Qinetiq Group Plc Annual Report 2013

Plain-text annual report

Q i n e ti Q G r o u p p l c A n n u a l R e p o r t a n d A c c o u n t s 2 0 1 3 Committed to delivering value QinetiQ Group plc Annual Report and Accounts 2013 Performance highlights Robust Group performance in tough markets Revenue £1,327.8m 2013 2012 Net cash/(debt) £74.0m £1,327.8m £1,469.6m 2013 2012 Underlying operating profit* £168.7m 2013 2012 Underlying operating margin* 12.7% £168.7m £159.6m^ 2013 2012 Underlying operating cash conversion* 104% Underlying earnings per share* 18.9p 2013 2012 Total dividend 3.80p 2013 2012 104% 148%^ 2013 2012 (Loss)/profit after tax (£133.2m) 3.80p 2.90p 2013 2012 £74.0m (£122.2m) 12.7% 10.9%^ 18.9p 13.6p^ (£133.2m) £246.3m^ All statements other than statements of historical fact included in this Annual Report, including, without limitation, those regarding the financial condition, results, operations and businesses of QinetiQ and its strategy, plans and objectives and the markets and economies in which it operates, are forward- looking statements. Such forward-looking statements, which reflect management’s assumptions made on the basis of information available to it at this time, involve known and unknown risks, uncertainties and other important factors which could cause the actual results, performance or achievements of QinetiQ or the markets and economies in which QinetiQ operates to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Nothing in this Annual Report should be regarded as a profit forecast. This Annual Report is intended to provide information to shareholders and is not designed to be relied upon by any other party. The Company and its Directors accept no liability to any other person other than under English law. Note: Year references (2013 and 2012) relate to the year ended 31 March. * Definitions of underlying measures of performance can be found in the glossary on page 116. ˄ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. Who we are We are experts in defence, aerospace and security. We employ more than 9,000 people worldwide, and our scientists and engineers solve some of the world’s most important problems. What we do We offer high-end technical knowledge underpinned by world-class research and innovation. We supply advice, assurance, test and evaluation, engineering solutions and training. Why we are different Our customers face challenges that define the modern world. They know that we are uniquely placed to understand these issues and work with them to ensure the success of their mission. Our people make the critical difference to customers by providing unique answers which combine technical expertise, deep domain knowledge and rigorous independent thinking. How we build confidence Our prized possession is trust. Customers around the world rely on the drive and dedication of our people to help them meet their goals – often in environments where there is no second chance for failure. We aim to deliver solutions that work first time, every time. Download our Investor Relations App You can view this Annual Report and Accounts and other results materials at QinetiQ.com. In addition, the QinetiQ Investor Relations App gives you all the latest investor and financial media information. The App allows you to get the latest share price information and corporate news, as well as review financial reports. www.QinetiQ.com Overview 1 2 4 Introduction Group overview Chairman’s statement Business review Chief Executive’s review 5 Strategy and business model 8 12 Key performance indicators 14 Operations review – UK Services 18 Operations review – US Services 22 Operations review – Global Products Chief Financial Officer’s review 24 Risks and uncertainties 30 Corporate responsibility 34 and sustainability review Corporate governance Board of directors 38 Corporate governance report 40 50 Remuneration report 62 Other statutory information 64 Statement of Directors’ responsibilities Financial statements 65 66 67 Independent auditor’s report Consolidated income statement Consolidated statement of comprehensive income Consolidated statement of changes in equity Consolidated balance sheet Consolidated cash flow statement Reconciliation of movement in net cash/debt Notes to the financial statements 67 68 69 69 70 112 Company balance sheet Notes to the Company 113 financial statements Five-year record 115 Additional information 116 Glossary 117 Shareholder information 118 Additional information QinetiQ Group plc Annual Report and Accounts 2013 1 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationOverview Group overview Understanding our business QinetiQ Group plc is a global business, listed on the London Stock Exchange. It employs over 9,000 employees principally in the UK and North America. Our services offerings, which account for more than 80% of total sales, are focused on providing expertise and knowledge in national markets. Our products business focuses on the provision of technology-based solutions to meet customer requirements, complemented by contract-funded research and development on a global basis. Under the QinetiQ brand we operate numerous businesses across multiple platforms, as illustrated below. This diversified portfolio is underpinned by a selection of long-term contracts. Reporting structure Read more on pages 14-23 Markets UK Services Defence US Services Global Products A i r W e a p o n s M a r i ti m e A u s t r a l i a i T r a n n g & i l S i m u a ti o n S e r v i c e s Revenue streams Research Relationship-based value selling at a fixed price or cost plus project consultancy contracts. Advice Contracts based on the provision of advice and specific facility services including manpower services. Test & Evaluation Long-term fixed price contracts with additional ad-hoc testing and evaluation projects. Advanced technology solutions Low volume, defence focused, bespoke requirements with incremental revenue from software, services and after sales support. Intellectual property exploitation and licensing Royalties and licence fees from third-party exploitation of intellectual property. 2 QinetiQ Group plc Annual Report and Accounts 2013 l l l l l l l l l l l l l l l l l l l l l l l C 4 I S R S e r v i c e s A c q u i s i ti o n l l l l l l l l S e c u r i t y l l l l C y v e i l l a n c e ® l l l l M i s s i o n S o l u ti o n s S y s t e m s A e r o s p a c e O p e r a ti o n s & E n g i n e e r i n g S y s t e m s S o ft w a r e & S o l u ti o n s L i f e c y c l e S u r v i v a b i l i t y S y s t e m s U n m a n n e d M a r i ti m e & T r a n s p o r t a ti o n O p t a S e n s e ® l l l l l l l l l l l l l l l l l l l l l l l l l l l S p a c e l l l l N e w T e c h n o l o g i e s l l l l Reporting structure Read more on pages 14-23 Markets Revenue by division (£m) Revenue by major customer type (£m) 19% 36% 45% UK Services US Services Global Products Total 2013 £m 597.3 475.6 254.9 1,327.8 2012 £m 610.1 534.5 325.0 1,469.6 36% 17% 47% UK Government US Government Other Total 2013 £m 480.3 620.8 2012 £m 482.8 730.5 226.7 1,327.8 256.3 1,469.6 Underlying operating profit* by division (£m) Revenue by geography (£m) 36% 51% 13% UK Services US Services Global Products Total 2013 £m 85.8 21.9 61.0 168.7 2012^ £m 61.3 32.1 66.2 159.6 7% 42% 51% United Kingdom North America Other Total 2013 £m 560.4 672.7 94.7 1,327.8 2012 £m 570.1 788.7 110.8 1,469.6 UK Services US Services Global Products A i r W e a p o n s M a r i ti m e A u s t r a l i a C 4 I S R S e r v i c e s A c q u i s i ti o n Revenue streams Research Relationship-based value selling at a fixed price or cost plus project consultancy contracts. Advice Contracts based on the provision of advice and specific facility services including manpower services. Test & Evaluation and evaluation projects. Long-term fixed price contracts with additional ad-hoc testing Advanced technology solutions Low volume, defence focused, bespoke requirements with incremental revenue from software, services and after sales support. Intellectual property exploitation and licensing Royalties and licence fees from third-party exploitation of intellectual property. l l l l l l l l l l l l l l l l l l T r a i n i n g & S i m u l a ti o n S e r v i c e s l l l l l l l l l l l l l S e c u r i t y l l l l Security Government Defence Other M i s s i o n l S o u ti o n s S y s t e m s A e r o s p a c e O p e r a ti o n s & E n g i n e e r i n g S y s t e m s S o ft w a r e & l S o u ti o n s L i f e c y c l e S u r v i v a b i l i t y S y s t e m s U n m a n n e d M a r i ti m e & T r a n s p o r t a ti o n O p t a S e n s e ® C y v e i l l a n c e ® l l l l l l l l l l l l l l l l l l l l l l l l l l l l l l l S p a c e l l l l N e w T e c h n o o g i e s l l l l l * Definitions of underlying measures of performance can be found in the glossary on page 116. ^ IAS 19 (revised) ‘Employee benefits’ has been adopted for FY13 and the FY12 comparatives have been restated accordingly. QinetiQ Group plc Annual Report and Accounts 2013 3 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationOverview Chairman’s statement Recognising the importance of shareholder returns Mark Elliott Chairman The Results The Group delivered a robust performance with underlying operating profit* increasing 6% to £168.7m (2012: £159.6m^). This was achieved despite revenue decreasing 10% on an organic basis at constant currency, principally reflecting the impact of continued budget uncertainty in the US on federal services spending and the expected second half reduction in conflict-related products. The underlying operating margin* increased to 12.7% (2012: 10.9%^), as a result of improvements in utilisation rates and project margins in UK Services, enhanced by the mix of Global Products sales that included a large proportion of spares. In addition, there was a one-off credit of £6m relating to a contract extension. These improvements more than offset lower margins in US Services. Underlying profit before tax* was £152.1m (2012: £110.2m^) with underlying net finance costs* falling to £16.6m (2012: £49.4m^), reflecting accelerated interest costs of £27.4m in the prior year following the completion of the programme to repay $177m of private placement debt. Full year underlying earnings per share* were 18.9p (2012: 13.6p^), a 39% increase, benefitting from the increase in operating profit and the decision in the prior year to pay down private placement debt. Significant adjusting items included a non-cash impairment of £255.8m to the acquired goodwill in the US Services division and a net exceptional restructuring cost of £16.3m (2012: £69.4m gain) primarily resulting from actions to place the US cost base on a more competitive footing, as indicated at the pre-close statement on 28 March 2013. Following the adoption of IAS 19 (revised) ‘Employee benefits’, net pension finance expense of £1.3m (2012: £7.2m^), is also included in adjusting items. Including these significant items, the statutory loss after tax was £133.2m (2012: £246.3m^ profit). Excluding the impact of £65m received from the Ministry Of Defence (MOD) in April 2012, underlying cash flow from operations* was £175.9m (2012: £235.4m) and underlying operating cash conversion* remained strong at 104% (2012: 148%^), despite increased contract-funded capital expenditure in UK Services. At 31 March 2013, the Group had achieved a net cash position of £74.0m, compared with net debt of £122.2m at 31 March 2012. Dividend The Board proposes a final dividend of 2.70p per share for the year ended 31 March 2013 (31 March 2012: 2.00p) making the full year dividend 3.80p (31 March 2012: 2.90p). Subject to approval at the Annual General Meeting, the final dividend will be paid on 6 September 2013 to shareholders on the register at 9 August 2013. The full year dividend represents an increase of 31% on the prior period and is in line with the Group’s progressive dividend policy, reflecting in-year growth in underlying earnings per share* and the Group’s commitment to delivering value to shareholders. Strategy Good progress has also been made in implementing the next phase of QinetiQ’s development, Organic-Plus. This programme is focused on building a leading technology-based solutions group with growing sustainable earnings, by applying the innovation and capabilities of our people in targeted sectors. The Group portfolio is actively managed to maximise value from strong defensible 4 QinetiQ Group plc Annual Report and Accounts 2013 core businesses, well positioned for growth once markets stabilise, and to explore a number of potentially scalable growth opportunities, while constantly testing emerging technologies for commercialisation. Our people QinetiQ’s success lies in its ability to recruit, retain and develop the skills of its employees. We have a track record of attracting some of the most talented scientific and technically minded individuals in the marketplace including apprentices and graduates, giving them the opportunity to use their skills on the most challenging problems in today’s world. We constantly strive to ensure we attract and develop the most diverse workforce in order that we can leverage this to solve customer challenges. Customer feedback recognises the unique skillset of our people and their ability to apply their knowledge to specific challenges. We take great pride in employing ‘People Who Know How.’ On behalf of the Board, I would like to thank all of our employees for their commitment and effort during this year. Corporate responsibility As a business operating across a broad spectrum of communities and geographies, we take our responsibilities as an employer and as a stakeholder in those communities very seriously. We are aware of the impact of our operations and have a range of programmes in place including environmental management, business ethics and community investment. We are mindful of the unique privilege that we have as a business working with customers with critical missions at their heart. Governance Effective management of risks and opportunities is essential to the delivery of the Group’s strategic objectives, as are achievement of sustainable shareholder value, protection of the Group’s reputation and meeting the requirements of good corporate governance. The Board is focused on ensuring a high standard of corporate governance is upheld across the Group. During the year, we made considerable progress to improve the effectiveness of our risk management processes and procedures (pages 30-33). Outlook Overall, the Group has delivered a robust performance in tough markets. UK Services was the stand-out performer, demonstrating its unique strengths as well as the benefits of our self-help programme, with Global Products continuing to diversify into non-conflict technologies such as OptaSense®, space technology and power line sensors. The decline in performance of US Services reflected the continuing very challenging market conditions and we have decided to initiate a strategic review of this division to determine the best way to maximise its value. A key step in transforming QinetiQ has been the achievement of net cash. Having paid down over half a billion pounds of debt in three years, we have both financial resilience and capacity to invest. We are now committed to delivering value by building a Group capable of both growth and high quality returns. UK Services is expected to remain steady this year but the heightened uncertainty around US federal services spending is causing low levels of visibility in US Services. As anticipated, budgetary pressures and the drawdown effect seen towards the end of last year are continuing to affect the timing and quantity of sales in Global Products. While the range of possible outcomes is wider than usual at this stage in the year and the full impact of sequestration remains unclear, the Board is maintaining its expectations for overall Group performance in the current year absent any material changes in customer requirements. Mark Elliott Chairman 23 May 2013 * Definitions of underlying measures of performance can be found in the glossary on page 116. ˄ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. People Who Know How to deliver space travel Our ion engines are ten times more efficient than conventional rockets, making the once impossible possible – like a new generation of leaner, faster, cheaper communications satellites, propelling a spacecraft at seven times the speed of a rifle bullet at the boundary of space or enabling ambitious missions to the inner and outer planets. People Who Know How to provide 21st century flight test training The Empire Test Pilots’ School (ETPS) trains flight test professionals from around the world. We were the first, and have been doing it for 70 years. Research, design, advice, disposal – QinetiQ is at the centre of aviation. People Who Know How to provide real-time information We’re the world leader in distributed acoustic sensing. OptaSense® is revolutionising oil well completion, fracking and seismic operations as well as ensuring pipeline integrity, by providing real-time, decision-ready information. We are building The Earth’s Nervous SystemTM. People Who Know How to keep people safe During Hurricane Sandy, real-time social media trending information delivered by Cyveillance® helped New Jersey’s emergency services respond more effectively to citizens in desperate need of assistance. People Who Know How to build confidence on the battlefield If you know what’s happening on the battlefield, you know the difference between victory and defeat. With our robotic systems and controllers, one operator can command multiple unmanned aircraft, vehicles and sensors to make the right decision, right away. People Who Know How to steer customers in the right direction If a submarine – or surface ship – runs aground, that’s a crisis. The commander has to do specific things in an optimal sequence. That’s where our decision support tools and expert advice help in the recovery process. People Who Know How to work in cyberspace Britain faces up to 1,000 cyber attacks every hour. Cyber crime costs the UK £27 billion annually. What to do? Invest in the cyber recruits who will defend our digital economy and national security. That’s why we sponsor the Cyber Security Challenge. Read more at cybersecuritychallenge.co.uk Good progress has been made in implementing Organic-Plus, our next phase of development, to continue growing sustainable earnings. For more information visit: www.QinetiQ.com Chief Executive’s review Committed to delivering value QinetiQ’s transformation began with a 24 month self-help programme. The portfolio was refocused to align with customers’ changing needs, to ensure a full understanding of profit potential, and to determine which businesses are scalable into significant core units. The Group is now organised as distinct businesses, each representing one of QinetiQ’s key areas of capability, with an accountable leader and a clear route map to maximise future performance. The new cadre of leaders running these businesses is building an open, commercial culture which has enabled the recent delayering of leadership in both the UK and the US. The self-help programme also addressed the Group’s immediate financial situation, driving a reduction in debt of over half a billion pounds in three years. Today the Group’s balance sheet carries net cash and has the strength to weather challenging defence markets and the capacity for carefully targeted investment choices. The Organic-Plus programme continues the disciplines established during phase one, including a focus on cash generation. This in turn enables investments in growth managed through a rigorous process for prioritising resources and monitoring returns. The goal is to drive value from the portfolio by investing in ‘Core’ capabilities which can win market share, while nurturing a select number of established (‘Explore’) services and solutions to determine their ability to scale into future core businesses. Early stage (‘Test for Value’) technologies and offerings come under evaluation as they are generated, to determine the best route to exploit value, including potential partnerships, divestment or closure. In parallel with the drive for profitable growth, over 1,400 projects have been implemented to date through the My Contribution programme, reducing costs substantially and driving improved productivity. Many of these projects directly help customers, so that QinetiQ’s people provide a critical point of difference for the Group in delivering ‘more for less’. The insights, engagement and dedication of the Group’s engineers and scientists feed directly into winning and retaining business – a unique value captured not only in the QinetiQ strapline of ‘People Who Know How’; but in the UK Fellows’ network which brings together a cadre of senior people recognised nationally and internationally for their particular technical expertise. A strategic review has been initiated to determine the route to maximum value in US Services. This division, which has been restructured, possesses some strong capabilities and market positions, but the Group needs to determine the best way to maximise its performance and potential. A business-by-business update on the Organic-Plus programme is provided in this review. Leo Quinn Chief Executive Officer Highlights Robust overall Group performance in tough markets during 2013: • 6% increase in underlying operating profit* driven by excellent performance in UK Services • Net cash position achieved through strong cash generation • 31% increase in full year dividend, reflecting in-year growth in underlying earnings per share* and the Group’s commitment to delivering value Good progress implementing Organic-Plus programme as route to delivering value: • Agreed five-year, £998m re-pricing of Long Term Partnering Agreement (LTPA) with MOD, underpinning core UK Services business • Non-cash £256m goodwill impairment in US Services; initiating strategic review • Expanding Global Products portfolio to increase focus on non-conflict markets • Positioning for sustainable earnings growth over the medium term * Definitions of underlying measures of performance can be found in the glossary on page 116. QinetiQ Group plc Annual Report and Accounts 2013 5 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Executive’s review continued Q&A with Leo Quinn Q Why do you call this a ‘transformation’, not a ‘turnaround’? A In a turnaround you simply take cost out and rebuild on a leaner base. A transformation is about changing the whole culture to embrace new values and operating principles. QinetiQ’s origins in Government gave it a unique legacy of know-how. Over the last three years, we’ve begun to create a culture from the ground up, a solid foundation that can help the Group survive and thrive in a competitive market. All credit to our people for accepting the challenge and embracing such a different ethos. Q What do you think is still left to do? A Real cultural transformation is a marathon, not a sprint. The most visible impact is in the early years: after that, the task is to develop consistency and resilience in the organisation by embedding discipline. As we implement QinetiQ’s next phase, it’s also about positioning the portfolio around growth, turning innovations into sustainable business models which deliver repeatable earnings. Q Is UK Services’ performance sustainable? A UK Services provides important independent support for its customers at home and abroad – R&D, test and evaluation, specialist advice – in key relevant areas such as weapons, airworthiness, maritime, C4ISR and security. We help them do more with less, enabling them to build something once and derive the benefits many times – our Weapons Science & Technology Centre is a good example. And new opportunities continue to emerge because both our customers and the threats to which they must respond continue to change. Q What does it mean to conduct a strategic review of US Services? A US Services has seen their revenues and profits decline in the face of challenging markets. The business has some strong positions with customers and the new management has delayered and taken out cost to retain competitive rates. Now over the coming months we will be conducting a strategic review to determine the best way to maximise the performance and potential of the division. Q How does UK Services differ from US Services? A First and foremost, the two markets are very different in size and structure, and so is our role. In the UK, we are a material provider of high-end technical advice and services to the UK Government and also an exporter. In the US, we are a provider predominantly to the US Government. That is a very large market, which is changing dramatically, and our position is mid-sized. Yet in key areas, such as C4ISR, space, cyberspace and unmanned systems, we are highly relevant to our US customer. 6 QinetiQ Group plc Annual Report and Accounts 2013 Q Why categorise the portfolio as ‘Core’, ‘Explore’ and ‘Test for Value’? A We need a consistent approach for tracking and extracting value from our investments and emerging businesses. This is about focus and choice: you have to have a strong methodology for decision-making. Each category has a clear role. Test for Value is our early-stage technology; Core is the robust, mature underpinning to customer relationships, market position and current shareholder returns. In between, Explore is exciting because these are proven businesses we are hoping over the mid-term to scale to significant sustainable revenue, and migrate into our Core. Q What of QinetiQ’s ability to generate clever new technologies? A QinetiQ still retains at its heart the ability of our scientific and engineering community to build innovative solutions. Over time those that develop into businesses get supported into growth. So our ‘People Who Know How’ provide the critical point of difference to customers and thus to winning and retaining new business. Q Can you take QinetiQ beyond its current markets? A Yes. QinetiQ has defence at its heart – but it can expand internationally, and also by rolling out its technologies and expertise into new sectors that offer higher growth potential. Part of our strategy is constantly to test some of those options to diversify through our Explore businesses. And the changing defence market itself throws off new opportunities for our Core. Q Where do you see QinetiQ in five years’ time? A I believe that QinetiQ’s renewed focus on its core capabilities will help it continue to grow as a strategic supplier to its present customers and in multiple adjacent markets. I could also see the Group transforming through its options in new markets. That depends on our achieving what I call breakout success in our strategy of turning technologies into commercial businesses. I want QinetiQ to become a byword for all that is innovative and expert in UK science and engineering. A year of achievement Investing in a new generation QinetiQ prides itself on the quality of its workforce, employing highly qualified and committed scientists and engineers who are dedicated to making a difference through their work. Our teams combine knowledge, passion, integrity and commitment. Combined with their security level clearance, they are able to work on some of the most complex problems that our customers face. The UK has always been a country known for innovation and QinetiQ is playing a key role in maintaining this. Recognised as a company with world leading engineers and scientists, QinetiQ gives graduates the opportunity to develop their professional skills via mentoring schemes and professional qualifications to become ‘People Who Know How’. During 2013 we have committed to increasing our graduate intake to over 80 graduates. Our long established graduate programme, listed in ‘The Guardian UK 300’, provides applicants with a structured two-year programme that helps provide them with the skills to become future business Supporting a changing MOD QinetiQ has an established track record of working with the UK Ministry of Defence, as illustrated through the Long Term Partnering Agreement (LTPA). MOD’s trusted advisor The LTPA provides test and evaluation and training support to the MOD and its military stakeholders. The contract enables accurate assessment of military capabilities throughout their lifetime, from concept to disposal, increasing reliability and fitness for purpose. Under the LTPA, QinetiQ manages 17 core MOD-owned sites and is responsible for providing test and evaluation (T&E) and training support services; maintaining associated equipment, land and buildings; as well as delivering an investment programme to ensure that the capability is maintained and developed to meet the MOD’s evolving needs. Driving continuous productivity improvements As a business that prides itself on innovation, QinetiQ provides a fertile foundation for new ideas to flourish. My Contribution is the channel by which employee insight, imagination, energy and enthusiasm are captured for the benefit of the Company and our customers. Business improvement In November 2010 My Contribution was launched to employees as part of the 24-month self-help plan. It became a channel by which employees could be encouraged to look at improved ways of working, ways to drive out unnecessary cost whilst also driving through improved productivity. leaders. The scheme attracts the country’s best science, maths, engineering, business/project management and IT graduates. During the current year, QinetiQ will also be increasing its apprentice intake from 34 to 80, helping the Group to move towards its target of 5% of the workforce being young engineers and scientists. Luke Greenaway and Simon Todd celebrating their gold medals at the prestigious 2013 WorldSkills UK competition organised by the National Apprenticeship Service. Providing the capability life-cycle In February 2013, the Company successfully completed its regular five-yearly review with the customer and, following demonstration of cost savings being achieved and the agreement of some minor changes in scope, a £998m contract was signed for the third five-year term. Commenting on the signing, Laurence Bryant, DE&S Director Weapons, MOD said: “Test and evaluation is essential for the effective management and mitigation of the risk in our acquisition programmes and for the enduring support of our front line capability. The LTPA provides this service to our Armed Forces, the MOD and equipment suppliers, and is crucial to maintaining our defence capability.” Tangible outputs Since launch, year-on-year the quantity of employee ideas has increased to over 12,000, delivering tens of millions of pounds in benefit for the business and our customers. Examples of projects arising from the scheme have included the materials management improvement project where the team designed, configured and implemented a SAP investment and production management system which tracks the life of a control material from creation to when it leaves QinetiQ. Other ideas include improving the interaction between our design, manufacturing and supply chain process, through the use of computer aided designs replacing the need for cardboard models. Annually we recognise the efforts of our teams at the My Contribution Showcase which forms an integral part of our annual leadership conference. QinetiQ Group plc Annual Report and Accounts 2013 7 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Executive’s review continued Maximising value by growing sustainable earnings Our approach QinetiQ’s overarching strategic goal is to maximise the Group’s value by growing sustainable earnings through optimising the portfolio. This strategy is known as Organic-Plus, and includes: • Active portfolio management to optimise business returns • Robust financial discipline to grow and maintain margins • Selective investment in ‘Core’ and ‘Explore’ portfolios and rigorous evaluation of investment options (‘Test for Value’). Investment is prioritised to grow market share in the ‘Core’ and to support accelerated business development in ‘Explore’. ‘Test for Value’ options must demonstrate a viable customer value proposition and a compelling potential to scale • Exploitation of customer-funded research and development into core defence and relevant markets • Customer intimacy to be a partner of choice for the long term, consistently striving to serve our customers better • Playing to QinetiQ strengths and assuming only those risks we are qualified to manage • Selective use of partnerships, alliances and acquisitions to accelerate compelling business development strategies and sustainable earnings growth • Monetising knowledge and IP via increased use of licensing approaches • Investment in our people and leadership development, particularly around commercial, customer engagement and people leadership development skills • Sustaining, building and leveraging our brand • Business development and investment in new geographies (e.g. Middle East, Scandinavia). The Value Pipeline The Value Pipeline consists of a portfolio of present and future earnings streams. The Group’s principal role is to manage the value pipeline for optimal returns, in large part by regulating the resource flows through the cycle. Common features across the portfolio are consistent application of the QinetiQ brand; implementation of a common set of business processes and robust corporate governance; all supported by shared services and functional resources that deliver efficiently and effectively in support of the business. Read more on page 10 Core Sustainable and defensible businesses, focused on growing market share. This is the ‘engine’ on which the Group’s reputation and customer relationships are built, the driver for continual renewal of its expertise and technology, and the source of the majority of its profit and cash flow. Explore High potential emergent businesses, typically with a proven competitive offering in a growth market, for which the challenge is to demonstrate a business model scalable to significant and sustainable size in order to become value accretive ‘Core’ businesses which increase diversification of the Group. Test for Value Portfolio of less mature options, typically based around innovative technology/know- how which must be tested and managed rigorously for commercial viability. Investment is required to achieve commercialisation: outcome most likely licence revenue/ partnership, discontinuation; or, in certain exceptions, move to ‘Explore’. 8 QinetiQ Group plc Annual Report and Accounts 2013 The Role of the Group The Executive Leadership is responsible for the strategic direction and leadership of the Company. Business architect • Determination of business boundaries Strategy • Define the direction and shape of the Group over the • Implementation of a ‘One QinetiQ’ approach to business process design and functional support long term Budgeting and planning • Portfolio management Leadership and people development • Talent and succession management framework • Executive coaching and development • Determination of portfolio composition • Professional development and reward policies • Business unit strategy approval, target setting and performance review • Investment appraisal and review • Acquisition and disposal strategy Performance monitoring • Review and challenge divisional performance • Resource allocation • Allocation of capital to investment priorities • Assignment of talented people • Sustainment and development of the Company’s knowledge, know-how and intellectual property Governance/risk management • Plc listing requirements • Definition and implementation of Group Operating Framework for safety, ethics, security and other regulatory requirements • Risk management • Governance of risk and regulatory frameworks • Investor relations Brand custodianship • Sustainment and development of the QinetiQ brand • Protection of Company’s brand, trademarks and corporate presence • Preservation and promotion of the Company’s reputation Role of the business units The business units are principally accountable for business unit strategy, sales, delivery and compliance with Group governance requirements. Each business unit has a diverse range of demand drivers, customers and competitors providing the Group resilience. Business unit strategy • Development of domain/sector specific strategy and business plans • Development and presentation of investment options for approval Human Resource management • Recruitment, development and motivation of people • Assignment of people to projects • People performance management • Involving and leveraging people for their ideas Risk management • Safe and ethical delivery of business activities • Development and management of business risk register • Market entry, marketing and customer development plans • Actions to mitigate risks and to capture opportunities Customer engagement and sales • Development and execution of key account plans • Remediation plans, where appropriate • Adherence to Group policy and regulatory frameworks • Implementation and measurement of sales campaigns • Implementation of Group Operating Framework at local level • Establishment of specific sales channels and supporting marketing • Acting at all times in a manner consistent with the QinetiQ brand and values Performance contract delivery • Project delivery • Business performance management • Investment project implementation Read more on UK Services on page 14 Read more on US Services on page 18 Read more on Global Products on page 22 QinetiQ Group plc Annual Report and Accounts 2013 9 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Executive’s review continued Progress through Organic-Plus The key elements of our strategy Core Sustainable and defensible businesses, focused on growing market share. This is the ‘engine’ on which the Group’s reputation and customer relationships are built, the driver for continual renewal of its expertise and technology, and the source of the majority of its profit and cash flow. Revenue c90% Explore High potential emergent businesses, typically with a proven competitive offering in a growth market, for which the challenge is to demonstrate a business model scalable to significant and sustainable size in order to become value accretive ‘Core’ businesses which increase diversification of the Group. Revenue c8% Test for Value Portfolio of less mature options, typically based around innovative technology/ know-how which must be tested and managed rigorously for commercial viability. Investment is required to achieve commercialisation: outcome most likely licence revenue/partnership, discontinuation; or, in certain exceptions, move to ‘Explore’. Revenue c2% 10 QinetiQ Group plc Annual Report and Accounts 2013 These businesses are focused on relatively resilient sectors in which the deep domain expertise of QinetiQ’s people is used to provide trusted independent advice and solutions for customers’ critical operations. These are the Group’s core capabilities, mostly comprising UK and US Services, and operating largely in the aerospace, defence and security markets. They exhibit relatively low risk characteristics with low capital requirements and strong, predictable cash flows. Much of the revenue is derived from longer-term contracts, with known dates for renewal and re-tender. QinetiQ’s core businesses retain and win market share by applying their technical expertise and their detailed understanding of customer domains to provide support for customers’ ongoing and developing needs. Core businesses will receive investment on a sustainable basis as these opportunities emerge and where existing expertise can be deployed in adjacent sectors and geographic markets, from the proven platform of UK or US capability. QinetiQ’s less mature businesses will be managed through a ‘Value Pipeline’ with a range of new capabilities at various stages of business readiness. The Group will selectively invest in these businesses to create a broader base of significant and, therefore, core businesses for the future. Over the medium term, these early-stage technologies will be managed rigorously to resolution, whether through investment, divestment, closure or trade-through, until project completion. These are businesses that have proven technology and customers, but have yet to prove that they can achieve significant scale. Examples include Cyveillance®, which delivers cyber intelligence solutions principally for US Fortune 500 customers, the OptaSense® fibre-optic sensing business, and Training & Simulation Services, which is using commercial-off-the-shelf technology to meet customer requirements to reduce the cost of training. These are businesses with proven technologies but that have yet to prove commercial viability. In some cases, the technology is being developed for a customer-funded programme, such as the E-X-Drive® hybrid electric drive transmission which is being developed as part of a consortium for the technology development phase of the US Army’s Ground Combat Vehicle Program. In other cases, the intellectual property is licensed out to reduce implementation and sales risks, with revenue dependent on third-party sales channels. Progress in 2013 Progress in 2013 UK Services • Re-pricing of the LTPA contract • Performance improvement in Australia with increased revenue and margin • 5-year £7m Royal Navy contract for optimisation of ship and submarine stealth characteristics • New £6m framework contract for C4ISR research US Services • $17m condition-based maintenance award for the US Army • $80m Tomahawk contract award by Naval Air Systems Command • Revenue continued to increase • Maximise the Core by winning Priorities in 2014 Priorities in 2014 market share in existing markets and marketing capabilities into new sectors and/or geographical markets • Assist MOD with its defence transformation programme on the NASA Engineering Services Contract at the Kennedy Space Center • $46m infrastructure support contract extension for the Customs and Border Protection Agency Global Products • Two key orders totalling $44m for Q-Net® • New customer contracts from Poland and the Czech Republic for Talon® • $13m US Government order for Dragon Runner™ 10 robot OptaSense® • £10m follow-on contract with Shell Cyveillance® • Grew year-on-year with improvement Training & Simulation Services • £7m extension to Distributed Synthetic Air Land Training (DSALT) programme at RAF Waddington • £4m enhancement to Army pre- deployment training contract in productivity Protective Monitoring • Cabinet Office GPG13 Accreditation Space • Successful launch of Proba V satellite for European Space Agency • Scale the Explore portfolio • Rigorous evaluation of investment priorities • OptaSense® to capitalise on end of exclusivity period with Shell • Training & Simulation Services to build on its position on the approved companies list for a $2bn IDIQ contract • Cyveillance to focus on delivery of commercial services, larger and higher margin contracts • Scale up the Space business • Sale of Zephyr® to EADS Astrium • New orders for ALARMTM • Energy from Waste refocused on core military customers • Integrated Warrior SystemTM pipeline opportunities • Smart Sensor SystemsTM selected by British Columbia Hydro to support its smart metering programme • Partnerships developed for GAJTTM GPS and MEWSTM to take products to market • Continue to assess viability of technology and markets • Sustain the rigour in Test for Value • Focus on non-conflict technologies • Monetise intellectual property QinetiQ Group plc Annual Report and Accounts 2013 11 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Executive’s review continued Measuring our progress Key performance indicators (KPIs) The Group’s strategy is underpinned by focusing on a number of performance indicators. This includes a range of financial and non-financial indicators to monitor Group and divisional performance. Similar indicators are used to review performance in each of the Group’s businesses. The key objectives of Board committees are described in the Governance section of the Annual Report and other non-financial key performance indicators are shown in the Corporate responsibility and sustainability review (pages 34-37). Relevance to strategy Our strategy is to grow the businesses through the Organic-Plus programme. Progress is measured through key performance indicators. Measurements of health and safety, productivity, customer satisfaction and employee engagement underpin sustainability. Financial measures such as order intake, organic sales growth, profitability and cash conversion track performance. Read more on page 10 Non-financial KPIs Health and Safety (UK RIDDOR1 rate per 1,000 employees) 1.90 2013 2012 Productivity (UK change projects generated) 1,431 2013 2012 Employee engagement score (UK on a scale of 0-1,000) 575.0 2013 2012 Customer satisfaction overall score (UK MOD KSM) 8.4 2013 2012 1.90 2.12 1,431 797 575.0 569.3 8.4 8.3 Description The RIDDOR1 rate is calculated using the total number of incidents reportable under RIDDOR, x1,000 divided by the average number of employees in that year. Comment Health and Safety performance is monitored to drive continual improvement in minimising risks to employees and to meet our long term objective of zero reportable incidents. Further details of the Group’s health and safety performance are with the CRS review (pages 34-37). 1 Reporting of Injuries, Diseases and Dangerous Occurrence Regulations. Description My Contribution is a dynamic framework designed to fundamentally develop and grow QinetiQ. The latent potential of thousands of ideas contributed by employees are pulled together into a managed process that develops and activates their concepts. The financial returns and benefits are measured through the My Contribution tracker. Description A measure of employee engagement on a scale of 0-1,000, based on the Best Companies Employee Survey. Through this channel, employees share their views of working at QinetiQ under the headings of management, leadership, My Company, personal growth, My Team, giving back to the community, fair deal and well-being. Comment My Contribution improves how the business delivers both internally and for customers. In addition, it improves the work environment for employees. Comment The annual survey enables comparison between QinetiQ and other UK companies. A separate engagement survey is undertaken for the US business. Description The Key Supplier Management (KSM) Framework is a mandatory survey administered annually by the MOD of its top 22 key suppliers. The 360-degree survey concentrates on the performance (delivery, engagement and relationship) of the largest and most strategically important contracts, totalling c40 contracts for QinetiQ. Comment This year the MOD suspended its KSM survey. A new survey, agreed by industry parties, will be applied to cover QinetiQ’s entire customer base in the coming year. In the US, customer satisfaction metrics are reviewed on a contract-by-contract basis and data is therefore not available. Work will shortly commence to seek a standardised survey measure across QinetiQ’s entire business. * Definitions of underlying measures of performance can be found in the glossary on page 116. ˄ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. 12 QinetiQ Group plc Annual Report and Accounts 2013 Financial KPIs Orders† £1,076.8m 2013 2012 Organic revenue growth -10% 2013 2012 Underlying operating profit £168.7m 2013 2012 Underlying operating margin 12.7% 2013 2012 Underlying EPS 18.9p 2013 2012 £1,076.8m £1,226.3m (10%) (11%) £168.7m £159.6m^ 12.7% 10.9%^ 18.9p 13.6p^ Underlying operating cash conversion 104% 2013 2012 Net cash/debt £74.0m 2013 2012 104% 148%^ £74.0m (£122.2m) Description The level of new orders (and amendments to existing orders) booked in the year. Comment Provides a measure of the Group’s ability to replace completed contracts/business with new contracts/business. † Excludes £998m LTPA repricing. Description The Group’s organic revenue growth is calculated by taking the increase in revenue over pro forma revenue, at constant exchange rates. Prior years pro-forma revenue excludes the impact of acquisition and disposals. Comment Organic revenue growth demonstrates the Group’s capability to expand its core operations within its chosen markets before the effect of acquisitions, disposals and currency translation. Description The underlying earnings before interest and tax. Comment Underlying operating profit* is used by the Group for internal performance analysis as a measure of operating profitability that is tracked over time. Description The Group’s calculation of underlying operating margin* is consistent with previous years. Underlying operating margin is calculated by taking the earnings before tax and interest as a percentage of revenue. Comment Underlying operating margin* can be used to show the underlying profitability of the revenue delivered by the Group. It can also be used to compare the Group’s performance with that of our peers, providing the definition of underlying operating profit is consistent. Description The underlying earnings per share* (EPS) expressed in pence per share. Comment EPS provides shareholders with a measure of the earnings generated by the business after deducting tax and interest. Underlying EPS performance also determines the level of payout for certain of the Group’s long-term incentive plans. Description The ratio of our net cash flow from operations (excluding reorganisations), less outflows on the purchase of intangible assets and property, plant and equipment to underlying operating profit* excluding the share of post-tax results of equity accounted joint ventures and associates. Comment Provides a measure of the Group’s ability to generate cash from normal operations and gives an indication of its ability to pay dividends, service its debt and to make discretionary investments. Description The Group’s measure of borrowings. Includes finance lease debtors/creditors and assets/liabilities in respect of derivative financial instruments. Refer to note 23 to the financial statements. Comment The level of net cash/debt provides a measure of the strength of the Group’s balance sheet. QinetiQ Group plc Annual Report and Accounts 2013 13 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewUK Services Delivering measurable value Case study: Weapons What we do • Technical assurance based on data generated by experiments, trials, modelling and research underpinned by three long-term contracts Our competitive advantage • Over 1,100 employees specialising in weapons expertise and range testing • Complex safety critical test and evaluation • Training support at ten sites specifically licensed to work with energetic materials Our people 60% Range engineers 40% Weapons systems experts Where we operate • Future opportunities include building on presence in Australia and Scandinavia to deliver international range capability and aerial target services 1. RAF Donna Nook 2. RAF Holbeach 3. Shoeburyness 4. Fort Halstead 5. Farnborough 6. Boscombe Down 7. Larkhill 8. Bristol 9. RAF Pembrey 10. Pendine 11. Manorbier 12. Aberporth 13. Malvern 14. Eskmeals 15. West Freugh 16. Ardeer 19 20 18 17 16 15 14 1 2 12 10 9 11 13 8 67 5 4 3 17. Hebrides 18. St Kilda 19. Cape Wrath 20. Tain 14 QinetiQ Group plc Annual Report and Accounts 2013 UK Services delivered a strong performance with underlying operating profit* increasing 40% to £85.8m (2012: £61.3m^) on relatively flat revenues of £597.3m (2012: £610.1m). The resulting underlying margin* of 14.4% (2012: 10.0%^) reflects improved alignment with customer needs, plus a more competitive cost base and processes for better project execution. The division’s performance also benefited from short-term demand in certain areas driving higher levels of utilisation, and the completion of final milestones on certain projects. In February, the division successfully completed the five-yearly periodic re-pricing of the Long Term Partnering Agreement (LTPA), agreeing terms with the MOD for the provision of core test and evaluation and training support services through to March 2018. Organic-Plus update UK Services’ core business combines world-leading expertise with unique facilities to provide technical assurance, test and evaluation, and training and simulation services. These capabilities are delivered mainly under long-term managed services contracts, which provide strong predictable cash flows and are the target for future sustainable expansion. The successful re-pricing of the 25-year LTPA contract, the key underpinning contract for the division’s Air, Weapons and Maritime businesses, represents an endorsement by the customer of the LTPA model as a vehicle for ‘building once using multiple times’ and delivering ‘more for less.’ In addition, UK Services is a market leader in the provision of shorter-cycle technical and information services in C4ISR, acquisition services and cyber security. QinetiQ’s Air business de-risks complex aviation programmes by testing military aircraft and equipment, evaluating the risks and assuring safety. Its long-standing relationships with key customers have been enhanced by integrated working and new contracts for test and evaluation that are delivering efficiencies and value. The Air business is also working to build on its strong track record in the provision of Unmanned Air System (UAS) services developed through the delivery of turn-key surveillance solutions to NATO forces operating in Afghanistan. Extensive testing by QinetiQ saw the introduction of the new sidearm, Glock 17 9mm, into the British Armed Forces. Revenue £597.3m 2013 2012 Underlying operating profit* £85.8m Underlying operating margin* 14.4% £597.3m 2013 £610.1m 2012 £85.8m 2013 £61.3m^ 2012 14.4% 10.0%^ Case study: Maritime What we do • Enable the frontline to deliver naval advantage and effective capability Our competitive advantage • A specialist body of maritime knowledge: platform design, performance and optimisation, maritime structural analysis and technical advice, through-life command information systems, integrated stealth and ranges and maritime safety • Technical breadth and depth of domain expertise • Specialist testing facilities • Focus on delivering through-life cost savings Our people 35% Naval engineers 20% Trials engineers and specialists 35% Command system specialists 10% Software developers Where we operate • Operating strategic assets across the UK including Haslar, Portsdown and Rosyth • The business operates three key strategic programmes with the UK MOD – Long Term Partnering Agreement – Naval Combat System Integration Support Services – Maritime Strategic Capabilities Agreement 10 11 12 1314 15 17 1 5 3 4 2 16 6 7 8 9 1. Bristol 2. Plymouth 3. Grove Point 4. Portland Bill 5. Winfrith 6. Haslar 7. 8. Funtington 9. Chichester Hospital Portsdown Technology Park 10. Rona 11. Applecross 12. Kyle of Lochalsh (BUTEC) 13. Loch Goil 14. Rosneath 15. Rosyth 16. Farnborough 17. Malvern QinetiQ Group plc Annual Report and Accounts 2013 15 Working with Lloyd’s Register and Strathclyde University, QinetiQ examined the future shape of the marine industry in its Global Marine Trends 2030 report. The Weapons business provides technical assurance based on data generated by experiments, trials, modelling and research, principally at the twenty strategically located ranges it operates and manages on behalf of the MOD. Shortly after year end, it was awarded a four-year contract for the management of the joint MOD/industry Weapons Science and Technology Centre and delivery of £8m per annum research into complex weapons, munitions and energetics. Weapons is exploring medium-term opportunities presented by QinetiQ’s ability to support the MOD in its defence transformation programme and is working with the customer on the assessment of its future options for munitions management. The business also operates ranges in Scandinavia and provides range control and safety systems in Australia. The pipeline includes opportunities to expand the provision of test and evaluation services to other international customers. QinetiQ’s Maritime business enables the frontline to deliver naval advantage and cost-effective capability. During the year, the business successfully completed the MOD’s first five-year review of the 15-year Maritime Strategic Capability Agreement (MSCA), reaffirming its role in maintaining expertise and strategic maritime capabilities. As such, the business has successfully negotiated the renewal of its three long-term underpinning contracts over the past 18 months. In addition, the business was awarded a five-year £7m contract for the operational signature services that it delivers to the Royal Navy for the measurement and optimisation of ship and submarine stealth characteristics. Note: Year references (2013 and 2012) relate to the year ended 31 March. * Definitions of underlying measures of performance can be found in the glossary on page 116. ˄ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewUK Services continued Case study: C4ISR What we do • Use research in information management and sensor systems to provide expert technical advice, research and solutions • Capabilities include: – Communications and Information Infrastructure – moving data through all forms of radio and fixed communications linked to data management techniques – Command and Control Systems – uses interoperability techniques to support system integration at all levels – Surveillance Systems – exploits the full spectrum of sensor sources to feed data to any communication and information management system in an open and interoperable manner – Survival – offers the latest techniques in saving life and minimising infrastructure damage in military operations and civil crisis management Our competitive advantage • A heritage of UK government research in information management and sensor systems • Joined-up thinking focused on unlocking the benefits of meeting current and imminent technical challenges • Largest supplier of C4ISR research to UK MOD Our people • The expertise of our teams covers: – Communication system design and operation – The efficient management of ‘big data’ – Optimising human interaction with information handling systems – Design and prototyping of new sensor systems and techniques – Design and implementation of open standard C4ISR networks that enable existing and new systems to be made interoperable – Enabling the survival of people in extreme environments and dangers – Technical and commercial customer advice in support of complex C4ISR or survival-based procurement programmes 35% Engineers 25% R&D Specialists 25% Consultants 15% Project managers 16 QinetiQ Group plc Annual Report and Accounts 2013 QinetiQ’s core C4ISR business manages and delivers significant enabling research contracts on behalf of the MOD. The deep domain expertise of its employees was reflected by the continued stream of research tasks delivered under contracts for electronic surveillance, secure information infrastructure and battlespace management, and the award of a new £6m framework contract. QinetiQ is a leading supplier of client-side technical services, providing advice to many of the operating centres within the MOD’s procurement agency DE&S, principally through its Acquisition Services business. While the proposal to introduce a GoCo model for DE&S is creating some short-term uncertainty, over the medium term it presents potential opportunities for QinetiQ. There is also demand for advice on the procurement of complex systems from international and non-defence customers, and during the year Acquisition Services extended its reach into the adjacent rail market with the award of a new contract with Transport for London. At the beginning of the year, a new leadership team was appointed for the managed services business in Australia, which reports into the UK Services division. The team’s initial focus was on integrating the business, strengthening governance, building competitiveness and creating conditions for growth. The business is now demonstrating both revenue and margin progression, and changes in the political landscape resulting from the forthcoming federal election may present further opportunities. During the year the business won an AU$8m contract with the Australian Directorate General of Technical Airworthiness which underpins much of the core aerospace revenue, and AU$1m of contracts in the rail industry representing an entry point into a new adjacent market. QinetiQ is a world leader in developing applications for information management and exploitation in the intelligence, surveillance and reconnaissance space. Secure hosting provides 24/7/52 critical services. Within the ‘Explore’ category, the Group is investing in key capabilities to supplement the underlying growth rates of the ‘Core’ business. A key opportunity is the Training and Simulation Services (TSS) business, which uses Commercial-Off-The-Shelf (COTS) technology to reduce the cost of training. TSS has grown its UK business through an 18-month, £7m extension to its flagship Distributed Synthetic Air Land Training (DSALT) programme at RAF Waddington, and a £4m enhancement to the pre-deployment training it delivers to the British Army. The US market is key to realising the potential of TSS, building on its position on the approved companies list for a $2bn IDIQ (indefinite delivery/ indefinite quantity) contract under which the US Navy is able to procure training and simulation services. The business is focused on the provision of modelling, simulation and training for the US Army, Navy and Marine Corps, with a new Orlando office due to open in June 2013. QinetiQ’s UK Security business protects critical national infrastructure and high-value commercial enterprises through the provision of consultancy, managed security services, secure information exchange, and threat and risk assessments. The ability to monitor and identify incidents on IT networks is a key customer concern and the business is investing to scale its protective monitoring solution which this year was accredited by the Cabinet Office under its GPG13 standards – the first time a private sector company has achieved this landmark accreditation. Case study: Security What we do • Consultancy services including bespoke Cyber Vigilance • Managed security services covering Cyber Defence • Commercial-off-the-shelf (COTS) products in our SyBard® range enabling secure information exchange • Cyber crime threat and risk assessments including – Strategic risk assessments – Risk management structure and risk mitigation process development – Incident reporting, reaction and recovery processes – Technical supply chain management and due diligence Our competitive advantage • A unique 50-year heritage of acting as strategic advisor to the UK Government at critical national security levels • Technical expertise across a broad span of technical domains • Independent of industry suppliers • Secure operations centre providing 24/7 protective monitoring • A founding member of the Cyber Security Challenge UK • In year achieved accreditation by the Cabinet Office under the GPG13 standards – the first time a private sector company has achieved this landmark accreditation Our people 100% Cyber specialists Our customers • Strong relationships with UK, Australian and Canadian governments • Leading the Enabling Secure Information Infrastructure (ESII) consortium for supply to MOD’s Defence Science and Technology Laboratory • Supplier to numerous blue chip customers QinetiQ Group plc Annual Report and Accounts 2013 17 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewUS Services Facing up to tough markets Case study: Cyveillance® What we do • People, processes and technology for early warning of threats from internet and social media across the globe • Cyber intelligence required to protect information, infrastructure and employees • Integrated, agile, open-source, service-orientated architecture and off-the-shelf solutions Our competitive advantage • Ability to combine physical and virtual security threats into an overall threat landscape • Global social media analysis to discover near real-time threats and predictors • Multi-lingual analysts analyse and prioritise predominant languages on the internet 21% Cyber analysts 22% Technical analysts 25% Intelligence analysts 32% Other Current customer base Financial Services Technology Energy Government Insurance Education Other 37% 14% 8% 8% 8% 7% 18% Revenue declined 12% on an organic basis at constant currency, impacted by continued budget uncertainty and reduced federal services spending. Customers continued to defer decisions, leading to the delay of new and incremental orders, the de-scoping of some existing work, and the cancellation of some re-competes with shorter-term extensions being awarded in their place. Some work was also switched to small business set-aside contracts. Actions, principally in US Services, to place the US cost base on a more competitive footing resulted in an exceptional charge of $26.1m. In the annual year-end assessment of the carrying value of goodwill, the impact of current market conditions resulted in a non-cash impairment charge of £255.8m. Underlying operating profit* was £21.9m (2012: £32.1m) and the underlying margin* was 4.6% (2012: 6.0%), as a result of the reduction in volume and the more competitive trading environment. In addition there was a change in revenue mix as lower margin NASA work replaced higher margin sales. A strategic review has been initiated to determine the route to maximum value in US Services. This division possesses some strong capabilities and market positions, but the Group needs to determine the best way to maximise its performance and potential. Organic-Plus update US Services has a broad customer base both within and beyond defence. Its core business supports customers across the US federal marketplace, delivering mission assurance, engineering, data analysis, software and systems integration, cyber solutions, modelling, training and simulation, logistics, managed services and field support. Key sources of competitive advantage include the division’s skilled employees, almost all of whom possess high levels of security clearance, and the fact that these businesses enjoy long-standing customer relationships and attractive, longer-term contract vehicles. Due to the ‘cost-plus’ nature of most federal services contracts, overhead costs have a significant impact on competitiveness, particularly in an environment where government budgets are under pressure. Restructuring was undertaken by QinetiQ North America during the year to reduce its cost base and maintain competitive rates. The majority of these cost reductions, which resulted in an exceptional charge of $26.1m, were in US Services and were focused on cutting property and infrastructure costs, as well as reducing 18 QinetiQ Group plc Annual Report and Accounts 2013 Cyveillance provides early warning of internet and social media threats. Revenue £475.6m 2013 2012 Underlying operating profit* £21.9m Underlying operating margin* 4.6% £475.6m 2013 £534.5m 2012 £21.9m 2013 £32.1m 2012 4.6% 6.0% Mission Solutions designs, integrates, installs and operates enterprise IT solutions. management layers. The focus was on reducing indirect costs while maintaining bid and proposal activity. Despite current budget pressures, the US Government contracting market remains large, and the DoD is committed to protecting investments in areas such as C4ISR, space, cyberspace and unmanned systems, in which QinetiQ possesses deep domain expertise. At the year end, US Services had over 100 proposals pending decision by federal customers at year end, with a total contract value of more than $1bn. Lifecycle Solutions provides engineering services and helps customers manage their fleets and supply chains. New contracts included a $17m award for condition-based maintenance from the US Army’s Tank Automotive Command and contracts for technical and logistics support from the US Army’s Aviation and Missile Command. Condition-based maintenance facilitates greater automation of current processes and QinetiQ’s track record with the US Army presents a number of future opportunities. The Software and Systems Engineering business supports the delivery of C4ISR and combat systems, and provides advice on procurement programmes and equipment lifecycles. The US Government’s increased focus on the Asia-Pacific region represents a resource shift to naval markets, and Software and Systems Engineering is working to build on its good base of support contracts in the maritime domain. During the year the business was awarded an $80m contract by Naval Air Systems Command for Tomahawk Command and Control work. It was also selected for a five-year blanket purchase agreement with a total ceiling value of $27m by the US Coast Guard National Pollution Funds Center. Case study: Mission Solutions What we do • Cyber intelligence protecting customers against cyber attack • Design, integrate, install and operate enterprise solutions including IT and operational systems Our competitive advantage • Leading industry experts • Key client relationships • Proven track record of best value performance • Trusted by Government to architect and secure networks in an increasingly hostile cyber environment 19% Technical experts 9% IT specialists 32% Engineers 6% Scientists 34% Other Where we operate 1 3 2 7 6 4 5 Note: Year references (2013 and 2012) relate to the year ended 31 March. * Definitions of underlying measures of performance can be found in the glossary on page 116. 1. Las Vegas NV 2. Albuquerque NM 3. Denver CO 4. Reston VA 5. Springfield VA 6. Washington DC Region 7. Cleveland OH QinetiQ Group plc Annual Report and Accounts 2013 19 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewUS Services continued Case study: Defense Solutions At the end of the year the two defense focused businesses, SSE and Lifecycle Solutions, were integrated creating Defense Solutions. Software & Systems Engineering • Support the delivery of C4ISR and combat systems, software and IT • Advice on systems engineering, procurement programmes and equipment lifecycles Lifecycle Solutions • Aviation expertise in condition-based maintenance • Help customers manage their fleets and supply chains Our competitive advantage • Highly skilled employees • Key client relationships • Track record of improving value for money through tools and process-based efficiencies • Leading edge open source, open architecture development 26% IT specialists 11% Training & simulation specialists 50% Engineers and program managers 7% Logistics experts 6% Other Where we operate 1. Ft Bliss TX 2. Ft Hood TX 3. Huntsville AL Redstone 4. Arsenal HSV AL 5. Clarksville TN 6. St. Charles MO 7. Belcamp MD 8. Hawaii 9. Campbell CA 10. San Diego CA 11. Stennis MS 12. Panama City FL 13. Charleston SC 15 16 9 10 6 1 2 11 12 8 14. Norfolk VA 15. Quantico VA 16. Arlington VA 7 14 5 4 3 13 20 QinetiQ Group plc Annual Report and Accounts 2013 At the end of the year, the division’s two defence-focused businesses – Lifecycle Solutions and Software & Systems Engineering, were integrated to create Defense Solutions, aligning existing programmes with business development initiatives and removing duplicated overheads. Aerospace Operations and Systems supports spaceflight through testing, engineering and launch services and has expertise across all aspects of a space mission from design to launch. Following commencement of work in March 2011, revenue has continued to increase on the NASA Engineering Services Contract at the Kennedy Space Center. The business also secured a 16-month extension to the contract for environmental test integration services at the Goddard Space Center. Future opportunities exist to leverage this growth in space services to compete for new business with NASA, as well as with commercial space companies and the United States Air Force (USAF). During the year, the business won new mission planning work with the USAF’s Electronics Systems Center at the Hanscom Air Force Base, and was selected for the TAASC II IDIQ contract by the USAF Material Command. Mission Solutions provides cyber security, enterprise information technology and software solutions principally to non-defence customers including intelligence agencies and the Department of Homeland Security (DHS). The majority of its employees have high levels of security clearance and work on customer sites. During the year the business commenced the provision of cyber security services at the Department of Transportation’s Volpe Center to protect US transportation control systems and critical national infrastructure. It also received a $46m contract extension from the DHS for infrastructure support for the Customs and Border Protection Agency. In IT and software solutions, the business is positioned in a highly competitive market and revenue has come under pressure during the year, but there are future opportunities for its higher end offerings such as the provision of Cloud-based solutions. Software & Systems Engineering helps the US Armed Forces, primarily the Navy and Marine Corps, deliver C4ISR and combat systems to operating forces. Aerospace Operations and Systems is working to upgrade and modify the NASA crawler transporter, supporting NASA’s space launch system. The Group is nurturing a select number of ‘Explore’ businesses including Cyveillance® which identifies and responds to critical, real-time intelligence on the Internet that represents a threat or risk to its customers. Its customer base, which includes the majority of the US Fortune 50, is primarily financial services companies but among this year’s new awards were customers in the technology, healthcare, FMCG, energy and professional services sectors. Following the appointment of a new leader in October 2012, the business grew its revenues year-on-year, delivered improvements in productivity and introduced 24/7 operations. Demand for cyber intelligence solutions is likely to increase with growing threats to people, infrastructure, Cloud-based systems, mobile devices and brand reputation. Cyveillance® is responding to this demand by focusing on the delivery of commercial services, larger contracts and higher margin offerings, particularly those that aggregate both physical and virtual threat information. Case study: Aerospace Operations & Systems What we do • Support spaceflight by testing software and spacecraft together with engineering and launch services • Analyse scientific data and manage risks Our competitive advantage • Highly skilled people • Involved in all aspects of a NASA mission/lifecycle from design to launch • Program management of complex contracts 16% Systems developers and analysts 9% Technicians 55% Engineers and support service managers 17% Program managers and operations 3% Other Where we operate 2 1 1. Los Angeles CA 2. Denver CO 3. Cleveland OH 4. NASA, Cape Canaveral FL 5. Melbourne FL 6. Greenbelt MD 3 6 4 5 QinetiQ Group plc Annual Report and Accounts 2013 21 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewGlobal Products Extending our offerings into wider markets Case study: Survivability What we do • Provide innovative products and solutions to US and allied governments, enabling them to protect people and assets, reduce operational costs and save lives Our competitive advantage • Sound engineering, product-focused culture • Innovative, cutting-edge technology base • Deep understanding of customer problems • Advanced engineering capabilities enabling rapid innovation to meet urgent mission challenges • Effective, affordable and timely solutions • The portfolio includes: EARS® Acoustic sensors enhancing personal safety LAST® Armor Field Installable Appliqué Armor System Q-Net® Protection against rocket-propelled grenades Where we operate IWS™ Integrated Warrior SystemTM PADS® Precision Air Drop system 1 2 Revenue was £254.9m (2012: £325.0m), a 21% decrease on an organic basis at constant currency, and was first half weighted, illustrating the lumpy profile of the division’s revenue and its dependency on the timing of shipments of key orders. Q-Net® revenue was strong at $120m but there was a reduction in demand for other conflict-related products associated with the drawdown of the US troop presence in Iraq and Afghanistan. Underlying operating profit* fell 8% to £61.0m (2012: £66.2m) as the reduction in revenues was partially offset by an improved mix of US product sales, which included a high proportion of spares, and a one-off credit of £6m relating to a contract extension for additional work already undertaken in the UK. Organic-Plus update Global Products focuses on the provision of product-based solutions to meet customer requirements, complemented by contract-funded research and development. The division combines a cutting edge technology base with an intimate understanding of customer problems. To reduce the volatility of its revenue profile over time, QinetiQ is seeking to increase its portfolio of products and to find new markets and applications for its existing offerings. The Survivability business provides innovative products to US and allied governments, enabling them to protect people and assets, thereby saving lives. In the first half of the year, it delivered two key orders for the Q-Net® vehicle survivability product with a combined value of $44m. These orders were for Navistar’s MaxxPro® MRAP vehicles and for the US Army’s Heavy Expanded Mobility Tactical Truck (HEMTT) – the first time Q-Net® has been fitted to a large haulage vehicle. The business is leveraging the convergence of multiple military capabilities in order to expand its range of product offerings. At the beginning of 2013, it launched its Integrated Warrior System™ that enables a soldier to plug-and-play multiple sensors through a lightweight, wearable vest and access data via a tablet or smartphone. The Unmanned Systems business is a world-leading provider of military robots. Although demand for TALON® robots has reduced as a result of the drawdown of US troops, the business is finding new markets and received $8m of TALON® orders from Poland and the Czech Republic. Unmanned Systems is also increasing its portfolio of products, receiving a $13m order from the US Government’s Joint IED Defeat Organisation for the new, lightweight Dragon Runner™ 10 robot and a $10m order from the US Army’s Rapid Equipping Force for innovative robotic applique kits that convert Bobcats into remote-control and semi- autonomous systems for route clearance missions. Other new products include lightweight tactical robotic controllers that can simultaneously command a variety of unmanned assets and unattended ground sensors. Waltham and Franklin MA 1. 2. Reston VA 22 QinetiQ Group plc Annual Report and Accounts 2013 Integrated Warrior SystemTM provides vital power and data connectivity to improve command and control and situational awareness. Revenue £254.9m 2013 2012 Underlying operating profit* £61.0m Underlying operating margin* 23.9% £254.9m 2013 £325.0m 2012 £61.0m 2013 £66.2m 2012 23.9% 20.4% Case study: OptaSense® What it does • Distributed acoustic sensing delivering highly valuable data • Converts standard fibre optic cable into thousands of virtual microphones with the equivalent of one every ten metres • Provides real-time, actionable data for oil field services including fracking and vertical seismic processing and other vertical markets such as security and border protection Our competitive advantage • Exclusive patents and licensing in rapidly expanding global markets • Proven technology with important commercial reference sites 127 Patent families 40 Countries of operation Significant expansion of team increasing from 4 to 140 employees over last four years Where we operate Oil and Gas Transport Defense and Security Utilities QinetiQ Group plc Annual Report and Accounts 2013 23 Optasense: taking the pulse of the planet. As military budgets are reduced, customer demand is increasing for solutions that extend the life of existing platforms and enhance their capability to meet new mission challenges. Global Products is also leveraging the innovative, products-focused culture of its employees to develop technology-based solutions for non-defence markets. An early example of this approach is a Smart Sensor System™ that precisely measures voltage and current on power grids to monitor the performance of distribution networks. The system was selected by British Columbia Hydro to support its smart metering programme and is currently in the testing and pre-production phase. The OptaSense® fibre-optic sensing business is the most mature of the ‘Explore’ opportunities in QinetiQ’s portfolio. The business delivered double digit revenue and profit growth, winning key infrastructure monitoring contracts to protect a strategic pipeline corridor in Iraq and the state-controlled Bijwasan pipeline in India. Whilst infrastructure services has been the key early adopter market for OptaSense®, oilfield services represents the biggest opportunity with a multi-billion-pound market potential. In this market, the business signed follow-on contracts with Shell to fund £10m of product development over the next three years and enable deployment of the technology throughout Shell within a recurring services model, as well as to other companies. The end of the exclusivity period with Shell is a significant milestone in the development of the OptaSense® business, which is now starting to contract with other companies across the oil and gas industry. QinetiQ’s Space business has been rigorously assessed over the last year and has the potential to deliver future profitable growth. Its key capabilities include ion engines and the Proba family of mini satellites, the latest of which was launched in early May by the European Space Agency. In the ‘Test for Value’ category, early stage offerings are being tested to determine the best route to maximise value. During the year, the Zephyr® High-Altitude-Long-Endurance UAS technology was divested to EADS Astrium for further development and the Energy from Waste business was re-focused on core defence markets. A number of capabilities, such as E-X-Drive® hybrid electric drive, continue to be developed for customer-funded programmes. Others, such as the GAJT™ GPS anti-jammer and the Modular Electronic Warfare System (MEWS™) are being taken to market by partners, reducing implementation and sales risks. Follow-on orders were received for the ALARM™ radar system which provides warning of in-coming rocket fire. The licensing of intellectual property remains an important revenue stream, particularly in non-defence markets. Note: Year references (2013 and 2012) relate to the year ended 31 March. * Definitions of underlying measures of performance can be found in the glossary on page 116. Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Financial Officer’s review Net cash position achieved “ The Group has reduced its net debt by over £600m and the balance sheet has the strength to weather challenging defence markets and the capacity for carefully targeted investment choices.” 2013 £m 597.3 475.6 254.9 1,327.8 2012 £m 610.1 534.5 325.0 1,469.6 UK Services revenue was relatively flat at £597.3m (2012: £610.1m). In February, the five-yearly periodic review of the Long Term Partnering Agreement (LTPA) was successfully completed, agreeing terms with the MOD under which the customer will pay £998m for the provision of core test and evaluation and training support services through to March 2018. US Services revenue was £475.6m (2012: £534.5m), a 12% decrease on an organic basis at constant currency, reflecting continued budget uncertainty and reduced federal services spending. Customers continued to defer decisions as a result of this uncertainty, leading to the delay of new and incremental orders, the de-scoping of some existing work, and the cancellation of some re-competes with shorter term extensions being awarded in their place. In the annual year-end assessment of the carrying value of goodwill, the impact of current market conditions resulted in a non-cash impairment charge of £255.8m. Global Products revenue was £254.9m (2012: £325.0m), a 21% decrease on an organic basis at constant currency, and was weighted to the first half of the year illustrating the division’s lumpy revenue profile and its dependency on the timing of shipment of key orders. Q-Net® revenue was strong at $120m, but, as expected, there was a reduction in demand for other conflict-related products associated with the drawdown of the US troop presence in Iraq and Afghanistan. David Mellors Chief Financial Officer Group results overview Revenue UK Services US Services Global Products Total Strengthening of the balance sheet £200m £0m (£200m) (£400m) (£600m) Working Capital Re(cid:31)rement beneﬁt obliga(cid:31)on (before tax) Net (debt)/cash 2009 2010 2011 2012 2013 Group revenue was £1,327.8m (2012: £1,469.6m), down 10% on an organic basis at constant currency, excluding a £2.4m reduction in revenue from the divestment of Spectro in the prior year, and a £6.2m increase due to the strengthening of the US dollar exchange rate. This reflects the uncertain trading environment in particular the impact of continued budget uncertainty and the expected reduction in the demand for conflict-related products following last year’s very strong performance. 24 QinetiQ Group plc Annual Report and Accounts 2013 Revenue by customer 2013: £1,327.8m Revenue by customer 2012: £1,469.6m 35% MOD 26% DoD 2% DHS 10% NASA Commercial Defence 6% Civil/Other Government agencies 21% 31% MOD 29% DoD 5% DHS 9% NASA Commercial Defence 7% Civil/Other Government agencies 19% Group summary Revenue (£m) Organic change at constant currency Underlying operating profit* (£m) Underlying operating margin* Underlying profit before tax* (£m) Underlying net finance expense (£m) Underlying effective tax rate* Basic earnings per share Underlying earnings per share* Dividend per share Underlying net cash from operations (post capex) (£m)* Underlying operating cash conversion* Net cash/(debt) (£m) Average US$/£ exchange rate Closing US$/£ exchange rate Underlying operating profit* UK Services US Services Global Products Total Underlying operating margin* 2013 1,327.8 (10)% 168.7 12.7% 152.1 16.6 19.2% (20.5)p 18.9p 3.80p 175.9 104% 74.0 1.58 1.52 2013 £m 85.8 21.9 61.0 168.7 12.7% 2012^ 1,469.6 (11)% 159.6 10.9% 110.2 49.4 19.5% 37.9p 13.6p 2.90p 235.4 148% (122.2) 1.60 1.60 2012^ £m 61.3 32.1 66.2 159.6 10.9% * Definitions of underlying performance measures can be found in the glossary on page 116. ^ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. QinetiQ Group plc Annual Report and Accounts 2013 25 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Financial Officer’s review continued UK Services delivered a strong performance with underlying operating profit* increasing 40% to £85.8m (2012: £61.3m^). The resulting underlying margin* of 14.4% (2012: 10.0%^) reflects improved alignment with customer needs plus a more competitive cost base and processes for better project execution as well as the completion of final milestones on certain projects. US Services underlying operating profit* was £21.9m (2012: £32.1m) and the underlying margin* was 4.6% (2012: 6.0%) as a result of the reduction in volume and the more competitive trading environment. In addition, there was a change in revenue mix as lower margin NASA work replaced higher margin sales. Global Products underlying operating profit* fell by 8% to £61.0m (2012: £66.2m) as the reduction in revenues was partially offset by an increase in underlying profit margin* from 20.4% in 2012 to 23.9%. The margin improvement reflects the mix of US product sales which included a high proportion of spares and a one-off credit of £6m relating to a contract extension for additional work already undertaken in the UK. The overall Group underlying operating margin* increased from 10.9%^ to 12.7%. Finance costs Net finance costs were £17.9m (2012: £56.6m^). The underlying net finance costs were £16.6m (2012: £49.4m^), with an additional £1.3m (2012: £7.2m^) in respect of the pension net finance expense reported within specific adjusting items. The reduction in underlying net finance costs* reflects the accelerated interest costs of £27.4m in the prior year, following the election to make early repayment of $177m of private placement debt, which also resulted in a reduction in the interest payable on the debt to £11.9m (2012: £17.5m). Taxation The Group’s underlying effective tax rate* was 19.2% (2012: 19.5%^). The rate is primarily dependent on the geographic split of profits between the UK and US businesses and the availability of Research and Development relief. The UK Government has been consulting on its proposal to introduce an ‘above the line’ credit for research and development to be recognised in operating profit as a replacement for the current credit, which is recognised in the tax line. The mandatory move to ‘above the line’ treatment of R&D credits will now be delayed until April 2016 subject to the Finance Bill receiving Royal Assent in early summer of 2013. At 31 March 2013 the Group has unused tax losses of £202.7m (2012: £200.0m) that are available to offset against future profits. Specific adjusting items* The performance of the Group after allowing for specific adjusting items is shown below: Underlying profit for the year attributable to equity shareholders of the parent company Impairment of goodwill Amortisation of intangible assets arising from acquisitions Net restructuring (charges)/recoveries Pension past service gain Pension net finance expense Net gain in respect of previously capitalised DTR programme bid costs Impairment of property Gain on disposal of property Gain on business divestments and disposals of investments Impairment of investments Tax impact of items above (Loss)/profit for the year attributable to equity shareholders of the parent company 2013 £m 122.9 (255.8) (14.0) (16.3) – (1.3) – (4.0) – 2.9 (0.6) 33.0 (133.2) 2012^ £m 88.7 – (20.3) 69.4 141.4 (7.2) 4.1 (1.9) 9.0 11.6 – (48.5) 246.3 26 QinetiQ Group plc Annual Report and Accounts 2013 Net proceeds received from the disposal of investments/businesses totalled £3.8m (2012: £13.9m), largely reflecting the disposal of its investment in Infoscitex by QNA. At 31 March 2013, net cash was £74.0m, (2012: net debt of £122.2m). This reflected the strong operating cash performance together with the receipt of £65m from MOD in April 2012. Total committed facilities available to the Group at year end amounted to £446.3m (2012: £429.4m) and the remaining Group debt has no maturity before 2016. Pensions The net pension deficit under IAS 19 (revised), after deducting deferred tax, was £40.4m (2012: £18.2m). The increase in net pension deficit is primarily driven by macro-economic factors, principally the reduction in the corporate bond yields that drive the liability discount rate, partially offset by the impact of the increase in the value of the equity and bond assets. The technical provisions basis of calculating scheme funding requirements differs from IAS 19 in that it does not use corporate bonds as a basis for the discount rate but instead uses the risk free rate from UK gilts, prudently adjusted for long-term expected returns for pre-retireds. Given the current extremely low gilt yields, perhaps exacerbated by quantitative easing, a funding valuation of the scheme would probably have resulted in a bigger deficit than the IAS 19 methodology if performed at the year end. The adoption of IAS 19 (revised) ‘Employee benefits’ has no impact on the closing net pension liability. The key assumptions used in the IAS 19 valuation of the scheme are: Assumption Discount rate Inflation Salary increase Life expectancy – male (currently aged 40) Life expectancy – female (currently aged 40) 2013 4.4% 2.7% 3.7% 90 92 2012 4.8% 2.6% 3.6% 90 92 The resulting statutory loss after tax was £133.2m (2012: £246.3m^ profit). There has been a non-cash impairment of the acquired goodwill in the US Services division of £255.8m, reflecting a severely constrained budget environment, exacerbated by the enactment of sequestration on 1 March 2013. Headroom in the cash generating units within the UK Services and Global Products divisions remains significant. The net restructuring cost of £16.3m primarily reflects a charge of $26.1m in QNA resulting from actions to place the US cost base on a more competitive footing. This programme will allow the business to maintain competitive rates. The majority of the cost reductions are in the US Services division and are focused on cutting property and infrastructure costs, as well as reducing management layers. The focus was on reducing indirect costs while maintaining bid and proposal activity. A charge of £4.0m (2012: £1.9m) was taken in the year against the Group’s owned properties. These properties are no longer occupied and, as no external tenant has been found, the assets are no longer generating a return. The £2.9m gain on business divestment (2012: £11.6m) reflects the $4.8m profit on the disposal of its investment in Infoscitex by QNA. An income statement charge of £0.6m (2012: nil) was taken in the year as a result of the impairment of the Group’s investment in Sciemus. Earnings per share Underlying earnings per share* were 18.9p compared with 13.6p^ for the year ended 31 March 2012 benefitting from the increase in operating profit and from last year’s decision to pay down private placement debt. Basic earnings per share reduced to (20.5)p (2012: 37.9p^). Dividend The Board proposes a final dividend of 2.70p per share for the year ended 31 March 2013 (31 March 2012: 2.00p). Subject to approval at the Annual General Meeting, the final dividend will be paid on 6 September 2013 to shareholders on the register at 9 August 2013. Other financials Cash flow The Group’s cash flow from operations before net restructuring recoveries/costs but after capital expenditure was £175.9m (2012: £235.4m). Underlying operating cash conversion* remained strong at 104% (2012: 148%^), despite the impact of increased contract- funded capital expenditure in UK Services. The net cash inflow in the year on restructuring was £63.1m (2012: £8.9m outflow), which includes the impact of £65m received from MOD in April 2012 relating to the March 2012 settlement which discharged the MOD from its accumulated liabilities for rationalisation costs incurred in previous years. * Definitions of underlying performance can be found in the glossary on page 116. ^ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. QinetiQ Group plc Annual Report and Accounts 2013 27 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewChief Financial Officer’s review continued Assumption Discount rate Inflation Salary increase Life expectancy Change in assumption Increase/decrease by 0.1% Increase/decrease by 0.1% Increase/decrease by 0.1% Increase by 1 year Indicative effect on scheme liabilities (before deferred tax) Decrease/increase by £25m Increase/decrease by £26m Increase/decrease by £4m Increase by £28m Each assumption is selected by the Group in consultation with the Company actuary and takes account of industry practice amongst comparator listed companies. The sensitivity of each of the key assumptions is shown in the table above. The market value of the assets at 31 March 2013 was £1,256.5m (2012: £1,107.9m) and the present value of scheme liabilities was £1,310.6m (2012: £1,139.4m). The most recent full actuarial valuation of the defined benefit section of the QinetiQ Pension Scheme was undertaken as at 30 June 2011 and resulted in an actuarially assessed deficit of £74.7m. On the basis of this full valuation, the Trustees of the scheme and the Company agreed the employer contribution rate of 12.7% from 30 June 2011, and past service deficit recovery payments of £10.5m per year for a six-year period from 1 April 2012. As part of a package of measures to stabilise the scheme, the Company has also contributed an asset in the form of an interest through a Scottish limited partnership in a future income stream of approximately £2.5m per annum, increasing in line with the Consumer Price Index, for 20 years secured on certain properties owned by the Group. Finally, the Company and Trustees also agreed the key provision that the Trustee will select the Consumer Price Index rather than the Retail Price Index as the relevant index for the increase of pensions in payment in respect of service before 1 June 2008 and for the revaluation of preserved benefit, resulting in the one-off past service credit of £141.4m in the year ended 31 March 2012. The next scheduled triennial valuation will be performed as at 30 June 2014. Capital risk The Group funds its operations through a mixture of equity funding and debt financing, including bank and capital market borrowings. At 31 March 2013 the Group’s total equity was £438.5m (2012: £599.4m). Net cash as defined by the Group was £74.0m (2012: net debt £122.2m). The capital structure of the Group reflects the judgement of the Directors of an appropriate balance of funding required. The Group’s target is to maintain its gearing ratio below 2xEBITDA. Treasury policy The Group treasury department works within a framework of policies and procedures approved by the Audit Committee. As part of these policies and procedures, there is strict control on the use of financial instruments. Speculative trading in financial instruments is not permitted. The policies are established to manage and control risk in the treasury environment and to align the treasury goals, objectives and philosophy of the Group. Funding and debt portfolio management The Group seeks to obtain certainty of access to funding in the amounts and maturities required to support the Group’s medium to long-term forecast financing requirements. Group borrowings are arranged by the Group treasury function. Interest risk management The Group seeks to reduce the volatility in its interest charge caused by rate fluctuations. A significant portion of the Group’s borrowings are fixed in the short to medium term through fixed-rate debt. 28 QinetiQ Group plc Annual Report and Accounts 2013 Foreign exchange risk management The principal exchange rate affecting the Group was the sterling to US dollar exchange rate. £/US$ – average rate £/US$ – closing rate £/US$ – opening rate The Group’s income and expenditure is largely settled in the functional currency of the relevant Group entity, mainly sterling or US dollar. The Group has a policy in place to hedge all material transaction exposure at the point of commitment to the underlying transaction. Uncommitted future transactions are not routinely hedged. The Group continues its practice of not hedging income statement translation exposure. To minimise the impact of currency depreciation of the net assets on its overseas subsidiaries, the Group seeks to borrow in the currencies of those subsidiaries, but only to the extent that its gearing covenant within its loan documentation, as well as its facility headroom, are likely to remain comfortably within limits. Tax risk management QinetiQ’s tax strategy is to ensure compliance with all relevant tax legislation, wherever we do business, whilst managing our effective and cash tax rates. Tax is managed in alignment with our corporate responsibility strategy in that we strive to be responsible in all our business dealings. These principles are applied in a consistent and transparent manner in pursuing the Group’s tax strategy and in all dealings with tax authorities around the world. Credit risk Credit risk arises when a counterparty fails to perform its obligations. The Group is exposed to credit risk on financial instruments such as liquid assets, derivative assets and trade receivables. Credit risk is managed by investing liquid assets in, and acquiring derivatives from, high-credit quality financial institutions. Trade receivables are subject to credit limits, control and approval procedures across the Group. The nature of the Group’s operations leads to concentrations of credit risk on its trade receivables. The majority of the Group’s credit risk is with the UK and US Governments and is therefore considered minimal. 2013 1.58 1.52 1.60 2012 1.60 1.60 1.60 Insurance The Group continually assesses the balance of risk arising from the operations undertaken against the insurance cover available for such activities and associated premiums payable for such cover. A prudent and consistent approach to risk retention and scope of cover is applied across the Group. The Group has a policy of self-insurance, through its captive insurance company, on the first layer of specific risks with insurance cover above these levels placed in the external market with third-party insurers. Employees Year-end employee numbers have decreased by 7% to 9,498 at 31 March 2013. The decline primarily reflects headcount reductions in the US to maintain competitiveness in the challenging market. Accounting standards As a UK-listed company, the Group is required to adopt EU endorsed IFRSs and comply with the Companies Act 2006. The effect of changes to financial reporting standards in the year is disclosed in note 1 to the financial statements. Critical accounting estimates and judgements in applying accounting policies A description and consideration of the critical accounting estimates and judgements made in preparing these financial statements is set out in note 1 to the financial statements. David Mellors Chief Financial Officer 23 May 2013 Employees by sector 2013: 9,498 Employees by sector 2012: 10,180 UK Services US Services Global Products 54% 35% 11% UK Services US Services Global Products 51% 39% 10% * Definitions of underlying measures of performance can be found in the glossary on page 116. ^ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. QinetiQ Group plc Annual Report and Accounts 2013 29 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewRisks and uncertainties Understanding and managing our risks Considerable progress has been made in the last year to improve the effectiveness of QinetiQ’s risk management processes. This has included greater clarification regarding the Board’s risk appetite specifically linked to the Company’s growth agenda and our Organic-Plus strategy. With the change of the Compliance Committee to the Risk & CSR Committee and its focus on risks where the primary impact is non-financial, the Audit Committee retains a focus on purely financial risks. The differentiation between pure financial and non-financial risk has aided both the Executive and Board risk review process, allowing for greater focus on the effectiveness of relevant mitigations. Risks continue to be assessed according to the likelihood of an event’s occurrence and its impact. The Group risk register includes an analysis of the potential exposures and severity of each risk (as a function of its likelihood and impact), the assumptions underlying each risk and the mitigation required to manage it. The Group risk register considers: • The authority, resources and coordination of those involved in the identification, assessment and management of the significant risks the organisation faces; • The response to the significant risks which have been identified by management and others; • The monitoring of reports from Group management; and • The maintenance of a control environment directed towards the proper management of risk. The Group risk register is reviewed by the Executive and the Board and, in addition, the risk owners present an update of current status and mitigating actions by rotation throughout the year. Risk Defence market Potential impact Mitigation The financial burden on both UK and US government budgets from the current economic downturn and the requirement to reduce budget deficits will lead to reduced spending in the markets in which the Group operates. In particular, the UK is reducing its defence budget by 8% in real terms by 2015 and, in addition, is seeking to remove significant overheating in its equipment programme. In the US, sequestration was enacted on 1 March 2013 and government departments are working through its impact on levels of expenditure and future project priorities. Any reduction in government defence and security spending in either the UK or the US could have an adverse impact on the Group’s financial performance. Our focus on a range of markets in aerospace, defence, security and intelligence provides a degree of portfolio diversification. The Group will continue to review trends in defence, aerospace and security expenditure in order to align the business with those trends. Whilst UK government expenditure remains under pressure the MOD has made considerable progress in balancing its budget. In defence research, where QinetiQ is the private sector market leader, spending has been stabilised at about £390m pa until 2015. Current plans of both US and UK governments are to drawdown troops from Afghanistan by the end of 2014. A significant shift in policy by either the US Administration or the UK Government, which resulted in a significant reduction in the number of forces personnel present in Afghanistan, or a change in the timing, may have a materially adverse impact on the Group’s financial performance. The Group manages this by maintaining a market focus and competitive positioning in adjacent markets, including defence services (which are not directly conflict-related), aerospace, space, security and intelligence, which provides a degree of portfolio diversification. The Group is also seeking to increase its portfolio of products and to find new markets and applications for its existing offerings. The aerospace, defence and security markets are highly competitive. The Group’s financial performance may be adversely affected should it not be able to compete in the markets in which it aims to operate. Government customers seek to prevent Organisational Conflicts of Interest (OCI) occurring where the companies provide solutions as part of the defence supply chain and consultancy services as a technical advisor. QinetiQ seeks to focus on areas within these markets in which its deep customer understanding, domain knowledge, technical expertise and platform independence provide a strong proposition and a significant advantage in competitive bidding. QinetiQ takes proactive steps to manage any potential OCI and to maintain its ability to provide independent advice through its consulting and systems engineering activities. A formal compliance regime operates in the UK with the MOD. In March 2012, QinetiQ agreed with the MOD that it could adopt the generic compliance regime in use with other companies, replacing a QinetiQ-specific one. This change will not affect the rigour of the compliance process. 