159711 Reed Report Cover 7/3/06 12:02 Page 1 > Elsevier > LexisNexis > Harcourt Education > Reed Business > R e e d E l s e v i e r A n n u a l i R e p o r t s a n d F n a n c i a l S t a t e m e n t s 2 0 0 5 Inspiring Discovery Annual Reports and Financial Statements 2005 For the Reed Elsevier Combined Businesses, Reed Elsevier PLC and Reed Elsevier NV 159711 Reed Report Cover 7/3/06 12:02 Page 2 Annual Reports and Financial Statements 2005 Financial highlights Report of the Chairman and the Chief Executive Officer Operating and financial review Structure and corporate governance Report of the Audit Committees Directors’ remuneration report Reed Elsevier combined financial statements Combined financial statements Accounting policies Notes to the combined financial statements Independent auditors’ report Reed Elsevier PLC annual report and financial statements Directors’ report Consolidated financial statements Group accounting policies Notes to the consolidated financial statements Independent auditors’ report on the consolidated financial statements Parent company financial statements Parent company accounting policies Independent auditors’ report on the parent company financial statements Reed Elsevier NV annual report and financial statements The Supervisory Board’s report The Executive Board’s report Consolidated financial statements Group accounting policies Notes to the consolidated financial statements Independent auditors’ report on the consolidated financial statements Additional information Parent company financial statements Parent company accounting policies Notes to the parent company financial statements Independent auditors’ report on the parent company financial statements Additional information Additional information for US investors Reed Elsevier combined businesses Reed Elsevier PLC Reed Elsevier NV Principal operating locations > 1 > 2 > 5 > 28 > 34 > 37 > 56 > 60 > 65 > 101 > 104 > 107 > 110 > 111 > 118 > 119 > 120 > 121 > 124 > 125 > 126 > 129 > 131 > 138 > 138 > 139 > 140 > 141 > 142 > 142 > 144 > 149 > 151 > 153 This document contains Annual Reports information and the Financial Statements in respect of the Reed Elsevier combined businesses and the two parent companies, Reed Elsevier PLC and Reed Elsevier NV. This, together with the separate summary document Reed Elsevier Annual Review and Summary Financial Statements 2005, forms the Annual Reports and Financial Statements of Reed Elsevier PLC and Reed Elsevier NV for the year ended 31 December 2005 and the two documents should be read together. Principal operating locations Reed Elsevier Annual Reports and Financial Statements 2005 153 Reed Elsevier 1-3 Strand, London WC2N 5JR, UK Tel: +44 (0)20 7930 7077 Fax: +44 (0)20 7166 5799 Radarweg 29 1043 NX Amsterdam, The Netherlands Tel: +31 (0)20 485 2434 Fax: +31 (0)20 618 0325 125 Park Avenue, 23rd Floor New York, NY 10017, USA Tel: +1 212 309 5498 Fax: +1 212 309 5480 Elsevier Reed Finance BV Radarweg 29 1043 NX Amsterdam, The Netherlands Tel: +31 (0)20 485 2434 Fax: +31 (0)20 618 0325 For further information or contact details, please consult our website: www.reedelsevier.com Elsevier Elsevier Radarweg 29 1043 NX Amsterdam, The Netherlands www.elsevier.com Elsevier The Boulevard, Langford Lane Kidlington, Oxford OX5 1GB, UK www.elsevier.com Elsevier 360 Park Avenue South New York NY 10010-1710, USA www.elsevier.com Elsevier Independence Square West Suite 300, The Curtis Centre Philadelphia, PA 19106-3399, USA www.us.elsevierhealth.com Elsevier 11830 Westline Industrial Drive St. Louis, M063146, USA www.us.elsevierhealth.com LexisNexis LexisNexis US 9393 Springboro Pike Miamisburg, Ohio 45342, USA www.lexisnexis.com LexisNexis US 121 Chanlon Road New Providence, N107974, USA www.martindale.com LexisNexis UK Halsbury House, 35 Chancery Lane London WC2A 1EL, UK www.lexisnexis.co.uk LexisNexis France 141 rue de Javel, 75747 Paris Cedex 15 France www.lexisnexis.fr Harcourt Education Harcourt School Publishers 6277 Sea Harbor Drive Orlando FL 32819, USA www.harcourtschool.com This report is printed on iRecycled Satin, manufactured from 70% FSC certified recycled fibres. Both the mill and printer involved in its production are accredited with ISO14001 environmental certification. The C02 emissions produced from the production and distribution of the Annual Reports and Financial Statements 2005 have been neutralised through forestry and energy friendly projects around the world. Holt Rinehart and Winston 10801 N. MoPac Expressway Building 3, Austin, TX 78759-5415, USA www.hrw.com Harcourt Assessment 19500 Bulverde Road San Antonio TX 78259, USA www.harcourtassessment.com Harcourt Achieve 10801 N. MoPac Expressway Building 3, Austin, TX 78759-5415, USA www.harcourtachieve.com Harcourt Education International Halley Court, Jordan Hill Oxford OX2 8EJ, UK www.harcourteducation.co.uk Reed Business Reed Business Information US 360 Park Avenue South New York NY 10010-1710, USA www.reedbusiness.com Reed Business Information UK Quadrant House, The Quadrant Sutton, Surrey SM2 5AS, UK www.reedbusiness.co.uk Reed Business Information Netherlands Hanzestraat 1 7006 RH Doetinchem The Netherlands www.reedbusiness.nl Reed Exhibitions Oriel House, 26 The Quadrant Richmond, Surrey TW9 1DL, UK www.reedexpo.com Designed by 35 London Printed in England by Greenaways 159711 Reed Report 01-27 7/3/06 12:03 Page 1 Reed Elsevier Annual Reports and Financial Statements 2005 1 Financial highlights For the year ended 31 December 2005 Reed Elsevier combined businesses Reported figures Revenue Operating profit Profit before tax Profit attributable to shareholders Net borrowings Adjusted figures Operating profit Profit before tax Profit attributable to shareholders Operating cash flow Operating margin Operating cash flow conversion Parent companies £ 2004 £m 4,812 766 631 459 2,532 1,066 934 687 1,013 22% 95% 2005 £m 5,166 839 701 462 2,694 