribute 5% of salary. At 31 March 2003, 578 employees were members of the Plan. Our policy on pensions continues to be under active review in the light of changes in tax legislation and accounting and because funding deficits have arisen from the fall in capital markets. Regulation of the Group 3i Group plc and relevant subsidiaries continue to be regulated by the Financial Services Authority. Risk management 3i has a comprehensive framework to manage the risks that are inherent in its business. This framework includes a risk committee whose purpose is to monitor the identification, assessment and management of key risks across the business. The main risks comprise economic risk, treasury and funding risk, investment risk and operational risk. Economic risk 3i invests mainly in European companies and continues to develop its operations in the US and Asia Pacific. However, the majority of the portfolio is still in UK companies and there is an element of exposure to the UK economic cycle. To mitigate this, 3i has invested in different sectors of the UK economy with different economic cycles. In addition, an increasing proportion of assets is invested in continental Europe, in the US and Asia Pacific, which may have different economic cycles. Treasury and funding risk The overall funding objective continues to be that each category of investment asset is broadly matched with liabilities and shareholders’ funds, with corresponding characteristics in terms of risk and maturity, and that funding needs are met ahead of planned investment. This objective continued to be met during the year to 31 March 2003. All assets and liabilities are held for non-trading purposes and, as a result, the Group does not have a trading book. The Group does not trade in derivatives and does not enter into transactions of either a speculative nature or unrelated to the Group’s investment activities. Derivatives are used to manage the risks arising from the Group’s investment activities. The main funding risks faced by the Group are interest rate risk and exchange rate risk. The level of these risks is mitigated by the overall funding objective and the Board regularly reviews and approves policies on the approach to each of these risks. 3i’s policy for exchange rate risk management is not generally to hedge its overall portfolio in continental Europe or the US. In line with its funding policy, part of those assets are funded by borrowings in local currency and, as a result, a partial hedge exists. 3i’s largest exposure is £0.7 billion in respect of net assets denominated in euros in continental Europe. The level of exposure to exchange rate risk is reviewed on a periodic basis. Day to day management of treasury activities is delegated to executive Directors and the Group Treasurer. Regular reports on the Group’s funding position have been considered during the year by the Board. There has been no change during the year or since the year end to the major funding risks faced by the Group, or to the Group’s approach to such risks. Investment risk This includes investing in companies that may not perform as expected, being over exposed to one sector of the economy and the portfolio valuation being partly based on stock market valuations. Investment levels are set, allocated and monitored by product area and geography. Within this framework, 3i invests in all sectors of the economy, except those, such as property, where the opportunity to invest in venture capital backed businesses meeting 3i’s investment criteria is limited. Management periodically reviews the portfolio, which is well diversified by industry sector, to ensure that there is no undue exposure to any one sector. 3i’s investment criteria focus on management ability and market potential. Investment appraisal and due diligence is undertaken in a rigorous manner by drawing on our international network and experts in individual industry sectors. In general, proposed investments over £5 million are presented to the Group’s Investment Committee or Technology Investment Committee, which are committees of senior management including executive Directors. The valuation of a large proportion of 3i’s equity portfolio is based on stock market valuations for the relevant industry sector. Quoted investments are valued using the mid-market price at the balance sheet date. About 44% of the unquoted equity portfolio is valued using stock market price-earnings ratios for the relevant industry sector discounted for non marketability. Accordingly, stock market valuations for individual sectors are an important factor in determining the valuation of 3i’s portfolio and the total return. There are regular reviews of holdings in quoted companies and exposure to individual sectors in order to monitor the level of risk and mitigate exposure where appropriate. In particular, the level of future funding of technology companies is kept under review. However, it is not possible to protect against the risks of a downturn in stock markets generally or in any specific sector. Accordingly, the valuation of 3i’s portfolio and opportunities for realisation depend on stock market conditions and the buoyancy of the wider mergers and acquisitions market. Operational risk This includes operational events such as human resources risks, legal and regulatory risks, IT systems problems, business disruption and shortcomings in internal controls. Line management at all levels is responsible for identifying, assessing, controlling and reporting operational risks. 20 3i Report and accounts 2003 01 Baroness Hogg Non-executive Chairman since January 2002 and a non-executive Director since 1997. Chairman of the Nominations Committee and the Valuations Committee and a member of the Remuneration Committee. Chairman of Frontier Economics Limited. A director of GKN plc, Carnival Corporation and Carnival plc. A Governor of the BBC. Formerly Chairman of Foreign & Colonial Smaller Companies PLC and director of The Energy Group plc, Martin Currie Portfolio Investment Trust plc, National Provident Institution and Scottish Eastern Investment Trust plc. Head of the Prime Minister’s Policy Unit from 1990 to 1995. Aged 57. 02 Oliver Stocken Non-executive Deputy Chairman since January 2002, Senior Independent Director since July 2002 and a non-executive Director since 1999. Chairman of the Audit and Compliance Committee and of the trustees of the 3i Group Pension Plan. A member of the Nominations Committee, the Remuneration Committee and the Valuations Committee. Chairman of Rutland Trust plc. A director of GUS plc, Pilkington plc, The Rank Group plc, Novar plc and Stanhope plc. Formerly Finance Director of Barclays plc. Aged 61. 03 Brian Larcombe Chief Executive since 1997 and an executive Director since 1992. A member of the Nominations Committee and the Valuations Committee. Joined 3i plc in 1974 becoming a Local Director in 1982 and a Regional Director in 1988. Appointed Finance Director and to the Executive Committee in 1992. A non-executive director of Smith & Nephew plc. Past Chairman of the British Venture Capital Association. Aged 49. 04 Dr John Forrest CBE FREng Non-executive Director since 1997. Chairman of the Remuneration Committee and a member of the Audit and Compliance Committee, the Nominations Committee and the Valuations Committee. Chairman of the UK Government Spectrum Management Advisory Group. Formerly Chief Executive of NTL, Technical Director of Marconi Defence Systems Limited and Professor of Electronic Engineering at University College, London. Aged 60. 05 Martin Gagen ACA Executive Director since 1997, responsible for US and Asia Pacific investment. Joined 3i plc in 1983 becoming a Local Director in 1990. Appointed to the Executive Committee in 1995 with joint responsibility for UK investment. Formerly a member of the British Venture Capital Association Council. Aged 47. Board of Directors 01 Baroness Hogg 02 Oliver Stocken 03 Brian Larcombe 06 Christine Morin-Postel 07 Rod Perry 10 Fred Steingraber 11 Tony Brierley 21 3i Report and accounts 2003 Board of Directors 09 Danny Rosenkranz Non-executive Director since 2000 and a member of the Audit and Compliance Committee, the Nominations Committee and the Remuneration Committee. Chairman of Foseco (Jersey) Limited and Pecaso Limited. Formerly Chief Executive of The BOC Group plc. Aged 57. 10 Fred Steingraber Non-executive Director since January 2002 and a member of the Nominations Committee. A director of Maytag Corporation and John Hancock Financial Trends Fund and a member of the supervisory board of Continental AG. Formerly Chairman and Chief Executive of AT Kearney, Inc and a director of Lawter International, Inc and Mercury Finance, Inc. Aged 64. Other members of Executive Committee 11 Tony Brierley Company Secretary since 1996, responsible for the Group’s legal, compliance, internal audit and company secretarial functions. Chairman of the Corporate Social Responsibility Committee. Joined 3i plc in 1983 becoming joint head of Legal department in 1990 and Deputy Company Secretary in 1994. Appointed to the Executive Committee in 1996. Aged 53. 12 Chris Rowlands A member of the Executive Committee since September 2002, responsible for European investment and growth capital investment worldwide. Joined 3i plc in 2002 having previously been employed by 3i plc from 1984 to 1996, becoming a Local Director in 1988 and a Regional Director in 1995. Formerly a Partner of Andersen. Aged 46. 13 Jonathan Russell A member of the Executive Committee since 1999, responsible for buy-out investment worldwide. Joined 3i plc in 1986 becoming a Local Director in 1992 and a Regional Director in 1998. Chairman of the European Private Equity and Venture Capital Association Buy-out Committee. Aged 43. 14 Paul Waller A member of the Executive Committee since 1999, responsible for European investment and fund management. Joined 3i plc in 1978 becoming a Local Director in 1983. Became a Regional Director in 1988 and took international responsibilities in 1990. Past Chairman of the European Venture Capital Association. Aged 48. 06 Christine Morin-Postel Non-executive Director since September 2002. A member of the Audit and Compliance Committee and the Nominations Committee. Formerly Chief Executive of Société Générale de Belgique and executive Vice-President and member of the Executive Committee of Suez. A director of Tractebel, Société Générale de Belgique and Arlington Capital Investors (Europe). Aged 56. 07 Rod Perry CEng MIEE Executive Director since 1999, responsible for group services and technology activities worldwide. Joined 3i plc in 1985 as an Industrial Adviser and became Head of Information Systems in 1989. Appointed to the Executive Committee in 1996. Aged 58. 08 Michael Queen FCA Executive Director since 1997, responsible for finance and a member of the Valuations Committee. Joined 3i plc in 1987 becoming a Local Director in 1990 and Group Financial Controller in 1996. Appointed to the Executive Committee in 1997. Past Chairman of the British Venture Capital Association. Aged 41. 04 Dr John Forrest 05 Martin Gagen 08 Michael Queen 09 Danny Rosenkranz 12 Chris Rowlands 13 Jonathan Russell 14 Paul Waller 22 3i Report and accounts 2003 Corporate Social Responsibility report Philosophy and approach 3i is an international business operating in 14 countries with fewer than 900 employees worldwide. 3i aims to conduct its business in a socially responsible manner. It is committed to being a responsible member of the communities in which it operates and recognises the mutual benefits of engaging and building relationships with those communities. 3i believes that respect for human rights is central to good corporate citizenship. In everything 3i does it aims to be commercial and fair, to maintain its integrity and professionalism and to respect the needs of shareholders, staff, suppliers, the local community and the businesses in which it invests. 3i endeavours to comply with the laws, regulations and rules applicable to its business and to conduct its business in accordance with established best practice in each of the countries in which it operates. Environmental, ethical and social responsibility issues and standards are also taken into consideration in all aspects of the business. 3i aims to be a responsible employer and has adopted corporate values and standards designed to help guide its employees in their conduct and business relationships. These values and standards are an integral part of 3i’s culture. Responsibilities and accountabilities The Board as a whole is responsible for ethical standards. The executive Directors are responsible for ensuring compliance with 3i’s corporate values and standards. A management committee, the Corporate Social Responsibility Committee (the “CSR Committee”), comprising Tony Brierley, Company Secretary and Chairman of the Committee, Patrick Dunne, Group Communications Director, Charles Richardson, Managing Director, Small and Medium Investments, and Liz Hewitt, 3i plc Director and currently on secondment to the Department of Trade and Industry, considers and reviews environmental, ethical and social issues relevant to 3i’s business and associated risks. It also monitors the operation, and reviews breaches, of 3i’s corporate responsibility policies and procedures. Tony Brierley has specific responsibility for 3i’s environmental policies, leading the development of new policies and targets and reporting to the Board. The CSR Committee, on behalf of the Board, identifies and assesses the significant risks and opportunities for 3i arising from social, ethical and environmental issues. A risk matrix methodology is used to identify new risks, monitor developing trends and best practice and consider changes in 3i’s business and culture. This risk matrix is reviewed and updated at each meeting of the Committee and significant risks are reported to 3i’s Risk Committee, whose work is set out in more detail on page 28 of the Directors’ report. The CSR Committee reports regularly to the Board. During the year, the Board considered a presentation on significant social, ethical and environmental issues for the Group. Training for Directors on corporate Royal Academy of Music Pyrenees trek Since 1991, 3i has been pleased to support the Royal Academy of Music, sponsoring student scholarships and the Sinfonia Orchestra. Unlike other leading international music schools, the Academy relies on voluntary funding for all student scholarships. We were proud to be lead sponsor of a concert given by Sir Elton John in December 2002, at which over £750,000 was raised. In July 2002, 3i’s Barcelona office organised a sponsored trek which involved climbing two peaks of around 3,400 metres in the Maladeta Nature Park in the Pyrenees mountains in northern Spain. Four of 3i’s staff in Barcelona together with four local advisers raised £3,600 to help re-equip the SOS Children’s Village, a children’s home in the Spanish town of Sant Feliu de Codines. 23 3i Report and accounts 2003 Corporate Social Responsibility report 3i recognises that the most significant risks to its short and long term value from environmental, ethical and social matters arise from its investment business. For example, if a company in which 3i has an investment acted irresponsibly on corporate responsibility issues, this might affect the monetary value of that investment and, as a shareholder in that investment, raise reputational issues for 3i. As an investor, 3i has the opportunity to influence the behaviour of the companies in which it has an investment and encourages the development and adoption of good corporate governance. This is achieved through the training of non-executive Directors who are appointed to sit on investee company boards and the raising of awareness within investee companies of social, environmental and ethical issues. However, as an investor in unquoted businesses, 3i does not have day-to-day operational control over these businesses. 3i has clear procedures to reduce the risks of 3i investing in businesses which operate in an environmentally, ethically or socially unacceptable manner. Where, after an investment has been made, 3i becomes aware that an investee company is not operating in an acceptable way, 3i will seek to use its influence to encourage improvement. Where that is not possible, 3i will seek to divest itself of the investment. Social responsibility as an employer Employment 3i’s staff are fundamental to the success of its business. Accordingly, one of 3i’s core values is to respect its staff and their needs. Employees are organised in small teams and an environment of co-operation is encouraged to ensure the highest standards of integrity and professionalism. In accordance with 3i’s core values, individual consultation with employees on matters affecting them, and fair and open communication, are a high priority. Periodically, internal communication surveys of employees are conducted for 3i by independent researchers. The September 2002 survey, conducted on 3i’s behalf by MORI, disclosed that 66% of the 251 randomly selected employees interviewed were satisfied with 3i’s internal communications and 70% felt informed about 3i. 85% spoke highly of 3i and indicated they would advocate 3i as an employer. The advocacy of 3i result compares favourably with MORI’s best practice norm of 67%, being the average of the best ten scores for a particular question. Improving internal communication continues to be a priority. 3i’s employment policies are described in more detail in the Directors’ report on page 27. Health and safety 3i recognises that the promotion of health and safety at work is an essential function of staff and management at all levels. In an endeavour to achieve high standards, appropriate policies and procedures have been put in place. These policies and procedures are the responsibility of Rod Perry, a Director of 3i Group plc. The purpose of 3i’s health and safety policy is to enable all members of 3i’s staff to go about their everyday business at 3i’s offices in the expectation that they can do so safely and without risk to their health. 3i imposes rigorous standards on its staff and sub- contractors and endeavours to ensure that the health, safety and welfare of its employees, visitors, customers, sub-contractors’ staff and the general public are not compromised. 3i aims to have no reportable accidents or incidents. During the year to 31 March 2003, no reportable accidents or incidents occurred under UK Health and Safety regulations and no reportable accidents or incidents occurred under similar regulations outside the UK. Social responsibility to the communities in which 3i operates Charitable and community support 3i’s charitable policy aims to support: • Causes based in the communities in which 3i has offices. • Staff who participate in charitable activities. 3i matches donations made by UK staff under the Give as You Earn scheme (“GAYE”) and the proceeds of staff fundraising efforts. In the period from May 2001 to April 2002, 3i was ranked top payroll giving employer by staff participation and 19th payroll giving employer by donation (source: The Giving Campaign). In the year to 31 March 2003, approximately 42% of 3i’s charitable donations were matching GAYE donations. • Charities relevant to its corporate activity. responsibility issues is provided through this system of regular reporting and by presentations on relevant corporate responsibility issues. A programme of presentations and discussions across the business and regular articles in 3i’s staff magazine are being used to raise awareness of corporate responsibility issues, to stimulate debate and provide employee training. All employees have a responsibility to be aware of, and abide by, 3i’s environmental, ethical and social policies and procedures. Employees are encouraged to make suggestions to improve processes and procedures, particularly those which lessen the impact of 3i on the environment. Social responsibility as an investor Investment policy 3i has a portfolio of investments in over 2,000 businesses in Europe, Asia Pacific and the United States. As an investor, corporate governance is a priority and account is taken of environmental, ethical and social issues when making investment decisions. 3i believes it is important to invest in companies whose managers act responsibly on environmental, ethical and social matters. 3i aims to invest in companies which: • respect human rights; • comply with current environmental, ethical and social legislation; • have proposals to address defined future legislation; • seek to comply with their industry standards and best practice. businessdynamics 3i was pleased to continue its long standing support for businessdynamics, which aims to “bring business to life for students, primarily by delivering programmes, in schools and colleges. These inform and inspire young people, aged 14-19 years, about the opportunities and challenges of business”. During 2002, these business awareness programmes reached 33,000 students (source: Annual Review). 24 3i Report and accounts 2003 Corporate Social Responsibility report and functions. In addition, 3i’s internal audit function carries out periodic reviews of risks and related controls in this area. The Committee may also supplement internal review processes with external reviews where necessary. The Committee is not aware of any material breaches of the Company’s policies and procedures for managing risks from corporate responsibility issues. The disclosures in this Corporate Social Responsibility report are the subject of an internal verification process. This process requires every statement made in this report to be verified. Charitable donations made in the year to 31 March 2003 amounted to £209,972, supporting over 100 different charities with donations ranging from £21 to £25,000. 3i supports businessdynamics, a charity which aims to help young people understand business. 3i also has a long running association with the Royal Academy of Music, sponsoring the Sinfonia Orchestra. During the year, 3i also supported The DePaul Trust, a charity which provides help for homeless and disadvantaged people in a number of British cities in which 3i has offices. The environment As a financial services business employing fewer than 900 employees worldwide, 3i’s direct environmental impact is relatively low. The Group measures its own energy and resource usage where practicable and sets targets to achieve improvement. The principal benchmarks against which the Group measures its performance are for: • CO2 emissions; and • recycling of paper and other materials. The Group also assesses the environmental standards of its suppliers, through its procurement policy. Performance and measurement To assist it in benchmarking 3i’s corporate responsibility performance, the CSR Committee has had informal discussions with other companies and specialists in this area. The Committee has monitored the implementation of corporate responsibility investment procedures, implemented appropriate risk management procedures and set strategic objectives for corporate responsibility. The CSR Committee measures 3i’s performance against two indices: • The Dow Jones Sustainability World Index (“DJSI”), a global index which tracks the financial performance of leading companies in terms of corporate sustainability; and • Business in the Community Corporate Responsibility Index (“BitC Index”), an index which aims to benchmark environmental, ethical and social performance and encourage sustainable development. 