30 QinetiQ Group plc Annual Report and Accounts 2013 Risk Contract profile Pension scheme Potential impact Mitigation A material element of the Group’s revenue is derived from one contract. The Long-Term Partnering Agreement (LTPA) is a 25-year contract to provide a variety of evaluation, testing and training services to the MOD. The original contract was signed in 2003. The LTPA operates under five-year periods with specific programmes, targets and performance measures set for each period. In the current year, the LTPA directly contributed 14% of the Group’s revenue and supported a further 8% through tasking services using LTPA managed facilities. The loss, cancellation or termination of, or significant reduction in, this contract would have a material, adverse impact on the Group’s future reported performance. The amounts payable under some government contracts can be significant and the timing of the receipt of orders could have a material impact on the Group’s performance in a given reporting period. Some of the Group’s revenue is derived from contracts that have a fixed price. There is a risk that the costs required for the delivery of a contract could be higher than those agreed in the contract, as a result of the performance of new or developed products, operational over-runs or external factors, such as inflation. Any significant increase in costs which cannot be passed on to a customer may reduce the profitability of a contract or even result in a contract becoming loss-making. The Group operates a defined benefit pension scheme in the UK. There is currently a deficit between the projected liability of the scheme and the value of the assets it holds. The size of the deficit may be materially affected by a number of factors, including inflation, investment returns, changes in interest rates, and improvements in life expectancy. An increase in the deficit may require the Group to increase the cash contributions to the scheme, which would reduce the Group’s cash available for other purposes. In February 2013, the Group successfully completed the five-yearly periodic review of the LTPA, agreeing terms with the MOD for the provision of core test, evaluation and training support services through to March 2018. The Group continues to achieve customer performance and satisfaction levels, and significantly exceeded the agreed minimum performance rating of 80% in 2012. While achieving the performance scores, the Group has achieved significant cost savings for the MOD on repeated services. The contract and orders pipeline is regularly reviewed by senior operational management. The nature of many of the services provided under such fixed-price arrangements is often for a defined amount of effort or resource rather than firm deliverables and, as a result, mitigates the risk of costs escalating. The Group ensures that its fixed-price bids and projects are reviewed for early detection and management of issues which may result in cost over-run. Pension scheme performance is reviewed regularly by Group management, in conjunction with the scheme’s independent trustees. External actuarial and investment advice is also taken on a regular basis to ensure that the scheme is managed in the best interests of both the Group and the scheme’s members. The most recent triennial funding valuation of the scheme, as at 30 June 2011, resulted in a deficit of £74.7m. The Group and trustees have agreed a package of measures to enhance the security of the scheme, including deficit recovery payments over six years, the use of CPI rather than RPI for indexation purposes, and an asset-backed funding programme. The next funding valuation of the scheme is at 30 June 2014. The Group and the Trustees continue to work on the de-risking of the liability profile of the scheme. US foreign ownership regulations In the US, the Group undertakes work that is deemed to be of importance to US national security and is therefore subject to foreign ownership regulations. Arrangements are in place to insulate these activities from undue foreign influence as a result of foreign ownership. Failure to comply with the regulations could result in sanctions, and suspension or debarment from government contracts, as well as reputational damage to the QinetiQ brand. The Group has procedures in place to ensure that these arrangements remain effective and to respond to any changes that might occur in US attitudes to foreign ownership of such activities. This section entitled ‘Management and control of US subsidiaries’ on page 45 of this report provides details of the proxy agreement between QinetiQ North America and the US DoD, that regulates the ownership, management and operation of QinetiQ’s principal US subsidiaries. QinetiQ Group plc Annual Report and Accounts 2013 31 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewRisks and uncertainties continued Risk Potential impact Mitigation Significant breach of relevant laws and regulations The Group operates in highly-regulated environments and is subject to numerous domestic and international laws. The Group recognises that its operations have the potential to have an impact on a variety of stakeholders and that failure to comply with particular regulations could result in a combination of fines, penalties, civil or criminal prosecution, and suspension or debarment from Government contracts, as well as reputational damage to the QinetiQ brand. Key areas of focus for the organisation include; Safety liability from failure of a product, service or advice as well as workplace health, safety and environmental matters. Bribery and Ethics US Proxy Regime International Trade Controls Tax legislation QinetiQ is liable to pay tax in the countries in which it operates, principally in the UK and the US. Changes in the tax legislation in these countries could have an adverse impact on the level of tax paid on the profits generated by the Group. The Group has procedures and, where appropriate, training in place to ensure that it meets all current regulations. Together, these ensure the Group manages corporately and at local business level, the effective identification, measurement, and control of regulatory risk. Local management continuously monitors local laws and regulations, and policies are in place for the appointment of advisors to support business development. Professional advice is sought when engaging in new territories to ensure that the Group complies with local and international regulations and requirements. Robust training, policy and processes exist to ensure the safety of products, services and advice and to protect employees and others affected by QinetiQ operations. Recent successes include external accreditation of our Safety Management System and continuing authorisations for regulated design and maintenance services in the aviation arena (page 34). QinetiQ also undertakes human factor and behavioural safety training to embed its safety culture. The QinetiQ Code of Conduct outlines a strong stance on anti-bribery supported by annual training of all employees, procedures and systems for managing international business, payments to commercial intermediaries, gifts and hospitality. Performance was reviewed externally and benchmarked against others in this sector (page 34). Procedures are in place to ensure that these regulations are adhered to, specifically with regard to communication with staff at QinetiQ’s principal US subsidiaries. Compliance data is maintained and monitored by the Executive and Board. Ongoing compliance has been supported by a programme to improve QinetiQ’s handling of legacy materials as well as to improve our systems and processes for the handling and management of new materials and electronic data. Investment in this area supports our plans for growth in the international arena as well as building confidence in how we manage existing regulatory requirements. External advice and consultation are sought on potential changes in tax legislation in both the UK and the US. This enables the Group to plan for and mitigate potential changes in legislation. The Group is currently actively engaging with HM Treasury on the proposal to move R&D tax credits out of the tax charge and ‘above the line’ into operating profit. Legislation has been published in the UK which, subject to Royal Assent, will bring a mandatory ‘above the line’ approach from 1 April 2016. This could increase the Group’s effective tax rate over time towards a blend of the US and UK corporation tax rates. The Group has £202.7m of tax losses carried forward as at 31 March 2013 (2012: £200.0m). 32 QinetiQ Group plc Annual Report and Accounts 2013 Risk Potential impact Mitigation Breaches of data security and failure of IT systems The Group operates in a highly-regulated information technology environment. The data held by QinetiQ is highly confidential and needs to be totally secure, particularly against a background of increasing cyber threat. A failure of systems could have an impact on contract delivery leading to a loss of customer satisfaction. A breach of data security could have an impact on our customers’ operations and have a significant reputational impact, as well as lead to the possibility of exclusion from some types of government contracts, with a detrimental impact on the Group’s financial performance. Working in a global market place The Group’s financial systems are required to be adequate to support US and UK government contracting regulations. QinetiQ operates internationally. The risks associated with having a large geographic footprint may include: regulation and administration changes, changes in taxation policy, political instability, civil unrest, and differences in culture and terms of reference, leading to a lack of common understanding with customers. Any such events could disrupt some of the Group’s operations and have a material impact on its future financial performance. The Group is exposed to volatility in exchange rates as a result of the international nature of its operations. This includes a translational impact on the key financial statements as a result of the Group reporting its financial results in sterling. The Group has limited transaction exposure as its revenue and related costs are often borne in the same currency, principally US dollars or sterling. Of the Group’s total revenue, approximately 45% is contracted in sterling, 50% in US dollars and 5% in other currencies. The Group relies on the proper functioning of the credit markets which could have an impact on both the availability and associated costs of financing. The Group is exposed to interest rate risk to the extent borrowings are issued at floating interest rates. Recruitment & retention QinetiQ operates in many specialised engineering, technical and scientific domains. There is a risk that key capabilities and competencies are lost through failure to recruit and retain employees within the organisation due to internal factors as well as across the sector due to macro factors affecting the desirability, intake and training of engineers, scientists and technologists. Information systems are designed with consideration of single points of failure and the removal of risk through minor and major system failures. The business maintains business continuity plans that cover both geography, e.g. sites and business units, and the technical capability of staff. These plans cover a range of scenarios, including loss of access to information technology systems. The plans are tested at appropriate intervals. Data security is assured through a multi-layered approach that provides a hardened environment, including robust physical security arrangements, data resilience strategies and the application of security technologies, as well as comprehensive internal and external testing of potential vulnerabilities. In addition, the systems are monitored and managed on a 24/7 basis. A significant amount of effort is invested in engaging with US and UK government contracting audit agencies to enable them to test and opine on relevant financial systems and data, and on implementing any recommended improvement plans. While the core activities of the Group are confined to the UK and the US, it continues to explore potential customer relationships across the globe. These new relationships are assessed for their inherent risks, using our International Business Opportunity Management process before being formally entered into. The Group actively hedges all significant transactional foreign exchange exposure, as described in the notes to the financial statements, and has adopted hedge accounting. The Group’s objective is to reduce medium- term volatility to cash flow, margins and earnings. The Group protects its balance sheets and reserves from adverse foreign exchange movements by financing acquisitions in North America with US dollar-denominated borrowings, thereby partially mitigating the risk as US dollar earnings are used to service and repay US dollar- denominated debt. The Group maintains a prudent level of committed funding facilities: a five-year multi-currency facility totalling £282.8m was provided by its relationship banks and signed in 2011. This is currently undrawn. The Group also uses fixed-rate debt instruments issued to US private placement investors with maturity dates up to 2019. The Group conducts regular activity to identify key roles and personnel. Succession plans are in place looking internally at suitable candidates ready now or in need of development to fill particular roles as well as external activity to identify talent in industry the organisation may wish to attract. QinetiQ Group plc Annual Report and Accounts 2013 33 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness review Corporate responsibility and sustainability review Meeting stakeholder expectations “ Managing risk, protecting our reputation and operating responsibly and safely are key priorities.” Leo Quinn, CEO Governance and strategy The Group Risk & CSR Committee (page 47 of this report) meets regularly and receives reports on ethics, environment, health and safety and broader corporate responsibility and sustainability issues. In the US, the QNA Board oversees these activities, obtaining independent assurance on the adequacy of its compliance programmes on an ongoing basis. Key policies and management systems underpin our corporate responsibility programmes. In the UK these include our environmental management system certified to ISO 14001, and our health and safety management system certified to OHSAS 18001. In the UK, a business assurance tool assists the assurance and monitoring process. Our US business has established policies, procedures and programmes in place to ensure compliance with US federal labour, environmental, health and safety and other laws and regulations. QNA has ISO 9001:2008 and ISO 9001:AS9100 certified at three key sites. In accordance with our corporate responsibility strategy, we aim to continue to embed our programmes such that ‘how we do business’ aligns with stakeholders’ expectations of responsible business. New initiatives that are designed to help us continuously improve our performance are also regularly introduced. Meaningful stakeholder engagement We seek to engage with key stakeholders to help shape our strategy and priorities. We regularly engage with investors directly and provide information to relevant ratings agencies. We have a regular dialogue with the MOD on sustainability. Employees are informed and involved in programmes through a range of channels such as the UK Employee Engagement Group as well as regular townhalls and employee surveys. Pursuing high ethical standards The Group’s Code of Conduct provides clear guidance on ethical standards and guides employee behaviour in business activities. Annual business ethics training is mandatory for all employees and the Group Board. We also run additional training for those in higher risk roles. Our Chief Ethics Officers are senior executives. Risk management is embedded in business processes and we use third parties for due diligence, where appropriate. 34 QinetiQ Group plc Annual Report and Accounts 2013 Employee involvement Safety, health and wellbeing The safety, health and wellbeing of our people remains a priority with a continuous focus on driving down accidents by providing training, raising awareness of safe working practice and improved reporting. QinetiQ’s UK occupational safety record continues to be strong; for example, the UK RIDDOR (Reporting of Injuries, Diseases and Dangerous Occurrences Regulations) rate for 2013 is 1.90 per 1,000 employees which is well below the Health and Safety Executive ‘all industries’ benchmark of 4.46 per 1,000 employees. There were no prosecutions or prohibition or improvement notices issued by regulators during year. Meeting our 2013 objective, our UK health and safety management system was certified to OHSAS 18001 supported by initiatives such as the QinetiQ Visible Active Leadership campaign, focusing on safety culture and behaviour and the Actions Speak Louder Than Words programme, empowering employees to take action and be active in accident prevention. “ We are delighted that our UK safety management system has been certified to OHSAS 18001, meeting our 2013 objective.” In our US operations, health and safety training is focused on empowering employees to operate safely. We have rolled out five specialist courses in health and safety within Technology Solutions. Additionally on our NASA contracts we have 980 employees trained in the NASA Voluntary Protection Program and 40 NASA Area Safety Representatives. Lost time incidents per 1,000 employees* QinetiQ Group (excluding QNA) QNA QinetiQ Group 2013 5.36 1.45 3.70 2012 5.53 1.12 3.55 It is important to the Company that we support our employees in their health and wellbeing. In the US, the Vitality Wellness Program introduced in 2011 as part of the existing Health in Motion initiative, supports employees and their families. Programme incentives include reduced health insurance premiums, prizes for attaining point levels and discounts on health clubs and equipment. 60% of employees who participate in Company medical insurance are engaged in the programme. The UK Wellbeing Programme provides practical help and assistance on a wide range of personal and work-related issues, including the provision of a confidential resource for support and information. In the UK, employees have access to a competitive range of employee benefits through QinetiQ Benefits+, a flexible benefits package. * Two QNA incidents have been reclassified and so 2012 LTI for QNA and for Group are slightly lower than reported last year. Safety objectives and performance 2013 objectives Progress and achievements Status 2014 objective • Reduction in reportable UK incidents to zero by 2014 • We continue to work towards zero reportable incidents by 2014 • Ongoing • Reduction in reportable UK incidents by 2014. • Attainment of OHSAS 18001 in • We have attained OHSAS 18001 • Achieved the UK by 2013 certification in the UK Case study: Safety stop On 20 July the employees in QinetiQ’s Air, Weapons and Maritime businesses stopped their daily activities and dedicated two hours to focus on the topic of safety. The event was designed to signal that safety comes first. As part of the ‘Safety Stop’ employees, together with some of our customers, discussed safety issues and how to improve safety further. The feedback generated over 800 safety ideas, many of which have been taken forward into daily operation. Safety of products, services and advice Whether providing traditional products, specialist advice or other services, delivering safely underpins our offering to customers. In recent years QinetiQ has invested heavily to attract and maintain competent engineers, technologists and scientists with specialist safety expertise. In the UK, Technical Assurance and Independent Design Review have been fully integrated into our day-to-day business delivery processes. Improvements continue to be driven by our Engineering and Technical Leadership Team, supported by independent assurance activity. In addition to maintaining and developing its design and maintenance accreditations for safety critical work, through various committees and working groups, QinetiQ actively supports collaborative working with its main UK customer, MOD, and other industry organisations to develop and implement common safety standards and practices. Our US business continues to use technical excellence to improve the safety and usability of their products and as a critical component in delivering support services in unique and safety critical environments for the Department of Defence and NASA. Involving our people An independent UK annual employee engagement survey had a response rate of 74%. Action planning is taking place at a divisional level to build on successes and address areas for improvement. The UK Employee Engagement Group (EEG) comprises 40 representatives at local and national level, elected by employees to improve engagement and act as a consultative body on developments within the Company. In the last year the EEG has become established and played an active role in monitoring and feeding back on employee views, with consultation on topics such as pay, pensions and employee wellbeing. In the US an employee survey response rate of 63% was achieved. For every employee submission, QNA made a charitable donation to the Fisher House Foundation, which helps veterans and their families with housing and medical requirements, resulting in a total donation of $13,000. Future plans for engagement in the US business include employee focus groups. Senior leaders from across the Group met at the annual QinetiQ Leadership conference in April this year. The Company operates the ‘My Contribution’ programme which enables employees to actively take part in business improvement. People Who Know How At QinetiQ, we aim to grow sustainable earnings and to increase our customer satisfaction. It is our ‘People Who Know How’, who will give QinetiQ its competitive advantage and consistently exceed our customers’ expectations. To ensure we increase our capability, QinetiQ UK is building a foundation for the future in Learning and People Development, providing our employees with the tools and opportunities to drive their own career, maximise potential and knowledge share. Performance will be supported through development toolkits, increased online learning capability and bespoke programmes delivered in house and by award winning suppliers. Our people agenda demonstrates QinetiQ’s commitment to offer development to all employees. We have increased the number of UK apprenticeships and, as well as the traditional subjects such as aeronautical engineering that we have been offering at our apprentice school for over 40 years, we have included new apprenticeships in areas such as facilities management. Sam Prichard, Apprentice (left), receiving an award for Mechanical Apprentice of the Year from Gaz Borland, MD Air. QinetiQ Group plc Annual Report and Accounts 2013 35 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewCorporate responsibility and sustainability review continued Case study : My Contribution – Energy Saving My Contribution offers QinetiQ employees the opportunity to get involved in business improvement, both in terms of making suggestions and being empowered to put them into action. This year’s My Contribution ‘Quick Win of the Year’ was awarded to Norman Terrill, Advisor – Shore Integration Facility, based at Portsdown Technology Park, whose achievements were recognised at the 2013 My Contribution Showcase. Norman identified a number of improvements which would help his local site to save energy. This included installing sensors and timers, putting in a process for turning off heavy equipment when not in use and introducing a ‘switch-off’ activity to the end of day security close down – all aimed at making sure that when rooms and equipment are not in use we’re not wasting electricity. Dr Sam Healy, Head of Sustainability and Corporate Responsibility, said: “It’s great to see someone with so much passion and energy recognised for their contribution. My Contribution empowers people to make a difference”. Norman Terrill (centre) receiving his award from Leo Quinn (left) and Mark Elliott (right). In the US, the employee performance appraisal process has been enhanced to improve employee ownership of career development, planning by supervisors and to better align employee development with our US business objectives. Employees are supported in the attainment of professional and technical certifications and degrees. Our US business is an ITIL (Information Technology Infrastructure Library) Foundation Certification Training provider, with two certified instructors. US employee service and accomplishments are recognised through a variety of bonus programs. Diversity and inclusion QinetiQ provides an environment of respect and inclusion that recognises and values the unique skills, experiences and perspectives that each employee contributes toward our business success. In the US, a Diversity Recruiting Strategy has been introduced to focus on the recruitment of under-represented groups. This strategy will particularly focus on creating a rich pipeline of candidates from these target groups for future positions. In the UK, we are committed to launching a new diversity and inclusion programme. Currently the percentage of women working in the UK business is 20% and 28% of the US workforce is female. We are committed to the fair treatment of people with disabilities in relation to applications, training, promotion and career development. If an existing employee becomes disabled, the Group’s policy is to provide continuing employment and training, wherever practicable. We have Two Ticks accreditation in the UK, demonstrating we are committed to employing disabled people. We value the diversity of experience which drives the creativity and innovation of our engineers and scientists – People Who Know How. The different approaches that our people take in solving our customers’ challenges gives us competitive advantage and the ability to retain and win new business. Environmental stewardship The reduction of the environmental impact of our operations remains a priority. Our UK Environmental Management System is certified to ISO 14001 and covers our estate and the sites we manage on behalf of the MOD. The delivery of test and evaluation and training support services is conducted on MOD sites, many of which are designated conservation areas of national and international importance, including St Kilda, a World Heritage Site. As a result, sustainability appraisals are regularly carried out to identify and mitigate any impact to the flora, fauna and any other sensitive receptors of the activities undertaken. Greenhouse gas emissions Monitoring of our UK carbon footprint shows a year-on-year reduction in emissions. Arrangements for data capture of greenhouse emissions across the Group have been rolled out using guidance and emission factors published by the Department of Environment, Food and Rural Affairs. A 15% reduction in carbon emissions over three years (with a 2012 baseline) is our target in the UK. This will be achieved by making infrastructure more energy efficient and engaging employees to change behaviour. The theme of our UK annual Environment Week campaign in 2013 was focused on more sustainable travel. Environmental objectives and performance 2013 objectives Progress Status 2014 objectives • 15% reduction in UK carbon emissions by • Programmes • Ongoing 2015 – to be delivered through investment projects, reducing business travel and improving employee engagement underway, absolute emissions reduced by 2% • Reduce carbon emissions in the UK by 15% (2012 baseline) by 2015. • Data streams to capture greenhouse gas emissions for Group. • Continue to improve waste management in the UK in relation to the whole waste hierarchy, not simply recycling • Training delivered and improved mapping of waste streams • Ongoing • Encouraging reduction in waste, increased re-use of assets, and enhanced segregation of waste streams for recycling. 36 QinetiQ Group plc Annual Report and Accounts 2013 The emissions data in the table below shows UK emissions for 2013. Our Australia business reported 333 tonnes CO2e from electricity use. UK Emissions (ktonnes CO2e) Scope 1 – gas1 Scope 1 – oil Scope 1 – travel2 Scope 2 – electricity Scope 3 – travel3 Total emissions 2013 9.51 5.06 5.69 44.19 5.40 69.85 2012 8.22 5.61 5.45 45.57 6.43 71.29 1 Gas usage up due to adverse weather conditions. 2 Travel includes land vehicles and aircraft. 3 Travel includes flights and cars but excludes trains and ferries. UK waste management We continue to focus on improving waste management through training, mapping waste streams, improving data collection processes and encouraging re-use of assets. Total waste this year was 4,904 tonnes, including 211 tonnes of hazardous waste. This represents an increase on last year’s total due to significant footprint rationalisation and building works, combined with the improved capture/robustness of data. There has been a significant diversion of waste from landfill (approximately 85%). The aim for 2014 is to continue encouraging reduction in waste, increased re-use of assets, and enhanced segregation of waste-streams for recycling. Sustainable procurement As a key supplier, our active engagement with the MOD on sustainability reflects our commitment to sustainable procurement. Investment in our community Our commitment to enthusing and attracting the next generation of scientists and engineers is reflected in our work undertaken on STEM (Science, Technology, Engineering and Maths) Outreach. This programme plays to the strengths of a highly skilled technical workforce and helps young people discover new opportunities for learning and for their future. In the UK our employee engagement scores on ‘giving something back’ rose by 6% due to the maturing of our volunteering programme, regularly celebrating the success of our community activities and getting employees actively involved in choosing our new UK charity partners. In the US we support educational enrichment through the National Guard Youth Foundation, World Affairs Council, Naval Historical Foundation and various robotics education programmes. There is also a particular focus on supporting wounded military and their families by contributions to a range of specialist organisations. Across the Group we have corporately donated £180,492 this year to registered charities. Of this amount £31,314 was donated to our UK corporate charities, £72,942 for education, £17,067 for military charities (other than the corporately chosen military charity) and £59,169 for diverse other causes. In addition employees have raised £30,184 for our UK corporate charities, chosen in April 2012 (RNLI, Cancer Research UK and Help for Heroes) for which they received matched funding and £31,633 through UK payroll giving. For detailed information on Corporate Responsibility and Sustainability visit: www.QinetiQ.com/responsibility Case study : Powerboat Challenge The QinetiQ Schools’ Powerboat Challenge provides pupils with an exciting and valuable opportunity to understand the importance of STEM within the marine industry. The annual competition is held in the Ocean Basin at Haslar by the Maritime Division. In 2012, 13 teams from ten schools in Hampshire and Dorset designed, built and raced their own model powerboats. The pupils were given a design brief by QinetiQ, along with some of the equipment and parts they need to build the boats and were supported by QinetiQ scientists and engineers throughout the project. They then raced their boats against each other and were judged by a panel of our experts. Commenting on the event Sarah Kenny, MD Maritime, said: “This event was about encouraging more youngsters to take up science subjects and become the marine engineers of the future. There’s a national skills shortage in engineering and part of QinetiQ’s commitment is to bring local schools here.” Sarah Kenny, MD Maritime, at the Powerboat Challenge. QinetiQ Group plc Annual Report and Accounts 2013 37 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationBusiness reviewCorporate governance Board of Directors Mark Elliott Non-executive Chairman (64) David Mellors Chief Financial Officer (44) Colin Balmer Non-executive Director (66) Appointment to the Board Appointed Non-executive Chairman in March 2010; Non-executive Director between June 2009 and February 2010. Committee memberships • Nominations Committee (Chairman) • Remuneration Committee • Risk & CSR Committee Skills and experience Mark is a Non-executive Director of G4S plc. He was a Non-executive Director of Reed Elsevier Group plc (and also Chairman of its Remuneration Committee) and Reed Elsevier NV from April 2003 until April 2013. He was previously General Manager of IBM Europe, Middle East and Africa and was a member of IBM’s Worldwide Management Council. The Board considers that Mark’s extensive experience in the technology services sector, in the US and Europe, together with his exposure to a variety of industry sectors on the boards of FTSE listed companies, is a valuable asset to the Group in terms of leadership and of addressing the strategic issues that affect the Group. Appointment to the Board Appointed Chief Financial Officer in August 2008. Committee memberships • Risk & CSR Committee • Security Committee Skills and experience David was previously deputy Chief Financial Officer of Logica plc. He was also Chief Financial Officer of Logica’s international division, covering operations in North America, Australia, the Middle East and Asia and, before that, was the Group Financial Controller. His earlier experience includes various roles with CMG plc, Rio Tinto plc and Price Waterhouse. He is a member of the Institute of Chartered Accountants in England & Wales. Appointment to the Board Appointed Non-executive Director in February 2003. Committee memberships • Audit Committee • Nominations Committee • Remuneration Committee • Risk & CSR Committee (Chairman) • Security Committee (Chairman) Skills and experience Colin is currently a member of the Board of the Royal Mint and Chair of its Audit Committee. He has held senior posts in government, including Managing Director of the Cabinet Office from 2003 until his retirement in 2006. He was previously Finance Director of the MOD and was responsible for QinetiQ’s privatisation. Notwithstanding that Colin has served on the Board for more than nine years, the Board considers that he remains independent in character and judgement. Further, the Board considers that Colin’s extensive knowledge of the development of QinetiQ, and his in-depth understanding of the working of government, continue to provide the Board with a unique insight into the issues government faces in delivering its procurement objectives. Appointment to the Board Appointed Chief Executive Officer in November 2009. Committee memberships • Nominations Committee • Risk & CSR Committee • Security Committee Skills and experience Leo was Chief Executive Officer of De La Rue plc between 2005 and 2009. He was previously Chief Operating Officer of Invensys plc’s Production Management Division and before that spent 16 years with Honeywell Inc. in a variety of senior management roles in the USA, Europe, the Middle East and Africa. He was formerly a Non-executive Director of Tomkins plc. Leo Quinn Chief Executive Officer (56) Michael Harper Deputy Chairman and Senior Independent Non-executive Director (68) Noreen Doyle Non-executive Director (64) Appointment to the Board Appointed Non-executive Director in November 2011. Appointed Deputy Chairman and Senior Independent Non-executive Director in February 2012. Committee memberships • Audit Committee • Nominations Committee • Remuneration Committee • Risk & CSR Committee • Security Committee Skills and experience Michael was appointed Chairman of BBA Aviation plc in June 2007, having joined the Board in February 2005. He is also Chairman of Ricardo plc. He was Chairman of Vitec Group plc from 2004 to 2012 and was previously a Director of Williams plc where, at the time of the demerger in 2000, he became Chairman of Kidde plc. The Board considers that Michael’s wealth of operational and corporate experience enables him to make a significant contribution to the Board. Appointment to the Board Appointed Non-executive Director in October 2005. Committee memberships • Audit Committee • Nominations Committee • Remuneration Committee (Chairman) • Risk & CSR Committee Skills and experience Noreen is a member of the Board of Credit Suisse Group (Zurich) and Chair of its UK regulated subsidiaries. She is a Non-executive Director of Newmont Mining Corporation (Denver), where she is Chair of the Audit Committee. From 2005 through 2012 she served on the Board of Rexam plc, where she was Chair of the Finance Committee. She was First Vice President of the European Bank for Reconstruction and Development (EBRD). Before EBRD, she worked in corporate finance and leveraged financing at Bankers Trust Company (now Deutsche Bank). The Board considers that Noreen’s extensive international business experience, particularly in corporate finance, risk management and banking, is of significant benefit to the Board. 38 QinetiQ Group plc Annual Report and Accounts 2013 Board statistics Board experience 75% Finance 75% Operational 75% International 75% Other PLC Board composition 25% Executive 75% Non-executive 87.5% Male 12.5% Female Board tenure 12.5% 0-2 years 12.5% 2-3 years 50% 3-5 years 25% 5-11 years Appointment to the Board Appointed Non-executive Director in April 2010. Committee memberships • Audit Committee • Remuneration Committee • Risk & CSR Committee • Nominations Committee • Security Committee Skills and experience Sir James commanded the aircraft carrier HMS Invincible and three other ships and submarines during a 37-year career in the Royal Navy that culminated in his appointment as Commander-in-Chief Fleet. Between operational duties he held several positions at the MOD and gained cross-Whitehall experience while on secondment to HM Treasury. The Board considers that Sir James’ expertise in the government contracting domain, particularly with the UK MOD and HM Treasury, is highly beneficial in the context of QinetiQ’s government-sourced operations. Appointment to the Board Appointed Non-executive Director in October 2010. Committee memberships • Audit Committee (Chairman) • Nominations Committee • Remuneration Committee • Risk & CSR Committee • Security Committee Skills and experience Paul is currently a Non-executive Director and Chair of the Audit & Risk Committee at Royal Mail Holdings plc. He is also a Director of Naked Energy Ltd and Knowledge Peers plc and a Trustee of Pilotlight. He was previously Senior Independent Director of Taylor Nelson Sofres plc, a Non-executive Director of Thomson SA and Tangent Communications plc, and has also been Group Finance Director of Carlton Communications plc and LASMO plc. The Board considers that Paul brings a broad range of experience in finance and corporate governance from a cross-section of industries, all of which leverage technology. Appointment Appointed as Company Secretary and Group General Counsel in January 2011. Skills and experience Jon joined QinetiQ from Chloride Group plc where he held a similar role. He has a background in legal private practice as well as general counsel and company secretarial experience in other FTSE250 companies. Admiral Sir James Burnell-Nugent Non-executive Director (63) Paul Murray Non-executive Director (51) Jon Messent Company Secretary and Group General Counsel (49) QinetiQ Group plc Annual Report and Accounts 2013 39 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governance Corporate governance Corporate governance report Mark Elliott Chairman Ensuring effective governance processes and systems of control within the Company continues to be a priority of the Board to ensure the optimum stewardship of the business and to provide a solid basis on which to build value and promote the long-term success of the Company. In my role as Chairman of the Board, I am pleased to report that the Board continues to demonstrate the range of expertise and engagement to challenge constructively and help develop strategy effectively. During the year, the terms of reference of the Board Committees were reviewed and updated where necessary, succession planning at both Executive Director and Non-executive Director level was reviewed and the skills matrix of the Board updated, to identify areas for development and to ensure that future appointments to the Board complement and enhance the existing capabilities. Diversity continues to be a key factor when considering the composition of the Board, not only in terms of gender but also in terms of background and experience. As a Board, we are mindful of our duties as Directors, particularly in terms of strategy and leadership, and we continue to maintain a dialogue with our key stakeholders on matters that are important to them. During the year, the Company consulted with its key investors in respect of issues such as executive remuneration and responses to market conditions; the Board met with business leaders in both the US and the UK to present the strategy and general direction of the Group as a whole; the Audit Committee maintained an ongoing dialogue with the external auditors and the internal audit function; non-financial risk oversight was transferred to the Risk & CSR Committee; and the full Board was available at the 2012 Annual General Meeting to meet with individual shareholders. The governance process will continue to evolve to allow for changes in regulation and best practice and to continue to promote the principles of good governance within the Company. Mark Elliott Chairman 40 QinetiQ Group plc Annual Report and Accounts 2013 The Board considers that QinetiQ has complied with the provisions of the 2010 version of the UK Corporate Governance Code (the ‘UK Code’) throughout the last financial year. In addition, during the year QinetiQ took steps to comply with the changes contained in the 2012 version of the Code within the required timeframe. Both versions of the UK Code and associated guidance are publicly available on the Corporate Governance page of the Financial Reporting Council’s website, www.frc.org.uk/corporate. This report provides details of the way the principles of the UK Code have been applied during the year. The Board – governance, processes and systems: Board objectives To demonstrate the highest standards of corporate governance in accordance with the UK Code to: • Ensure the continuing evolution and implementation of the Group’s strategy to deliver value to all stakeholders: customers, employees and shareholders; • Develop challenging objectives for the business and monitor management performance against those goals; • Provide a framework of effective controls to assess and manage risks, with clear expectations of conduct to the highest standards of ethics; • Provide support and constructive challenges to the Chief Executive Officer to promote the Group’s success; • Demonstrate leadership in management systems around health, safety and environment; and • Manage succession planning for the Board and the Group’s executive management. Composition of the Board Details of the Board of Directors are on pages 38-39. The Board currently has eight members: the Non-executive Chairman; five other Non-executive Directors; and two Executive Directors – the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO). There have been no changes to the Board during the year. Non-executive Chairman Non-executive Directors Executive Directors Total 1 5 2 8 Mark Elliott has been the Non-executive Chairman of QinetiQ since 1 March 2010, having first joined the Board as a Non-executive Director on 1 June 2009. The Board considers its overall size and composition to be appropriate, having regard in particular to the independence of character and integrity of all the Directors and the experience and skills that they bring to their duties, which prevents any individual or small group from dominating its decision-making. The Board has due regard to the benefits of diversity (including gender diversity) when considering its composition. It considers that the skills and experience of its individual members, particularly in the areas of UK/US defence and security, the commercialisation of innovative technologies, corporate finance, mergers and acquisitions, and risk management, have been fundamental in the pursuit of QinetiQ’s strategic initiatives (as described in the Chief Executive Officer’s statement on pages 5-11 of this report) in the past year. In addition, the quoted company experience of members of the Board in a variety of industry sectors and international markets has also been invaluable to the Group as it seeks to consolidate its position in its core markets and geographic territories. Roles and responsibilities The Board of Directors: • is responsible for overseeing the Executive Directors’ management of operations and, in this capacity, determines the Group’s strategic and investment policies; • monitors the performance of the Group’s senior management team and organises its business to have regular interaction with key members of senior management; and • is responsible for overseeing the management of the business of the Group. Its powers are subject to the Articles of Association and any applicable legislation and regulation. Chairman and Chief Executive Officer The roles of Chairman and CEO are separate, and the Board has clearly articulated their responsibilities in writing. The Chairman, Mark Elliott • is responsible for the effective operation of the Board; and • is responsible for ensuring that all Directors are enabled and encouraged to play their full part in its activities. The CEO, Leo Quinn • is responsible to the Board for directing and promoting the profitable operation and development of the Group, consistent with enhancing long-term stakeholder value. This includes: – the day-to-day management of the Group; – formulating, communicating and executing Group strategy; and – the implementation of Board policies. Senior Independent Director The Senior Independent Non-executive Director is Michael Harper. Michael is also the Deputy Chairman of the Board. The Senior Independent Director, Michael Harper: • serves as an additional point of contact for shareholders should they feel that their concerns are not being addressed through the normal channels; and • is available to fellow Non-executive Directors, either individually or collectively, should they wish to discuss matters of concern in a forum that does not include the Chairman, the Executive Directors or the senior management of QinetiQ. Independence of Non-executive Directors Of the current Directors of the Company, the Board considers all the Non-executive Directors to be independent of QinetiQ’s executive management and free from any business or other relationships that could materially interfere with the exercise of their independent judgement. Notwithstanding that Colin Balmer has served on the Board for more than nine years, the Board considers that he remains independent in character and judgement and the Board has found no information or circumstances to lead it to conclude otherwise. As detailed on page 38, the Board views Colin’s considerable knowledge of the history of QinetiQ, and his experience of working in government, as highly beneficial to the Board as a whole. Colin is assisting with the search for a new Non-Executive director to refresh the Board membership, as detailed in the section on the Nominations Committee on page 46. The Board considers that more than half its members were independent Non-executive Directors throughout the last financial year. Performance of the Board In accordance with the UK Code, QinetiQ continues each year to evaluate the performance of the Board and its Committees. An external evaluation of the Board’s effectiveness was carried out by Independent Audit Limited in the year ended 31 March 2012 and reported in that year’s annual report and accounts. During the year, the following progress was made against the actions arising from that external review: • With regard to risk strategy and the oversight of risk management, the Compliance Committee has evolved into a Risk & CSR Committee with an increased focus on reviewing the Group’s risk appetite and overseeing the management of non-financial risks; • Non-executive Directors are provided with opportunities to meet members of senior management and site visits are organised on request; • The manner in which information is presented to the Board has been revised to provide greater clarity and to identify the actions required; and • Closer links continue to be fostered with the Board of the US business to improve oversight of matters specific to that business. In addition to considering progress against the external review, the following evaluations took place during the year: Board Effectiveness questionnaire: A Board Effectiveness questionnaire was circulated to each member of the Board for completion and the results evaluated by the Chairman and considered at the May Board meeting. The questionnaire covered the following areas: • The role of the Board and its skills mix, including background, knowledge, experience and diversity; • The clarity of the Board decision-making process and information provided to the Board; • The assessment of Risk Appetite and the oversight of Group risks; and • The level of engagement with management and other stakeholders. QinetiQ Group plc Annual Report and Accounts 2013 41 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceCorporate governance report continued Individual performance reviews: The Chairman carried out a review of the performance of the Non-executive Directors and the Executive Directors, and the Senior Independent Non-executive Director carried out a review of the performance of the Chairman. In carrying out the reviews, feedback was obtained from fellow directors, the Company Secretary and senior management. The overall conclusion of these reviews was that the Board continues to be effective in its fulfilment of its governance responsibilities and that the actions agreed following the previous year’s external evaluation were being embedded in the Board processes and would continue to evolve and be reviewed as part of a process of continuous improvement. Directors’ induction, ongoing training and information All newly-appointed Directors take part in an induction programme which is tailored to meet their specific needs in relation to information on the Group. The induction programme includes an induction pack, which is refreshed to ensure that it contains the most up-to-date information available. In addition, a series of visits to Group sites, giving the opportunity to meet the senior management, is provided to new Directors to enable them to gain a full understanding of the business. All Directors are encouraged to visit QinetiQ’s principal sites, and to meet a wide cross-section of employees (including members of the senior management team). Training is also available on key business issues or developments in policy, regulation or legislation on an ‘as needed’ basis. The Company provides business-wide computer-based training for employees and the Board in relation to compliance with its business ethics policies and practices. As part of the corporate planning process, the Board has the opportunity to question the Business Managing Directors and the Executive Directors on the formulation of the corporate plan at Division level and the plan’s impact on Group strategy. Each of the Directors has access to the services of the Company Secretary, and there is also an agreed procedure for the Directors to seek independent advice at the Company’s expense. Re-election of Directors Rules concerning the appointment and replacement of Directors of the Company are contained in the Articles of Association. Changes to the Articles must be submitted to shareholders for approval. According to the Articles of Association, all Directors are subject to election by shareholders at the first Annual General Meeting (AGM) following their appointment, and to re-election thereafter at intervals of no more than three years. In line with best practice reflected in the UK Code, however, the Company requires each serving member of the Board to be put forward for election or re-election on an annual basis at each AGM. Board meetings and attendance The Board has regular scheduled meetings. Seven scheduled Board meetings and one Board meeting via telephone conference were held in the last financial year. Members of the Board were also invited to attend a dinner on the occasion of each scheduled Board meeting, to assist with the process of relationship building and to ensure that key strategic initiatives were discussed thoroughly. During the year, the Chairman and the Non-executive Directors met on four occasions without Executive Directors present. The table below shows the number of meetings of the Board and its principal committees held during the last financial year, and individual Directors’ attendance. Matters reserved to the Board The Board operates through a comprehensive set of processes, which define the schedule of matters to be considered by the Board and its Committees during the annual business cycle, the level of delegated authorities (both financial and non-financial) available to Executive Directors and other layers of management in the business, and QinetiQ’s business ethics, risk management, and health, safety and environmental processes. The Board devotes one entire meeting each year to consider strategy and planning issues that have an impact on the Group, from which the corporate plan is generated. It is also regularly kept up to date on strategic issues throughout the year. The Board has a clearly articulated set of matters which are specifically reserved to it for consideration. These include: • reviewing the annual budgets; • raising indebtedness; • granting security over Group assets; • approving Group strategy and the corporate plan; • approving the annual and interim report and accounts; • approving significant investment, bid, acquisition and divestment transactions; • approving human resources policies (including pension arrangements); • reviewing material litigation; and • monitoring the overall system of internal controls, including risk management. Attendance at meetings of the Board and its Committees – April 2012 to March 2013* Members Mark Elliott Colin Balmer Admiral Sir James Burnell-Nugent Noreen Doyle Michael Harper David Mellors Paul Murray Leo Quinn Board 8/8 7/8 8/8 8/8 8/8 8/8 8/8 8/8 * Any absences from meetings were owing to illness or travel difficulties. 