1,142 1,002 754 1,080 22% 95% £ 2005 em 7,542 1,225 1,023 675 3,933 1,667 1,463 1,101 1,577 22% 95% Reported profit attributable Adjusted profit attributable Average US$: £/a exchange rate Reported earnings per share Adjusted earnings per share Dividend per share Reed Elsevier PLC Reed Elsevier NV 2005 £m 235 399 1.82 18.6p 31.5p 14.4p 2004 £m 235 363 1.83 18.6p 28.7p 13.0p Change % 0% +10% 0% +10% +11% 2005 em 338 551 1.25 g0.43 g0.70 g0.359 2004 am 338 505 1.24 a0.43 a0.64 a0.330 e 2004 am 7,074 1,126 928 675 3,570 1,567 1,373 1,010 1,490 22% 95% e % Change 0% +9% 0% +9% +9% % Change at constant currencies +7% +12% +14% +3% +8% +9% +11% +8% % Change at constant currencies +11% +11% The Reed Elsevier combined businesses encompass the businesses of Reed Elsevier Group plc and Elsevier Reed Finance BV, together with their two parent companies, Reed Elsevier PLC and Reed Elsevier NV (the “Reed Elsevier combined businesses”). The results of Reed Elsevier PLC reflect its shareholders’ 52.9% economic interest in the Reed Elsevier combined businesses. The results of Reed Elsevier NV reflect its shareholders’ 50% economic interest in the Reed Elsevier combined businesses. The respective economic interests of the Reed Elsevier PLC and Reed Elsevier NV shareholders take account of Reed Elsevier PLC’s 5.8% interest in Reed Elsevier NV. Following a regulation adopted by the European Parliament, the Reed Elsevier combined businesses and the two parent companies now prepare their consolidated financial statements in accordance with International Financial Reporting Standards (IFRS) with effect from the 2005 financial year. Comparative amounts for the year ended 31 December 2004 have been restated in accordance with Reed Elsevier’s accounting policies under IFRS, adopting a 1 January 2004 transition date, other than in respect of IAS39 – Financial Instruments, for which the transition date was 1 January 2005. Adjusted figures are presented as additional performance measures and are stated before the amortisation of acquired intangible assets, acquisition integration costs, gains on disposals and investments, related tax effects and movements on deferred tax balances not expected to crystallise in the near term. Reconciliations between the reported and adjusted figures are provided in the notes to the combined financial statements. The percentage change at constant currencies refers to the movements at constant exchange rates, using 2004 full year average and hedged rates. 159711 Reed Report 01-27 7/3/06 12:03 Page 2 2 Report of the Chairman and the Chief Executive Officer Report of the Chairman and the Chief Executive Officer We are pleased to report on a year of overall good progress at Reed Elsevier. Our financial targets of 5% organic revenue growth and double digit adjusted earnings growth at constant currencies have been delivered and are reiterated as our targets for 2006. Three of our four divisions are performing well and delivered on or exceeded their individual divisional targets for organic revenue growth. The Education business however disappointed in two significant markets and firm action is being taken to address the related product, marketing and organisational issues. Overall, revenue growth has accelerated, underlying operating margins have continued to improve, cash generation is strong, and good and growing returns achieved on invested capital. Strategically and operationally we have also made positive progress. We have expanded our content, introduced new innovative online information products and services, deployed market leading technology and expertise, widened our distribution in winning new customers globally, and broadened our product offerings to meet the expanding needs of our customers in a digital environment. One third of our revenues are now electronic and internet delivered, and the opportunities to add further value to our customers and shareholders through online information and applications is very promising. Financial results and progress Total revenues in 2005 were up 7% at constant currencies, with underlying revenue growth of 5% excluding acquisitions and disposals, up from the 3% underlying growth seen in 2004. In scientific and medical markets, demand has remained strong for scientific research and medical information within a more supportive funding environment particularly for online product and in the expanding health professions. In legal markets, good demand growth has been seen for online productivity tools and practice solutions, and in international online expansion and risk management. In education markets, strong growth in the US K-12 basal business, driven by success in an expanded state textbook adoptions market, was in large part offset by a weak supplemental market and a significant underperformance in the supplemental and assessment businesses. In business to business markets, we are now seeing a more positive overall environment. The exhibitions business grew strongly as markets recovered and, whilst print advertising remains subdued, the online services in which we have been investing over the last few years continued their rapid growth. Adjusted operating profits were up 8% at constant currencies, or 6% underlying, with operating margins showing underlying improvement of 0.2 percentage points through a combination of the revenue growth and firm cost control. Adjusted operating cashflow was strong at £1,080m/a1,577m, with a 95% conversion of adjusted operating profits into cash as capital expenditures levelled off and through tight management of working capital as the business expands. The return on capital employed in the business increased by 0.4 percentage points to 9.4% and recent acquisitions are delivering, or are expected to deliver, over 10% return on capital within three years, with continuing good growth in returns thereafter. Adjusted pre-tax profits at constant