3i has again been selected as a constituent of the DJSI during the year and was placed in the top half of its industry group on a global basis. 3i’s overall sustainability performance was described as very good (source: SAM Research Inc.). 3i aims to continue to be included within this index and to maintain its position in the next DJSI assessment. 3i participated in the first annual BitC Corporate Responsibility Index, one of only 53 FTSE 100 companies and the only investment company to participate in the Index. 3i’s management profile was B, a company moving beyond a basic commitment. The results of the BitC Index have been considered by the CSR Committee and a number of actions are being taken with the objective of improving 3i’s performance in this Index in the future. During the year, 3i commissioned an external management consultancy, ERM, to conduct a review of corporate responsibility at 3i. As a result of that review, a number of recommendations relating to procedures, communication and training are being implemented. Each of 3i’s business unit and department heads is required to confirm on an annual basis that their operating procedures, including investment procedures, are consistent with 3i’s standards and controls and that these procedures are operating in practice. 3i’s performance management appraisal process reviews the performance of individual members of staff against agreed objectives and the knowledge, skills and behaviours expected by 3i. This process includes 360 degree feedback for all employees. 3i’s offices are the subject of health and safety audits to ensure high standards are adopted on a consistent basis worldwide. Audit and verification The CSR Committee has an ongoing role of monitoring the operation of 3i’s corporate responsibility policies and procedures. The identification and management of corporate responsibility risks is integral to the ongoing operational processes of 3i’s business units 25 3i Report and accounts 2003 Directors’ report Principal activity 3i Group plc is Europe’s leading venture capital company. The principal activity of the Company and its subsidiaries (“the Group”) is investment. It invests in a wide range of growing independent businesses. Its objective is to maximise shareholder value through growth in total return. Tax and investment company status The Company is an investment company as defined by section 266 of the Companies Act 1985 and carries on business as an investment trust. The Inland Revenue has approved the Company as an investment trust under section 842 of the Income and Corporation Taxes Act 1988 for the financial period ended 31 March 2002. Since that date the Company has directed its affairs so as to enable it to continue to be so approved. Regulation The Company is an authorised deposit taker regulated by the Financial Services Authority. 3i Investments plc and 3i Japan GP Limited, both wholly owned subsidiaries of the Company, are authorised persons under the Financial Services and Markets Act 2000 and regulated by the Financial Services Authority. Where applicable, certain Group subsidiaries’ businesses outside the United Kingdom are regulated by relevant authorities. Results and dividends The accounts of the Company and the Group for the year to 31 March 2003 appear on pages 39 to 66. Consolidated total return for the period was a negative sum of £935 million (2002: negative sum of £960 million). An interim dividend of 4.9p per share was paid on 8 January 2003. The Directors recommend a final dividend of 8.6p per share be paid in respect of the year to 31 March 2003 to shareholders on the register at the close of business on 20 June 2003. By a deed of waiver dated 9 June 1994, Mourant & Co. Trustees Limited as trustee of The 3i Group Employee Trust waived (subject to certain minor exceptions) all dividends declared by the Company after 26 May 1994 in respect of shares from time to time held by it (currently 8,173,810 shares) as trustee of that trust. Operations The Company owns substantially all the Group’s investments. The Group operates through a network of 31 offices across Europe, Asia Pacific and the US. The Group manages a number of funds established with major institutions and pension funds to make equity and equity related investments in unquoted businesses in Europe and Asia Pacific. 3i Investments plc acts as investment manager to the Company and certain of its subsidiaries. 3i Investments plc also acts as investment manager to 3i Smaller Quoted Companies Trust plc, 3i Bioscience Investment Trust plc and 3i European Technology Trust plc, investment trusts listed on the London Stock Exchange. 3i Investments plc also manages the 3i Group Pension Plan. Business review The Chairman’s statement on pages 2 and 3, the Chief Executive’s statement on pages 4 and 5, the Operating review on pages 6 to 13 and the Financial review on pages 14 to 19 report on the Group’s development during the year to 31 March 2003, its position at that date and the Group’s likely future development. Share capital In the year to 31 March 2003, the issued share capital of the Company increased by 1,314,425 shares to 610,918,253 shares as a result of the issue of shares to the trustee of The 3i Group Share Incentive Plan, the exercise of options under The 3i Executive Share Option Plan, The 3i Group 1994 Executive Share Option Plan and The 3i Group Sharesave Scheme and the issue of shares to the nine vendors of SFK Finance Oy. Details of these share issues are provided in note 39 to the accounts on page 62. Major interests in shares As at 2 May 2003, the Company had been notified of the following interests in the Company’s shares in accordance with sections 198 to 208 of the Companies Act 1985: FMR Corporation and Fidelity International Limited and their subsidiary companies Prudential plc and subsidiary companies Legal & General Investments Management Limited Scottish Widows Investment Partnership Limited % 9.79 5.17 3.42 2.98 Number of shares 59,828,417 31,613,446 20,914,010 18,215,747 Directors and their interests The names of the present Directors are set out on pages 20 and 21. Save for Lord Camoys who ceased to be a Director on 10 July 2002, Mme C J M Morin-Postel who was appointed as a Director on 12 September 2002 and Dr R D M J Summers and Mr P B G Williams who ceased to be Directors on 31 December 2002, all the Directors served throughout the period under review. Having been appointed as a Director since the Annual General Meeting held in 2002, Mme C J M Morin-Postel retires in accordance with the Articles of Association and, being eligible, offers herself for reappointment. In accordance with the Articles of Association Mr M M Gagen, Mr M J Queen and Mr F D Rosenkranz retire by rotation and, being eligible, offer themselves for reappointment. Details of the Directors’ interests in the Company’s shares are shown in note 39 to the accounts on page 62. Save as shown in note 39 on page 62, no Director had any disclosable interest in the shares, debentures or loan stock of the Company or in the shares, debentures or loan stock of its subsidiaries during the period. Save as shown in note 39 on page 62 there have been no changes in the above interests between 31 March 2003 and 2 May 2003. No Director was materially interested in any contract or arrangement subsisting during or at the end of the financial period that was significant in relation to the business of the Company. Directors’ service contracts Details of Directors’ employment contracts are set out in the Remuneration report on page 35. 26 3i Report and accounts 2003 Directors’ report Management arrangements 3i plc provides the Group with certain corporate and administrative services, for which no regulatory authorisation is required, under contracts which provide for fees based on the work done and costs incurred in providing such services. The contract between 3i plc and 3i Investments plc may be terminated by either party on three months’ notice. The contracts between 3i plc and other Group companies may be terminated by either party on reasonable notice. 3i Investments plc provides the Group with investment management and other services, for which regulatory authorisation is required, under contracts which provide for fees based on the work done and costs incurred in providing such services. These contracts may be terminated by either party on reasonable notice. Corporate governance Throughout the year to 31 March 2003, the Company complied with all the provisions set out in section 1 of the Combined Code on corporate governance (“the Combined Code”). The Company’s approach to corporate governance The Company has a policy of seeking to comply with established best practice in the field of corporate governance. In addition, one of the core values communicated within the Group is a belief that the highest standard of integrity is essential in business. The Board’s responsibilities and processes The Board is responsible to shareholders for the overall management of the Group. It determines matters including financial strategy and planning and takes major business decisions. It is assisted by various specialised committees of the Board, all of which have written terms of reference which are reviewed from time to time. Details of the principal Board Committees are set out below. The organisational structure put in place by the Board is further described below under the heading “internal control”. The regular reports and papers received by the Directors before Board and Committee meetings are supplemented by information specifically requested by the Directors from time to time. Roles of the Chairman and the Chief Executive The division of responsibilities between the Chairman of the Board and the Chief Executive is clearly defined and was reviewed at the appointment of the current Chairman. The Chairman leads the Board in the determination of its strategy and in the achievement of its objectives. The Chairman is responsible for organising the business of the Board but has no involvement in the day-to-day business of the Group. The Chairman facilitates the effective contribution of non-executive Directors and constructive relations between executive and non-executive Directors. The Chief Executive has direct charge of the Group on a day-to-day basis and is accountable to the Board for the financial and operational performance of the Group. The Chief Executive has formed a management committee called Executive Committee to enable him to carry out the responsibilities delegated to him by the Board. The Committee comprises the executive Directors, the Company Secretary, Mr C P Rowlands, Mr J B C Russell and Mr P Waller. The Committee meets on a regular basis to consider operational matters and the implementation of the Group’s strategy. Senior Independent Director On Lord Camoys ceasing to be a Director on 10 July 2002, Mr O H J Stocken was appointed Senior Independent Director, to whom, in accordance with the Combined Code, concerns can be conveyed. Directors All the non-executive Directors including the Chairman are considered by the Board to be independent for the purposes of the Combined Code. The Board assesses and reviews the independence of each of the non-executive Directors at least annually. The Board has regard to the potential relevance and materiality of a Director’s interests and relationships when assessing independence rather than applying rigid criteria in a mechanistic manner. The varied backgrounds of the non-executive Directors (details of which are set out in the biographies on pages 20 and 21) enable them to bring an independent judgement to bear on the Board’s deliberations and help to ensure the continuing effectiveness of the executive Directors and the Group’s management. The Company’s Articles of Association provide for: a) Directors to retire at the first AGM after their appointment and for the number nearest to, but not exceeding, one third of the remaining Directors to retire by rotation at each AGM; b) all Directors to retire at least every three years as required by the Combined Code; and c) any Director aged 70 or over at the date of the AGM to retire. Subject to the Articles of Association, retiring Directors are eligible for reappointment. The Company has procedures for Directors to take independent professional advice, if necessary. All the Directors have access to the advice and services of the Company Secretary, the appointment or removal of whom is a matter for the full Board. The Board’s Committees The Board has established a number of Committees to assist it in fulfilling its responsibilities. Details of the work and composition of the Audit and Compliance Committee are set out below under the heading “internal control”. The Valuations Committee consists of Baroness Hogg (Chairman), Dr J R Forrest, Mr B P Larcombe, Mr M J Queen and Mr O H J Stocken. The Committee considers and recommends to the Board the valuations of the Group’s investments to be included in the interim and final accounts of the Group. The Committee met twice during the year. Details of the work and composition of the Remuneration Committee are set out in the Remuneration report. 27 3i Report and accounts 2003 Directors’ report The Nominations Committee consists of Baroness Hogg (Chairman), Dr J R Forrest, Mr B P Larcombe, Mme C J M Morin-Postel, Mr F D Rosenkranz, Mr F G Steingraber and Mr O H J Stocken. The Committee met four times during the year. At the request of the Board, the Committee considers and makes recommendations to the Board on the appointment of Directors and proposes which non-executive Directors should be invited to retire, having regard to the changing needs of the Board as a whole from time to time. The size and composition of the Board and the balance of its membership as between executive and non-executive Directors is regularly reviewed by the Nominations Committee and the Board. A formal and transparent process for the appointment of Directors has been established with the objective of identifying the skill and experience profile required of new Directors and identifying suitable candidates. The Committee is supported by specialist recruitment consultants, to identify suitable candidates for appointment as non-executive Directors, where appropriate. Directors’ training and development The Company has developed a training programme, which provides a framework within which training for new Directors can be planned. Newly appointed Directors are offered relevant training on the responsibilities of directors of a listed company. On appointment, all non-executive Directors have discussions with the Chairman and the Chief Executive following which appropriate briefings on the responsibilities of directors, the Company’s business and the Company’s procedures are arranged. The Company provides opportunities for non-executive Directors to obtain a thorough understanding of the Company’s business by meeting members of the senior management team who in turn arrange, as required, visits to investment offices and support departments. The non-executive Directors are encouraged to let either the Chairman or the Company Secretary know if there are any particular individuals in the Company they would like to meet or if there are any areas of the Company’s business in which they are particularly interested. Presentations on different aspects of the Company’s business are made regularly to Directors. Board effectiveness The Board has established a process led by the Chairman with the assistance of the Senior Independent Director for evaluating on an annual basis the performance of the Board, its Committees and individual Directors with particular attention to those who are due for re-appointment. The results of the Board evaluation process are shared with the Board as a whole. The Company’s relationship with its shareholders The Company recognises the importance of maintaining a purposeful relationship with all its shareholders. The Company uses its AGM as an opportunity to communicate with its shareholders. At the Meeting, business presentations are made by the Chief Executive and the Finance Director. The Chairmen of the Remuneration, Audit and Compliance and Nominations Committees are available to answer shareholders’ questions. The Chief Executive and the Finance Director, together with the Group Communications Director, meet with the Company’s principal institutional shareholders to discuss relevant issues as they arise. The Chairman ensures that regular reports are received by the non-executive Directors from the Company’s brokers with the objective of ensuring that non-executive Directors remain aware of shareholders’ views. The Chairman also maintains a dialogue with shareholders as required. In accordance with the Combined Code, the Notice of the 2002 AGM was dispatched to shareholders not less than 20 working days before the meeting. At that meeting, details of proxy votes received were made available in accordance with the recommendations of the Combined Code. In accordance with the Company’s Articles of Association, on a poll, every member who is present in person or by proxy has one vote for each share held. Portfolio management and voting policy In relation to unquoted investments, the Group’s approach is to seek to add value to the businesses in which the Group invests through the Group’s extensive experience, resources and contacts. In relation to quoted investments, the Group’s policy is to exercise voting rights on matters affecting the interests of the Group and its managed funds. Employment The Group’s policy is one of equal opportunity in the selection, training, career development and promotion of employees, regardless of gender, ethnic origin, religion and whether disabled or otherwise. The Group treats applicants and employees with disabilities equally and fairly and provides facilities, equipment and training to assist disabled employees to do their jobs. Should an employee become disabled during their employment, efforts are made to retain them in their current employment or to explore the opportunities for their retraining or redeployment within the Group. The Group also provides financial support, through a Company Disability Scheme, to disabled employees who are unable to work. The Group’s principal means of keeping in touch with the views of its employees are through employee appraisals, informal consultations and regular staff surveys. These processes have been maintained and are undergoing further development. Managers throughout the Group have a continuing responsibility to keep their staff fully informed of developments and to communicate financial results and other matters of interest. This is achieved by structured communication including regular meetings of employees. 3i has clear grievance and disciplinary procedures in place, which include comprehensive procedures on discrimination and 3i’s equal opportunities policy. 3i also has an employee assistance programme which provides a confidential, free and independent counselling service and is available to all staff and their families in the UK. There are clearly defined staff policies for pay and working conditions. 3i’s employment policies are designed to provide a competitive reward package which will attract and retain high quality staff, whilst ensuring that the cost element of these rewards remains at an appropriate level. Remuneration policy is reviewed by the Remuneration Committee of the Board. All UK employees receive a base salary and are eligible for a performance related bonus. 3i operates an Inland Revenue approved Share Investment Plan to encourage employees’ involvement in the performance of the Group and also operates share plans for senior executives and investment staff. Further details of these plans are set out in the Remuneration report. 28 3i Report and accounts 2003 Directors’ report In its international operations, 3i’s remuneration policy is influenced by market conditions and practices in the countries in which it operates. The overall remuneration package of employees in 3i’s non-UK operations is similar in structure to that available to UK employees, except that employees outside the UK (other than expatriate UK employees) do not participate in the 3i Group Pension Plan. Instead they participate in local state or company pension schemes as appropriate to local market conditions. As at the most recent valuation date, 98% of UK employees were members of the 3i Group Pension Plan (details of which are set out in the Remuneration report). Executives both in the UK and in 3i’s non-UK operations may also participate in “carried interest” schemes, which link executive remuneration to the performance of investments in executives’ business units. Charitable and political donations Charitable donations made by the Group in the year to 31 March 2003 amounted to £209,972. Excluding the Company’s matching of Give As You Earn contributions by staff, approximately 22% of those charitable donations were to charities which advance education, approximately 55% went to causes which aim to relieve poverty or benefit the community, or both, and approximately 23% went to medical charities. Further details of charitable donations are set out in the Corporate Social Responsibility report on pages 22 to 24. In accordance with the Group’s policy of not making donations to political parties, no donations were made to political parties during the year. Under the Companies Act 1985, as amended, the Company is required to disclose particulars of any donation to any EU political organisation and EU political expenditure incurred during the year. During the period, 3i plc, the main trading company of the Group, made payments to three organisations, detailed below, which may fall within the definition of donations to EU political organisations. These payments (annual subscriptions to the Industry Forum of £2,938 and the Enterprise Forum of £1,880 and corporate membership of the European Business Network of £1,040) amounted to £5,858. Policy for paying creditors The Group’s policy is to pay creditors in accordance with the CBI Prompt Payers Code of Good Practice copies of which can be obtained from the Confederation of British Industry at Centre Point, 103 New Oxford Street, London WC1A 1DU. The Company had no trade creditors during the year. 3i plc, the main trading company of the Group, had trade creditors outstanding at the year end representing 10 days of purchases. Statement of Directors’ responsibilities The Directors are required by UK company law to prepare accounts which give a true and fair view of the state of affairs of the Company and the Group as at the end of the period and of the profit for the period. The Directors have responsibility for ensuring that proper accounting records are kept which disclose with reasonable accuracy the financial position of the Group and enable them to ensure that the accounts comply with the Companies Act 1985. They have a general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the Group and to prevent and detect fraud and other irregularities. Suitable accounting policies, which follow generally accepted accounting practice and are explained in the notes to the accounts, have been applied consistently and applicable accounting standards have been followed. In addition, reasonable and prudent judgements and estimates have been used in the preparation of the accounts. Going concern The Directors are satisfied that the Company and the Group have adequate resources to continue to operate for the foreseeable future. For this reason, they continue to adopt the “going concern” basis for preparing the accounts. Internal control The Board is responsible for the Group’s system of internal control and reviews its effectiveness at least annually. Such a system is designed to manage rather than eliminate the risk of failure to achieve business objectives and can provide only reasonable and not absolute assurance against material misstatement or loss. The full Board meets regularly and has formally adopted a schedule of matters which are required to be brought to it or its duly authorised Committees for decision. This is aimed at maintaining full and effective control over appropriate strategic, financial, operational and compliance issues. The Board has put in place an organisational structure with clearly defined lines of responsibility and delegation of authority. Each year the Board considers and approves a rolling strategic plan and an annual budget. In addition, there are established procedures and processes for planning and controlling expenditure and the making of investments. There are also information and reporting systems for monitoring the Group’s businesses and their performance. An Audit and Compliance Committee, comprising Mr O H J Stocken (Chairman), Dr J R Forrest, Mme C J M Morin-Postel and Mr F D Rosenkranz, all independent non-executive Directors, reviews the effectiveness of the internal control environment of the Group and the Group’s compliance with its regulatory requirements. During the year the Committee met four times. The Committee receives regular reports from the internal and external auditors, the regulatory compliance function and Risk Committee and monitors their activities and effectiveness. The Committee reviews the interim and annual accounts of the Company before their approval by the Board and reviews the scope of the annual audit and any audit findings. The Committee also oversees the Company’s relations with its external auditors and recommends to the Board the appointment of the Company’s auditors and approves the terms of their engagement. Risk Committee is a management committee formed by the Chief Executive whose purpose is to review the business of the Group in order to ensure that business risk is considered, assessed and managed as an integral part of the business. There is an ongoing process for identifying, evaluating and managing the Group’s significant risks. This process was in place for the year ended 31 March 2003 and up to the date of this report. The process is regularly reviewed by the Board and complies with the internal control guidance for Directors on the Combined Code, issued by the Turnbull Committee. The process established for the Group includes: Policies • Core values, Group standards and Group controls together comprising the Group’s high level principles and controls, with which all staff are expected to comply. • Manuals of policies and procedures, applicable to all business units, with procedures for reporting weaknesses and for monitoring corrective action. • A code of business conduct, with procedures for reporting compliance therewith. 