42 QinetiQ Group plc Annual Report and Accounts 2013 Audit 5/5 4/5 5/5 5/5 5/5 – 5/5 – Committee Nominations 4/4 3/4 4/4 4/4 4/4 – 4/4 4/4 Remuneration 6/6 5/6 6/6 5/6 6/6 – 6/6 – Risk & CSR 5/5 5/5 5/5 4/5 5/5 5/5 5/5 5/5 Operation of the Board The Board receives a written report from the CEO and CFO, together with a separate report on investor relations which is prepared in consultation with QinetiQ’s brokers, and a report produced by the Company Secretary on key legal and regulatory issues that affect the Group. The CEO’s and CFO’s Executive report addresses the key strategic initiatives which have had an impact on the Group since the previous Board meeting, with particular focus on the progress of each of the businesses. Other key areas of focus include health, safety and environmental matters; employee and organisational issues; corporate responsibility; the status of key account management/customer relationship initiatives; the pipeline of potential bids, acquisitions, disposals and investments; and the post-acquisition performance of recently acquired businesses. The Board also receives updates from key functional areas on an ‘as needed’ basis, on issues such as human resources, treasury, corporate responsibility, real estate, security, trade controls and pensions. Key issues considered by the Board in the past year include: • succession planning; • strategy; • the proxy regime in respect of the US business; • liaison with the MOD in respect of specific changes to the Company’s UK defined benefit pension scheme; and • the review of the LTPA contract. Conflicts of interest The Company requires Directors to disclose proposed outside business interests before they are entered into. This enables prior assessment of any conflict, or potential conflict, of interest and any impact on time commitment. An annual review of all external interests is carried out by the Board. Directors’ responsibilities Statements explaining the Directors’ responsibilities for preparing the Group’s Annual Report and financial statements and the auditor’s responsibilities for reporting on those statements are on pages 64-65. Other Directors’ information Details of Executive Directors’ service contracts and the Non- executive Directors’ letters of appointment are set out in the Report of the Remuneration Committee on page 58. Copies of Directors’ service contracts and letters of appointment will be available for inspection at the Company’s Annual General Meeting. Other management committees During the year, responsibility for the day-to-day management of the Group’s activities, with the exception of QinetiQ’s US operations (which are managed through the Proxy Board, as described in the section on page 45 headed ‘Management and control of US subsidiaries’), was conducted through the QinetiQ Executive Team (QET). The QET comprised the Group CEO, Group CFO, functional directors and the Sector MDs of each of the three UK business divisions. The QET met on a monthly basis, and received weekly updates on key operational issues by way of pre-scheduled conference calls. The activities of the QET were supplemented by the QinetiQ North America (QNA) Board and its Executive Management Team. Since the end of the year, the QET has been re-designated as an Operating Committee, with a specific focus on the achievement of the Group’s strategic goals in respect of growth and operational excellence. The Committee membership has been adjusted to comprise the Group CEO, Group CFO, UK Divisional MDs, HR, Business Development and Operations Directors. Board Committees The Board has established five principal Committees: the Audit Committee, the Nominations Committee, the Remuneration Committee, the Risk & CSR Committee and the Security Committee. Each operates within written terms of reference approved by the Board, details of which are set out in the Investor Relations section of the website, www.QinetiQ.com. Where a Committee is not attended by the full Board, details of the key issues discussed, and decisions taken, are circulated to all members of the Board after the relevant Committee meeting. Details of each of these Committees are summarised on pages 46-49. The composition of the Committee memberships was reviewed by the Board at its meeting in November 2012. It was agreed to continue with all-Director membership of Committees, other than where prohibited by the UK Code or statutory requirements. Details of each Committee member’s attendance at Committee meetings are set out in the table on page 42. Risk management and internal controls The Board is ultimately responsible for the Group’s system of internal control and for reviewing its effectiveness in safeguarding shareholders’ interests and the Company’s assets. The system is designed to manage and mitigate, 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. Identification and review of risks QinetiQ managers are responsible for the identification and evaluation of significant risks applicable to their areas of business, together with the design and operation of suitable internal controls to ensure effective mitigation. These risks, which are related to the achievement of business objectives, are assessed on a continual basis and may be associated with a variety of internal and external events, including control breakdowns, competition, disruption, regulatory requirements and natural and other catastrophes. The Board, the Audit Committee and the Risk & CSR Committee regularly review significant risks to the business. Self-certification process An annual process of hierarchical self-certification, which provides a documented and auditable trail of accountability for the operation of the system of internal control, has been established. This self-certification process is informed by a rigorous and structured self-assessment that addresses compliance with Company policy. It provides for successive assurances to be given at increasingly higher levels of management and, finally, to the Board. The process is informed by the internal audit function, which also provides a degree of assurance as to the operation and validity of the system of internal control. QinetiQ Group plc Annual Report and Accounts 2013 43 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceCorporate governance report continued Internal control The centrally provided internal audit programme is prioritised according to risks identified by the Company and is integrated across all business and functional dimensions, thereby reducing issues of overlap or gaps in coverage. These risks are identified dynamically and the Board and the UK executives are involved in the process. A similar process is undertaken within the Company’s QNA business, thereby providing assurance on the adequacy and efficacy of internal controls in this business. The risk management process and the system of internal control necessary to manage risks are managed by the Audit Committee (financial risks) and the Risk & CSR Committee (non-financial risks) and each Committee presents its findings to the Board. The internal audit function independently reviews the risk identification and control processes implemented by management and reports to the respective Committee. The Audit Committee and the Risk & CSR Committee also review the assurance process, ensuring that an appropriate mix of techniques is used to obtain the level of assurance required by the Board. Each Committee presents its findings to the Board on a regular basis. The Board reviewed the effectiveness of the system of internal control that was in operation during the financial year ended 31 March 2013. The Board also routinely challenges management to ensure that the systems of internal control are constantly improving to maintain their effectiveness. The internal control and risk management systems described above, as well as finance policy and codes of practice, apply to the Company’s process of financial reporting and the preparation of consolidated accounts. A structured approach to the review and challenge of financial information is also an essential element of the process. Anti-bribery and the prevention of corruption QinetiQ has internal procedures in place that are designed to ensure compliance with the UK Bribery Act, and other international regulations and best practice relating to the prevention of corruption, which are applicable to its business. Compliance is managed through a risk-based approach, using a combination of internal expertise and external, internationally recognised organisations, such as TRACE, international law firms and other expert service providers, who conduct anti-corruption due diligence reviews of all third-party commercial intermediaries used by QinetiQ’s businesses. Going concern The Group’s activities, combined with the factors that are likely to affect its future development and performance, are set out in the CEO’s Statement on pages 5-11. The CFO’s Review on pages 24-29 sets out details of the financial position of the Group, the cash flows, committed borrowing facilities, liquidity and the Group’s policies and processes for managing its capital and financial risks. Note 25 to the financial statements also provides details of the Group’s hedging activities, financial instruments, and its exposure to liquidity and credit risk. The market conditions in which the Group operates have been, and are expected to continue to be, challenging as spending from the Group’s key customers in its primary markets in the UK and US remains under pressure. Despite these challenges, the Directors believe that the Group is well positioned to manage its overall business risks successfully. After making the appropriate enquiries, including a review of the latest two-year budget, the Directors have a reasonable expectation that the Group has adequate resources to continue in operational existence for the foreseeable future. Consequently, the Annual Report and Accounts have been prepared on a going concern basis. Communication with shareholders The Company attaches significant importance to the effectiveness of its communications with shareholders. During the last financial year, the Company maintained regular dialogue with institutional shareholders and the financial community, which included presentations of the full-year and half-year results, investor ‘road shows’ held in the UK and US, and regular meetings with major shareholders and industry analysts. In addition, each member of the Board attended the Company’s Annual General Meeting in July 2012 and was available to take questions. The Chairman proactively offers to attend meetings with key shareholders on a regular basis. In addition, the Chairman, the Senior Independent Director and Non-executive Directors routinely attend key financial calendar events and make themselves available to meet shareholders as required. All shareholders and potential shareholders can gain access to the Annual Report, presentations to investors and other significant information about QinetiQ in the ‘Investors’ section of the Company’s website, www.QinetiQ.com. Holders of ordinary shares have the opportunity to attend the Company’s Annual General Meeting (AGM) and to ask questions. The Chairs of the Audit, Remuneration, Nominations, Risk & CSR and Security Committees are available at that meeting to answer any questions on the work of the Committees. The Company confirms that it will send the Notice of Meeting and relevant documentation to all shareholders at least 20 working days before the date of the AGM. For those shareholders who have elected to receive communications electronically, notice is given of the availability of documents in the ’Investors’ section of the Group’s website. All shareholders will be entitled to vote on the resolutions put to the AGM and, to ensure that all votes are counted, a poll will be taken on all the resolutions in the Notice of Meeting. The results of the votes on the resolutions will be published on the Group’s website. Responsibility for maintaining regular communications with shareholders rests with the CEO and the CFO, assisted by an investor relations function. The Board is informed on a regular basis of key shareholder issues, including share price performance, the composition of the shareholder register and City expectations. 44 QinetiQ Group plc Annual Report and Accounts 2013 The Boards and Board Committees of each of the Company and QNA meet on a regular basis and review and discuss the important commercial and governance activities taking place within QNA. Group policies are shared with QNA and, to the extent they are suitable in QNA’s security, market and operational circumstances, are applicable within QNA, subject always to the requirement that QNA must conduct its business affairs without external control or influence, and to the requirements necessary to protect the US national security interest. In addition, the Company extends its involvement in QNA’s activities through the conduct of regular and frequent business meetings and communications at the CEO, CFO, HR and Legal levels in the interests of transparency and good governance. During the coming year, the Company will be looking to continue to improve the quality of its engagement with shareholders and to explore with investors any additional practical means by which it can give effect to the requirements of the Financial Reporting Council’s UK Stewardship Code for institutional investors, and of the UK Code. Details of the Company’s share capital, which are required to be disclosed in accordance with rule 7.2.6 of the FCA’s Disclosure and Transparency Rules, and the Directors’ powers in relation to issuing and buying back shares can be found on page 63 in the Other Statutory Information section of this Annual Report. Management and control of US subsidiaries QinetiQ’s principal US subsidiaries are currently required by the US National Industrial Security Program to maintain facility security clearances and to be insulated from foreign ownership, control or influence. To comply with these requirements, QinetiQ North America, Inc. (QNA), a wholly-owned subsidiary of QinetiQ in the US and the holding company for the substantive part of QinetiQ’s US operations, and the US DoD, have entered into a proxy agreement that regulates the management and operation of these companies. Pursuant to this proxy agreement, QinetiQ has appointed four US citizens (Peter Marino, Riley Mixson, John Currier and Vince Vitto), who hold the requisite US security clearances, as proxy holders to exercise the voting rights in QNA. The proxy holders are also appointed as Directors of the relevant US subsidiaries and, in addition to their powers as Directors, have power under the proxy arrangements to exercise all prerogatives of share ownership of QNA. The proxy holders have a fiduciary duty, and agree, to perform their role in the best interests of shareholders (including the legitimate economic interest), and in a manner consistent with the national security interests of the US. QinetiQ Group plc does not have any representation on the boards of the subsidiaries covered by the proxy agreement, but regularly attends board meetings. QinetiQ Group plc may not remove the proxy holders other than for acts of gross negligence or wilful misconduct or for breach of the proxy agreement (with the consent of the US Defense Security Service). In terms of the power to govern, the proxy agreement vests certain powers solely with the proxy holders and certain powers solely with QinetiQ. For example, the proxy holders cannot carry out any of the below without QinetiQ’s express approval: • sell or dispose of, in any manner, capital assets or the business of QNA; • pledge, mortgage or encumber assets of QNA for purposes other than obtaining working capital or funds for capital improvements; • merge, consolidate, reorganise or dissolve QNA; and • file or make any petition under the federal bankruptcy laws or similar law or statute of any state or any foreign country. Unlike minority interest holders with protective veto rights, QinetiQ can unilaterally require the above to be carried out and these are, therefore, considered to be significant participative features. In addition, QinetiQ can require the payment of dividends, and the pay-down of parent company loans, from QNA. QinetiQ Group plc Annual Report and Accounts 2013 45 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceCorporate governance report continued Security Committee Colin Balmer Chair Security Committee Membership The Security Committee is chaired by Colin Balmer. The other Committee members are Admiral Sir James Burnell-Nugent, Michael Harper, David Mellors, Paul Murray and Leo Quinn. Main responsibilities The Committee was established in June 2009 to enable UK nationals on the Board to consider matters of a UK national security dimension that have an impact on QinetiQ’s UK business. There was no requirement for the Committee to meet during the year. Nominations Committee Mark Elliott Chair Nominations Committee Membership The Nominations Committee is chaired by Mark Elliott. The other Committee members are Colin Balmer, Admiral Sir James Burnell- Nugent, Noreen Doyle, Michael Harper, Paul Murray and Leo Quinn. Main responsibilities The role of the Committee is to ensure that the composition of the Board and Committees has the optimum balance of skills, knowledge and experience, and to oversee succession planning for the Board and senior management. It considers diversity, including skills mix, international industry experience and gender, when seeking to appoint a new Director to the Board. The Committee meets as necessary and when called by its Chair. During the financial year ended 31 March 2013, the Committee met on four occasions. Overview Key areas of focus during the year were: • the review of the size and composition of the Board and its Committees; • the review and updating of the matrix recording the skills and experience of the current Board; and • the review of succession planning processes at Executive Director, Non-executive Director and senior management levels. 46 QinetiQ Group plc Annual Report and Accounts 2013 Board Diversity policy During the year, the Nominations Committee recommended, and the Board approved, a Board Diversity Policy. The key statement and objectives of that policy (the full text of which is available on the Group’s website) are as follows: Statement: • The QinetiQ Board recognises the benefits of diversity. Diversity of skills, background, knowledge, international and industry experience, and gender, amongst many other factors, will be taken into consideration when seeking to appoint a new Director to the Board. Notwithstanding the foregoing, all Board appointments will always be made on merit. Objectives: • The Board should ensure an appropriate mix of skills and experience to ensure an optimum Board and efficient stewardship; • The Board should ensure that it comprises Directors who are sufficiently experienced and independent in character and judgement; and • The Board aims to increase the proportion of women on the Board to 25% by 2015. Thereafter, the Board aims to maintain a minimum Board composition of 25% women, such percentage to be reviewed annually. Details of the steps being taken in respect of diversity within the Group generally can be found in the Corporate Responsibility and Sustainability Review on pages 34-37. Succession planning As a result of the succession planning review, a specification was prepared of the role and capabilities required to refresh the Board within the required timescale. The Committee recommended, and the Board appointed, two executive search firms, The Zygos Partnership in the UK and Spencer Stuart in the USA, to progress the search for potential Non-executive Director candidates. Both firms are signatories to the Voluntary Code of Conduct for Executive Search Firms, which requires them to ensure that at least 30% of the candidates are women, and have no other connections with the Company. As at the date of this report, the search remains ongoing. Remuneration Committee Noreen Doyle Chair Remuneration Committee Membership The Remuneration Committee is chaired by Noreen Doyle. The Committee sets remuneration and incentives for Executive Directors and approves and monitors remuneration and incentives for senior executives of the Group. The other Committee members are Colin Balmer, Admiral Sir James Burnell-Nugent, Mark Elliott, Michael Harper and Paul Murray. Other attendees The CEO, the CFO, the HR Director and the Group Reward Director normally attend meetings to provide information and advice. Overview The Committee meets as necessary, although normally at least three times a year. During the financial year ended 31 March 2013, it met on six occasions. During the year, the Committee received advice from its appointed independent advisors, Towers Watson, who also provided market data and advice to help the Committee determine whether performance targets had been met. Towers Watson also provided other consulting services during the year to QinetiQ, but did not provide advice on executive remuneration matters other than to the Committee. The Committee has reviewed the remuneration and rewards of the Company’s Executive Directors and senior management and has processes in place to ensure that: • the level of reward given to the Executive Directors and senior management is stretching and designed to promote the long-term success of the Company; and • remuneration incentives remain consistent with the Company’s risk management policies and systems. No Executive Director or employee of QinetiQ is permitted to be present or participate in the Committee’s discussions about their own remuneration. Main responsibilities The Committee has three primary functions: • to oversee the sound operation of the Company’s non-financial risk management systems; • to monitor non-financial risk exposures, including security, trade controls, ethics, corporate social responsibility and health, safety and environment; and • to monitor adherence to the generic compliance system. The Committee has an annual calendar of activities and meets as necessary, although normally not less than four times a year. During the financial year ended 31 March 2013, the Committee met on five occasions. Overview During the past year, the Committee continued to carry out its core functions by way of regular reporting in accordance with its annual calendar. The Committee continued to oversee health, safety and environment, trade controls, ethics and security through quarterly reports from the heads of those functions in the business. A summary of the key focus and activities of the health, safety and environment and ethics functions is set out in the Corporate Responsibility and Sustainability Review on pages 34-37. During the year, the Committee’s Terms of Reference were reviewed and updated to be consistent with best practice. Key areas of focus during the year were: • the operation of the QNA Proxy Regime; Further information on the activities of the Remuneration Committee during the last financial year is set out in the Remuneration Report on pages 50-51. Risk & CSR Committee Colin Balmer Chair Risk & CSR Committee Membership The Risk & CSR Committee is chaired by Colin Balmer. All of the other members of the Board are members of the Committee. The name of the Committee was changed from the Compliance Committee in 2012 as a result of a review of risk governance arrangements and the move from the bespoke MOD Compliance Regime to a generic MOD conflict of interest management system (the “generic compliance system”) in alignment with that followed by other defence companies. This change was effected by way of the amendment of the rights attaching to the Special Share held by HM Government, following receipt of the requisite MOD approval and shareholder approval at the 2012 Annual General Meeting. The Committee’s Terms of Reference were reviewed and updated in 2012 to take account of the changes. • the move to the generic MOD compliance system; • a review of the Company’s risk management processes; • a review of the Risk Register in accordance with FRC recommendations; • a review of the Company’s risk appetite and providing clarity to executive management on acceptable levels of risk; and • trials involving human subjects that fall within the scope of the Helsinki Protocol. Generic compliance system The Committee continues to monitor the generic compliance system, which is designed to give the MOD customer confidence that QinetiQ is able to provide impartial advice during any competitive evaluation of a procurement where the Company wishes to operate on both the ‘buy’ and the ‘supply’ sides. The aim is to achieve a balance between meeting the needs of the procurement customers in the MOD (principally Defence Equipment & Support) and the need to allow QinetiQ the flexibility to exploit research into the supply chain and pursue its planned commercial activities, without compromising the defence or security interests of the UK. Oversight of the operation of the system is provided by the Committee. The Board nominates two senior executives to act as Compliance Implementation Director and Compliance Audit Director. It receives a bi-annual report on the compliance areas that it monitors from the internal audit function. The Committee addresses any issues that would arise if QinetiQ were to fail to comply with the requirements of the generic compliance system. No breaches were noted during the year. The Company will continue with rigorous management of potential conflicts of interest while ensuring that proportionate governance is maintained by the Board. QinetiQ Group plc Annual Report and Accounts 2013 47 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceCorporate governance report continued Audit Committee Paul Murray Chair Audit Committee Membership The Audit Committee is chaired by Paul Murray. The Board considers him to have recent and relevant financial experience, given his former roles as Group Finance Director of Carlton Communications plc and LASMO plc, and through his current role as Audit Committee Chairman at Royal Mail Holdings plc. The other members of the Committee are Colin Balmer, Admiral Sir James Burnell-Nugent, Noreen Doyle and Michael Harper, all of whom the Board considers to be independent. The members bring extensive experience of corporate management in senior executive positions to the Company. Other attendees The CEO, CFO, Director of Group Finance, Group Internal Audit Manager, the QinetiQ North America (QNA) Internal Audit Manager and representatives of the external auditor normally attend Audit Committee meetings. Main responsibilities The Audit Committee monitors the Group’s integrity in financial reporting and reviews the effectiveness of the financial risk management framework. The Committee has an annual calendar of activities, in addition to which it identifies particular areas of focus during the year. The Audit Committee meets as necessary and at least four times a year. During the financial year ended 31 March 2013, the Committee met on five occasions. The external auditor has the right to request that a meeting of the Audit Committee be convened. During the past financial year, and in accordance with its terms of reference, the Committee met with QinetiQ’s external auditor on three separate occasions, without Executive Directors present, to discuss the audit process. The Committee also met with the Group Internal Audit Manager on two separate occasions, without Executive Directors present. Overview Key areas of focus during the year were: • QNA risks, issues and mitigating actions; • effectiveness of internal controls; • effectiveness of governance arrangements; • effectiveness of external audit; and • review of audit process for full-year and half-year results. QNA risks, issues and mitigating actions As detailed on page 45 concerning ‘Management and control of US subsidiaries’, the Company’s holding of its QNA assets is regulated by a proxy agreement. This arrangement, whose purpose is to insulate QNA from foreign ownership control or influence, directly impacts the way in which the Company’s Board is able to gain comfort on the effectiveness of QNA’s systems of internal control. 48 QinetiQ Group plc Annual Report and Accounts 2013 QNA is subject to external audit, by the same auditor as for the Company, KPMG. The Company has the opportunity to meet with QNA’s external auditor independently. Further, the Company is able to review in detail, with the Chair of the QNA Audit Committee and the QNA Internal Audit Manager, the audit work within QNA and to gain an understanding of the systems of internal control, and their effectiveness. Review of internal controls The Audit Committee continually reviews the effectiveness of the systems of internal control to gain assurance that an effective control framework is maintained. Reports on the effective operation of the control framework are received from management and reviewed by the Committee along with key policies and processes including whistleblowing arrangements. Regular reports on the operation of internal controls and risk management processes are also received from the internal audit function. Particular attention is given to the timely and effective implementation of remedial actions, either identified by the business directly, or by internal audit. The Committee also regularly reviews the effectiveness of the financial risk management framework, including reviewing key financial risks and assessing the effectiveness of management’s remedial action plans. As detailed above, the Committee meets regularly with the Chair of the QNA Audit Committee and the QNA Internal Audit Manager to gain assurance on the effectiveness of the QNA internal controls framework. In addition, the Committee, on behalf of the Board, undertakes an annual assessment of the control environment. Governance reviews As reported in the Report and Accounts in respect of the year ended 31 March 2012, during that year the Committee undertook externally-facilitated governance reviews in respect of the effectiveness of the Committee itself, the internal audit function and risk governance. The recommendations from those reviews were progressed by the Committee Chairman during the past financial year and resulted in the reconfiguration of the Audit and Compliance Committees into an Audit Committee and a Risk & CSR Committee, with the former dealing with financial risks and the latter with non-financial risks, as well as oversight of the overall risk management process. The Terms of Reference of both Committees were amended to reflect the change and the schedules of annual activity updated accordingly. In addition, changes were made to the structure and linkage between the Committee and the QNA Audit Committee to improve regulatory and governance reporting. During the current year, reviews of the effectiveness of the Audit Committee and the Internal Audit function were carried out as follows: • a review by the Committee Chairman of the recommendations from the previous year’s externally-facilitated reviews and of the performance against those recommendations; and • high-level questions and answers completed by the Non- executive Directors and reviewed by the Committee Chairman. The results of the reviews were considered at the May Committee meeting and the outcome showed that the governance improvements had been effective and had been embedded in the business. The implementation of some actions, particularly in relation to QNA, remain ongoing but in line with agreed action plans. External Audit effectiveness review The effectiveness and independence of the external audit process was assessed by the Internal Audit function during the year. The review comprised the following elements: • a questionnaire which was completed by the Non-executive Directors and senior QinetiQ staff; • interviews with the KPMG partner and senior managers; and • interviews with senior business managers. The results of the review were considered at the March Committee meeting and it was noted that the external audit function continued to be both independent and effective. A small number of recommendations regarding audit scoping and reporting have been made which will be adopted by KPMG in their future work. Other areas of review During the year, the Committee also reviewed the activities of the tax, insurance and treasury functions, as well as overseeing the level of KPMG’s audit fees. The Committee confirms its view that it has received sufficient, reliable and timely information from management in the last financial year to enable it to fulfil its responsibilities. Financial statements The Committee reviews whether suitable accounting policies have been adopted, whether management has made appropriate estimates and judgements and also seeks support from the external auditors to assess them. The Committee reviewed the following main issues for the year ended 31 March 2013: • The basis of and key assumptions relating to management’s assessment of the carrying value of the goodwill associated with the US Services business. • The basis for and judgements made by management in determining the liabilities recorded for litigation, potential claims and other disputes. • The accounting for longer term contracts and, in particular, the basis of the estimates of forecast costs to complete on a significant contract. • The key assumptions and their sources used in accounting for the Group’s defined benefit retirement obligations. • The disclosures in the preliminary announcement and annual report and accounts, in particular those relating to risk, goodwill, specific overlying items and the operation of the proxy regime in the US. • The adoption and application of new accounting standards, and in particular IAS19 (revised). Based upon the business assurance process and discussions with management and the external auditors, the Committee was satisfied that the disclosures and assumptions were reasonable and appropriate for a business of the Company’s size and complexity, that the auditors had fulfilled their responsibilities in scrutinising the financial statements for any material misstatements and that the disclosures were satisfactory. The Audit Committee will consider in 2013 how to adapt, if necessary, the Group’s procedures to provide advice to the Board to meet with the requirements of the new 2012 UK Corporate Governance Code (as applicable to the Group for its next financial year, ending 31 March 2014, and beyond) on whether the Annual Report and Accounts, taken as a whole, are fair, balanced and understandable and provide all information necessary to a shareholder to assess the Group’s performance, business model and strategy. External Auditor independence: Non-audit services The Company views it as essential that the external auditor is both independent of any conflict of interest and perceived to be so. To safeguard auditor independence and objectivity, the Company has a Code of Practice within its Operating Framework which sets out the principles for regulating the award of non-audit work to the external auditor. The policy clearly articulates the non-audit services which are prohibited, the non-audit services which can be purchased and the key approval requirements for non-audit work. Pursuant to the policy, the Committee ensures that any other advisory and/or consulting services provided by the external auditor do not conflict with its statutory audit responsibilities and are conducted through entirely separate working teams; such advisory and/or consulting services generally only cover regulatory reporting, tax, and mergers and acquisitions work. The cost and nature of non-audit work undertaken by the auditor is regularly reviewed by the Committee during the financial year and is included at regular intervals in its annual schedule as a standing item. This process enables the Committee to take corrective action if it believes that there is a risk of the auditor’s independence being undermined through the award of such work. It is also QinetiQ’s policy that no KPMG employee may be appointed to a senior position within the QinetiQ Group without the prior approval of the CFO. Any non-audit services conducted by the auditor require the consent of the CFO or the Chairman of the Audit Committee before being initiated; any services exceeding £50,000 in value require the consent of the Audit Committee as a whole. In the last financial year, there have not been any non-audit services conducted by KPMG that exceeded £50,000 in value. The Committee concluded, therefore, that there had not been any conflict of interest that might compromise the independence of KPMG’s audit work. Auditor reappointment KPMG has been the auditor of the QinetiQ Group since its formation in 2001 as the result of a competitive tender, and the Company’s auditor since its incorporation in 2002. During that time, there have been periodic changes in audit partners in accordance with professional and regulatory standards to protect independence and objectivity. The members of the Audit Committee have declared themselves satisfied with the performance of KPMG as the Company’s auditor in the last financial year. A rotation of KPMG’s lead audit partner was last undertaken during 2012 and it is anticipated that the new lead audit partner will continue in this role for a maximum of five years. Having reviewed the effectiveness and the independence of the external auditor, the Committee has not considered it necessary to conduct a tender process for the appointment of its auditor. The Committee has recommended to the Board that KPMG be reappointed for the financial year ending 31 March 2014. In accordance with FRC guidance on transitional arrangements for the implementation of the 2012 version of the UK Code, it is the Company’s current intention to align the process for putting the external audit contract out to tender with the conclusion of the five-year tenure of the audit partner. The Committee will continue, however, with the annual review of the performance of the external auditor and act accordingly. QinetiQ Group plc Annual Report and Accounts 2013 49 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceCorporate governance report continued Remuneration report The key purpose of the Committee is to ensure that the remuneration structure supports the Company’s strategy and that we are able to attract, retain and motivate the highest calibre executives by rewarding the creation of long-term sustainable value. Report of the Remuneration Committee The following Report of the Remuneration Committee has been approved by the Board for submission to shareholders. The Report covers the remuneration of Directors and includes specific disclosures relating to their compensation, shares and other interests. The report also describes the share-based incentive plans available to Executive Directors and to other employees. This report has been prepared and, where appropriate, audited, in accordance with statutory and regulatory requirements. Membership and Governance Members of the Committee are appointed by the Board. The Committee comprises at least three members (not including the Group Chairman of the Board), all of whom are independent non-Executive Directors. The Group Chairman of the Board also serves on the Committee as an additional member if he or she was considered independent on appointment as Chairman. Only members of the Committee have the right to attend Committee meetings. However, other individuals such as the Chief Executive, the Group HR Director and external advisers are invited to attend for all or part of any meeting, as and when appropriate. The Board appoints the Committee Chairman who is an independent, non-executive director. In the absence of the Committee Chairman and/or an appointed deputy, the remaining members present shall elect one of themselves to chair the meeting who would qualify under these terms of reference to be appointed to that position by the Board. The Chairman of the Board is not permitted to be Chairman of the Committee. The following Non-executive Directors were members of the Remuneration Committee for the year ended 31 March 2013: • Noreen Doyle (Chair) • Mark Elliott (Group Chairman) • Colin Balmer • Admiral Sir James Burnell-Nugent • Paul Murray • Michael Harper The full Terms of Reference of the Committee can be found on the QinetiQ website (www.QinetiQ.com). Noreen Doyle Chair Remuneration Committee Introduction I am pleased to present the Remuneration Committee’s report on Directors’ compensation for the year to 31 March 2013. The primary objectives of our remuneration policy are: • Attracting and retaining top talent; • Incentivising key executives and managers; • Ensuring an approach which values the diversity of our workforce; • Driving superior performance in both the short and long term; and • Alignment with the interests of shareholders. Beginning in 2009, QinetiQ has created and implemented a self-help programme to support its transformation. Following on from the success of this effort, the Company has begun its transition to the next stage in its development. Accordingly, with input from its advisors, Towers Watson, the Remuneration Committee undertook a market review and developed a revised compensation package which was endorsed at the Annual General Meeting in July 2012. • The Value Sharing Plan (VSP) was designed in 2010 for the Company’s self-help phase and was considered to be a time bound Long Term Incentive Plan (LTIP). The current phase for the Company is aimed at resumption of growth, both in the UK and the USA, despite defence markets forecast to be flat or falling, and therefore a new Performance Share Plan (PSP) was adopted to align with this objective. • To enhance further management’s alignment with shareholder interests, the mandatory deferral for Executive Directors under the Deferred Annual Bonus (DAB) plan was increased to 50% of bonus earned. • In addition, we match our stretch business objectives to an increased Annual Cash Bonus plan opportunity for our Executive Directors. These changes were implemented during the year ended March 2013 after shareholder approval and as we are only part way through the next phase of our journey we are not proposing to alter our remuneration policy for the coming financial year. We believe the plan we have in place supports the business goals and ensures commensurate levels of remuneration with business performance. This is demonstrated in reward attributed to the closing financial year as, despite challenging markets, 2013 has been a strong year which is reflected in our Executive Directors’ performance-based remuneration. Since 2010, our total shareholder return has increased by 60% which demonstrates the significant return on shareholder value. In line with our overall remuneration policy, the Committee has determined 3% salary increases for the CEO and CFO which will be effective July 2013. To help develop clarity around our Executive Directors’ remuneration, we have improved the format and flow of our report in line with best practice. 50 QinetiQ Group plc Annual Report and Accounts 2013 Activities During the year, the Committee met six times. The Committee received advice from its appointed independent advisors, Towers Watson, who also provided market data and advised on the comparator group’s TSR so that the Committee could determine whether share plan performance targets had been met. The Chief Executive, Group HR Director and Group Reward Director also provided information and advice to the Committee. The Committee meetings covered a number of topics including: May July • 2012 Annual Cash Bonus plan results • Revised Performance Share Plan rules prior to shareholder approval • Share plan allocations and nominations • Share plan performance and vesting November • Government reforms January March • Remuneration Committee programme for the year • Review of Executive team shareholding • Reward and retention – all employee • IAS 19 impact on incentives* • Executive pay trends • Executive incentive arrangements • Changes to the Directors’ Remuneration Report • Projected share plan vesting • Executive team salary review • Executive team Annual Bonus Plan design • Share plan allocations * In November 2012, the Committee discussed the impact of accounting changes on incentives. IAS 19 (revised) ‘Employee benefits’ has been adopted for the year ended 31 March 2013 and the prior year comparatives have been restated accordingly, which has had specific impacts on the income statement. The reporting changes resulted in the baseline financials for the Performance Share Plan, Deferred Annual Bonus plan and Annual Cash Bonus plan being revised to accommodate the accounting changes while retaining the incentive structure. Directors’ remuneration policy The Committee aims to maintain a remuneration policy, consistent with the Company’s business strategy and objectives, which: • attracts, retains and motivates individuals of high calibre; • is responsive to both Company and personal performance; and • is competitive within relevant employment markets. The remuneration policy is built on the following philosophy: • remuneration packages are structured to support business strategy and conform to current best practice; • appropriate rewards are given for meeting specific target objectives set at the beginning of each year; • incremental compensation is achieved for attaining stretch performance targets; • objectives are measured on metrics designed to be consistent with sustainable long-term business performance; • all decisions are made taking into account the diversity of our people at Director level; and • to monitor pay and employment conditions elsewhere in the Group. The total remuneration levels of the Executive Directors are reviewed annually by the Committee, taking into account: • performance of the executive against specific targets set at the beginning of each year; • competitive market practice and remuneration levels based on a consistent competitor group reviewed annually; and • the general economic environment, particularly in the defence sector. Each year, the packages are benchmarked independently by our advisors, Towers Watson, using two comparator groups: one group is based on company size, measured by market capitalisation and revenue and the second group is sector specific. The first group is used as the primary reference with cross checking against the second group to capture any industry specific features; there are approximately 20 companies in each group. The lower quartile, mid-market and upper quartile reference points are captured and the packages of the CEO and CFO are then benchmarked against these to ensure they remain competitive at the mid-market level. The Executive Directors’ remuneration package is made up of the following components: Base Salary Annual Cash Bonus Long-Term Incentives: PSP & DAB Beneﬁts: Pension, Car Allowance Remuneration Package Performance driven QinetiQ Group plc Annual Report and Accounts 2013 51 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceRemuneration report continued The table below shows our overarching policy and framework for Executive Directors’ remuneration. The application of this policy is detailed within this report. Element Base salary To attract and retain the talent needed to lead our business. Purpose Operation and performance measures Opportunity Changes for coming financial year Aim to pay base salaries in line with the market median against the comparator groups No changes to policy but details of the salary detailed above. No minimum or maximum increases to base salary are determined. increases for the coming financial year can be found on page 56. For year ended 31 March 2013, the on-target and maximum bonus opportunities were There are no changes to policy for the increased to 75% and 150% of base salary, respectively, to bring QinetiQ’s Executive coming financial year Directors in line with the market median. Executive Directors salaries are reviewed annually, along with those of all other members of the executive team by the Remuneration Committee and any change is effective 1 July. Reference is made to both the internal and external environment. Specifically to the external environment, reference is made to the market data provided by the advisors to the Remuneration Committee which covers all aspects of reward. Other factors taken into account when considering whether or not to award a base salary increase: • The performance of the Executive over the previous twelve months; • The business environment for the year ahead; • Potential all employee salary review budget for the coming year; • All other aspects of remuneration (the reward mix); • The critical nature of the appointment with respect to delivering business results; • An executive’s position in terms of career development, potential and lifecycle; and • Retention risk and the ability to replace higher value skills if needed in the market Executive Directors participate in an annual bonus plan which is non-pensionable. Bonuses are determined by Group performance targets for operating profit; underlying operating cash flow; and underlying EPS. • The bonus accrues on a linear basis between entry, target and maximum performance thresholds • The relative performance against financial targets for each measure will trigger a payment which may be adjusted at Remuneration Committee discretion The targets are set at the beginning of each year and amended if applicable to reflect: • Acquisitions and disposals • Restructuring costs • Business structure changes • Restated corporate allocations • Board approved budget adjustments • Final IAS 19 pensions finance cost A percentage of all annual cash bonuses earned are deferred and paid in shares under the Deferred Annual Bonus Plan (DAB) as detailed below. Specifics around the Annual Bonus Plan reward potential for Executive Directors for the coming year can be found on page 56 and the achievement of bonus for year ended 31 March 2013 can also be found here. Annual Cash Bonus To recognise exceptional and stretching business performance with exceptional reward. Deferred Annual Bonus Plan (DAB) – Current The Deferred Annual Bonus Plan aligns the interests of executives with shareholders and contributes to the retention of key individuals by ensuring that executives take part of their annual bonus awards in shares rather than cash. Any deferred bonus will be matched by the Company based on underlying EPS performance up to a maximum match of 100% of the deferred element. In order for the matching shares to vest, underlying EPS growth, measured over three years, must exceed defined targets. The matching element of the DAB begins to vest at 25% once the underlying EPS CAGR hits 3%, rising on a linear scale until maximising at 100% match for 10% CAGR in EPS. Executive Directors have a mandatory deferral of 50% of any bonus earned. For others in No changes to policy for the coming the executive team, the mandatory deferral is 20% with an additional voluntary deferral financial year. of up to 30% (50% total). Any deferred bonus will be matched by the Company up to a maximum match of 100%. 