currencies were up 9%, and, including a lower effective tax rate, adjusted earnings per share were up 11%. The financial results are reported this year under International Financial Reporting Standards (IFRS) for the first time, with the comparative period restated accordingly. The derivation of our new benchmark figures is set out in note 9 to the combined financial statements. At reported exchange rates, total revenues were £5,166m/a7,542m, up 7% when reported in both sterling and euros, and adjusted earnings per share were up 10% for Reed Elsevier PLC at 31.5p and up 9% for Reed Elsevier NV at a0.70. The equalised final dividends proposed by the respective boards are 10.7p for Reed Elsevier PLC and a0.267 for Reed Elsevier NV, both up 11%. Together with the interim dividends, these give total dividends for the year of 14.4p and a0.359 respectively, up 11% for Reed Elsevier PLC and 9% for Reed Elsevier NV on the prior year dividends. (The difference in dividend growth rates reflects the impact of currency movements since the prior year dividend declaration dates.) This increase in dividends reflects the more progressive dividend policy announced last year that more closely aligns dividend growth with growth in adjusted earnings. Use of cash Free cashflow for the year before dividends increased by £108m/a150m to £764m/a1,116m. Of this, 44%, i.e. £336m/a491m, was paid out by way of dividends and 37%, i.e. £284m/a415m, was spent on acquisitions net of minor disposals. Having reviewed our financial position and outlook, we are introducing with effect from this year an annual share repurchase programme to further improve capital efficiency. The amount may vary from year to year but we would expect, subject to prevailing market and business conditions, 159711 Reed Report 01-27 7/3/06 12:03 Page 3 Reed Elsevier Annual Reports and Financial Statements 2005 3 to spend approximately $350m (£200m/a290m) on share repurchases in 2006 and approximately $1 billion (£600m/a870m) over three years. With the stronger free cash flow and positive growth outlook, we believe that this new programme will enhance shareholder returns whilst retaining the financial capability to continue to develop the business through both organic and acquisition investment. This programme, together with our dividend policy, is expected to return to shareholders in the region of 70–80% of free cash flow in 2006. The repurchase of shares in Reed Elsevier PLC and Reed Elsevier NV will reflect the equalisation ratio. It is expected that the free cashflow available after dividends and share repurchases will be used to make acquisitions that accelerate Reed Elsevier’s strategic development and growth, and deliver superior financial returns. To the extent that acquisition opportunities arise beyond the available free cashflow, we would expect these to be funded from debt. Divisional performance and business progress The Elsevier science and medical business saw strong subscription renewals, growing online sales and successful second half medical book publishing to deliver 8% revenue growth at constant currencies, including a part year contribution from the MediMedia MAP business acquired in August. Organic revenue growth was 5%, up from 4% in the prior year, with underlying margin similar to the prior year despite the costs of the newly launched Scopus database and other products. This revenue momentum should continue with opportunities to improve underlying margins through revenue growth and continued cost efficiency. LexisNexis showed very good growth in the year with delivery on the three key strategic initiatives: to expand the business from research into total practice solutions; to grow a significant business in risk management; and to expand internationally through innovative online product and services. Strong demand for online information and workflow solutions was seen in North American and International markets, and US corporate and federal markets saw continued recovery in online news and business information, higher patent volumes and strong demand in risk management. LexisNexis saw overall revenues up 13% at constant currencies and improving margins, with 6% organic revenue growth, against a target of 5% and against 4% growth in 2004. There was a strong contribution from recent acquisitions including Seisint, which saw continued strong demand for its powerful risk management products with 20% year on year sales growth. Harcourt Education had a disappointing year. There was a strong performance in the US schools basal business, taking a leading share in new state textbook adoptions in the core curriculum subjects in which we compete, coming no.1 in Elementary and no.2 in Secondary. This was however in large part offset by a combination of weak supplemental markets and significant underperformance in the supplemental and assessment businesses. In a weak supplemental market, we saw greater attrition in the backlist, which was not well aligned with the No Child Left Behind Act, and growth from new publishing was unable to compensate. In assessment, we won fewer new state testing contracts than anticipated and saw a cut back on catalog product in a slow new publishing year. Harcourt Education’s revenue growth was 3% at constant currencies, or 2% excluding acquisitions and disposals against the 9–10% growth targeted. Underlying margin was broadly maintained through firm cost management throughout the year. Firm action has been taken to address the performance issues in supplemental and assessment and to reinvigorate growth through management and organisational changes, new and accelerated publishing programmes, and much strengthened sales activities. The benefits of this should start to be felt in 2006 although the greater impact on revenue growth and margin development should be from 2007. 