29 3i Report and accounts 2003 Directors’ report Processes • Appointment of experienced and professional staff, both by recruitment and promotion, of the necessary calibre to fulfil their allotted responsibilities. • A planning framework which incorporates a Board approved rolling Strategic Plan, with objectives for each business unit. • Formal business risk reviews performed by management which evaluate the potential financial impact and likelihood of identified risks and possible new risk areas, set control, mitigation and monitoring procedures and review actual occurrences identifying lessons to be learnt. • A comprehensive system of financial reporting to the Board, based on an annual budget with monthly reports against actual results, analysis of variances, scrutiny of key performance indicators and regular re-forecasting. • Regular treasury reports to the Board, which analyse the funding requirements of each class of assets, track the generation and use of capital and the volume of liquidity, measure the Group’s exposure to interest and exchange rate movements and record the level of compliance with the Group’s funding objectives. • A compliance department whose role is to integrate regulatory compliance procedures into the Group’s systems. • Well defined procedures governing the appraisal and approval of investments including detailed investment and divestment approval procedures incorporating appropriate levels of authority and regular post investment reviews. Verification • An internal audit department which undertakes periodic examination of business units and processes and recommends improvements in controls to management. • The external auditors who are engaged to express an opinion on the annual accounts. • An Audit and Compliance Committee which considers significant control matters and receives reports from the internal and external auditors and the regulatory compliance function on a regular basis. The internal control system is monitored and supported by an internal audit function which operates on an international basis and reports to management and the Audit and Compliance Committee on the Group’s operations. The work of the internal auditors is focused on the areas of greatest risk to the Group determined on the basis of the Group’s risk management process. The external auditors independently and objectively review the approach of management to reporting operating results and financial condition. In co-ordination with the internal auditors, they also review and test the system of internal financial control and the information contained in the Report and accounts to the extent necessary for expressing their opinion. Auditors’ independence and objectivity Subject to annual appointment by shareholders, auditor performance is monitored on an ongoing basis and formally reviewed every five years, the next review being scheduled for 2003. The Audit and Compliance Committee recognises the importance of ensuring the independence and objectivity of the Company’s auditors. It reviews the nature and extent of the services provided by them, the level of their fees and the element comprising non-audit fees. Safeguards have been put in place to reduce the likelihood of compromising auditor independence, including the following principles which are applied in respect of services provided by the auditors and other accounting firms and monitored by the Audit and Compliance Committee: • Services required to be undertaken by the auditors, which include regulatory returns, formalities relating to borrowings, shareholder and other circulars. This work is normally allocated directly to the auditors. • Services which it is most efficient for the auditors to provide. In this case, information relating to the service is largely derived from the Company’s audited financial records, for example, corporate tax services. This work is normally allocated to the auditors subject to consideration of any impact on their independence. • Services that could be provided by a number of firms including general consultancy work. All significant consultancy projects are normally put out to tender and work would be allocated to the auditors only if it did not present a potential threat to the independence of the audit team. Other services under this category include due diligence within the investment process. If this service were to be provided by the auditors, the specific team engaged would be independent of the audit team. Details of the fees paid to the auditors are disclosed in note 13 to the accounts on page 50. Auditors In accordance with section 384 of the Companies Act 1985, a resolution proposing the reappointment of Ernst & Young LLP as the Company’s auditors will be put to members at the forthcoming Annual General Meeting. By order of the Board A W W Brierley Secretary 14 May 2003 Registered Office 91 Waterloo Road London SE1 8XP 30 3i Report and accounts 2003 Remuneration report Introduction Although 3i is a constituent of the FTSE 100 Index, its business operates exclusively within the venture capital sector. The majority of the Company’s competitors comprise either partnerships of individuals managing funds for investment on behalf of third parties or unquoted subsidiaries of larger banking or financial services groups. Whilst the environment in financial markets has been tough, the venture capital market has continued to be well funded and, despite falling investment returns, competitor organisations have been able to offer substantial rewards for their staff and competition for quality, trained executives remains aggressive. In addition to cash bonuses, remuneration structures in the venture capital market include share plans as well as carried interest or co-investment schemes, which allow executives to share directly in the future profits on investments subject normally to a variety of conditions relating to the performance of those investments. It is against this challenging background that the Company’s Remuneration Committee (“the Committee”) has had to formulate and implement its remuneration policy to ensure that the Company is able to continue to attract, retain and motivate management of the quality required to ensure the continued vibrancy and success of the business as a whole. The Committee is also conscious of the need to align the interests of staff and shareholders. One of the ways in which this is achieved is by encouraging the holding of the Company’s shares by its staff. The Company’s policy has therefore been to provide long term incentives to its executives through share plans and, where appropriate, carried interest schemes. At 31 March 2003 over 75% of the Company’s UK staff were shareholders. Remuneration Committee Composition and terms of reference The Committee consists only of independent non-executive Directors. Its members throughout the year to 31 March 2003 (“the year”) were Dr J R Forrest (the Committee Chairman), Baroness Hogg, Mr F D Rosenkranz and Mr O H J Stocken. None of the members of the Committee sits with any other Director on the board of any other quoted company. The Committee’s terms of reference take into account the provisions of the Combined Code on corporate governance. Activities during the year The Committee met six times during the year to consider remuneration policy and to determine, on behalf of the Board, the specific remuneration packages for each of the executive Directors. In addition, the Committee considered and made recommendations to the Board on the Company’s framework of executive remuneration and its costs. Assistance to the Committee Persons who materially assisted the Committee with advice on Directors’ remuneration in the year were: Monks Partnership, an external remuneration consultant appointed by the Committee, the Group’s Human Resources Director, Mr R B Gregory and (except in relation to his own remuneration) the Chief Executive, Mr B P Larcombe. Mr Gregory was not appointed by the Committee. Monks Partnership is part of PricewaterhouseCoopers LLP. During the year, PricewaterhouseCoopers LLP provided the Group’s investment business with taxation, payroll and corporate restructuring advice, due diligence services and the services of an employee on secondment. Performance graphs The left hand graph below compares the Company’s total shareholder return for the five financial years of the Company to 31 March 2003 with the total shareholder return of the FTSE All-Share Index. The Directors consider that since the Company invests in a broad range of industrial and commercial sectors the FTSE All-Share Index is the most appropriate index against which to compare the Company’s performance. The right hand graph below compares the diluted net asset value per share at each of the last five financial year ends (with dividends reinvested) against the total shareholder return of the FTSE All-Share Index on those dates. This has been included because changes in net asset value per share relative to the FTSE All-Share Index are an important indicator of the performance of the Company’s assets. 3i total shareholder return versus FTSE All-Share total return (cumulative) years ended 31 March 3i diluted NAV versus FTSE All-Share total return (cumulative) years ended 31 March 200 150 100 50 0 1998 1999 2000 2001 2002 2003 200 150 100 50 0 1998 1999 2000 2001 2002 2003 3i FTSE All-Share 3i diluted NAV (with dividends reinvested) FTSE All-Share 31 3i Report and accounts 2003 Remuneration report Audit The tables in this report have been audited by Ernst & Young LLP. Directors’ remuneration policy Non-executive Directors The Board’s policy for the current financial year in relation to non-executive Directors (including the Chairman) continues to be to pay fees which are competitive with the fees paid by other FTSE 100 companies. Non-executive Directors’ fees are determined by the Board as a whole, within the limits set by the Company’s Articles of Association, having taken advice from Monks Partnership. Non-executive Directors’ remuneration was restructured with effect from 1 April 2002 by reducing the annual fees for Committee membership (from £5,000 to £3,500) and increasing the annual fees for Committee Chairmanship (from £4,000 to £7,500) and Board membership (from £25,000 to £30,000). No changes were made with effect from 1 April 2003. Non-executive Directors are not eligible for bonuses, share options, long-term incentives, pensions or performance related remuneration. Details of the non-executive Directors’ remuneration for the year are provided in the table on page 32. The Company does not currently expect its policy on non-executive Directors’ remuneration for subsequent financial years to change significantly. Executive Directors The Board’s policy for the current financial year in relation to executive Directors is to pay salaries and benefits sufficient to attract, retain and motivate Directors of the calibre required. The variable elements of each executive Director’s remuneration (comprising annual cash bonuses and long-term incentives) are intended to form a significant component of the executive Director’s total remuneration package. In particular, the salaries of the executive Directors are intended to represent less than half of the executive Directors’ potential rewards with the remainder of the rewards being related to individual and Company performance. The Committee has due regard to competitive market data in relation to similar jobs in comparable organisations including other FTSE 100 companies and companies in the financial services sector. The Company’s policy is also influenced by remuneration practice in the venture capital sector. The Committee is sensitive to wider issues including pay and employment conditions elsewhere in the Group when setting executive Directors’ pay levels and takes into account the Company’s reward strategy generally, before deciding specific packages for the executive Directors. The executive Directors’ performance related compensation is designed to encourage, where practicable, investment in, and the holding of, shares in the Company so as to align the interests of Directors and shareholders. The Company aims to provide pension benefits which are competitive with other FTSE 100 companies and companies in the financial services sector. The Company does not currently expect its policy on executive Directors’ remuneration for subsequent financial years to change significantly. Executive Directors’ remuneration packages The remuneration packages of the executive Directors consist of the following elements: Salaries Executive Directors’ base salaries are determined by the Committee in accordance with the policy referred to above. Annual cash bonuses All employees, including executive Directors, are eligible for non-pensionable discretionary annual cash bonuses. Executive Directors’ bonuses are determined by the Committee. Bonuses for the year, details of which are set out in the table on page 32, have been determined by the Committee based on achievement against a range of corporate and personal objectives. Corporate objectives for the year ended 31 March 2003 which were considered by the Committee included changes in the Company’s net asset value per share compared to the FTSE All-Share Index, total return and levels of revenue, costs and realisations. Personal objectives included clearly defined management targets relating to individual responsibilities. Long-term incentives The Committee determines the levels of long term incentives granted to executive Directors. The Committee regards the purposes of such awards as being both to align the interests of executives with those of shareholders and also to provide levels of potential reward which make continued employment with the Company attractive in relation to opportunities available elsewhere. The Group’s current long-term incentive arrangements for executive Directors consist of: (a) The 3i Group Discretionary Share Plan (the “Discretionary Share Plan”); and (b) US carried interest plans. The Discretionary Share Plan The Company operates a shareholder approved executive share plan which conforms with the Association of British Insurers’ (“ABI”) guidelines on dilution limits. Awards under this plan are not pensionable. The level of annual awards is reviewed each year taking account of market practice and the specific circumstances facing the Company. The Committee determines awards to executives based on an assessment of performance. All awards are granted subject to a performance target, the achievement of which will normally be a condition precedent to the exercise of the awards. Careful consideration is given each year to appropriately demanding performance targets. US carried interest plans At the Annual General Meeting in July 2002, shareholders approved the participation of the executive Director responsible for the Company’s US business, currently Mr M M Gagen, in the carried interest plans available to investment executives based in the US. These awards are not pensionable. Details of the awards made to Mr Gagen during the year are set out in the table on page 34. 32 3i Report and accounts 2003 Remuneration report Directors’ remuneration during the year Executive Directors B P Larcombe M M Gagen R W Perry M J Queen Dr R D M J Summers (retired 31.12.02) P B G Williams (retired 31.12.02) Non-executive Directors Baroness Hogg (as Deputy Chairman to 31.12.01) Baroness Hogg (as Chairman from 01.01.02) O H J Stocken (as Director to 22.01.02) O H J Stocken (as Deputy Chairman from 23.01.02) Dr J R Forrest C J M Morin-Postel (appointed 12.09.02) F D Rosenkranz F G Steingraber (appointed 01.01.02) The Lord Camoys (retired 10.07.02) Sir George Russell (retired 31.12.01) Total Total excluding pay in lieu of notice Salary and fees £’000 Pay in lieu of notice £’000 Annual cash bonus £’000 Benefits in kind £’000 Total remuneration Year to 31 March 2003 £’000 Total remuneration Year to 31 March 2002 £’000 578 586 296 334 257 242 – 220 – 75 48 18 37 30 9 – 2,730 2,730 – – – – 231 229 – – – – – – – – – – 460 150 – 100 100 – – – – – – – – – – – – 350 350 1 11 20 1 15 1 – – – – – – – – – – 49 49 729 597 416 435 503 472 – 220 – 75 48 18 37 30 9 – 3,589 3,129 546 715 363 318 334 318 51 55 30 17 40 – 31 6 30 209 3,063 3,063 Notes 1 Annual cash bonuses relate to the year to 31 March 2003 and are expected to be paid in July 2003. 2 During the year, Mr M M Gagen was based in the US on an expatriate assignment. Of the salary paid £310,000 was pensionable under the 3i Group Pension Plan and the balance represented expatriate salary supplements and allowances. 3 The non-cash elements of executive Directors’ remuneration packages (shown in the column headed “benefits in kind”) were company cars and fuel (Mr R W Perry and Dr R D M J Summers), health insurance (all of the executive Directors), life insurance premiums (Mr M M Gagen) and taxation advice (Mr M M Gagen). 4 Following his ceasing to be a Director and during the year Dr R D M J Summers had use of a company car and fuel (estimated monetary value: £4,713). During the year Lord Camoys was given a retirement gift at a cost of £2,000. Mr W J R Govett, a former Director, was paid £5,000 in respect of his directorship of Gardens Pension Trustees Limited, one of the trustees of the 3i Group Pension Plan. Options to subscribe for shares The table below provides details of executive share options held by the Directors who held office during the year. Executive Directors B P Larcombe M M Gagen Year of grant Held at 1 April 2002 Granted during the year Exercised during the year Held at 31 March 2003 (or retirement if earlier) Exercise price £ Date from which exercisable 1995 1995 1996 1997 1998 1999 2000 2001 2002 1993 1994 1997 1998 1999 2000 18,500 20,600 98,200 99,802 72,209 45,654 25,272 192,000 572,237 24,467* 5,000* 91,013 30,454 9,006 24,106 184,046 327,015 327,015 – – – – – – – – – – – – – – – – – – 18,500 20,600 98,200 99,802 72,209 45,654 25,272 192,000 327,015 899,252 24,467* 5,000* 91,013 30,454 9,006 24,106 184,046 3.34 4.23 4.50 5.20 6.64 7.28 13.75 10.00 6.73 1.68 2.72 5.20 6.64 7.28 13.56 05.01.98 14.12.98 25.06.99 16.06.00 22.06.01 06.07.02 28.06.03 09.08.04 27.06.05 30.07.99 22.06.00 16.06.00 22.06.01 06.07.02 03.07.03 Expiry date 04.01.05 13.12.05 24.06.06 15.06.07 21.06.08 05.07.09 27.06.10 08.08.11 26.06.12 29.07.03 21.06.04 15.06.07 21.06.08 05.07.09 02.07.10 33 3i Report and accounts 2003 Remuneration report Options to subscribe for shares continued R W Perry M J Queen Dr R D M J Summers (retired 31.12.02) P B G Williams (retired 31.12.02) Year of grant 1994 1995 1996 1997 1997 1998 1999 2000 2001 2002 1994 1995 1996 1997 1998 1999 2000 2001 2002 1995 1996 1997 1998 1999 2000 2001 1995 1996 1997 1998 1999 2000 2001 Held at 1 April 2002 Granted during the year 14,000*† 1,600* 38,700* 40,800* 58,378* 29,381* 10,734* 20,294 100,000 313,887 4,000*† 1,800* 40,850* 37,073* 62,177 36,002 30,795 114,000 326,697 15,050 88,500 111,180 14,632 35,270 10,747 120,000 395,379 29,350* 59,600* 95,343 30,454 9,006 18,464 114,000 356,217 145,670 145,670 184,318 184,318 – – Exercised during the year – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – Held at 31 March 2003 (or retirement if earlier) 14,000*† 1,600* 38,700* 40,800* 58,378* 29,381* 10,734* 20,294 100,000 145,670 459,557 4,000*† 1,800* 40,850* 37,073* 62,177 36,002 30,795 114,000 184,318 511,015 15,050 88,500 111,180 14,632 35,270 10,747 120,000 395,379 29,350* 59,600* 95,343 30,454 9,006 18,464 114,000 356,217 Exercise price £ 2.72 3.61 4.50 4.91 5.12 5.67 7.28 13.75 10.00 6.73 2.72 3.61 4.50 5.20 6.64 7.28 13.75 10.00 6.73 4.23 4.50 5.20 6.64 7.28 13.75 10.00 4.23 4.50 5.20 6.64 7.28 13.75 10.00 Date from which exercisable 22.06.97 03.07.98 25.06.99 06.01.00 17.12.00 16.12.01 06.07.02 28.06.03 09.08.04 27.06.05 22.06.97 03.07.98 25.06.99 16.06.00 22.06.01 06.07.02 28.06.03 09.08.04 27.06.05 14.12.98 25.06.99 16.06.00 22.06.01 06.07.02 28.06.03 09.08.04 14.12.98 25.06.99 16.06.00 22.06.01 06.07.02 28.06.03 09.08.04 Expiry date 21.06.04 02.07.05 24.06.06 05.01.07 16.12.07 15.12.08 05.07.09 27.06.10 08.08.11 26.06.12 21.06.04 02.07.05 24.06.06 15.06.07 21.06.08 05.07.09 27.06.10 08.08.11 26.06.12 13.12.05 24.06.06 15.06.07 21.06.08 05.07.09 27.06.10 08.08.11 13.12.05 24.06.06 15.06.07 21.06.08 05.07.09 27.06.10 08.08.11 The performance condition has not yet been met for those options shown in italics. * Awarded before appointment as a Director. † Of these options half became exercisable on the date shown and half became exercisable three years from that date. Notes 1 Options normally only become exercisable if the performance conditions referred to below are met. 2 Options granted in 1993 and 1994 were granted under The 3i Executive Share Option Plan (the “1984 Plan”) and are normally exercisable between the third and tenth anniversaries of the date of grant save that half of the options granted were not normally exercisable before the sixth anniversary. These options are normally exercisable only if the net asset value per share on the last day of the financial period ending immediately before the third anniversary of the date of grant or on the last day of any financial period thereafter, is equal to or in excess of the net asset value per share on the date of grant compounded by the respective annual percentage movement in the Retail Prices Index (“RPI”). 