52 QinetiQ Group plc Annual Report and Accounts 2013 Element Base salary Purpose Operation and performance measures Opportunity To attract and retain the talent needed to lead our business. Executive Directors salaries are reviewed annually, along with those of all other members of the executive team by the Remuneration Committee Aim to pay base salaries in line with the market median against the comparator groups detailed above. No minimum or maximum increases to base salary are determined. Changes for coming financial year No changes to policy but details of the salary increases for the coming financial year can be found on page 56. Annual Cash Bonus To recognise exceptional and Executive Directors participate in an annual bonus plan which stretching business performance is non-pensionable. with exceptional reward. Bonuses are determined by Group performance targets for operating For year ended 31 March 2013, the on-target and maximum bonus opportunities were increased to 75% and 150% of base salary, respectively, to bring QinetiQ’s Executive Directors in line with the market median. There are no changes to policy for the coming financial year and any change is effective 1 July. Reference is made to both the internal and external environment. Specifically to the external environment, reference is made to the market data provided by the advisors to the Remuneration Committee which covers all aspects of reward. award a base salary increase: Other factors taken into account when considering whether or not to • The performance of the Executive over the previous twelve months; • The business environment for the year ahead; • Potential all employee salary review budget for the coming year; • All other aspects of remuneration (the reward mix); • The critical nature of the appointment with respect to delivering business results; and lifecycle; and in the market • An executive’s position in terms of career development, potential • Retention risk and the ability to replace higher value skills if needed profit; underlying operating cash flow; and underlying EPS. • The bonus accrues on a linear basis between entry, target and maximum performance thresholds • The relative performance against financial targets for each measure will trigger a payment which may be adjusted at Remuneration The targets are set at the beginning of each year and amended if Committee discretion applicable to reflect: • Acquisitions and disposals • Restructuring costs • Business structure changes • Restated corporate allocations • Board approved budget adjustments • Final IAS 19 pensions finance cost A percentage of all annual cash bonuses earned are deferred and paid in shares under the Deferred Annual Bonus Plan (DAB) as detailed below. Specifics around the Annual Bonus Plan reward potential for Executive Directors for the coming year can be found on page 56 and the achievement of bonus for year ended 31 March 2013 can also be found here. Deferred Annual Bonus Plan (DAB) – Current The Deferred Annual Bonus Plan aligns the interests of executives Any deferred bonus will be matched by the Company based on underlying EPS performance up to a maximum match of 100% of the deferred with shareholders and contributes element. In order for the matching shares to vest, underlying EPS growth, Executive Directors have a mandatory deferral of 50% of any bonus earned. For others in the executive team, the mandatory deferral is 20% with an additional voluntary deferral of up to 30% (50% total). No changes to policy for the coming financial year. Any deferred bonus will be matched by the Company up to a maximum match of 100%. to the retention of key individuals measured over three years, must exceed defined targets. The matching by ensuring that executives take element of the DAB begins to vest at 25% once the underlying EPS CAGR part of their annual bonus awards hits 3%, rising on a linear scale until maximising at 100% match for 10% in shares rather than cash. CAGR in EPS. QinetiQ Group plc Annual Report and Accounts 2013 53 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceRemuneration report continued Element Purpose Operation and performance measures Opportunity Changes for coming financial year Performance Share Plan (PSP) – Current Deferred Annual Bonus Plan (DAB) – Closed The objective of QinetiQ’s long-term incentive programmes for Executive Directors is to align their rewards with returns to shareholders by a focus on increasing shareholder value over the medium to long term. The current Long Term Incentive Plan mechanism for Executive Directors is the PSP which is also provided to other senior leaders. This replaced the Value Sharing Plan (see below) in July 2012 and better aligns to our current phase of resurrecting growth. No longer in use – unvested awards from previous years PSP awards are contingent on meeting pre-determined performance criteria. Awards are earned based on an equal weighting of relative Total Shareholder Return (TSR) performance and absolute underlying Earnings per Share (EPS) growth. The underlying EPS performance criterion for the PSP awards begin to vest at 25% once the underlying EPS CAGR hits 3% rising on a linear scale until maximising at 100% for 10% CAGR. TSR performance is measured against the constituents of the FTSE 250 excluding Investment Trusts. 30% of the TSR awards begin to vest once performance reaches the median of the comparator group rising on a linear basis until performance reaches the upper quartile. Further detail of the thresholds for both measures can be found on page 56. For awards made prior to the year ended 31 March 2013, the matching element of the DAB begins to vest (25%) once the underlying EPS CAGR exceeds 7%, maximising at 100% match for 15% CAGR in underlying EPS. Performance Share Plan (PSP) – Closed No longer in use – unvested awards from previous years Value Sharing Plan (VSP) – Closed The VSP was approved by shareholders in July 2010. It is a long-term incentive plan which was designed to reinforce QinetiQ’s strategy of focusing on shareholder value creation. This plan is no longer in use – unvested awards from previous years. Awards are earned based on an equal weighting of relative Total Shareholder Return (TSR) performance and absolute underlying Earnings per Share (EPS) growth. The underlying EPS performance criterion for the PSP awards begin to vest at 25% once the underlying EPS CAGR hits 7% rising on a linear scale until maximising at 100% for 15% CAGR. TSR performance is measured against the constituents of a bespoke sector related peer group of companies. 30% of the TSR awards begin to vest once performance reaches the median of the comparator group rising on a linear basis until our performance reaches the upper quartile. Under the VSP, additional shareholder value created is measured in two ways: • Total shareholder return (TSR) – QinetiQ’s TSR out-performance of the FTSE 250 Index (excluding Investment Trusts). Participants will be entitled to a vesting of shares under the TSR Element only if the Committee is also satisfied that this is justified by the underlying financial performance of the Company over the performance period. • Underlying Profit Before Tax (PBT) – determined by PBT growth above the cost of equity of 8.5% a year, adjusted by the dividend yield. VSP awards granted in May 2011 were weighted equally between the two performance indicators: 50% Total Shareholder Return (TSR) and 50% underlying Profit Before Tax (PBT). For awards made in July 2010, the weighting was 70% PBT and 30% TSR. Any awards earned will vest 50% after three years and 50% after four years. Pension and other benefits To ensure Executive Directors’ total remuneration remains attractive and competitive. N/A Personal shareholding policy The Board believes that a meaningful way to align Executives’ interests with those of shareholders is for the Executives to build up and retain a personal holding in QinetiQ shares. In November 2011 the Committee reviewed the executive shareholding policy and increased the length of time allowed to accumulate the required shareholding from four to five years to align with market norms. The CEO and CFO are required to hold shares in QinetiQ with a value equivalent to one times their base salary in QinetiQ shares. 54 QinetiQ Group plc Annual Report and Accounts 2013 Individual participants’ award levels are determined by the Committee annually. No changes to policy for the coming Executive Directors are eligible to receive awards with a maximum value of 200% of base salary per annum. However, the intention is to normally set the awards at 150%. financial year. Prior to the year ended 31 March 2013, Executive Directors had a mandatory deferral of This Plan is no longer in use, however, there 40% of any bonus earned and were permitted to voluntarily defer an additional 10% remain awards unvested. of their bonus into QinetiQ shares up to a maximum of 50%. Any deferred bonus will be matched up to a maximum of 100%. Leo Quinn has outstanding awards under this plan based on his joining arrangements This Plan is no longer in use, however, there and details of the vesting which will occur in June 2013 can be found on page 56. remain awards unvested. The VSP provided executives with a pre-defined number of shares for each £1m of This Plan is no longer in use, however, there Additional Shareholder Value created. remain awards unvested. Previous awards issued to Executive Directors are due to vest between July 2013 and May 2015. made in July 2010. More details of the VSP can be found on page 57, together with the vestings of awards Benefits include a pension or contribution in lieu, car allowance, health insurance, life No changes to policy for the coming assurance and membership of the Group’s employee Share Incentive Plan which is open financial year. to all UK employees. The Group’s policy is to offer all UK employees membership in the QinetiQ Pension Scheme, as described in note 29 to the financial statements. Executives whose benefits are likely to exceed the Lifetime Allowance may opt out of the QinetiQ Pension Plan. In such cases, the individual will be paid a supplement in lieu of pension contributions. N/A No changes to policy for the coming financial year. Performance Share Plan (PSP) – Current The objective of QinetiQ’s long-term PSP awards are contingent on meeting pre-determined performance incentive programmes for Executive criteria. Awards are earned based on an equal weighting of relative Total Directors is to align their rewards with returns to shareholders by a focus on increasing shareholder value over the medium to long term. Shareholder Return (TSR) performance and absolute underlying Earnings per Share (EPS) growth. The underlying EPS performance criterion for the PSP awards begin to vest at 25% once the underlying EPS CAGR hits 3% rising on a linear scale The current Long Term Incentive until maximising at 100% for 10% CAGR. Plan mechanism for Executive Directors is the PSP which is also provided to other senior leaders. This replaced the Value Sharing Plan (see below) in July 2012 and better aligns to our current phase of resurrecting growth. TSR performance is measured against the constituents of the FTSE 250 excluding Investment Trusts. 30% of the TSR awards begin to vest once performance reaches the median of the comparator group rising on a linear basis until performance reaches the upper quartile. Further detail of the thresholds for both measures can be found on page 56. per Share (EPS) growth. The underlying EPS performance criterion for the PSP awards begin to vest at 25% once the underlying EPS CAGR hits 7% rising on a linear scale until maximising at 100% for 15% CAGR. TSR performance is measured against the constituents of a bespoke sector related peer group of companies. 30% of the TSR awards begin to vest once performance reaches the median of the comparator group rising on a linear basis until our performance reaches the upper quartile. • Total shareholder return (TSR) – QinetiQ’s TSR out-performance of the FTSE 250 Index (excluding Investment Trusts). Participants will be entitled to a vesting of shares under the TSR Element only if the Committee is also satisfied that this is justified by the underlying financial performance of the Company over the performance period. • Underlying Profit Before Tax (PBT) – determined by PBT growth above the cost of equity of 8.5% a year, adjusted by the dividend yield. VSP awards granted in May 2011 were weighted equally between the two performance indicators: 50% Total Shareholder Return (TSR) and 50% underlying Profit Before Tax (PBT). For awards made in July 2010, the weighting was 70% PBT and 30% TSR. Any awards earned will vest 50% after three years and 50% after four years. long-term incentive plan which was designed to reinforce QinetiQ’s strategy of focusing on shareholder value creation. This plan is no longer in use – unvested awards from previous years. Pension and other To ensure Executive Directors’ total N/A benefits remuneration remains attractive and competitive. Element Purpose Operation and performance measures Opportunity Individual participants’ award levels are determined by the Committee annually. Executive Directors are eligible to receive awards with a maximum value of 200% of base salary per annum. However, the intention is to normally set the awards at 150%. Changes for coming financial year No changes to policy for the coming financial year. Deferred Annual Bonus Plan (DAB) – Closed No longer in use – unvested awards For awards made prior to the year ended 31 March 2013, the matching from previous years element of the DAB begins to vest (25%) once the underlying EPS CAGR exceeds 7%, maximising at 100% match for 15% CAGR in underlying EPS. Prior to the year ended 31 March 2013, Executive Directors had a mandatory deferral of 40% of any bonus earned and were permitted to voluntarily defer an additional 10% of their bonus into QinetiQ shares up to a maximum of 50%. This Plan is no longer in use, however, there remain awards unvested. Any deferred bonus will be matched up to a maximum of 100%. Performance Share No longer in use – unvested awards Awards are earned based on an equal weighting of relative Total Plan (PSP) – Closed from previous years Shareholder Return (TSR) performance and absolute underlying Earnings Leo Quinn has outstanding awards under this plan based on his joining arrangements and details of the vesting which will occur in June 2013 can be found on page 56. This Plan is no longer in use, however, there remain awards unvested. Value Sharing Plan The VSP was approved by Under the VSP, additional shareholder value created is measured in two (VSP) – Closed shareholders in July 2010. It is a ways: The VSP provided executives with a pre-defined number of shares for each £1m of Additional Shareholder Value created. This Plan is no longer in use, however, there remain awards unvested. Previous awards issued to Executive Directors are due to vest between July 2013 and May 2015. More details of the VSP can be found on page 57, together with the vestings of awards made in July 2010. Personal The Board believes that a In November 2011 the Committee reviewed the executive shareholding shareholding policy meaningful way to align Executives’ policy and increased the length of time allowed to accumulate the interests with those of shareholders required shareholding from four to five years to align with market norms. N/A is for the Executives to build up and retain a personal holding in QinetiQ shares. The CEO and CFO are required to hold shares in QinetiQ with a value equivalent to one times their base salary in QinetiQ shares. No changes to policy for the coming financial year. QinetiQ Group plc Annual Report and Accounts 2013 55 Benefits include a pension or contribution in lieu, car allowance, health insurance, life assurance and membership of the Group’s employee Share Incentive Plan which is open to all UK employees. No changes to policy for the coming financial year. The Group’s policy is to offer all UK employees membership in the QinetiQ Pension Scheme, as described in note 29 to the financial statements. Executives whose benefits are likely to exceed the Lifetime Allowance may opt out of the QinetiQ Pension Plan. In such cases, the individual will be paid a supplement in lieu of pension contributions. Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governance Remuneration report continued Policy Implementation The following section of this report details the implementation of the above policies during year ended March 2013 (2013) and how they will be implemented for the coming financial year (2014). Performance Share Plan (PSP) In 2013 the VSP was replaced by the Performance Share Plan (PSP). The value of the awards made to the Executive Directors in 2013 are detailed below: Base salary Executive Director Leo Quinn David Mellors 2014 £615,322 £391,400 2013 £597,400 £380,000 Based on the market review, salary increases of £11,400 p.a. (3%) were approved for the CFO and £17,922 (3%) for the CEO respectively, effective 1 July 2013, based on performance and their compensation level, vis a vis the market. Leo Quinn David Mellors 2014 Award 150% of base salary 150% of base salary 2013 Award 150% of base salary 150% of base salary The graph below shows the targets against which the performance will be measured and the vesting mechanics. TSR Performance vs FTSE 250 (excluding investment trusts) – 50% of award Award vesting Percentile performance Annual bonus 2014 Executive Director Leo Quinn David Mellors On Target payment 75% 75% Maximum payment 150% 150% On Target payment 75% 75% Maximum payment 150% 150% 100% 30% 2013 Actual bonus earned 150% 150% The 2013 and 2014 bonus potential and 2013 actual awards are set out above, expressed as a percentage of salary. The annual cash bonus opportunity will remain unchanged for 2014 and the measures used to determine performance will also remain unchanged. Part of all annual cash bonuses earned are deferred and paid in shares, as described below. Both the CFO and CEO were measured against Group targets as shown below. Median Upper quartile Underlying EPS* Performance – 50% of award % award vesting CAGR underlying EPS* 100% 25% Group Underlying Operating Proﬁt* 60% Group Underlying Cash Flow* 20% Underlying Earnings per Share* 20% In 2013 the stretch financial targets were exceeded and therefore drove the maximum bonus achievement of 150% of base salary, which is also captured in the Directors’ Remuneration table later in this report. Deferred Annual Bonus (DAB) Plan In 2013 the CEO deferred 50% and the CFO deferred 40% of their 2012 annual cash bonus plans. These will vest in three years (June 2015) and according to future underlying EPS performance any deferred bonus will be matched, up to 100%, based on the following underlying EPS* performance: Underlying EPS* CAGR over three years: Less than 3% 3% Between 3% and 10% 10% or more Percentage of Shares Vesting 0% 25% between 25% and 100% (linear) 100% 3% 10% PSP vesting June 2013 When the CEO was recruited in 2009, the Board agreed to: • an award of 420,900 shares under the PSP and • a variation of the existing PSP whereby Leo Quinn would receive a matching PSP award for his investment of £1m shares of QinetiQ, which equated to 725,688 shares. Based on the underlying EPS* and TSR performance criteria in effect at the time of these grants, a portion of these grants will vest on 1 June 2013. The actual and required performance for these awards is as detailed below: TSR Performance vs comparator Group – 50% of award Award vesting Percentile performance 100% 30% Median Upper quartile 50% of the 2013 annual cash bonus will be deferred into the DAB and will be matched on the same performance basis as the above in three years (June 2016). The TSR for the performance period was 49.1% against a comparator group median performance of 56.1% (including delisted companies) resulting in QinetiQ’s performance being placed at the 42nd percentile. Therefore all of the TSR-related shares will lapse. * Definitions of underlying measures of performance can be found in the glossary on page 116. 56 QinetiQ Group plc Annual Report and Accounts 2013 Underlying EPS* Performance – 50% of award % award vesting CAGR EPS* 100% 25% 7% 15% Based on underlying EPS* of 11.2p^ at 31 March 2010 and 18.9p at 31 March 2013, the three year growth of 69% exceeds the maximum performance threshold and therefore all awards allocated to EPS performance will vest in full resulting in 573,294 shares vesting to Leo Quinn on 1 June 2013. Value Sharing Plan (VSP) – closed Since the VSP was replaced by the PSP in year ending 31 March 2013, there were no awards made under the VSP during this financial year. However, shares previously awarded during year ending 31 March 2011 and 2012 remain unvested. Leo Quinn, David Mellors and a limited number of senior executives participated in the VSP, which rewards Executives with a defined number of shares for every £1m of value created over and above three-year performance hurdles. Details of outstanding awards made in previous years under this plan can be found on page 60 within the table of interests of Executive Directors under long-term incentive plans. Performance of awards made in July 2010 has been measured against Total Shareholder Return and underlying Profit Before Tax as at 31 March 2013. Details of this performance and the relative vesting (provided the Executive Director remains in service) in July 2013 and July 2014 are detailed below: 2010 VSP – Total Shareholder Return 30% of the shares were awarded for a TSR measure of growth in market capitalisation plus net equity cash flows to shareholders over and above the equivalent return from investing in the FTSE 250 index (excluding investment trusts) Leo Quinn was awarded 600 shares per £1m TSR ASV David Mellors was awarded 300 shares per £1m TSR ASV Calculation: QinetiQ’s TSR over the period was 49.1% and the TSR for the FTSE 250 Index was 56.4% Additional shareholder value based on TSR is therefore: QinetiQ TSR out-performance of -7.3% (= 49.1%-56.4%) Therefore, despite a strong increase in total shareholder return, TSR awards will lapse 2010 VSP – Underlying Profit Before Tax 70% of the shares were awarded for growth in value based on PBT (times a fixed multiple, plus net equity cash flows to shareholders) over and above a hurdle return rate of 8.5% P.A. The fixed multiple was calculated from the average market cap in the PBT measure of growth in market capitalisation plus net equity cash flows to shareholders over and above the equivalent return from investing in the FTSE 250 index (excluding investment trusts). Leo Quinn was awarded 1400 shares per £1m PBT ASV David Mellors was awarded 700 shares per £1m PBT ASV Calculation: QinetiQ’s average market cap over the three months to 31 March 2010 was £905.8m Group adjusted PBT for the financial year ended 31 March 2010 was £88.2m Market cap as a (fixed) multiple of PBT for 2010 VSP awards is therefore 10.27 ( = £905.8m / £88.2m), Group adjusted PBT for the financial year ending 31 March 2013 is £152.1m, and dividends to shareholders over the three-year period amount to £36.5m Additional shareholder value based on PBT is therefore: PBT in 2013 of £152.1m multiplied by the fixed multiple of 10.27 equals a value of £1,562.07m (= £152.1m x 10.27) plus £36.5m (paid dividends) equals £1,598.57m (= £1,562.07m +£36.5m) less hurdle rate of £1,157.00m (= £905.8m x (1+8.5%)3) equals additional shareholder value for PBT element of award of £441.57m (= £1,598.51m-£1,157.00m) Therefore, Leo Quinn will be eligible for 618,204 (1,400 x 441.57) shares; David Mellors will be eligible for 309,102 (700 x 441.57) shares 50% of these shares will vest in July 2013 and the remaining 50% will vest in July 2014 ^ IAS 19 (revised) ‘Employee benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. QinetiQ Group plc Annual Report and Accounts 2013 57 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceRemuneration report continued Benefits In 2013, Leo Quinn received contributions of 25% of base salary (£148,262) in lieu of a pension. David Mellors is a member of the Company’s DC pension scheme and the Company contributes 20% of base salary with any contributions above the annual allowance of £50,000, paid as cash in lieu of pension. Contributions to the Defined Contribution section of the QinetiQ Pension Scheme were as follows: Executive Directors David Mellors 2013 2012 £50,000 £50,000 The value of other benefits can be found in the Directors Remuneration table which can be found on page 59. * Contributions to the DC pension scheme paid by the Company were £38,675 with additional contributions arising through salary sacrifice. Personal shareholding policy The CEO achieved his required personal shareholding upon joining the Company and the CFO reached his 100% base salary requirement in November 2012. Directors’ terms and conditions Service agreements for the Executive and the Non-executive Directors are reviewed annually and amended as appropriate. Date of most recent service agreement Date of appointment Executive Directors Leo Quinn David Mellors Non-executive Directors Mark Elliott (Group Chairman) 10 February 2010 June 2009 Colin Balmer Noreen Doyle 20 January 2006 20 January 2006 February 2003 October 2005 Admiral Sir James Burnell-Nugent Paul Murray Michael Harper 10 April 2010 25 October 2010 22 November 2011 April 2010 October 2010 November 2011 QinetiQ’s policy is that Executive Directors should have service agreements with a rolling term providing for a maximum of one year’s notice. Consequently, Executive Directors do not have a contractual notice period in excess of 12 months. In the event of early termination, this ensures that compensation is restricted to a maximum of 12 months’ basic salary and benefits. The Committee will generally consider mitigation to reduce the compensation payable to a departing Executive Director. Non-executive Directors’ letters of appointment are renewed on a rolling twelve-month basis subject to reappointment at the Annual General Meeting. There are no provisions for compensation on early termination. Non-executive Directors’ fees The Group Chairman reviews the fees of the Non-executive Directors, other than his own, and makes recommendations to the Board. Non-executive Directors receive additional fees as agreed by the Board for chairing Board committees to take account of the additional responsibilities of the role. The Chairman’s fees are reviewed by the Senior Independent Non-executive Director who makes recommendations to the Board. 58 QinetiQ Group plc Annual Report and Accounts 2013 The level of fees paid by UK organisations of a similar size and complexity to QinetiQ is considered in setting the remuneration policy for Non-executive Directors. The fees are neither performance- related nor pensionable. Non-executive Directors are not eligible to participate in bonus, profit sharing or employee share schemes. A review of Non-executive Director’s fees was carried out in July 2012, using independent market research, which resulted in an increase of £3,000 per annum in the basic fee for Non-executive Directors and an increase of £2,000 per annum in the fee for chairing a committee, as detailed in the following table: Non-executive Chairman Basic fee for UK Non-executive Director Basic fee for US resident Non-executive Director Additional fee for chairing a committee Additional fee to Deputy Chairman/Senior Independent Non-executive Director Fees from 1/4/12 to 31/7/12 £225,000 £40,000 $100,000 or £50,000 £7,000 Fees from 1/8/2012 £225,000 £43,000 $100,000 or £50,000 £9,000 £10,000 £10,000 As the Group Chairman is a US resident, the Board has agreed an accommodation allowance of £75,000 per annum. Excluding the Group Chairman, an additional fee of $4,000 is payable to US-resident Non-executive Directors per UK Board Meeting. UK resident Non-executive Directors are paid an additional fee of £2,500 per meeting held in the USA. Employee plans The Share Incentive Plan is operated in the UK and Australia in the form of a share purchase award with matching Company contribution to encourage employee ownership and engagement in the business. Executive plans In addition to the VSP and PSP, the Company operates the following executive share plans: • QinetiQ Share Option Scheme (QSOS) – no awards were made during the year under QSOS but provision exists for annual awards up to a face value of 300% of salary. • Stock Award Plan – Restricted Stock Units (RSU) – RSU awards are used in QinetiQ North America to retain and motivate senior managers. The RSU awards vest in four equal tranches over a four-year period. 2013 grants were subject to a vesting schedule which was partly time-based and partly based on the achievement of growth targets: % Organic operating income growth achieved <5% 5%-12.5% >12.5%-15% % RSU Award Vesting 0% 25%-100% (linear) 100%-125% (linear) Awards are granted based on business performance, balanced with the need to attract, retain and motivate high-calibre employees. Executive Directors do not participate in the two plans above. 28 October 2009 20 May 2008 November 2009 August 2008 Management of share-based rewards The Committee also oversees arrangements for share-based rewards in respect of managers and the wider workforce. Dilution limits In accordance with ABI guidelines, no more than 10% of the Company’s issued share capital will be used under all of the Company’s share schemes during a 10-year period. The dilution as at 31 March 2013 was significantly below this 10% level, and below 5% in respect of executive schemes. In addition, the Board intends to continue to satisfy a proportion of awards with purchased shares held in an employee benefit trust. Five-year Total Shareholder Return The graph shows the Company’s TSR over the period from 31 March 2008 to 31 March 2013 compared to the FTSE 250 index (excluding investment trusts) over the same period based on spot values. The Committee has chosen to demonstrate the Company’s performance against FTSE 250 (excluding investment trusts) as it is an appropriate sector comparison within the index in which the Company is listed. Qine(cid:17)Q FTSE250 excluding Investment Trusts TSR Summary 200 150 100 50 0 31 M ar 08 31 M ar 09 31 M ar 10 31 M ar 11 30 M ar 12 28 M ar 13 Audited information Directors’ remuneration The information about Directors’ remuneration and Directors’ interests on pages 59-61 has been audited. The table below shows the aggregate remuneration of the Directors for the year ended 31 March 2013. Executives Leo Quinn (d) David Mellors (e) Total for Executive Directors Non Executives Mark Elliott Colin Balmer Noreen Doyle Paul Murray Admiral Sir James Burnell-Nugent Michael Harper Former Directors Sir David Lees (g) Admiral Ed Giambastini (h) David Langstaff (i) Total for Non-executive Directors Total – All Directors Salary/fees (a) Bonus (b) Other benefits (c) Payment in lieu of pension Total 2013 Total 2012 £593,050 £377,500 £970,550 £896,100 £570,000 £1,466,100 £225,000 £55,333 £55,333 £55,333 £47,000 £57,000 – – – – – – – – – £494,999 £1,465,549 – – – – £1,466,100 £52,106 £21,183 £73,289 £75,000 – – – – – – – – £75,000 £148,289 £148,262 £36,825 £185,087 £1,689,518 £1,005,508 £2,695,026 £1,495,284 £866,644 £2,361,928 – – – – – – £300,000 £55,333 £55,333 £55,333 £47,000 £57,000 £300,000 £46,167 £52,000 £52,000 £45,000 £18,577 – – – – £185,087 – – – £569,999 £3,265,025 £55,834 £21,292 £2,115 £592,985 £2,954,913 a) Before adjustments to basic pay for salary sacrifice pensions. b) The figure shown for bonus is paid in both cash and shares under the DAB. c) Includes car allowance and health insurance benefits for executives and accommodation for Group Chairman. d) Salary for Leo Quinn reflects increase from £580,000 to £597,400 effective 1 July 2012. e) Salary for David Mellors reflects increase from £370,000 to £380,000 effective 1 July 2012. f) Fees for NEDs increased on 1 August 2013 (page 58). g) Sir David Lees resigned from the Board on 31 Jan 2012. h) Admiral Ed Giambastini resigned from the Board on 2 August 2011. i) David Langstaff resigned from the Board on 18 April 2011. Pensions Contributions to the Defined Contribution section of the QinetiQ Pension Scheme were as follows: For the year ended 31 March Executive Directors David Mellors 2013 2012 £50,000 £50,000 Contributions for David Mellors to the scheme paid by the Company were £38,675 with additional contributions arising through salary sacrifice. Leo Quinn received contributions of 25% of base salary in lieu of a pension. QinetiQ Group plc Annual Report and Accounts 2013 59 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governance Remuneration report continued Interests of Executive Directors under long-term incentive share plans as at 31 March 2013 Grant date Number at 1 April 2012 Granted in year (maximum potential of awards) Exercised/ vested in year Lapsed in year Number at 31 March 2013 Leo Quinn Matching award TSR (b) Matching award EPS (b) PSP Mirror TSR (b) PSP Mirror EPS (b) VSP TSR VSP TSR VSP PBT VSP PBT VSP TSR VSP TSR VSP PBT VSP PBT DAB Match PSP EPS PSP TSR DAB Match 16/12/09 16/12/09 16/12/09 16/12/09 29/07/10 29/07/10 29/07/10 29/07/10 26/05/11 26/05/11 26/05/11 26/05/11 01/07/11 09/08/12 09/08/12 29/06/12 362,844 362,845 210,450 210,450 271,800 271,800 634,200 634,200 382,950 382,950 382,950 382,950 226,777 – – – – – – – – – – – – – – – – 280,032 280,032 229,596 Total Leo Quinn 4,717,166 789,660 David Mellors PSP TSR PSP EPS DAB Match VSP TSR VSP TSR VSP PBT VSP PBT VSP TSR VSP TSR VSP PBT VSP PBT DAB Match PSP EPS PSP TSR DAB Match Total David Mellors Total Executive Directors 04/08/09 04/08/09 01/07/09 29/07/10 29/07/10 29/07/10 29/07/10 26/05/11 26/05/11 26/05/11 26/05/11 01/07/11 09/08/12 09/08/12 29/06/12 100,000 100,000 6,859 135,900 135,900 317,100 317,100 191,475 191,475 191,475 191,475 70,379 – – – 1,949,138 6,666,304 – – – – – – – – – – – – 178,125 178,125 117,173 473,423 1,263,083 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 100,000 100,000 6,859 – – – – – – – – – – – – 206,859 206,859 362,844 362,845 210,450 210,450 271,800 271,800 634,200 634,200 382,950 382,950 382,950 382,950 226,777 280,032 280,032 229,596 5,506,826 – – – 135,900 135,900 317,100 317,100 191,475 191,475 191,475 191,475 70,379 178,125 178,125 117,173 2,215,702 7,722,528 Market price on date of grant 165p (a) 165p (a) 165p (a) 165p (a) 124.9p 124.9p 124.9p 124.9p 112.3p 112.3p 112.3p 112.3p 129.1p 166.0p 166.0p 157.1p 135.0p 135.0p 144.7p 124.9p 124.9p 124.9p 124.9p 112.3p 112.3p 112.3p 112.3p 129.1p 166.0p 166.0p 157.1p Earliest vest date Latest vest date 01/06/13 01/06/13 01/06/13 01/06/13 29/07/13 29/07/14 29/07/13 29/07/14 26/05/14 26/05/15 26/05/14 26/05/15 01/07/14 09/08/15 09/08/15 30/06/15 04/08/12 04/08/12 01/07/12 29/07/13 29/07/14 29/07/13 29/07/14 26/05/14 26/05/15 26/05/14 26/05/15 01/07/14 09/08/15 09/08/15 30/06/15 01/06/13 01/06/13 01/06/13 01/06/13 29/07/13 29/07/14 29/07/13 29/07/14 26/05/14 26/05/15 26/05/14 26/05/15 01/07/14 09/08/15 09/08/15 30/06/15 04/08/12 04/08/12 01/07/12 29/07/13 29/07/14 29/07/13 29/07/14 26/05/14 26/05/15 26/05/14 26/05/15 01/07/14 09/08/15 09/08/15 30/06/15 a) Shares awarded to the CEO in 2009 were based on an average market price of 138.0p representing the average price over the ten days before joining. b) On appointment the CEO was granted a mirror PSP award, subject to the same EPS and TSR performance conditions as above. In addition, the CEO invested c. £1m in QinetiQ shares, for which he received an additional matching PSP award, subject to the same EPS and TSR performance conditions. The awards in the table above are subject to the performance conditions described on page 54. The price of a QinetiQ share at 31 March 2013 was 207.4p The highest and lowest prices of a QinetiQ share during the year ended 31 March 2013 were 214.6p and 141.5p respectively. There have been no changes to the interests shown above between 31 March 2013 and 23 May 2013. There is no exercise price for any of the above awards. 60 QinetiQ Group plc Annual Report and Accounts 2013 Executive Directors’ interests in the All-Employee Share Incentive Plan (SIP) Leo Quinn David Mellors Interest as at 1 April 2012 2,398 3,595 Partnership and dividend shares acquired during year 921 947 Interest as at 31 March 2013 3,319 4,542 Interest as at 23 May 2013 3,450 4,673 The SIP is HMRC approved and under the plan rules matching shares are not awarded until the three year time condition has been satisfied. Therefore these shares are not included in the above table. Directors’ interests in shares The table below shows the beneficial interests in ordinary shares (including, where applicable, shares held under the SIP and DAB) of the Directors who were in office as at 31 March 2013 and their connected persons. Executive Directors Leo Quinn David Mellors Non-executive Directors Mark Elliott Colin Balmer Noreen Doyle Admiral Sir James Burnell-Nugent Paul Murray Michael Harper Approved by the Board and signed on its behalf. Noreen Doyle Chair of the Remuneration Committee 23 May 2013 Number 1p Ord Shares held at 23 May 2013 Number 1p Ord Shares held at 31 March 2013 Number 1p Ord Shares held at 1 April 2012 1,112,580 215,860 1,112,449 215,729 125,000 7,662 24,662 11,419 56,077 20,000 125,000 7,662 24,662 11,419 56,077 20,000 882,716 98,500 125,000 7,662 24,662 11,419 56,077 10,000 QinetiQ Group plc Annual Report and Accounts 2013 61 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceCorporate governance Other statutory information Directors’ Report For the purposes of the Companies Act 2006, the Directors’ Report, which includes the Business Review, is set out on pages 1-64. Principal activity QinetiQ Group plc is a public limited company listed on the London Stock Exchange and incorporated in England and Wales with registered number 4586941. QinetiQ Group plc is the parent company of a group whose principal activities during the year were the supply of technical support, training, test and evaluation, and know-how to customers in the global defence, aerospace and security markets. Customers include government organisations, such as the UK MOD and the US DoD, and a range of other government and commercial customers globally. Research and development One of the Group’s principal business streams is the provision of funded research and development (R&D) for customers. The Group also invests in the commercialisation of promising technologies across all areas of business. The majority of R&D-related expenditure is incurred on behalf of customers as part of specific funded research contracts. R&D costs are included in the income statement and R&D income is reflected within revenue. In the financial year, the Group recorded £335.6m (2012: £346.3m) of total R&D-related expenditure, of which £311.0m (2012: £331.1m) was customer-funded work and £24.6m (2012: £15.2m) was internally funded. Additionally, £0.3m (2012: £0.3m) of late-stage development costs was capitalised and £0.9m (2012: £2.3m) of capitalised development costs was amortised in the year. Policy and practice on payment of suppliers The policy of the Group is to agree terms of payment prior to commencing trade with a supplier and to abide by those terms based on the timely submission of satisfactory invoices. The Group has a policy of agreeing payment terms of not less than 60 days with suppliers, except in exceptional circumstances. At 31 March 2013, the trade payables of the Group represented 31 days of annual purchases (2012: 24 days). Political and charitable contributions QinetiQ does not make political donations to parties as that term would be commonly recognised. The legal definition of that term is, however, quite broad and may have the effect of covering a number of normal business activities that would not commonly be perceived to be political donations, such as sponsorship of events. These may include legitimate interactions in making MPs and others in the political world aware of key industry issues and matters that affect QinetiQ, and that make an important contribution to their understanding of QinetiQ, the markets in which it operates, and the work of their constituents. Charitable donations during the year across the Group amounted to £180,492 (2012: £108,400). Information on charitable activities can be found in the Corporate Responsibility and Sustainability Review on pages 34-37. 62 QinetiQ Group plc Annual Report and Accounts 2013 Share capital As at 31 March 2013, the Company had allotted and fully paid up share capital of 660,476,373 ordinary shares of 1p each with an aggregate nominal value of £6.6m (including shares held by employee share trusts) and one Special Share with a nominal value of £1. Details of the shares in issue during the financial year are shown in note 27 on page 102. The rights of ordinary shareholders are set out in the Articles of Association. The holders of ordinary shares are entitled to receive the Company’s Reports and Accounts, to attend and speak at General Meetings of the Company, to exercise voting rights in person or by appointing a proxy, and to receive a dividend where declared or paid out of profits available for that purpose. The Special Share is held by HM Government through the Secretary of State for Defence and it confers certain rights under the Articles of Association which are detailed in note 27 on page 102. These include the right to require certain persons with a material interest in QinetiQ to dispose of some or all of their ordinary shares on the grounds of national security or conflict of interest. The Special Share may only be held by and transferred to HM Government. At any time the Special Shareholder may require QinetiQ to redeem the share at par and, if wound up, the Special Shareholder would be entitled to be repaid capital before other shareholders. Any variation of the rights attaching to the Special Share requires the written approval of the MOD. In 2012, the rights attaching to the Special Share were amended following receipt of the requisite MOD approval and shareholder approval at the 2012 Annual General Meeting. The amendments included removal of the MOD’s right to veto any transaction or activity and the introduction of a generic MOD conflict of interest management system in alignment with that followed by other defence companies. Directors’ interests in contracts At the date of this Report, there is no contract or arrangement with the Company or any of its subsidiaries that is significant in relation to the business of the Group as a whole in which a Director of the Company is materially interested. Indemnities The directors of QinetiQ Pension Scheme Trustee Limited, a Group company and the trustee of the QinetiQ Pension Scheme (QPS), benefit from an indemnity contained in the rules of the QPS. The indemnity would be provided out of the QPS assets. Change of control – significant agreements The following significant agreements contain provisions entitling the counterparties to require prior approval, exercise termination, alteration, or other similar rights in the event of a change of control of the Company, or if the Company ceases to be a UK company: • The Combined Aerial Target Service contract is a 20-year contract awarded to QinetiQ by the MOD on 14 December 2006. The terms of this contract require QinetiQ Limited to remain a UK company which is incorporated under the laws of any part of the UK, or an overseas company registered in the UK, and that at least 50% of the Board of Directors are UK nationals. The terms also contain change of control conditions and restricted share transfer conditions which require prior approval from HM Government if there is a material change in the ownership of QinetiQ Limited’s share capital, unless the change relates to shares listed on a regulated market – ‘material’ is defined as being 10% or more of the share capital. In addition, there are restrictions on transfers of shares to persons from countries appearing on the restricted list as issued by HM Government; • The Long-Term Partnering Agreement (LTPA) is a 25-year contract, which QinetiQ Limited signed on 28 February 2003, to provide test, evaluation and training services to the MOD. This contract contains conditions under which the prior approval of HM Government is required if the contractor, QinetiQ Limited, ceases to be a subsidiary of the QinetiQ Group, except where such change in control is permitted under the Shareholders Agreement to which the MOD is a party. The Company is party to a multi-currency Revolving Credit Facility, with a US$250m tranche and a £118m tranche, provided by the Group’s six global relationship banks, that expires on 4 February 2016. Under the terms of the facility, if there is a change of control of the Company, any lender may request, by not less than 60 days’ notice to the Company, that its commitment be cancelled and all outstanding amounts be repaid to that lender at the expiry of such notice period. On 6 December 2006, QinetiQ US Holdings, Inc., formerly known as QinetiQ North America, Inc. (as Borrower) and the Company (as Guarantor) entered into a Note Purchase Agreement to issue US$125m 5.50% Senior Notes due 6 December 2016. $77m has been repaid early and the remaining debt outstanding as at 31 March 2013 was $48m. Under the terms of the agreement, if either (1) the MOD ceases to retain in its capacity as Special Shareholder its Special Shareholder’s Rights; or (2) there is a change of control of the Company, and in either case where there has been a rating downgrade, or where there are no rated securities (unless a rating of at least investment grade is not obtained within 90 days of the change of control), the Notes must be offered for prepayment by the Company within 21 days of the change of control. The prepayment date would be no later than 45 days after the offer of prepayment by the Company. On 5 February 2009, QinetiQ US Holdings, Inc. (as Borrower) and the Company (as Guarantor) entered into a Note Purchase Agreement to issue US$62m 7.13% Senior Notes due 5 February 2016 and US$238m 7.62% Senior Notes due 5 February 2019. $100m has been repaid early and the remaining debt outstanding as at 31 March 2013 was $43m of 7.13% Senior Notes and $157m of 7.62% Senior Notes. Under the terms of the agreement, if either (1) the MOD ceases to retain in its capacity as Special Shareholder its Special Shareholder’s Rights; or (2) there is a change of control of the Company, the Notes must be offered for prepayment within 21 days of the change of control. The prepayment date would be no later than 45 days after the offer of prepayment by the Company. During 2013 the Group completed the previously announced programme to repay $177m of private placement debt. Financial instruments Information on the Group’s financial risk management objectives and policies, and its exposure to credit risk, liquidity risk, interest rate risk and foreign currency risk is in note 25 on page 93. Branches The Company and its subsidiaries have established branches in a number of different countries in which they operate; their results are, however, not material to the Group’s financial results. Major shareholders At 31 March 2013, the Group had been notified under DTR5 of the following shareholdings: Shareholder Artisan Partners* Ruane Cunniff & Goldfarb, Inc. Schroders Investec Norges Bank Fidelity Management and Research Company Fidelity International Limited Number of ordinary shares 92,608,147 64,117,000 35,429,785 33,160,928 33,123,896 32,986,143 % of issued share capital 14.02 9.71 5.36 5.02 5.02 4.99 31,258,590 4.73 * Since 31 March 2013, the Company has been notified by Artisan Partners that their interest has changed. At 21 May 2013, being the latest practicable date prior to the issue of this report, the most recent interest notified by Artisan consisted of 85,419,672 ordinary shares (12.93% of the issued share capital). The Company had received no other notification of any further interests or of any changes in the interests detailed above. Allotment/purchase of own shares At the Company’s Annual General Meeting (AGM) held in July 2012, the shareholders passed resolutions which authorised the Directors to allot relevant securities up to an aggregate nominal value of £4,403,174 (£2,201,587 pursuant only to a rights issue), to disapply pre-emption rights (up to 5% of the issued ordinary share capital) and for the Company to purchase ordinary shares (up to 10% of its ordinary share capital). Equivalent resolutions will be laid before the 2013 AGM. During the year, the Company provided funding to the QinetiQ Group plc Employee Benefit Trust (the ‘Trust’), which holds shares in connection with its employee share schemes, to make market purchases of the Company’s ordinary shares to cover future obligations under outstanding share option and other share-based awards. Further details are disclosed in note 28 on page 103. As at 31 March 2013, the Trust held 10,478,906 ordinary shares of 1p each (the ‘Trust Shares’). The trustees of the Trust have agreed to waive their entitlement to dividends payable on the Trust Shares. The Trust holds further ordinary shares in respect of deferred shares held on behalf of participants in the Company’s Deferred Annual Bonus Plan. Dividends received by the Trust in respect of the deferred shares are paid direct to the plan participants on receipt and are not retained in the Trust. QinetiQ Group plc Annual Report and Accounts 2013 63 Business reviewCorporate governanceFinancial statementsOverviewAdditional informationCorporate governanceOther statutory information continued Restrictions on transfer of shares As outlined in note 27 on page 102, the Special Share confers certain rights under the Company’s Articles of Association to require certain persons with an interest in QinetiQ’s shares that exceed certain prescribed thresholds to dispose of some or all of their ordinary shares on the grounds of national security or conflict of interest. Articles of Association Save in respect of any variation to the rights attaching to the Special Share, the Company has not adopted any special rules relating to the amendment of the Company’s Articles of Association, other than as provided under UK corporate law. Employee Share Scheme Equiniti Share Plan Trustees Limited acts as trustee in respect of all ordinary shares held by employees under the QinetiQ Group plc Share Incentive Plan (the ‘Plan’). Equiniti Share Plan Trustees Limited will send a Form of Direction to all employees who hold shares under the Plan, and will vote on all resolutions proposed at general meetings in accordance with the instructions received. In circumstances where ordinary shares are held by the corporate sponsored nominee service, Equiniti Corporate Nominees Limited will send a Proxy Form to all shareholders using such corporate nominee service, and will vote on all resolutions proposed at general meetings in accordance with the instructions received. Annual General Meeting The Company’s AGM will be held on Thursday 25 July 2013 at 11.00am, at The Royal Berkshire Hotel, London Road, Sunninghill, Ascot, Berkshire, SL5 0PP. Details of the business to be proposed and voted on at the meeting are contained in the Notice of the Annual General Meeting, which is sent to all shareholders and is also published on the Company’s website, www.QinetiQ.com. Auditor Following their intention to gradually wind down the activity in the registered firm, KPMG Audit Plc have notified the Company that they are not seeking reappointment as auditor. A resolution to appoint KPMG LLP, an intermediate parent of KPMG Audit Plc, will be proposed at the AGM. Statement of Directors’ responsibilities in respect of the Annual Report and financial statements The Directors are responsible for preparing the Annual Report and the Group and parent company financial statements in accordance with applicable law and regulations. Company law requires the Directors to prepare Group and parent company financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with IFRSs as adopted by the EU and applicable law and have elected to prepare the parent company financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice). Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent company and of their profit or loss for that period. In preparing each of the Group and parent company financial statements, the Directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • for the Group financial statements, state whether they have been prepared in accordance with IFRSs as adopted by the EU; 64 QinetiQ Group plc Annual Report and Accounts 2013 • for the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and • prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business. The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the parent company’s transactions and disclose with reasonable accuracy at any time the financial position of the parent company and enable them to ensure that its financial statements comply with the Companies Act 2006. They have 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. Under applicable law and regulations, the Directors are also responsible for preparing a Directors’ Report, Directors’ Remuneration Report and Corporate Governance Statement that comply with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Company’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Statement of disclosure of information to the auditor The Directors who held office at the date of approval of this Directors’ report have confirmed that, so far as the Directors are aware, there is no relevant audit information of which the Company’s auditor is unaware; and the Directors have taken all the steps they reasonably should have taken as Directors to make themselves aware of any relevant audit information and to establish that the Company’s auditor is aware of that information. Responsibility statement of the Directors in respect of the Annual Report The Directors in office as at the date of this Report confirm that to the best of their knowledge: • The financial statements of the Group have been prepared in accordance with IFRS as adopted by the EU, and for the Company under UK GAAP, in accordance with applicable United Kingdom law, and give a true and fair view of the assets, liabilities, financial position and profit or loss of the Group; and • The Directors’ Report includes a fair review of the development and performance of the business and the position of the Group, together with a description of the principal risks and uncertainties that face the Group. By order of the Board Jon Messent Company Secretary Cody Technology Park Ively Road Farnborough Hampshire GU14 0LX 23 May 2013 Independent auditor’s report to the members of QinetiQ Group plc We have audited the financial statements of QinetiQ Group plc for the year ended 31 March 2013 set out on pages 66-114. The financial reporting framework that has been applied in the preparation of the Group financial statements is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the EU. The financial reporting framework that has been applied in the preparation of the parent company financial statements is applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice). This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. 