3i Group
Annual Report 2004

Plain-text annual report

3i Group plc 91 Waterloo Road London SE1 8XP UK Telephone +44 (0)20 7928 3131 Fax +44 (0)20 7928 0058 Website www.3igroup.com M39404 May 2004 3i Group plc Report and accounts 2004 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 4 3i is a world leader in private equity and venture capital. We focus on buy-outs, growth capital and venture capital 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. These underpin the value that we deliver to our portfolio and to our shareholders. 3i Report and accounts 2004 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 2004 1 UK (including retail shareholders) 2 Continental Europe 3 US 4 Other international Share price Share price at 31 March 2004 High during the year (19 February 2004) Low during the year (1 April 2003) 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 16 June 2004 18 June 2004 11.00 am 7 July 2004 16 July 2004 January 2005 79.08% 6.81% 11.94% 2.17% 629p 686p 418p % 2.53 3.22 4.42 20.37 49.82 19.64 100.00 Number of holdings Individuals 27,543 6,513 176 22 0 0 34,254 Number of holdings Corporate bodies 2,968 2,185 603 371 101 7 6,235 Balance as at 31 March 2004 15,549,390 19,733,637 27,107,090 124,970,339 305,631,519 120,487,184 613,479,159 The table above provides details of the number of shareholdings within each of the bands stated in the Register of Members at 31 March 2004. 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 3970 Investor relations and general enquiries For all investor relations and general enquiries about 3i Group plc, including requests for further copies of the 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 e-mail ir@3igroup.com or visit our 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 authorised and regulated by the Financial Services Authority as a deposit taker. Designed and produced by Radley Yeldar (London). Printed by CTD Printers Limited. 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. Contents Chairman’s statement Chief Executive’s statement 02 04 06 Our business focus 08 25 30 32 38 46 Operating and financial review Corporate responsibility report Board of Directors Directors’ report Remuneration report Independent auditors’ report Consolidated statement of total return Financial statements 47 47 Reconciliation of movement in shareholders’ funds Consolidated revenue statement 48 49 Consolidated balance sheet Parent company balance sheet 50 51 Consolidated cash flow statement 52 Accounting policies 54 Notes to the accounts 68 Principal subsidiary undertakings and joint ventures Ten largest investments Forty other large investments Additional financial information 69 Portfolio valuation methodology 70 71 72 New investment analysis 73 Portfolio analysis 75 Realisations analysis 75 Funds under management 76 Private equity and venture capital – an introduction Inside back cover Information for shareholders Investor relations and general enquiries With thanks to the members of the 3i team who took part in the photography contained in this report. 3i Report and accounts 2004 “3i delivers a strong overall performance” Financial highlights Total return Revenue profit before tax Return on opening shareholders’ funds £531m 18.1% £139m £228m 14.0p Dividend per share Realised profits Total return Return on opening shareholders’ funds Revenue profit before tax Realisation proceeds Realised profits on disposal of investments Unrealised profits on revaluation of investments Investment (including co-investment funds) Diluted net asset value per share Dividend per share Portfolio by value (£m) as at 31 March 2004 Buy-outs Growth capital Venture capital Total 2,306 1,487 533 4,326 £531m 18.1% £139m £923m £228m £336m £979m 553p 14.0p 12% 35% 53% 01 3i Report and accounts 2004 Chairman’s statement “a highly-focused business with good momentum” At the time of our interim results announcement in November 2003, I noted that we had seen an encouraging performance in the first six months of the financial year, driven by better results from our buy-out, growth capital and venture capital businesses. I also said that as business confidence improved there would be some excellent opportunities for 3i to invest. This has indeed proved to be the case. The results for the year to 31 March 2004 demonstrate the improvement in each of our areas of activity. The total return for the year of £531 million represented 18.1% on opening shareholders’ funds, a strong overall performance. 3i’s share price performed well in the year to 31 March 2004. Total shareholder return of 54.4% compared with 31.0% for the FTSE All-Share total return index over the same period. The Board is recommending a final dividend of 8.9p, making a total dividend of 14.0p, an increase of 3.7% from 13.5p last year. The benefits of our product focus are now becoming clear. Geographically, 3i’s returns in the UK, continental Europe and Asia Pacific were strong. Investment picked up well in the second half. Total new investment, including co-investment funds, was £979 million during the year as a whole. Realisations proceeds totalled £923 million and equity assets were sold at a 58% premium to their value at the start of the year. 02 In March 2004, 3i announced Brian Larcombe’s intention to retire at the forthcoming Annual General Meeting in July. Brian became our Chief Executive in 1997 and has been with the Company for almost 30 years. He joined the Board in 1992 and as Finance Director played a key role in the flotation of 3i in 1994. Under his leadership, the business has been transformed into a dynamic, integrated international business. The Board and I would like to thank him for this and pay tribute to his contribution to our industry as a whole. The process for identifying Brian’s successor is under way and we will be making an announcement by the Annual General Meeting. Our staff have achieved a great deal over the year and the good performance of the Group is the result of not only some fine individual efforts but excellent teamwork. 3i’s ability to put together the best team for the job from around the world is giving the business an edge and flexibility that few competitors can match. 3i Report and accounts 2004 Chairman’s statement Baroness Hogg Chairman 12 May 2004 For any company, corporate responsibility should be an important issue. I hope that you will see from this report that 3i takes its responsibilities seriously, not only as a company but also as an investor. An essential element of the governance of 3i is the work carried out by the committees of the Board. I would like to thank John Forrest, who is stepping down from the Board at the AGM, for all he has done for 3i in seven years as a non-executive Director, and particularly for his work in chairing the Remuneration Committee. After three tough years for the Group, we now have a highly-focused business, clear competitive advantage, a strong balance sheet, good momentum on the new investment front and a healthy result for the year to 31 March 2004. Our latest Enterprise Barometer survey indicates greater business confidence in our market place and augurs well for the year ahead. 03 3i Report and accounts 2004 Chief Executive’s statement “much-improved portfolio health, good uplifts in value and strong realisation profits” Results I am pleased to report good results for the year with a total return of £531 million. This significant improvement follows a three year period of substantial change for 3i, during which we refocused the investment business, restructured and slimmed down the organisation, and strengthened our investment processes. These changes, together with our continued international growth, are now delivering much-improved portfolio health, good uplifts in the value of the portfolio and strong realisation profits. 3i continues to lead the European market in our three chosen segments of mid-market buy-outs, growth capital and early stage technology (“venture capital”). As the year progressed, we increased the momentum of investment activity, which resulted in almost £1 billion being invested during the year, including co-investment funds. For the year, our buy-out and growth capital businesses generated returns of 22.4% and 26.8% respectively. Our venture business delivered a substantial improvement, with a return of (6.0)%, though its return was broadly break-even before the impact of currency translation losses. Our overall return of 18.1% can compare with performance data, produced by Thomson Venture Economics, which shows an overall return for European private equity and venture capital funds of (1.4)% for calendar year 2003. Although the data is not strictly comparable, it does suggest that 3i is performing well within the top quartile of the industry. 3i’s return compares with returns of 25.7% and 31.0% on the FTSE 100 and FTSE All-Share total return indices respectively. It is normal that our returns lag an upturn in quoted markets. This is because the valuations of 3i’s 04 Brian Larcombe Chief Executive 12 May 2004 3i Report and accounts 2004 Chief Executive’s statement unquoted investments are generally based on historical earnings and our venture capital assets are not marked up in line with a rise in quoted markets. Market conditions Market conditions and business confidence have improved steadily since the beginning of the financial year. The improvement in capital markets and mergers and acquisition activity encouraged a rise in investment activity as companies began to return to growth agendas. The new issues market remains quiet across Europe, with only a small number of significantly-sized IPOs being achieved. Strategy and competitive advantage 3i’s development in recent years has been built on the four key elements of our strategy: developing the business internationally, building a balanced investment business, using the network as a key competitive advantage and investing in growth companies. Today, 3i is active in Europe, Asia Pacific and the US, with 42% of our assets now outside the UK. Of our investment in the year, 51% was in continental Europe and a further 10% in the US and Asia Pacific. Buy-outs account for 53% of assets, growth capital 35% and venture capital 12%. 3i’s network of relationships around the world continues to deliver significant competitive advantage and is integral to all that we do. Market access, the ability to convert opportunities into good investments, add value to our portfolio companies and realise value, all depend upon it. Our strategy of investing in companies with significant potential to grow is increasingly appropriate in a low inflation and more internationally competitive environment. Strategy implementation We have continued to drive improvement throughout the business, particularly investment focus, in ensuring the best from the network and in further efficiency programmes. The combination of increased productivity and a smaller number of companies in the portfolio enabled a reduction in headcount of 13% from 858 to 750 during the year. “3i is in great shape and well positioned to grow value for our shareholders” A further change during the year was that our teams in Bristol, Glasgow and Leeds are now focused on portfolio management. We are also in the process of moving our teams in Padua and Nantes back to Milan and Paris respectively. Across our three activities, 3i’s scale has allowed us to develop a multi-specialist approach which can deliver the best resource to new business opportunities and from the management of key relationships with major companies and professional advisers. A good illustration of this is our ability, within industry sectors, to bring together the chief executives of our portfolio companies and directors of the leading international businesses. This provides origination opportunities and creates value for our portfolio companies. The establishment of specialist teams is especially clear in our venture business. This is now focused on nine of our offices, located in the main technology hubs within Europe, the US and Asia Pacific and coordinated by sector leadership teams in healthcare, software, communications and ESAT (electronics, semiconductors and advanced technologies). Outlook 3i has withstood some of the most volatile market conditions that I have seen in my 30 years in the industry and has come through strongly. It is a leader in its industry and one of the few genuinely international businesses with competitive scale. The general macroeconomic drivers look more favourable, the business model is delivering in each of our three key areas of activity: buy-outs, growth capital and venture capital and the business has the people, the network and the capital strength to grow significant value for our shareholders. I would like to thank the Board, the staff and our shareholders for the tremendous support I have enjoyed in leading 3i. I would also pay tribute to the entrepreneurs who build the businesses that our industry supports and acknowledge it is largely their visions that provide our opportunity. 05 3i Report and accounts 2004 Our business focus “a significant improvement in all products” Buy-outs 3i’s buy-out business is focused on the mid and smaller buy-out markets in Europe and Asia Pacific. “A strong financial performance for the year as a whole and a substantial pick up in investment activity in the second half. For the year ahead, we will continue to drive value growth from the portfolio and, if market conditions remain supportive, increase the level of new investments and realisations.” Jonathan Russell Head of Buy-outs Portfolio value £2,306m 53% Five investments from the year Company Business description Country Gant Marketing and design of premium branded apparel Herold Mediatel Telephone directories Sweden Austria MIB AG Refresco SVP Facilities management Switzerland Fruit juice producer Netherlands Telephone consultancy service France * Including funds. Transaction size £m Amount invested £m* 73 173 43 208 33 8.5 20.6 11.8 40.3 4.9 Group financial highlights (£m) for year to 31 March 2004 Financial highlights (£m) for year to 31 March 2004 Total return Investment* Realisation proceeds (35) 335 231 Total return 189 146 492 464 313 174 Investment* 339 120 Realisation proceeds 206 442 50 258 Realised profits 123 70 35 Realised profits 62 61 Unrealised value movement (42) 247 131 Unrealised value movement 161 86 06 Buy-outs Growth capital Venture capital Mid-market buy-outs Smaller buy-outs 3i Report and accounts 2004 Our business focus Growth capital Venture capital Our growth capital business is focused on high growth companies, expanding organically or through acquisition. “A strong financial performance for the year on the back of good value growth and realisation profits. Our focus continues to be to build portfolio value and increase the level of new investment.” 3i’s venture capital business is focused on the healthcare, software, communications and electronics, semiconductors and advanced technologies (“ESAT”) sectors. Chris Rowlands Head of Growth capital “We have achieved a significant turnaround in financial performance. As technology markets continue to improve, the priority now is to grow the value of our portfolio and add new high potential businesses to it.” Rod Perry Head of Venture capital Portfolio value £1,487m 35% Portfolio value £533m 12% Five investments from the year Five investments from the year Company Business description CSMC Foundry semiconductor services Republic Ltd Fashion retailers and wholesalers TeknikMagasinet Retail of home electronics and hobby products Vanyera Outsourced catering Williams Lea Outsourced print services * Including funds. Country China UK Sweden Spain UK Amount invested £m* Company Business description 6.5 Microsulis Medical devices Country UK 13.8 MobiApps Wireless tracking and monitoring devices Singapore 6.1 8.2 33.3 Pedestal Software Software vendor UbiNetics Wireless telecommunications Vonage Broadband telephony US UK US * Including funds. Amount invested £m* 13.6 1.9 2.2 11.0 6.5 Financial highlights (£m) for year to 31 March 2004 Financial highlights (£m) for year to 31 March 2004 Total return Investment* Realisation proceeds 231 Total return (35) 313 Investment* 339 Realisation proceeds 174 120 Realised profits 70 Realised profits 35 Unrealised value movement 131 Unrealised value movement (42) 07 3i Report and accounts 2004 Operating and financial review “clear competitive advantage” This review includes a description of 3i’s business and strategy and comments on 3i’s performance during the year in the context of the economic and market environment and other influences. The review also discusses 3i’s financial position, including changes to its capital structure, and comments on the main risks inherent in 3i’s business and the framework used to manage them. 3i’s business and strategy 3i’s business 3i’s business focus continues to be to invest in buy-outs, growth capital and venture capital. Geographically, most of our investment is in businesses based in western Europe, although 3i does have growing investment operations in the US and in the Asia Pacific region. In the US, 3i currently invests in businesses engaged in technology sectors; while elsewhere 3i invests across a broader range of industry sectors and in each of the investment activities identified above. Buy-outs 3i invests in European mid-market buy-out transactions with a value between B25 million and B800 million. The vendors of the businesses being sold are typically large corporates disposing of non-core activities or private groups with succession issues. 3i targets the mid-market because that is where we believe we can create the most value. There is less competition for transactions in this market than for larger deals and price is less likely to be the sole or key criterion in “winning the deal” – we believe that, in the mid-market, the relationships we build through our local presence are just as important. Additionally, the nature and size of businesses in this market are such that we are more able to add value through strategic, operational and management input; and, in this market, the underlying businesses will generally have greater growth potential than larger ones and be of such a size as to make them more attractive acquisition targets for a greater number of strategic purchasers. 3i is also active in the smaller buy-out market (below B25 million), both in western Europe and in the Asia Pacific region. This is a more fragmented segment of the market and one in which 3i’s local network provides good access to the private vendors, management teams and local advisers involved. 08 focused i Williams Lea Business description: Outsourced print management and information management services Country: UK Investment type: Growth capital new longer-term contracts as the market moves towards a model of full outsourcing of information and document management. This strategy involves a mix of organic growth and growth through acquisition. In addition, the business has plans to strengthen its presence in continental Europe as well as North America and the Indian subcontinent, in line with its customer requirements. In February 2004, 3i invested £33 million in Williams Lea, the UK market leader in the provision of outsourced print management and information management services to major financial institutions and corporates. 3i has been invested in this £200 million revenue company since 1965. This is a growth capital investment, with 3i’s funding being used both to finance growth by the business and to enable a rationalisation of the shareholder base of approximately 300 individuals. The growth element of the funding is intended to enable Williams Lea to increase its service offering to its existing blue chip customer base and also to secure 3i Report and accounts 2004 Operating and financial review a Refresco Business description: Fruit juice producer Country: Netherlands Investment type: Buy-outs 312 million buy-out of Refresco 160 million In September 2003, 3i led the 1 Holding BV, investing (together with Eurofund IV) and taking a substantial stake in the business. Refresco is one of Europe’s largest suppliers of fruit juices and soft drinks to food retailers, principally under private label. This was a secondary buy-out from a Dutch/German/UK syndicate who were selling because they were unable to fund the continuing buy and build strategy. 3i’s Benelux team has known the management for over four years and also had strong contacts within the original investor group. The 3i team involved local Dutch investment professionals supported by London-based executives and our food sector specialists. We introduced a chairman with experience of multi-site, international, low cost manufacturing and of growing businesses through acquisition and supplying to large retailers. The investment strategy is to grow revenues and increase margins, both organically and by way of acquisition, in a rapidly consolidating European market. 3i has been active in using its network to source potential acquisition candidates. fresh 09 3i Report and accounts 2004 Operating and financial review Growth capital 3i makes growth capital investments of between £5 million and £50 million, across a broad range of sectors, business sizes and funding needs. These investments typically involve 3i acquiring minority stakes in established businesses. We therefore seek to ensure a high level of influence and an attractive yield in these situations. 3i’s growth capital business 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 3i’s strategy of local presence, sector specialisation, sharing knowledge and offering local businesses access to 3i’s international network of relationships. p Angel Springs Business description: Supplier of watercoolers and bottled water Country: UK Investment type: Buy-outs In December 2003, 3i led the simultaneous acquisition and merger of three UK office watercooler businesses to form Angel Springs, thereby creating one of the largest independent national cooler businesses in the UK. The watercooler market is growing strongly on the back of the trend to healthier living habits and increased water consumption and is undergoing a phase of consolidation in the UK and continental Europe as a number of larger food and drink groups pursue market share through acquisition strategies. The investment strategy is to integrate the three businesses, drive organic growth and then 10 sell to one of the industry consolidators or a new strategic entrant to the market. The managing director of the new group is someone with whom 3i had previously successfully invested within the watercoolers sector and whose operational and other abilities it believes will enable a successful integration of the three businesses. 3i further strengthened the management team by introducing a chairman with relevant experience from its Independent Directors Programme and a finance director with whom it had also successfully worked before. cool 3i Report and accounts 2004 Operating and financial review “a balanced business” Venture capital 3i’s venture capital business is targeted at four key sub-sectors – healthcare, communications, software and electronics, semiconductors and advanced technologies (“ESAT”). The main geographic focus is western Europe and the US, though 3i does also invest in the Asia Pacific region. Investment in venture capital takes the form of participation in a series of “funding rounds” and we therefore separate out “first investments” (those in businesses where 3i is not already invested) and “further investments”. 3i aims to invest between £1 million and £10 million in each new opportunity and, depending on circumstances and market conditions, we would generally expect 3i’s venture capital investment to be split broadly 50:50 between first investments and further investments in any year. p Cambridge Silicon Radio Business description: Designer and manufacturer of single-chip Bluetooth wireless devices Country: UK Investment type: Venture capital In February 2004, Cambridge Silicon Radio (“CSR”), a leading manufacturer of single-chip Bluetooth wireless devices in which 3i had invested a total of £7 million, achieved a successful IPO on the Official List of the London Stock Exchange. This represented an important milestone for CSR and provided 3i with a partial realisation of its investment in the business. At the IPO price of 200p, CSR was valued at £240 million and 3i’s holding was worth £30 million. 3i sold about one-third of its holding in the IPO. 3i supported the spin out of CSR from Cambridge Consultants Ltd in 1999. 3i recognised that the Bluetooth market was expanding and was impressed by the quality of CSR’s technology, which supports short-range wireless data and voice communications between different devices. Since 1999, 3i has backed CSR through three subsequent funding rounds and negotiated a shareholder agreement with a major corporate. CSR decided to partner with 3i because of its local presence, its global network of corporate and other contacts and its track record of backing successful semiconductor-related businesses. 