3 Options granted between 1 January 1995 and 31 March 2001 were granted under The 3i Group 1994 Executive Share Option Plan (the “1994 Plan”) and are normally exercisable between the third and tenth anniversaries of the date of grant provided a performance condition has been met over a rolling three year period. This requires that the adjusted net asset value per share (after adding back dividends paid during the three year performance period) at the end of the three year period is equal to or in excess of the net asset value per share at the beginning of the period compounded annually over the period by the annual increase in the RPI plus 4%. 4 Options granted after 31 March 2001 were granted under The 3i Group Discretionary Share Plan (the “Discretionary Share Plan”) and are normally exercisable between the third and tenth anniversaries of the date of grant to the extent a performance target has been met over a performance period of three years from the date of grant. If, however, the minimum threshold for vesting is not achieved in the first three years from grant, the performance period is extended to four and then five years from the date of grant but from the same base year. The performance target applicable to options granted since 31 March 2001 is set out in the table below: Annual percentage compound growth in net asset value per share with dividends reinvested, relative to the annual percentage change in the Retail Prices Index Below RPI + 5 percentage points At least RPI + 5 percentage points At levels of performance between RPI + 5 percentage points and RPI + 10 percentage points the grant will vest pro rata At least RPI + 10 percentage points Percentage of the grant vesting 0% 50% 100% 34 3i Report and accounts 2003 Remuneration report Notes continued 5 The performance conditions referred to above were based on increases in net asset value so as to enable a significant proportion of executive Directors’ potential remuneration to be linked to an increase in the assets of the Company. The intention has been to approximate to the performance conditions attached to carried interest schemes in the venture capital market whilst retaining the essential feature of aligning executives’ interests with those of the Company’s shareholders. The Committee determines whether the performance conditions have been fulfilled on the basis of calculations which are reviewed by the Company’s auditors. The minimum target of RPI +5%, and the maximum target of RPI +10% for options granted since 31 March 2001, were chosen as being appropriately demanding in the prevailing market conditions at the time. 6 Following their ceasing to hold office as Directors, Dr R D M J Summers and Mr P B G Williams are permitted to exercise outstanding options under The 3i Group Discretionary Share Plan (being those granted in 2001 and 2002) within six months of the performance condition being satisfied and to exercise outstanding options under the 1994 Plan (being the balance of their outstanding options) within 12 months of ceasing to hold office. 7 For US legal and regulatory reasons, in 2001 Mr M M Gagen was granted phantom share options (contractual rights to payments in circumstances designed to mirror the effect of an option to acquire shares under the Discretionary Share Plan) on the same terms and conditions as share options granted to other Directors in that year. The details of these phantom share options are set out in the table below: Executive Director M M Gagen Held at 1 April 2002 Granted during the year Exercised during the year Held at 31 March 2003 Exercise Market price on date of exercise £ price £ Date from which exercisable Expiry date 114,000 – – 114,000 10.00 – 09.08.04 08.08.11 8 The mid-market price of shares in the Company at 31 March 2003 was 416.5p and the range during the period 1 April 2002 to 31 March 2003 was 406.5p to 810.5p. The aggregate of the amount of gains made by Directors on the exercise of share options in the year was £nil (2002: £398,344). Options under the 1984 Plan, the 1994 Plan and the Discretionary Share Plan have been granted with exercise prices not less than the prevailing market value. Options are granted at no cost to the option holder. No options held by Directors lapsed during the year. US Carried Interest Plan Awards The following table provides details of the awards made to Mr M M Gagen under the US carried interest plans. Points as at 1 April 2002 Points allocated during the year Payments received during the year Points as at 31 March 2003 Executive Director M M Gagen nil 115 (2000 Vintage) 52 (2001 Vintage) 111 (2002 Vintage) 135 (2003 Vintage) – – – – 115 (2000 Vintage) 52 (2001 Vintage) 111 (2002 Vintage) 135 (2003 Vintage) The plans operate on the basis of annual “vintages” of investments and points are used to allocate carried interest between participants. New investments made in a particular financial year belong to the same vintage. Further investments in subsequent years are treated as belonging to the vintage in which the first investment was made. Payments will be made to the executive Director in relation to his points for a particular vintage when proceeds from the realisation of investments are received. If the value of any remaining investments for a vintage (both realised and unrealised) exceeds a specified internal rate of return (10% for the vintage years ended 31 March 2000 and 2001 and 8% for the vintage years ended 31 March 2002 and 2003), a proportion of the realised profits will be paid to the executive Director in accordance with his points. If the specified internal rate of return is not achieved, a lesser amount will be paid to the executive Director. The number of points allocated to the US based Director was determined by the Committee after taking into account market practice in the US. The conditions determining payments under the plans were chosen so as to link participants rewards to realised profits from investments. The points set out in the above table provide Mr M M Gagen with the opportunity (subject as mentioned above) to benefit over time by the amount of profit realised on investments having an aggregate original cost of $4.6 million representing 0.95% of the investments made by the US business during the relevant period. Currently these investments are valued at below cost and the points have no accrued value. The Share Incentive Plan Eligible UK employees, including executive Directors, may participate in an Inland Revenue approved Share Incentive Plan. During the year participants could invest up to £125 per month from their pre-tax salaries in the Company’s shares (referred to as partnership shares). For each share so acquired the Company granted two free additional shares (referred to as matching shares). Dividends are reinvested on behalf of participants in further shares (referred to as dividend shares). Details of shares acquired by the executive Directors under this Plan during the year are set out in the table below. Executive Directors B P Larcombe R W Perry M J Queen Dr R D M J Summers (retired 31.12.02) P B G Williams (retired 31.12.02) Held at 31 March 2003 (or retirement if earlier) Partnership shares Held at 31 March 2003 (or retirement if earlier) Matching shares Held at 31 March 2003 (or retirement if earlier) Dividend shares Held at 1 April 2002 – – – – – 293 293 276 211 211 586 586 552 422 422 8 8 6 2 2 Notes Since 31 March 2003, Mr B P Larcombe, Mr R W Perry and Mr M J Queen have each acquired a further 28 partnership shares and have each been awarded a further 56 matching shares. 35 3i Report and accounts 2003 Remuneration report Pension arrangements The executive Directors are, and until their ceasing to be Directors on 31 December 2002, Dr R D M J Summers and Mr P B G Williams were, members of the 3i Group Pension Plan which is a defined benefit contributory scheme to which, at the most recent valuation date, 98% of UK employees belonged. The Plan provides for a pension, subject to Inland Revenue limits, of two-thirds of basic annual salary (limited to the Earnings Cap where this applies) on retirement (normally at age 60) after 25 years’ service and less for service under 25 years. The Plan also provides life cover of four times salary, pensions payable in the event of ill health and spouses’ pensions on death. Further details of the Plan are set out in note 11 to the accounts on pages 48 to 50. Details of the pension entitlements of Directors who served during the year are provided in the table below. The final column of the table gives the difference between the transfer value of the Director’s pension entitlement at the start of the year and the transfer value at the end of the year, less the contributions paid by the Director. The difference over the year is the result of any extra benefits earned over the year and any change in the value placed on £1 p.a. of pension by the actuaries. The value placed by the actuaries on £1 p.a. of pension reflects financial conditions at the time (eg the level of the stock market or returns available on government bonds) and the method and assumptions they use to calculate transfer values from time to time. Changes in the value placed on £1 p.a. of pension can be positive or negative and can have much greater impact than the actual pension benefits earned. (Note 1) (Note 1) Complete years of pensionable service at 31 March 2003 Age at 31 March 2003 (Notes 1 and 3) Increase in accrued pension (excluding inflation) during the year to 31 March 2003 £’000 p.a. (Notes 1 and 3) Total accrued pension at 31 March 2003 £’000 p.a. (Note 4) Transfer value of increase in accrued benefit at 31 March 2003, less Director’s contribution £’000 p.a. (Notes 1 and 2) Increase in accrued pension (including inflation) during the year to 31 March 2003 £’000 p.a. (Note 6) (Note 6) Transfer value of accrued benefits at 31 March 2003 £’000 Transfer value of the accrued benefits at 31 March 2002 £’000 Difference between transfer value at start and end of the accounting year, less Director’s contribution £’000 Executive Directors B P Larcombe M M Gagen R W Perry M J Queen Dr R D M J Summers (retired 31.12.02) P B G Williams (retired 31.12.02) 49 47 57 41 58 56 28 18 17 15 30 32 26 9 16 15 (10) (12) 409 152 140 135 212 201 272 81 292 122 663 1,090 32 11 18 17 (7) (10) 5,396 1,809 2,852 1,255 4,121 4,076 4,145 1,370 1,942 891 3,457 3,130 1,250 439 909 363 664 946 Notes 1 In the case of Dr R D M J Summers and Mr P B G Williams, 31 December 2002, being the date of leaving service. 2 The increase in accrued pension shown reflects the difference between deferred pensions on leaving, payable from age 60, except for Dr Summers and Mr Williams. For Dr Summers and Mr Williams, the figures shown are the difference between the amount of immediate pension granted to them on their leaving service and the amount of the deferred pension to which they would have been entitled if they had left on 31 March 2002. 3 The pensions shown, except for Dr Summers and Mr Williams, are deferred pensions payable from age 60. Dr Summers’s and Mr Williams’s figures represent the immediate pension granted on their leaving service, which was equal to their then accrued pensions reduced for early payment. 4 The transfer values have been calculated on the basis of actuarial advice in accordance with relevant professional guidance (Actuarial Guidance Note GN11 (version 8.1)) and, in the case of Dr Summers and Mr Williams reflect the benefits taken on early retirement. 5 Additional voluntary contributions are excluded from the above table. 6 The transfer values have been calculated on the basis of actuarial advice in accordance with relevant professional guidance (Actuarial Guidance Note GN11 (version 8.1)) and, in the case of Dr Summers and Mr Williams, reflect the benefits due to be paid after 31 March 2003 only. Directors’ service contracts The non-executive Directors, including the Chairman, hold office in accordance with the Articles of Association of the Company and do not have service contracts. Non-executive Directors’ appointment letters provide that there is no entitlement to compensation or other benefits on ceasing to be a Director. Company policy is that in normal circumstances executive Directors’ notice periods should not exceed one year. Each executive Director has an employment contract with 3i plc (or, in the case of Mr M M Gagen, 3i Corporation) with a notice period not exceeding 12 months. Save for these notice periods the contracts have no unexpired terms. The contract of employment of each Director (other than Mr Gagen) dates from when he was first employed by the Group, being 23 September 1974 for Mr B P Larcombe, 1 July 1985 for Mr R W Perry and 22 June 1987 for Mr M J Queen. Mr Gagen’s contract of employment is dated 12 July 2000. These contracts contain no specific provisions for the payment of compensation in the event of early termination. The Committee considers that compensation payments on early termination of employment should depend on individual circumstances. The duty of Directors to mitigate their loss will always be a relevant factor. Under the rules of the Company’s share option and long-term incentive award plans, a Director may be permitted to exercise options and awards within 12 months of leaving the Company for all the Plans, except the Discretionary Share Plan, under which a Director may be permitted to exercise options within six months of the date the options vest, if at all. 36 3i Report and accounts 2003 Remuneration report Directors’ share interests As at 31 March 2003 the current executive Directors had the holdings in the Company’s shares shown below. B P Larcombe M M Gagen R W Perry M J Queen 31 March 2003 shares 741,845 91,055 22,436 130,135 31 March 2002 shares 740,958 91,055 21,509 129,285 These figures exclude conditional rights to acquire shares under the Management Equity Investment Plan detailed below in the section headed Historic awards. Full details of the Directors’ interests in the Company’s shares are shown in note 39 to the accounts on page 62. Historic awards This section of the Remuneration report gives details of historic awards held by Directors under the Management Equity Investment Plan. Deferred share bonuses under the Management Equity Investment Plan For years up to 31 March 2001 executives could receive part of their annual bonus in the form of a deferred award of shares. The value of these awards was reported each year as remuneration for the year in respect of which they were awarded. Awards took the form of share options issued by an employee benefit trust to acquire shares at no cost to themselves after three years provided they remained in employment with the Group and, in the case of executive Directors, they had maintained an agreed shareholding during the three year period. There was no performance condition since the award was considered part of the bonus already earned. In 1997 and 1998, instead of granting nil-cost options, executives were granted market value options but also received a deferred cash bonus of the same amount which was payable only for the purpose of funding the exercise price payable when awards were exercised. Executive Directors B P Larcombe M M Gagen R W Perry M J Queen Dr R D M J Summers (retired 31.12.02) P B G Williams (retired 31.12.02) Year of grant Held at 1 April 2002 Granted during the year Exercised during the year Held at 31 March 2003 (or retirement if earlier) Exercise price £ Date from which exercisable 1997 1998 1999 2000 2001 1998 1999 2000 1998 1999 2000 2001 1997 1998 1999 2000 2001 1996 1997 1998 1999 2000 2001 1997 1998 1999 2000 2001 11,348 12,443 13,681 9,699 6,400 53,571 9,049 8,333 6,668 24,050 6,787* 5,970* 5,819 3,600 22,176 5,075* 8,144 8,333 6,668 4,000 32,220 13,144 10,766 9,049 10,447 7,274 4,500 55,180 9,602 9,049 8,333 6,668 4,000 37,652 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 11,348 12,443 13,681 9,699 6,400 53,571 9,049 8,333 6,668 24,050 6,787 5,970 5,819 3,600 22,176 5,075 8,144 8,333 6,668 4,000 32,220 13,144 10,766 9,049 10,447 7,274 4,500 55,180 9,602 9,049 8,333 6,668 4,000 37,652 5.155 6.63 Nil Nil Nil 6.63 Nil Nil 6.63 Nil Nil Nil 5.155 6.63 Nil Nil Nil Nil 5.155 6.63 Nil Nil Nil 5.155 6.63 Nil Nil Nil 09.06.00 15.06.01 23.07.02 28.06.03 09.08.04 15.06.01 23.07.02 28.06.03 15.06.01 23.07.02 28.06.03 09.08.04 09.06.00 15.06.01 23.07.02 28.06.03 09.08.04 12.07.99 09.06.00 15.06.01 23.07.02 01.01.03 01.01.03 09.06.00 15.06.01 23.07.02 01.01.03 01.01.03 Expiry date 08.06.04 14.06.05 22.07.06 27.06.07 08.08.08 14.06.05 22.07.06 27.06.07 14.06.05 22.07.06 27.06.07 08.08.08 08.06.04 14.06.05 22.07.06 27.06.07 08.08.08 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 31.12.03 * Awarded before appointment as a Director. Note Dr R D M J Summers and Mr P B G Williams are permitted to exercise their deferred share bonuses within 12 months of their ceasing to be Directors. 37 3i Report and accounts 2003 Remuneration report Long-term incentive awards As well as receiving share bonus awards, from 1997 to 2000 executives could also be offered awards linked to the longer term performance of the Group. Participants were awarded a share option by an employee benefit trust to acquire shares at no cost to themselves after five years provided a performance condition had been satisfied. In 1997 and 1998, instead of granting nil-cost options, executives were granted market value options but also received a deferred cash bonus of the same amount which was payable only for the purpose of funding the exercise price payable when awards were exercised. Year of grant Held at 1 April 2002 Granted during the year Exercised during the year Held at 31 March 2003 (or retirement if earlier) Exercise price £ Date from which exercisable Executive Directors B P Larcombe M M Gagen R W Perry M J Queen Dr R D M J Summers (retired 31.12.02) P B G Williams (retired 31.12.02) 1997 1998 1999 2000 1997 1998 1999 2000 1998 1999 2000 1998 1999 2000 1997 1998 1999 2000 1997 1998 1999 2000 17,313 7,682 12,714 51,518 89,227 28,353 1,652 38,182 30,090 98,277 23,540* 842* 21,054 45,436 27,348 46,817 25,776 99,941 22,175 4,119 7,407 38,094 71,795 28,353 1,652 21,298 33,353 84,656 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 17,313 7,682 12,714 51,518 89,227 28,353 1,652 38,182 30,090 98,277 23,540 842 21,054 45,436 27,348 46,817 25,776 99,941 22,175 4,119 7,407 38,094 71,795 28,353 1,652 21,298 33,353 84,656 5.155 6.63 Nil Nil 5.155 6.63 Nil Nil 5.155 Nil Nil 5.155 Nil Nil 5.155 6.63 Nil Nil 5.155 6.63 Nil Nil Expiry date 08.06.04 14.06.05 22.07.06 27.06.07 08.06.04 14.06.05 22.07.06 27.06.07 08.06.04 22.07.06 27.06.07 08.06.04 22.07.06 27.06.07 31.12.03 31.12.03 31.12.03 09.06.02 15.06.03 23.07.04 28.06.05 09.06.02 15.06.03 23.07.04 28.06.05 09.06.02 23.07.04 28.06.05 09.06.02 23.07.04 28.06.05 09.06.02 01.01.03 01.01.03 09.06.02 01.01.03 01.01.03 31.12.03 31.12.03 31.12.03 * Awarded before appointment as a Director. Notes In accordance with the rules of the Plan, Dr R D M J Summers and Mr P B G Williams are permitted, within 12 months of their ceasing to be Directors, to exercise the awards granted in 1997, 1998 and 1999 (being those with release dates of 2002, 2003 and 2004 respectively), to the extent that the three year performance condition was satisfied (being 100% for the 1997 and 1998 awards and 64.6% for the 1999 awards). The awards granted in 2000 (being those with original release dates of 2005) lapsed following their ceasing to be Directors. The performance condition provides that no shares vest unless the increase in the Company’s total shareholder return (TSR) over a three year performance period is equal to or exceeds the compounded annual increase in the RPI over the period + 6% per annum. If the Company’s TSR over the period is equal to the compounded annual increase in the RPI over the period + 6% per annum, 35% of the shares vest and all shares vest if TSR is equal to or exceeds RPI + 20% per annum. At performance between these levels, a proportion of shares vest. If the minimum performance condition is not achieved in the three year performance period, the performance period is extended up to a maximum period of seven years but from the same base year. The Committee decided that a performance condition linked to shareholder return was in shareholders’ interests and by linking the condition to RPI inflationary increases were discounted. The minimum TSR target of RPI + 6% per annum, and the maximum TSR target of RPI + 20% per annum, were chosen as being suitably demanding at that time whilst aligning the interests of participants and shareholders. The Group’s Human Resources department calculates whether and the extent to which the performance condition has been satisfied in accordance with the formula and this calculation is audited by the Company’s auditors. By order of the Board Baroness Hogg Chairman 14 May 2003 38 3i Report and accounts 2003 Independent auditors’ report to the members of 3i Group plc We have audited the Group’s financial statements for the year ended 31 March 2003, which comprise Consolidated statement of total return, Reconciliation of movement in shareholders’ funds, Consolidated revenue statement, Consolidated balance sheet, Parent company balance sheet, Consolidated cash flow statement, Accounting policies and the related notes 1 to 49. These financial statements have been prepared on the basis of the accounting policies set out therein. We have also audited the information in the Remuneration report that is described as having been audited. This report is made solely to the Company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors The Directors’ responsibilities for preparing the Annual Report and the financial statements in accordance with applicable United Kingdom law and accounting standards are set out in the Statement of Directors’ responsibilities. Our responsibility is to audit the financial statements and the part of the Remuneration report to be audited in accordance with relevant legal and regulatory requirements, United Kingdom Auditing Standards and the Listing Rules of the Financial Services Authority. We report to you our opinion as to whether the financial statements give a true and fair view and whether the financial statements and the part of the Remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985. We also report to you if, in our opinion, the Directors’ report is not consistent with the financial statements, if the Company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law or the Listing Rules regarding Directors’ remuneration and transactions with the Group is not disclosed. We review whether the corporate governance statement on pages 26 to 29 reflects the Company’s compliance with the seven provisions of the Combined Code specified for our review by the Listing Rules, and we report if it does not. We are not required to consider whether the Board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the Group’s corporate governance procedures or its risk and control procedures. We read other information contained in the Annual Report and consider whether it is consistent with the audited financial statements. This other information comprises Chairman’s statement, Chief Executive’s statement, Operating review, Financial review, Corporate Social Responsibility report, Directors’ report, Remuneration report, Principal subsidiary undertakings and joint ventures, Portfolio valuation methodology and Investment analysis. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any other information. Basis of audit opinion We conducted our audit in accordance with United Kingdom Auditing Standards issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements and the part of the Remuneration report to be audited. It also includes an assessment of the significant estimates and judgements made by the Directors in the preparation of the financial statements, and of whether the accounting policies are appropriate to the Group’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the financial statements and the part of the Remuneration report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion, we also evaluated the overall adequacy of the presentation of information in the financial statements and the part of the Remuneration report to be audited. Opinion In our opinion, the financial statements give a true and fair view of the state of affairs of the Company and of the Group as at 31 March 2003 and of the loss of the Group for the year then ended; and the financial statements and the part of the Remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985. Ernst & Young LLP Registered Auditor London 14 May 2003 39 3i Report and accounts 2003 Consolidated statement of total return for the year to 31 March 2003 Notes Revenue 2003 £m Capital 2003 £m Total 2003 £m Revenue 2002 £m Capital profits Realised profits/(losses) on disposal of investments Unrealised (losses) on revaluation of investments Total operating income before interest payable Interest payable Administrative expenses Amortisation of goodwill Cost of changes to organisational structure Return before tax and currency translation adjustment Tax Return for the year before currency translation adjustment 2 3 1 6 9 12 1 14 Currency translation adjustment Total return Total return per share Basic (pence) Diluted (pence) 184 (1,165) (981) 10 (53) (1,024) (89) – (5) (1,118) 35 (1,083) 2 (1,081) 184 (1,165) (981) 308 (110) (783) (153) – (10) (946) 3 (943) 8 (935) 298 (57) 241 (64) – (5) 172 (32) 140 6 146 355 (114) 241 (121) (2) (9) 109 (3) 106 (4) 102 Capital 2002 £m (39) (890) (929) – (6) (935) (50) (71) (9) (1,065) 4 (1,061) (1) (1,062) Total 2002 £m (39) (890) (929) 355 (120) (694) (171) (73) (18) (956) 1 (955) (5) (960) 23.9p 23.9p (177.1)p (176.9)p (153.2)p (153.0)p 16.8p 16.7p (174.5)p (173.3)p (157.7)p (156.6)p Reconciliation of movement in shareholders’ funds Opening balance Revenue return Capital return Total return Dividends Proceeds of issues of shares Movement in the year Closing balance 2003 £m 3,945 146 (1,081) (935) (81) 7 2002 £m 4,973 102 (1,062) (960) (78) 10 (1,009) (1,028) 2,936 3,945 40 3i Report and accounts 2003 Consolidated revenue statement for the year to 31 March 2003 Interest receivable Interest receivable and similar income arising from debt securities and other fixed income securities held as financial fixed asset investments Interest receivable on loan investments Fixed rate dividends Other interest receivable and similar income Interest payable Net interest income Dividend income from equity shares Share of net (losses)/profits of joint ventures Fees receivable Other operating income Total operating income Administrative expenses and depreciation Amortisation of goodwill Cost of changes to organisational structure Profit on ordinary activities before tax Tax on profit on ordinary activities Profit for the year Dividends Interim Final Profit retained for the year Earnings per share Basic (pence) Diluted (pence) Notes 2003 £m 2002 £m 4 4 5 6 7 8 9 12 13 14 16 16 17 17 96 17 113 34 147 (57) 90 106 (1) 46 – 241 (64) – (5) 172 (32) 140 (29) (52) 59 113 19 132 46 178 (114) 64 111 9 56 1 241 (121) (2) (9) 109 (3) 106 (29) (49) 28 22.9p 22.9p 17.4p 17.3p There is no material difference between the reported revenue and the revenue on an unmodified historical cost basis. 41 3i Report and accounts 2003 Consolidated balance sheet as at 31 March 2003 Assets Treasury bills and other eligible bills Loans and advances to banks Debt securities held for treasury purposes Debt securities and other fixed income securities held as financial fixed asset investments Loan investments Fixed income shares Equity shares Listed Unlisted Interests in joint ventures Share of gross assets Share of gross liabilities Intangible fixed assets Goodwill Tangible fixed assets Own shares Other assets Prepayments and accrued income Total assets Liabilities Deposits by banks Debt securities in issue Other liabilities Accruals and deferred income Provisions for liabilities and charges Subordinated liabilities Called up share capital Share premium account Capital redemption reserve Capital reserve Revenue reserve Equity shareholders’ funds Total liabilities Memorandum items Contingent liabilities Guarantees and assets pledged as collateral security Commitments Approved by the Board Baroness Hogg Brian Larcombe Directors 14 May 2003 Notes 2003 £m 1,336 228 1,564 187 2,188 2,375 104 (81) 19 20 21 21 21 21 22 24 25 26 27 28 29 30 35 36 37 38 39 40 40 40 40 48 49 2002 £m 1 563 191 2003 £m 1 527 283 2002 £m 1,408 324 1,732 413 2,964 3,377 3,939 5,109 133 (98) 23 – 45 44 64 73 4,999 423 1,350 56 173 10 51 2,063 305 349 1 1,940 341 2,936 4,999 19 270 35 – 50 54 61 69 6,133 519 1,339 53 181 12 84 2,188 305 342 1 3,021 276 3,945 6,133 27 411 42 3i Report and accounts 2003 Parent company balance sheet as at 31 March 2003 Assets Loans and advances to banks Debt securities held for treasury purposes Debt securities and other fixed income securities held as financial fixed asset investments Loan investments Fixed income shares Equity shares Listed Unlisted Interests in joint ventures Shares in Group undertakings Tangible fixed assets Other assets Prepayments and accrued income Total assets Liabilities Deposits by banks Debt securities in issue Other liabilities Accruals and deferred income Provisions for liabilities and charges Subordinated liabilities Called up share capital Share premium account Capital redemption reserve Capital reserve Revenue reserve Equity shareholders’ funds Total liabilities Memorandum items Contingent liabilities Guarantees and assets pledged as collateral security Commitments Approved by the Board Baroness Hogg Brian Larcombe Directors 14 May 2003 Notes 19 20 21 21 21 21 22 23 25 27 28 29 30 35 36 37 38 39 40 40 40 40 48 49 2003 £m 1,258 224 1,482 180 1,999 2,179 2002 £m 1,334 318 1,652 406 2,694 3,100 2003 £m 431 283 3,661 1 66 26 72 50 4,590 248 997 441 47 – 2 1,735 305 349 1 1,762 438 2,855 4,590 16 260 2002 £m 489 191 4,752 12 137 31 64 49 5,725 323 985 376 47 – 2 1,733 305 342 1 2,939 405 3,992 5,725 21 394 43 3i Report and accounts 2003 Consolidated cash flow statement for the year to 31 March 2003 Operating activities Interest received and similar income arising from debt securities and other fixed income securities held as financial fixed asset investments Other interest received and similar income Interest paid on borrowings Dividends received from equity shares Fees and other net cash receipts Operating and administrative costs paid Net cash inflow from operating activities Taxation received/(paid) Capital expenditure and financial investment Investment in equity shares, fixed income shares and loans Investment in equity shares and loans acquired from joint ventures Sale, repayment or redemption of equity shares, fixed income shares and loan investments Fees intrinsic to acquisition or disposal of investments Investment interest paid Investment administrative expenses Investment in joint ventures Divestment or repayment of interests in joint ventures Disposal of investment properties Purchase of tangible fixed assets Sale of tangible fixed assets Net cash flow from capital expenditure and financial investment Acquisitions Acquisition of subsidiary undertakings Equity dividends paid Management of liquid resources Net cash flow before financing Financing Debt due within one year Debt due after more than one year Issues of shares Net cash flow from financing Increase/(decrease) in cash Notes 2003 £m 2002 £m 75 31 (58) 102 46 (68) 128 4 (673) (17) 975 10 (53) (94) (54) 19 – (5) 1 109 – (78) 15 178 (104) (32) 7 (129) 102 51 (113) 109 62 (148) 63 (2) (804) (233) 1,123 – (6) (59) (347) 281 7 (7) 1 (44) (51) (78) 293 181 (394) 165 10 (219) 49 (38) 42 43 47 46 46 44 46 44 3i Report and accounts 2003 Accounting policies A Accounts presentation and convention These accounts have been prepared under the historical cost convention modified to include certain investments and fixed assets at valuation and in accordance with the revised Statement of Recommended Practice – Financial Statements of Investment Trust Companies (“revised SORP”) – and applicable accounting standards, except as described below concerning the treatment of capital profits. As the Company is a deposit taker regulated by the Financial Services Authority, the accounts have also been prepared in accordance with the requirements of Part VII of the Companies Act 1985 in respect of banking companies and groups. The Articles of Association of the Company prohibit the distribution of its capital profits. Accordingly, the Company’s capital profits, shown in note 40, are included in the capital reserve. In order to use consistent accounting policies in the Group accounts, the capital profits of subsidiary undertakings have been excluded from consolidated revenue and included in capital reserve. These capital profits of subsidiary undertakings are distributable. The Revenue statement of the Company has been omitted from these accounts in accordance with section 230 of the Companies Act 1985. The recommendations contained within the revised SORP, issued by the Association of Investment Trust Companies in January 2003, have been adopted in these accounts. As a result, fee income and costs earned or incurred as an intrinsic part of an intention to acquire or dispose of an investment have been accounted for in full as part of capital return, as opposed to being credited to revenue or allocated between revenue and capital. To the extent that taxation losses have been transferred between capital and revenue in order to be utilised against excess taxable profits, the transfer is reflected in the Statement of total return, Revenue statement and note 14. The adoption of these recommendations has had no effect on total return and, as a result, in accordance with the revised SORP, comparatives have not been changed. Administrative expenses associated with making and managing investments and finance costs are allocated between capital and revenue. During the year, the methodology used to identify those administrative expenses available for allocation has been revised; this has resulted in a higher level of expenses being available. The allocation of finance costs has been revised to reflect the trend of returns within the portfolio. These returns have become increasingly based on total investment packages as opposed to the individual investment instruments making up the package. In order to reflect this, all finance costs less interest income on surplus funds has been allocated between revenue and capital. In the year to 31 March 2001, the proportion of available costs allocated to capital reserve was increased from 70% to 80%, this was to reflect returns moving in favour of capital returns due to higher technology investment. This allocation has now reverted to 70% for both administrative expenses and net finance costs. In accordance with the revised SORP, comparatives have not been restated. B Joint ventures and associated undertakings Entities whose business is in a field of activity which is closely related or complementary to that of the Group and in which holdings are intended to be retained on a long term basis and are jointly controlled by the Group and one or more venturers under a contractual agreement are treated as joint ventures. These joint ventures are accounted for using the gross equity method of accounting. The Directors believe that equity accounting for investments which may come within the Companies Act definition of associated undertakings, because 3i exerts significant influence, would not give a true and fair view of the income from the investment activities of the Group, since this is better measured by the inclusion of dividends and interest income. It is impracticable to quantify the effects of this departure. The treatment adopted is in accordance with Financial Reporting Standard 9 – Associates and Joint Ventures. C Goodwill Goodwill is the difference between the cost of acquisition of shares in subsidiary undertakings and joint ventures and the aggregate fair value of the entity’s identifiable assets and liabilities at the date of acquisition. Goodwill is capitalised as an intangible asset and amortised over its estimated useful economic life. This amortisation is allocated between revenue and capital based on the expected future split of returns of the businesses acquired. At each balance sheet date, consideration is given to the effect changing circumstances have on the value of goodwill. D Fixed assets in use by the Group Fixed assets in use by the Group are depreciated by equal annual instalments over their estimated useful lives as follows: office equipment five years; computer equipment three years; computer software three years; motor vehicles four years. Properties in use by the Group are included at external professional valuation, which is carried out at each balance sheet date. Depreciation is not provided against the value of the buildings as the amount is immaterial and impairment is considered annually. Motor vehicles being acquired on hire purchase are capitalised in the balance sheet and depreciated over their estimated useful lives. The interest element of the rental obligations is charged to the revenue account over the period of the agreement and represents a constant proportion of the balance of capital repayments outstanding. E Financial fixed assets Loan investments, fixed income and equity share investments, together with interests in joint ventures and the shares in Group undertakings, are regarded as financial fixed assets as they are held for long term investment purposes. 45 3i Report and accounts 2003 Accounting policies F Valuation of financial fixed assets and investment properties Investment packages comprising mixtures of equity shares, fixed income shares and loan investments, together with financial fixed assets of joint ventures, are included at valuation on the following bases: a Listed investments are valued at mid-market price. b Quoted shares for which an active market exists elsewhere are valued at mid-market price, except for shares quoted on secondary markets which are valued at latest traded price less an appropriate discount for illiquidity. c Unquoted equity shares are valued by the Directors as follows: where the latest accounts show a profit, the valuation is made by reference to a price based on the application to the latest reported earnings of price-earnings ratios appropriate to similar listed investments. If the resultant valuation is less than half the book amount of net assets in those accounts, the valuation is based on half the book amount of those assets. Where the latest accounts show a loss, the valuation is based on half the book amount of net assets in those accounts. In each of these cases an appropriate discount is applied to the valuations to reflect restricted marketability and where appropriate they are modified to take account of special factors relating to each investment which are considered to affect the valuation. Where no accounts have been received for a period following the initial investment, the investment is valued at cost. For technology companies where cost or carrying value is no longer considered appropriate, the valuation is changed to fair value using the most appropriate criteria available. d Unquoted fixed income shares and loan investments are valued at the lower of cost or recoverable amount. e In all of the above categories of investment where failure has occurred the loss is charged against realised capital profits. f Deferred consideration is included at the estimated present value of the expected proceeds. Investment properties are included at external professional valuation. G Income recognition Dividends receivable on listed shares are brought into account on the ex-dividend date. Dividends receivable on shares where no ex-dividend date is quoted are brought into account when the right to receive payment is established. The fixed return on a loan investment is recognised on a time apportionment basis so as to reflect the effective yield on the loan. Other income, including interest receivable from derivatives, is recognised on the accruals basis except for income from finance leases and hire purchase contracts, which is credited to revenue so as to result in a constant periodic rate of return on the net cash investment. H Administrative expenses Administrative expenses which comprise the costs of making and managing investments and the management of the Group are accounted for on an accruals basis. Costs associated with making and managing investments are allocated to revenue and capital profits. Costs of management of the Group are charged to revenue profit. Costs incurred as an intrinsic part of an intention to acquire or dispose of an investment have been accounted for in full as part of capital return as opposed to being allocated between revenue and capital. I Finance costs Finance costs, including those of derivatives, are accounted for on an accruals basis. Discounts, premiums and expenses arising on the issue of bonds and notes are amortised over the period of the related borrowing. Finance costs of borrowing that relates to the financing of investments where future capital profits as well as revenue profits can be earned, are allocated to revenue and capital profits. Other finance costs are charged to revenue profit. J Trading assets Loans and advances to customers and other non-investment assets are carried at the lower of book amount and recoverable amount. K Deferred tax Provision is made for deferred tax, using the liability method, on all material timing differences between the treatment of certain items for taxation and accounting purposes. Deferred tax is provided at a rate at which it is anticipated the timing difference will reverse. Deferred tax assets are recognised only when there is evidence that there will be taxable profits in the future to offset the deferred tax asset. L Foreign currency translation Foreign currency revenue items, assets and liabilities, including those of non-UK subsidiary undertakings, are translated into sterling at the exchange rates ruling at the balance sheet date, with the exception of borrowings covered by forward exchange contracts which are translated at the contracted rates of exchange. Exchange adjustments arising on the translation of investments, borrowings and net assets including those of overseas subsidiary undertakings are dealt with through the appropriate reserves. Exchange adjustments arising on realised transactions are dealt with in the revenue or capital profit for the period as appropriate. M Pensions Contributions made to pension schemes are charged so as to spread the cost of pensions over the employees’ working lives within the Group. The regular cost is attributed to individual periods using the projected unit method. Variations in pension cost, which are identified as a result of independent actuarial valuations, are spread over the average remaining service lives of the current employees. To the extent to which such costs, after interest, do not equate with cash contributions an accrual or prepayment is recognised in the balance sheet. 46 3i Report and accounts 2003 Notes to the accounts 1 Segmental analysis of total return The Group carries on its private equity and venture capital business in four geographical areas, the United Kingdom, continental Europe, the US and Asia Pacific and has one principal activity – the making of investments. The information shown below is based on the geographical location of investee companies and for the US and Asia Pacific also includes the results of older joint venture businesses. Geographical areas Interest receivable and similar income arising from debt securities and other fixed income securities held as financial fixed asset investments Dividend income from equity shares Fees receivable Other income Total operating income before interest payable Revenue profit before tax Capital profit before tax Total return before tax Net assets Total assets Geographical areas Interest receivable and similar income arising from debt securities and other fixed income securities held as financial fixed asset investments Dividend income from equity shares Fees receivable Other income Total operating income before interest payable Revenue profit before tax and goodwill Capital profit before tax and goodwill Total return before tax and goodwill Goodwill Total return before tax Net assets Total assets 2 Realised profits/(losses) on disposal of investments Net proceeds Opening valuation of investments disposed Investments written off Other Realised profits/(losses) on disposal Represented by: Listed Unlisted United Kingdom 2003 £m Continental Europe 2003 £m 96 89 30 29 244 186 (586) (400) 2,158 3,360 United Kingdom 2002 £m 117 99 32 37 285 137 (431) (294) – (294) 2,851 4,067 16 17 24 3 60 (12) (377) (389) 568 1,348 Continental Europe 2002 £m 14 11 21 18 64 (17) (465) (482) (73) (555) 862 1,653 US 2003 £m – – – 1 1 (2) (140) (142) 159 198 US 2002 £m – – – 1 1 (7) (67) (74) – (74) 179 295 Asia Pacific 2003 £m 1 – 2 – 3 – (15) (15) 51 93 Asia Pacific 2002 £m 1 1 3 – 5 (2) (31) (33) – (33) 53 118 2003 £m 970 (755) (79) 48 184 8 176 184 Total 2003 £m 113 106 56 33 308 172 (1,118) (946) 2,936 4,999 Total 2002 £m 132 111 56 56 355 111 (994) (883) (73) (956) 3,945 6,133 2002 £m 1,112 (1,002) (151) 2 (39) 12 (51) (39) Other includes £50 million (2002: £3 million) in respect of subordinated liabilities no longer repayable, as explained in note 38. 