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 auditor’s 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 auditor As explained more fully in the Directors’ responsibilities statement set out on page 64, the Directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit, and express an opinion on, the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors. Scope of the audit of the financial statements A description of the scope of an audit of financial statements is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate. Opinion on financial statements In our opinion: • the financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 March 2013 and of the Group’s profit for the year then ended; • the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the EU; • the parent company financial statements have been properly prepared in accordance with UK Generally Accepted Accounting Practices; and • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006; and, as regards the Group financial statements, Article 4 of the IAS Regulation. Opinion on other matters prescribed by the Companies Act 2006 In our opinion: • the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006; and • the information given in the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion: • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or • the parent company financial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns; or • certain disclosures of Directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: • the Directors’ statement, set out on page 44, in relation to going concern; • the part of the corporate governance statement on pages 40-49 relating to the Company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review; and • certain elements of the report to shareholders by the Board on Directors’ remuneration. Anthony Sykes Senior Statutory Auditor for and on behalf of KPMG Audit Plc, Statutory Auditor Chartered Accountants 15 Canada Square London E14 5GL 23 May 2013 F i n a n c i a l s t a t e m e n t s QinetiQ Group plc Annual Report and Accounts 2013 65 Business reviewCorporate governanceOverviewAdditional information Consolidated income statement for the year ended 31 March all figures in £ million Revenue Operating costs excluding depreciation, amortisation and impairment Other income EBITDA (earnings before interest, tax, depreciation and amortisation) Depreciation and impairment of property, plant and equipment Impairment of goodwill Amortisation of intangible assets Group operating (loss)/profit Gain on business divestments and disposal and impairment of investments Finance income Finance expense (Loss)/profit before tax Taxation income/(expense) (Loss)/profit for the year attributable to equity shareholders Earnings per share Basic Diluted Note 2, 3 Underlying 1,327.8 2013 Specific adjusting items* – Total 1,327.8 Underlying 1,469.6 2012 (restated^) Specific adjusting items* – Total 1,469.6 (1,132.9) 5.8 2 (16.3) – (1,149.2) 5.8 (1,275.6) 5.2 223.9 – (1,051.7) 5.2 200.7 (16.3) 184.4 199.2 223.9 423.1 (28.0) – (4.0) 168.7 – 1.7 (18.3) 152.1 (29.2) (4.0) (255.8) (14.0) (290.1) 2.3 – (1.3) (289.1) 33.0 (32.0) (255.8) (18.0) (121.4) 2.3 1.7 (19.6) (137.0) 3.8 (30.6) – (9.0) 159.6 – 2.2 (51.6) 110.2 (21.5) (1.9) – (20.3) 201.7 11.6 – (7.2) 206.1 (48.5) (32.5) – (29.3) 361.3 11.6 2.2 (58.8) 316.3 (70.0) 122.9 (256.1) (133.2) 88.7 157.6 246.3 18.9p 18.7p (20.5)p (20.5)p 13.6p 13.5p 37.9p 37.6p 3, 14 12 13 3 5 6 6 4 7 11 11 * For details of ‘specific adjusting items’ refer to note 4 to the financial statements. ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. Refer to note 1 to the financial statements. 66 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Consolidated statement of comprehensive income for the year ended 31 March all figures in £ million (Loss)/profit for the year Items that will not be reclassified to profit or loss: Actuarial loss recognised in defined benefit pension schemes Tax on items that will not be reclassified to profit and loss Total items that will not be reclassified to profit or loss Items that may be reclassified subsequently to profit or loss: Foreign currency translation differences for foreign operations Decrease in fair value of hedging derivatives Reclassification of hedging derivatives to the income statement Impairment loss on revalued investments Fair value gains/(losses) on available-for-sale investments Tax on items that may be reclassified to profit or loss Total items that may be reclassified subsequently to profit or loss Other comprehensive expense for the year, net of tax 2013 (133.2) 2012 (restated^) 246.3 (42.1) 10.1 (32.0) 24.6 (0.1) – (4.1) 0.3 – 20.7 (11.3) (102.9) 27.0 (75.9) (1.9) (0.4) 0.2 – (1.2) 0.1 (3.2) (79.1) Total comprehensive (expense)/income for the year (144.5) 167.2 Consolidated statement of changes in equity for the year ended 31 March all figures in £ million At 1 April 2012 Loss for the year Other comprehensive income/ (expense) for the year, net of tax Purchase of own shares Share-based payments settlement Share-based payments Dividends At 31 March 2013 At 1 April 2011 Profit for the year (restated^) Other comprehensive expense for the year, net of tax (restated^) Purchase of own shares Share-based payments Dividends At 31 March 2012 Issued share capital 6.6 – Capital redemption reserve 39.9 – Share premium 147.6 – Hedge reserve 0.1 – Translation reserve 19.7 – Retained earnings 385.4 (133.2) Non- controlling interest 0.1 – Total 599.3 (133.2) – – – – – 6.6 6.6 – – – – – 6.6 – – – – – 39.9 39.9 – – – – – 39.9 – – – – – 147.6 147.6 – – – – – 147.6 (0.1) – – – – – 0.2 – (0.1) – – – 0.1 24.6 – – – – 44.3 21.6 – (1.9) – – – 19.7 (35.8) (0.4) 0.7 3.4 (20.1) 200.0 241.5 246.3 (77.1) (12.0) 3.1 (16.4) 385.4 (11.3) (0.4) 0.7 3.4 (20.1) 438.4 457.4 246.3 (79.1) (12.0) 3.1 (16.4) 599.3 – – – – – 0.1 0.1 – – – – – 0.1 Total equity 599.4 (133.2) (11.3) (0.4) 0.7 3.4 (20.1) 438.5 457.5 246.3 (79.1) (12.0) 3.1 (16.4) 599.4 ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. Refer to note 1 to the financial statements. QinetiQ Group plc Annual Report and Accounts 2013 67 Consolidated balance sheet as at 31 March all figures in £ million Non-current assets Goodwill Intangible assets Property, plant and equipment Other financial assets Investments Deferred tax asset Current assets Inventories Other financial assets Trade and other receivables Investments Assets classified as held for sale Cash and cash equivalents Total assets Current liabilities Trade and other payables Current tax Provisions Other financial liabilities Non-current liabilities Retirement benefit obligation Provisions Other financial liabilities Other payables Total liabilities Net assets Capital and reserves Ordinary shares Capital redemption reserve Share premium account Hedging and translation reserve Retained earnings Capital and reserves attributable to shareholders of the parent company Non-controlling interest Total shareholders’ funds Note 2013 2012 12 13 14 23 15 16 17 23 19 18 20 23 21 22 23 29 22 23 21 27 290.4 57.8 241.4 4.3 0.4 32.4 626.7 25.5 2.6 284.2 1.4 – 240.4 554.1 1,180.8 (458.0) (14.2) (12.4) (2.0) (486.6) (54.1) (22.7) (171.3) (7.6) (255.7) (742.3) 438.5 6.6 39.9 147.6 44.3 200.0 438.4 0.1 438.5 519.3 71.8 246.6 6.9 5.8 17.0 867.4 31.2 2.4 404.8 1.1 5.1 117.8 562.4 1,429.8 (498.7) (13.7) (3.4) (84.9) (600.7) (31.5) (13.2) (164.4) (20.6) (229.7) (830.4) 599.4 6.6 39.9 147.6 19.8 385.4 599.3 0.1 599.4 The financial statements were approved by the Board of Directors and authorised for issue on 23 May 2013 and were signed on its behalf by: Mark Elliott Chairman Leo Quinn Chief Executive Officer David Mellors Chief Financial Officer 68 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Consolidated cash flow statement for the year ended 31 March all figures in £ million Net cash inflow from operations before restructuring costs Net cash inflow/(outflow) relating to restructuring Cash inflow from operations Tax paid Interest received Interest paid Net cash inflow from operating activities Purchases of intangible assets Purchases of property, plant and equipment Proceeds from sale of property, plant and equipment Equity accounted investments and other investment funding Purchase of subsidiary undertakings Proceeds from sale of interests in subsidiary undertakings Net cash outflow from investing activities Repayment of bank borrowings Settlement of forward contracts Purchase of own shares Dividends paid to shareholders Capital element of finance lease rental payments Capital element of finance lease rental receipts Net cash outflow from financing activities Increase in cash and cash equivalents Effect of foreign exchange changes on cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year Reconciliation of movement in net cash/debt for the year ended 31 March all figures in £ million Increase in cash and cash equivalents in the year Add back net cash flows not impacting net debt Change in net debt resulting from cash flows Other movements including foreign exchange Movement in net debt in the year Net debt at beginning of year Net cash/(debt) at end of year Note 26 23 Note 23 23 23 23 23 2013 194.4 63.1 257.5 (1.6) 0.8 (35.8) 220.9 (0.6) (27.1) 9.2 3.8 – – (14.7) (63.0) (1.3) (0.4) (20.1) (2.8) 3.0 (84.6) 121.6 1.0 117.8 240.4 2013 121.6 64.1 185.7 10.5 196.2 (122.2) 74.0 2012 250.8 (8.9) 241.9 (23.3) 1.0 (39.5) 180.1 (0.7) (22.0) 7.3 3.6 (0.9) 11.2 (1.5) (133.6) (1.6) (12.0) (16.4) (2.8) 3.0 (163.4) 15.2 0.4 102.2 117.8 2012 15.2 135.0 150.2 (11.5) 138.7 (260.9) (122.2) QinetiQ Group plc Annual Report and Accounts 2013 69 Notes to the financial statements 1. Significant accounting policies Accounting policies The following accounting policies have been applied consistently to all periods presented in dealing with items that are considered material in relation to the Group’s financial statements. In the income statement, the Group presents specific adjusting items separately. In the judgement of the Directors, for the reader to obtain a proper understanding of the financial information, specific adjusting items need to be disclosed separately because of their size and incidence. Specific adjusting items include: • amortisation of intangibles arising from acquisitions; • pension curtailment gains/losses; • pension past service credits/costs; • pension net finance expense; • gains/losses on business divestments and disposal of investments; • • gains/losses on disposal of property; • • • net gain in respect of previously capitalised DTR programme bid costs; and • impairment of property; impairment of goodwill and other intangible assets; tax on the above items. restructuring costs; Pension finance income and pension finance expense were, prior to this accounting period, reported within underlying performance. With effect from this accounting period the pension net finance expense is included within specific adjusting items in the middle column of the income statement and the comparative financial information has been restated accordingly. In the judgement of the Directors the exclusion of this non-cash financial item (which can swing from net expense to net income) leads to a better understanding of the financial information, given its volatility. Basis of preparation The Group’s financial statements, approved by the Directors, have been prepared on a going concern basis as discussed in the Directors’ Report on page 44 and in accordance with International Financial Reporting Standards as adopted by the EU (‘IFRS’) and the Companies Act 2006 applicable to companies reporting under IFRS. The Company has elected to prepare its parent company financial statements in accordance with UK GAAP; these are presented on pages 112-114. The financial statements have been prepared under the historical cost convention, as modified by the revaluation of available-for-sale financial assets and other relevant financial assets and liabilities. Non-current assets held for sale are held at the lower of carrying amount and fair value less costs to sell. The Group’s reporting currency is sterling and unless otherwise stated the financial statements are rounded to the nearest £100,000. The Company has implemented IAS 19 (revised) ‘Employee benefits’ in the year ended 31 March 2013, electing to adopt this standard early. There are three specific impacts on the income statement, as outlined below: • A reclassification of the administration costs of the defined benefit pension scheme, including the levy for the Pension Protection Fund, from finance expense to underlying operating profit; • A change in the calculation of the interest income on plan assets. This was previously based on the expected returns on the various asset types held within the investment portfolio. It is now calculated at the same rate used to calculate the interest expense on the pension liability, being a discount rate derived from corporate bonds. The difference between this calculated return and the actual return is reported as an actuarial gain/loss through reserves; and • The reporting of a combined net figure within finance expense, rather than showing the pension interest income and pension interest expense gross, within finance income and finance expense respectively. Subsequent to the early adoption of IAS 19 (revised) ‘Employee benefits’, the Group has also elected to disclose the finance expense on the net pension liability as a specific adjusting item within the middle column of the consolidated income statement. The comparative figures for the income statement for the year ended 31 March 2012 have been restated to show the effect of this early adoption and the reclassification as a specific adjusting item. The effect of adopting IAS 19 (revised) on the Group’s profit for the prior full-year period is to reduce both underlying and total reported profit after tax by £11.6m. The subsequent effect of the reclassification of net finance expense from underlying performance to within specific adjusting items is to increase underlying profit by £5.5m, although it has no impact on total reported profit. The combined effect of the two adjustments on the Group’s profit for the full-year period to 31 March 2012 is therefore to reduce the underlying profit after tax by £6.1m to £88.7m and to reduce total reported profit after tax by £11.6m to £246.3m. If the reclassification of pension finance income and pension finance expense had been made in isolation, without early adoption of IAS 19 (revised), there would have been no impact on the Group’s total reported profit for the period. Underlying profit after tax for the year ended 31 March 2012 would have decreased by £4.9m, with an equal increase in profit after tax in respect of specific adjusting items in the middle column of the income statement. 70 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n The full impact on the income statement, for the year ended 31 March, is set out in the table below: all figures in £ million Operating profit Gain on disposals Finance income Finance expense Tax Profit after tax EPS – basic EPS – diluted 2012 (restated) Specific adjusting items* 201.7 11.6 – (7.2) (48.5) 157.6 Underlying 159.6 – 2.2 (51.6) (21.5) 88.7 13.6p 13.5p 2012 (reported) Specific adjusting items* 201.7 11.6 – – (50.2) 163.1 Total 361.3 11.6 2.2 (58.8) (70.0) 246.3 37.9p 37.6p Underlying 161.3 – 69.8 (112.8) (23.5) 94.8 14.6p 14.5p Total 363.0 11.6 69.8 (112.8) (73.7) 257.9 39.6p 39.4p * For details of ‘specific adjusting items’ refer to note 4 to the financial statements. The impact on the statement of comprehensive income, for the year ended 31 March, is as follows: all figures in £ million Profit for the year Other comprehensive income for the year, net of tax Total comprehensive income for the year attributable to equity shareholders 2012 (restated) 246.3 (79.1) 167.2 2012 (reported) 257.9 (90.7) 167.2 There is no change to the net pension liability or to net assets as a result of the early adoption of IAS 19 (revised). As a result no restatement of the balance sheet is required. Basis of consolidation The consolidated financial statements comprise the financial statements of the Company and its subsidiary undertakings to 31 March 2013. The purchase method of accounting has been adopted. Those subsidiary undertakings acquired or disposed of in the period are included in the consolidated income statement from the date control is obtained to the date that control is lost (usually on acquisition and disposal respectively). A subsidiary is an entity over which the Group has the power to govern financial and operating policies in order to obtain benefits. Potential voting rights that are currently exercisable or convertible are considered when determining control. An associate is an undertaking over which the Group exercises significant influence, usually from 20%-50% of the equity voting rights, in respect of financial and operating policy. A joint venture is an undertaking over which the Group exercises joint control. Associates and joint ventures are accounted for using the equity method from the date of acquisition to the date of disposal. The Group’s investments in associates and joint ventures are held at cost including goodwill on acquisition and any post-acquisition changes in the Group’s share of the net assets of the associate less any impairment to the recoverable amount. Where an associate or joint venture has net liabilities, full provision is made for the Group’s share of liabilities where there is a constructive or legal obligation to provide additional funding to the associate or joint venture. The financial statements of subsidiaries, joint ventures and associates are adjusted where necessary to ensure compliance with Group accounting policies. On consolidation, all intra-Group income, expenses and balances are eliminated. Revenue Revenue represents the value of work performed for customers, and is measured net of value added taxes and other sales taxes on the following bases: Service contracts The Group’s service contract arrangements are accounted for under IAS 18 ‘Revenue’. Revenue is recognised once the Group has obtained the right to consideration in exchange for its performance. No profit is recognised on contracts until the outcome of the contract can be reliably estimated. When the outcome of a contract can be reliably estimated, revenue and costs are recognised by reference to the stage of completion of the contract activity at the balance sheet date. This is normally measured by the proportion of contract costs incurred for work performed to date compared with the estimated total contract costs after making suitable allowances for technical and other risks related to performance milestones yet to be achieved. When it is probable that total contract costs will exceed total contract revenue, the expected loss is recognised immediately as an expense. The Group generally does not undertake construction contracts. Goods sold Sales of goods are recognised in the income statement on delivery of the product or when the significant risks and rewards of ownership have been transferred to the customer and revenue and costs can be reliably measured. Royalties and intellectual property Royalty revenue is recognised over the period to which the royalty relates. Intellectual property revenue can be attributed either to perpetual licences or to limited licences. Limited licences are granted for a specified period and revenue is recognised over the period of the licence. Perpetual licences are granted for unlimited time frames and revenue is recognised when the risks and rewards of ownership are transferred to the customer. QinetiQ Group plc Annual Report and Accounts 2013 71 Financial statements Notes to the financial statements continued 1. Significant accounting policies continued Segmental information Segmental information is presented according to the Group’s management structure and the markets in which it operates. Segmental results represent the contribution of the different segments to the profit of the Group. Corporate expenses are allocated to the corresponding segments. Unallocated items mainly comprise specific adjusting items. Specific adjusting items are referred to in note 4. Eliminations represent inter-company trading between the different segments. Segmental assets and liabilities information is not regularly provided to the chief operating decision maker. Research and development expenditure Research and development costs incurred on behalf of a customer as part of a specific project are directly chargeable to the customer on whose behalf the work is undertaken. These costs are recognised within operating costs and revenue is recognised in respect of the R&D services performed. Internally funded development expenditure is capitalised in the balance sheet where there is a clearly defined project, the expenditures are separately identifiable, the project is technically and commercially feasible, all costs are recoverable by future revenue and the resources are committed to complete the project. Such capitalised costs are amortised over the forecast period of sales resulting from the development. All other research and development costs are expensed to the income statement in the period in which they are incurred. If the research phase cannot be clearly distinguished from the development phase, the respective project-related costs are treated as if they were incurred in the research phase only and expensed. Financing Financing represents the financial expense on borrowings accounted for using the effective rate method and the financial income earned on funds invested. Exchange differences on financial assets and liabilities and the income or expense from interest hedging instruments that are recognised in the income statement are included within finance income and finance expense. Financing also includes the net finance expense in respect of defined benefit pension schemes. Taxation The taxation charge is based on the taxable profit for the year and takes into account taxation deferred because of temporary differences between the treatment of certain items for taxation and accounting purposes. Current tax and deferred tax are charged or credited to the income statement, except where they relate to items charged or credited to equity, in which case the relevant tax is charged or credited to equity. Deferred taxation is the tax attributable to the temporary differences that appear when taxation authorities recognise and measure assets and liabilities with rules that differ from those of the consolidated financial statements. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using rates enacted or substantively enacted at the balance sheet date. Any changes in the tax rates are recognised in the income statement unless related to items directly recognised in equity. Deferred tax liabilities are recognised on all taxable temporary differences excluding non-deductible goodwill. Deferred tax assets are recognised on all deductible temporary differences provided that it is probable that future taxable income will be available against which the asset can be utilised. Deferred tax assets and liabilities are offset only where there is a legally enforceable right to offset and there is an intention to settle balances on a net basis. Business combinations Business combinations are accounted for using the acquisition method as at the acquisition date, which is the date on which control is transferred to the Group. The Group measures goodwill as the acquisition-date fair value of the consideration transferred, including the amount of any non-controlling interest in the acquiree, less the net of the acquisition-date fair values of the identifiable assets acquired and liabilities assumed, including contingent liabilities as required by IFRS 3. Consideration transferred includes the fair values of assets transferred, liabilities incurred by the Group to the previous owners of the acquiree, equity interests issued by the Group to the previous owners of the acquiree, equity interests issued by the Group, contingent consideration and share-based payment awards of the acquiree that are replaced in the business combination. Any contingent consideration payable is recognised at fair value at the acquisition date. Subsequent changes to the fair value of contingent consideration that is not classified as equity are recognised in the consolidated income statement. If a business combination relates to the termination of pre-existing relationships between the Group and the acquiree, then the lower of the termination amount, as contained in the agreement, and the value of the off-market element is deducted from the consideration transferred and recognised in other expenses. Transaction costs that the Group incurs in connection with a business combination, such as finder’s fees, legal fees, due diligence fees, and other professional fees and consulting fees, are expensed as incurred. Non-controlling interests are measured either at the non-controlling interest’s proportion of the net fair value of the identifiable assets, liabilities and contingent liabilities recognised or at fair value. The method used is determined on an acquisition-by-acquisition basis. Goodwill Goodwill on acquisitions of subsidiaries is included in intangible assets. Goodwill on acquisitions of joint ventures and associates is included in the carrying value of equity accounted investments. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity include the carrying amount of goodwill related to the entity sold. 72 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Intangible assets Intangible assets arising from business combinations are recognised at fair value and are amortised over their expected useful lives, typically between one and nine years. Internally generated intangible assets are recorded at cost, including labour, directly attributable costs and any third-party expenses. Purchased intangible assets are recognised at cost less amortisation. Intangible assets are amortised over their respective useful lives on a straight-line basis as follows: Intellectual property rights Development costs Other 2-8 years 1-4 years 1-9 years Property, plant and equipment Property, plant and equipment are stated at cost less depreciation. Freehold land is not depreciated. Other tangible non-current assets are depreciated on a straight-line basis over their useful economic lives to their estimated residual value as follows: Freehold buildings Leasehold land and buildings Plant and machinery Fixtures and fittings Computers Motor vehicles 20-25 years Shorter of useful economic life and the period of the lease 3-10 years 5-10 years 3-5 years 3-5 years Assets under construction are included in property, plant and equipment on the basis of expenditure incurred at the balance sheet date. In the case of assets constructed by the Group, the value includes the cost of own work completed, including directly attributable costs and interest. The useful lives, depreciation methods and residual values applied to property, plant and equipment are reviewed annually and, if appropriate, adjusted accordingly. Impairment of tangible, goodwill, intangible and held for sale assets At each reporting date the Group assesses whether there is an indication that an asset may be impaired. If the carrying amount of any asset exceeds its recoverable amount an impairment loss is recognised immediately in the income statement. In addition, goodwill is tested for impairment annually irrespective of any indication of impairment. If the carrying amount exceeds the recoverable amount, the respective asset or the assets in the cash generating unit (CGU) are written down to their recoverable amounts. The recoverable amount of an asset or CGU is the higher of its fair value less costs to sell and its value in use. The value in use is the present value of the future cash flows expected to be derived from an asset or CGU calculated using an appropriate pre-tax discount rate. Impairment losses are expensed to the income statement. Investments in debt and equity securities Investments held by the Group are classified as either a current asset or as a non-current asset and those classified as available for sale are stated at fair value, with any resultant gain or loss, other than impairment losses, being recognised directly in equity. When these investments are derecognised, the cumulative gain or loss previously recognised directly in equity is recognised in the income statement. The fair value of quoted financial instruments is their bid price at the balance sheet date. The fair value of unquoted equity investments is based on the price of the most recent investment by the Group or a third party, if available, or derived from the present value of forecast future cash flows. Inventories Inventory and work-in-progress are stated at the lower of cost and net realisable value. Work-in-progress and manufactured finished goods are valued at production cost. Production cost includes direct production costs and an appropriate proportion of production overheads. A provision is established when the net realisable value of any inventory item is lower than its cost. Bid costs Costs incurred in bidding for work are normally expensed as incurred. In the case of large multi-year government contracts the bidding process typically involves a competitive bid process to determine a preferred bidder and then a further period to reach financial close with the customer. In these cases, the costs incurred after announcement of the Group achieving preferred bidder status are deferred to the balance sheet within work-in-progress. From the point financial close is reached, the costs are amortised over the life of the contract. If an opportunity for which the Group was awarded preferred bidder status fails to reach financial close, the costs deferred to that point will be expensed in the income statement immediately, when it becomes likely that financial close will not be achieved. Trade and other receivables Trade and other receivables are stated net of provisions for doubtful debts. Amounts recoverable on contracts are included in trade and other receivables and represent revenue recognised in excess of amounts invoiced. Payments received on account are included in trade and other payables and represent amounts invoiced in excess of revenue recognised. QinetiQ Group plc Annual Report and Accounts 2013 73 Financial statements Notes to the financial statements continued 1. Significant accounting policies continued Cash and cash equivalents Cash and cash equivalents comprise cash at bank and short-term deposits that are readily convertible into cash. In the cash flow statement overdraft balances are included in cash and equivalents. Current and non-current liabilities Current liabilities include amounts due within the normal operating cycle of the Group. Interest-bearing current and non-current liabilities are initially recognised at fair value and then stated at amortised cost with any difference between the cost and redemption value being recognised in the income statement over the period of the borrowings on an effective interest rate basis. Costs associated with the arrangement of bank facilities or the issue of loans are held net of the associated liability presented in the balance sheet. Capitalised issue costs are released over the estimated life of the facility or instrument to which they relate using the effective interest rate method. If it becomes clear that the facility or instrument will be redeemed early, the amortisation of the issue costs will be accelerated. Provisions A provision is recognised in the balance sheet when the Group has a present legal or constructive obligation as a result of a past event which can be reliably estimated, and it is probable that an outflow of economic benefits will be required to settle the obligation. Where appropriate, provisions are determined by discounting the expected cash flows at an appropriate discount rate reflecting the level of risk and the time value of money. Financial instruments Financial assets and financial liabilities are recognised on the Group’s balance sheet when the Group becomes a party to the contractual provisions of the instrument. The de-recognition of a financial instrument takes place when the Group no longer controls the contractual rights that comprise the financial instrument, when the instrument expires, or when the instrument is sold, terminated or exercised. Derivative financial instruments Derivative financial instruments are initially recognised and thereafter held at fair value, being the market value for quoted instruments or valuation based on models and discounted cash flow calculations for unlisted instruments. Fair value hedging Changes in the fair value of derivatives designated as fair value hedges of currency risk or interest rate risk are recognised in the income statement. The hedged item is held at fair value with respect to the hedged risk with any gain or loss recognised in the income statement. Cash flow hedging Changes in the fair value of derivatives designated as a cash flow hedge that are regarded as highly effective are recognised in equity. The ineffective portion is recognised immediately in the income statement. Where a hedged item results in an asset or a liability, gains and losses previously recognised in equity are included in the cost of the asset or liability. Gains and losses previously recognised in equity are removed and recognised in the income statement at the same time as the hedged transaction. Leased assets Leases are classified as finance leases when substantially all the risks and rewards of ownership are held by the lessee. Assets held under finance leases are capitalised and included in property, plant and equipment at the lower of the present value of minimum lease payments and fair value at the inception of the lease. Assets are then depreciated over the shorter of their useful economic lives or the lease term. Obligations relating to finance leases, net of finance charges arising in future periods, are included under financial liabilities. Rentals payable under operating leases are charged to the income statement on a straight-line basis over the term of the lease. Foreign currencies Transactions in foreign currencies are recorded using the rate of exchange ruling at the date of the transaction. Monetary assets and liabilities in foreign currencies are translated at period-end rates. Any resulting exchange differences are taken to the income statement. Gains and losses on designated forward foreign exchange hedging contracts are matched against the foreign exchange movements on the underlying transaction. The individual financial statements of each Group company are presented in its functional currency. On consolidation, assets and liabilities of overseas subsidiaries, associated undertakings and joint ventures, including any related goodwill, are translated to sterling at the rate of exchange at the balance sheet date. The results and cash flows of overseas subsidiaries, associated undertakings and joint ventures are translated to sterling using the average rates of exchange during the period. Exchange adjustments arising from the re-translation of the opening net investment and the results for the period to the period-end rate are taken directly to equity and reported in the Statement of Comprehensive Income. Post-retirement benefits The Group provides both defined contribution and defined benefit pension arrangements. The liabilities of the Group arising from defined benefit obligations, and the related current service cost, are determined using the projected unit credit method. Valuations for accounting purposes are carried out bi-annually. Actuarial advice is provided by external consultants. For the funded defined benefit plans, the excess or deficit of the fair value of plan assets less the present value of the defined benefit obligation are recognised as an asset or a liability respectively. For defined benefit plans, the cost charged to the income statement consists of current service cost, net interest cost, and past service cost. The finance element of the pension charge is shown in finance expense and the remaining service cost element is charged as a component of employee costs in the income statement. Actuarial gains and losses and re-measurement gains and losses are recognised immediately in full through the statement of comprehensive income. Contributions to defined contribution plans are charged to the income statement as incurred. 74 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Share-based payments The Group operates share-based payment arrangements with employees. The fair value of equity-settled awards for share-based payments is determined on grant and expensed straight line over the period from grant to the date of earliest unconditional exercise. The fair value of cash-settled awards for share-based payments is determined each period end until they are exercised or lapse. The value is expensed straight line over the period from grant to the date of earliest unconditional exercise. The charges for both equity and cash-settled share-based payments are updated annually for non-market-based vesting conditions. Share capital Ordinary share capital of the Company is recorded as the proceeds received, less issue costs. Company shares held by the employee benefit trusts are held at the consideration paid. They are classified as own shares within equity. Any gain or loss on the purchase, sale or issue of Company shares is recorded in equity. Restatement of prior periods for finalisation of fair values arising on acquisitions The fair values of the net assets of acquired businesses are finalised within 12 months of the acquisition date. All fair value adjustments are recorded with effect from the date of acquisition and, consequently, may result in the restatement of previously reported financial results. Recent accounting developments Significant developments adopted by the Group in 2013 IAS 19 (revised) ‘Employee benefits’. The amendments became effective for accounting periods beginning on or after 1 January 2013. QinetiQ has elected to early-adopt the revised standard during 2013. The main impact on QinetiQ is the change in measurement of the expected return on scheme assets in the income statement; now measured with reference to the discount rate previously applied solely to scheme liabilities. Under the previous requirements, expected return on assets was measured at an appropriately calculated rate which was normally higher than the discount rate. As a result, there is likely to be an increase in the net pension finance expense in the profit and loss account, offset by changes in the actuarial gains/losses recognised in other comprehensive income. Other amendments include changes to the recognition and treatment of curtailment gains, presentation of scheme administration expenses and the removal of the corridor method. The latter had not previously been applied by the Group. Developments adopted by the Group in 2013 with no material impact on the financial statements The following EU-endorsed amendments, improvements and interpretations of published standards are effective for accounting periods beginning on or after 1 April 2012 and have been adopted with no material impact on the Group’s financial statements: IFRS 7 ‘Financial Instruments – Disclosures’. The amendment introduces new requirements about transfers of financial assets including disclosure for financial assets that are not derecognised in their entirety; and financial assets that are derecognised in their entirety but for which the entity retains continuing involvement. IAS 12 ‘Income Taxes’. The amendment introduces an exception to the current measurement principles of deferred tax assets and liabilities arising from investment property measured using the fair value model in accordance with IAS 40 ‘Investment Property’. IFRS 1 ‘First Time Adoption of IFRS’. This change adds an exemption that an entity can apply at the date of transition to IFRSs after being subject to severe hyperinflation. Developments expected in future periods of which the impact is being assessed FRS 100, 101 and 102. FRS 100 sets out the application of financial reporting requirements in the UK and Republic of Ireland and FRS 101 or ‘IFRS with reduced disclosures’ outlines the reduced disclosure framework available for use by qualifying entities choosing to report under IFRS. FRS 102 is applicable in the UK and Republic of Ireland and is known as the ‘new UK GAAP’. The mandatory effective date for the new framework of reporting is for accounting periods beginning on or after 1 January 2015. A qualifying entity is defined as a parent or subsidiary undertaking which is consolidated in publicly available consolidated financial statements. QinetiQ’s subsidiaries meet the criteria; they currently report under UK GAAP and it is likely that the new FRS 102 will be the preferred option – a full analysis is currently being undertaken. Revenue from Contracts with Customers. The Group awaits the final publication of the new IFRS standard ‘Revenue from Contracts with Customers’ which is expected to be published by June 2013. The new Standard will replace IAS 18 ‘Revenue’ and IAS 11 ‘Construction Contracts’. It will become effective for accounting periods on or after 1 January 2017 and will therefore be applied for the first time to the Group accounts in 2018; the IASB have indicated that early adoption will not be permitted. The Group has begun a systematic review of all existing major contracts to ensure that the impact and effect of the new Standard is fully understood and any changes to current accounting procedures are highlighted and acted upon well in advance of the effective date. Leases. Following the issue of the first exposure draft in 2011, the IASB and FASB are reconsidering the proposed accounting standard for lease accounting. A revised exposure draft is expected by June 2013. The first exposure draft removes the distinction between finance leases and operating leases and requires all leased assets to be accounted for in a similar way to finance leases. A right-of-use asset and matching liability will be recognised on the balance sheet, with lease expenditure and depreciation reported in the income statement. QinetiQ Group plc Annual Report and Accounts 2013 75 Financial statements Notes to the financial statements continued 1. Significant accounting policies continued Developments expected in future periods with no material impact on the Group’s financial statements The Directors anticipate that the adoption of the following new, revised, amended and improved published standards and interpretations, which were in issue at the date of authorisation of these Financial Statements, will have no material impact on the Financial Statements of the Group when they become applicable in future periods: • IFRS 7 ‘Financial Instruments: Disclosures’; • IFRS 1 ‘First-time Adoption of IFRS’; • IAS 1 ‘Presentation of Financial Statements’; • Annual Improvements IFRS 2009-2011 cycle; • • • • • • • IFRS 9 ‘Financial Instruments’; IFRS 10 ‘Consolidated Financial Statements’; IFRS 11 ‘Joint Arrangements’; IFRS 12 ‘Disclosure of Interests in Other Entities’; IFRS 13 ‘Fair Value Measurement’; IAS 27 ‘Separate Financial Statements’; and IAS 28 ‘Investments in Associates’. Critical accounting estimates and judgements in applying accounting policies The following commentary is intended to highlight those policies that are critical to the business based on the level of management judgement required in their application, their complexity and their potential impact on the results and financial position reported for the Group. The level of management judgement required includes assumptions and estimates about future events that are uncertain and the actual outcome of which may result in a materially different outcome from that anticipated. Revenue and profit recognition The estimation process required to evaluate the potential outcome of contracts and projects requires skill, knowledge and experience from a variety of sources within the business to assess the status of the contract, costs to complete, internal and external labour resources required and other factors. This process is carried out continuously throughout the business to ensure that project and contract assessments reflect the latest status of such work. No profit is recognised on a contract until the outcome can be reliably estimated. Business combinations Intangible assets recognised on business combinations have been valued using established methods and models to determine estimated value and useful economic life, with input, where appropriate, from external valuation consultants. Such methods require the use of estimates which may produce results that are different from actual future outcomes. The Group tests annually whether goodwill has suffered any impairment. This process relies on the use of estimates of the future profitability and cash flows of its CGUs which may differ from the actual results delivered. In addition, the Group reviews whether identified intangible assets have suffered any impairment. Further details on the sensitivity of the carrying value of goodwill to changes in the key assumptions are set out in note 12. Consolidation of US subsidiaries As described on page 49, the Group and the US Department of Defense (DoD) have entered into a proxy agreement that regulates the ownership, management and operation of the Group’s 100% owned subsidiary, QinetiQ North America, Inc. and its subsidiaries. Having considered the terms of the proxy agreement, the Directors consider that the Group has control over the operating and financial policies of QinetiQ North America and, therefore, consolidates the subsidiaries in the consolidated accounts. Post-retirement benefits The Group’s defined benefit pension obligations and net income statement costs are based on key assumptions, including discount rates, mortality, inflation and future salary and pension increases. Management exercises its best judgement, in consultation with actuarial advisors, in selecting the values for these assumptions that are the most appropriate to the Group. Small changes in these assumptions at the balance sheet date, individually or collectively, may result in significant changes in the size of the deficit or the net income statement costs. Any change in these assumptions would have an impact on the retirement benefit obligation recognised. Further details of these assumptions are set out in note 29. Research and development expenditure Internally-funded development expenditure is capitalised when criteria are met and is written off over the forecast period of sales resulting from the development. Management decides on the adequacy of future demand and the potential market for such new products in order to justify capitalisation of internally-funded development expenditure. These can be difficult to determine when dealing with innovative technologies. Actual product sales may differ from these estimates. Tax In determining the Group’s provisions for income tax and deferred tax, it is necessary to assess the likelihood and timing of recovery of tax losses created, and to consider transactions in a small number of key tax jurisdictions for which the ultimate tax determination is uncertain. To the extent that the final outcome differs from the tax that has been provided, adjustments will be made to income tax and deferred tax provisions held in the period the determination is made. 76 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 2. Revenue and other income Revenue and other income is analysed as follows: Revenue by category For the year ended 31 March all figures in £ million Sales of goods Services Royalties and licences Revenue Share of joint ventures’ and associates’ profit after tax Other income Total other income 2013 201.7 1,118.7 7.4 1,327.8 0.1 5.7 5.8 2012 253.2 1,209.4 7.0 1,469.6 0.1 5.1 5.2 Revenue and profit after tax of joint ventures and associates was £17.0m and £0.3m respectively (2012: £26.1m and £0.2m respectively). The figures in the table above represent the Group share of this profit after tax. Other income is in respect of property rentals and the recovery of other related property costs. Revenue by customer geographic location For the year ended 31 March all figures in £ million North America United Kingdom Other Total Revenue by major customer type For the year ended 31 March all figures in £ million UK Government US Government Other Total 2013 672.7 560.4 94.7 1,327.8 2013 480.3 620.8 226.7 1,327.8 2012 788.7 570.1 110.8 1,469.6 2012 482.8 730.5 256.3 1,469.6 Revenue from the UK Government was generated by the UK Services and Global Products operating segments. Revenue from the US Government was generated by the US Services and Global Products operating segments. QinetiQ Group plc Annual Report and Accounts 2013 77 Financial statements Notes to the financial statements continued 3. Segmental analysis Operating segments For the year ended 31 March all figures in £ million UK Services US Services Global Products Total operating segments Operating profit before specific adjusting items1 Specific adjusting items before amortisation, depreciation and impairment Impairment of property Impairment of goodwill Amortisation of intangible assets arising from acquisitions Operating (loss)/profit Gain on business divestments and disposal and impairment of investments Net finance expense (Loss)/profit before tax Taxation income/(expense) (Loss)/profit for the year 4 12 5 6 7 Note 2013 2012 (restated^) Revenue 597.3 475.6 254.9 1,327.8 Operating profit 85.8 21.9 61.0 168.7 168.7 (16.3) (4.0) (255.8) (14.0) (121.4) 2.3 (17.9) (137.0) 3.8 (133.2) Revenue 610.1 534.5 325.0 1,469.6 Operating profit 61.3 32.1 66.2 159.6 159.6 223.9 (1.9) – (20.3) 361.3 11.6 (56.6) 316.3 (70.0) 246.3 1 The measure of profit presented to the chief operating decision maker is operating profit stated before specific adjusting items. ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. For details refer to note 1 to the financial statements. No measure of segmental assets and liabilities has been disclosed as this information is not regularly provided to the chief operating decision maker. Depreciation and amortisation by business segment For the year ended 31 March 2013 all figures in £ million Depreciation of property, plant and equipment Amortisation of purchased or internally developed intangible assets For the year ended 31 March 2012 all figures in £ million Depreciation of property, plant and equipment and impairment of plant and equipment Amortisation and impairment of purchased or internally developed intangible assets UK Services 21.6 US Services 2.6 3.6 25.2 0.2 2.8 UK Services US Services 23.2 8.4 31.6 3.0 0.3 3.3 Global Products 3.8 0.2 4.0 Global Products 4.4 0.3 4.7 Total 28.0 4.0 32.0 Total 30.6 9.0 39.6 Excludes specific adjusting items not included within the measure of operating profit reported to the chief operating decision maker. Non-current assets (excluding deferred tax) by geographic location all figures in £ million Year ended 31 March 2013 Year ended 31 March 2012 UK 262.6 Rest of World 331.7 UK 281.1 Rest of World 569.3 Total 594.3 Total 850.4 78 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 4. Profit/loss before tax The following items have been charged in arriving at profit/loss before tax: all figures in £ million Fees payable to the auditor: Audit of the Group’s annual accounts Audit of the accounts of subsidiaries of the Company and its associated pension scheme Audit-related assurance services All other non-audit services Total auditor’s remuneration 2013 2012 (restated^) 0.6 0.2 0.1 – 0.9 0.6 0.2 0.1 0.1 1.0 The Group has adopted the statutory changes in relation to the disclosure of the Group auditor’s remuneration in line with the UK Companies’ Regulations 2011 (Statutory Instrument 2011/2198) for the year ended 31 March 2013. 2012 fees have been reclassified accordingly. all figures in £ million Depreciation of property, plant and equipment: Owned assets: before impairment Owned assets: impairment Foreign exchange gain Research and development expenditure – customer funded contracts Research and development expenditure – Group funded The following specific adjusting items have been (charged)/credited in arriving at profit/loss before tax: all figures in £ million Net restructuring (charges)/recoveries Pension past service gain Gain on disposal of property Net gain in respect of previously capitalised DTR programme bid costs Specific adjusting items before amortisation, depreciation and impairment Impairment of goodwill Impairment of property Intangible impairment and acquisition amortisation Specific adjusting items operating (loss)/profit Gain on business divestments and disposal of investments Unrealised impairment of investments Gain on business divestments and disposal/impairment of investments Defined benefit pension scheme net finance expense Total specific adjusting items (loss)/profit before tax Note 12 14 13 5 5 5 2013 2012 (28.0) (4.0) 1.0 (311.0) (24.6) 2013 (16.3) – – – (16.3) (255.8) (4.0) (14.0) (290.1) 2.9 (0.6) 2.3 (1.3) (289.1) (28.2) (4.3) 0.2 (331.1) (15.2) 2012 (restated^) 69.4 141.4 9.0 4.1 223.9 – (1.9) (20.3) 201.7 11.6 – 11.6 (7.2) 206.1 The net restructuring recovery of £69.4m in 2012 primarily relates to the agreement with the UK MOD in March 2012 involving a payment to QinetiQ of £65.0m that was received in April 2012. The agreement involves the discharging of MOD from its accumulated liabilities for restructuring costs incurred in previous years, together with MOD agreement to changes in its Special Shareholder rights, and certain other operational issues. ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. For details refer to note 1 to the financial statements. QinetiQ Group plc Annual Report and Accounts 2013 79 Financial statements Notes to the financial statements continued 5. Gain on business divestments and disposal and impairment of investments For the year ended 31 March all figures in £ million Gain on business divestments Gain on disposal of investments Unrealised impairment of investments 2013 – 2.9 (0.6) 2.3 2012 8.0 3.6 – 11.6 The gain on business divestments relates to the disposal of QinetiQ’s investment in Infoscitex Inc. The prior year gain on business divestments includes the disposal of Spectro Inc., a business within the Global Products division, for consideration before costs of US$20.5m and a gain on disposal of £4.7m. Of the £3.6m prior year gain on disposal of investments, £2.8m relates to the sale of QinetiQ’s investment in Nomad Holdings Limited. 