3i brought together the current management team, assisting with the recruitment of a chairman, chief executive officer, chief financial officer and financial controller and introducing a non-executive director from its Independent Directors Programme. 3i also introduced CSR to a number of business partners and advisers and supported the company through its IPO process. in-touch 11 3i Report and accounts 2004 Operating and financial review d Vonage Business description: Telecoms Country: US Investment type: Venture capital In February 2004, 3i co-led a $40 million late-stage technology venture funding round in Vonage, a leading provider of broadband “voice-over internet protocol” (VoIP) telephony services, based in New Jersey. The funding, of which 3i contributed $12 million, will be used to accelerate the expansion of Vonage’s service in North America and Europe and to support development of new innovative offerings. The broadband telephony market is projected to expand rapidly over the next decade, due to its significant price advantages and superior functionality over the use of traditional circuit-switched telephone lines. 3i’s knowledge of the global communications market and ability to help accelerate the company’s international expansion through its network of offices were critical to 3i’s ability to secure the opportunity. Since making the investment, 3i has introduced the company to a number of potential customers and partners in the US, Europe and Asia. Vonage has seen a significant acceleration of its business in recent months and, by May 2004, had surpassed 150,000 subscribers in the US. “we invest in businesses with the potential to grow profits significantly” connected 3i’s strategy The key elements of 3i’s strategy are as follows: – to develop the business internationally; – to build a balanced investment business; – to use the network as our key competitive advantage; and – to invest in companies where there is potential to grow profits significantly. Globally, private equity and venture capital investment is concentrated in the US and Europe, with the Asia Pacific region showing strong growth. We currently have a strong European presence and aim to grow our activities in the US and Asia. 3i targets investment across a broad range of industrial sectors and also invests at all stages of the corporate lifecycle, from start-ups to buy-outs. We continue to target businesses where we believe we can help to grow profits significantly. Integral to our strategy is the ability to use 3i’s network to generate returns that are greater than those of our competitors. As business becomes increasingly international and complex, we believe that the network provides 3i with real competitive advantage through each phase of the investment lifecycle – origination of the investment opportunity, developing and validating the business case, structuring and making the investment, implementing the operational plan for the business, and exit. 12 3i Report and accounts 2004 Operating and financial review fun o TeknikMagasinet Business description: Retailer of home electronics and hobby products Country: Sweden Investment type: Growth capital In January 2004, 3i completed a £6 million investment in TeknikMagasinet, a Swedish retailer of home electronics and hobby products with a current turnover of approximately £20 million per annum. This growth capital investment comprises a mixture of equity shares and loans, with 3i taking a substantial minority stake in the business. The company has a market- leading position in this sector, with 37 retail outlets across Sweden. The strategy that 3i’s investment is supporting includes a rapid extension of the chain of outlets in Sweden, as well as expansion of the network into the other Nordic countries. 3i’s local presence in Stockholm, as well as in Helsinki and Copenhagen, together with its experience and expertise in the retail sector and in growing retail businesses, enabled it to secure the opportunity. 3i has introduced a chairman and two additional non-executive directors with relevant capabilities and experience to help the business achieve its growth strategy. 13 3i Report and accounts 2004 Operating and financial review s Gant Business description: Marketing and design of premium branded apparel “3i’s network is integral to all that we do” Country: Investment type: Sweden Buy-outs In June 2003, 3i co-led the 1109 million buy-out of Gant Company AB, an international marketer and designer of premium branded apparel. 3i, together with 3i Eurofund III, invested 113 million, taking a significant minority stake. 3i was introduced to Gant in late 2002 by a member of 3i’s Independent Directors Programme who was a deputy non-executive director on the board of Gant. The approach followed the abandonment of IPO plans due to adverse market conditions. Insights gained from previous investments in this sector helped 3i to understand, contribute to and validate the value growth strategy for the business and gain exclusivity almost from the start of the process. 3i used its local presence in Stockholm, supported by colleagues from its Spanish, Italian and UK offices with sector specific knowledge, to ensure that it had the best “angles” for the opportunity. The transaction was complicated by the diverse vendor group which consisted of the three founders, a multi-national business and a private equity firm. Exit plans are currently focused on achieving an IPO on the Stockholm Stock Exchange in two to four years’ time. smart 14 3i Report and accounts 2004 Operating and financial review The main elements of what we refer to as “our network” are as follows: – local presence – this enables 3i to build strong relationships with entrepreneurs, corporates, universities, research organisations and intermediaries, and is particularly important in the deal origination phase of the investment lifecycle; – sector specialisation – underpinning 3i’s ability to build meaningful business relationships, sector specialisation is critical in the phases of developing and validating the investment case and subsequently implementing the growth strategy. Our sector teams are drawn from 3i’s Industry Group, which comprises around 20 experienced senior industry specialists, and 3i’s investment and portfolio management executives; – “product” specialisation – each of buy-outs, growth capital equity and venture capital investment business and, for 3i, the benefits of sharing these across the organisation represent a substantial source of competitive advantage. We believe we have in place the systems, processes and structures and, as importantly, the corporate culture to help 3i maximise the potential benefits; – relationships with corporates – another benefit of 3i’s scale and organisation is that we have meaningful relationships with a large number of corporates in each of the geographies in which we operate. These relationships are particularly useful at the origination, investigation and exit phases of an investment. Furthermore, 3i’s ability to make effective business introductions across a range of geographies is increasingly a critical factor in our ability to “win deals” and provides 3i with a distinctive source of value creation; and and venture capital has teams of specialist investment executives skilled in project management and financial structuring specific to the product. 3i’s scale and structure also allow us to utilise specialist skills in a number of other areas, including portfolio management, restructuring and turnarounds, and exits and IPOs of companies from 3i’s portfolio; – strengthening boards and management teams – the “People Programmes” 3i runs for chairmen, chief executives, chief financial officers and independent directors provide an excellent resource for building and strengthening boards and operational management; and are also a strong source of both investment opportunities and due diligence capability. – sharing knowledge and contacts – the importance of knowledge and strong relationships in each phase of the investment lifecycle is difficult to overstate in the private d Senoble Business description: Manufacturer of dairy products and chilled desserts Country: France Investment type: Growth capital In March 2004, 3i made a substantial growth capital investment in Senoble, a B 600 million turnover French manufacturer of dairy products and chilled desserts, taking a 25% equity stake in the business. The investment was made to support capital expenditure. Senoble, which has operations in France and Spain, is the leading manufacturer of private label milk- based products, but also produces a range of desserts under its own Senoble brand and a number of low-calorie products under the Weight Watchers brand through an exclusive licence for France. The investment opportunity was originated through some direct marketing by one of 3i’s French food sector specialists. The depth of 3i’s network in the food industry in Europe (demonstrated through the pan European Food & Drink Sector conference at the IESE Business School in Barcelona in November) and the breadth of its sector experience and expertise were key differentiators in 3i’s ability to secure the opportunity. 3i has introduced a non-executive director with strong dairy sector and private label experience. The investment strategy is premised upon strong growth of sales, mainly through increasing exports, and improvement in margins. 15 lhea thy 3i Report and accounts 2004 Operating and financial review Organisation and office network There have been no changes since March 2003 in the leadership of our three investment businesses. Jonathan Russell continues to lead the pan European mid- market buy-out business; Chris Rowlands leads the growth capital and smaller buy-out business; and Rod Perry leads the venture capital business. Within each of these activities, a panel of our most experienced investors ensures rigorous application of our investment processes and provides guidance to help ensure we maximise value across each phase of the investment lifecycle. These panels also seek to ensure, on a case-by- case basis, that we assemble “the best team for the job” from the regional, sector and product specialists. The investment and divestment approval functions for larger transactions are carried out by two Investment Committees, addressing technology and non-technology investments respectively. The membership of these Investment Committees is drawn from 3i’s Executive Committee. “net investors in the second half” 3i’s Smi (small and medium-sized investments) initiative, which was established in 2001 and which reports to Chris Rowlands, continues to be successful in generating returns from some of the older and lower-growth investments and, importantly, in enabling non-Smi investment professionals to focus on identifying investment opportunities and managing larger investments. At 31 March 2004, £698 million of value (16% of 3i’s total portfolio) and 849 investments (45% by number of 3i’s total portfolio) were managed by the Smi team. There were no changes to the office network during the year, though we have just announced that 3i’s offices in Padua and Nantes will close in the summer of 2004. 3i will then have a total of 29 offices (25 across Europe and two each in the US and the Asia Pacific region). We continue to recognise the need to deploy resources through critical mass teams based in locations of greatest opportunity. To this end, 3i’s Glasgow, Bristol and Leeds offices were, in February, directed to focus on portfolio management, with the executives responsible for new investment in these offices being redeployed. We do not anticipate any substantial changes to the current network of offices. During the year, headcount was reduced from 858 to 750, reflecting a continued application of the cost reduction measures and changes in investment processes and resource alignment initiated over recent years. 16 Operating review Macroeconomic and market conditions The macroeconomic environment in the regions where 3i has operations improved substantially during the financial year under review. Looking at the period as a whole, perhaps the key defining features of the economic environment were as follows: gradually improving consumer and business confidence from the lows experienced during the extended build-up to hostilities in Iraq, though ongoing geo-political uncertainty appears to be a fact of life; the significant strengthening during the period of sterling and the euro compared with the US dollar and a number of Asian currencies, which has impacted the competitive position of a number of our portfolio businesses; improving economic growth outlook for the US and, to a lesser degree, for Europe, though across most of Europe levels of government spending remain high; and the strength of the Chinese economy and the implications of this for western economies and businesses. Stock market conditions and mergers and acquisitions (“M&A”) activity levels also showed improvement through the financial year. Most stock market indices rose substantially, reflecting improving confidence in underlying economic growth and the prospects for corporate earnings. The increased business confidence, improving stock market conditions and continuing low interest rates are all enabling and encouraging businesses to recommence their disposal and acquisition strategies, though the number of completed M&A transactions remains subdued, both in Europe and globally. 3i Report and accounts 2004 Operating and financial review The private equity and venture capital markets are also showing increased activity after a slow first half of 2003. Market statistics for 2003 show that total private equity and venture capital investment in Europe fell by 16.5% compared with 2002, with “high technology” investment down 25%, “growth” investment down by 29.4% and buy-out investment down by 9.5%. The second quarter experienced the lowest levels of investment (as expected, given the prevailing uncertainty and consequent deferment of business decisions), with strong increases in the third and fourth quarters. Elsewhere, the “high technology” segment of the market in North America showed a 5% increase in total investment over 2002; and investment levels in Asia Pacific rose very substantially in 2003 to a new “all-time high”. Conditions for realisations were difficult for most of 2003, with relatively few active trade buyers and continuing low levels of IPOs by historical standards. Market statistics for Europe show a 25% fall in the number of divestments in 2003 compared with 2002. However, we are seeing encouraging levels of renewed interest by trade buyers for strategic assets and the IPO markets are showing signs of re-opening, at least for strongly performing and profitable businesses. There were also a number of features specific to the markets of each of our three investment businesses. Activity in the pan European mid-market for buy-outs was driven largely by strategic reorganisation and restructuring initiatives within conglomerates under continuing pressure to sell off non-core assets and manage their balance sheets. In addition, secondary buy-outs (where a private equity investor buys a business from another private equity investor) were a significant feature during the period, accounting for 31.3% of investment (by transaction value) in 2003. This is a reflection of the amount of buy-out funds raised and seeking investment opportunities and also, on the sell side, of the pressure on some funds to sell investments and return cash to investors. Within the European growth capital market, investment in 2003 was down sharply on 2002, largely as a result of growth and acquisition plans being deferred in an environment of business uncertainty during the first half of the year. Since then, these strategies have increasingly been recommenced and we believe that the use of private equity to facilitate cross-border expansion within the European market is a key driver of investment opportunity. The venture capital markets are seeing increased levels of IT spending by businesses as well as improved conditions for realisations as the appetite of corporates for buying venture-backed businesses improves and stock markets re-open to some extent to technology companies. Reduced levels of competition following the fallout from the “technology bubble” are also a feature of the marketplace in Europe, though competition for particularly good opportunities is still significant. “the strategy is delivering” 17 3i Report and accounts 2004 Operating and financial review Total return 3i achieved a total return of £531 million for the financial year, which equates to 18.1% on opening shareholders’ funds. While this compares with returns on the FTSE 100 and FTSE All-Share total return indices of 25.7% and 31.0% respectively, it is normal that 3i’s returns lag an upturn in quoted markets. This is because our valuations of unquoted investments are generally based on historical earnings and our venture capital investments are not marked up in line with a rise in quoted markets. The components of the total return are shown in table 1; and table 2 contains an analysis of total return by business and geography. Comparison of 3i’s compound annual return with the Chart A: FTSE All-Share total return index for the years to 31 March 2004 1 year 3 years 5 years 7 years 10 years 18.1% 31.0% (10.1)% (3.8)% 0.3% (2.7)% 4.0% 3.5% 8.1% 6.9% 3i return FTSE All-Share Table 1: Total return Total operating income before interest payable Interest payable Management expenses Realised profits on disposal of investments Unrealised profits/(losses) on revaluation of investments Carried interest and investment performance plans Other – Revenue return – Capital return Total return 2004 £m 267 (93) (163) 228 336 (40) (4) 134 397 531 Table 2: Total return by business and geography year to 31 March 2004 (£m) Buy-outs Growth capital Venture capital Total UK 123 238 25 386 Continental Europe US Asia Pacific 185 (16) (28) 141 (4) 1 (24) (27) 31 8 (8) 31 Returns are stated after currency translation losses. 2003 £m 308 (110) (163) 190 (1,159) (12) 11 146 (1,081) (935) Total 335 231 (35) 531 18 The main drivers of the total return were a good level of profitable realisations and strong growth in the value of the portfolio. The latter was due to two main factors: the use of higher earnings multiples, as a result of rising stock markets; and a good level of “first-time uplifts” on a number of recent investments in the mid-market buy-out portfolio as they moved from being valued at cost to being valued on the earnings basis. The total return also reflects an unrealised loss on foreign currency translation of £64 million, arising on 3i’s euro- and US dollar-denominated portfolios net of currency borrowings, as sterling appreciated over the year relative to the euro (up 3%) and the US dollar (up 16%). Improved results in each of 3i’s business areas underpinned the overall return. The mid-market buy-out return of 22.6% (on opening shareholders’ funds attributed to this activity) was largely driven by growth in the value of the portfolio, with strong first-time uplifts on a number of recent investments and a minimal level of provisions. Returns in the smaller buy-out and growth capital businesses, of 22.1% and 26.8% respectively, were driven by strong realisations, while the portfolios increased in value mainly as a result of using higher earnings multiples. Both businesses continued to generate a good income yield. The venture capital business produced a total return of (6.0)%, though its return was broadly break-even before the impact of foreign currency translation losses. There were a small number of funding rounds at higher company valuations, allowing us to increase the carrying value of these investments, but we have not sought to reflect in the valuations of unquoted venture capital investments the significant rise in quoted technology indices over the year. Geographically, 3i’s returns in the UK, continental Europe and Asia Pacific were strong. The return in the UK of 22.2% was driven mainly by a high level of profitable realisations and healthy value growth in the portfolio. Whilst the buy-out and growth capital businesses were the main contributors to the UK’s return, the venture capital business also achieved a positive return. In continental Europe, 3i’s return of 14.5% (17.5% before the impact of unrealised foreign currency translation losses of £29 million) was largely due to the high level of first-time uplifts. In Asia Pacific, the sale of our investment in Vantec Corporation, the logistics business acquired from Nissan in 2001, was the main contributor to our 34.3% return. The US business made a loss of (7.4)% before taking account of the £17 million translation difference arising on the dollar-denominated portfolio (net of dollar borrowings). 3i Report and accounts 2004 Operating and financial review Table 6: Realisation proceeds by business and geography (£m) UK Continental Europe US Asia Pacific Total 2004 2003 2004 2003 2004 2003 2004 2003 2004 2003 Buy-outs 229 467 178 142 Growth capital Venture capital Total 303 199 34 66 76 61 33 30 608 727 245 238 – – 10 10 – – 2 2 57 4 464 613 2 1 5 339 270 – 120 93 60 9 923 976 Realisations Despite a relatively poor environment for realisations, 3i generated good realisation proceeds of £923 million (2003: £976 million) and strong realised profits of £228 million (2003: £190 million). Realised profits are stated net of write-offs, which amounted to £50 million (2003: £79 million). The aggregate uplift over 31 March 2003 valuations on equity realisations was 58% and, including sales and redemptions of loans and fixed income shares, 18% of the opening portfolio was realised. Table 6 shows an analysis of realisation proceeds by business and geography. The growth capital and smaller buy-out businesses were particularly active in generating realisations, mainly through a focus on selling investments that have been in the portfolio for several years. Sales of quoted equity benefited from the general rise in equity markets, with £40 million of profits generated over 31 March 2003 valuations (an uplift of 51%). Four investee companies achieved IPOs during the year, with the most high profile probably being that achieved by Cambridge Silicon Radio (“CSR”) in February (see panel on page 11). The successful IPO of CSR, a leading manufacturer of single- chip Bluetooth wireless devices, at a market capitalisation of £240 million was seen as a key test of the stock market’s appetite in Europe. Investment 3i invested a total of £784 million (£979 million including investment on behalf of co-investment funds), which is a 9.5% increase over the prior year. During the first half of the year, 3i invested £211 million, with the balance of £573 million being invested in the second half. The substantial increase in the second half was largely due to 3i’s ability to complete new investment opportunities that had built up in the new investment pipeline up to 30 September – in contrast to the low pipeline coming in to the financial year, reflecting the deferral of many strategic decisions by businesses and investors in an environment of business uncertainty during the extended build-up to the hostilities in Iraq. An analysis of the amount invested by business and geography is given in table 5. Buy-out transactions represented 42% of total investment, growth capital 37% and venture capital 21%. Of the amount invested in venture capital, 55% was further investment into existing portfolio companies. Continental European investment represented 51% of investment, up from 42% in the prior year, and is a reflection of our ability, through the network, to source and complete larger deals across Europe. The UK represented 39% (down from 44%), with the US and Asia Pacific investing 8% and 2% respectively. Table 3: Summary of changes to investment portfolio Opening portfolio Investment Realisation proceeds Realised profits on disposal of investments Unrealised profits/(losses) on revaluation of investments Other Closing portfolio Table 4: First and subsequent investment New first investments Further funding or drawdown on existing arrangements Total 2004 £m 2003 £m 3,939 5,109 784 (923) 228 336 (38) 716 (976) 190 (1,159) 59 4,326 3,939 2004 £m 535 249 784 2003 £m 432 284 716 Table 5: Investment by business and geography (£m) UK Continental Europe US Asia Pacific Total 2004 2003 2004 2003 2004 2003 2004 2003 2004 2003 Buy-outs 86 163 240 149 Growth capital Venture capital Total 166 112 111 75 57 43 50 80 309 318 401 304 – 3 58 61 – 32 42 74 – 9 4 – 326 312 15 289 234 5 169 170 13 20 784 716 19 3i Report and accounts 2004 Operating and financial review Unrealised value movement The unrealised value movement on the revaluation of investments was a positive £336 million, representing a significant improvement on the £1,159 million value reduction in the prior year. An analysis of the different components of the value movement is given in table 7. The weighted average earnings multiple applied to investments valued on an earnings basis rose from 8.1 to 12.0 over the period. The impact of increased earnings multiples on investments valued on an earnings basis at the start and end of the year generated value growth of £287 million (2003: £244 million value reduction). There was a fall of 4% over the year in the aggregate attributable earnings of investments valued on an earnings basis at the start and end of the year, giving rise to a value reduction of £37 million (2003: £48 million value increase). Two larger investments whose profits fell significantly during 2003 were the main components of this value reduction, but the fall in earnings is also due to the use of historical audited accounts (therefore not reflecting the more recent upturn in the economic environment) in valuing most of this component of the portfolio. Table 7: Unrealised profits/(losses) on revaluation of investments Earnings multiples Earnings First-time valuation uplift from cost Provisions Down rounds and restructuring Other movements on unquoted investments Quoted portfolio Total “strong first-time uplifts” 2004 £m 287 (37) 238 (143) (70) 1 60 336 2003 £m (244) 48 31 (379) (361) (45) (209) (1,159) It should be noted (by reference to table 7) that the value movement relating to first-time uplifts includes £71 million which is due to earnings growth and that the “other movements on unquoted investments” item includes £7 million in respect of companies that recovered from making losses to being profitable. The net value movement due to earnings growth is therefore a £41 million increase. First-time uplifts totalled £238 million (2003: £31 million). This is a reflection of the quality of investments made in recent years and the results beginning to come through as value growth strategies in investee businesses are implemented. Provisions for investments in businesses which may fail totalled £143 million (2003: £379 million) and valuation reductions relating to the application of our downround methodology and restructuring provisions fell significantly to £70 million (2003: £361 million). The latter figure is stated net of valuation increases of £65 million, arising as a result of investee companies raising funds from new investors at increased values. The quoted investments held at the end of the year increased in value by an aggregate £60 million over the year. Carried interest and investment performance plans Market practice in the private equity and venture capital industry is to offer investment staff the opportunity to participate in returns from successful investments. Amounts payable on the successful realisation of investments in the year to 31 March 2004 totalled £8 million. A further £32 million has been accrued in respect of amounts potentially payable if assets are ultimately realised at the values they were held at in the accounts at 31 March 2004. Income and costs The main elements of income and costs are shown in table 1. Total operating income before interest payable was £267 million (2003: £308 million). The decrease when compared with the prior year reflects a lower level of special interest and dividend receipts during the year and the realisation of a small number of higher yielding investments. Fee income is marginally lower than in the prior year, although there was a substantial increase in the second half of the year, with arrangement and negotiation fees contributing strongly. 