2006 is not a strong adoption year, but the years 2007 to 2009 are, and strong publishing plans are in place to maintain Harcourt’s leading adoption position. Reed Business, after several years of market decline and no growth, saw improvement in its markets, with strong demand for online services and exhibitions. The rapid growth in our online revenues reflects the benefit of the sustained investment in new online product and services over several years despite difficult business markets. Print advertising remained variable by geography and sector, in part reflecting migration to online. Reed Business revenues increased by 5% at constant currencies, both in total and underlying, against a 2005 organic growth target of 4–5% and the 2% growth achieved in the prior year, and saw margins improve. Whilst there is some uncertainty as to the economic outlook in major developed economies, the momentum going into 2006, particularly in exhibitions and online, is positive and Reed Business has the same 4–5% organic growth target as last year with further margin improvement expected. The operating and financial review describes the performances of our businesses in greater detail. Across our business, the focus has been on driving our business online, and the benefits of this are increasingly evident in the strengthening of our revenue growth. Online now accounts for one third of our revenues and, although print is still important and expanding, the longer term future and faster growth opportunities are online. For the customer, online products have greater utility, can be more widely 159711 Reed Report 01-27 7/3/06 12:03 Page 4 4 Report of the Chairman and the Chief Executive Officer accessed, can be integrated into workflows, and drive higher productivity. For Reed Elsevier, online provides opportunities to expand the product range, increase competitive differentiation, widen distribution, and build stronger relationships to deliver superior growth and margin improvement. The customer is a more effective professional; Reed Elsevier is a more valued partner. Board changes At the Annual General Meeting last year, Morris Tabaksblat retired as chairman after six years service. The boards are extremely grateful for the guidance that Morris provided over that period. He was an outstanding Chairman and guided the boards and management through a period of considerable change, first in helping to stabilise the business and then leading a period of strong recovery. John Brock also retired after six years service and we thank him for his substantial contribution in that time. Strauss Zelnick was elected as a non-executive director, bringing a wide experience of the media sector to our board discussions. Outlook Looking to 2006, the market environments in which we operate are broadly encouraging, and, whilst noting that 2006 is a slower year for state textbook adoptions, we are again targeting underlying revenue growth for 2006 of at least 5% and double digit adjusted earnings per share growth at constant currencies. Looking further out, we are encouraged by the growing momentum in the business and the success in developing and marketing innovative online services. 2007 to 2009 should also see the benefit of three strong years in the adoption calendar in US education. We will continue to focus on expanding the business and increasing the returns on capital. The share repurchase plan announced on 16 February 2006 will, we believe, enhance shareholder returns whilst retaining the financial flexibility to continue to increase the value of the business through acquisition as well as organic development. The longer term outlook is promising. We have a clear consistent strategy and growing market success. The digital environment continues to expand our opportunity and we are very focused on exploiting our content, brands, market positions and technology to drive sustainable long term growth for the benefit of our customers and shareholders alike. Finally, we want to take this opportunity to thank all at Reed Elsevier for their outstanding commitment and contribution during the year. Jan Hommen Chairman Sir Crispin Davis Chief Executive Officer 159711 Reed Report 01-27 7/3/06 12:03 Page 5 Operating and financial review Reed Elsevier Annual Reports and Financial Statements 2005 5 Description of business Reed Elsevier Reed Elsevier is one of the world’s leading publishers and information providers. The principal operations are in North America and Europe and include science and medical, legal, education and business publishing. Total revenues for the year ended 31 December 2005 were £5,166m/a7,542m principally derived from subscriptions, circulation and copy sales, advertising sales and exhibition fees. Reed Elsevier is well positioned in markets with attractive growth prospects and has a clear investment led growth strategy focused on building revenue momentum across all our businesses. Long term growth in our markets is expected to be sustained by the continuing demand for professional information. The increasing levels of scientific, medical, legal and business activity as well as the commitment to measurable improvements in educational standards are generating more demand for high quality, specialist information. In addition, professionals are looking for significant improvements in productivity through access to highly functional online services and associated workflow tools. Our strategy is aimed at delivering strong sales growth in our markets with innovative and superior products based on our content development skills and technology leadership supported by strong sales and marketing capabilities. We expect to see sustainable growth in our core information offerings and to develop these further through organic and acquisition investment to meet the expanding needs of our customers and to address emerging opportunities in new geographical and commercial markets. Our commitment to our ongoing investment programmes is aimed at