47 3i Report and accounts 2003 Notes to the accounts 3 Unrealised (losses) on revaluation of investments Listed Unlisted 2003 £m (169) (996) (1,165) 2002 £m (246) (644) (890) 4 Interest receivable and similar income arising from debt securities and other fixed income securities held as financial fixed asset investments Interest receivable on loan investments – unlisted Fixed rate dividends – unlisted UK 2003 £m 79 17 96 Non-UK 2003 £m 17 – 17 Total 2003 £m 96 17 113 UK 2002 £m 98 19 117 Non-UK 2002 £m 15 – 15 Interest receivable of £41 million (2002: £30 million) has been received by way of loan notes and a corresponding amount has been included in additions to loan investments. 5 Other interest receivable and similar income Interest receivable on money market assets, treasury debt securities and similar income 6 Interest payable Interest payable has been allocated as follows: Revenue reserve Capital reserve 2003 £m 34 2003 £m 57 53 110 Total 2002 £m 113 19 132 2002 £m 46 2002 £m 114 6 120 Interest payable during the year was allocated so that interest payable less other interest receivable and similar income was allocated to revenue and capital profits based on the expected split of returns between revenue and capital. This split is expected to be 30% revenue and 70% capital. In previous years, interest payable, other than that relating to TH Technologieholding GmbH group, was allocated to the financing of assets which could only earn future revenue profits and was therefore charged to revenue profits. 7 Dividend income from equity shares Listed Unlisted 8 Fees receivable Fees have been accounted for as follows: Revenue reserve Capital reserve UK 2003 £m 3 86 89 Non-UK 2003 £m 1 16 17 Total 2003 £m 4 102 106 UK 2002 £m 8 91 99 Non-UK 2002 £m 2 10 12 2003 £m 46 10 56 Total 2002 £m 10 101 111 2002 £m 56 – 56 Fees receivable during the year earned as an intrinsic part of an intention to acquire or dispose of an investment have been accounted for directly in the capital reserve as a result of adopting the revised Investment Trust SORP. In previous years, all fees were accounted for in the revenue reserve. 48 3i Report and accounts 2003 Notes to the accounts 9 Administrative expenses and depreciation Staff costs Wages and salaries Social security costs Other pension costs Other administrative expenses Depreciation Total administrative expenses Total administrative expenses have been allocated as follows: Revenue reserve Capital reserve 2003 £m 67 7 15 89 57 7 153 64 89 153 2002 £m 74 8 16 98 65 8 171 121 50 171 The average monthly number of employees during the year was 922 (2002: 1,084). At 31 March 2003, the number of employees was 858 (2002: 944). In addition to the staff costs shown above, an amount of £6 million (2002: £1 million) has been charged against realised capital profits in respect of carried interest payable to employees. Costs incurred during the year as an intrinsic part of an intention to acquire or dispose of an investment have been accounted for directly to the capital reserve. In previous years, they were available for allocation. Costs associated with making and managing investments were allocated to revenue and capital profits based on the expected split of returns between revenue and capital. This split is expected to be 30% revenue and 70% capital (2002: 20% revenue and 80% capital). 10 Directors’ emoluments Details of Directors’ emoluments are contained within the Remuneration report on pages 30 to 37. 11 Pension arrangements The Group operates a number of pension schemes. The main scheme, which covers most employees, is the 3i Group Pension Plan (“the Plan”). The cost of the Plan recognised in the accounts was £12 million (2002: £13 million) and other plans was £3 million (2002: £3 million). This is a funded defined benefit scheme, the assets of which are independent of the Group’s finances and are administered by trustees. The Group accounts for pension arrangements in accordance with Statement of Standard Accounting Practice 24 – Accounting for Pension Costs (SSAP 24). The Plan is the subject of an actuarial valuation every three years. The last full valuation was made at 30 June 2001 on the projected unit method. At that date, the market value of the assets was £246 million, and the actuarial value of the assets (taken to be market value) was sufficient to cover 92% of the value of benefits that had accrued to members after allowing for assumed increases in earnings and benefits. The principal assumptions were as follows: Price inflation Rate of return pre-retirement Rate of return post-retirement Salary increases (excluding promotion) Pension increases Accrued liabilities 2.7% 8.2% 5.2% 5.2% 3.0% Future contributions 2.7% 8.6% 5.5% 5.2% 3.0% The deficit at 30 June 2001 has been spread over a ten year period, the average remaining service lives of the existing employees, using the percentage of payroll method. The net cost and contributions in respect of the main scheme comprises: Regular cost Variation from regular cost (including interest) Net cost for the year Contributions – cash 2003 £m 11 1 12 25 2002 £m 11 2 13 22 As a result of adverse economic and market conditions since 30 June 2001, the market value of the Plan’s assets at 31 March 2003 would have been sufficient to cover 66% of the value of benefits that had accrued to members after allowing for assumed increases in earnings and benefits. If these conditions persist until the next triennial actuarial valuation of the Plan at 30 June 2004, the SSAP 24 based net cost will increase for 2005. Following advice from independent actuaries, no employer’s contributions were made during the period from 1 July 1985 to 1 April 2002 except that during the year to 31 March 2002 two payments were made into the Plan totalling £22 million. Employer’s contributions to the Plan recommenced on 1 April 2002. For the year to 31 March 2003, standard contributions were agreed to be 31.5% of members’ pensionable salaries. An additional £13 million was also paid on 31 March 2003. An amount of £13 million (2002: £nil) included in prepayments represents the cumulative difference between the net pension cost and contributions made. 49 3i Report and accounts 2003 Notes to the accounts 11 Pension arrangements continued New employees joining 3i and the Plan after 1 September 2002 are required to contribute 5% of their monthly pensionable salaries. Under its rules, the Plan was non contributory for employees, joining prior to 1 September 2002, from 1 April 1978 to 31 December 2002. From 1 January 2003, the rules of the Plan were changed and employees who joined the Plan prior to 1 September 2002 were required to contribute 1% of monthly pensionable salary, currently this will increase by 1% each year to a target of 5% of pensionable salary. After a review of the discretionary early retirement arrangements of the Plan, the employer’s standard contribution rate changed from 1 April 2003 to 29.2%. R W Perry and O H J Stocken are Directors of 3i Group plc and were also throughout the year Directors of Gardens Pension Trustees Limited, one of two Corporate Trustees of the 3i Group Pension Plan. Financial Reporting Standard 17 – Retirement Benefits (“FRS17”) changes the basis of accounting for pensions and other post-retirement benefits. Under the transitional arrangements for the introduction of FRS17, certain additional disclosures are required and these are given below. The actuarial valuation at 30 June 2001 was updated to 31 March 2002 and 31 March 2003 by an independent qualified actuary in accordance with FRS17. The Plan’s liabilities have been measured using the projected unit method. The valuation for FRS17 purposes is based on the membership details and demographic assumptions used in the most recent actuarial valuation. The Plan assets have been updated to market value as at 31 March 2003. The key FRS17 assumptions used for the Plan were: Price inflation Salary increases (excluding promotion) Pension increases Discount rate The assets of the Plan and their expected return were: Equities Gilts Other Present value of Plan liabilities Net pension liability 2003 2.5% 4.0% 3.0% 5.6% 2002 2.5% 5.0% 3.0% 6.1% Long term rate of return expected at 31 March 2003 7.5% 4.5% 3.8% Long term rate of return expected at 31 March 2002 8.5% – 5.2% 2003 Value £m 144 42 27 213 (303) (90) A deferred tax asset has not been recognised on this deficit because its utilisation is considered unlikely in the foreseeable future. If FRS17 had been adopted in the financial statements, the following amounts would have been recognised in the total return for the year to 31 March 2003: Revenue account Amount charged to administrative expenses Current service cost Vested past service Total administrative expenses Amount charged to other finance costs Expected return on Plan assets Interest on Plan liabilities Net return Revenue return Capital account Difference between expected and actual return on Plan assets Experience (losses) on Plan liabilities Changes in assumptions underlying the present value of Plan liabilities Actuarial (losses) recognised in total return Total return 2002 Value £m 212 – 39 251 (265) (14) 2003 £m (11) (1) (12) 20 (16) 4 (8) (76) (5) (12) (93) (101) 50 3i Report and accounts 2003 Notes to the accounts 11 Pension arrangements continued The movement in pension deficit is as follows: Opening balance Current service cost Past service cost Contributions Other financial interest Actuarial (losses) recognised in capital reserve Movement in the year Closing balance History of experience gains and losses: Difference between the expected and actual return on Plan assets: Amount Percentage of Plan assets (closing) Experience gains and losses on Plan liabilities: Amount Percentage of present value of Plan liabilities (closing) Total amount recognised in Statement of total return: Amount Percentage of present value of Plan liabilities (closing) If FRS17 had been fully implemented net assets would have reduced by: FRS17 deficit SSAP 24 prepayment 2003 £m 90 13 103 12 Cost of changes to organisational structure A provision of £10 million (2002: £18 million) was made for organisational changes of the Group and staff reductions made during the year. This has been allocated between the revenue reserve £5 million (2002: £9 million) and the capital reserve £5 million (2002: £9 million) based on the underlying nature of the cost. 13 Profit on ordinary activities before tax This is arrived at after charging: Depreciation on owned assets Depreciation on hire purchase assets 2003 £m 6 1 Auditors’ remuneration The auditors received fees for the audit of the Group of £0.7 million (2002: £0.6 million), which included £0.2 million (2002: £0.2 million) for the Company. In addition, £0.7million (2002: £1.2 million) was paid by the Group to Ernst & Young for non-audit work. Total fees paid are analysed below: Statutory audit fee Additional assurance Total audit related services Taxation advisory services Other services Group reorganisation Investment due diligence Other Total non-audit related services 2003 £m 0.7 0.2 0.9 0.2 – 0.1 0.2 0.3 2003 £m (14) (11) (1) 25 4 (93) (76) (90) 2003 £(76)m 36% £(5)m 2% £(93)m 31% 2002 £m 14 – 14 2002 £m 6 2 2002 £m 0.6 0.1 0.7 0.2 0.3 0.3 0.3 0.9 51 3i Report and accounts 2003 Notes to the accounts 13 Profit on ordinary activities before tax continued Non-audit services, including regulatory reports and taxation advice, were undertaken by Ernst & Young in accordance with the principles in the Directors’ report on page 29. Audit related services are services required to be undertaken by the auditors which include the statutory and interim audits, regulatory returns and formalities relating to borrowing, shareholder and other circulars. This work is normally allocated to the auditors. Tax advisory services are services which it is most efficient for the auditors to provide and is allocated to them subject to consideration of any impact on their independence. Other services are services that could be provided by a number of firms, including general consultancy work. All significant projects are normally put out to tender and work would be allocated to the auditors only if it did not present a potential threat to the independence of the audit team. 14 Tax The tax charge/(credit) for the year comprises: Charge/(credit) in respect of costs allocated to capital profits but utilised against revenue profits UK corporation tax at 30% (2002: 30%) Less relief for foreign tax Foreign tax Adjustment in respect of previous periods Current tax charge/(credit) for the year Deferred tax Charge/(credit) for the year Revenue 2003 £m Capital 2003 £m Revenue 2002 £m Capital 2002 £m 30 2 (2) 3 (1) 32 – 32 (30) – – (1) – (31) (4) (35) – 2 (2) 4 (1) 3 – 3 – – – – – – (4) (4) The charge/(credit) for the year all relates to the Company and its subsidiary undertakings Factors affecting the charge for the year The tax charge for the year differs from the standard rate of corporation tax in the UK, currently 30% (2002: 30%), and the differences are explained below: Return before tax Return before tax multiplied by standard UK corporation tax rate of 30% (2002: 30%) Effects of: Expenses not deductible for tax purposes Short term timing differences Current period unutilised tax losses Non-taxable UK dividend income Foreign tax Foreign tax credits available for double tax relief Adjustments in respect of previous periods Capital losses not allowable because of Investment Trust status Current tax charge/(credit) for the year Revenue 2003 £m 172 52 Capital 2003 £m (1,118) (335) Revenue 2002 £m 109 33 Capital 2002 £m (1,065) (320) 1 1 7 (29) 3 (2) (1) – 32 – – – – – – – 304 (31) 1 (5) 10 (37) 4 (2) (1) – 3 – – – – – – – 320 – The Group’s investments and capital return are primarily included in the Group’s ultimate parent company, the affairs of which are directed so as to allow it to be approved as an investment trust. As investment trusts are exempt from capital gains tax, the Group’s capital return is largely not taxable. Factors that may affect future tax charges The Group currently has and expects to continue to generate surplus tax losses. A deferred tax asset in respect of these surplus losses is not recognised because their utilisation is considered unlikely in the foreseeable future. 15 Profit after tax The amount dealt with in the revenue account of the Company is £101 million (2002: £110 million). 16 Dividends Interim paid 4.9p per share (2002: 4.9p per share paid) Final proposed 8.6p per share (2002: 8.1p per share paid) 2003 £m 29 52 81 2002 £m 29 49 78 52 3i Report and accounts 2003 Notes to the accounts 17 Earnings and net assets per share Revenue profit for the year Weighted average number of shares – Basic Earnings per share Net assets Number of shares Net asset value per share – Diluted – Basic – Diluted – Basic – Diluted – Basic – Diluted 2003 £140m 610m 611m 22.9p 22.9p 2002 £106m 609m 613m 17.4p 17.3p £2,936m 611m 611m 481p 480p £3,945m 610m 612m 647p 645p The difference between the basic and diluted weighted average number of shares is the dilutive effect of share options. 18 Related undertakings The Directors are of the opinion that the number of undertakings in respect of which the Company is required to disclose information under Schedule 5 to the Companies Act 1985 is such that compliance would result in information of excessive length being given. In accordance with section 231 of that Act, information regarding principal subsidiary undertakings and joint ventures is set out on page 66. Full information will be annexed to the Company’s next annual return. As permitted by Financial Reporting Standard 8 – Related Party Disclosures – transactions or balances with Group entities that have been eliminated on consolidation are not reported. 19 Loans and advances to banks Repayable on demand Maturity of other loans and advances to banks Repayable: within three months between one year and five years 20 Debt securities held for treasury purposes Repayable within one year The Group 2003 £m 99 The Group 2002 £m 48 The Company 2003 £m 34 The Company 2002 £m 9 313 115 527 461 54 563 282 115 431 430 50 489 The Group 2003 £m 283 The Group 2002 £m 191 The Company 2003 £m 283 The Company 2002 £m 191 21 Debt securities and other fixed income securities held as financial fixed asset investments and equity shares Debt securities and fixed income shares Loan investments Fixed income shares Equity shares Listed Unlisted Total Maturity of debt securities and fixed income shares Repayable within one year Repayable after more than one year The Group 2003 £m The Group 2002 £m The Company 2003 £m The Company 2002 £m 1,336 228 1,564 187 2,188 2,375 1,408 324 1,732 413 2,964 3,377 1,258 224 1,482 180 1,999 2,179 1,334 318 1,652 406 2,694 3,100 3,939 5,109 3,661 4,752 101 1,463 1,564 115 1,617 1,732 95 1,387 1,482 109 1,543 1,652 53 3i Report and accounts 2003 Notes to the accounts 21 Debt securities and other fixed income securities held as financial fixed asset investments and equity shares continued Opening balances Cost Unrealised appreciation Additions at cost Additions at cost from joint venture Disposals, repayments and write-offs Transfers Unrealised appreciation Currency translation 31 March 2003 Represented by: Cost Unrealised appreciation Listed UK Non-UK Unlisted UK Non-UK Opening balances Cost Unrealised appreciation Additions at cost Additions at cost from joint venture Disposals, repayments and write-offs Transfers Transfers to other Group companies Unrealised appreciation Currency translation 31 March 2003 Represented by: Cost Unrealised appreciation Listed UK Non-UK Unlisted UK Non-UK The Group Equity shares 2003 £m The Group Loan investments 2003 £m The Group Fixed income shares 2003 £m The Group Total 2003 £m 2,685 692 3,377 327 17 (479) 99 (1,068) 102 2,375 2,751 (376) 2,375 158 29 187 1,130 1,058 2,188 1,640 (232) 1,408 384 – (369) (121) 5 29 1,336 1,563 (227) 1,336 – – – 995 341 1,336 450 (126) 324 6 – (133) 34 (1) (2) 228 355 (127) 228 – – – 211 17 228 The Company Equity shares 2003 £m The Company Loan investments 2003 £m The Company Fixed income shares 2003 £m 2,415 685 3,100 306 17 (408) 99 (21) (983) 69 2,179 2,477 (298) 2,179 158 22 180 1,129 870 1,999 1,554 (220) 1,334 366 – (349) (121) (3) 12 19 1,258 1,466 (208) 1,258 – – – 993 265 1,258 440 (122) 318 6 – (128) 34 – (4) (2) 224 350 (126) 224 – – – 208 16 224 4,775 334 5,109 717 17 (981) 12 (1,064) 129 3,939 4,669 (730) 3,939 158 29 187 2,336 1,416 3,752 The Company Total 2003 £m 4,409 343 4,752 678 17 (885) 12 (24) (975) 86 3,661 4,293 (632) 3,661 158 22 180 2,330 1,151 3,481 54 3i Report and accounts 2003 Notes to the accounts 21 Debt securities and other fixed income securities held as financial fixed asset investments and equity shares continued Group companies have invested in or made commitments to 13 limited partnerships. These investments represented the following proportions of the total commitments of all investors in these partnerships: Partnership 3i Europe Investment Partners No. 1 3i Europe Investment Partners No. 2 3i 94 LMBO Plan 3i UK Investment Partners 3i Smaller MBO Plan 3i NPM Smaller MBO Plan 3i UKIP II LP 3i Europartners II LP 3i Parallel Ventures LP 3i Europartners IIIA LP 3i Europartners IIIB LP 3i Asia Pacific Technology LP 3i Nippon Buyouts Venture Capital Investment Limited Partnership Proportion of total commitments 0.92% <0.01% <0.01% 0.23% <0.01% <0.01% <0.01% <0.01% <0.01% <0.01% <0.01% <0.01% 0.03% The proportion of total commitments shown above are those at both 31 March 2003 and 31 March 2002. Although Group companies act as the general partner and the manager of each partnership, since their rights as such are held in a fiduciary capacity, the investments are included as equity share investments. Unrealised appreciation on unlisted equity investments includes £6 million (2002: £13 million) which represents the net carried interest that would be received by the Group if all investments held by the limited partnerships were realised at their valuation on the balance sheet date. The Group received fee income of £34 million (2002: £35 million) and distributions of £7 million (2002: £2 million) from this activity. 22 Interests in joint ventures Opening balances Cost Share of post acquisition retained surpluses less losses Unrealised appreciation Additions Disposals and repayment Transfers Share of net surplus less losses Unrealised appreciation Currency translation 31 March 2003 Represented by: Cost Share of post acquisition retained surpluses less losses Unrealised appreciation The additions to joint ventures were mainly the investment of equity in and loans to Woodrose AB. Details of the Group’s interest in its principal joint venture, which is unlisted and outside the UK, is given on page 66. 