20 3i Report and accounts 2004 Operating and financial review Chart B: Portfolio value by investment type (£m) as at 31 March 2004 Buy-outs Growth capital Venture capital Quoted Tota l 533 254 Chart C: Portfolio value by geography (£m) as at 31 March 2004 UK Continental Europe US Asia Pacific Tota l 234 75 1,511 Chart D: Portfolio value by FTSE classification (£m) as at 31 March 2004 155 Resources Industrials Consumer goods Services and utilities Financials 238 2,201 1,338 The portfolio At 31 March 2004, the portfolio comprised 1,878 investments, a reduction from 2,162 a year earlier and a reflection of the strategy of seeking exits from investments where we believe the value growth potential is not sufficiently attractive. We would expect this number to continue to decrease over the medium term. £4,326m Charts B, C and D show the portfolio analysed by 2,506 £4,326m investment type, geography and sector respectively and demonstrate the balance we seek in the business. At the year end, 53% of the portfolio is represented by buy-outs, 35% by growth capital investments and 12% by venture capital investments. Geographically, 58% is in the UK, 35% in continental Europe, 5% in the US and 2% in Asia Pacific. 3i’s portfolio, in contrast to many others in the private equity and venture capital industry, has relatively low exposure to individual company risk, with the top 10 investments representing 13% by value at the year end and the top 50 investments 35%. 1,018 1,026 Fund management activities Fund management activities comprise the management of both private equity funds and quoted funds. 1,275 The private equity funds are primarily co-invested Information technology 614 Tota l £4,326m Chart E: as at 31 March 2004 Third party funds under management (£m) 2004 2003 1,875 600 1,587 452 Unquoted co-investment funds Quoted funds Net interest payable decreased, reflecting the reduction in net borrowings and also the lower average rate of interest on long-term borrowings following the B550 million convertible bond issue in August 2003. Management expenses of £163 million (2003: £163 million) include fundraising costs of £6 million incurred in connection with the Eurofund IV fundraising and a higher level of staff bonuses than in the prior year. alongside 3i’s own capital when financing buy-outs, enabling an investment to be made without 3i holding a majority interest. During the year, 3i earned fee income of £31 million (2003: £34 million) from the management of private equity funds. In addition, 3i receives carried interest in respect of third-party funds under management. During the year, 3i received £1.7 million in respect of realised investments and accrued an additional £1.7 million in respect of unrealised investments. At 31 March 2004, the invested portfolio managed on behalf of private equity fund investors was valued at £1,324 million (2003: £1,158 million), excluding undrawn commitments. During the year, we announced that the final closing of Eurofund IV, the latest fund targeted at pan European mid-market buy-outs, would take place by 30 June 2004. It is expected that third party commitments will amount to at least B800 million over the life of the fund, enabling 3i (together with the fund) to invest up to B3 billion in buy-outs over the next three years. 3i Asset Management manages 3i’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, 3i Bioscience Investment Trust plc and 3i European Technology Trust plc). At 31 March 2004, total third party quoted funds under management were £600 million. Fees earned from quoted fund management amounted to £4 million (2003: £4 million). 21 3i Report and accounts 2004 Operating and financial review Accounting policies and valuation New valuation methodology In August 2003, the British Venture Capital Association (“BVCA”) issued new valuation guidelines for private equity and venture capital investments, which resulted in changes being made to 3i’s portfolio valuation methodology (summarised on page 69). The new methodology has been approved by the Board and was applied in carrying out the 31 March 2004 portfolio valuation. The net impact of these changes on the overall valuation of the portfolio was immaterial. Changes to accounting policies There have been no changes to accounting policies during the year. Introduction of international financial reporting standards In June 2002, the European Union adopted a regulation that requires, from 1 January 2005, European listed companies to prepare their consolidated financial statements in accordance with international accounting standards. 3i’s 31 March 2006 financial statements will therefore be prepared in accordance with International Financial Reporting Standards (“IFRS”). These comprise not only IFRS but also International Accounting Standards (“IAS”). Details of 3i’s implementation programme are discussed on page 53. 22 Chart F: Balance sheet summary (£m) as at 31 March 2004 Portfolio and other net assets Net borrowings Shareholders’ funds 2004 2003 2004 2003 2004 2003 936 1,013 4,331 3,949 3,395 2,936 Financial review Cash flows The key cash flows during the year were the aggregate cash outflow of £756 million in respect of investment and cash inflows totalling £913 million in respect of proceeds received on realising investments. Net cash inflow for the year was £45 million (2003: £170 million), reducing net borrowings at the year end to £936 million (2003: £1,013 million). With the significant growth in the value of the portfolio during the year, gearing fell to 28% at 31 March 2004 compared with 35% a year earlier. Capital structure 3i’s capital structure comprises a combination of shareholders’ funds, long-term borrowing, short-term borrowing and liquid treasury assets and cash. The major changes in capital structure during the year, other than the growth in shareholders’ funds, were the B550 million convertible bond issue completed in August 2003 and the replacement of the £625 million multi-currency facility in January with a new B595 million revolving credit facility. The convertible bonds are due in 2008 and have a conversion price of 842p (a 45% premium to the “reference price” of 580p) and an annual coupon of 1.375%. Long-term borrowing at 31 March 2004 is £1,595 million and is repayable as follows: £5 million between one and two years, £944 million between two and five years and £646 million after five years. In addition, at the year end, 3i had committed and undrawn borrowing facilities amounting to £583 million and cash and other liquid assets totalling £819 million. We are confident we have in place adequate funding for foreseeable investment needs. 3i Group plc has credit ratings with Moodys and Standard & Poor’s of Aa3/stable and A+/stable respectively. 3i Report and accounts 2004 Operating and financial review Regulation and risk management Introduction 3i Group plc and relevant subsidiaries continue to be authorised and regulated by the Financial Services Authority. 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 (58%) 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 in 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 ended 31 March 2004. All assets and liabilities are held for non-trading purposes and, as a result, 3i does not have a trading book. 3i does not trade in derivatives and does not enter into transactions of either a speculative nature or unrelated to 3i’s investment activities. Derivatives are used to manage the risks arising from 3i’s investment activities. The main funding risks faced by 3i 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 £0.8 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 3i’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 3i, or to 3i’s approach to such risks. “growth in shareholders’ funds” 23 3i Report and accounts 2004 Operating and financial review 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 private equity and 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 are 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 3i’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 closing mid-market price at the balance sheet date. 48% of the unquoted portfolio is valued using stock market earnings multiples 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. 24 “financial capacity and flexibility” 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. This is supported by a framework of core values, 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 3i’s 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. Conclusion The year under review saw a strong return on opening shareholders’ funds, driven mainly by healthy realisation profits and good value growth from the portfolio. In addition, 3i took advantage of improving conditions to invest just under £1 billion (including co-investment funds) in good businesses with attractive growth prospects. 3i’s balance sheet at the year end is strong, with gearing at a relatively low 28%, providing the financial capacity and flexibility to vary investment and realisation activity in line with market conditions. 3i Report and accounts 2004 Corporate responsibility report Our approach Philosophy As an international business operating in 14 countries with around 750 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 every aspect 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. The Corporate Responsibility Committee (the “Committee”), comprising Tony Brierley, Company Secretary and Chairman of the Committee, Patrick Dunne, Group Communications Director, Charles Richardson, Manager of a UK portfolio management team, and Hans Middelthon, an investment executive in 3i’s Oil and Gas team, considers and reviews environmental, ethical and social issues relevant to 3i’s business and associated risks. It also monitors and reviews the operation of 3i’s corporate responsibility policies and procedures. Tony Brierley has specific responsibility for 3i’s environmental policies, leading the development of new initiatives and targets and reporting to the Board. He is also a member of the Leadership Team of Business in the Environment. The 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 36 of the Directors’ report. The Committee reports regularly to the Board. All employees have a responsibility to be aware of, and abide by, 3i’s environmental, ethical and social policies which are available to all staff through 3i’s intranet. Employees are encouraged to make suggestions to improve processes and procedures. 25 3i Report and accounts 2004 Corporate responsibility report Environment As a corporate The environment As a financial services business employing around 750 employees worldwide, 3i’s direct environmental impact is relatively low. 3i measures its own energy and resource usage where practicable and sets targets to achieve improvement. The principal benchmarks against which 3i measures its performance are for: – CO2 emissions; and – recycling of paper and other materials. 3i also assesses the environmental standards of suppliers, through its procurement policy. In Kind Direct During the year, 3i supported In Kind Direct, a UK charity which distributes manufacturers’ surplus goods to other UK voluntary organisations. These include essentials such as toiletries and tools, office supplies and equipment, and household products and appliances, which might otherwise be disposed of in landfill sites. 3i was particularly pleased to support a charity which utilises surplus products in an environmentally efficient manner. 26 As an employer 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. 3i has comprehensive behaviour policies to help ensure that employees treat their colleagues and others with courtesy and respect. 3i also has a whistle blowing policy setting out procedures for staff to raise in confidence matters of concern, for an appropriate and independent investigation of such matters and, where necessary, for follow-up action. 3i’s employment policies are described in more detail in the Directors’ report on pages 35 and 36. 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 Michael Queen, the Finance Director. 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 subcontractors and endeavours to ensure that the health, safety and welfare of its employees, visitors, customers, subcontractors’ staff and the general public are not compromised. 3i’s objective is not to have any reportable accidents or incidents. During the year to 31 March 2004, 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. 3i’s health and safety procedures are independently reviewed annually. As a member of Tommy’s Pregnancy Accreditation Programme, 3i complies with criteria for pregnancy management, geared towards creating a positive environment for parents-to-be in the workplace. 3i Report and accounts 2004 Corporate responsibility report As an investor Investment policy 3i has a portfolio of investments in over 1,800 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 owners and 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. 3i recognises that the most significant risks to 3i’s short- term and long-term value arising from environmental, ethical and social matters arise from its investment business. If a company in which 3i has an investment acts irresponsibly on corporate responsibility issues, this might affect the monetary value of that investment and, as a shareholder in that company, raise reputational issues for 3i. Although 3i does not have operational control over the companies in which it invests, it does have the opportunity to influence the behaviour of these businesses and encourages the development and adoption of good corporate governance. This is achieved through the training of investment staff and non-executive directors who are appointed to the boards of investee companies and the raising of awareness within investee companies of social, environmental and ethical issues. 3i has clear procedures to reduce the risks of 3i investing in businesses which operate in an environmentally, ethically or socially unacceptable manner. When reviewing businesses for potential investment, investment executives are required to consider whether any corporate responsibility risks arise and, if any risks are identified, to follow 3i’s corporate responsibility investment procedures. Depending on the nature of the risk identified and its seriousness, a condition precedent or post completion undertaking requiring that the situation be remedied may be required from the investee company or its management. Alternatively, it may be decided not to proceed with the investment. 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. Training and development Encouraging the continuous development of staff is important to 3i and its business. During the year, a revised training and development programme was launched for 3i staff. This programme includes courses on communications and presentations, working within a management matrix environment, coaching and mentoring, and networking and management skills. In addition, investment staff are required to complete an investment training programme on joining 3i and all staff are encouraged to attend external courses on subjects relevant to their roles within 3i. During the year, in addition to these external courses, approximately 300 employees attended training and development courses. It is a legal and regulatory requirement that all executives involved in making or managing investment transactions receive anti-money laundering training and refresher training on a rolling two year basis. All relevant executives have received anti-money laundering training and, during the year, 3i delivered a refresher training presentation to all relevant executives. A programme of role-play-based workshops 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. During the year, nine workshops, covering 336 employees, were held in the UK. Workshops will be held in continental Europe, Asia Pacific and the US in the coming year. Following feedback from these workshops, a fact sheet, explaining 3i’s approach to corporate responsibility and providing further information for staff, is being circulated. Training for Directors on corporate responsibility issues is achieved through a system of regular Board reporting and by Board presentations on relevant corporate responsibility issues. 27 3i Report and accounts 2004 Corporate responsibility report Charity and community 3i’s charitable policy 3i’s charitable policy aims to support: – causes based in the communities in which 3i has offices; – charitable activities of staff. 3i matches donations made by UK staff under the Give as You Earn scheme (“GAYE”) and the proceeds of staff fundraising efforts. In the year to 31 March 2004, approximately 32% of 3i’s charitable donations were matching GAYE donations; – charities relevant to its corporate activity, for example, 3i supports businessdynamics, a charity which aims to help young people understand business. Charitable donations made in the UK in the year to 31 March 2004 amounted to £253,419, supporting a variety of different charities with donations ranging up to £35,000. RAM 3i’s support of the Royal Academy of Music, sponsoring student scholarships and the Symphonia Orchestra, dates back to 1991. Unlike other international music schools, the academy relies on voluntary funding for all student scholarships. We were delighted to give the students the opportunity to perform at a gala concert in Paris celebrating 3i’s 20 years in France. 28 Young V ic The Young Vic theatre in London runs a scheme to enable children, otherwise denied the opportunity, to enjoy and be inspired by theatre. 3i has become an active participant in this scheme by donating £10,000. Making a difference Staff across 3i engage in a range of community support projects. The two examples above are of team away days in Frankfurt and London. One involved a council house makeover in Frankfurt and the other, decorating part of the Lorrimore Drop-In Centre in London, a day centre which provides support to people with mental health needs. 3i Report and accounts 2004 Corporate responsibility report How are we doing? Performance and measurement To assist it in benchmarking 3i’s corporate responsibility performance, the Committee has had informal discussions with other companies and specialists in this area. The Committee has overseen the formulation and implementation of corporate responsibility investment procedures, implemented appropriate risk management procedures and set strategic targets and objectives for corporate responsibility. 3i’s performance is measured 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 (“BitC”), 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 top in its industry group on a global basis, an improvement on last year. The DJSI researchers commented that “3i is clearly positioned among the best in the financial services industry” (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 second annual BitC Corporate Responsibility Index. 3i was included in the BitC’s “Top 100 Companies that Count”. 3i’s performance score increased from 46.33% in the 2002 Index to 85.45% in the 2003 Index. 3i aims to continue to be included within this Index and to maintain its performance. 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. All 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 Committee is responsible for 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 and functions. 3i’s internal audit function carries out periodic independent reviews of risks and related controls in this area, including compliance with 3i’s corporate responsibility investment procedures. The Committee may also supplement internal review processes with external reviews where necessary. The Committee is not aware of any material breaches of 3i’s policies and procedures for managing risks from corporate responsibility issues. The disclosures in this Corporate responsibility report are the subject of a process requiring every statement made in this report to be verified. “3i is clearly positioned among the best in the financial services industry .” “It is a real achievement to be one of the Companies that Count.” 29 3i Report and accounts 2004 Board of Directors 09/02/08 01/03 01 Baroness Hogg Non-executive Chairman since 2002 and a non-executive Director since 1997. Chairman of the Nominations Committee and the Valuations Committee. Chairman of Frontier Economics Limited. Deputy Chairman of GKN plc and a director of Carnival Corporation and Carnival plc. A Governor of the London Business School. From 1995 to 2002 Chairman of Foreign & Colonial Smaller Companies PLC. Formerly Head of the Prime Minister’s Policy Unit. Aged 57. 30 04/07 02 Oliver Stocken Non-executive Deputy Chairman and Senior Independent Director since 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 62. 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 in 1974. 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 50. 04 Dr John Forrest CBE FREng Non-executive Director since 1997. A member of the Audit and Compliance Committee, the Remuneration Committee, the Nominations Committee and the Valuations Committee. Chairman of CDS Limited and of the Interregnum plc International Advisory Board. Formerly Chief Executive of NTL, Technical Director of Marconi Defence Systems Limited and Professor of Electronic Engineering at University College, London. Aged 61. 