delivering a comprehensive range of highly functional information based products and services that deliver greater productivity and success for our business and professional customers. Our strategy to deliver strong top line growth is accompanied by continued commitment to outstanding execution built on strong management, organisational effectiveness and tight cost control. We have established long term financial targets which are to achieve above market revenue growth and double digit adjusted earnings per share growth at constant currencies. The business is strongly cash generative. Elsevier Elsevier comprises worldwide scientific, technical and medical publishing and communications businesses. Total revenues for the year ended 31 December 2005 were £1,436m/ a2,097m. Elsevier is headquartered in Amsterdam and its principal operations are located in Amsterdam, London, Oxford, New York, Philadelphia, St Louis, San Francisco, Paris, Munich, Madrid, Singapore, Tokyo and Delhi. Growth in the scientific information market is driven by ever increasing scientific research and discovery and the demands for greater efficiency and productivity in the research process. In healthcare, advances in medical science and procedures and the demand for improved medical outcomes give rise to the need for high quality specialist information and associated online tools. The Science & Technology division of Elsevier supplies scientific and technical information for libraries, scientists and professionals across the world serving a wide range of research fields. It is the leading global academic journal publisher and each year publishes over 170,000 new research articles in some 1,200 journals and over 1,000 new book titles. Elsevier also publishes secondary material in the form of supporting bibliographic data, indexes and abstracts, and tertiary information in the form of review and reference works. Its flagship electronic product, ScienceDirect, is a full text online research service holding over 7 million scientific articles and an expanding portfolio of books currently Forward Looking Statements The Reed Elsevier Annual Reports and Financial Statements 2005 contain forward looking statements within the meaning of Section 27A of the Securities Act 1933, as amended, and Section 21E of the Securities Exchange Act 1934, as amended. These statements are subject to a number of risks and uncertainties and actual results and events could differ materially from those currently being anticipated as reflected in such forward looking statements. The terms ‘expect’, ‘should be’, ‘will be’, and similar expressions identify forward looking statements. Factors which may cause future outcomes to differ from those foreseen in forward looking statements include, but are not limited to: general economic conditions and business conditions in Reed Elsevier’s markets; exchange rate fluctuations; customers’ acceptance of its products and services; the actions of competitors; legislative, fiscal and regulatory developments; changes in law and legal interpretation affecting Reed Elsevier’s intellectual property rights and internet communications; and the impact of technological change. 159711 Reed Report 01-27 7/3/06 12:03 Page 6 6 Operating and financial review comprising 49 major reference works, 145 book series and seven handbooks in 170 volumes. The ScienceDirect database is accessed by over 10 million users each year and has provided significant improvements in productivity through quicker and easier access to high quality content. Elsevier continues to develop its electronic product offerings and in 2005 saw the first full year of operation of Scopus, an abstract and index database and navigational tool which significantly enhances research productivity. The Scopus database now has nearly 30 million abstracts of scientific research articles from 15,000 peer reviewed publications, 13 million patents, and references to 180 million web pages. The Health Sciences division of Elsevier comprises an international network of nursing, health professions and medical publishing and communications businesses. The division supplies healthcare and medical information to medical researchers, practicing professionals and students. Its principal geographic markets are the United States, the United Kingdom, Germany, France and Spain. The division publishes over 500 journals, including a number of journals for learned societies, and over 10,000 book titles and clinical reference works. Elsevier is also seeing acceleration in the development of electronic products. These include multimedia products for use by both medical faculties and students to support core textbooks as well as online products for practitioner reference. Internationally, Elsevier is leveraging both its print and online content into new markets through foreign language versions. The Excerpta Medica Communications business publishes customised information for healthcare professionals, medical societies and pharmaceutical companies. Elsevier aims to be the most valued source of information products for scientific researchers and health professionals. Its key strategic areas of focus are: quality of content; customer service and customer relations; development of productivity enhancing online solutions; expanded penetration of targeted high growth markets; and organisational efficiency. In 2005, Elsevier underwent a major reorganisation to upgrade its organisational capabilities and improve accountability and customer and product focus. Elsevier’s journals are generally sold to libraries on a paid subscription basis, with subscription agents facilitating the administrative process. Medical and healthcare journals are also frequently sold to individuals through direct mail and learned societies. Electronic products, such as ScienceDirect, Scopus and MDConsult, are generally sold by Elsevier’s dedicated sales force