6. Finance income and expense For the year ended 31 March all figures in £ million Receivable on bank deposits Finance lease income Finance income Amortisation of recapitalisation fee Payable on bank loans and overdrafts Payable on US dollar private placement debt1 Finance lease expense Unwinding of discount on financial liabilities Finance expense before specific adjusting items Defined benefit pension scheme net finance expense Finance expense Net finance expense 2013 1.0 0.7 1.7 (0.6) (1.4) (14.2) (0.6) (1.5) (18.3) (1.3) (19.6) (17.9) 2012 (restated^) 1.3 0.9 2.2 (0.6) (1.6) (46.8) (0.8) (1.8) (51.6) (7.2) (58.8) (56.6) 1 During 2012, the Group elected to make early repayment of US$177m of private placement debt from surplus cash. Net finance expense in 2012 was affected by an accelerated interest charge of £27.4m in respect of these early repayments. ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. For details refer to note 1 to the financial statements. 80 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 7. Taxation all figures in £ million Analysis of charge Current UK tax expense/(income) Overseas corporation tax Current year Adjustment for prior year Current tax expense Deferred tax expense/(income) Deferred tax impact of change in rates Deferred tax in respect of prior years Taxation expense/(income) Factors affecting tax charge in year Principal factors reducing the Group’s current year tax charge below the UK statutory rate are explained below: Profit/(loss) before tax Tax on profit/(loss) before tax at 24% (2012: 26%) Effect of: Expenses not deductible for tax purposes, research and development relief and non- taxable items Current tax losses for which no deferred tax asset was recognised Deferred tax impact of change in rates Deferred tax in respect of prior years Effect of different rates in overseas jurisdictions Taxation expense/(income) Effective tax rate Before specific adjusting items* 2013 Specific adjusting items* 0.8 (0.2) – 0.6 28.0 0.6 – 29.2 (0.2) 1.5 0.4 1.7 (34.4) (0.9) 0.6 (33.0) Before specific adjusting items* 2012 (restated^) Specific adjusting items* – 15.5 (2.3) 13.2 5.3 1.4 1.6 21.5 13.1 2.3 – 15.4 33.1 – – 48.5 Total 0.6 1.3 0.4 2.3 (6.4) (0.3) 0.6 (3.8) Total 13.1 17.8 (2.3) 28.6 38.4 1.4 1.6 70.0 152.1 (289.1) (137.0) 110.2 206.1 316.3 36.5 (69.4) (32.9) 28.6 53.6 82.2 (12.4) (2.2) 0.7 0.1 6.5 29.2 19.2% 49.0 – (0.1) – (12.5) (33.0) 36.6 (2.2) 0.6 0.1 (6.0) (3.8) 2.8% (11.8) (2.5) (14.3) (4.3) 1.4 0.9 6.7 21.5 19.5% – – – (2.6) 48.5 (4.3) 1.4 0.9 4.1 70.0 22.1% Factors affecting future tax charges The effective tax rate continues to be below the statutory rate in the UK, primarily as a result of the benefit of research and development relief in the UK. The effective tax rate is expected to remain below the UK statutory rate in the medium term, subject to any tax legislation changes and the geographic mix of profits. The 2013 Finance Bill allows the continued recognition of R&D tax credits in the tax line until April 2016, when mandatory ‘Above The Line’ treatment is introduced, which could increase the Group’s effective tax rate over time to a blend of the US and UK corporation tax rates. The 2013 Budget delivered on 20 March 2013 announced that the UK corporation tax rate will reduce to 21% on 1 April 2014 and to 20% on 1 April 2015. A reduction in the rate from 24% to 23% (effective from 1 April 2013) was substantively enacted on 3 July 2012. These changes will reduce the Group’s future tax charge accordingly. The deferred tax asset at 31 March 2013 has been calculated based on the rate of 23% substantively enacted at the balance sheet date. It has not yet been possible to quantify the full anticipated effect of the announced rate reductions in 2014 and 2015, although these will further reduce the Group’s future tax charge and reduce the Group’s deferred tax asset accordingly. At 31 March 2013, the Group had unused tax losses of £202.7m (2012: £200.0m) potentially available for offset against future profits. *Definitions of underlying measures of performance and specific adjusting items can be found in the glossary on page 116. ^IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. For details refer to note 1 to the financial statements. QinetiQ Group plc Annual Report and Accounts 2013 81 Financial statements Notes to the financial statements continued 8. Dividends An analysis of the dividends paid and proposed in respect of the years ended 31 March 2013 and 2012 is provided below: Interim 2013 Final 2013 (proposed) Total for the year ended 31 March 2013 Interim 2012 Final 2012 Total for the year ended 31 March 2012 Pence per share 1.10 2.70 3.80 0.90 2.00 2.90 Date paid/ payable Feb 2013 Sept 2013 Feb 2012 Sept 2012 £m 7.1 17.6 24.7 5.8 13.0 18.8 The Directors propose a final dividend of 2.70p (2012: 2.00p) per share. The dividend, which is subject to shareholder approval, will be paid on 6 September 2013. The ex-dividend date is 7 August 2013 and the record date is 9 August 2013. 9. Analysis of employee costs and numbers The largest component of operating expenses is employee costs. The year-end and average monthly number of persons employed by the Group, including Directors, analysed by business segment, were: UK Services US Services Global Products Total The aggregate payroll costs of these persons were as follows: all figures in £ million Wages and salaries Social security costs Pension costs Share-based payments costs Employee costs before US restructuring costs US restructuring costs Total employee costs As at 31 March 2013 Number 5,145 3,350 1,003 9,498 2012 Number 5,157 3,940 1,083 10,180 Note 28 Monthly average 2013 Number 5,141 3,607 1,024 9,772 2013 496.0 38.8 41.0 5.5 581.3 7.3 588.6 2012 Number 5,170 4,349 1,118 10,637 2012 561.9 41.5 42.2 4.2 649.8 – 649.8 10. Directors and other senior management personnel The Directors and other senior management personnel of the Group during the year to 31 March 2013 comprise the Board of Directors and the QinetiQ Executive Team. The remuneration and benefits provided to Directors and the QinetiQ Executive Team are summarised below: all figures in £ million Short-term employee remuneration including benefits Post-employment benefits Share-based payments costs Termination benefits Total 2013 6.7 0.2 2.3 0.9 10.1 2012 6.8 0.2 1.9 – 8.9 Short-term employee remuneration and benefits include salary, bonus, and benefits. Post-employment benefits relate to pension amounts. 82 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l 11. Earnings per share Basic earnings per share is calculated by dividing the profit attributable to equity shareholders by the weighted average number of ordinary shares in issue during the year. The weighted average number of shares used excludes those shares bought by the Group and held as own shares (see note 27). For diluted earnings per share the weighted average number of shares in issue is adjusted to assume conversion of all potentially dilutive ordinary shares arising from unvested share-based awards including share options. Underlying basic earnings per share figures are presented below, in addition to the basic and diluted earnings per share, because the Directors consider this gives a more relevant indication of underlying business performance and reflects the adjustments to basic earnings per share for the impact of specific adjusting items, amortisation of acquired intangible assets and tax thereon. For the year ended 31 March Basic EPS (Loss)/profit attributable to equity shareholders Weighted average number of shares Basic EPS 2013 2012 (restated^) £ million Million Pence (133.2) 648.7 (20.5) 246.3 650.5 37.9 Diluted EPS (Loss)/profit attributable to equity shareholders Weighted average number of shares Effect of dilutive securities1 Diluted number of shares Diluted EPS 1 The loss attributable to equity shareholders in the year ended March 2013 results in the effect of dilutive securities on the weighted average number £ million Million Million Million Pence (133.2) 648.7 – 648.7 (20.5) 246.3 650.5 4.0 654.5 37.6 of shares being nil in 2013. Underlying basic EPS (Loss)/profit attributable to equity shareholders Loss/(profit) after tax in respect of acquisition amortisation and specific adjusting items Underlying profit after taxation Weighted average number of shares Underlying basic EPS Underlying diluted EPS (Loss)/profit attributable to equity shareholders Loss/(profit) after tax in respect of specific adjusting items Underlying profit after taxation Weighted average number of shares Effect of dilutive securities Diluted number of shares Underlying diluted EPS £ million (133.2) 246.3 £ million £ million Million Pence £ million £ million £ million Million Million Million Pence 256.1 122.9 648.7 18.9 (133.2) 256.1 122.9 648.7 7.1 655.8 18.7 i n f o r m a (cid:2) o n (157.6) 88.7 650.5 13.6 246.3 (157.6) 88.7 650.5 4.0 654.5 13.5 ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. For details refer to note 1 to the financial statements. 12. Goodwill all figures in £ million Cost At 1 April Disposals Foreign exchange At 31 March Impairment At 1 April Disposals Impairment Foreign exchange At 31 March Net book value at 31 March 2013 2012 564.2 – 28.8 593.0 (44.9) – (255.8) (1.9) (302.6) 566.2 (3.0) 1.0 564.2 (45.1) 0.3 – (0.1) (44.9) 290.4 519.3 QinetiQ Group plc Annual Report and Accounts 2013 83 Financial statements Notes to the financial statements continued 12. Goodwill continued Goodwill at 31 March 2013 was allocated across various CGUs in the following segments: UK Services (two), Global Products (two) and US Services (one). Goodwill is attributable to the excess of consideration over the fair value of net assets acquired and includes expected synergies, future growth prospects and employee knowledge, expertise and security clearances. The Group tests goodwill impairment for each CGU annually, or more frequently if there are indications that goodwill might be impaired. Impairment testing is dependent on management’s estimates and judgements, particularly as they relate to the forecasting of future cash flows, the discount rates selected and expected long-term growth rates. Significant headroom exists in all CGU’s with the exception of US Services, discussed below, and management considers that there are no likely variations in the key assumptions which would lead to an impairment being recognised in any of the other CGU’s. Key assumptions Cash flows The value-in-use calculations use discounted future cash flows based on financial plans approved by the Board covering a two-year period. Cash flows for periods beyond this period are extrapolated based on the second year of the two-year plan, with a terminal growth-rate assumption applied. Cash flows of the US Services division in 2013 were affected adversely by the continued budget uncertainty and reduced Federal spending which resulted in 12% organic reduction in revenue compared to the prior year. Customers continue to defer decisions leading to delay of new and incremental orders, the de-scoping of some existing work and the cancellation of some contract re-competes with shorter-term extensions being awarded in their place. The cash flow assumptions for the US Services CGU reflect the challenges described above. Terminal growth rates The specific plans for each of the CGUs have been extrapolated using a terminal growth rate of 2.0%-3.0% (2012: 2.0%-3.0%). Growth rates are based on management’s estimates which take into consideration the long-term nature of the industry in which the CGUs operate and external forecasts as to the likely growth of the industry in the longer term. Discount rates The Group’s weighted average cost of capital was used as a basis in determining the discount rate to be applied adjusted for risks specific to the market characteristics of CGUs as appropriate on a pre-tax basis. This is considered to appropriately estimate a market participant discount rate. The pre-tax discount rates applied for the two UK Services CGUs were 10.6% and 10.7%, for the US Services CGU 9.7%, and for the Global Products CGUs 9.7% and 10.4%. Sensitivity analysis shows that both the discount rate and growth rate assumptions are key variables that have an impact on the outcome of the recoverable amount. Significant CGUs The value in use of the US Services CGU, calculated using the key assumptions discussed above, was lower than the carrying value of the CGU’s net operating assets which resulted in an impairment of £255.8m. Sensitivity analysis shows that a decrease or increase of 1% in the discount rate assumption would result in an impairment of £180.2m or £301.2m respectively. Sensitivity analysis also shows that a decrease or increase of 1% in the terminal growth rate would result in an impairment of £300.0m or £182.1m. The carrying value of goodwill for this CGU as at 31 March 2013, after impairment, was £142.8m and its net operating assets excluding goodwill were £88.0m. A reduction of 5% in the value of the terminal year cash flows would result in an additional £12.4m reduction in the carrying value of goodwill. The Technology Solutions CGU in the US has significant headroom. An increase in the discount rate or a decrease in the terminal growth rate of 1% would not cause the net operating assets to exceed their recoverable amount. The carrying value of goodwill for this CGU as at 31 March was £111.7m. The Technology Solutions CGU in the UK and the individual CGUs within UK Services all have significant headroom. An increase in the discount rate or a decrease in the terminal growth rate by 1% would not cause the net operating assets to exceed their recoverable amount. The carrying value of goodwill for the Technology Solutions CGU in the UK as at 31 March was £5.7m. The carrying value of goodwill for the two UK Services CGUs as at 31 March was £27.5m and £2.7m. The Directors have not identified any other likely changes in other significant assumptions between 31 March 2013 and the signing of the financial statements that would cause the carrying value of the recognised goodwill to exceed its recoverable amount. 84 QinetiQ Group plc Annual Report and Accounts 2013 13. Intangible assets Year ended 31 March 2013 all figures in £ million Cost At 1 April 2012 Additions – internally developed Additions – purchased Disposals Transfers Foreign exchange At 31 March 2013 Amortisation and impairment At 1 April 2012 Amortisation charge for year Disposals Foreign exchange At 31 March 2013 Net book value at 31 March 2013 Year ended 31 March 2012 all figures in £ million Cost At 1 April 2011 Additions – internally developed Additions – purchased Disposals Disposals – recognised on divestments Transfers Foreign exchange At 31 March 2012 Amortisation and impairment At 1 April 2011 Amortisation charge for year Impairments Disposals Disposals – recognised on divestments Transfers Foreign exchange At 31 March 2012 Net book value at 31 March 2012 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Total 263.5 0.3 0.3 (1.2) 0.6 10.4 273.9 191.7 18.0 (1.2) 7.6 216.1 Total 267.2 0.3 0.4 (0.4) (4.2) – 0.2 263.5 164.0 26.8 2.5 (0.1) (1.8) – 0.3 191.7 36.6 – 0.3 (1.2) 0.5 0.3 36.5 33.1 3.1 (1.2) 0.3 35.3 36.8 – 0.4 (0.4) – (0.2) – 36.6 26.7 4.2 2.5 (0.1) – (0.2) – 33.1 1.2 57.8 Acquired intangible assets Intellectual property Customer relationships Brand names Development costs Other intangible assets Acquired intangible assets Customer relationships Intellectual property Brand names Development costs Other intangible assets 147.7 – – – – 7.5 155.2 92.8 10.0 – 5.0 107.8 47.4 55.2 – – – – 2.1 57.3 46.5 2.6 – 1.9 51.0 6.3 9.6 – – – – 0.5 10.1 6.0 1.4 – 0.4 7.8 2.3 14.4 0.3 – – 0.1 – 14.8 13.3 0.9 – – 14.2 0.6 147.3 – – – – – 0.4 147.7 79.5 12.9 – – – – 0.4 92.8 54.9 55.3 – – – – – (0.1) 55.2 40.9 5.7 – – – – (0.1) 46.5 8.7 13.9 – – – (4.2) – (0.1) 9.6 6.1 1.7 – – (1.8) – – 6.0 3.6 13.9 0.3 – – – 0.2 – 14.4 10.8 2.3 – – – 0.2 – 13.3 1.1 3.5 71.8 Impairment of other intangible assets of £2.5m was incurred in the UK Services business segment and related to certain software assets no longer being utilised. QinetiQ Group plc Annual Report and Accounts 2013 85 Financial statements Notes to the financial statements continued 14. Property, plant and equipment Year ended 31 March 2013 all figures in £ million Cost At 1 April 2012 Additions Disposals Transfers Transfer from ‘assets classified as held for sale’ Foreign exchange At 31 March 2013 Depreciation At 1 April 2012 Charge for year Impairment Disposals Transfers Transfer from ‘assets classified as held for sale’ Foreign exchange At 31 March 2013 Net book value at 31 March 2013 Year ended 31 March 2012 all figures in £ million Cost At 1 April 2011 Additions Disposals Disposals – recognised on divestments Transfer Foreign exchange At 31 March 2012 Depreciation At 1 April 2011 Charge for year Impairment Disposals Disposals – recognised on divestments Transfer At 31 March 2012 Net book value at 31 March 2012 Land and buildings Plant, machinery and vehicles Computers and office equipment Assets under construction 307.8 0.3 (1.1) 4.0 8.4 0.6 320.0 121.6 11.8 4.0 (0.8) 0.1 3.3 0.5 140.5 179.5 153.6 1.5 (3.1) 10.2 – 0.9 163.1 121.3 11.8 – (2.9) – – 0.6 130.8 32.3 48.6 0.6 (2.8) 5.7 – 1.0 53.1 38.9 4.4 – (2.6) (0.1) – 0.7 41.3 11.8 18.4 24.7 (4.9) (20.5) – 0.1 17.8 – – – – – – – – Land and buildings Plant, machinery and vehicles Computers and office equipment Assets under construction 305.8 0.5 (0.4) (0.1) 2.0 – 307.8 110.3 10.7 1.9 (0.4) (0.1) (0.8) 121.6 186.2 150.1 2.8 (3.9) (1.0) 5.6 – 153.6 112.2 12.0 0.8 (3.5) (0.6) 0.4 121.3 32.3 48.2 1.0 (3.1) (0.4) 2.8 0.1 48.6 33.8 5.5 1.6 (2.0) (0.4) 0.4 38.9 13.1 17.7 (2.0) – (10.4) – 18.4 – – – – – – – Total 528.4 27.1 (11.9) (0.6) 8.4 2.6 554.0 281.8 28.0 4.0 (6.3) – 3.3 1.8 312.6 Total 517.2 22.0 (9.4) (1.5) – 0.1 528.4 256.3 28.2 4.3 (5.9) (1.1) – 281.8 Impairment of land and buildings of £4.0m (2012: £1.9m), expensed in the consolidated income statement as a specific adjusting item, relates to vacant owned properties where there have been no external tenants following vacancies arising in the year. 17.8 241.4 9.7 18.4 246.6 Under the terms of the Business Transfer Agreement with the MOD, certain restrictions have been placed on freehold land and buildings, and certain plant and machinery related to them. These restrictions are detailed in note 30. 86 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 15. Non-current investments As at 31 March all figures in £ million Non-current assets Current assets Current liabilities Non-current liabilities Net assets of joint ventures and associates Other non-current investments Total There were no material transactions with joint ventures and associates. 2013 2012 Joint venture and associates financial results 0.3 2.3 2.6 (2.0) – (2.0) 0.6 – 0.6 Group net share of joint ventures and associates 0.1 1.1 1.2 (0.9) – (0.9) 0.3 0.1 0.4 Joint venture and associates financial results 1.7 8.7 10.4 (5.2) (1.0) (6.2) 4.2 – 4.2 Group net share of joint ventures and associates 0.5 2.8 3.3 (2.0) (0.3) (2.3) 1.0 4.8 5.8 16. Deferred tax Deferred tax assets and liabilities are offset only where there is a legally enforceable right to do so and there is an intention to settle the balances net. Movements in the deferred tax assets and liabilities are shown below: Year ended 31 March 2013 Deferred tax asset all figures in £ million At 1 April 2012 Released through income statement Created through equity Prior-year adjustment Foreign exchange Transfer to current tax Deferred tax impact of change in rates Gross deferred tax asset at 31 March 2013 Less: liability available for offset Net deferred tax asset at 31 March 2013 Deferred tax liability all figures in £ million At 1 April 2012 Created through the income statement Foreign exchange Gross deferred tax liability at 31 March 2013 Less: asset available for offset Net deferred tax liability at 31 March 2013 Pension liability 13.3 (9.2) 10.1 – – – (0.5) 13.7 Accelerated capital allowances 3.1 (2.3) – (0.1) – – (0.1) 0.6 Hedging – – – – – – – – Short-term timing differences 34.2 (5.9) – 0.3 1.9 (0.6) – 29.9 Amortisation (33.6) 23.8 (2.0) (11.8) Total 50.6 (17.4) 10.1 0.2 1.9 (0.6) (0.6) 44.2 (11.8) 32.4 Total (33.6) 23.8 (2.0) (11.8) 11.8 – At the balance sheet date the Group had unused tax losses of £202.7m (2012: £200.0m) potentially available for offset against future profits. No deferred tax asset has been recognised in respect of this amount because of uncertainty over the timing of its utilisation. These losses can be carried forward indefinitely. QinetiQ Group plc Annual Report and Accounts 2013 87 Financial statements Notes to the financial statements continued 16. Deferred tax continued Year ended 31 March 2012 Deferred tax asset all figures in £ million At 1 April 2011 (Released)/created through income statement Created through equity Prior-year adjustment Foreign exchange Transfer to current tax Deferred tax impact of change in rates Gross deferred tax asset at 31 March 2012 Less: liability available for offset Net deferred tax asset at 31 March 2012 Deferred tax liability all figures in £ million At 1 April 2011 Created through the income statement Foreign exchange Transfer to deferred tax asset Gross deferred tax liability at 31 March 2012 Less: asset available for offset Net deferred tax liability at 31 March 2012 17. Inventories As at 31 March all figures in £ million Raw materials Work in progress Finished goods 18. Current asset investments As at 31 March all figures in £ million Available for sale investment Pension liability 32.4 (48.7) 30.7 – – – (1.1) 13.3 Accelerated capital allowances 0.6 3.2 – (0.5) – 0.1 (0.3) 3.1 Short-term timing differences 37.6 – – (1.1) 0.1 (2.4) – 34.2 Hedging 0.1 (0.2) 0.1 – – – – – Amortisation (36.9) 3.6 (0.1) (0.2) (33.6) 2013 16.5 4.7 4.3 25.5 2013 1.4 Total 70.7 (45.7) 30.8 (1.6) 0.1 (2.3) (1.4) 50.6 (33.6) 17.0 Total (36.9) 3.6 (0.1) (0.2) (33.6) 33.6 – 2012 20.2 1.2 9.8 31.2 2012 1.1 At 31 March 2013 the Group held a 4.9% shareholding in pSivida Limited (31 March 2012: 4.9%), a company listed on NASDAQ and the Australian and Frankfurt Stock Exchanges. The investment is held at fair value of £1.4m (2012: £1.1m) using the closing share price at 31 March 2013 of AUS$2.22 per share (31 March 2012: AUS$1.94 per share). 88 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 19. Trade and other receivables As at 31 March all figures in £ million Trade receivables Amounts recoverable under contracts Other receivables Prepayments 2013 143.4 112.2 15.2 13.4 284.2 2012 164.5 141.6 82.9 15.8 404.8 In determining the recoverability of trade receivables, the Group considers any changes in the credit quality of the trade receivable from the date credit was granted to the reporting date. Credit risk is limited as a result of the high percentage of revenue derived from UK and US defence and other government agencies. Accordingly, the Directors believe that no credit provision in excess of the allowance for doubtful debts is required. As at 31 March 2013 the Group carried a provision for doubtful debts of £1.9m (2012: £4.0m). Other receivables decreased significantly from 2012 due to the receipt of £65m from MOD in respect of the recovery of prior year restructuring costs. Ageing of past due but not impaired receivables all figures in £ million Up to three months Over three months Movements in the doubtful debt provision all figures in £ million At 1 April Created Released Utilised At 31 March 2013 37.1 3.4 40.5 2013 4.0 0.7 (1.9) (0.9) 1.9 2012 36.5 4.1 40.6 2012 5.8 3.7 (4.2) (1.3) 4.0 The maximum exposure to credit risk in relation to trade receivables at the reporting date is the fair value of trade receivables. The Group does not hold any collateral as security. 20. Assets classified as held for sale As at 31 March all figures in £ million Property, plant and equipment Total assets held for sale 2013 – – 2012 5.1 5.1 The Group does not hold any assets classified as held for sale as at the balance sheet date. Assets previously held for sale included various properties in the UK that are surplus to the Group’s requirements and are being marketed for sale. These assets no longer meet the criteria for disclosure under IFRS 5; the prospective buyer has withdrawn and hence the sale of these assets is no longer expected to complete within the forthcoming twelve months. QinetiQ Group plc Annual Report and Accounts 2013 89 Financial statements Notes to the financial statements continued 21. Trade and other payables As at 31 March all figures in £ million Trade payables Other tax and social security Other payables Accruals and deferred income Total current trade and other payables Payments received on account Other payables Total non-current trade and other payables Total trade and other payables 22. Provisions Year ended 31 March 2013 all figures in £ million At 1 April 2012 Reclassification Created in year Released in year Unwind of discount Utilised in year Foreign exchange At 31 March 2013 Current liability Non-current liability At 31 March 2013 2013 43.7 25.9 16.9 371.5 458.0 7.0 0.6 7.6 465.6 Other 16.5 (11.9) 3.5 (1.9) – – – 6.2 0.1 6.1 6.2 2012 38.5 48.2 17.7 394.3 498.7 20.3 0.3 20.6 519.3 Total 16.6 – 23.5 (2.2) 0.7 (3.6) 0.1 35.1 12.4 22.7 35.1 Restructuring 0.1 – 17.0 – – (1.9) 0.1 15.3 9.9 5.4 15.3 Property – 11.9 3.0 (0.3) 0.7 (1.7) – 13.6 2.4 11.2 13.6 Restructuring provisions relate mainly to cost reduction initiatives in the US and include redundancy and vacant property provisions. Redundancy provisions are expected to be utilised within 12 months and provisions in respect of vacant property will be utilised in line with the remaining lease period. Lease periods extend out to 2019. Property provisions, other than those relating to restructuring discussed above, relate to under-utilised properties in the UK. The extent of the provision is affected by the timing of when properties can be sub-let and the proportion of space that can be sub-let. Based on current assessment the provision will be utilised within 13 years. Other provisions relate to environmental and other liabilities, the magnitude and timing of utilisation of which are determined by a variety of factors. 90 QinetiQ Group plc Annual Report and Accounts 2013 23. Net cash/debt As at 31 March all figures in £ million Current financial assets/(liabilities) US$ private placement notes – 7.13% US$ private placement notes – 7.62% Deferred financing costs Borrowings Derivative financial instruments Finance lease debtor/(creditor) Total current financial assets/(liabilities) Non-current assets/(liabilities) US$ private placement notes – 7.13% US$ private placement notes – 5.50% US$ private placement notes – 7.62% Deferred financing costs Borrowings Derivative financial instruments Finance lease debtor/(creditor) Total non-current financial assets/(liabilities) Cash Cash equivalents Total cash and cash equivalents Total net cash/(debt) as defined by the Group Assets 2013 Liabilities – – – – 0.1 2.5 2.6 – – – – – – 4.3 4.3 32.6 207.8 240.4 – – 0.6 0.6 (0.2) (2.4) (2.0) (29.2) (32.1) (106.4) 0.5 (167.2) (0.1) (4.0) (171.3) – – – Net – – 0.6 0.6 (0.1) 0.1 0.6 (29.2) (32.1) (106.4) 0.5 (167.2) (0.1) 0.3 (167.0) 32.6 207.8 240.4 74.0 Assets 2012 Liabilities – – – – 0.1 2.3 2.4 – – – – – 0.1 6.8 6.9 46.2 71.6 117.8 (15.9) (67.3) 0.6 (82.6) (0.1) (2.2) (84.9) (26.6) (30.4) (102.0) 1.0 (158.0) – (6.4) (164.4) – – – Net (15.9) (67.3) 0.6 (82.6) – 0.1 (82.5) (26.6) (30.4) (102.0) 1.0 (158.0) 0.1 0.4 (157.5) 46.2 71.6 117.8 (122.2) O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l At 31 March 2013 £2.7m (2012: £5.2m) of cash was held by the Group’s captive insurance subsidiary, including £0.2m (2012: £0.2m) that was restricted in its use. All US$ private placement notes have been issued as fixed-rate bonds and have not been converted to floating-rate. Further analysis of the terms and maturity dates for financial liabilities are set out in note 25. In the year ended 31 March 2013 the Group completed the previously announced programme to repay US$177m of private placement debt. i n f o r m a (cid:2) o n Reconciliation of net cash flow to movement in net cash/debt all figures in £ million Increase in cash and cash equivalents in the year Repayment of US$ private placement notes Settlement of forward contracts Capital element of finance lease payments Capital element of finance lease receipts Change in net cash/debt resulting from cash flows Amortisation of deferred financing costs Finance lease receivables Finance lease payables Foreign exchange and other non-cash movements Movement in net cash/debt in year Net debt at beginning of year Net cash/(debt) at 31 March 2013 2013 121.6 63.0 1.3 2.8 (3.0) 185.7 (0.5) 0.7 (0.6) 10.9 196.2 (122.2) 74.0 2012 15.2 133.6 1.6 2.8 (3.0) 150.2 (0.6) 0.9 (0.8) (11.0) 138.7 (260.9) (122.2) QinetiQ Group plc Annual Report and Accounts 2013 91 Financial statements Notes to the financial statements continued 23. Net cash/debt continued Finance leases Group as a lessor The minimum lease receivables under finance leases fall as follows: all figures in £ million Amounts receivable under finance leases Within one year In the second to fifth years inclusive Less: unearned finance income Present value of minimum lease payments Minimum lease payments 2013 2012 Present value of minimum lease payments 2013 2012 3.0 4.5 7.5 (0.7) 6.8 3.0 7.5 10.5 (1.4) 9.1 2.5 4.3 6.8 – 6.8 2.3 6.8 9.1 – 9.1 The Group leases out certain buildings under finance leases over a 12-year term that expires in 2015. Group as a lessee The minimum lease payments under finance leases fall due as follows: all figures in £ million Amounts payable under finance leases Within one year In the second to fifth years inclusive Less future finance charges Present value of minimum lease payments Classified as follows: Financial liability – current Financial liability – non-current Minimum lease payments 2013 2012 Present value of minimum lease payments 2013 2012 2.8 4.2 7.0 (0.6) 6.4 2.8 7.1 9.9 (1.2) 8.7 2.4 4.0 6.4 – 6.4 2.4 4.0 6.4 2.2 6.4 8.6 – 8.6 2.2 6.4 8.6 The Group utilises certain buildings under finance leases. Average lease terms are typically between two and ten years (31 March 2012: between two and ten years). 24. Operating leases Group as a lessor The Group receives rental income on certain properties. The Group had contracted with tenants for the following future minimum lease payments: all figures in £ million Within one year In the second to fifth years inclusive Greater than five years Group as a lessee all figures in £ million Lease and sub-lease income statement expense – minimum lease payments The Group had the following total future minimum lease payment commitments: all figures in £ million Within one year In the second to fifth years inclusive Greater than five years 2013 7.8 23.8 3.4 35.0 2013 23.1 2013 21.4 58.1 20.5 100.0 2012 7.1 23.4 1.6 32.1 2012 22.1 2012 18.9 67.8 22.5 109.2 Operating lease payments represent rentals payable by the Group on certain property, plant and equipment. Principal operating leases are negotiated for a term of approximately ten years. 92 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 25. Financial risk management The Group’s international operations and debt financing expose it to financial risks that include the effects of changes in foreign exchange rates, interest rates, credit risks and liquidity risks. Treasury and risk management policies, which are set by the Board, specify guidelines on financial risks and the use of financial instruments to manage risk. The instruments and techniques used to manage exposures include foreign currency derivatives and interest rate derivatives. Group treasury monitors financial risks and compliance with risk management policies. A) Fair values of financial instruments The fair value hierarchy is as follows: Level 1 – measured using quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 – measured using inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and Level 3 – measured using inputs for the assets or liability that are not based on observable market data (i.e. unobservable inputs). The following table presents the Group’s assets and liabilities that are measured at fair value at 31 March 2013: all figures in £ million Assets Current other investments Current derivative financial instruments Non-current other investments Liabilities Current derivative financial instruments Non-current derivative financial instruments Total Note Level 1 Level 2 Level 3 Total 18 23 23 23 1.4 – – – – 1.4 – 0.1 – (0.2) (0.1) (0.2) – – 0.1 – – 0.1 1.4 0.1 0.1 (0.2) (0.1) 1.3 For cash and cash equivalents, trade and other receivables and bank and current borrowings, the fair value of the financial instruments approximate to their carrying value as a result of the short maturity periods of these financial instruments. For trade and other receivables, allowances are made within the carrying value for credit risk. For other financial instruments, the fair value is based on market value, where available. Where market values are not available, the fair values have been calculated by discounting cash flows to net present value using prevailing market-based interest rates translated at the year-end rates, except for unlisted fixed asset investments where fair value equals carrying value. QinetiQ Group plc Annual Report and Accounts 2013 93 Financial statements Notes to the financial statements continued 25. Financial risk management continued All financial assets and liabilities have a fair value that is identical to book value at 31 March 2013 and 31 March 2012 except where noted below: Note Available for sale Loans and receivables Financial liabilities at amortised cost Derivatives used as hedges Total carrying value As at 31 March 2013 all figures in £ million Financial assets Non-current Finance leases Other investments Current Finance leases Trade and other receivables Derivative financial instruments Current asset investments Cash and cash equivalents Total financial assets Financial liabilities Non-current Trade and other payables Bank and other borrowings Finance leases Derivative financial instruments Current Trade and other payables Derivative financial instruments Finance leases Bank overdraft, finance cost and private placement Total financial liabilities 23 15 23 19 23 18 23 21 23 23 23 21 23 23 23 – 0.1 – – – 1.4 – 1.5 – – – – – – – – – 4.3 – 2.5 284.2 – – 240.4 531.4 – – – – – – – – – – – – – – – – – (7.6) (167.2) (4.0) – (458.0) – (2.4) 0.6 (638.6) Total fair value 4.4 0.1 3.0 284.2 0.1 1.4 240.4 533.6 (7.6) (197.7) (4.2) (0.1) (458.0) (0.2) (2.8) – – – – 0.1 – – 0.1 4.3 0.1 2.5 284.2 0.1 1.4 240.4 533.0 – – – (0.1) (7.6) (167.2) (4.0) (0.1) – (0.2) – (458.0) (0.2) (2.4) – (0.3) 0.6 (638.9) 0.6 (670.0) Total 1.5 531.4 (638.6) (0.2) (105.9) (136.4) 94 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n As at 31 March 2012 all figures in £ million Financial assets Non-current Finance leases Derivative financial instruments Other investments Current Finance leases Trade and other receivables Derivative financial instruments Current asset investments Cash and cash equivalents Total financial assets Financial liabilities Non-current Trade and other payables Bank and other borrowings Finance leases Current Trade and other payables Derivative financial instruments Finance leases Bank overdraft, finance cost and private placement Total financial liabilities Note Available for sale Loans and receivables Financial liabilities at amortised cost Derivatives used as hedges Total carrying value Total fair value 23 23 15 23 19 23 18 23 21 23 23 21 23 23 23 – – 4.8 – – – 1.1 – 5.9 – – – – – – – – 6.8 – – 2.3 404.8 – – 117.8 531.7 – – – – – – – – – – – – – – – – – (20.6) (158.0) (6.4) (498.7) – (2.2) (82.6) (768.5) – 0.1 – – – 0.1 – – 0.2 – – – – (0.1) – – (0.1) 6.8 0.1 4.8 2.3 404.8 0.1 1.1 117.8 537.8 (20.6) (158.0) (6.4) (498.7) (0.1) (2.2) 7.2 0.1 4.8 3.0 404.8 0.1 1.1 117.8 538.9 (20.6) (185.7) (6.8) (498.7) (0.1) (2.8) (82.6) (768.6) (82.6) (797.3) Total 5.9 531.7 (768.5) 0.1 (230.8) (258.4) QinetiQ Group plc Annual Report and Accounts 2013 95 Financial statements Notes to the financial statements continued 25. Financial risk management continued B) Interest rate risk The Group operates an interest rate policy designed to optimise interest costs and to reduce volatility in reported earnings. The Group’s current policy is to require rates to be fixed for 30-80% of the level of borrowings, which is achieved primarily through fixed-rate borrowings, and through the use of interest rate swaps. Where there are significant changes in the level and/or structure of debt, policy permits borrowings to be 100% fixed, with regular Board reviews of the appropriateness of this fixed percentage. At 31 March 2013 100% (2012: 100%) of the Group’s borrowings were at fixed rates with no adjustment for interest rate swaps. Financial assets/(liabilities) As at 31 March 2013 all figures in £ million Sterling US dollar Euro Australian dollar Other As at 31 March 2012 all figures in £ million Sterling US dollar Euro Australian dollar Other Fixed or capped 6.8 – – – – 6.8 Fixed or capped 9.1 – – – – 9.1 Financial asset Financial liability Floating 219.6 9.2 0.9 8.2 2.5 240.4 Non-interest bearing 0.1 0.1 – 1.4 – 1.6 Fixed or capped (6.4) (167.7) – – – (174.1) Floating – – – – – – Non-interest bearing (0.3) – – – – (0.3) Financial asset Financial liability Floating 95.2 14.9 0.2 5.5 2.0 117.8 Non-interest bearing 4.9 – – 1.1 – 6.0 Fixed or capped (8.6) (242.2) – – – (250.8) Floating – – – – – – Non-interest bearing (0.1) – – – – (0.1) Floating-rate financial assets attract interest based on the relevant national LIBID equivalent. Floating-rate financial liabilities bear interest at the relevant national LIBOR equivalent. Trade and other receivables/payables and deferred finance costs are excluded from this analysis. For the fixed or capped-rate financial assets and liabilities, the average interest rates (including the relevant marginal cost of borrowing) and the average period for which the rates are fixed are: Financial assets: Sterling Financial liabilities: Sterling US dollar Total financial liabilities 2013 Weighted average interest rate % Weighted average years to maturity 13.4 12.1 7.1 7.3 2.5 2.5 4.9 4.8 Fixed or capped £m 6.8 (6.4) (167.7) (174.1) 2012 Weighted average interest rate % Weighted average years to maturity 13.4 12.1 7.2 7.4 3.5 3.5 4.3 4.3 Fixed or capped £m 9.1 (8.6) (242.2) (250.8) Sterling assets and liabilities consist primarily of finance leases with the weighted average interest rate reflecting the internal rate of return of those leases. Interest rate risk management The Group private placement borrowings are fixed-rate, while the revolving credit facility is floating-rate and undrawn as at 31 March. 96 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n C) Currency risk Transactional currency exposure The Group is exposed to foreign currency risks arising from sales or purchases by businesses in currencies other than their functional currency. It is Group policy that when such a sale or purchase is certain, the net foreign exchange exposure is hedged using forward foreign exchange contracts. Hedge accounting documentation and effectiveness testing are undertaken for all the Group’s transactional hedge contracts. The table below shows the Group’s currency exposures, being exposures on currency transactions that give rise to net currency gains and losses recognised in the income statement. Such exposures comprise the monetary assets and liabilities of the Group that are not denominated in the functional currency of the operating company involved. Functional currency of the operating company all figures in £ millions 31 March 2013 – sterling 31 March 2012 – sterling US$ 0.9 13.4 Net foreign currency monetary assets/(liabilities) Other 1.9 2.2 AUS$ 1.5 6.6 Euro (2.5) 1.7 Total 1.8 23.9 The amounts shown in the table take into account the effect of the forward contracts entered into to manage these currency exposures. The Group enters into forward foreign currency contracts to hedge the currency exposures that arise on sales and purchases denominated in foreign currencies, as the transaction occurs. The principal contract amounts of the outstanding forward currency contracts as at 31 March 2013 against sterling are net US dollars bought £2.5m (US$4.0m) and net euros sold £10.8m (€12.8m). Translational currency exposure The Group has significant investments in overseas operations, particularly in the United States. As a result, the sterling value of the Group’s balance sheet can be significantly affected by movement in exchange rates. The Group seeks to mitigate the effect of these translational exposures by matching the net investment in overseas operations with borrowings denominated in their functional currencies unless the cost of such hedging activity is uneconomic. This is achieved by borrowing in the local currency or, in some cases, indirectly through the use of forward foreign exchange contracts. D) Financial credit risk The Group is exposed to credit-related losses in the event of non-performance by counterparties to financial instruments, but does not currently expect any counterparties to fail to meet their obligations. Credit risk is mitigated by a Board-approved policy of only selecting counterparties with a strong investment grade long-term credit rating for cash deposits. In the normal course of business, the Group operates notional cash pooling systems, where a legal right of set-off applies. The maximum credit-risk exposure in the event of other parties failing to perform their obligations under financial assets, excluding trade and other receivables, totals £248.8m (2012: £133.0m). The Group held cash and cash equivalents of £240.4m at 31 March 2013 (2012: £117.8m), which represents the maximum credit exposure on these assets. The cash and cash equivalents were held with different financial institutions which were rated single A or better, although £207.8m was invested in AAA-rated money funds at the year end. QinetiQ Group plc Annual Report and Accounts 2013 97 Financial statements Notes to the financial statements continued 25. Financial risk management continued E) Liquidity risk Borrowing facilities As at 31 March 2013, the Group had a Revolving Credit Facility (RCF) of US$250m and £118m (2012: US$250m and £118m). The RCF is contracted until 2016 and is unutilised as shown in the table below: Committed facilities 31 March 2013 Freely available cash and cash equivalents Available funds 31 March 2013 Committed facilities 31 March 2012 Freely available cash and cash equivalents Available funds 31 March 2012 Interest rate: LIBOR plus 1.20% Total £m 282.8 Drawn £m – 1.20% 274.2 – Undrawn £m 282.8 240.2 523.0 274.2 112.6 386.8 Gross contractual cash flows for borrowings and other financial liabilities The following are the contractual maturities of financial liabilities, including interest payments. The cash flows associated with derivatives that are cash flow hedges are expected to have an impact on profit or loss in the periods shown. As at 31 March 2013 all figures in £ million Non-derivative financial liabilities Trade and other payables US private placement debt Recapitalisation fee Finance leases Derivative financial liabilities Forward foreign currency contracts – cash flow hedges As at 31 March 2012 all figures in £ million Non-derivative financial liabilities Trade and other payables US private placement debt Recapitalisation fee Finance leases Derivative financial liabilities Forward foreign currency contracts – cash flow hedges Book value Contractual cash flows 1 year or less 1-2 years 2-5 years (465.6) (167.7) 1.1 (6.4) (465.6) (226.8) – (7.0) (458.0) (11.6) – (2.8) (0.3) (638.9) (0.3) (699.7) (0.2) (472.6) (7.6) (11.6) – (2.8) (0.1) (22.1) – (89.8) – (1.4) – (91.2) Book value Contractual cash flows 1 year or less 1-2 years 2-5 years (519.3) (242.2) 1.6 (8.6) (519.3) (310.9) – (9.8) (498.7) (95.3) – (2.8) (0.1) (768.6) (0.1) (840.1) (0.1) (596.9) (20.6) (11.1) – (2.8) – (34.5) – (87.8) – (4.2) – (92.0) More than 5 years – (113.8) – – – (113.8) More than 5 years – (116.7) – – – (116.7) 98 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n F) Derivative financial instruments As at 31 March all figures in £ million Forward foreign currency contracts – cash flow hedges Derivative assets/(liabilities) at the end of the year As at 31 March all figures in £ million Expected to be recognised: In one year or less Between one and two years G) Maturity of financial liabilities As at 31 March 2013 Asset gains 2013 Liability losses Net Asset gains 2012 Liability losses 0.1 0.1 (0.3) (0.3) (0.2) (0.2) 0.2 0.2 (0.1) (0.1) Asset gains 2013 Liability losses Net Asset gains 2012 Liability losses 0.1 – 0.1 (0.2) (0.1) (0.3) (0.1) (0.1) (0.2) 0.1 0.1 0.2 (0.1) – (0.1) all figures in £ million Due in one year or less Due in more than one year but not more than two years Due in more than two years but not more than five years Due in more than five years As at 31 March 2012 all figures in £ million Due in one year or less Due in more than one year but not more than two years Due in more than two years but not more than five years Due in more than five years Trade and other payables 458.0 7.6 – – 465.6 Bank borrowings and loan notes (0.6) (0.5) 61.3 106.4 166.6 Finance leases and derivative financial instruments 2.6 2.8 1.3 – 6.7 Trade and other payables 498.7 20.6 – – 519.3 Bank borrowings and loan notes 82.6 (0.6) 56.5 102.1 240.6 Finance leases and derivative financial instruments 2.3 2.0 4.4 – 8.7 Net 0.1 0.1 Net – 0.1 0.1 Total 460.0 9.9 62.6 106.4 638.9 Total 583.6 22.0 60.9 102.1 768.6 QinetiQ Group plc Annual Report and Accounts 2013 99 Financial statements Notes to the financial statements continued 25. Financial risk management continued H) Sensitivity analysis The Group’s sensitivity to changes in foreign exchange rates and interest rates on financial assets and liabilities as at 31 March 2013 is set out in the table below. The impact of a weakening in sterling on the Group’s financial assets and liabilities would be more than offset in equity and income by its impact on the Group’s overseas net assets and earnings respectively. Sensitivity on Group assets other than financial assets and liabilities is not included in this analysis. The amounts generated from the sensitivity analysis are forward-looking estimates of market risk assuming that certain market conditions occur. Actual results in the future may differ materially from those projected as a result of developments in the global financial markets that may cause fluctuations in interest and exchange rates to vary from the hypothetical amounts disclosed in the table below, which should not, therefore, be considered to be a projection of likely future events and losses. The estimated changes for interest rate movements are based on an instantaneous decrease or increase of 1% (100 basis points) in the specific rate of interest applicable to each class of financial instruments from the levels effective at 31 March 2013, with all other variables remaining constant. The estimated changes for foreign exchange rates are based on an instantaneous 10% weakening or strengthening in sterling against all other currencies from the levels applicable at 31 March 2013, with all other variables remaining constant. Such analysis is for illustrative purposes only – in practice market rates rarely change in isolation. The figures shown below relate primarily to the translational impact on the Group’s US$ debt. This debt is held in the US so there is no transactional impact. The impact of transactional risk on the Group’s monetary assets/liabilities that are not held in the functional currency of the entity holding those assets/liabilities is minimal. A 10% weakening in sterling would result in a £0.1m increase in profit before tax. 1% decrease in interest rates 10% weakening in sterling Equity – – – Profit before tax (2.2) (0.1) (0.1) Equity – (17.6) 1.4 Profit before tax – (1.3) – 1% increase in interest rates 10% strengthening in sterling Equity – – – Profit before tax 2.2 0.1 0.1 Equity – 14.4 (1.2) Profit before tax – 1.1 – 1% decrease in interest rates 10% weakening in sterling Equity – – – Profit before tax (0.7) – (0.1) Equity – (25.3) 1.0 Profit before tax – (2.0) – 1% increase in interest rates 10% strengthening in sterling Equity – – – Profit before tax 1.0 0.1 0.1 Equity – 20.7 (1.0) Profit before tax – 1.6 – As at 31 March 2013 all figures in £ million Sterling US dollar Other all figures in £ million Sterling US dollar Other As at 31 March 2012 all figures in £ million Sterling US dollar Other all figures in £ million Sterling US dollar Other 100 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 26. Cash flows from operations For the year ended 31 March all figures in £ million (Loss)/profit after tax for the year Adjustments for: Taxation (income)/expense Net finance costs Gain on business divestments and disposal of investments Impairment of investments Amortisation of purchased or internally developed intangible assets Amortisation of intangible assets arising from acquisitions and impairments Impairment of goodwill Depreciation and impairment of property, plant and equipment Loss/(gain) on disposal of property, plant and equipment Share of post-tax profit of equity accounted entities Share-based payments charge Gain in respect of previously capitalised DTR programme bid costs Changes in retirement benefit obligations Pension curtailment gain Pension past service gain Net movement in provisions Decrease in inventories Decrease in receivables (Decrease)/increase in payables Changes in working capital Cash generated from operations Add back: cash (inflow)/outflow relating to restructuring Net cash flow from operations before restructuring costs 2013 (133.2) 2012 (restated^) 246.3 (3.8) 17.9 (2.9) 0.6 4.0 14.0 255.8 32.0 0.8 (0.1) 5.5 – (20.1) (0.7) – 17.7 187.5 6.6 124.1 (60.7) 70.0 257.5 (63.1) 194.4 70.0 56.6 (11.6) – 9.0 20.3 – 32.5 (5.8) (0.1) 4.2 (4.1) (60.7) (1.1) (141.4) (15.8) 198.3 12.1 1.2 30.3 43.6 241.9 8.9 250.8 ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. Refer to note 1 to the financial statements. QinetiQ Group plc Annual Report and Accounts 2013 101 Financial statements Notes to the financial statements continued 27. Share capital and other reserves Shares allotted, called up and fully paid: At 1 April 2011 Issued in the year At 31 March 2012 Issued in the year At 31 March 2013 Ordinary shares of 1p each (equity) Special Share of £1 (non-equity) £ – Number 6,604,764 660,476,373 – 6,604,764 660,476,373 – 6,604,764 660,476,373 – £ 1 – 1 – 1 Number 1 – 1 – 1 Total £ – Number 6,604,765 660,476,374 – 6,604,765 660,476,374 – 6,604,765 660,476,374 – Except as noted below all shares in issue at 31 March 2013 rank pari passu in all respects. Rights attaching to the Special Share QinetiQ carries out activities which are important to UK defence and security interests. To protect these interests in the context of the on-going commercial relationship between the MOD and QinetiQ, and to promote and reinforce the Compliance Principles, the MOD holds a Special Share in QinetiQ. QinetiQ obtained MOD consent to changes in its Special Shareholder rights, which were approved by shareholders at the 2012 AGM. The changes to the Special Share were disclosed in the 2012 Annual Report. Subsequent to the changes approved at the 2012 AGM the Special Share confers certain rights on the holder: a) to require the Group to implement and maintain the Compliance System (as defined in the Articles of Association) so as to make at all times effective its and each member of QinetiQ Controlled Group’s application of the Compliance Principles, in a manner acceptable to the Special Shareholder; b) to refer matters to the Board for its consideration in relation to the application of the Compliance Principles; c) to require the Board to obtain Special Shareholder’s consent: i) ii) if at any time when the chairman is not a British Citizen, it is proposed to appoint any person to the office of chief executive, who is not a British Citizen; and if at any time when the chief executive is not a British Citizen, it is proposed to appoint any person to the office of chairman, who is not a British Citizen; d) to require the Board to take action to rectify any omission in the application of the Compliance Principles, if the Special Shareholder is of the opinion that such steps are necessary to protect the defence or security interests of the United Kingdom; and e) to demand a poll at any of QinetiQ’s meetings (even though it may have no voting rights except those specifically set out in the Articles). The Special Shareholder has an option to purchase defined Strategic Assets of the Group in certain circumstances. The Special Shareholder has, inter alia, the right to purchase any Strategic Assets which the Group wishes to sell. Strategic Assets are normally testing and research facilities (see note 30 for further details). The Special Share may only be issued to, held by and transferred to HM Government (or as it directs). At any time the Special Shareholder may require QinetiQ to redeem the Special Share at par. If QinetiQ is wound up the Special Shareholder will be entitled to be repaid the capital paid up on the Special Share before other shareholders receive any payment. The Special Shareholder has no other right to share in the capital or profits of QinetiQ. The Special Shareholder must give consent to a general meeting held on short notice. The Special Share entitles the Special Shareholder to require certain persons who hold (together with any person acting in concert with them) a material interest in QinetiQ to dispose of some or all of their Ordinary Shares in certain prescribed circumstances on the grounds of national security or conflict of interest. The Directors must register any transfer of the Special Share within seven days. Other reserves The translation reserve includes the cumulative foreign exchange difference arising on translation since the Group transitioned to IFRS. Movements on hedge instruments, where the hedge is effective, are recorded in the hedge reserve until the hedge ceases. The capital redemption reserve, which was created following the redemption of preference share capital and the bonus issue of shares, cannot be distributed. Own shares Own shares represent shares in the Company that are held by independent trusts and include treasury shares and shares held by the employee share ownership plan. Included in retained earnings at 31 March 2013 are 11,238,669 shares (2012: 12,819,460 shares). 