05 Martin Gagen Executive Director since 1997, responsible for US and Asia Pacific investment. Joined 3i in 1983. Appointed to the Executive Committee in 1995 with joint responsibility for UK investment. Formerly Deputy Chairman of the British Venture Capital Association Council. Aged 48. 06 Christine Morin-Postel Non-executive Director since 2002. A member of the Audit and Compliance Committee, the Remuneration Committee and the Nominations Committee. A director of Pilkington plc, Alcan, Inc and Arlington Capital Investors (Europe). Formerly Chief Executive of Société Générale de Belgique and executive Vice-President and member of the Executive Committee of Suez. Aged 57. 07 Rod Perry CEng MIEE Executive Director since 1999, responsible for technology investment activities worldwide and human resources. Joined 3i in 1985 as an Industrial Adviser and became Head of Information Systems in 1989. Appointed to the Executive Committee in 1996 with responsibility for group services and later Asia Pacific investment. Aged 59. 3i Report and accounts 2004 Board of Directors 06/14 13/11 10/12/05 08 Michael Queen FCA Executive Director since 1997. Responsible for finance and group services and a member of the Valuations Committee. Joined 3i in 1987. From 1994 to 1996 seconded to HM Treasury. Appointed Group Financial Controller in 1996 and became Finance Director and a member of Executive Committee in 1997. Past Chairman of the British Venture Capital Association. Aged 42. 09 Danny Rosenkranz Non-executive Director since 2000. Chairman of the Remuneration Committee and a member of the Audit and Compliance Committee and the Nominations Committee. Chairman of Foseco (Jersey) Limited and Pecaso Limited. Formerly Chief Executive of The BOC Group plc. Aged 58. 10 Fred Steingraber Non-executive Director since 2002 and a member of the Nominations Committee. A director of Maytag Corporation and John Hancock Financial Trends Fund. A member of the Board of Governors of The Chicago Stock Exchange and 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 65. 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 Responsibility Committee. Joined 3i in 1983. Appointed to the Executive Committee in 1996. Aged 54. 12 Chris Rowlands A member of the Executive Committee since 2002, responsible for European investment and growth capital investment worldwide. Joined 3i in 2002 having previously been employed by 3i from 1984 to 1996. Formerly a Partner of Andersen. Aged 47. 13 Jonathan Russell A member of the Executive Committee since 1999, responsible for buy-out investment worldwide. Joined 3i in 1986. 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 in 1978. Past Chairman of the European Private Equity and Venture Capital Association. Aged 49. 31 3i Report and accounts 2004 Directors’ report Principal activity 3i Group plc is a world leader in private equity and venture capital. 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 2003. Since that date, the Company has directed its affairs to enable it to continue to be so approved. Regulation The Company is authorised and regulated by the Financial Services Authority as a deposit taker. 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 2004 appear on pages 47 to 68. Consolidated total return for the period was £531 million (2003: negative sum of £935 million). An interim dividend of 5.1p per share was paid on 7 January 2004. The Directors recommend a final dividend of 8.9p per share be paid in respect of the year to 31 March 2004 to shareholders on the register at the close of business on 18 June 2004. 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 9,859,472 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 and the Operating and financial review on pages 8 to 24 report on the Group’s development during the year to 31 March 2004, its position at that date and the Group’s likely future development. Share capital In the year to 31 March 2004, the issued share capital of the Company increased by 2,560,906 shares to 613,479,159 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 plans and The 3i Group Sharesave Scheme and the issue of shares to the nine vendors of SFK Finance Oy. Major interests in shares As at 4 May 2004, 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 % 9.02 5.99 3.41 Number of shares 55,332,661 36,755,893 20,914,010 Directors’ interests Details of the Directors’ interests in the Company’s shares are shown in note 40 to the accounts on page 65. Save as shown in note 40 on page 65, 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 40 on page 65, there have been no changes in the above interests between 31 March 2004 and 4 May 2004. 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 44. 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. 32 3i Report and accounts 2004 Directors’ report Corporate governance Throughout the year to 31 March 2004, the Company complied with the provisions of section 1 of the Combined Code on corporate governance issued by the Hampel Committee on Corporate Governance in June 1998 (“the Combined Code”). The Company has already taken steps to enable it to comply, with effect from 1 April 2004, with the new Combined Code (“the new Combined Code”) published by the Financial Reporting Council in July 2003. 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. The Board has adopted core values and Group standards which set out the behaviours expected of staff in their dealings with shareholders, customers, colleagues, suppliers and other stakeholders of the Company. 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. The Board has approved a formal schedule of matters reserved to it and its duly authorised Committees for decision. These include: – approval of the Group’s overall strategy, annual operating budget and strategic plan; – approval of the Company’s interim and final accounts and changes in the Group’s accounting policies or practices; – changes relating to the capital structure of the Company or its status as a regulated entity; – major capital projects; – major changes in the nature of business operations; – investments and divestments in the ordinary course of business above certain limits set by the Board from time to time; – adequacy of internal control systems; – appointments to the Board and Executive Committee; – principal terms and conditions of employment of members of Executive Committee; – changes in employee share schemes and carried interest schemes. Matters delegated to management include implementation of the Board approved strategy, day to day operation of the business, the appointment of all executives below Executive Committee and the formulation and execution of risk management practices and policies. The Board has put in place an organisational structure. This is further described below under the heading “internal control”. A Group succession and contingency plan is prepared by management and reviewed annually by the Board. The purpose of this plan is to identify suitable candidates for succession to key senior management positions, agree their training and development needs, and ensure the necessary human resources are in place for the Company to meet its objectives. During the year, there were six regular meetings of the Board of Directors. All the Directors attended those meetings. The roles of the Chairman and the Chief Executive The division of responsibilities between the Chairman of the Board, Baroness Hogg, and the Chief Executive, Mr B P Larcombe, is clearly defined and has been approved by the Board. The 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, ensuring its effectiveness and setting its agenda. The Chairman 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 Chairman ensures that regular reports from the Company’s brokers are circulated to the non-executive Directors to enable non-executive Directors to remain aware of shareholders’ views. Through involvement in the interim and full year reporting process, the Company’s results presentations and the Company’s Annual General Meeting, the Chairman ensures effective communication with the Company’s shareholders. The Chief Executive 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 The Board has appointed Mr O H J Stocken as Senior Independent Director, to whom, in accordance with the Combined Code, concerns can be conveyed. Directors The Board currently comprises the Chairman, five independent non-executive Directors and four executive Directors. The names of the Directors together with their biographical details are set out on pages 30 and 31. All the Directors served throughout the period under review. In addition to fulfilling the legal responsibilities of a director, a non-executive Director is expected to bring an independent judgment to bear on issues of strategy, performance, resources and standards of conduct and to help the Board provide the Company with effective leadership. In addition, a non-executive Director is expected to ensure high standards of financial probity on the part of the Company and monitor the effectiveness of the executive Directors. The Board’s discussions, and its approval of the Group’s rolling strategic plan and annual budget, provide the non-executive Directors with the opportunity to challenge the Company’s management and assist in the development of strategy. The non-executive Directors receive monthly management accounts and regular management reports and information which enable them to scrutinise the Company’s and management’s performance against agreed objectives. This is further described below under the heading “internal control”. 33 3i Report and accounts 2004 Directors’ report Directors’ independence All the non-executive Directors, including the Chairman, are considered by the Board to be independent for the purposes of the new Combined Code. The Board assesses and reviews the independence of each of the non-executive Directors at least annually having regard to the potential relevance and materiality of a Director’s interests and relationships rather than applying rigid criteria in a mechanistic manner. The Board has considered Mr O H J Stocken and Mme C J M Morin-Postel’s common directorship of Pilkington plc and concluded that it does not affect their independence. The Board’s Committees The Board is assisted by various specialised committees of the Board which report regularly to the Board. The membership of these Committees is regularly reviewed by the Board. When considering committee membership and chairmanship, the Board aims to ensure that undue reliance is not placed on particular Directors. These Committees all have clearly defined and written terms of reference. The terms of reference of the Audit and Compliance Committee, the Remuneration Committee and the Nominations Committee provide that no one other than the Committee Chairman and members may attend a meeting unless invited to attend by the Committee. Details of the work of these Committees are set out below. Audit and Compliance Committee During the year, the Audit and Compliance Committee comprised 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. The Board is satisfied that the Committee Chairman, Mr Stocken, has recent and relevant financial experience. The terms of reference of the Audit and Compliance Committee are available on the Company’s website. The Committee reviews the effectiveness of the internal control environment of the Group and the Group’s compliance with its regulatory requirements. Further details of this work are described below under the heading “internal control”. The Committee receives regular reports from the internal and external auditors, the regulatory compliance function and Risk Committee, details of which are described below under the heading “internal control”, 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, reappointment and removal of the Company’s auditors and approves the terms of their engagement and their fees. The Committee meets with the heads of the internal audit and compliance functions, and the external auditors, at least once a year in the absence of management. The Committee also reviews the Company’s “whistle blowing policy” to ensure that arrangements are in place for staff to raise, in confidence, matters of concern, for an appropriate and independent investigation of such matters and, where necessary, for follow-up action. During the year, there were four meetings of the Audit and Compliance Committee. All members of the Committee attended those meetings, other than Mme C J M Morin-Postel who attended three meetings. Remuneration Committee During the year, the Remuneration Committee comprised Dr J R Forrest (Chairman), Baroness Hogg (who ceased to be a member on 31 March 2004), Mr O H J Stocken and Mr F D Rosenkranz. On 1 April 2004, Mr F D Rosenkranz became the Chairman, and Mme C J M Morin-Postel was appointed a member, of the Committee. All the members of the Committee are independent non-executive Directors. The terms of reference of the Remuneration Committee are available on the Company’s website. Details of the work of the Remuneration Committee are set out in the Remuneration report. During the year, there were seven meetings of the Remuneration Committee. All members of the Committee attended those meetings, other than Dr J R Forrest who attended six meetings. Nominations Committee During the year, the Nominations Committee comprised 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. Mr R W Perry has been co-opted to assist the Committee in the appointment of a new Chief Executive. The terms of reference of the Nominations Committee are available on the Company’s website. These provide that the Chairman shall not chair the Committee when dealing with the appointment of the Chairman’s successor. The Nominations Committee and the Board regularly review the composition of the Board to ensure the balance of its membership, as between executive and non-executive Directors, and its profile, in terms of size and length of service and experience of individual Directors, remain appropriate. A formal, rigorous and transparent process for the appointment of Directors has been established with the objective of identifying the skills and experience profile required of new Directors and identifying suitable candidates. The procedure includes the appraisal and selection of potential candidates, including (in the case of non-executive Directors) whether they have sufficient time to fulfil their roles. Where appropriate, specialist recruitment consultants assist the Committee to identify suitable candidates for appointment. The Committee’s recommendations for appointment are put to the full Board for approval. Following the appointment of new non-executive Directors, the Company’s major shareholders will be offered the opportunity to meet them. During the year, there were three meetings of the Nominations Committee. All members of the Committee attended those meetings, save that Mr B P Larcombe did not attend when succession to the post of Chief Executive was discussed. Mr R W Perry attended one meeting of the Committee. Valuations Committee During the year, the Valuations Committee comprised Baroness Hogg (Chairman), Dr J R Forrest, Mr B P Larcombe, Mr M J Queen and Mr O H J Stocken. The Valuations 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 and changes to valuations policy. During the year, there were three meetings of the Valuations Committee. All members of the Committee attended those meetings. 34 3i Report and accounts 2004 Directors’ report The Company Secretary The Company Secretary is responsible for advising the Board, through the Chairman, on governance matters. All Directors have access to the advice and services of the Company Secretary. The Company’s Articles of Association and the schedule of matters reserved to the Board for decision provide that the appointment and removal of the Company Secretary is a matter for the full Board. Information Regular reports and papers are circulated to the Directors in a timely manner in preparation for Board and Committee meetings. These papers are supplemented by information specifically requested by the Directors from time to time. Directors’ training and development The Company has developed a training policy which provides a framework within which training for Directors is planned with the objective of ensuring Directors understand the duties and responsibilities of being a director of a listed company. All Directors are required to update their skills and maintain their familiarity with the Company and its business continually. Presentations on different aspects of the Company’s business are made regularly to the Board. 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 Company has procedures for Directors to take independent legal or other professional advice about the performance of their duties. Performance evaluation The Board has established a formal process, led by the Chairman, for the annual evaluation of the performance of the Board, its principal Committees and individual Directors with particular attention to those who are due for reappointment. A list of questions is drawn up by the Chairman with the assistance of an independent consultant. These questions provide a framework for the evaluation process. The Chairman conducts the annual performance evaluation of each of the Directors, taking into account the views of the other Directors. The Senior Independent Director conducts the annual performance evaluation of the Chairman, taking into account the views of all Directors. The results of the overall evaluation process are discussed with the independent consultant, communicated to the Board and followed by appropriate action. Re-election Subject to the Company’s Articles of Association, the Companies Acts and satisfactory performance evaluation, non-executive Directors are appointed for an initial period of three years. Before the third or sixth anniversary of the non-executive Director’s first appointment, the Director discusses with the Board whether it is appropriate for a further three year term to be served. The reappointment of Directors who have served for more than nine years is subject to annual review. The Company’s Articles of Association provide for: a) Directors to retire at the first Annual General Meeting (“AGM”) after their appointment by the Board 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; 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. In accordance with the Articles of Association, at the AGM to be held on 7 July 2004, Baroness Hogg, Dr J R Forrest and Mr B P Larcombe will retire by rotation and, being eligible, Baroness Hogg offers herself for reappointment. Biographical details of the Directors are set out on pages 30 and 31 and the Board’s recommendation for reappointment is set out in the Notice of the AGM. Relations with shareholders The Board recognises the importance of maintaining a purposeful relationship with all its shareholders. 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 maintains a dialogue with shareholders on strategy, corporate governance and Directors’ remuneration as required. In addition to receiving regular reports from the Company’s brokers, the brokers make presentations to the Board and have private discussions with the non-executive Directors. Non-executive Directors are invited to attend the Company’s presentation to analysts and offered the opportunity to meet shareholders. Constructive use of the AGM 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 Notice of the AGM held on 9 July 2003 was dispatched to shareholders not less than 20 working days before the Meeting. At that Meeting, details of proxy votes received were made available and, in accordance with the recommendations of the new Combined Code, at the AGM to be held on 7 July 2004, details of the number of abstentions will also be made available. 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. 35 3i Report and accounts 2004 Directors’ report The Group’s principal means of keeping in touch with the views of its employees continue to be through employee appraisals, informal consultations, team briefings and staff surveys. 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. The Group has clear grievance and disciplinary procedures in place, which include comprehensive procedures on discrimination and the Group’s equal opportunities policy. The Group 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. The Group’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. All UK employees receive a base salary and are eligible for a performance related bonus. The Group operates an Inland Revenue approved Share Incentive Plan to encourage employees’ involvement in the performance of the Group and operates share plans for senior executives and investment staff. Further details of these plans are set out in the Remuneration report. In its international operations, the Group’s remuneration policy is influenced by market conditions and practices in the countries in which it operates. The overall remuneration package of employees in the Group’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). Investment executives both in the UK and in the Group’s non-UK operations may also participate in investment performance plans and carried interest schemes, which allow executives to share directly in the future profits on investments. Charitable and political donations Charitable donations made by the Group in the year to 31 March 2004 amounted to £253,419. Excluding the Company’s matching of Give As You Earn contributions by staff, approximately 29% of those charitable donations were to charities which advance education, approximately 50% went to causes which aim to relieve poverty or benefit the community, or both, and approximately 21% went to medical charities. Further details of charitable donations are set out in the Corporate responsibility report on pages 25 to 29. In line with Group policy, 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, the Enterprise Forum of £1,880 and the Federal Trust of £300) amounted to £5,118. 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 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 judgments 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. Through the regular meetings of the Board and the schedule of matters reserved to the Board or its duly authorised Committees for decision, the Board aims to maintain 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. 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 2004 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; 36 3i Report and accounts 2004 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 coordination 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 2008. The Audit and Compliance Committee reviewed auditor performance during the year and concluded that Ernst & Young LLP’s appointment as the Company’s auditor should be continued. The 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. The Audit and Compliance Committee Chairman is notified of all assignments allocated to Ernst & Young over a set threshold, other than those related to due diligence within the Group’s investment process where the team engaged would be independent of the audit team. 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. Included in this category is due diligence work relating to 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 14 to the accounts on page 57. Ernst & Young LLP 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 12 May 2004 Registered Office 91 Waterloo Road London SE1 8XP 37 3i Report and accounts 2004 Remuneration report Introduction Although 3i is a constituent of the FTSE 100 Index, its business operates within the private equity and 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. After a difficult period, the environment in financial services has improved and recruitment activity has begun to increase. The venture capital market continues to be well funded and competitor organisations continue to be able to offer substantial rewards for their staff and competition for quality, trained executives remains aggressive. In addition to cash bonuses and share awards, investment executives in the venture capital market are often given the opportunity to participate in 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 policies 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, investment performance plans and carried interest schemes. Remuneration Committee Composition and terms of reference The Committee comprises only independent non-executive Directors. Its members throughout the year to 31 March 2004 (“the year”) were Dr J R Forrest (the Committee Chairman), Baroness Hogg (who ceased to be a member on 31 March 2004), Mr F D Rosenkranz and Mr O H J Stocken. None of the members of the Committee sits with any executive Director on the board of any other quoted company. Mme C J M Morin-Postel joined the Committee on 1 April 2004 when Mr F D Rosenkranz became Committee Chairman. The Committee’s terms of reference take into account the provisions of the new Combined Code on corporate governance and are available on the Company’s website. Activities during the year The Committee met seven 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 and all other members of the Chief Executive’s management committee (called “Executive Committee”). In addition, the Committee considered and made recommendations to the Board on the Company’s framework of executive remuneration and its costs. Details of attendance at meetings by members of the Committee are set out in the Directors’ report. Assistance to the Committee Persons who materially assisted the Committee with advice on Directors’ remuneration in the year were: PricewaterhouseCoopers LLP (“PwC”), 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. During the year, PwC provided the Group’s investment business with taxation, payroll and corporate restructuring advice, due diligence services, property 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 2004 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 long-term performance of the Company’s assets. 