directly to customers and end users. Books are sold by Elsevier’s sales force through book stores, both traditional and online, wholesalers and, particularly in medical and healthcare markets, directly to customers. Competition within the science and technology and medical publishing fields is generally on a title by title basis. Competing journals are typically published by learned societies and by other professional publishers. To a limited extent, competing journals are also published using emerging business models such as the “open access” model whereby publications are free to the user and funded instead through fees charged to authors and from governmental and other subsidies, or the “open archiving” model whereby content is made freely available after a period following publication. LexisNexis LexisNexis provides legal, tax, regulatory and business information to professional, business and government customers internationally. Total revenues for the year ended 31 December 2005 were £1,466m/a2,140m. Legal and regulatory markets worldwide are seeing continuing growth driven by the increasing level of legislation and litigation, as well as the increasing number of lawyers. Additional opportunities are also developing beyond the core research market, through the delivery of value added services to meet demands for greater legal efficiency and productivity. Increasingly legal information and services are being delivered online, with considerable potential to deliver such products in markets outside the United States where online migration is significantly lower than in the US legal market. In recent years, LexisNexis has, with its comprehensive US public records databases, expanded in the market for risk management. This is growing dramatically due to increasing credit card losses and insurance fraud and the demand for identity verification. LexisNexis North America offers legal information products in electronic and print formats to law firms and practitioners, law schools and state and local governments in the United States and Canada. Headquartered in New York, the principal operations are located in Ohio, New Jersey and Florida. The North American Legal Markets division provides statutes and case law for all 50 US states and Canada as well as research, analysis and citation services from Matthew Bender, Michie and Shepard’s. The Martindale Hubbell Law Directory and martindale.com databases provide access to the qualifications and credentials of over one million lawyers and law firms worldwide. LexisNexis also increasingly provides total practice solutions, combining content with online workflow tools. These tools include electronic discovery, court docket tracking, e-filing, expert identification, legal document preparation, client development, and many other lawyer tasks. The Corporate and Federal Markets division offers LexisNexis products and services to corporations, federal government agencies and academic institutions together with news, business, financial and public records 159711 Reed Report 01-27 7/3/06 12:03 Page 7 Reed Elsevier Annual Reports and Financial Statements 2005 7 content. Its risk management applications are designed to assist customers in managing risk through fraud detection and prevention, identity verification, pre-employment screening and due diligence. Outside North America, LexisNexis International serves markets in Europe, Africa, Asia Pacific and Latin America with a range of local and international legal, tax, regulatory and business information in electronic and print formats. The most significant businesses are in the UK and France. LexisNexis aims to be the leading preferred provider of productivity enhancing information and information-based workflow and client development solutions in its markets. The key strategic areas of focus are: to expand the business from research into total practice solutions; to grow a significant business in risk management; to expand internationally through innovative online product and services; and to continuously improve cost effectiveness. LexisNexis’s principal competitor in US legal markets is West (The Thomson Corporation), while the principal US competitors in corporate and government markets are West, Factiva (a Reuters/Dow Jones joint venture) and Choicepoint. Major international competitors include The Thomson Corporation, Wolters Kluwer and Factiva. Harcourt Education Harcourt Education publishes school textbooks and related instructional and assessment materials, principally in the United States, the United Kingdom, Australia, New Zealand and southern Africa. Headquartered in New York, the principal operating locations are in Florida, Texas and Oxford. Total revenues for the year ended 31 December 2005 were £901m/a1,315m. Growth in Harcourt Education’s markets is driven by long standing commitments to improve educational standards. Such commitments remain strong and require sustained investment in proven educational programmes. In recent years, there has also been further emphasis on the measurement of the educational results of students, both to monitor and assist improvement in individual educational outcomes and to improve accountability. Overall funding for education is expected to continue to increase. In the United States, Harcourt School Publishers is a publisher of print and technology enabled instructional materials for students in kindergarten to 6th grade. Holt, Rinehart and Winston offers educational textbooks and related instructional materials for students in middle and secondary schools. The major customers of Harcourt Education’s US schools publishing businesses are state boards of education and local district and school boards. Of the 50 US states, 20 periodically purchase educational programmes through an adoption process. This process entails state education committees approving a shortlist of education materials from which