102 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 28. Share-based payments The Group operates a number of share-based payment plans for employees. The total share-based payment expense in the year was £5.5m of which £3.8m related to equity settled schemes and £1.7m related to cash settled schemes (year to 31 March 2012: £4.2m, of which £3.7m related to equity settled schemes and £0.5m to cash settled schemes). 2003 Employee share option scheme (2003 ESOS) Under the employee share option scheme all employees as at 25 July 2003 received share options which vested when the Group completed its IPO and which must be exercised within ten years of grant. The options are settled by shares. Outstanding at start of year Exercised during year Forfeited during year Outstanding at end of year 2013 2012 Weighted average exercise price 2.3p 2.3p 2.3p 2.3p Number 461,242 (68,080) (40,848) 352,314 Weighted average exercise price 2.3p 2.3p 2.3p 2.3p Number 544,640 (40,848) (42,550) 461,242 The 2003 ESOS are equity-settled awards; those outstanding at 31 March 2013 had an average remaining life of 0.3 years (2012: 1.3 years). In respect of the share options exercised during the year, the average share price on the date of exercise was 178.2p (2012: 125.4p). The exercise price of the outstanding options was 2.3p. Of the outstanding awards at the year end 352,314 were exercisable (2012: 461,242). QinetiQ Share Option Scheme (QSOS) No new options were granted during the year under the QSOS. All outstanding share options vested and were forfeited during the prior year. The exercise price of QSOS options was equal to the average market price of the Group’s shares at the date of the grant. For 2012, the vesting of options outstanding at the end of the year depended on the growth of earnings per share (EPS) over the measurement period; 25% of options would vest if underlying EPS growth were 22.5% for the period and 100% would vest if growth were at least 52%. No options would vest if EPS growth were below 22.5%. Options would vest on a straight-line basis if EPS growth were between 22.5% and 52%. None of the performance conditions were met. Outstanding at start of year Forfeited during year Outstanding at end of year 2013 2012 Weighted average exercise price – – – Number – – – Weighted average exercise price 198.7p 198.7p – Number 3,349,939 (3,349,939) – QSOS grants are equity-settled awards and those outstanding at 31 March 2013 had an average remaining life of nil years (2012: nil years). There were no QSOS awards in 2013 (2012: nil). No options were outstanding at the year end (2012: nil). Performance Share Plan (PSP) In the year, the Group made awards of conditional shares to certain UK senior employees under the Performance Share Plan. The awards vest after three years with 50% of the awards subject to total shareholder return conditions and 50% subject to EPS conditions as detailed in the Remuneration Report. Outstanding at start of year Granted during year Forfeited/lapsed during year Outstanding at end of year 2013 Number of shares 3,684,486 4,857,004 (1,190,283) 7,351,207 2012 Number of shares 3,438,612 1,240,500 (994,626) 3,684,486 PSP awards are equity-settled awards and those outstanding at 31 March 2013 had an average remaining life of 1.8 years (2012: 1.1 years). There is no exercise price for these PSP awards. Monte Carlo modelling was used to fair value the TSR element of the awards at grant date. Assumptions used in the models included 29% (2012: 34%) for the average share price volatility of the FTSE comparator group and 47% (2012: 36%) for the average correlation to the comparator group. The weighted average fair value of grants made during the year was £1.35 (2012: £0.88). Of the options outstanding at the end of the year nil were exercisable (2012: nil). QinetiQ Group plc Annual Report and Accounts 2013 103 Financial statements Notes to the financial statements continued 28. Share-based payments continued Restricted Stock Units (RSU) In the year the Group granted RSU awards to certain senior US employees under the RSU plan. The awards vest over one, two, three and four years. Of the awards granted before 2012 half are dependent on achieving QNA organic profit growth targets and half on a time-based criterion. The time-based criterion requires the employee to have been in continual service up to the date of vesting. QNA organic profit growth is measured over the most recent financial year compared with the previous financial year, with 125% of this element awarded at a QNA organic profit growth rate above 15%, 100% awarded at 12.5%, 75% awarded at 10% and 25% awarded at 5%. The 2012 grants are entirely dependent on achieving QNA organic profit growth targets. 67.5% of the 2013 grants are dependent on achieving QNA organic profit growth targets and 32.5% are dependent on a time-based criterion. Outstanding at start of year Granted during year Exercised during year Forfeited/lapsed during year Outstanding at end of year 2013 Number of shares 5,458,526 2,379,877 (694,197) (1,894,345) 5,249,861 2012 Number of shares 7,936,513 1,651,250 (2,478,688) (1,650,549) 5,458,526 RSUs are equity-settled awards; those outstanding at 31 March 2013 had an average remaining life of 1.4 years (2012: 1.3 years). There is no exercise price for these RSU awards. The weighted average share price at date of exercise was £1.47 (2012: £1.14). The weighted average fair value of grants made during the year was £1.73 (2012: £1.10). Of the awards outstanding at the end of the year 24,031 were exercisable (2012: 20,724). Value Sharing Plan (VSP) In 2012 and 2011, the Group granted VSP awards to certain senior UK employees under the VSP Plan. The awards vest over a three-year performance period: 50% of the 2012 awards and 70% of the 2011 awards are dependent on creating additional shareholder value, measured as net cash returns to investors and the increase in PBT over an 8.5% hurdle; 50% of the 2012 awards and 30% of the 2011 awards are dependent on total shareholder return (TSR) against a comparator group of FTSE 250 listed companies (less investment trusts) over a three-year performance period. Half the awards vest three years from the date of grant, the remaining half of the awards vest four years from the date of grant. Further details of the vesting conditions of the scheme are in the Remuneration Report on page 54. Outstanding at start of year Granted during year Forfeited during year Outstanding at end of year 2013 Number of shares 11,105,340 – (255,300) 10,850,040 2012 Number of shares 6,287,640 5,361,300 (543,600) 11,105,340 VSP awards are equity-settled awards; those outstanding at 31 March 2013 had an average remaining life of 0.7 years (2012: 1.7 years). There is no exercise price for these VSP awards. Of the awards outstanding at the end of the year nil were exercisable (2012: nil). Group Share Incentive Plan (SIP) Under the QinetiQ Share Incentive Plan the Group offers UK employees the opportunity of purchasing up to £125 worth of shares a month at the prevailing market rate. The Group will make a matching share award of a third of the employee’s payment. The Group’s matching shares may be forfeited if the employee ceases to be employed by QinetiQ within three years of the award of the shares. There is no exercise price for these SIP awards. Outstanding at start of year Awarded during year Exercised during year Forfeited during year Outstanding at end of year 2013 Number of matching shares 1,319,468 217,899 (450,015) (77,689) 1,009,663 2012 Number of matching shares 1,382,025 358,350 (331,536) (89,371) 1,319,468 SIP matching shares are equity-settled awards; those outstanding at 31 March 2013 had an average remaining life of 1.5 years (2012: 1.5 years). There is no exercise price for these SIP awards. Of the shares outstanding at the end of the year nil were exercisable (2012: nil). 104 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Group Deferred Annual Bonus Plan (DAB) Under the QinetiQ Deferred Annual Bonus Plan the Group requires certain senior executives to defer part of their annual bonus as shares and be entitled to matching awards to a maximum of 1:1 based on EPS performance. The number that will vest is dependent on the growth of EPS over the measurement period of three years as detailed in the QSOS EPS conditions above. No awards will vest if EPS CAGR is less than 7% for options granted prior to 2013 and 3% for 2013 grants. Outstanding at start of year Granted during year Forfeited during year Outstanding at end of year 2013 Number of matching shares 448,682 470,119 (4,180) 914,621 2012 Number of matching shares 6,859 480,922 (39,099) 448,682 DAB matching shares are equity-settled awards; those outstanding at 31 March 2013 had an average remaining life of 1.8 years (2012: 2.2 years). There is no exercise price for these DAB awards. Of the shares outstanding at the end of the year nil were exercisable (2012: nil). Cash Alternative Units (CAU) In the year, the Group granted CAU awards to certain employees in the UK and US. Outstanding at start of year Awarded during year Exercised during the year Forfeited during year Outstanding at end of year 2013 Number of shares 1,309,000 1,407,729 (298,500) (171,250) 2,246,979 2012 Number of shares – 1,321,000 – (12,000) 1,309,000 CAUs are cash-settled awards which vest over one, two, three and four years from the date of grant. The CAUs have no performance criteria attached, other than the requirement that the employee remains in employment with the Group. Those awards outstanding at 31 March 2013 had an average remaining life of 1.7 years (2012: 1.8 years). There is no exercise price for these awards. The fair value of the grants at 31 March 2013 was £2.07 (2012: £1.59) being the Group’s closing share price on that day. The share price on the date of exercise was £1.67. The carrying amount of the liability of the grants at the balance sheet date was £1.8m (2012: £0.5m). Of the awards outstanding at the end of the year nil were exercisable. Share-based award pricing – other Share-based awards that vest based on non-market performance conditions, including certain PSP, RSUs and Deferred Annual Bonus awards, have been valued at the share price at grant, less attrition. For the 2003 Share Option Scheme, there was a pre-bonus issue weighted average share price of £1 and a weighted average exercise price of £1 based on third-party transactions in the Company’s shares in the period immediately before the issue of the share options. Before the IPO in February 2006, there was no active market for the Company’s shares and expected volatility was, therefore, determined using the average volatility for a comparable selection of businesses. Since the Group had no established pattern of dividend payments at this time, no dividends were assumed in this model. QinetiQ Group plc Annual Report and Accounts 2013 105 Financial statements Notes to the financial statements continued 29. Post-retirement benefits The Company has implemented IAS 19 (revised) ‘Employee benefits’ in the year ended 31 March 2013, electing to adopt this standard early. Comparative figures have been restated to show the effect of this early adoption. Refer to note 1 to the financial statements. Defined contribution plans In the UK the Group operates the Group Personal Pension Plan (GPP) for the majority of its UK employees. This is a defined contribution scheme managed by Zurich. A defined contribution plan is a pension plan under which the Group and employees pay fixed contributions to a third party financial provider. The Group has no legal or constructive obligations to pay further contributions if the fund does not hold sufficient assets to pay all employees the benefits relating to employee service in the current and prior periods. For defined contribution plans, the Group pays contributions to publicly or privately administered pension insurance plans on a mandatory, contractual or voluntary basis. The Group has no further payment obligations once the contributions have been paid. The contributions are recognised as an employee benefit expense when they are due. Prepaid contributions are recognised as an asset to the extent that a cash refund or a reduction in the future payments is available. Defined benefit pension plans A defined benefit plan is a pension plan that is not a defined contribution plan. Typically, defined benefit plans define an amount of pension benefit that an employee will receive on retirement, usually dependent on one or more factors such as age, years of service and final pensionable earnings. The liability recognised in the balance sheet in respect of defined benefit pension plans is the present value of the defined benefit obligation at the end of the reporting period less the fair value of plan assets. The defined benefit obligation is calculated bi-annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using interest rates of high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating to the terms of the related pension obligation. In countries where there is no deep market in such bonds, the market rates on government bonds are used. Actuarial gains and losses arising from experience adjustments and changes in actuarial assumptions are charged or credited to equity in other comprehensive income in the period in which they arise. Past-service costs are recognised immediately in income. In the UK the Group operates the QinetiQ Pension Scheme (‘the Scheme’) for a significant proportion of its UK employees. This provides future service pension benefits to transferring Civil Service employees. All Group employees who were members, or eligible to be members, of the Principal Civil Service Pension Scheme or the UKAEA principal Non-Industrial Superannuation Scheme were invited to join the DB section of the Scheme from 1 July 2001, together with all new employees who were previously members of schemes which are part of the Public Sector Transfer Club. The Scheme is a final salary plan, which provides benefits to members in the form of a guaranteed level of pension payable for life. The level of benefits provided depends on the members’ length of service and their salary in the final years leading up to retirement. In the Scheme, pensions in payment are generally updated in line with the consumer price index. The benefit payments are made from trustee-administered funds. Plan assets held in trusts are governed by UK regulations as is the nature of the relationship between the Group and the Trustees and their composition. Responsibility for the governance of the Scheme – including investment decisions and contribution schedules – lies jointly with the Company and the Board of Trustees. The Board of Trustees must be composed of representatives of the Company and plan participants in accordance with the Scheme’s regulations. The expected employer cash contribution to the Scheme for the year ending 31 March 2014 is £20.6m (2013: £40.8m). The Group has no further payment obligations once the contributions have been paid. Triennial funding valuation The most recent full actuarial valuation of the Scheme was undertaken as at 30 June 2011 and resulted in an actuarially assessed deficit of £74.7m. On the basis of this full valuation, the Trustees of the Scheme and the Company agreed the employer contribution rate of 12.7% from 30 June 2011, past service deficit recovery payments of £10.5m a year for a six-year period from 1 April 2012 and an immediate one-off contribution of £40m into the Scheme. As part of a package of measures to provide stability to the Scheme, the Company has also contributed an asset in the form of an interest through a Scottish limited partnership (see below) in a future income stream of approximately £2.5m per annum, increasing in line with the Consumer Price Index, for 20 years secured on certain properties owned by the Group. Finally, the Company and Trustees also agreed, in the year to 31 March 2012, the key provision that the Trustees will select the Consumer Price Index rather than the Retail Price Index as the relevant index for the increase of pensions in payment in respect of service before 1 June 2008 and for the revaluation of preserved benefits. Prior to this the Retail Price Index had always been used as the relevant index. This change resulted in a one-off past service credit of £141.4m in 2012. The next scheduled triennial valuation will be performed as at 30 June 2014. 106 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n QinetiQ’s Pension Funding Partnership Structure Following the 30 June 2011 valuation, a package of pension changes has been agreed with the Trustees to provide stability to the Scheme. As part of the package of proposals, on 26 March 2012 QinetiQ established the QinetiQ PFP Limited Partnership (the ‘Partnership’) with the Scheme. Under this arrangement, properties to the capitalised value of £32.3m were transferred to the Partnership. The transfers were affected through a 20-year sale and leaseback agreement. The Scheme’s interest in the Partnership entitles it to an annual distribution of approximately £2.5m for 20 years; indexed with reference to CPI. These contributions will replace part of the regular contributions made under the past deficit recovery payments plan. The Scheme’s interest in the Partnership will revert back to QinetiQ Limited in 2032. The Partnership is controlled by QinetiQ and its results are consolidated by the Group. Under IAS 19, the interest held by the Scheme in the Partnership does not qualify as a plan asset for the purposes of the Group’s consolidated financial statements and is therefore not included within the fair value of plan assets. As a result, the Group’s consolidated financial statements are unchanged by the Partnership. In addition, the value of the property transferred to the Partnership and leased back to QinetiQ remains on the balance sheet. QinetiQ retains the operational flexibility to substitute properties of equivalent value within the Partnership and has the option to settle outstanding amounts due under the interest before 2032 if it so chooses. Other UK schemes In the UK the Group has a small number of employees for whom benefits are secured through the Prudential Platinum Scheme. The net pension deficits of this scheme at 31 March 2013 amounted to £nil (2012: £nil). QinetiQ also offers employees access to a Group Self Invested Personal Pension Plan, but no Company contributions are paid to this arrangement. QinetiQ Pension Scheme net pension liability The fair value of the QinetiQ Pension Scheme assets, which are not intended to be realised in the short term and may be subject to significant change before they are realised, and the present value of the Scheme’s liabilities, which are derived from cash flow projections over long periods, and thus inherently uncertain, were: all figures in £ million Equities LDI investment* Corporate bonds Alternative bonds** Government bonds Property Other Total market value of assets Present value of Scheme liabilities Net pension liability before deferred tax Deferred tax asset Net pension liability 2013 487.3 205.9 276.8 174.8 – 81.3 30.4 1,256.5 (1,310.6) (54.1) 13.7 (40.4) 2012 583.2 – 194.6 – 183.5 82.4 64.2 1,107.9 (1,139.4) (31.5) 13.3 (18.2) 2011 564.1 – 158.7 – 165.3 78.0 15.0 981.1 (1,105.7) (124.6) 32.4 (92.2) 2010 714.6 – 69.5 – 69.6 53.4 8.8 915.9 (1,063.2) (147.3) 41.2 (106.1) 2009 473.7 – 78.4 – 83.2 – 12.1 647.4 (752.6) (105.2) 29.4 (75.8) * The Scheme has assets invested in a Liability Driven Investment portfolio. As at 31 March 2013 this hedges against approximately 14% of the interest rate and 11% of the inflation rate risk, as measured on the Trustees’ gilt-funding basis. ** Includes allocations to high-yield bonds, secured loans and emerging market debt. QinetiQ Group plc Annual Report and Accounts 2013 107 Financial statements Notes to the financial statements continued 29. Post-retirement benefits continued Changes to the fair value of Scheme assets all figures in £ million Opening fair value of Scheme assets Interest income on Scheme assets Re-measurement gain on Scheme assets Contributions by the employer Contributions by plan participants Net benefits paid out and transfers Administrative expenses Closing fair value of Scheme assets Changes to the present value of the defined benefit obligation all figures in £ million Opening defined benefit obligation Current service cost Interest cost Contributions by plan participants Actuarial loss/(gain) on Scheme liabilities based on: Change in financial assumptions Change in demographic assumptions Experience losses/(gains) Curtailment gain Past service gain Net benefits paid out and transfers Closing defined benefit obligation Total income/expense recognised in the income statement all figures in £ million Pension costs charged to the income statement: Current service cost Past service gain (including curtailments) Net interest on the net defined benefit liability Administrative expenses Total expense/(income) recognised in the income statement (gross of deferred tax) 2013 1,107.9 53.3 78.4 40.8 0.1 (22.0) (2.0) 1,256.5 2013 1,139.4 18.7 54.6 0.1 103.8 – 16.7 (0.7) – (22.0) 1,310.6 2013 18.7 (0.7) 1.3 2.0 21.3 2012 (restated^) 981.1 54.0 18.2 83.2 0.1 (27.0) (1.7) 1,107.9 2012 (restated^) 1,105.7 20.8 61.2 0.1 113.2 18.7 (10.8) – (142.5) (27.0) 1,139.4 2012 (restated^) 20.8 (142.5) 7.2 1.7 (112.8) ^ IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 comparatives have been restated accordingly. Refer to note 1 to the financial statements. 108 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Assumptions The major assumptions (weighted to reflect individual Scheme differences) were: Rate of increase in salaries Discount rate applied to Scheme liabilities CPI inflation assumption Assumed life expectancies in years: Future male pensioners (currently aged 60) Future female pensioners (currently aged 60) Future male pensioners (currently aged 40) Future female pensioners (currently aged 40) 2013 3.7% 4.4% 2.7% 88 90 90 92 2012 3.6% 4.8% 2.6% 88 90 90 92 The assumptions used by the actuary are the best estimates chosen from a range of possible actuarial assumptions which, because of the timescale covered, may not necessarily be borne out in practice. It is important to note that these assumptions are long term and, in the case of the discount rate and the inflation rate, are measured by external market indicators. The mortality assumptions as at 31 March 2013 were 90% of S1PMA for males and 100% of S1PFA for females, based on year of birth making allowance for improvements in mortality in line with CMI_2011 Core Projections and a long-term rate of improvement of 1.25% per annum. These assumptions are the same as in the prior year. The balance sheet net pension liability is a snapshot view which can be significantly influenced by short-term market factors. The calculation of the surplus or deficit depends, therefore, on factors which are beyond the control of the Group – principally the value at the balance sheet date of equity shares in which the Scheme has invested and long-term interest rates which are used to discount future liabilities. The funding of the Scheme is based on long-term trends and assumptions relating to market growth, as advised by qualified actuaries and investment advisors. The weighted average duration of the defined benefit obligation is approximately twenty years. Sensitivity analysis of the principal assumptions used to measure Scheme liabilities Assumption Discount rate Rate of inflation Salary increase Rate of mortality Change in assumption Increase/decrease by 0.1% Increase/decrease by 0.1% Increase/decrease by 0.1% Increase by one year Indicative impact on Scheme liabilities (before deferred tax) Decrease/increase by £25m Increase/decrease by £26m Increase/decrease by £4m Increase by £28m The above sensitivity analyses are based on a change in an assumption while holding all other assumptions constant. In practice, this is unlikely to occur, and changes in some of the assumptions may be correlated. When calculating the sensitivity of the defined benefit obligation to significant actuarial assumptions the same method (projected unit credit method) has been applied as when calculating the pension liability recognised within the statement of financial position. The methods and types of assumption did not change. Risks Through its defined benefit pension plans, the Group is exposed to a number of risks, the most significant of which are detailed below: Volatility in market conditions Choice of accounting assumptions Inflation rate risk Results under IAS 19 can change dramatically depending on market conditions. The defined benefit obligation is linked to yields on AA-rated corporate bonds, while many of the assets of the Scheme are invested in other assets. Changing markets in conjunction with discount rate volatility will lead to volatility in the net pension liability on the Group’s balance sheet and in other comprehensive income. To a lesser extent this will also lead to volatility in the IAS 19 pension expense in the Group’s income statement. The calculation of the defined benefit obligation (DBO) involves projecting future cash flows from the Scheme many years into the future. This means that the assumptions used can have a material impact on the balance sheet position and profit and loss charge. In practice future experience within the Scheme may not be in line with the assumptions adopted. For example, members could live longer than foreseen or inflation could be higher or lower than allowed for in the DBO calculation. The majority of the plan’s benefit obligations are linked to inflation, and higher inflation will lead to higher liabilities. The accounting assumptions noted above are used to calculate the year-end net pension liability in accordance with the relevant accounting standard, IAS 19 (revised) ‘Employee benefits’. Changes in these assumptions have no impact on the Group’s cash payments into the Scheme. The payments into the Scheme are reassessed after every triennial valuation. The triennial valuations are calculated on a funding basis and use a different set of assumptions, as agreed with the pension Trustees. QinetiQ Group plc Annual Report and Accounts 2013 109 Financial statements Notes to the financial statements continued 30. Transactions with the MOD The MOD continues to own its Special Share in QinetiQ which conveys certain rights as set out in note 27. Transactions between the Group and the MOD are disclosed as follows: Recovery of UK restructuring costs QinetiQ reached agreement with the UK MOD in March 2012 involving a payment to QinetiQ of £65m that was received after the year end in April 2012. The agreement involves the discharging of the MOD from its accumulated liabilities for restructuring costs incurred in previous years, together with MOD agreement to changes in its Special Shareholder rights, and certain other operational issues. Freehold land and buildings and surplus properties Under the terms of the Group’s acquisition of part of the business and certain assets of DERA from the MOD on 1 July 2001, the MOD retained certain rights in respect of the freehold land and buildings transferred. i) Restrictions on transfer of title The title deeds of those properties with strategic assets (see below) include a clause that prevents their transfer without the approval of the MOD. The MOD also has the right to purchase any strategic assets in certain circumstances. ii) Property claw-back agreement The MOD retains an interest in future profits on disposal following a ‘trigger event’. A ‘trigger event’ includes the granting of planning permission for development and/or change of use, and the disposition of any of the acquired land and buildings. During the 12 years from 1 July 2001, following a ‘trigger event’, the MOD is entitled to claw-back a proportion of the gain on each individual property transaction in excess of a 30% gain on a July 2001 professional valuation. The proportion of the excess gain due to the MOD is based on a sliding scale that reduces over time from 50% to 9% and at 31 March 2013 stood at 9% (2012: 16%). The July 2001 valuation was approximately 16% greater in aggregate than the consideration paid for the land and buildings on 1 July 2001. MOD’s generic compliance regime In the year ended 31 March 2013 the Group moved from the bespoke MOD Compliance Regime to a generic MOD conflict of interest management system (the ‘generic compliance system’) in alignment with that followed by other Defence companies. Adherence to the generic compliance system is monitored by the Risk & CSR Committee. Refer to the Corporate Governance Report on page 47. Strategic assets Under the Principal Agreement with the MOD, the QinetiQ controlled Group is not permitted without the written consent of the MOD, to: i) dispose of or destroy all or any part of a strategic asset; or ii) voluntarily undertake any closure of, or cease to provide a strategic capability by means of, all or any part of a strategic asset. The net book value of assets identified as being strategic assets as at 31 March 2013 was £1.4m (2012: £1.5m). Long-Term Partnering Agreement On 27 February 2003 QinetiQ Limited entered into a Long-Term Partnering Agreement to provide Test and Evaluation (T&E) facilities and training support services to the MOD. This is a 25-year contract with a total revenue value of up to £5.6bn, dependent on the level of usage by the MOD, under which QinetiQ Limited is committed to providing T&E services with increasing efficiencies through cost saving and innovative service delivery. 31. Contingent liabilities and assets Subsidiary undertakings within the Group have given unsecured guarantees of £54.3m at 31 March 2013 (2012: £55.1m) in the ordinary course of business. The Company has on occasion been required to take legal action to protect its intellectual property rights, to enforce commercial contracts or otherwise and similarly to defend itself against proceedings brought by other parties. Provisions are made for the expected costs associated with such matters, based on past experience of similar items and other known factors, taking into account professional advice received, and represent management’s best estimate of the likely outcome. The timing of utilisation of these provisions is uncertain pending the outcome of various court proceedings and negotiations. However, no provision is made for proceedings which have been or might be brought by other parties unless management, taking into account professional advice received, assesses that it is more likely than not that such proceedings may be successful. Contingent liabilities associated with such proceedings have been identified but the Directors are of the opinion that any associated claims that might be brought can be resisted successfully and therefore the possibility of any outflow in settlement is assessed as not probable. The Group has not recognised contingent amounts receivable relating to the Chertsey property which was disposed of during 2004 or the Fort Halstead property disposed of in September 2005. Additional consideration, subject to clawback due to the MOD pursuant to the arrangements referred to in note 30, is potentially due on the purchasers obtaining additional planning consents, with the quantum dependent on the scope of the consent achieved. The Group has also not recognised contingent amounts receivable relating to property impairments in prior years that may potentially be recovered from the MOD. Recovery is subject to future negotiations. It is not considered practicable to calculate the value of this contingent asset. 110 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n 32. Capital commitments The Group had the following capital commitments for which no provision has been made: all figures in £ million Contracted 2013 18.0 2012 14.1 Capital commitments at 31 March 2013 include £15.8m (2012: £13.0m) in relation to property, plant and equipment that will be wholly- funded by a third-party customer under long-term contract arrangements. 33. Subsidiaries The companies listed below are those which were part of the Group at 31 March 2013 and which, in the opinion of the Directors, significantly affected the Group’s results and net assets during the year. The Directors consider that those companies not listed are not significant in relation to the Group as a whole. A comprehensive list of all subsidiaries will be disclosed as an appendix to the Group’s annual return. Name of company Subsidiaries1,2,3 QinetiQ Holdings Limited QinetiQ Limited QinetiQ Overseas Holdings Limited QinetiQ North America, Inc. QinetiQ US Holdings, Inc. Analex Corporation Apogen Technologies, Inc. Foster-Miller, Inc. Westar Aerospace & Defence Group, Inc. Principal area of operation Country of incorporation UK UK UK USA USA USA USA USA USA England & Wales England & Wales England & Wales USA USA USA USA USA USA 1 Accounting reference date is 31 March. All principal subsidiary undertakings listed above have financial year ends of 31 March and 100% of the ordinary shares are owned by the Group. 2 QinetiQ Holdings Limited is a direct subsidiary of QinetiQ Group plc. All other subsidiaries are held indirectly by other subsidiaries of QinetiQ Group plc. 3 All companies except for holding companies are operating companies engaged in the Group’s principal activities as described on page 62. QinetiQ Group plc Annual Report and Accounts 2013 111 Company balance sheet as at 31 March all figures in £ million Fixed assets Investments in subsidiary undertaking Current assets Debtors Current liabilities Creditors amounts falling due within one year Net current assets Net assets Capital and reserves Equity share capital Capital redemption reserve Share premium account Profit and loss account Capital and reserves attributable to shareholders There are no other recognised gains and losses. Note 2013 2012 2 3 4 6 6 6 6 451.4 451.4 77.7 77.7 (140.1) (62.4) 389.0 6.6 39.9 147.6 194.9 389.0 447.6 447.6 – – (118.3) (118.3) 329.3 6.6 39.9 147.6 135.2 329.3 The financial statements of QinetiQ Group plc (company number 4586941) were approved by the Board of Directors and authorised for issue on 23 May 2013 and were signed on its behalf by: Mark Elliott Chairman Leo Quinn Chief Executive Officer David Mellors Chief Financial Officer 112 QinetiQ Group plc Annual Report and Accounts 2013 Notes to the Company financial statements 1. Accounting policies The following accounting policies have been applied consistently in dealing with items which are considered material in relation to the Company’s financial statements. Basis of preparation The financial statements have been prepared under the historical cost convention and in accordance with applicable UK accounting standards. As permitted by section 408(4) of the Companies Act 2006, a separate profit and loss account dealing with the results of the Company has not been presented. Investments In the Company’s financial statements, investments in subsidiary undertakings are stated at cost less any impairment in value. Share-based payments The fair value of equity-settled awards for share-based payments is determined on grant and expensed straight line over the period from grant to the date of earliest unconditional exercise. The fair value of cash-settled awards for share-based payments is determined at each period end until they are exercised or lapse. The value is expensed straight line over the period from grant to the date of earliest unconditional exercise. The charges for both equity and cash-settled share-based payments are updated annually for non-market-based vesting conditions. Further details of the Group’s share-based payment charge are disclosed in note 28 to the Group financial statements. The cost of share-based payments is charged to subsidiary undertakings. 2. Investment in subsidiary undertaking As at 31 March all figures in £ million Subsidiary undertaking – 100% of ordinary share capital of QinetiQ Holdings Limited Capital contributions arising from share-based payments to employees of subsidiaries 2013 424.3 27.1 451.4 2012 424.3 23.3 447.6 A list of all principal subsidiary undertakings of QinetiQ Group plc is disclosed in note 33 to the Group financial statements. O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l 3. Debtors As at 31 March all figures in £ million Amounts owed by Group undertakings 4. Creditors As at 31 March all figures in £ million Amounts owed to Group undertakings 5. Share capital The Company’s share capital is disclosed in note 27 to the Group financial statements. 2013 77.7 2012 – i n f o r m a (cid:2) o n 2013 140.1 2012 118.3 QinetiQ Group plc Annual Report and Accounts 2013 113 Financial statements Notes to the Company financial statements continued 6. Reserves all figures in £ million At 1 April 2012 Profit Purchase of own shares Share based payments – settlement Dividend paid Share-based payments At 31 March 2013 At 1 April 2011 Profit Purchase of own shares Dividend paid Share-based payments At 31 March 2012 Issued share capital 6.6 – – – – – 6.6 6.6 – – – – 6.6 Capital redemption reserve 39.9 – – – – – 39.9 39.9 – – – – 39.9 Share premium 147.6 – – – – – 147.6 147.6 – – – – 147.6 Profit and loss 135.2 75.7 (0.4) 0.7 (20.1) 3.8 194.9 145.0 14.8 (11.9) (16.4) 3.7 135.2 Total equity 329.3 75.7 (0.4) 0.7 (20.1) 3.8 389.0 339.1 14.8 (11.9) (16.4) 3.7 329.3 The capital redemption reserve is not distributable and was created following redemption of Preference Share capital. 7. Share-based payments The Company’s share-based payment arrangements are set out in note 28 to the Group financial statements. 8. Other information Directors’ emoluments, excluding Company pension contributions, were £3.3m (2012: £3.0m). These emoluments were all in relation to services provided on behalf of the QinetiQ Group with no amount specifically relating to their work for the Company. Details of the Directors’ emoluments, share schemes and entitlements under money purchase pension schemes are disclosed in the Remuneration Report. The remuneration of the Company’s auditors for the year to 31 March 2013 was £146,000 (2012: £15,000), which was for audit of the Group’s annual accounts and audit related assurance services. No other services were provided by the auditors to the Company. 114 QinetiQ Group plc Annual Report and Accounts 2013 O v e r v i e w B u s i n e s s r e v i e w C o r p o r a t e g o v e r n a n c e F i n a n c i a l s t a t e m e n t s i A d d (cid:2) o n a l i n f o r m a (cid:2) o n Five-year record for the years ended 31 March (unaudited) all figures in £ million UK Services US Services Global Products Revenue UK Services US Services Global Products Underlying operating profit1 QinetiQ North America EMEA Ventures Revenue QinetiQ North America EMEA Ventures Underlying operating profit1 Underlying operating margin1 Underlying profit before tax1 Profit/(loss) before tax Profit/(loss) after tax Underlying basic EPS1 (pence) Basic EPS (pence) Diluted EPS (pence) Dividend per share Underlying net cash from operations (post capex)1 Net cash/(debt) Average number of employees Orders £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m % £m £m £m Pence Pence Pence Pence £m £m £m 2013 597.3 475.6 254.9 1,327.8 85.8 21.9 61.0 168.7 20125 610.1 534.5 325.0 1,469.6 61.3 32.1 66.2 159.6 20114,5 652.7 607.3 442.6 1,702.6 45.7 45.9 52.1 143.7 12.7 152.1 (137.0) (133.2) 18.9 (20.5) (20.5) 3.80 175.9 74.0 9,772 1,076.8 10.9 110.2 316.3 246.3 13.6 37.9 37.6 2.90 235.4 (122.2) 10,637 1,226.3 8.4 103.8 7.9 (8.8) 13.0 (1.3) (1.3) 1.60 265.8 (260.9) 12,033 1,559.7 20103 800.1 818.8 6.5 1,625.4 67.7 61.1 (8.5) 120.3 7.4 85.7 (66.1) (63.3) 11.1 (9.7) (9.7) 1.58 20092 765.6 842.3 9.4 1,617.3 83.0 84.2 (15.6) 151.6 9.4 130.2 114.0 93.6 15.9 14.3 14.3 4.75 169.2 (457.4) 13,604 1,400.9 175.2 (537.9) 13,882 1,596.0 1 Underlying measures are stated before specific adjusting items. Definitions of underlying measures of performance are in the glossary on page 116. Underlying financial measures are presented because the Board believes these provide a better representation of the Group’s long-term performance trend. 2 Operating profit and operating margins for 2009 have been restated to show the net finance element of the IAS 19 pension cost in the finance income and expense lines. This was previously reported in other operating costs. 3 The Group’s management structure changed with effect from 1 April 2010. Segmental data for 2009 and 2010 has been retained on the old structure as reported in previous financial statements. 4 The 2011 figures have been restated to reflect the transfer of businesses from Global Products to UK Services and US Services at the beginning of the 2012 financial year. 5 IAS 19 (revised) ‘Employee Benefits’ has been adopted for 2013 and the 2012 and 2011 comparatives have been restated accordingly. Refer to note 1 to the financial statements. QinetiQ Group plc Annual Report and Accounts 2013 115 Glossary ABI Association of British Insurers AGM Annual General Meeting OHSAS Occupational Health and Safety Advisory Services Organic Growth The level of year-on-year growth, expressed as Book to bill ratio Ratio of funded orders received in the year to revenue for the year, adjusted to exclude revenue from the 25-year LTPA contract BPS Basis points BSI British Standards Institution a percentage, calculated at constant foreign exchange rates, adjusting comparatives to incorporate the results of acquired entities but excluding the results for any disposals or discontinued operations for the same duration of ownership as the current period CAGR Compound Annual Growth Rate C4ISR Command, control, communications, computers, intelligence, surveillance and reconnaissance COTS Commercial off-the-shelf CPI Consumer Price Index CR Corporate Responsibility DAB Deferred Annual Bonus DERA Defence Evaluation and Research Agency, the majority of which was transferred into QinetiQ in 2001 DHS US Department of Homeland Security DoD US Department of Defense DTR MOD’s Defence Training Rationalisation programme DE&S MOD’s Defence, Equipment and Support organisation EBITDA Earnings before interest, tax, depreciation and amortisation EMEA Europe, Middle East and Australasia EPS Earnings per share Funded backlog The expected future value of revenue from contractually committed and funded customer orders (excluding £3.4bn value of the remaining 15 years of the LTPA contract) Gearing ratio This is the ratio of net debt to adjusted EBITDA in accordance with the Group’s credit-facility ratios. EBITDA is adjusted to exclude charges for share- based payments. Net debt is adjusted to reflect the same exchange rates as used for EBITDA and to reflect other requirements of the debt-holders’ covenant calculations GWh Giga-Watt hours IAS IDIQ IFRS IPO International Accounting Standards Indefinite Delivery/Indefinite Quantity International Financial Reporting Standards Initial Public Offering KPI Key Performance Indicator LIBID London inter-bank bid rate LIBOR London inter-bank offered rate LSE London Stock Exchange LTPA Long-Term Partnering Agreement – 25-year contract established in 2003 to manage the MOD’s test and evaluation ranges MOD UK Ministry of Defence PBT Profit before tax PSP Performance Share Plan QNA QinetiQ North America QSOS QinetiQ Share Option Scheme R&D Research and development ROCE Return on Capital Employed RSU Restricted Stock Unit Specific adjusting items Net restructuring charges/recoveries; net pension finance expense; pension curtailment gains; pension past service gains; contingent payments on acquisition treated as remuneration; net gain/loss in respect of previously capitalised DTR programme bid costs; impairment of property; impairment of intangible assets; gain/loss on business combinations and divestments; gain/loss on disposal of investments; and tax thereon TSR Total Shareholder Return UK Corporate Governance Code Guidelines of the Financial Reporting Council to address the principal aspects of corporate governance UK GAAP UK Generally Accepted Accounting Practice Underlying basic earnings per share Underlying effective tax rate Underlying net cash from operations (post capex) Underlying net finance costs Underlying operating cash conversion Underlying operating margin Underlying operating profit Underlying profit before tax Basic earnings per share as adjusted to exclude ‘specific adjusting items’ The tax charge for the year excluding the tax impact of ‘specific adjusting items’ expressed as a percentage of underlying profit before tax Net cash inflow from operations before restructuring costs less net cash outflow on purchase/sale of intangible assets and property, plant and equipment Interest cost on the defined benefit pension scheme’s liability offset by the interest income on the scheme’s assets The ratio of underlying net cash from operations (post capex) to underlying operating profit excluding share of post-tax result of equity-accounted joint ventures and associates Underlying operating profit expressed as a percentage of revenue Operating profit as adjusted to exclude ‘specific adjusting items’ Profit before tax as adjusted to exclude ‘specific adjusting items’ Unfunded Orders Typically long-term contracts awarded by the US Government which the customer funds incrementally over the life of the contract. The Group does not recognise such awards into the reported backlog until funding is confirmed NASA National Aeronautics and Space Administration (USA) VSP Value Sharing Plan 116 QinetiQ Group plc Annual Report and Accounts 2013 Shareholder information Share administration The Company’s registrar is Equiniti. If you have any queries regarding your shareholding, including dividend payments and change of address notifications, please contact Equiniti, either in writing at the address shown on the next page, by telephone on 0871 384 2021* or online at https://help.shareview.co.uk – from here, if you need further assistance, you will be able to email Equiniti securely. Equiniti also offers Shareview, a free of charge service enabling you to access and maintain your shareholding online. Through Shareview you can register for electronic communications, see details of balance movements and complete certain amendments online, such as changes to dividend mandate instructions. To take advantage of Shareview, register online at www.shareview.co.uk, click on ‘Register’ and follow the steps. * Lines are open 8.30am to 5.30pm, Monday to Friday, excluding Bank Holidays. Calls to 0871 numbers are charged at 8p per minute plus network extras. Direct dividend payments If you would like to have your dividend paid directly into a UK bank or building society account, please contact Equiniti or complete the dividend mandate attached to your dividend cheque. The associated tax voucher will still be sent to your registered address. If you live outside the UK, Equiniti offers a global payments service which is available in certain countries and could enable you to receive your dividends direct into your bank account in your local currency. Further details can be obtained direct from Equiniti or online at www.shareview.co.uk. Consolidated tax vouchers Shareholders who have dividends paid direct into a bank or building society account receive a Consolidated Tax Voucher which details all dividends paid for the year. Under this process, a shareholder’s dividend is paid direct to their bank account each time a dividend is paid and once a year they receive a tax voucher detailing all dividends paid for that year. Shareholders who prefer to continue receiving tax vouchers with each dividend payment can contact Equiniti Registrars to request this. Electronic communications The Company offers shareholders the option to receive documentation and communications electronically, via the Company’s website. The wider use of electronic communications enables fast receipt of documents, reduces the Company’s printing, paper and postal costs and reduces the Company’s environmental impact. Shareholders can register for electronic communications at www.shareview.co.uk and may also cast their vote for the 2013 AGM online quickly and easily using the Sharevote service by visiting www.sharevote.co.uk. Donating shares to charity Analysis of Share Register at 31 March 2013 Shareholders with small numbers of shares which may be uneconomic to sell may wish to consider donating them to the charity ShareGift (registered charity no. 1052686). Details are available at www.sharegift.org.uk or by telephone on 020 7930 3737. Unsolicited telephone calls or correspondence We are aware that some shareholders might have received unsolicited telephone calls or correspondence concerning investment matters. These are typically from overseas-based ‘brokers’ who target UK shareholders, offering to sell them what often turn out to be worthless or high risk shares in US or UK investments. These ‘brokers’ can be very persistent and extremely persuasive. If you receive any unsolicited investment advice, check that the firm is properly authorised by the Financial Conduct Authority by visiting www.fca.gov.uk and selecting Financial Services Register, or report the matter to the FCA by calling 0800 111 6768. If the calls persist, hang up. If you deal with an unauthorised firm, you will not be eligible to receive payment under the Financial Services Compensation Scheme. Share price Details of current and historical share prices can be found on the Company’s website at www.QinetiQ.com/investors. The table below shows the share price trend during the year ended 31 March 2013. 220 210 200 190 180 170 160 150 140 130 120 M ar 12 Apr 12 M ay 12 Jun 12 Jul 12 Aug 12 Sep 12 Oct 12 N ov 12 Dec 12 Jan 13 Feb 13 M ar 13 The share prices used in the graph above are the mid-market closing prices as derived from the London Stock Exchange Daily Official List. By type of holder By size of holding Individuals Institutions and Others Total 1-500 501-1,000 1,001-5,000 5,001-10,000 10,001-100,000 Over 100,000 Total Number of holdings 6,338 936 7,274 4,534 710 1,288 252 260 230 7,274 % of total holdings 87.13% 12.87% 100.00% 62.33% 9.76% 17.71% 3.46% 3.58% 3.16% 100.00% Shares held 7,623,106 652,853,267 660,476,373 937,002 573,836 3,150,133 1,883,532 9,257,487 644,674,383 660,476,373 % of share capital 1.15% 98.85% 100.00% 0.14% 0.09% 0.48% 0.28% 1.40% 97.61% 100.00% QinetiQ Group plc Annual Report and Accounts 2013 117 i A d d ti o n a l i n f o r m a ti o n Business reviewCorporate governanceFinancial statementsOverview Additional information Key dates 25 July 2013 25 July 2013 7 August 2013 9 August 2013 6 September 2013 30 September 2013 21 November 2013 February 2014 31 March 2014 May 2014 Corporate website The Company’s website is www.QinetiQ.com. The QinetiQ Annual Report 2013 can be viewed at www.QinetiQ.com/Investors together with shareholder information and information on the Company, its performance, the Annual General Meeting and latest presentations. From the website, you can access the following: Latest information • Latest and historic share prices • Financial calendar • Regulatory (RNS) news • Corporate governance Shareholder services • Register online via Shareview • Common questions • Dividend history Archive information • Financial results and trading updates • Company reports • Company presentations Contacts • Investor contacts Corporate responsibility • Further details of our corporate responsibility policy can be found at www.QinetiQ.com/cr Investor relations app The QinetiQ Annual Report 2013 can also be viewed on our investor relations app for the iPad downloadable from the App Store. 118 QinetiQ Group plc Annual Report and Accounts 2013 Interim management statement Annual General Meeting Ordinary shares marked ex-dividend Final 2013 dividend record date Final 2013 dividend payment date Half year financial period end Half-yearly results announcement Interim management statement (provisional date) Financial year end Preliminary results announcement Company information Registered office Cody Technology Park Ively Road Farnborough Hampshire GU14 0LX Tel: +44 (0) 8700 100 942 Company Registration Number 4586941 Auditor KPMG Audit Plc Chartered Accountants 15 Canada Square London E14 5GL Registrar Equiniti Aspect House Spencer Road Lancing West Sussex BN99 6DA Advisors Corporate brokers J.P.Morgan 25 Bank Street London E14 5JP UBS Investment Bank 1 Finsbury Avenue London EC2M 2PP Principal legal advisor Ashurst LLP Broadwalk House 5 Appold Street London EC2A 2HA Designed by www.luminous.co.uk Photography Page 14 Glock © Crown copyright 2012 Page 15 Global Marine Trends fourtwentyseven design Registered office Cody Technology Park Ively Road, Farnborough Hampshire GU14 0LX United Kingdom Tel: +44 (0) 8700 100 942 www.QinetiQ.com Company Registration Number 4586941 ©QinetiQ Group plc QINETIQ/13/01287 Q i n e ti Q G r o u p p l c A n n u a l R e p o r t a n d A c c o u n t s 2 0 1 3

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