3i total shareholder return versus FTSE All-Share total return years ended 31 March (cumulative) 3i diluted NAV versus FTSE All-Share total return years ended 31 March (cumulative) 250 200 150 100 50 250 200 150 100 50 0 1999 2000 2001 2002 2003 2004 0 1999 2000 2001 2002 2003 2004 3i FTSE All-Share 3i diluted NAV (with dividends reinvested) FTSE All-Share Audit The tables in this report have been audited by Ernst & Young LLP. 38 3i Report and accounts 2004 Remuneration report 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 (other than those of the Chairman, which are determined by Remuneration Committee) are determined by the Board as a whole, within the limits set by the Company’s Articles of Association, having taken advice from PwC. During the year the basic non-executive Director’s fee was £30,000, the annual fee for Committee membership was £3,500 and the annual fee for Committee Chairmanship was £7,500. These fees were reviewed with effect from 1 April 2004 and the basic non-executive Directors’ fee was increased to £36,000 per annum, the Committee membership fee was reduced to £2,000 per annum and the Committee Chairmanship fee was left unchanged at £7,500 per annum. 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 40. The Company does not currently expect its policy on non-executive Directors’ remuneration for subsequent financial years to change significantly. Executive Directors The Company’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 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 way in which this policy is applied in practice has been reviewed as described below. Executive Directors’ remuneration packages The remuneration packages of the executive Directors consist of salaries, annual bonuses and long-term incentives. In addition, the US based Director participates in a carried interest plan. Salaries Executive Directors’ base salaries are determined by the Committee in accordance with the policy referred to above. During the year and for some years previously Directors’ salaries as well as the salaries of other members of Executive Committee have been benchmarked against salaries for comparable jobs in FTSE 100 companies of similar market capitalisation. The exception to this was Mr M M Gagen (who is based in the US and whose responsibilities include the Group’s US business) whose salary is benchmarked against comparable positions in US venture capital businesses. The Committee has decided that given their active role in the investment business, the remuneration of those UK based Directors (and other members of Executive Committee) with direct responsibility for investment businesses should be benchmarked against comparable positions in private equity and venture capital businesses. The only Director to whom this currently applies is Mr R W Perry. Annual 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 40, have been determined by the Committee based on achievement against a range of corporate and personal objectives set at the beginning of the year. The Committee has reviewed bonus policy and adopted a framework for setting future bonuses. The Committee will determine target bonuses for each Director at the beginning of each year based on appropriate market comparators. These target bonuses will be achievable if both corporate performance targets and personal performance targets are met. In the case of Directors with direct responsibility for investment businesses the target bonus also depends on meeting business unit objectives. Bonuses above target level will be granted for outstanding performance. The Committee has set target bonuses for the year to 31 March 2005 for Directors at 90% of salary. The maximum bonus achievable will be twice the target bonus. The Committee will consider each year the extent to which it would be appropriate for a part of the annual bonus to be payable in shares deferred for two years and only payable if the Director is still employed by the Company. Any bonus above the level of 1.5 times the target bonus will in any event be in the form of deferred shares. The Committee, however, retains the right to make discretionary adjustments in exceptional circumstances. The main measures to be used for assessing corporate performance will be: – total shareholder return and change in net asset value per share both in absolute terms and compared with the FTSE All-Share index; – total non-market driven return compared with budget; and – one to three year internal rate of return compared with performance of the venture capital industry as a whole. The Committee will also take into account a number of more detailed indicators of performance and activity, such as the level of investment, realised profits and costs. Long-term incentives and carried interest plans The Committee determines the levels of long-term incentives and carried interest granted to executive Directors. The Committee regards the purposes of such awards as being to align the interests of executives with those of shareholders and to make continued employment with the Company attractive in relation to opportunities available elsewhere in the venture capital and private equity industry. During the year the long- term incentive arrangements for executive Directors, except the US based Director, consisted of share options and performance share awards under The 3i Group Discretionary Share Plan (the “Discretionary Share Plan”). The US based Director received awards under the US carried interest plan. 39 3i Report and accounts 2004 Remuneration report 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. During the year awards of share options and performance shares were made to Directors, details of which are set out in the tables on pages 41 and 42. During the year the Committee reviewed its practices on share awards for Directors. It decided that it would not make any changes to the way in which performance share awards are made under the Discretionary Share Plan. Details of the performance condition used for share options from 2001 to 2003 are set out in note 4 on page 42. From 2004, the Committee proposes to set a performance condition for share options that would result in 50% of options vesting if net asset value per share with dividends re-invested increases on average by more than RPI plus three percentage points per annum over a three year performance period and 100% vesting if such net asset value increases by RPI plus eight percentage points or more. At the same time, the Committee proposes to remove the opportunities for the performance condition to be retested after four and five years (if the performance condition is not satisfied earlier) which are contained in the condition used previously. In line with the Committee’s desire to bring the Company’s long-term incentives at Board level closer to practice in the venture capital industry, from 2004 the Committee proposes to raise the maximum annual award. The maximum level of award will be increased (in terms of face value) from the existing maximum level of four times salary to six times salary. This maximum applies to performance share awards and share options in combination taking into account their relative expected values. Carried interest plans During the year the executive Director responsible for the Company’s US business, currently Mr M M Gagen, participated in the carried interest plans available to investment executives based in the US. These awards are not pensionable. Details are set out in the table on page 43. Although the Committee believes the changes in share based long-term incentives referred to above will help to bridge the gap between the Company’s remuneration policies for executive Directors and arrangements in the venture capital industry, the Committee believes the Company should go further and extend to those executive Directors directly responsible for specific investment businesses the possibility of participating in the carried interest arrangements it has already put in place below Board level and for the US-based Director. The Company therefore proposes to put forward at the 2004 Annual General Meeting proposals to allow executive Directors directly responsible for specific investment businesses to participate in the carried interest plans that have been established for the Group’s investment executives. It is not proposed that the Chief Executive or the Finance Director be eligible to participate in these plans. This year the Committee does not intend to extend such arrangements to any members of the Board other than the executive Director responsible for the Company’s US and Asia Pacific operations, Mr M M Gagen, who is already in such an arrangement in respect of his US responsibilities, which was approved by shareholders in 2002. If the Company were to extend participation in carried interest to a Director, this would replace a major part of the share-based incentives which the Director would otherwise receive. Full details of the proposals relating to carried interest are set out in the Notice of the 2004 Annual General Meeting. 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 December 2002) P B G Williams (retired 31 December 2002) Non-executive Directors Baroness Hogg O H J Stocken Dr J R Forrest C J M Morin-Postel (appointed 12 September 2002) F D Rosenkranz F G Steingraber The Lord Camoys (retired 10 July 2002) Total Salary and fees £’000 598 432 319 364 – – 220 75 48 34 37 30 – 2,157 Bonus £’000 531 246 341 360 – – – – – – – – – 1,478 Benefits Total Total remuneration remuneration Year to Year to in kind 31 March 2004 31 March 2003 £’000 £’000 £’000 2 9 17 2 – – – – – – – – – 30 1,131 687 677 726 – – 220 75 48 34 37 30 – 3,665 729 597 416 435 503 472 220 75 48 18 37 30 9 3,589 Notes 1 Bonuses relate to the year to 31 March 2004 and are expected to be paid in July 2004. 2 During the year, Mr M M Gagen was based in the US. Of the salary paid £310,000 was pensionable under the 3i Group Pension Plan. 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), health insurance (Mr B P Larcombe, Mr M J Queen and Mr R W Perry), and taxation advice and storage charges (Mr M M Gagen). 4 Mr W J R Govett, a former Director, was paid £5,000 as a director of Gardens Pension Trustees Limited, one of the trustees of the 3i Group Pension Plan. 5 Mr B P Larcombe served as a non-executive Director of Smith & Nephew plc and retained Directors’ fees of £35,000. 40 3i Report and accounts 2004 Remuneration report 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 R W Perry M J Queen Year of grant Held at 1 April 2003 Granted during the year Exercised during Held at the year 31 March 2004 1995 1995 1996 1997 1998 1999 2000 2001 2002 2003 1993 1994 1997 1998 1999 2000 1994 1995 1996 1997 1997 1998 1999 2000 2001 2002 2003 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 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 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 30,795 114,000 184,318 511,015 100,352 100,352 – 35,211† 35,211 57,218 57,218 18,500 – – – – – – – – – 18,500 24,467 – 91,013 – – – 115,480 14,000 – – – – – – – – – – 14,000 – – – – – – – – – – – – 20,600 98,200 99,802 72,209 45,654 25,272 192,000 327,015 100,352 981,104 – 5,000* – 30,454 9,006 24,106 68,566 – 1,600* 38,700* 40,800* 58,378* 29,381* 10,734* 20,294 100,000 145,670 35,211 480,768 4,000*# 1,800* 40,850* 37,073* 62,177 36,002 30,795 114,000 184,318 57,218 568,233 Exercise price £ 3.34 4.23 4.50 5.20 6.64 7.28 13.75 10.00 6.73 5.68 1.68 2.72 5.20 6.64 7.28 13.56 2.72 3.61 4.50 4.91 5.12 5.67 7.28 13.75 10.00 6.73 5.68 2.72 3.61 4.50 5.20 6.64 7.28 13.75 10.00 6.73 5.68 Market price on date of excercise £ Date from which exercisable 6.48 5.975 6.30 6.575 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 25.06.06 30.07.99 22.06.00 16.06.00 22.06.01 06.07.02 03.07.03 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 25.06.06 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 25.06.06 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 24.06.13 29.07.03 21.06.04 15.06.07 21.06.08 05.07.09 02.07.10 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 24.06.13 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 24.06.13 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. † Options granted to Mr R W Perry in 2003 were pro-rated approximately in the proportion that his prospective service from the date of grant to his normal retirement date at age 60 bore to the performance period of three years. 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 that 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 RPI plus 4%. 41 3i Report and accounts 2004 Remuneration report Notes continued 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% 5 These performance conditions 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, was chosen as being appropriately demanding in the prevailing market conditions at the time. 6 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 2003 Granted during the year Exercised during the year Held at 31 March 2004 Exercise price £ Market price on date of exercise £ Date from which exercisable Expiry date 114,000 – – 114,000 10.00 – 09.08.04 08.08.11 7 The mid-market price of shares in the Company at 31 March 2004 was 629p and the range during the period 1 April 2003 to 31 March 2004 was 418p to 686p. The aggregate of the amount of gains made by Directors on the exercise of share options in the year (including on exercise of awards under the Management Equity Investment Plan detailed on pages 44 and 45) was £1,122,425 (2003: £nil). The amount attributable to Mr B P Larcombe was £239,729 (2003: £nil). 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. Performance Share Awards The table below provides details of performance share awards held by the Directors who held office during the year. Held at 1 April 2003 Granted during the year Vested during Held at the year 31 March 2004 Market price on date of grant £ Date of vesting Executive Director B P Larcombe R W Perry† M J Queen † Performance shares awarded to Mr R W Perry in 2003 were pro-rated approximately in the proportion that his prospective service from the date of grant to his normal retirement date at age 60 75,264 26,408 42,913 75,264 26,408 42,913 £5.56 £5.56 £5.56 24.06.06 24.06.06 24.06.06 – – – – – – bore to the performance period of three years. Performance share awards are awards of shares, which are transferred to the participant by an employee benefit trust on terms that the shares may, in certain circumstances, be forfeited. While the shares are subject to forfeiture they may not be sold, transferred or used as security. Awards are subject to a performance condition determining whether and to what extent the award will vest. Non-vested shares are forfeited. The performance condition provides for shares to vest based on the Company’s “percentage rank” by total shareholder return for the period of three years from grant (averaged over a 60 day period) compared to a comparator group. The comparator group consists of the FTSE 100 index constituents at the grant date (adjusted for mergers, demergers and delistings during the performance period). A company’s percentage rank is its rank in the comparator group divided by the number of companies in the group at the end of the performance period expressed as a percentage. If the Company’s percentage rank is less than 50% none of the shares vest. At a percentage rank of 50%, 35% of the shares vest and at 75%, all the shares vest. Between these points shares vest pro rata. This condition was chosen to align the interests of executive Directors and shareholders by linking a proportion of their remuneration to shareholder returns relative to a comparator index of which the Company is a constituent. The Committee will determine the extent to which this condition has been met based on calculations prepared by the Committee’s remuneration consultant. 42 3i Report and accounts 2004 Remuneration report US Carried Interest Plan Awards The following table provides details of the awards provided to Mr M M Gagen under the US carried interest plans. Executive Director M M Gagen Points as at 1 April 2003 Points allocated during the year Payments received during the year Points as at 31 March 2004 115 (2000 Vintage) 52 (2001 Vintage) 111 (2002 Vintage) 135 (2003 Vintage) 135 (2004 Vintage) – – – – – 115 (2000 Vintage) 52 (2001 Vintage) 111 (2002 Vintage) 135 (2003 Vintage) 135 (2004 Vintage) The plans operate on the basis of five annual “vintages” of investments from 2000 to 2004 inclusive 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 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, 2003 and 2004), 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, no amounts 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 US $6,056,000. Currently the points have no accrued value. The Share Incentive Plan Eligible UK employees, including executive Directors, may participate in the 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) which are normally subject to forfeiture if the employee ceases to be employed within three years of grant. 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. Held at 1 April 2003 Partnership shares Held at 1 April 2003 Matching shares Held at Held at Held at 1 April 2003 31 March 2004 31 March 2004 31 March 2004 Dividend shares Partnership shares Matching shares Dividend shares Held at Executive Directors B P Larcombe R W Perry M J Queen 293 293 276 586 586 552 8 8 6 545 545 529 1,090 1,090 1,058 33 33 31 Note Since 31 March 2004, Mr B P Larcombe, Mr R W Perry and Mr M J Queen have each acquired a further 20 partnership shares and have been awarded a further 40 matching shares. During the year, shares were awarded at prices between 448p and 659p per share. Pension arrangements The executive Directors are 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 12 to the accounts on pages 56 and 57. 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, 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 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. Age at pension at 31 March 2004 31 March 2004 31 March 2004 31 March 2004 £’000 p.a. £’000 p.a. benefits at 31 March 2004 31 March 2004 31 March 2003 £’000 £’000 p.a. £’000 (Note 2) (Note 3) Transfer value of increase in accrued benefits at accrued 31 March 2004, less Director’s contribution £’000 p.a. Total (Note 1) Increase in accrued pension (including inflation) during the year to (Note 3) Transfer value of the accrued benefits at Transfer value of the (Note 5) Difference between transfer values at start and end of the accrued accounting year, less Director’s contribution £’000 (Note 1) Increase in accrued pension (excluding inflation) during the year to Complete years of pensionable service at Executive Directors B P Larcombe M M Gagen R W Perry M J Queen 50 48 58 42 29 19 18 16 2 4 16 18 422 160 159 157 5 37 317 147 13 8 20 22 5,275 1,786 3,284 1,331 5,396 1,809 2,852 1,255 (129) (26) 428 72 Notes 1 The increase in accrued pension shown reflects the difference between deferred pensions on leaving, payable from age 60. 2 The pensions shown are deferred pensions payable from age 60. 3 The transfer values have been calculated on the basis of actuarial advice in accordance with the relevant professional guidance applicable at 31 March 2004 (GN11 Actuarial Guidance Note (version 9.1)). 4 Additional voluntary contributions are excluded from the above table. 5 The transfer values have been calculated on the basis of actuarial advice in accordance with the relevant professional guidance applicable at 31 March 2003 (GN11 Actuarial Guidance Note (version 8.1)). 43 3i Report and accounts 2004 Remuneration report 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 other than Mr M M Gagen has an employment contract with 3i plc with a notice period of 12 months if notice is given by the employer and six months if notice is given by the Director. Save for these notice periods the contracts have no unexpired terms. These contracts of employment date from when the Directors were 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. These contracts contain no specific provisions for the payment of compensation in the event of early termination. Mr M M Gagen has an employment contract with 3i Corporation dated 12 July 2000 under which he is required to give six months’ notice but which may be terminated by the employer by immediate notice. In the event of termination of employment by the employer on immediate notice (other than for cause) Mr M M Gagen will be entitled to receive his base salary for a period of 12 months following 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 other 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 is entitled to exercise options within six months of the date the options vest, if at all. Directors’ share interests As at 31 March 2004 the current executive Directors had the shareholdings in the Company’s shares shown below. B P Larcombe M M Gagen R W Perry M J Queen 31 March 2004 31 March 2003 shares 741,845 91,055 22,436 130,135 shares 761,126 91,055 37,217 130,919 These figures exclude conditional rights to acquire shares under the Management Equity Investment Plan detailed below in the section headed Historic awards and performance share awards under the Discretionary Share Plan. Full details of the Directors’ interests in the Company’s shares are shown in note 40 to the accounts on page 65. 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 Until 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. Year of grant Held at 1 April 2003 Granted during the year Exercised during Held at the year 31 March 2004 Exercise Market price on price date of exercise £ £ Date from which exercisable 1997 1998 1999 2000 2001 1998 1999 2000 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 – – – – – – – – – – – – – – – – – – – – – 11,348 – – – – 11,348 – 8,333 6,668 15,001 – 5,970 – – 5,970 5,075 – – – – 5,075 – 12,443 13,681 9,699 6,400 42,223 9,049 – – 9,049 6,787 – 5,819 3,600 16,206 – 8,144 8,333 6,668 4,000 27,145 5.155 6.63 Nil Nil Nil 6.63 Nil Nil 6.63 Nil Nil Nil 5.155 6.63 Nil Nil Nil 6.34 6.25 6.25 5.55 5.82 Executive Directors B P Larcombe M M Gagen R W Perry M J Queen * Awarded before appointment as a Director. 44 Expiry date 08.06.04 14.06.05 22.07.06 27.06.07 08.08.08 09.06.00 15.06.01 23.07.02 28.06.03 09.08.04 15.06.01 23.07.02 28.06.03 14.06.05 22.07.06 27.06.07 15.06.01 23.07.02 28.06.03 09.08.04 14.06.05 22.07.06 27.06.07 08.08.08 09.06.00 15.06.01 23.07.02 28.06.03 09.08.04 08.06.04 14.06.05 22.07.06 27.06.07 08.08.08 3i Report and accounts 2004 Remuneration report Performance linked awards under the Management Equity Investment Plan 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 2003 Granted during the year Exercised during Held at the year 31 March 2004 Exercise Market price on price date of exercise £ £ Date from which exercisable Expiry date Executive Directors B P Larcombe M M Gagen R W Perry M J Queen 1997 1998 1999 2000 1997 1998 1999 2000 1998 1999 2000 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 – – – – – – – – – – – – – – – – – – 17,313 – – – 17,313 28,353 – – – 28,353 23,540 – – 23,540 27,348 – – 27,348 – 7,682 12,714 51,518 71,914 – 1,652 38,182 30,090 69,924 – 842 21,054 21,896 – 46,817 25,776 72,593 5.155 6.63 Nil Nil 5.155 6.63 Nil Nil 5.155 Nil Nil 5.155 Nil Nil 6.34 6.25 5.55 5.82 09.06.02 15.06.03 23.07.04 28.06.05 08.06.04 14.06.05 22.07.06 27.06.07 09.06.02 15.06.03 23.07.04 28.06.05 08.06.04 14.06.05 22.07.06 27.06.07 09.06.02 23.07.04 28.06.05 08.06.04 22.07.06 27.06.07 09.06.02 23.07.04 28.06.05 08.06.04 22.07.06 27.06.07 * Awarded before appointment as a Director. 