school districts can purchase. The remaining 30 states without an adoption process, known as open territories, allow individual school districts to purchase any educational programmes. Harcourt Education has achieved strong performance in recent years both in the adoption states and open territories based on strong curriculum product in key subjects such as reading and literature, science and health and elementary maths and social studies. Harcourt Achieve is a publisher of supplemental school and adult education materials as well as providing professional development services for teachers. Greenwood-Heinemann publishes monograph and reference lists and professional resources for teachers. Harcourt Assessment develops assessment products and services for elementary, secondary and higher education as well as tests for practising and research psychologists. In educational testing, it provides a range of achievement, aptitude and guidance testing services for measuring student progress. It is well known for the Stanford Achievement Test, now in its 10th edition. In clinical testing, it provides psychologists with assessment tests for many aspects of human behaviour, intelligence and development. The Wechsler products, including the Wechsler Preschool and Primary Scale of Intelligence, are licensed for publication in over 30 countries. Outside the United States, Harcourt Education International is a provider of textbooks and related instructional materials to the UK primary and secondary schools market through the Heinemann, Rigby and Ginn imprints and other English language markets in Australia, New Zealand and southern Africa. Harcourt Education aims to be the leading provider of educational resources to improve student performance. The key strategic areas of focus are: to sustain high quality, effective product through strong editorial processes in new publishing and continuous innovation; to expand online teaching and assessment resources; to deepen customer relationships to become the provider of choice of customised solutions; and to improve cost effectiveness through further upgrade of organisational capabilities, investment in technology and cost reduction. The principal competitors of Harcourt Education are Pearson, McGraw Hill and Houghton-Mifflin. Reed Business Reed Business provides information and marketing solutions to business professionals in the United States, the United 159711 Reed Report 01-27 7/3/06 12:03 Page 8 8 Operating and financial review Kingdom, continental Europe, Australia and Asia. The division also organises trade exhibitions internationally. Total revenues for the year ended 31 December 2005 were £1,363m/a1,990m. Business to business magazines provide an effective marketing channel through which advertisers reach their target audiences, increasingly delivered through leading brands in each sector. Alongside print magazines, demand is growing for online products which provide improvements in productivity through quicker and easier access to more comprehensive and searchable data. Business to business marketing spend has been driven historically by levels of corporate profitability, which itself has followed overall growth in GDP and business investment. Reed Business Information publishes over 400 trade magazines, directories, newsletters and loose leaf publications, and over 200 websites and online services. Important magazine titles include Variety and Interior Design in the United States; Computer Weekly, Estates Gazette, Flight International and New Scientist in the United Kingdom; and Elsevier and FEM in the Netherlands. Reed Business Information also publishes directories in selected markets. Through its Reed Construction Data business, it provides nationwide coverage of construction project information for the United States. In the majority of Reed Business Information’s sectors, strong demand is being seen for online services. Reed Business Information has been particularly successful in developing online products and services, which have been growing at over 30% per annum and now account for nearly 20% of Reed Business Information revenues. These products include totaljobs.com, a major online recruitment site in the UK; ICIS-LOR, a global information and pricing service for the petrochemicals sector; zibb.nl, a business information service in the Netherlands; and Kellysearch.com, an industrial search engine which is being launched internationally. Reed Exhibitions organises trade exhibitions and conferences internationally, with 460 events in 38 countries, attracting over 90,000 exhibitors and more than 5 million visitors annually. Its exhibitions and conferences encompass a wide range of sectors, including IT, manufacturing, aerospace, defence, leisure, electronics, food and hospitality, travel and entertainment. Increasingly Reed Exhibitions is also developing online services to increase the effectiveness and efficiency of its trade shows. Reed Business Information aims to be the first choice of business professionals for information and decision support in its individual markets and for marketing services. Its key strategic areas of focus are: to continue to grow rapidly existing and new online products and services in key markets; to further upgrade the portfolio through investment, acquisition and divestment; to expand geographically in fast growing markets; and to continuously improve organisational effectiveness through investment in people, further development of online competencies, and cost reduction programmes. Business to business magazines are primarily distributed on a “controlled circulation” basis in the United States, whereby the product is delivered without charge to qualified buyers within a targeted industry group based on circulation lists developed and maintained by the publisher. Magazines distributed on this basis are wholly dependent on advertising for their