23 Shares in Group undertakings Opening balance Additions Disposals Provisions Currency translation Closing balance Details of the principal subsidiary undertakings are given on page 66. The Group 2003 £m The Company 2003 £m 91 (6) (50) 35 54 (24) (12) (1) (35) 6 23 115 (7) (85) 23 14 – (2) 12 – (1) (12) – 2 – 1 1 – – 1 The Company 2003 £m 137 16 (25) (78) 16 66 55 3i Report and accounts 2003 Notes to the accounts 24 Goodwill Opening cost Currency translation Disposal Cost at 31 March 2003 Opening amortisation Currency translation Disposal Amortisation at 31 March 2003 Book amount at 31 March 2003 Book amount at 31 March 2002 25 Tangible fixed assets Investment properties Properties in use by the Group Other fixed assets in use by the Group Properties Opening balances Cost Unrealised appreciation Additions Disposals Unrealised appreciation Represented by: Cost Unrealised appreciation Freehold Leasehold – 50 years and over Other fixed assets in use by the Group Opening cost Additions Disposals Cost at 31 March 2003 Opening depreciation Charge for year Disposals Depreciation at 31 March 2003 Book amount at 31 March 2003 Book amount at 31 March 2002 2003 £m 93 11 (104) – 93 11 (104) – – – The Group 2003 £m 5 27 13 45 The Group 2002 £m – 34 16 50 The Company 2003 £m – 26 – 26 The Company 2002 £m – 31 – 31 The Group The Company Investment properties 2003 £m Investment properties 2003 £m The Group Properties in use by the Group 2003 £m The Company Properties in use by the Group 2003 £m – – – 5 – – 5 5 – 5 5 – 5 The Group Office equipment 2003 £m 53 4 (1) 56 40 6 – 46 10 13 – – – – – – – – – – – – – 23 11 34 – (1) (6) 27 22 5 27 9 18 27 The Group Motor The Group Hire purchase vehicles motor vehicles 2003 £m 5 1 (1) 5 2 1 (1) 2 3 3 2003 £m 1 – (1) – 1 – (1) – – – 21 10 31 – – (5) 26 21 5 26 8 18 26 The Group Total 2003 £m 59 5 (3) 61 43 7 (2) 48 13 16 56 3i Report and accounts 2003 Notes to the accounts 25 Tangible fixed assets continued Obligations under motor vehicle hire purchase contracts Amounts payable: within one year between two and five years Finance charge allocated to future periods 26 Own shares Opening cost Disposals 31 March 2003 The Group 2003 £m The Group 2002 £m 1 1 2 – 2 1 1 2 – 2 2003 £m 54 (10) 44 Investment in own shares consists of shares in 3i Group plc held by The 3i Group Employee Trust to meet its obligations under the Group’s share schemes. The market value of these shares at 31 March 2003 was £34 million (2002: £76 million). The Trustee has waived its right to receive dividends on the shares held by the Trust. The purchase of the shares is funded by an interest free loan from 3i Group plc. 27 Other assets Non-investment leases Tax recoverable Development properties Other debtors Amounts due from Group undertakings 28 Prepayments and accrued income Interest receivable Certificates of tax deposit 29 Deposits by banks With agreed maturity dates or periods of notice Maturity of deposits with agreed maturity dates or periods of notice Repayable: within three months between three months and one year between two years and five years The Group 2003 £m – 4 – 60 The Group 2002 £m 1 9 2 49 64 61 The Company 2003 £m – 1 – 9 62 72 The Company 2002 £m – 3 – 9 52 64 The Group 2003 £m 71 2 73 The Group 2002 £m 66 3 69 The Company 2003 £m 48 2 50 The Company 2002 £m 46 3 49 The Group 2003 £m 423 The Group 2002 £m 519 The Company 2003 £m 248 The Company 2002 £m 323 66 3 354 423 153 3 363 519 66 3 179 248 153 3 167 323 57 3i Report and accounts 2003 Notes to the accounts 30 Debt securities in issue Bonds and notes Other debt securities in issue Bonds and notes Fixed rate (guaranteed) 3i International BV Total fixed rate Variable rate Unsecured loan notes Total variable rate Notes issued under the £2,000 million Note Issuance Programme Fixed rate Public issues 3i Group plc 3i Group plc 3i Group plc Private placings Total fixed rate Variable rate Public issues 3i Holdings plc Private placings Total variable rate Total bonds and notes Maturity of bonds and notes Repayable: on demand or within one year between one year and two years between two years and five years after five years Other debt securities in issue European Investment Bank Other Maturity of other debt securities in issue Repayable: within three months between three months and one year between one year and two years between two years and five years The Group 2003 £m 1,183 167 1,350 The Group 2003 £m 150 150 2 2 The Group 2002 £m 1,189 150 1,339 The Company 2003 £m 830 167 997 The Company 2002 £m 835 150 985 The Group 2002 £m The Company 2003 £m The Company 2002 £m 150 150 4 4 – 1 1 – 2 2 Rate Repayment 7.75% 2003 2007-2010 Rate Repayment The Group 2003 £m The Group 2002 £m The Company 2003 £m The Company 2002 £m 6.875% 6.875% 5.750% 2007 2023 2032 2007 200 200 400 22 822 200 9 209 200 200 400 2 802 200 33 233 200 200 400 20 820 9 9 1,183 1,189 830 200 200 400 – 800 33 33 835 The Group 2003 £m The Group 2002 £m The Company 2003 £m The Company 2002 £m 175 2 405 601 1,183 The Group 2003 £m 22 145 167 115 42 5 5 167 28 155 3 1,003 1,189 25 – 205 600 830 28 5 – 802 835 The Group 2002 £m 33 117 150 The Company 2003 £m 22 145 167 The Company 2002 £m 33 117 150 115 11 22 2 150 115 42 5 5 167 115 11 22 2 150 58 3i Report and accounts 2003 Notes to the accounts 30 Debt securities in issue continued The Group had the following committed multi-currency facilities at 31 March 2003: Negotiated April 1997 June 2001 Facility £625m Drawn – £360m £351m Drawn margin (over LIBOR) Undrawn commitment fee 0.150% 0.0750% 0.175% 0.0875% Maturity 18 April 2004 Years 6 to 7 21 June 2006 Years 1 to 5 31 Interest rate sensitivity gap analysis Interest rate risk emanates from the Group’s loan investments and the Group’s funding. The Group’s policy is that fixed rate lending is matched with fixed rate borrowings and the interest rate resetting profile of variable rate lending is matched with that of variable rate borrowings through gearing the portfolio. Financial instruments including interest rate swaps are used as part of this matching process. Equity investments, which are mainly funded by shareholders’ funds but also partially by borrowings in similar currencies, give rise to an interest rate sensitivity gap as a result of the equity investments being non-interest bearing and having no fixed maturity date. The interest rate sensitivity gap at 31 March 2003 was: Assets Treasury bills and other eligible bills Loans and advances to banks Debt securities held for treasury purposes Debt securities and other fixed income securities held as financial fixed assets Loan investments Fixed income shares Equity shares Other assets Liabilities Deposits by banks Debt securities in issue - Other liabilities Subordinated liabilities Shareholders’ funds Interest rate sensitivity gap Cumulative gap More than three months but not more than six months 2003 £m – 105 55 More than six months but not more than one year 2003 £m – 10 – More than one year but not more than five years 2003 £m – – – Not more than three months 2003 £m – 412 228 More than five years 2003 £m 1 – – Non-interest bearing 2003 £m – – – 438 – – – 1,078 316 (44) – – – 272 806 806 67 – – – 227 104 126 – – – 230 (3) 803 65 – – – 75 3 (34) – – – (31) 106 909 328 – – – 328 – 302 – – – 302 26 935 438 – – – 439 – 1,000 – 51 – 1,051 (612) 323 – 228 2,375 249 2,852 – – 239 – 2,936 3,175 (323) – Total 2003 £m 1 527 283 1,336 228 2,375 249 4,999 423 1,350 239 51 2,936 4,999 – – 59 3i Report and accounts 2003 Notes to the accounts 31 Interest rate sensitivity gap analysis continued Assets Treasury bills and other eligible bills Loans and advances to banks Debt securities held for treasury purposes Debt securities and other fixed income securities held as financial fixed assets Loan investments Fixed income shares Equity shares Other assets Liabilities Deposits by banks Debt securities in issue Other liabilities Subordinated liabilities Shareholders’ funds Interest rate sensitivity gap Cumulative gap Not more than three months 2002 £m – 509 161 More than three months but not more than six months 2002 £m – 54 30 More than six months but not more than one year 2002 £m – – – More than one year but not more than five years 2002 £m – – – More than five years 2002 £m 1 – – Non-interest bearing 2002 £m – – – 496 – – – 1,166 448 144 – – – 592 574 574 98 – – – 182 68 (28) – – – 40 142 716 95 – – – 95 3 108 – – – 111 (16) 700 273 – – – 273 – (106) – – – (106) 379 1,079 446 – – – 447 – 1,221 – 84 – 1,305 (858) 221 – 324 3,377 269 3,970 – – 246 – 3,945 4,191 (221) – Total 2002 £m 1 563 191 1,408 324 3,377 269 6,133 519 1,339 246 84 3,945 6,133 – – 32 Currency exposures Currency rate risk emanates from the Group’s international operations. The policy regarding currency risk is set out in the Financial review on page 19. Currency swaps are used as part of applying that policy. The Group’s structural currency exposures at 31 March 2003 were as follows: Currency Sterling Euro US dollar Swiss franc Swedish krona Other Subtotal Total Currency Sterling Euro US dollar Swiss franc Swedish krona Other Subtotal Total Variable rate loan investments 2003 £m 397 91 37 – 1 – 129 526 Variable rate loan investments 2002 £m 572 72 3 – 3 – 78 650 Fixed rate loan investments 2003 £m 496 181 62 38 20 13 314 810 Fixed rate loan investments 2002 £m 534 155 51 6 4 8 224 758 Other investment assets 2003 £m 1,450 656 221 26 217 61 1,181 2,631 Other investment assets 2002 £m 2,178 841 347 27 280 63 1,558 3,736 Other net assets before borrowings 2003 £m 688 69 10 2 20 4 105 793 Other net assets before borrowings 2002 £m 503 186 24 1 10 19 240 743 Short term variable rate borrowings 2003 £m 14 (113) (32) (25) – (39) (209) (195) Short term variable rate borrowings 2002 £m (80) (61) (96) (22) – (14) (193) (273) Other variable rate borrowings 2003 £m 200 42 – – (354) – (312) (112) Other variable rate borrowings 2002 £m 71 (53) – – (353) – (406) (335) Fixed rate borrowings 2003 £m (1,244) (259) – – – (14) (273) (1,517) Fixed rate borrowings 2002 £m (1,034) (231) (14) – – (55) (300) (1,334) Net assets 2003 £m 2,001 667 298 41 (96) 25 935 2,936 Net assets 2002 £m 2,744 909 315 12 (56) 21 1,201 3,945 60 3i Report and accounts 2003 Notes to the accounts 33 Liquidity The Group’s liquidity policy is based on a maturity ladder approach with all mismatch limits of cash flows between cumulative assets and cumulative liabilities over various time periods approved by the Board. The limits for shorter periods are also agreed with the Financial Services Authority. 34 Fair value of financial assets and financial liabilities The Group does not have a trading book and it holds all assets and liabilities in a non-trading book. Financial assets Quoted and unquoted equity investments and quoted fixed income shares are included in the consolidated balance sheet at market value or Directors’ valuation which equates to fair value. Unquoted fixed income shares and loan investments are included in the consolidated balance sheet at the lower of cost or recoverable amount. No liquid and active market exists, either for the unquoted fixed income share or loan investments or their component parts. The fair value of other financial assets equates to their book value in the consolidated balance sheet. Financial liabilities 3i’s borrowings finance loan investments, fixed income shares and equity shares. As stated above, these unquoted loan and fixed income share investments are included in the consolidated balance sheet at the lower of cost or recoverable amount. These investments are not shown at an estimated market value as no active and liquid market exists for them. The Report and accounts therefore do not include any recognition of the effect of their yield being above or below current market yields. However, Financial Reporting Standard 13 – Derivatives and other financial instruments: disclosures – requires disclosure of the fair value of those elements of the Group’s borrowings that are listed even though, in some cases, the market for those borrowings is not particularly active. The remainder of the Group’s borrowings, which are unlisted, do not have a liquid or active market. The fair value of the listed element of financial liabilities at 31 March 2003 was £1,214 million (2002: £1,222 million), which compares with a book amount of £1,205 million (2002: £1,208 million). These borrowings are used to fund investments which, in general, yield a net margin to the Group and which would therefore have a higher fair value than the fair value of the borrowing. The fair value of other financial liabilities equates to their book value in the consolidated balance sheet. Derivatives The Group does not trade in derivatives. The derivatives held hedge specific exposures and have maturities designed to match the exposures they are hedging. It is the intention to hold both the financial instruments giving rise to the exposure and the derivative hedging them until maturity and therefore no net gain or loss is expected to be realised. The book value of derivatives represents net interest receivable/(payable) on such instruments at the balance sheet date. The fair value represents the replacement cost of the instruments at the balance sheet date. No unrealised gains or losses are included in the balance sheet. The amount of unrecognised gains or losses at the balance sheet date equates to the difference between fair value and book value. The fair values and book values at 31 March 2003 of the swaps were: Interest rate swaps Currency swaps Fair value 2003 £m (24) (21) (45) Fair value 2002 £m (5) 2 (3) Book value 2003 £m 6 2 8 Book value 2002 £m 6 1 7 All swaps held at 31 March 2003 mature before 31 March 2041. The principal outstanding on currency swap agreements and notional principal outstanding on interest rate swap agreements were: Fixed rate to variable rate Variable rate to fixed rate Variable rate to variable rate Fixed rate to fixed rate Included in the above are currency swaps amounting to 2003 £m 688 1,193 170 – 2002 £m 715 1,064 175 60 164 271 All financial instruments are unsecured. However, 3i does not expect non-performance by the counterparties, whose credit ratings are reviewed regularly. 61 3i Report and accounts 2003 Notes to the accounts 35 Other liabilities Obligations under hire purchase contracts Proposed dividend Taxation payable Amounts due to Group undertakings The Group 2003 £m 2 52 2 The Group 2002 £m 2 49 2 56 53 The Company 2003 £m – 52 – 389 441 The Company 2002 £m – 49 – 327 376 The amounts due to Group undertakings include £338 million (2002: £215 million) due after more than one year. 36 Accruals and deferred income Interest payable Other accruals 37 Provisions for liabilities and charges Opening balance Charge for year Utilised in year Movement for the year 31 March 2003 The Group 2003 £m 43 130 173 The Group 2002 £m 45 136 181 The Company 2003 £m 26 21 47 The Company 2002 £m 28 19 47 Costs of organisational changes 2003 £m 8 10 (8) 2 10 Deferred tax 2003 £m 4 (4) – (4) – Total 2003 £m 12 6 (8) (2) 10 The provision for the cost of organisational changes relates to organisational changes and staff reductions in the year to 31 March 2003. This is explained in note 12. The remaining provision is expected to be largely utilised in the year to 31 March 2004. Deferred tax Full provision has been made for deferred tax relating to capital allowances and other timing differences. Capital allowances and other timing differences Accelerated capital allowances Other timing differences Relief for losses Unrealised appreciation less expected losses The Group 2003 £m The Group 2002 £m The Company 2003 £m The Company 2002 £m – – – – – – (1) 4 (3) – 4 4 – – – – – – – – – – – – The Group has generated surplus tax losses and expects to continue to do so in the future. A deferred tax asset in respect of these surplus losses has not been recognised because their utilisation is considered unlikely in the foreseeable future. 38 Subordinated liabilities Subordinated liabilities comprise limited recourse funding from Kreditanstalt für Wiederaufbau (“KfW”), a German federal bank. This funding, which individually finances investment assets, is at various fixed rates of interest and maturity is dependent upon the disposal of the associated assets. This funding is subordinated to other creditors of the individual group undertakings to which these funds have been advanced. During March, 3i Group plc agreed to purchase from KfW c72 million (£50 million) owed by Technologieholding Fonds VC GmbH and Technologieholding Fonds NBL GmbH for a consideration of c9 million (£6 million). The final legal agreement was signed on 29 April 2003. As an adjusting post balance sheet event this has been accounted for in the year to 31 March 2003 and results in a realised capital profit in the year of £39 million. Additionally, during the year, £11 million of loans were waived by KfW. 62 3i Report and accounts 2003 Notes to the accounts 39 Called up share capital Ordinary shares of 50p each Authorised Opening balance Movement for the year 31 March 2003 Issued, called up and fully paid Opening balance Allotted on exercise of options under The 3i Executive Share Option Plan and The 3i Group 1994 Executive Share Option Plan at between 167p and 664p per share Allotted on exercise of options under The 3i Group Sharesave Scheme at 467p per share Allotted under The 3i Group Share Incentive Plan at between 431p and 764p per share Allotted to vendors of SFK Finance Oy at 1210p per share Movement for the year 31 March 2003 The Company 2003 Number The Company 2003 £m 700,000,000 120,000,000 820,000,000 609,603,828 790,552 117,083 342,877 63,913 1,314,425 610,918,253 350 60 410 305 – – – – – 305 The market price of shares on the date on which the terms of the issues were fixed, was the price at which those shares were allotted, except in relation to those allotted under The 3i Group Sharesave Scheme where the market price of the shares was 583p. There were options outstanding to subscribe for the shares of the Company under The 3i Executive Share Option Plan, The 3i Group 1994 Executive Share Option Plan, The 3i Group Discretionary Share Plan and The 3i Group Sharesave Scheme as follows: 31 March 2003 31 March 2002 Number of options 22,280,605 20,419,430 Period of exercise 2003 to 2012 2002 to 2011 Exercise price 168p to 1375p 168p to 1375p The interests of the Directors (all of which are beneficial) in the shares of the Company are shown below: Baroness Hogg The Lord Camoys (retired 10 July 2002) Dr J R Forrest C J M Morin-Postel (appointed 12 September 2002) F D Rosenkranz F G Steingraber O H J Stocken B P Larcombe M M Gagen R W Perry M J Queen Dr R D M J Summers (retired 31 December 2002) P B G Williams (retired 31 December 2002) 31 March 2003 or date of retirement if earlier 12,355 10,200 1,500 – 30,000 – 12,249 741,845 91,055 22,436 130,135 639,573 306,127 31 March 2002 or date of appointment if later 9,355 10,200 1,500 – 15,000 – 6,108 740,958 91,055 21,509 129,285 638,938 305,481 31 March 2003 or date of retirement if earlier Conditional* – – – – – – – 53,571 24,050 22,176 32,220 55,180 37,652 31 March 2002 or date of appointment if later Conditional* – – – – – – – 53,571 24,050 22,176 32,220 55,180 37,652 * Represents conditional rights to acquire shares pursuant to share bonus awards granted under the Management Equity Investment Plan, described on page 36. In addition to the interests shown above, the executive Directors also have beneficial interests in the conditional rights to acquire shares pursuant to the performance linked awards granted under the Management Equity Investment Plan, which are detailed in the table on page 35. Each of the employees of the Group (including each of the executive Directors) is a potential beneficiary of The 3i Group Employee Trust and as such is interested (within the meaning of section 324 of the Companies Act 1985) in the 8,193,026 shares held by the trust at 31 March 2003. (Shares at 31 March 2002: 9,716,940.) This number of shares includes the shares over which Directors are mentioned above as having conditional rights to acquire under the Management Equity Investment Plan. Details of Directors’ share options under the Group’s Executive Share Option Plans are shown in the Remuneration report on pages 32 to 33. Dr R D M J Summers retained from 1 April 2002 to 31 December 2002 an interest in one share of c7 in 3i SA and an interest in one share of c16 in 3i Gestion SA, subsidiary undertakings of the Company, in order to comply with provisions in the Articles of Association of those companies. Since 31 March 2003, there have been changes in the Directors’ interests in shares. As at 2 May 2003, each of these Directors were beneficially interested in the following number of additional shares: B P Larcombe (84), R W Perry (84) and M J Queen (84). In addition, as at that date, the number of shares held by The 3i Group Employee Trust was 8,177,679. 63 3i Report and accounts 2003 Notes to the accounts 40 Reserves Opening balances Retained revenue for the year Realised profits on disposal of investments Change in value of retained investments Fees receivable allocated to capital reserve Interest payable allocated to capital reserve Administrative expenses allocated to capital reserve Cost of changes to organisational structure allocated to capital reserve Tax on capital items Increase in respect of shares issued Currency translation adjustment Movement for the year 31 March 2003 The balance on the capital reserve represents: Realised profits Unrealised appreciation Opening balances Retained revenue for the year Realised profits on disposal of investments Change in value of retained investments Interest payable allocated to capital reserve Administrative expenses allocated to capital reserve Capital contribution to subsidiary undertakings Tax on capital items Increase in respect of shares issued Currency translation adjustment Movement for the year 31 March 2003 The balance on the capital reserve represents: Realised profits Unrealised appreciation Retained profits 31 March 2003 Revenue and realised capital profits 31 March 2002 Revenue and realised capital profits The Group Revenue 2003 £m 276 59 The Group The Group Share premium Capital redemption 2003 £m 1 2003 £m 342 6 65 341 7 7 349 – 1 The Company Revenue 2003 £m 405 20 The Company The Company Share premium Capital redemption 2003 £m 1 2003 £m 342 13 33 438 7 7 349 – 1 The Group Capital 2003 £m 3,021 184 (1,165) 10 (53) (89) (5) 35 2 (1,081) 1,940 2,692 (752) 1,940 The Company Capital 2003 £m 2,939 115 (1,128) (25) (55) (100) 5 11 (1,177) 1,762 2,441 (679) 1,762 The Company £m Subsidiary undertakings £m Joint ventures £m Total £m 2,879 3,022 161 23 (7) (6) 3,033 3,039 The Company’s Articles of Association prohibit the distribution of capital profits. As a result, the balance of its capital reserve, both realised and unrealised, is not distributable. 64 3i Report and accounts 2003 Notes to the accounts 41 Unrealised appreciation Unrealised appreciation represents the difference between the original cost of investments and their carrying value, less charges Opening balance after tax Value surplus realised Value deficit written back on realisation Change in value surplus Tax credit Movement for the year Closing balance after tax 42 Reconciliation of revenue profit before tax to net cash flow from operating activities Revenue profit before tax Depreciation of equipment and vehicles Amortisation of goodwill Tax on investment income included within income from overseas companies Interest received by way of loan notes Movement in other assets associated with operating activities Movement in prepayments and accrued income associated with operating activities Movement in accruals and deferred income associated with operating activities Movement in provisions for liabilities and charges Reversal of losses/(profits) of joint ventures less distribution received Net cash inflow from operating activities 43 Acquisition of subsidiary undertakings Analysis of the net outflow of cash from the acquisition of subsidiary undertakings is: Cash and acquisition costs Cash acquired Net cash flow 2003 £m 2002 £m 258 (38) 189 (1,165) 4 (1,010) (752) 1,281 (268) 131 (890) 4 (1,023) 258 2003 £m 172 7 – (1) (41) (9) 12 (15) 2 1 128 2003 £m – – – 2002 £m 109 8 2 (2) (30) (5) 13 (31) 8 (9) 63 2002 £m 54 (3) 51 The acquisitions in 2002 did not have a material effect on the items prescribed in Financial Reporting Standard 1 (Revised 1996) – Cash Flow Statements – for inclusion in the consolidated cash flow. 44 Analysis of changes in financing during the year Opening balance Exchange movements Cash inflows from financing Cash outflows from financing Non-cash movements Movement for the year Closing balance Share capital and share premium 2003 £m 647 Deposits and debt securities repayable after more than one year 2003 £m 1,548 – 7 – – 7 654 47 6 (45) (184) (176) 1,372 Share capital and share premium 2002 £m 637 – 10 – – 10 647 Deposits and debt securities repayable after more than one year 2002 £m 1,457 (10) 220 (78) (41) 91 1,548 65 3i Report and accounts 2003 Notes to the accounts 45 Reconciliation of net cash flows to movement in net debt Increase/(decrease) in cash in the year Cash flow from management of liquid resources Cash flow from debt financing Cash flow from subordinated liabilities Cash flow from finance leases Change in net debt from cash flows Foreign exchange movements Non-cash changes Movement in net debt in the year Net debt at start of year Net debt at end of year 46 Analysis of net debt Cash and deposits repayable on demand Treasury bills, other loans, advances and treasury debt securities Deposits and debt securities repayable within one year Deposits and debt securities repayable after one year Subordinated liabilities repayable after one year Finance leases 47 Cash flows arising from management of liquid resources Other loans, advances and treasury debt securities Net cash inflow from management of liquid resources 48 Contingent liabilities Contingent liabilities relating to guarantees available to third parties in respect of investee companies 2003 £m 49 (15) 143 (7) – 170 (46) 50 174 (1,189) (1,015) 2002 £m (38) (293) 252 (24) 1 (102) 5 9 (88) (1,101) (1,189) 1 April 2002 £m 48 Cash flow £m 49 Exchange Other non-cash changes movement £m £m – 2 31 March 2003 £m 99 707 (310) (1,548) (84) (2) (1,189) (15) 104 39 (7) – 170 20 (11) (47) (10) – (46) – (184) 184 50 – 50 2003 £m 15 15 712 (401) (1,372) (51) (2) (1,015) 2002 £m 293 293 The Group 2003 £m The Group 2002 £m The Company 2003 £m The Company 2002 £m 19 27 16 21 The Company has guaranteed the creditors of 3i plc and 3i Holdings plc at the dates of their capital reductions to a maximum of the amounts of those capital reductions. The amounts of the capital reductions were £140 million in respect of 3i plc and £250 million in respect of 3i Holdings plc. The Company has guaranteed the payment of principal, premium, if any, and interest on all the interest swap agreements of 3i Holdings plc. The Company, 3i Holdings plc and 3i plc have jointly and severally guaranteed the payment of principal, premium, if any, and interest on the bonds and notes issued by 3i International BV as listed in note 30. The Company has guaranteed the payment of principal, premium, if any, and interest on notes issued under the £2,000 million Note Issuance Programme by 3i Holdings plc and 3i International BV. The Company has guaranteed the payment of principal and interest on amounts drawn down under the £625 million revolving credit facilities by 3i plc and 3i Holdings plc and the £360 million revolving credit facility by 3i Holdings plc. At 31 March 2003, 3i Holdings plc had drawn down £nil (2002: £10 million) and £175 million (2002: £187 million) respectively under these facilities. A wholly owned subsidiary undertaking of the Company, Technologieholding VC GmbH, has guarantees of £2 million (2002: £2 million) to Kreditanstalt für Wiederaufbau, a provider of subordinated loans to four of its wholly owned subsidiary undertakings. At 31 March 2003, there was no material litigation outstanding against the Company or any of its subsidiary undertakings. 