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 F D Rosenkranz Chairman, Remuneration Committee 12 May 2004 45 3i Report and accounts 2004 Independent auditors’ report to the members of 3i Group plc We have audited the Group’s financial statements for the year ended 31 March 2004, 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 are responsible for preparing the Annual Report including the financial statements which are required to be prepared in accordance with applicable United Kingdom law and accounting standards as set out in the Statement of Directors’ responsibilities in relation to the Financial Statements. Our responsibility is to audit the financial statements and the part of the Directors’ 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 33 to 37 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 responsibility report, Directors’ report, unaudited part of the 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 judgments 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 2004 and of the profit 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 12 May 2004 46 3i Report and accounts 2004 Consolidated statement of total return for the year to 31 March 2004 Capital profits Realised profits on disposal of investments Unrealised profits/(losses) on revaluation of investments Carried interest and investment performance plans Total operating income before interest payable Interest payable Administrative expenses Cost of changes to organisational structure Return before tax and currency translation adjustment Tax Return for the year before currency translation adjustment Currency translation adjustment Total return Total return per share Basic (pence) Diluted (pence) Revenue 2004 £m Capital 2004 £m Notes 2 3 4 1 7 10 13 1 15 228 336 564 (40) 524 5 (42) 487 (91) – 396 25 421 (24) 397 262 (51) 211 (72) – 139 (29) 110 24 134 Total 2004 £m 228 336 564 (40) 524 267 (93) 698 (163) – 535 (4) 531 – 531 Revenue 2003 £m Capital 2003 £m Total 2003 £m 190 (1,159) (969) (12) (981) 10 (53) (1,024) (89) (5) (1,118) 35 (1,083) 2 (1,081) 190 (1,159) (969) (12) (981) 308 (110) (783) (153) (10) (946) 3 (943) 8 (935) 298 (57) 241 (64) (5) 172 (32) 140 6 146 21.9p 21.0p 64.9p 62.2p 86.8p 83.2p 23.9p 23.9p (177.1)p (176.9)p (153.2)p (153.0)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 2004 £m 2,936 134 397 531 (84) 12 459 2003 £m 3,945 146 (1,081) (935) (81) 7 (1,009) 3,395 2,936 47 3i Report and accounts 2004 Consolidated revenue statement for the year to 31 March 2004 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) of joint ventures Fees receivable Other operating income Total operating income Administrative expenses and depreciation 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) There is no material difference between the reported revenue and the revenue on an unmodified historical cost basis. Notes 2004 £m 2003 £m 5 5 6 7 8 9 10 13 14 15 17 17 18 18 84 8 92 33 125 (51) 74 94 (1) 43 1 211 (72) – 139 (29) 110 (31) (53) 26 96 17 113 34 147 (57) 90 106 (1) 46 – 241 (64) (5) 172 (32) 140 (29) (52) 59 18.0p 17.2p 22.9p 22.9p 48 3i Report and accounts 2004 Consolidated balance sheet as at 31 March 2004 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 Tangible fixed assets Own shares Other assets Prepayments and accrued income Total assets Liabilities Deposits by banks Debt securities in issue Convertible bonds 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 12 May 2004 Notes 2004 £m 1,312 150 1,462 225 2,639 2,864 80 (53) 20 21 22 22 22 22 23 25 26 27 28 29 30 31 36 37 38 39 40 41 41 41 41 48 49 2003 £m 1 527 283 2004 £m 1 534 284 2003 £m 1,336 228 1,564 187 2,188 2,375 4,326 3,939 104 (81) 27 40 55 80 65 5,412 215 1,128 367 57 199 6 45 2,017 307 359 1 2,337 391 3,395 5,412 21 333 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 49 Notes 20 21 22 22 22 22 23 24 25 27 28 29 30 31 36 37 38 39 40 41 41 41 41 48 49 2004 £m 1,217 148 1,365 219 2,440 2,659 2003 £m 1,258 224 1,482 180 1,999 2,179 2004 £m 435 284 4,024 10 47 25 83 44 4,952 113 925 367 256 76 – – 1,737 307 359 1 2,085 463 3,215 4,952 21 271 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 3i Report and accounts 2004 Parent company balance sheet as at 31 March 2004 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 Convertible bonds 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 12 May 2004 50 3i Report and accounts 2004 Consolidated cash flow statement for the year to 31 March 2004 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 (paid)/received 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 Purchase of tangible fixed assets Sale of tangible fixed assets Net cash flow from capital expenditure and financial investment 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 (Decrease)/increase in cash Notes 2004 £m 2003 £m 66 35 (59) 93 41 (86) 90 (2) (756) – 913 5 (42) (91) (25) 25 (2) 1 28 (83) (15) 18 (232) 200 12 (20) 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) (2) 49 43 47 46 46 44 46 51 3i Report and accounts 2004 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 Statement of Recommended Practice – Financial Statements of Investment Trust Companies (“SORP”) – and applicable accounting standards, except as described below concerning the treatment of capital profits. As the Company is authorised and regulated by the Financial Services Authority as a deposit taker, 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 41, 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. As the charge for carried interest and investment performance plans has become more significant, it has been shown separately this year to give greater clarity. Consequently, certain comparatives have been restated to reflect this. Fees receivable earned and deal related costs incurred as an intrinsic part of an intention to acquire or dispose of an investment, have been accounted for directly in the capital reserve. 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 15. Administrative expenses associated with making and managing investments are allocated between capital and revenue. Finance costs less interest income on surplus funds have been allocated between revenue and capital. This allocation is 70% to capital and 30% to revenue for both administrative expenses and net finance costs. 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 the Group 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 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. D 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. E 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 the Directors’ estimate of Fair Value on the following bases: a Listed investments and quoted shares for which an active market exists are valued at mid-market price. This value is reduced by an appropriate discount dependent on the size of the Group’s holding relative to normal trading volumes. b Unquoted investments are valued by the Directors as follows: new investments are generally valued at cost until the first set of accounts for a full financial period subsequent to investment are received. An enterprise value for the investee company is estimated using various methodologies, and, after adjusting for higher-ranking debt and an appropriate marketability discount, is apportioned over the remaining instruments including the Group’s investments in loans, fixed income shares and equity shares. Standard methodologies include applying an average sector earnings multiple to operating profits, valuation by reference to the net asset base and the price of recent investments made in the investee company. If failure is expected the equity shares are valued at nil and the fixed income shares and loan investments are valued at the lower of cost or net recoverable amount. c In all of the above categories of investment where failure has occurred the loss is charged against realised capital profits. d Deferred consideration is included at the estimated present value of the expected future proceeds. Investment properties are included at external professional valuation. F 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. 52 3i Report and accounts 2004 Accounting policies G 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. H 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. I Trading assets Loans and advances to customers and other non-investment assets are carried at the lower of book amount and recoverable amount. J 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. Provision is also made for deferred tax on the unrealised appreciation of investment held by certain subsidiaries, as reduced by losses, where these are expected to crystallise in the future. 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. K 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. L 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. International financial reporting standards In June 2002, the European Union adopted a regulation that requires, from 1 January 2005, European listed companies to prepare their consolidated financial statements in accordance with international accounting standards. The Group’s 2006 financial statements will therefore be prepared in accordance with International Financial Reporting Standards (“IFRS”). These comprise not only IFRS but also International Accounting Standards (“IAS”). In the light of the European Union decision, the International Accounting Standards Board (“IASB”) announced its commitment to have a platform of high quality, improved standards in place by the end of March 2004. This has largely been met. Certain key standards continue to be under review. These include IAS 39 ‘Financial Instruments: Recognition and Measurement’ and IAS 19 ‘Employee Benefits’. In addition, a project is being undertaken to devise a Statement of Comprehensive Income, which would replace the single column profit and loss account required by IAS 1 ‘Presentation of Financial Statements’. Under IFRS the SORP generally ceases to be applicable. However, it is as yet unclear how the Inland Revenue intends to apply going forward the Investment Trust status requirements of section 842 Income and Corporation Taxes Act 1988. Dependent on this is the continuing need to maintain a separate analysis of Revenue and Capital. The Group will also be impacted by IAS 10 ‘Events after the Balance Sheet Date’ in accordance with which dividends payable are accounted for in the period in which they are declared as opposed to under current UK GAAP when they are accounted for in the period when they are proposed. During 2003, the Group formed a project team and initiated a programme to change its accounting policies and practices to be IFRS compliant by 2005. Activities during 2003/2004 have included documenting differences between the Group’s current accounting policies and IFRS, detailed planning for the move to IFRS, identification of implementation methodologies, the specification of IT requirements and raising awareness of IFRS throughout the Group. Additionally, the team is assisting functions to consider the wider business impacts of the move to IFRS and the convergence of current UK GAAP with IFRS. This work is advancing to plan. The main risks and uncertainties relate to the standards that have not yet been fully finalised. However, the Group is confident that it will be able to meet requirements for financial reporting during the year to 31 March 2006. 53 3i Report and accounts 2004 Notes to the accounts 1 Segmental analysis of total return The Group carries on its private equity 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 Capital profit before tax Total return before tax Net assets Total assets 2 Realised profits on disposal of investments Net proceeds Opening valuation of investments disposed Investments written off Other Realised profits on disposal Represented by: Listed Unlisted United Kingdom 2004 £m Continental Europe 2004 £m US 2004 £m Asia Pacific 2004 £m 67 83 22 28 200 126 261 387 2,405 3,414 United Kingdom 2003 £m 96 89 30 29 244 186 (586) (400) 2,158 3,360 22 10 24 5 61 13 131 144 848 1,703 Continental Europe 2003 £m 16 17 24 3 60 (12) (377) (389) 568 1,348 2 1 – – 3 (1) (26) (27) 84 211 1 – 2 – 3 1 30 31 58 84 US 2003 £m Asia Pacific 2003 £m – – – 1 1 (2) (140) (142) 159 198 1 – 2 – 3 – (15) (15) 51 93 2004 £m 923 (653) (50) 8 228 21 207 228 Total 2004 £m 92 94 48 33 267 139 396 535 3,395 5,412 Total 2003 £m 113 106 56 33 308 172 (1,118) (946) 2,936 4,999 2003 £m 976 (755) (79) 48 190 8 182 190 Other includes £4 million (2003: £50 million) in respect of subordinated liabilities no longer repayable, as explained in note 39. 3 Unrealised profits/(losses) on revaluation of investments Listed Unlisted 54 2004 £m 50 286 336 2003 £m (169) (990) (1,159) 3i Report and accounts 2004 Notes to the accounts 4 Carried interest and investment performance plans Charge for investment performance plans Carried interest 2004 £m 34 6 40 2003 £m 12 – 12 As is normal in the private equity industry, the Group offers its investment executives the opportunity to participate in the returns from successful investments. The two principal methods of achieving this are the Group’s investment performance plans (“IPP”) and carried interest arrangements. Under the IPP, payments are made on the basis of realised capital profits on investments pooled by team and by year. Payments are made if the realised profits and valuation of remaining investments within a pool indicate that a performance hurdle will be exceeded. Payments are accrued as the increase in asset value is recognised. Charge for IPP – realised – unrealised 2004 £m 8 26 34 Listed Unlisted 2003 £m 6 6 12 Under the carried interest arrangements, participants purchase a carried interest in future investments within a pool before the investments are made. This entitles them to receive a proportion of the cash flows from those investments in excess of a performance hurdle. Listed Unlisted The accounts show the change in value during the year of all outstanding carried interest held by participants in investments held at 31 March 2004. Carried interest – realised – unrealised 2004 £m – 6 6 2003 £m – – – In the year to March 2004, participants purchased a carried interest in respect of all first investments to be made by the Group over the two year period to 31 March 2006. 5 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 Interest receivable on loan investments – unlisted Fixed rate dividends – unlisted UK 2004 £m 60 7 67 UK 2003 £m 79 17 96 Non-UK 2004 £m 24 1 25 Non-UK 2003 £m 17 – 17 Total 2004 £m 84 8 92 Total 2003 £m 96 17 113 Interest receivable of £28 million (2003: £41 million) has been received by way of loan notes and a corresponding amount has been included in additions to loan investments. 7 Interest payable Interest payable has been allocated as follows: Revenue reserve Capital reserve 2004 £m 51 42 93 2003 £m 57 53 110 Interest payable 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. 8 Dividend income from equity shares UK 2004 £m 3 80 83 UK 2003 £m 3 86 89 Non-UK 2004 £m 1 10 11 Non-UK 2003 £m 1 16 17 2004 £m 43 20 (15) 48 Total 2004 £m 4 90 94 Total 2003 £m 4 102 106 2003 £m 46 16 (6) 56 9 Fees receivable Fees have been accounted for as follows: Revenue reserve Capital reserve – fees receivable – deal related costs Fees receivable earned and deal related costs incurred as an intrinsic part of an intention to acquire or dispose of an investment, have been accounted for directly in the capital reserve. 10 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 2004 £m 77 11 15 103 55 5 163 72 91 163 2003 £m 67 7 15 89 57 7 153 64 89 153 6 Other interest receivable and similar income Interest receivable on money market assets, treasury debt securities and similar income 2004 £m 33 2003 £m 34 The average monthly number of employees during the year was 833 (2003: 922). At 31 March 2004, the number of employees was 750 (2003: 858). In addition to the staff costs shown above, the amounts shown in note 4 have been charged against capital profits in respect of carried interest and investment performance plans. 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. 11 Directors’ emoluments Details of Directors’ emoluments are contained within the Remuneration report on pages 38 to 45. 55 3i Report and accounts 2004 Notes to the accounts 12 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 £10 million (2003: £12 million) and other plans was £5 million (2003: £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 10 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 2004 £m 10 – 10 24 2003 £m 11 1 12 25 As a result of adverse economic and market conditions since 30 June 2001, the market value of the Plan’s assets at 31 March 2004 would have been sufficient to cover 77% 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. During the year, the Board of the Company agreed to provide a guarantee to the Trustees of the Plan in respect of the liabilities to the Plan of 3i plc, the principal employer under the Plan. This guarantee had not been executed by 31 March 2004. 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. An additional £13 million was paid in March 2003. 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 in October 2003. An amount of £27 million (2003: £13 million) included in prepayments represents the cumulative difference between the net pension cost and contributions made. 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%. Mr R W Perry and Mr 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. 56 12 Pension arrangements continued The actuarial valuation at 30 June 2001 was updated to 31 March 2003 and 31 March 2004 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 2004. The key FRS17 assumptions used for the Plan were: Price inflation Salary increases (excluding promotion) Pension increases Discount rate 2004 2.9% 4.4% 3.0% 5.5% 2003 2.5% 4.0% 3.0% 5.6% The assets of the Plan and their expected return were: Long-term rate of return expected at 31 March 2004 7.9% 4.7% 4.6% Equities Gilts Other Present value of Plan liabilities Net pension liability 2004 Value Long-term rate of return expected at £m 31 March 2003 7.5% 4.5% 3.8% 187 62 23 272 2003 Value Long-term rate of return expected at £m 31 March 2002 8.5% – 5.2% 144 42 27 213 (355) (83) (303) (90) 2002 2.5% 5.0% 3.0% 6.1% 2002 Value £m 212 – 39 251 (265) (14) 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: 2004 £m 2003 £m 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 the 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 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 (9) (1) (10) 14 (17) (3) (13) 30 (12) (22) (4) (17) 2004 £m (90) (9) (1) 24 (3) (4) 7 (83) (11) (1) (12) 20 (16) 4 (8) (76) (5) (12) (93) (101) 2003 £m (14) (11) (1) 25 4 (93) (76) (90) 3i Report and accounts 2004 Notes to the accounts 12 Pension arrangements continued 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) 2004 2003 £30m 11% £(76)m 36% £(12)m 3% £(5)m 2% £(4)m 1% £(93)m 31% If FRS17 had been fully implemented net assets would have reduced by: FRS17 deficit SSAP 24 prepayment 2004 £m 83 27 110 2003 £m 90 13 103 13 Cost of changes to organisational structure There was no provision made for organisational changes of the Group and staff reductions during the year. A provision of £10 million was made during 2003. This was allocated between the revenue reserve £5 million and the capital reserve £5 million based on the underlying nature of the cost. 14 Profit on ordinary activities before tax This is arrived at after charging: Depreciation on owned assets Depreciation on hire purchase assets 2004 £m 4 1 2003 £m 6 1 Auditors’ remuneration The auditors received fees for the statutory audit of the Group of £0.8 million (2003: £0.7 million), which included £0.2 million (2003: £0.2 million) for the Company. Total fees paid by the Group to Ernst & Young LLP are analysed below: Audit services Statutory audit fee – UK – overseas Audit related regulatory reporting – UK Total audit services Further assurance services Tax services (compliance and advisory services) Other services: Investment due diligence Secondment to the Group’s investment business Repatriation and HR advice Total other fees 2004 £m 2003 £m 0.5 0.3 0.1 0.9 0.1 0.2 0.4 0.1 – 0.8 0.5 0.2 0.1 0.8 0.1 0.2 0.1 – 0.2 0.6 Audit 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. 14 Profit on ordinary activities before tax continued Tax and further assurance 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 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 in this category include due diligence within the investment process. If this were to be provided by the auditors, the specific team engaged would be independent of the audit. In addition to the above the Group has identified £2.2 million of investment related fees paid to Ernst & Young LLP by investee companies, where the Group’s investee companies and investment teams have appointed the service provider. It is estimated that Ernst & Young LLP receive less than 10% of the total investment related fees paid to the four largest accounting firms. 15 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% 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 Charge/(credit) in respect of costs allocated to capital profits but utilised against revenue profits UK corporation tax at 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 2004 £m Capital 2004 £m 26 3 (3) 3 – 29 – 29 (26) – – – – (26) 1 (25) Revenue 2003 £m Capital 2003 £m 30 2 (2) 3 (1) 32 – 32 (30) – – (1) – (31) (4) (35) 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% (2003: 30%), and the differences are explained below: Return before tax Return before tax multiplied by standard UK corporation tax rate of 30% Effects of: Expenses not deductible for tax purposes Short-term timing differences Current period unutilised tax losses Non-taxable UK dividend income Repatriated profits of overseas group undertakings Foreign tax Foreign tax credits available for double tax relief Adjustments in respect of previous periods Capital (profits)/losses not (chargeable)/allowable because of Investment Trust status Current tax charge/(credit) for the year Revenue 2004 £m 139 Capital 2004 £m 396 42 119 – – 4 (28) 11 3 (3) – – 29 – – – – – – – – (145) (26) 57 3i Report and accounts 2004 Notes to the accounts 15 Tax continued Return before tax Return before tax multiplied by standard UK corporation tax rate of 30% Effects of: Expenses not deductible for tax purposes Short-term timing differences Current period unutilised tax losses Non-taxable UK dividend income Repatriated profits of overseas group undertakings Foreign tax Foreign tax credits available for double tax relief Adjustments in respect of previous periods Capital (profits)/losses not (chargeable)/allowable because of Investment Trust status Current tax charge/(credit) for the year Revenue 2003 £m 172 Capital 2003 £m (1,118) 52 (335) 1 1 7 (29) – 3 (2) (1) – 32 – – – – – – – – 304 (31) 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. 16 Profit after tax The amount dealt with in the revenue account of the Company is £79 million (2003: £101 million). 17 Dividends Interim paid 5.1p per share (2003: 4.9p per share paid) Final proposed 8.9p per share (2003: 8.6p per share paid) 18 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 2004 £m 31 53 84 2003 £m 29 52 81 2004 £110m 612m 642m 18.0p 17.2p 2003 £140m 610m 611m 22.9p 22.9p £3,395m 613m 614m 554p 553p £2,936m 611m 611m 481p 480p The difference between the basic and diluted weighted average number of shares used in the calculation of earnings per share and total return per share is the dilutive effect of the convertible bonds and share options. The difference between the basic and diluted number of shares used in the calculation of net asset value per share is the dilutive effect of share options. 19 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 68. 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. 20 Loans and advances to banks Repayable on demand Maturity of other loans and advances to banks Repayable: within three months between three months and one year The Group 2004 £m 94 The Group The Company 2004 £m 50 2003 £m 99 The Company 2003 £m 34 325 115 534 313 115 527 270 115 435 282 115 431 21 Debt securities held for treasury purposes Repayable within one year The Group 2004 £m 284 The Group The Company 2004 £m 284 2003 £m 283 The Company 2003 £m 283 22 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 The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m 1,312 150 1,462 225 2,639 2,864 1,336 228 1,564 187 2,188 2,375 1,217 148 1,365 219 2,440 2,659 1,258 224 1,482 180 1,999 2,179 Total 4,326 3,939 4,024 3,661 Maturity of debt securities and fixed income shares Repayable within one year Repayable after more than one year 93 101 89 95 1,369 1,462 1,463 1,564 1,276 1,365 1,387 1,482 58 3i Report and accounts 2004 Notes to the accounts 22 Debt securities and other fixed income securities held as financial fixed asset investments and equity shares continued 22 Debt securities and other fixed income securities held as financial fixed asset investments and equity shares continued The Group Group companies have invested in or made commitments to 15 limited partnerships. These investments represented the following proportions of the total commitments of all investors in these partnerships: Opening balances Cost Unrealised appreciation Additions at cost Disposals, repayments and write-offs Transfers Unrealised appreciation Currency translation 31 March 2004 Represented by: Cost Unrealised appreciation Listed UK Non-UK Unlisted UK Non-UK Opening balances Cost Unrealised appreciation Additions at cost Disposals, repayments and write-offs Transfers Transfers from other Group companies Unrealised appreciation Currency translation 31 March 2004 Represented by: Cost Unrealised appreciation Listed UK Non-UK Unlisted UK Non-UK The Group Equity shares 2004 £m The Group Loan investments 2004 £m The Group Fixed income shares 2004 £m 2,751 (376) 2,375 356 (497) 69 661 (100) 2,864 2,579 285 2,864 156 69 225 1,387 1,252 2,639 1,563 (227) 1,336 401 (325) (80) 11 (31) 1,312 1,528 (216) 1,312 – – – 831 481 1,312 355 (127) 228 27 (92) 11 (20) (4) 150 297 (147) 150 – 2 2 114 34 148 Total 2004 £m 4,669 (730) 3,939 784 (914) – 652 (135) 4,326 4,404 (78) 4,326 156 71 227 2,332 1,767 4,099 The Company The Company The Company The Company Equity shares 2004 £m Loan investments 2004 £m Fixed income shares 2004 £m 2,477 (298) 2,179 333 (430) 68 3 596 (90) 2,659 2,361 298 2,659 156 63 219 1,386 1,054 2,440 1,466 (208) 1,258 354 (304) (78) 2 13 (28) 1,217 1,412 (195) 1,217 – – – 828 389 1,217 350 (126) 224 27 (89) 10 – (20) (4) 148 294 (146) 148 – 2 2 113 33 146 Total 2004 £m 4,293 (632) 3,661 714 (823) – 5 589 (122) 4,024 4,067 (43) 4,024 156 65 221 2,327 1,476 3,803 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 Europartners IVa LP 3i Europartners IVb LP 3i Europartners IVd LP 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% <0.01% <0.01% <0.01% The proportion of total commitments shown above are those at both 31 March 2004 and 31 March 2003 except for the commitments made to 3i Europartners IVa LP, 3i Europartners IVb LP and 3i Europartners IVd LP, which were made during the year. 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 £5 million (2003: £6 million) which represents the net carried interest that would be received by the Group if all investments held by the limited partnerships, which have already achieved their necessary hurdle, were realised at their valuation on the balance sheet date. The Group received fee income of £31 million (2003: £34 million) and distributions of £2 million (2003: £7 million) from this activity. 23 Interests in joint ventures Opening balances Cost Share of post acquisition retained surpluses less losses Unrealised appreciation Additions Repayment Share of net surplus less losses Unrealised appreciation Currency translation 31 March 2004 Represented by: Cost Share of post acquisition retained surpluses less losses Unrealised appreciation The Group The Company 2004 £m 2004 £m 115 (7) (85) 23 25 (25) (2) 10 (4) 27 111 (9) (75) 27 1 – – 1 25 – – (16) – 10 26 – (16) 10 The additions to joint ventures were investment in the equity of Atle Industri AB by the Company. The repayments were a repayment of loan from Woodrose AB. The gross assets of the joint ventures are debt securities and other fixed income securities held as financial fixed assets. The gross liabilities are other liabilities. Details of the Group’s interest in its principal joint ventures, which are unlisted and outside the UK, is given on page 68. 59 3i Report and accounts 2004 Notes to the accounts 24 Shares in Group undertakings 25 Tangible fixed assets continued Other fixed assets in use by the Group Opening cost Additions Disposals Cost at 31 March 2004 Opening depreciation Charge for year Disposals Depreciation at 31 March 2004 Book amount at 31 March 2004 Book amount at 31 March 2003 The Group The Group Office Hire purchase equipment motor vehicles 2004 £m 5 1 (3) 3 2 1 (2) 2004 £m 56 – – 56 46 4 (1) 49 7 10 1 2 3 The Group Total 2004 £m 61 1 (3) 59 48 5 (3) 50 9 13 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 Additions Disposals 31 March 2004 The Group 2004 £m The Group 2003 £m – 2 2 – 2 1 1 2 – 2 2004 £m 44 20 (9) 55 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 2004 was £62 million (2003: £34 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 Tax recoverable Other debtors Amounts due from Group undertakings The Group 2004 £m 3 77 The Group The Company 2004 £m – 7 2003 £m 4 60 The Company 2003 £m 1 9 80 64 76 83 62 72 28 Prepayments and accrued income Interest receivable Certificates of tax deposit The Group 2004 £m 65 – 65 The Group The Company 2004 £m 44 – 44 2003 £m 71 2 73 The Company 2003 £m 48 2 50 Opening balance Additions Disposals Capital reduction of Group undertaking Currency translation Closing balance The Company 2004 £m 66 14 (24) (7) (2) 47 Details of the principal subsidiary undertakings are given on page 68. 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 Unrealised appreciation Represented by: Cost Unrealised appreciation Freehold Leasehold – 50 years and over The Group 2004 £m 5 The Group The Company 2004 £m – 2003 £m 5 The Company 2003 £m – 26 9 40 27 13 45 25 – 25 26 – 26 The Group The Company Investment properties 2004 £m Investment properties 2004 £m The Group The Company Properties Properties in use by in use by the Group the Group 2004 2004 £m £m 5 – 5 – 5 5 – 5 5 – 5 – – – – – – – – – – – 22 5 27 (1) 26 22 4 26 9 17 26 21 5 26 (1) 25 21 4 25 8 17 25 60 3i Report and accounts 2004 Notes to the accounts 29 Deposits by banks 30 Debt securities in issue continued The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m Maturity of bonds and notes The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m 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 30 Debt securities in issue Bonds and notes Other debt securities in issue Bonds and notes Fixed rate (guaranteed) 3i International BV 7.75% – matured 2003 Total fixed rate Variable rate Unsecured loan notes Various maturities – 2007-2010 Total variable rate Notes issued under the £2,000 million Note Issuance Programme Fixed rate Public issues 3i Group plc 6.875% – matures 2007 3i Group plc 6.875% – matures 2023 3i Group plc 5.750% – matures 2032 Private placings Total fixed rate Variable rate Public issues 3i Holdings plc – matures 2007 Private placings Total variable rate 215 423 113 248 41 – 174 215 66 3 354 423 41 – 72 113 66 3 179 248 The Group 2004 £m 1,008 120 1,128 The Group The Company 2004 £m 805 120 925 2003 £m 1,183 167 1,350 The Company 2003 £m 830 167 997 The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m – – 2 2 150 150 2 2 – 1 1 – 1 1 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 2 4 401 601 1,008 The Group 2004 £m – 120 120 175 2 405 601 1,183 – 4 201 600 805 25 – 205 600 830 The Group The Company 2004 £m – 120 120 2003 £m 22 145 167 The Company 2003 £m 22 145 167 106 115 106 115 11 1 2 120 42 5 5 167 11 1 2 120 42 5 5 167 The Group had the following committed multi-currency facilities at 31 March 2004: Negotiated June 2001 Facility Drawn Drawn margin (over LIBOR) Undrawn commitment fee (matures 21 June 2006) £360m £144m 0.1750% 0.0875% The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m The drawn margin on the c595 million facility increases to 0.225% if the (matures 29 October 2008) e595m £30m 0.2000% 0.1000% November 2003 200 200 400 2 802 200 4 204 200 200 400 22 822 200 9 209 200 200 400 – 800 200 200 400 20 820 4 4 9 9 Total bonds and notes 1,008 1,183 805 830 drawn amount is between 33% and 66% of the facility, and to 0.25% if the drawn amount is greater than 66% of the facility. 31 Convertible bonds The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m Repayable between two years and five years 367 – 367 – On 1 August 2003, 3i Group plc issued c550 million 1.375% Convertible Bonds due 2008. They are convertible at the option of the Bondholder to ordinary shares at any time from 11 September 2003 to 25 July 2008. The number of shares to be issued on conversion will be determined by dividing the principal of the bond by the conversion price in effect on the conversion date. The initial conversion price is £8.416757. Unless previously realised and cancelled, redeemed or converted, these bonds will be redeemed on 1 August 2008. If certain conditions are met, the Issuer may redeem all, but not some only, of the Bonds for the time being outstanding at their principal amount. The Issuer may make a payment in cash as an alternative to issuing shares upon either conversion or redemption. Interest is payable on the bonds in equal semi annual instalments in arrears on 12 January and 12 July each year. The fair value of the convertible bonds at 31 March 2004 was £374 million. 61 3i Report and accounts 2004 Notes to the accounts 32 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 2004 was: More than three months but not more than six months 2004 £m – 65 40 More than six months but not more than one year 2004 £m – 50 – More than one year but not more than five years 2004 £m – – – Not more than three months 2004 £m – 419 244 More than five years 2004 £m 1 – – Non-interest bearing 2004 £m – – – 424 – – – 1,087 215 (174) – – – – 41 39 – – – 144 – (24) – – – – (24) 59 – – – 109 – 21 – – – – 21 301 – – – 301 – 388 367 – – – 755 489 – – – 490 – 917 – – 45 – 962 – 150 2,864 267 3,281 – – – 262 – 3,395 3,657 1,046 1,046 168 1,214 88 1,302 (454) 848 (472) 376 (376) – 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 2004 £m 1 534 284 1,312 150 2,864 267 5,412 215 1,128 367 262 45 3,395 5,412 – – Total 2003 £m 1 527 283 1,336 228 2,375 249 4,999 423 1,350 – 239 51 2,936 4,999 – – 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 Convertible bonds Other liabilities Subordinated liabilities Shareholders’ funds Interest rate sensitivity gap Cumulative gap 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 Convertible bonds Other liabilities Subordinated liabilities Shareholders’ funds Interest rate sensitivity gap Cumulative gap 62 3i Report and accounts 2004 Notes to the accounts 33 Currency exposures Currency rate risk emanates from the Group’s international operations. The policy regarding currency risk is set out in the Operating and financial review on page 23. Currency swaps are used as part of applying that policy. The Group’s structural currency exposures at 31 March 2004 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 2004 £m 341 102 32 – 1 – 135 476 Variable rate loan investments 2003 £m 397 91 37 – 1 – 129 526 Fixed rate loan investments 2004 £m 429 256 47 41 52 11 407 836 Fixed rate loan investments 2003 £m 496 181 62 38 20 13 314 810 Other investment assets 2004 £m 1,622 862 268 68 185 41 1,424 3,046 Other investment assets 2003 £m 1,450 656 221 26 217 61 1,181 2,631 Other net assets before borrowings 2004 £m 721 28 7 3 26 7 71 792 Other net assets before borrowings 2003 £m 688 69 10 2 20 4 105 793 Short-term variable rate borrowings 2004 £m 60 72 (120) (21) (133) (12) (214) (154) Other variable rate borrowings 2004 £m 223 60 – – (144) – (84) 139 Short-term variable rate borrowings 2003 £m 14 (113) (32) (25) – (39) (209) (195) Other variable rate borrowings 2003 £m 200 42 – – (354) – (312) (112) Fixed rate borrowings 2004 £m (1,132) (595) – – – (13) (608) (1,740) Fixed rate borrowings 2003 £m (1,244) (259) – – – (14) (273) (1,517) Net assets 2004 £m 2,264 785 234 91 (13) 34 1,131 3,395 Net assets 2003 £m 2,001 667 298 41 (96) 25 935 2,936 34 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. 35 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 The Group’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 2004 was £1,424 million (2003: £1,214 million), which compares with a book amount of £1,367 million (2003: £1,205 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. 63 3i Report and accounts 2004 Notes to the accounts 35 Fair value of financial assets and financial liabilities continued The fair values and book values at 31 March 2004 of the swaps were: 38 Provisions for liabilities and charges continued Deferred tax Interest rate swaps Currency swaps Fair value 2004 £m (19) (8) (27) Fair value 2003 £m (24) (21) (45) Book value 2004 £m 1 – 1 Book value 2003 £m 6 2 8 All swaps held at 31 March 2004 mature before 31 March 2041. The principal outstanding on currency swap agreements and notional principal outstanding on interest rate swap agreements were: The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m Unrealised appreciation less expected losses 1 – – – 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. 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 2004 £m 507 1,032 170 70 2003 £m 688 1,193 170 – 109 164 39 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 and become non-repayable as assets fail. The carrying values of the non-recourse funding are adjusted to reflect the amounts expected to be payable when assets are failing. All financial instruments are unsecured. However, the Group does not expect non-performance by the counterparties, whose credit ratings are reviewed regularly. As a method of settling this non-recourse funding, 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). This resulted in a realised capital profit in the year to 31 March 2003 of £39 million. The Group 2004 £m The Group The Company 2004 £m 2003 £m The Company 2003 £m 40 Called up share capital Authorised Ordinary shares of 50p each Unclassified shares of 10p each Issued, called up and fully paid Ordinary shares of 50p each 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 607p 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 448p and 660p per share Allotted to vendors of SFK Finance Oy at 1210p per share Movement for the year 31 March 2004 The Company The Company 2004 £m 2004 Number 820,000,000 1,000,000 410 – 610,918,253 305 2,013,050 231,283 252,660 63,913 2,560,906 613,479,159 2 – – – 2 307 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. 36 Other liabilities Obligations under hire purchase contracts Proposed dividend Taxation payable Amounts due to Group undertakings 2 53 2 57 2 52 2 56 – 53 – 203 256 – 52 – 389 441 The amounts due to Group undertakings include £141 million (2003: £338 million) due after more than one year. 37 Accruals and deferred income Interest payable Other accruals The Group 2004 £m 33 166 199 The Group The Company 2004 £m 25 51 76 2003 £m 43 130 173 The Company 2003 £m 26 21 47 38 Provisions for liabilities and charges Opening balance Charge for year Utilised in year Movement for the year 31 March 2004 Cost of organisational changes 2004 £m 10 – (7) (7) 3 Property 2004 £m – 2 – 2 2 Deferred tax 2004 £m – 1 – 1 1 Total 2004 £m 10 3 (7) (4) 6 The provision for the cost of organisational changes relates to organisational changes and staff reductions in the two years to 31 March 2003. The Group has a number of leasehold properties whose rent and unavoidable costs exceed the economic benefits expected to be received. These costs have been provided for and arise over the period of the lease. 64 3i Report and accounts 2004 Notes to the accounts 40 Called up share capital continued 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 2004 31 March 2003 Number of options Period of exercise Exercise price 22,919,966 2004 to 2013 272p to 1375p 22,280,605 2003 to 2012 168p to 1375p The interests of the Directors (all of which are beneficial) in the ordinary shares of the Company are shown below: 31 March 2004 Baroness Hogg 12,355 Dr J R Forrest 1,500 C J M Morin-Postel 2,000 F D Rosenkranz 30,000 F G Steingraber – O H J Stocken 12,582 B P Larcombe 836,390 M M Gagen 91,055 R W Perry 63,625 173,832 M J Queen * Represents conditional rights to acquire shares pursuant to deferred share bonus awards 31 March 2003 12,355 1,500 – 30,000 – 12,249 741,845 91,055 22,436 130,135 31 March 2004 Conditional* – – – – – – 42,223 9,049 16,206 27,145 31 March 2003 Conditional* – – – – – – 53,571 24,050 22,176 32,220 granted under the Management Equity Investment Plan, described on page 44. The share interests shown above for each of Mr B P Larcombe, Mr R W Perry and Mr M J Queen include performance share awards which are subject to forfeiture and are detailed in the table on page 42. 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 45. 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 9,884,767 shares held by the trust at 31 March 2004. (Shares at 31 March 2003: 8,193,026.) 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 page 41. Since 31 March 2004, there have been changes in the Directors’ interests in shares. As at 4 May 2004, each of these Directors were beneficially interested in the following number of additional shares: Mr B P Larcombe (60), Mr R W Perry (60) and Mr M J Queen (60). In addition, as at that date, the number of shares held by The 3i Group Employee Trust was 9,879,752. 41 Reserves Opening balances Retained revenue for the year Realised profits on disposal of investments Change in value of retained investments Carried interest and investment performa plans nce Fees receivable allocated to capital reserve Interest payable allocated to capital reserve Administrative expenses allocated to capital reserve Tax on capital items Increase in respect of shares issued Currency translation adjustment Movement for the year 31 March 2004 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 Carried interest and investment performance plans Interest payable allocated to capital reserve Administrative expenses allocated to capital reserve Increase in respect of shares issued Currency translation adjustment Movement for the year 31 March 2004 The balance on the capital reserve represents: Realised profits Unrealised appreciation The Group Revenue 2004 £m 341 26 The Group Share premium 2004 £m 349 The Group Capital redemption 2004 £m 1 The Group Capital 2004 £m 1,940 228 336 (40) 5 (42) (91) 25 (24) 397 2,337 2,567 (230) 2,337 10 10 359 24 50 391 – 1 The Company The Company The Company The Company Share premium 2004 £m 349 Capital redemption 2004 £m 1 Capital 2004 £m 1,762 Revenue 2004 £m 438 (5) 10 10 359 30 25 463 – 1 179 289 (40) (23) (56) (26) 323 2,085 2,313 (228) 2,085 65 3i Report and accounts 2004 Notes to the accounts 41 Reserves continued 44 Analysis of changes in financing during the year Subsidiary The Company £m undertakings Joint ventures £m £m Total £m 2,776 191 (9) 2,958 Opening balance Deposits and debt securities repayable after more than one year 2004 £m 1,372 Share capital and share premium 2004 £m 654 Deposits and debt securities repayable after more than one year 2003 £m 1,548 Share capital and share premium 2003 £m 647 2004 £m £m 2003 45 Reconciliation of net cash flows to movement in net debt Exchange movements Cash inflows from financing Cash outflows from financing Non-cash movements Movement for the year Closing balance – 12 – – 12 666 (16) 367 (168) (5) 178 1,550 – 7 – – 7 654 (Decrease)/increase in cash in the year Cash flow from management of liquid resources Cash flow from debt financing Cash flow from subordinated liabilities 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 2004 £m (2) 15 33 (1) 45 27 5 77 (1,015) (938) 47 6 (45) (184) (176) 1,372 2003 £m 49 (15) 143 (7) 170 (46) 50 174 (1,189) (1,015) Retained profits 31 March 2004 Revenue and realised capital profits 31 March 2003 Revenue and realised capital profits 2,879 161 (7) 3,033 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. 42 Unrealised appreciation Unrealised appreciation represents the difference between the original cost of investments and their carrying value, less charges Opening balance after tax (752) 258 Value deficit/(surplus) realised Value deficit written back on realisation Change in value surplus Carried interest Tax credit Movement for the year 66 152 336 (32) – 522 (38) 189 (1,159) (6) 4 (1,010) Closing balance after tax (230) (752) 43 Reconciliation of revenue profit before tax to net cash flow from operating activities Revenue profit before tax Depreciation of equipment and vehicles 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 of joint ventures less distribution received Net cash inflow from operating activities 2004 £m 139 5 (1) (28) (19) (1) (1) (5) 1 90 2003 £m 172 7 (1) (41) (9) 12 (15) 2 1 128 66 3i Report and accounts 2004 Notes to the accounts 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 flow from management of liquid resources 48 Contingent liabilities Contingent liabilities relating to guarantees available to third parties in respect of investee companies 1 April 2003 £m 99 712 (401) (1,372) (51) (2) (1,015) Cash flow £m (2) 15 232 (199) (1) – 45 Exchange Other non-cash movement £m (3) (2) 14 16 2 – 27 changes 31 March 2004 £m 94 725 (160) (1,550) (45) (2) (938) £m – – (5) 5 5 – 5 2004 £m (15) (15) 2003 £m 15 15 The Group 2004 £m 21 The Group The Company 2004 £m 21 2003 £m 19 The Company 2003 £m 16 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 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 by 3i Holdings plc under the £360 million and the c595 million revolving credit facilities. At 31 March 2004, 3i Holdings plc had drawn down £72 million (2003: £175 million) and £30 million (2003: £nil) respectively under these facilities. At 31 March 2004, there was no material litigation outstanding against the Company or any of its subsidiary undertakings. 49 Commitments Share and loan investments The Group 2004 £m 333 The Group The Company 2004 £m 271 2003 £m 270 The Company 2003 £m 260 67 3i Report and accounts 2004 Principal subsidiary undertakings and joint ventures Principal subsidiary undertakings at 31 March 2004 Name 3i Holdings plc 3i International Holdings 3i plc 3i Investments plc 3i Japan GP Limited 3i Europe plc 3i Nordic plc 3i Asia Pacific plc Gardens Pension Trustees Limited Ship Mortgage Finance Company public limited company 3i Corporation (USA) 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 £1 140,000 shares of £1 100 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) 15,000 shares of common stock (no par value) Principal activity Holding company Holding company Services Investment manager General partner company Investment advisory services Investment advisory services Investment advisory services Pension fund trustee Advisory services 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 Investment advisory services 3i Gestion SA (France) 200,000 shares of c16 Investment manager 3i Austria GmbH (Austria) c50,000 Investment advisory services Registered office 91 Waterloo Road London SE1 8XP 880 Winter Street Suite 330 Waltham MA 02451, USA Bockenheimer Landstrasse 55 60325 Frankfurt am Main, Germany Rosental 3-4 80331, 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 2004 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 2004, the entire issued share capital of 3i Holdings plc was held by the Company. 