49 Commitments Share and loan investments The Group 2003 £m 270 The Group 2002 £m 411 The Company 2003 £m 260 The Company 2002 £m 394 66 3i Report and accounts 2003 Principal subsidiary undertakings and joint ventures Principal subsidiary undertakings at 31 March 2003 Name 3i Holdings plc 3i International Holdings 3i plc 3i Investments plc 3i Japan GP Limited 3i Europe plc 3i Nordic plc Gardens Pension Trustees Limited 3i Asia Pacific plc Ship Mortgage Finance Company public limited company 3i International BV (The Netherlands) Issued and fully paid share capital 1,000,000 shares of £1 2,715,973 shares of £10 10,000,000 shares of £1 10,000,000 shares of £1 250,000 shares of £1 500,000 shares of £1 500,000 shares of £1 100 shares of £1 140,000 shares of £1 4,000,000 ordinary shares of £1 of which 3,000,000 are fully paid and 1,000,000 are partly paid (50p per share) 40 shares of c454 Principal activity Holding company Holding company Services Investment manager General partner company Investment advisory services Investment advisory services Pension fund trustee Investment advisory services Advisory services Fundraising activities 3i Corporation (USA) 15,000 shares of common stock (no par value) Investment manager 3i Deutschland Gesellschaft für Industriebeteiligungen mbH (Germany) c25,564,594 Investment manager TH Technologieholding GmbH (Germany) c25,565 Holding company 3i Finland Oy (Finland) 500 shares of c340 3i SA (France) 3i Investissements SA (France) 3i Gestion SA (France) 3i Austria GmbH (Austria) 2,008,200 shares of c7 1,500,000 shares of c15 200,000 shares of c16 c50,000 Investment advisory services Investment company Investment company Investment manager Investment advisory services Registered office 91 Waterloo Road London SE1 8XP Teleportboulevard 140 1043 EJ Amsterdam The Netherlands 880 Winter Street Suite 330 Waltham MA 02451, USA Bockenheimer Landstrasse 55 60325 Frankfurt am Main, Germany Romanstrasse 35 80639, Munich Germany Mikonkatu 25 00100, Helsinki Finland 168 Avenue Charles de Gaulle, 92200 Neuilly sur Seine France Am Graben 19/4 1010, Vienna Austria The list above comprises the principal subsidiary undertakings as at 31 March 2003 all of which were wholly owned. They are incorporated in Great Britain and registered in England and Wales unless otherwise stated. Each of the above subsidiary undertakings is included in the consolidated accounts of the Group. As at 31 March 2003, the entire issued share capital of 3i Holdings plc was held by the Company. The entire issued share capital of 3i Investissements SA was held by the Company except for three shares which were held by subsidiary undertakings of the Company and for three shares which were held by individuals associated with the Group. The entire issued share capital of all the other principal subsidiary undertakings listed above was held by subsidiary undertakings of the Company, save that four shares in 3i Gestion SA and four shares in 3i SA were held by individuals associated with the Group. Principal joint venture at 31 March 2003 Incorporated in the country stated Name Woodrose Invest AB (Sweden) Issued and fully paid share capital 101,000 shares of SEK 100 Percentage attributable to the Group % 50 Principal place of business and Principal activity registered office Investment company Box 7847 Group’s share of results based on accounts to 31 March 2003 10399 Stockholm Sweden As at 31 March 2003, a subsidiary undertaking of the Company held, on behalf of the Company, 50% of the shares of Woodrose Invest AB. 67 3i Report and accounts 2003 Portfolio valuation methodology A description of the methodology used to value 3i’s portfolio is set out below in order to provide more detailed information than is included each year in the accounting policies for the valuation of the portfolio. The valuation of 3i’s portfolio for the interim and annual accounts is arrived at using a systematic process based on objective criteria. The aim is to value the portfolio as a whole on a prudent and consistent basis. There has been no change to the valuation policy since 3i’s flotation in 1994 and it complies in all material respects with the guidelines of the British Venture Capital Association. Quoted investments Quoted investments are valued at the closing mid-market price at the balance sheet date, except for investments quoted on secondary markets including AIM which are discounted by 25%. Where there are restrictions on dealing in quoted investments, an appropriate discount is applied to the restricted shares. Unquoted equity shares A three-stage valuation process is used: 1 The first stage is to value all unquoted equity investments in the manner described below: New investments are generally valued at cost for the first 12 months or, if later, until the receipt of audited accounts covering a period of at least six months since the date of investment. Any investment in a company which has failed or is expected to fail within the next 12 months is valued at nil. The value of other investments (except technology investments) is arrived at by applying 3i’s proportion of equity shares held to the valuation of the company calculated by multiplying the latest audited earnings by the average price-earnings ratio of the relevant sector of the FTSE SmallCap Index (or international equivalent), adjusted downwards by 3i to exclude loss-making companies. If the result of this calculation is less than half of 3i’s share of net tangible assets, then the investment is valued at half of 3i’s share of net tangible assets. The value of technology investments is arrived at as set out above except that where the investment is in a company which is performing to plan the valuation is not initially reduced below cost. 2 All investments valued at more than £4 million by the first stage of the process, together with any investments which the local office responsible for the investment considers to have a value in excess of £4 million and all technology investments valued at cost, are individually reviewed in line with internal guidelines for factors which may affect the value and their valuations may, as a result, be adjusted. These factors include: • reliable financial information more recent than the audited accounts; • non-recurring profits and losses and abnormal tax charges; • imminent sale or IPO; • significant third party transactions, which includes further rounds of finance to technology companies. Valuation increases are only recognised where there are substantial new outside investors and significant milestones have been achieved; • for technology companies where cost or carrying value is no longer considered appropriate, investments are reduced to a fair value using the most appropriate criteria available; • potential issues of shares dilutive to 3i or other shareholders; • forecasts by the investee business of lower earnings; • an industry standard basis of valuation, for example property companies, which are valued by reference to their net assets; • large cash holdings; and • very high gearing. This process applies to approximately two-thirds of unquoted equity investments by value. 3 The third stage is to apply the following discounts to reflect the illiquidity of unquoted investments: • investments valued at cost or half net tangible assets • investments valued at expected disposal proceeds or IPO value • investments valued on an earnings basis nil 10% 25% Unquoted fixed income shares and loan investments Unquoted fixed income shares and loan investments are generally valued at cost unless the company has failed or is expected to fail within the next 12 months when they are valued at the lower of cost and net recoverable amount. An analysis of the equity portfolio by valuation method is given in the portfolio analysis on page 70. 68 3i Report and accounts 2003 Ten largest investments At 31 March 2003, the Directors’ valuation of the ten largest investments was a total of £409 million. These investments cost £371 million. Investment Travelex Holdings Ltd4 Foreign currency services Equity shares Nordisk Renting AB5 Renting real estate Equity shares Malmberg Investments BV Educational publisher Equity shares Loans Mettis Group Ltd Orthopaedic and aerospace component service provider Equity shares Loans SR Technics Holding AG6 Repair and maintenance of aeroplane engines and frames Equity shares Loans Beltpacker plc Manufacture/marketing of healthcare/beauty products, footwear and accessories Equity shares Loans Westminster Health Care Holdings Ltd Care homes operator Equity shares Loans ERM Holdings Ltd7 Environmental consultancy Equity shares Loans Pets at Home Ltd Retailer in pets and pet supplies Equity shares Loans Aspen Insurance Holdings Ltd6 Property/casualty insurance underwriters Equity shares First invested in 1998 2001 2001 1999 2002 2000 2002 2001 1995 2002 Cost1 £m Proportion of equity shares held Directors’ valuation1 £m Income in the year2 £m Net assets3 £m Earnings3 £m 19.6% 35.0% 41.8% 40.0% 32.2% 38.9% 49.6% 39.0% 26.0% 6.7% – – 67 67 7 19 26 1 50 51 7 33 40 12 43 55 1 37 38 – 35 35 2 27 29 30 30 60 60 47 47 26 19 45 – 43 43 7 33 40 – 38 38 1 37 38 1 35 36 5 27 32 30 30 45 140 15 26 16 3 (19) (11) 15 (13) 3 1 (3) (3) – 2 1 1 3 3 – 2 2 – 3 3 – 1 1 – – – – 3 3 – 4 4 – 2 2 – – Notes 1 The investment information is in respect of 3i’s holding and excludes any co-investment by 3i managed funds. 2 Income in the year represents dividends received (inclusive of any overseas withholding tax) and gross interest receivable in the year to 31 March 2003. 3 Net assets and earnings figures are taken from the most recent audited accounts of the investee business. The figures shown are the total earnings and net assets of each business. Because of the varying rights attaching to the classes of shares held by 3i, it could be misleading to attribute a certain proportion of earnings and net assets to the proportion of equity capital held. Negative earnings and net assets are shown in brackets. 4 The cost of the equity held in Travelex Holdings Ltd is £121,000. 5 This investment has been sold since the year end. 6 These companies were incorporated in 2002 and no audited accounts are available, consequently no net assets or earnings are disclosed. 7 The cost of the equity held in ERM Holdings Ltd is £463,000. 69 3i Report and accounts 2003 New investment analysis Analysis of the equity, fixed income and loan investments made by 3i Group. This analysis excludes investments in joint ventures. Investment by geography (3i only – excluding co-investment funds) (£m) UK Continental Europe US Asia Pacific Total Investment by geography (including co-investment funds) (£m) UK Continental Europe US Asia Pacific Total Continental European investment (£m) Benelux France Germany/Austria/Switzerland Ireland Italy Nordic Spain Other European† Total † Other European includes investments in countries where 3i did not have an office at the year end. Investment by product (£m) Buy-outs Growth capital Early stage technology Total Investment by FTSE industrial classification (£m) Resources Industrials Consumer goods Services and utilities Financials Information technology Total 2003 318 304 74 20 716 399 436 74 22 931 67 36 149 2 32 69 75 6 436 482 273 176 931 12 328 194 197 54 146 931 2002 377 312 119 26 834 443 446 119 31 1,039 64 84 146 2 13 90 45 2 446 361 258 420 1,039 15 110 206 352 26 330 1,039 2001 786 560 134 49 1,529 1,006 770 134 62 1,972 63 117 346 17 64 16 131 16 770 687 362 923 1,972 67 256 371 482 55 741 1,972 2000 705 306 28 31 1,070 894 422 28 32 1,376 39 84 130 – 48 – 95 26 422 579 340 457 1,376 17 201 167 546 48 397 1,376 1999 693 137 1 6 837 899 241 1 6 1,147 3 63 83 – 21 – 68 3 241 609 327 211 1,147 69 376 237 330 41 94 1,147 70 3i Report and accounts 2003 Portfolio analysis The Group’s equity, fixed income and loan investments total £3,939 million at 31 March 2003. Portfolio value by geography (including co-investment funds) (£m) UK Continental Europe US Asia Pacific Total Portfolio value by geography (3i only – excluding co-investment funds) (£m) UK Continental Europe US Asia Pacific Total Continental European portfolio value (£m) Benelux France Germany/Austria/Switzerland Ireland Italy Nordic Spain Other European† Total † Other European includes investments in countries where 3i did not have an office at the year end. Portfolio value by product (£m) Buy-outs Growth capital Early stage technology Total Portfolio value by FTSE industrial classification (£m) Resources Industrials Consumer goods Services and utilities Financials Information technology Total Portfolio value by valuation method (£m) Imminent sale or IPO Listed Secondary market Earnings Cost Further advance Net assets Other Loan investments and fixed income shares Total 2003 3,041 1,773 182 101 5,097 2,494 1,175 180 90 3,939 101 186 319 8 69 273 211 8 1,175 2,001 1,349 589 3,939 186 944 873 1,018 274 644 3,939 37 187 30 938 607 155 139 282 1,564 3,939 2002 4,018 1,984 270 101 6,373 3,386 1,373 264 86 5,109 78 253 385 18 103 304 222 10 1,373 2,253 1,814 1,042 5,109 268 1,117 1,080 1,318 273 1,053 5,109 51 413 89 1,210 1,077 186 132 219 1,732 5,109 2001 4,792 2,039 246 98 7,175 4,121 1,363 235 86 5,805 92 254 556 45 142 26 234 14 1,363 2,338 2,099 1,368 5,805 232 1,081 1,237 1,538 256 1,461 5,805 106 818 266 1,033 1,078 244 147 157 1,956 5,805 2000 5,240 1,514 192 64 7,010 4,668 1,049 190 63 5,970 59 203 533 28 71 6 135 14 1,049 2,622 2,357 991 5,970 185 1,247 1,138 1,648 251 1,501 5,970 241 1,103 483 1,226 626 143 144 119 1,885 5,970 1999 4,565 882 14 12 5,473 4,036 495 14 12 4,557 2 173 196 – 44 – 80 – 495 2,372 1,735 450 4,557 176 1,258 952 1,559 196 416 4,557 88 742 75 1,192 404 38 113 82 1,823 4,557 71 3i Report and accounts 2003 Portfolio analysis Buy-out portfolio value by valuation method (£m) Imminent sale or IPO Listed Secondary market Earnings Cost Net assets Other Loan investments and fixed income shares Total Growth capital portfolio value by valuation method (£m) Imminent sale or IPO Listed Secondary market Earnings Cost Further advance Net assets Other Loan investments and fixed income shares Total Early stage technology portfolio value by valuation method (£m) Imminent sale or IPO Earnings Cost Further advance Net assets Other Loan investments and fixed income shares Total Technology portfolio value by stage (£m) Early stage Late stage Quoted Buy-outs Growth capital Total 2003 12 67 7 536 149 40 115 1,075 2,001 14 120 23 377 187 42 98 69 419 1,349 11 25 271 113 1 98 70 589 2002 14 144 15 635 132 36 90 1,187 2,253 28 269 74 544 234 26 88 96 455 1,814 9 31 711 160 8 33 90 1,042 2001 30 279 23 551 130 32 43 1,250 2,338 32 539 243 442 134 22 114 43 530 2,099 44 40 814 222 1 71 176 1,368 2000 33 573 21 649 100 45 19 1,182 2,622 44 530 462 511 102 – 98 72 538 2,357 164 66 424 143 1 28 165 991 589 1,042 1,368 991 103 294 250 647 1,236 290 214 170 674 1,716 723 231 7 961 2,329 1,074 312 2 1,388 2,379 1999 47 382 14 608 81 36 16 1,188 2,372 23 360 61 526 109 – 75 60 521 1,735 18 58 214 38 2 6 114 450 450 329 193 2 524 974 The early stage portfolio comprises investments in immature businesses which typically require further funding. The late stage portfolio comprises investments in more mature, typically self funding businesses, including investments made by way of buy-outs and growth capital. Early stage technology portfolio value by sector (£m) Healthcare Communications Electronics, semiconductors and advanced technologies Software Total 195 112 72 210 589 288 185 139 430 1,042 237 264 140 727 1,368 181 223 166 421 991 116 89 86 159 450 72 3i Report and accounts 2003 Realisations analysis Analysis of the Group’s realisation proceeds (excluding third party co-investment funds). The analysis below excludes divestment of non-venture capital investments in FTSE 350 companies, 31 March 2003: £nil (2002: £156 million, 2001: £49 million). Realisations proceeds by geography (£m) UK Continental Europe US Asia Pacific Total Realisations proceeds (£m) IPO Sale of quoted investments Trade and other sales Loan and fixed income share repayments Total Realisations proceeds by FTSE industrial classification (£m) Resources Industrials Consumer goods Services and utilities Financials Information technology Total 2003 727 238 2 9 976 37 110 493 336 976 60 294 192 330 42 58 976 2002 794 133 10 2 939 55 370 303 211 939 52 193 255 288 18 133 939 2001 1,366 181 – 4 1,551 253 536 470 292 1,551 34 211 278 338 33 657 1,551 2000 986 145 – 1 1,132 48 351 423 310 1,132 6 197 176 497 20 236 1,132 1999 754 98 – – 852 75 165 292 320 852 14 262 180 378 18 n/a 852 n/a The current FTSE industrial classifications came into effect on 1 April 1999. Changes made included the introduction of information technology. With the exception of 1999, the classification shown analyses investment and the portfolio by FTSE classification in use at each balance sheet date. Funds under management (£m) Third party unquoted co-investment funds Quoted investment companies† Total † Also includes the 3i Group Pension Plan. 2003 1,587 452 2,039 2002 1,995 761 2,756 2001 2,131 870 3,001 2000 2,261 818 3,079 1999 1,470 474 1,944 Contents 02 Chairman’s statement 04 Chief Executive’s statement 06 Operating review 14 Financial review 20 Board of Directors 22 Corporate Social Responsibility report 25 Directors’ report 30 Remuneration report 38 Independent auditors’ report Financial statements 39 Consolidated statement of total return 39 Reconciliation of movement in shareholders’ funds 40 Consolidated revenue statement 41 Consolidated balance sheet 42 Parent company balance sheet 43 Consolidated cash flow statement 44 Accounting policies 46 Notes to the accounts 66 Principal subsidiary undertakings and joint ventures Additional financial information 67 Portfolio valuation methodology 68 Ten largest investments 69 New investment analysis 70 Portfolio analysis 72 Realisations analysis 72 Funds under management Inside back cover Information for shareholders Investor relations and general enquiries Five year record Net asset value per share (p) Dividend per share (p) Total return (£m) Return on opening shareholders’ funds (%) Revenue profit after tax (£m) Realisation proceeds (£m) Realised profits/(losses) on disposal of investments (£m) 2003 480 2002 2001 2000 1999 645 815 847 601 13.5 13.0 13.0 12.2 11.3 (935) (960) (142) 1,579 (23.7) (19.3) (2.7) 43.8 140 976 184 106 116 115 939 1,551 1,132 (39) 453 350 177 5.1 110 852 180 Unrealised value movement on revaluation of investments (£m) (1,165) (890) (676) 1,167 (90) Investment (£m) Share price at 31 March (p) 931 1,039 1,972 1,376 1,147 417 787 1,122 1,318 626 Comparison of 3i compound annual return v. FTSE All-Share (%) for the years ending 31 March 2003 (15.8) (15.4) (2.0) (6.6) 3 years 5 years 7 years 10 years 3i return FTSE All-Share 3.7 2.0 10.1 5.5 3i Report and accounts 2003 Information for shareholders Financial calendar Ex-dividend date Record date Annual General Meeting Final dividend to be paid Interim dividend expected to be paid Shareholder profile Location of investors at 31 March 2003 1 UK (including retail shareholders) 2 Continental Europe 3 US 4 Other international Share price Share price at 31 March 2003 High during the year (2 April 2002) Low during the year (9 October 2002) Balance analysis summary Range 1 – 1,000 1,001 – 10,000 10,001 – 100,000 100,001 – 1,000,000 1,000,001 – 10,000,000 10,000,001 – highest Total 18 June 2003 20 June 2003 11.00am 9 July 2003 18 July 2003 January 2004 83.46% 6.44% 6.73% 3.37% 417p 811p 407p Number of holdings Individuals 28,603 6,770 194 21 0 0 35,588 Number of holdings Corporate bodies 3,846 2,511 646 373 100 7 7,483 Balance as at 31 March 2003 16,559,435 21,168,608 30,214,167 131,242,917 290,082,185 121,650,941 610,918,253 % 2.71 3.47 4.95 21.48 47.48 19.91 100.00 The table above provides details of the number of shareholdings within each of the bands stated in the Register of Members at 31 March 2003. Registrars For shareholder administration enquiries, including changes of address, please contact: Lloyds TSB Registrars The Causeway Worthing West Sussex BN99 6DA Telephone +44 (0)870 600 3953 Investor relations and general enquiries For all investor relations and general enquiries about 3i Group plc, including requests for further copies of the Annual Report and accounts, please contact: Group Communications 3i Group plc 91 Waterloo Road London SE1 8XP Telephone +44 (0)20 7928 3131 Fax +44 (0)20 7928 0058 email ir@3igroup.com or visit our new investor relations website www.3igroup.com for full up-to-date investor relations information including the latest share price, recent annual and interim reports, results presentations and financial news. 3i Group plc is a deposit taker regulated by the Financial Services Authority. Designed and produced by Radley Yeldar (London). Printed by CTD Capita. The paper used for the production of this brochure is manufactured from 50% totally chlorine free pulps sourced from plantation forests, offcuts and forest thinnings. The further 50% is manufactured from recycled fibres. 3i Group plc Report and accounts 2003 3 i l G r o u p p c R e p o r t a n d a c c o u n t s 2 0 0 3 3i Group plc 91 Waterloo Road London SE1 8XP England Telephone +44 (0)20 7928 3131 Fax +44 (0)20 7928 0058 Website www.3igroup.com M38703 May 2003 

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