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 were held by individuals associated with the Group. Principal joint ventures at 31 March 2004 Incorporated in the country stated Name Woodrose Invest AB (Sweden) Atle Industri AB (Sweden) Issued and fully paid share capital 501,000 shares of SEK 100 5,000 shares of SEK 100 Percentage attributable to the Group % 50 Principal activity Investment company 50 Investment company Principal place of business and registered office Box 7847 10399 Stockholm Sweden Box 7847 10399 Stockholm Sweden Group’s share of results based on accounts to 31 March 2004 31 March 2004 As at 31 March 2004, the Company held 50% of the shares of Atle Industri AB and a subsidiary undertaking of the Company held, on behalf of the Company, 50% of the shares of Woodrose Invest AB. 68 3i Report and accounts 2004 Portfolio valuation methodology A description of the methodology used to value the Group’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 methodology complies in all material aspects with the guidelines of the British Venture Capital Association. Basis of valuation Investments are reported at the Directors’ estimate of Fair Value at the reporting date. Fair Value represents the amount for which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. General In estimating Fair Value, we seek to use a methodology that is appropriate in light of the nature, facts and circumstances of the investment and its materiality in the context of the total portfolio. Methodologies are applied consistently from period to period, except where a change would result in a better estimation of Fair Value. Given the uncertainties inherent in estimating Fair Value, a degree of caution is applied in exercising judgments and making the necessary estimates. Quoted investments Quoted investments are valued at the closing mid-market price at the reporting date. This value is reduced by a Marketability Discount of between 0% and 25% dependent on the size of the Group’s holding relative to normal trading volumes in that stock. Where there are formal restrictions on dealing in a particular security, a discount is applied, reducing over the term of the restriction. In the case of a six-month restriction, a discount of 20% would normally be used. Unquoted investments Most unquoted investments are valued using one of the following methodologies: – cost, less any required provision; – earnings multiple; – net assets; – price of recent investment; – expected sales proceeds. New investments are valued at cost for the first 12 months and then until another methodology becomes more appropriate. This generally occurs when the first full set of accounts covering a period of at least six months since the date of investment becomes available. Any investment in a company that has failed or is expected to fail within the next 12 months has the equity shares valued at nil and the fixed income shares and loan instruments valued at the lower of cost and net recoverable amount. Generally, the process of estimating the Fair Value of an investment involves selecting one of the above methodologies and using that to derive an Enterprise Value for the investee company. The process is then to: – deduct from the Enterprise Value all financial instruments ranking ahead of the Group; – apply an appropriate Marketability Discount; – apportion the remaining value over the other financial instruments including the Group’s loans, fixed income shares and equity shares. Where that apportionment indicates a shortfall against the loans or fixed income shares, then the Group considers whether, in estimating Fair Value, the shortfall should be applied, and if so, to what extent. The Marketability Discount will generally be between 10%-30% with the level set to reflect the Group’s influence over the exit prospects and timing for the investee company. When using the earnings multiple methodology, earnings before interest and tax (“EBIT”) are used, adjusted to a maintainable level and taxed at the standard corporation tax rate. Generally, the latest full year historical accounts are used unless there is an indication of a forecast downturn in earnings in the current or forecast year, in which case those earnings may be used. An appropriate multiple is applied to these earnings to derive an Enterprise Value. Normally the multiple will be the average taxed EBIT multiple for the relevant sector of the FTSE Global SmallCap Europe index, adjusted downwards by the Group to exclude loss- making companies. Where a company reports an operating loss or the industry standard valuation methodology is by reference to the asset base, then the value may be estimated using the net assets methodology. The price of recent investment methodology is used mainly for investments in venture capital companies and includes cost of the investment or valuation by reference to a subsequent financing round. Valuation increases above cost are only recognised if that round involved a new external investor and the company is meeting milestones set by the investors. The relevance of this methodology can be eroded over time due to changes in the technology, business or market which may indicate an impairment has occurred. In this case, carrying values will be reduced to reflect Fair Value. Other factors that may be taken into account include: – the expected effect of ratchets, options and liquidation preferences; – any industry standard valuation methodology; – offers received as part of a sale process which may either support the value derived from another methodology or be used as the valuation less a Marketability Discount of typically 10%. For the Group’s smaller investments, the valuation is determined by a more mechanistic approach using information from the latest audited accounts. Equity shares are valued at the higher of an earnings or net assets methodology. Fixed income shares and loan investments are valued at the lower of cost and net recoverable amount. Approximately 15% by value of the Group’s unquoted investments are valued using this methodology. An analysis of the portfolio by valuation method is given in the portfolio analysis on page 73. 69 3i Report and accounts 2004 Ten largest investments At 31 March 2004, the Directors’ valuation of the ten largest investments was a total of £557 million. These investments cost £284 million. Investment SR Technics Holding AG Technical solutions provider for commercial aircraft fleets Equity shares Loans Fonecta Group Oy Directory services Equity shares Loans Betapharm Arzneimittel GmbH4 Supplier of generic prescription drugs Equity shares Loans Westminster Health Care Holdings Ltd Care homes operator Equity shares Loans Travelex Holdings Ltd5 Foreign currency services Equity shares De Telefoongids Holding BV Directory services Equity shares Loans ERM Holdings Ltd6 Environmental consultancy Equity shares Loans Pets at Home Group Ltd Retailer of pets and pet supplies Equity shares Loans Williams Lea Group Ltd Outsourced print services Equity shares Malmberg Investments BV Educational publisher Equity shares Loans First invested in 2002 2002 2003 2002 1998 2002 2001 1995 1965 2001 Cost1 £m Proportion of equity shares held Directors’ valuation1 £m Income in the year2 £m Net assets3 £m Earnings3 £m 32.2% 33.5% 66.2% 49.6% 19.6% 22.1% 38.1% 26.0% 38.1% 41.8% 6 32 38 4 – 4 3 61 64 1 37 38 – – 8 15 23 – 32 32 2 25 27 33 33 7 18 25 45 32 77 67 – 67 3 61 64 20 37 57 57 57 40 15 55 15 32 47 21 25 46 45 45 24 18 42 – 2 2 – 2 2 – – – 2 3 5 – – – 1 1 – 2 2 – 2 2 – – – 1 1 6 (2) 15 2 6 4 45 15 30 (3) (4) (2) 18 18 39 16 4 – Notes 1 The investment information is in respect of the Group’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 2004. 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 the Group, 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 Betapharm Arzneimittel GmbH was incorporated in 2003 and no audited accounts are available, consequently no net assets or earnings are disclosed. 5 The cost of the equity held in Travelex Holdings Ltd is £121,000. 6 The cost of the equity held in ERM Holdings Ltd is £398,000. 70 3i Report and accounts 2004 Forty other large investments In addition to the ten largest investments shown on page 70, detailed below are forty other large investments which are substantially all of the Group’s remaining investments valued over £15 million. This does not include three investments, which have been excluded for commercial reasons. Investment Tato Holdings Ltd Pharmadule Emtunga AB Smartstream Technologies Group Ltd Aspen Insurance Holdings plc2 Cannon Avent Group plc Refresco Holding BV Ben Sherman Ltd Pinewood Shepperton plc Total Home Entertainment Ltd Grup Maritim TCB SL Morse plc2 Beltpacker plc PaperPak Holdings Ltd Extec Holdings Ltd Goromor XXI SL Early Learning Holdings Ltd Nimbus Holdings Ltd HSS Hire Service Holdings Ltd Mettis Group plc Target Express Ltd Petrofac Ltd E2V Holdings Ltd LDV Ltd Alö intressenter AB Vendôme SA Westvan (2001) Ltd CSR plc2 Azzurri Communications Ltd SCP Global Technologies, Inc Local Press Ltd LGC Ltd Deutsche Telefon Und Marketing Services AG Incline Global Technology Services Ltd Specialised Petroleum Services Group Ltd Kaye Office Supplies Ltd Venture Production plc2 Litchwer Pharma AG Asia Multiplex SARL Corinth Healthcare Ltd Mölnlycke Health Care AB Description of business Manufacture and sale of specialist chemicals Modular facilities to pharmaceutical/biotech, offshore and telecom sectors Software and services Property/casualty insurance underwriters Manufacture of branded consumer products Fruit juice producer Manufacture of shirts and swimwear Film/TV studios Wholesale and distribution of home entertainment products Operation of port concessions Technology reseller Manufacturer/marketing healthcare/beauty products, footwear, accessories Manufacture of incontinence products Mobile crushers, screeners and shredders Manufacturer of frites and glazes for ceramic tiles Branded designer and retailer of educational toys Music label and entertainment Tool hire Manufacture and sale of forgings Freight transport by road Oilfield services Switching, sensing and imaging components Manufacture of light commercial vehicles Manufacture of front end loaders Manufacturer of cosmetic and toiletry products Speciality paper manufacturer Single-chip wireless devices Telecommunication services Semiconductor CAP equipment Newspaper publisher Research laboratory Service telephony Repair and remanufacture of flat panel displays Oilfield wellbore clean up Stationery and office equipment wholesalers Oil and gas production Producer of herbal medicines Multiplex cinema operator Provision of locum and managed services to the healthcare market Manufacture of single-use surgical and wound care products Notes 1 The investment information is in respect of the Group’s holding and excludes any co-investment by 3i managed funds. 2 Quoted company (including secondary markets). First invested in 1989 2003 2000 2002 1995 2003 1993 2000 2003 1999 1995 2000 2002 2002 2002 2001 2001 2004 1999 2000 2002 2002 1993 2002 2002 1995 1999 2000 2003 2004 1996 1998 2002 1999 1993 1997 2004 2002 2000 2001 Cost1 £m 2 35 26 30 5 31 4 20 28 13 8 55 14 11 24 6 24 24 38 43 22 14 18 21 11 15 3 15 14 18 – 9 17 16 6 5 16 10 10 14 Directors’ valuation1 £m 37 35 34 34 32 31 31 30 28 28 27 26 26 24 24 24 24 24 23 22 22 22 20 20 20 20 20 19 18 18 18 17 17 17 16 16 16 15 15 15 71 3i Report and accounts 2004 New investment analysis Analysis of the equity, fixed income and loan investments made by the Group. This analysis excludes investments in joint ventures. Investment by product (£m) Buy-outs Growth capital Venture capital Total 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 Italy Nordic Spain Other European† Total † Other European includes investments in countries where 3i did not have an office at 31 March 2004. Investment by FTSE industrial classification (£m) Resources Industrials Consumer goods Services and utilities Financials Information technology Total 2004 492 313 174 979 309 401 61 13 784 375 526 61 17 979 73 89 186 19 106 34 19 526 11 219 306 290 33 120 979 2003 482 273 176 931 318 304 74 20 716 399 436 74 22 931 67 36 149 32 69 75 8 436 12 328 194 197 54 146 931 2002 361 258 420 1,039 377 312 119 26 834 443 446 119 31 1,039 64 84 146 13 90 45 4 446 15 110 206 352 26 330 1,039 2001 687 362 923 1,972 786 560 134 49 1,529 1,006 770 134 62 1,972 63 117 346 64 16 131 33 770 67 256 371 482 55 741 1,972 2000 579 340 457 1,376 705 306 28 31 1,070 894 422 28 32 1,376 39 84 130 48 – 95 26 422 17 201 167 546 48 397 1,376 72 3i Report and accounts 2004 Portfolio analysis The Group’s equity, fixed income and loan investments total £4,326 million at 31 March 2004. Portfolio value by product (£m) Buy-outs Growth capital Venture capital Total 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 Italy Nordic Spain Other European† Total † Other European includes investments in countries where 3i did not have an office at 31 March 2004. 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 (including other technology assets valued below cost) Loan investments and fixed income shares Total 2004 2,306 1,487 533 4,326 3,024 2,299 241 86 5,650 2,506 1,511 234 75 4,326 181 234 454 53 332 224 33 1,511 155 1,018 1,026 1,275 238 614 4,326 174 225 29 1,347 509 149 103 328 1,462 4,326 2003 2,001 1,349 589 3,939 3,041 1,773 182 101 5,097 2,494 1,175 180 90 3,939 101 186 319 69 273 211 16 1,175 186 944 873 1,018 274 644 3,939 37 187 30 938 607 155 139 282 1,564 3,939 2002 2,253 1,814 1,042 5,109 4,018 1,984 270 101 6,373 3,386 1,373 264 86 5,109 78 253 385 103 304 222 28 1,373 268 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 2,338 2,099 1,368 5,805 4,792 2,039 246 98 7,175 4,121 1,363 235 86 5,805 92 254 556 142 26 234 59 1,363 232 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 2,622 2,357 991 5,970 5,240 1,514 192 64 7,010 4,668 1,049 190 63 5,970 59 203 533 71 6 135 42 1,049 185 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 73 3i Report and accounts 2004 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 Venture capital portfolio value by valuation method (£m) Imminent sale or IPO Earnings Cost Further advance Net assets Other technology assets valued below cost Other Loan investments and fixed income shares Total Technology portfolio value by stage (£m) Venture capital Late stage technology Quoted Buy-outs Growth capital 2004 103 103 1 834 78 20 61 1,106 2,306 38 122 28 513 202 32 82 169 301 1,487 33 – 229 117 1 64 34 55 533 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 79 19 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 23 10 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 15 56 176 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 2 26 165 991 533 589 1,042 1,368 991 136 305 317 758 1,291 103 294 250 647 1,236 290 214 170 674 1,716 723 231 7 961 2,329 1,074 312 2 1,388 2,379 181 223 166 421 991 Total The venture capital 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. Venture capital portfolio value by sector (£m) Healthcare Communications Electronics, semiconductors and advanced technologies Software Total 169 117 73 174 533 195 112 72 210 589 288 185 139 430 1,042 237 264 140 727 1,368 74 3i Report and accounts 2004 Realisations analysis Analysis of the Group’s realisations proceeds (excluding third party co-investment funds). Realisations proceeds by product (£m) Buy-outs Growth capital Venture capital Total 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 2004 464 339 120 923 608 245 10 60 923 7 118 532 266 923 14 216 167 352 80 94 923 2003 613 270 93 976 727 238 2 9 976 37 110 493 336 976 60 294 192 330 42 58 976 2002 308 370 261 939 794 133 10 2 939 55 370 303 211 939 52 193 255 288 18 133 939 2001 530 351 670 1,551 1,366 181 – 4 1,551 253 536 470 292 1,551 34 211 278 338 33 657 1,551 2000 538 435 159 1,132 986 145 – 1 1,132 48 351 423 310 1,132 6 197 176 497 20 236 1,132 Funds under management (£m) Third party unquoted co-investment funds Quoted investment companies† Total † Also includes the 3i Group Pension Plan. 2004 1,875 600 2,475 2003 1,587 452 2,039 2002 1,995 761 2,756 2001 2,131 870 3,001 2000 2,261 818 3,079 75 3i Report and accounts 2004 Private equity and venture capital – an introduction Nature of private equity and venture capital The private equity and venture capital industry covers three broad categories of investment: – Early stage investment (sometimes called “venture investment”) – this is investment in early stage or start up businesses, usually engaged in life sciences research or technology development activities. Here, the investor (“the VC”) would usually take a minority equity stake (i.e. less than 50% of the equity shares) in the business as part of a syndicate of venture investors; and the aim of the investment is to provide funding for development or research expenditure through a series of investment “rounds”. Progress and prospects are re-assessed ahead of the provision of further funding. – Growth capital (or development capital) investment – this involves the provision of capital to accelerate the growth of established businesses and generally involves the VC taking 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. – Buy-out investment – this involves the purchase of an existing independent business or subsidiary or division of a corporate group from its current owners. This category of investment includes management buy-outs, management buy-ins, institutional buy-outs, etc. Here, the equity in the post buy-out business is usually shared between the management team and the VC, with the VC usually holding a majority stake. The finance for the buy-out would generally comprise around 60% of senior and mezzanine debt (usually provided by banks and mezzanine providers), with substantially all of the balance of the purchase price coming from the VC and a relatively small amount coming from the management team. In order to reflect the mismatch between the equity finance provided by the VC and the management team and the equity stake taken by each in the underlying business, a large part of the VC’s finance is generally provided in the form of redeemable preference shares or shareholder loans. Like any other investment, the objective of the VC is to earn attractive returns on its investment commensurate with the risk being Investment objective taken. The returns come either in the form of income (interest, dividends or fees) or capital gains. The contrast with investment in quoted companies is that the VC will usually prefer to crystallise its capital gain through a trade sale (i.e. a sale to a corporate purchaser) or flotation on the public markets of the underlying business. This preference tends to make private equity and venture capital investment medium to long term in nature, since time is required to implement the value growth strategy for the business and there will also be a wish to optimise the timing of the “exit”. The investment lifecycle capability on the part of the VC: The investment lifecycle for an investment can be broken down into five distinct phases, with each involving significant resource and – Origination – the ability to access and create investment opportunities is critical to the VC’s business model. – Developing and validating the investment case – this phase involves capability in the areas of judgment, knowledge and experience within the particular business area in which the opportunity lies; building a management team and working with them to develop the value growth strategy; consideration of the exit strategy; and due diligence on all significant assumptions and inputs to the investment case. – Structuring and making the investment – this phase involves financial structuring, negotiation and project management skills on the part of the VC. Relationships with banks, mezzanine finance providers, intermediaries and others are also important. – Implementing the value growth strategy – this phase involves “actually making it happen”, delivering value growth between making the investment and exit. If the strategy involves corporate acquisitions or mergers, restructuring the business, achieving growth in turnover or operating profits, the VC would need to have the required capability to ensure these are achieved. As important is the ability to assess and strengthen the management team as the life cycle proceeds – this might involve having access to a pool of management talent in order to match a particular need to a particular management skill-set. – Exit – this phase generally involves a trade sale or flotation of the underlying business. Exit prospects and strategy should generally be reviewed on an ongoing basis during the investment’s life – and the sale or flotation itself requires resource and capability from the VC, since both are lengthy and complex processes. Types of investment vehicle The predominant vehicle in the industry is the independent, private, fixed-life, closed-end fund, usually organised as a limited partnership. These funds typically have a fixed life of 10 years. Investments generally consist of an initial commitment of capital which is then drawn down as the investment manager finds investment opportunities. Capital is returned to the investor via earnings distributions and sales of investments. Some investment vehicles are organised as captive or semi-captive funds. A captive fund invests only for the interest of its parent organisation (which may be a bank or investment bank, insurance company, university, or whatever). A semi-captive fund mixes capital from both outside investors and the parent organisation. Both captive and semi-captive funds tend to be “evergreen” in nature – income from investments and proceeds received on the realisation of investments are substantially retained for further investment rather than being returned to investors. There are also a limited number of private equity and venture capital investment companies, such as 3i, whose shares are listed on a stock exchange. These tend to be evergreen in nature and offer investors a relatively liquid exposure to private equity and venture capital. Drivers of private equity and venture capital investment Some of the main drivers giving rise to investment opportunities are as follows: – Stock market conditions and M&A activity levels – a strong stock market acts in many ways as an “engine” for private equity and venture capital, since it allows acquisitive listed companies to purchase businesses at attractive prices and also is more receptive to businesses seeking a listing. The ability of the VC to “exit” at reasonably high values is a key part of the investment model, and exit assumptions will be a key input to the pricing parameters at the time of investing. In addition, strong activity levels in the M&A market (which will often follow from good stock market conditions) tend to provide a source of investment opportunities when the acquiring group disposes of the unwanted parts of the business acquired. – Restructuring by large corporate groups – as corporate groups change strategic direction or focus on core activities, they will often seek to sell unwanted or non-core subsidiaries or divisions, providing a good source of buy-out opportunities. – Entrepreneurial culture – this is to do with the eagerness, across a society, of individuals to start up or grow businesses or to give up a secure corporate job for the opportunity to run or manage an independent business. – Growth strategies – the pursuit of profits by businesses will often involve the use of growth strategies. Whether the strategy is to grow organically or through acquisition, there will usually be a funding requirement, which can be met through the provision of growth capital. – Regulatory factors – regulatory factors will often act to force corporations to sell off business units or to limit or restrict courses of action by parties operating in the complex world of business. Additionally, regulatory factors can act to incentivise certain types of investment or courses of action. Either way, regulation can give rise to investment opportunity for private equity and venture capital. – Technological developments and expenditure on information technology technology area, as entrepreneurs seek to exploit the development and research opportunities arising. – both of these factors act as engines for investment in the early stage – Succession issues – especially in family-owned businesses, succession issues can give rise to investment opportunities. 76 3i is a world leader in private equity and venture capital. We focus on buy-outs, growth capital and venture capital 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. These underpin the value that we deliver to our portfolio and to our shareholders. 3i Report and accounts 2004 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 2004 1 UK (including retail shareholders) 2 Continental Europe 3 US 4 Other international Share price Share price at 31 March 2004 High during the year (19 February 2004) Low during the year (1 April 2003) 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 16 June 2004 18 June 2004 11.00 am 7 July 2004 16 July 2004 January 2005 79.08% 6.81% 11.94% 2.17% 629p 686p 418p % 2.53 3.22 4.42 20.37 49.82 19.64 100.00 Number of holdings Individuals 27,543 6,513 176 22 0 0 34,254 Number of holdings Corporate bodies 2,968 2,185 603 371 101 7 6,235 Balance as at 31 March 2004 15,549,390 19,733,637 27,107,090 124,970,339 305,631,519 120,487,184 613,479,159 The table above provides details of the number of shareholdings within each of the bands stated in the Register of Members at 31 March 2004. 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 3970 Investor relations and general enquiries For all investor relations and general enquiries about 3i Group plc, including requests for further copies of the 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 e-mail ir@3igroup.com or visit our 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 authorised and regulated by the Financial Services Authority as a deposit taker. Designed and produced by Radley Yeldar (London). Printed by CTD Printers Limited. 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. Contents 02 Chairman’s statement 04 Chief Executive’s statement 06 Our business focus 08 Operating and financial review 25 Corporate responsibility report 30 Board of Directors 32 Directors’ report 38 Remuneration report 46 Independent auditors’ report Financial statements 47 Consolidated statement of total return 47 Reconciliation of movement in shareholders’ funds 48 Consolidated revenue statement 49 Consolidated balance sheet 50 Parent company balance sheet 51 Consolidated cash flow statement 52 Accounting policies 54 Notes to the accounts 68 Principal subsidiary undertakings and joint ventures Additional financial information 69 Portfolio valuation methodology 70 Ten largest investments 71 Forty other large investments 72 New investment analysis 73 Portfolio analysis 75 Realisations analysis 75 Funds under management 76 Private equity and venture capital – an introduction Inside back cover Information for shareholders Investor relations and general enquiries With thanks to the members of the 3i team who took part in the photography contained in this report. 3i Group plc 91 Waterloo Road London SE1 8XP UK Telephone +44 (0)20 7928 3131 Fax +44 (0)20 7928 0058 Website www.3igroup.com M39404 May 2004 3i Group plc Report and accounts 2004 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 4 

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