revenues. In the United Kingdom, business magazines are distributed both on a “controlled circulation” basis and a “paid circulation” basis. In the Netherlands, a higher proportion of publications is sold by “paid circulation”. Distribution of magazines is conducted primarily through national postal services, supplemented by news-stand sales through unaffiliated wholesalers. Online products and services are generally sold through dedicated sales forces and intermediaries, including revenue sharing arrangements with other online service providers, and by direct promotion. Exhibition space is sold through industry specific and national sales teams. Reed Business Information’s titles compete with a number of publishers on a title by title basis in individual market sectors, the largest competitors being: Penton Media, Advanstar, VNU, Hanley Wood, McGraw Hill, and CMP Media (United Business Media) in the United States; EMAP, VNU and CMP Media in the United Kingdom; and Wolters Kluwer, VNU and SDU in the Netherlands. Competition in trade exhibitions and conferences is very fragmented. Within the United States, the main competitor is VNU. Outside the United States, competition comes primarily from industry focused trade associations and convention centre and exhibition hall owners. 159711 Reed Report 01-27 7/3/06 12:03 Page 9 Reed Elsevier Annual Reports and Financial Statements 2005 9 Resources and investment Reed Elsevier’s most important resources are its intangible publishing assets and its workforce of some 36,500 employees. Reed Elsevier’s businesses own numerous market leading brands, imprints, titles and technology platforms. Within Elsevier, ScienceDirect is the world’s largest full text online scientific research service. Many of Elsevier’s 1,700 journals are the foremost publications in their field and a primary point of reference for new research. The Lancet has been publishing medical research, news and analysis since 1823. Similarly, Elsevier’s booklist contains numerous pre-eminent and long standing titles. Within LexisNexis, lexis.com is recognised as one of the foremost online research tools for practicing lawyers, providing subscribers with access to over 4.9 billion searchable documents. The Shepard’s Citations Service is a well known and highly reputed reference resource (“Shepardizing” is a common process for US lawyers checking the authority of cases or statutory references). Many of the Harcourt Education brands and imprints, including Harcourt School and Holt, Rinehart & Winston have maintained market leading positions for over fifty years. The Stanford Achievement Test Series is the most widely recognised educational achievement test in the United States. Reed Business’s well known magazine titles such as Variety, Estates Gazette and Elsevier are widely read for their authoritative content and up to date industry intelligence, while many of the Reed Exhibitions shows, which include World Travel Market, Mipim, MIDEM, Batimat and the PGA Merchandise Show, are acknowledged as the premier marketing events in their field. Reed Elsevier maintains and enhances the value of its intangible assets through continuous investment in the brands and imprints, new publishing, innovative product and market development, and in the technology platforms and publishing infrastructure on which they are based. Within Elsevier, the most significant investments in recent years have been in the ScienceDirect platform, digitisation of the archive of over 7 million research articles, and in the Scopus database. Other significant areas of investment have been in new online clinical reference tools and other e-health products and in online editorial and production systems. In LexisNexis, substantial investment has been made in its online research functionalities and in the development of the global online delivery platform first launched in 2004 and now being rolled out in major territories. Significant investment has also been made in new content development and in expanded sales and marketing activities. A major second data centre was completed in 2005 to expand operational capabilities and provide greater flexibility in continuous delivery. Harcourt Education maintains significant and expanding investment in new educational textbook programmes, and, in 2005, successfully introduced the Stanford Learning First classroom based online interim assessment product and the Unison scoring, administration and reporting platform on which it is based. Within Reed Business, the focus has been on developing new online products and services, including webzines, recruitment sites, search and subscription information and data services. The ongoing investment includes the international expansion of the Kellysearch online industrial search engine and the continuing development of the successful Totaljobs.com online recruitment website together with investment in the enabling infrastructure for all these web services. Reed Exhibitions has also continued to expand its portfolio through new launches and geographical expansion. These investments are largely embedded within the cost base of the businesses as new product development and market initiatives are a continuous activity. Reed Elsevier’s workforce is highly skilled and a large proportion are graduates. We employ almost 6,000 IT specialists and developers, over 8,000 editorial staff, and some 10,000 specialist marketing, sales and customer service staff. Reed Elsevier aims to be an employer of choice, known for its best practices in recruiting and developing employees. We seek to employ a workforce which reflects the diversity of our customers and communities. Our labour and employment practices are consistent with the principles of the United Nations Global Compact regarding fair and non- discriminatory labour practices. Every two years or so we conduct a global employee opinion survey to identify areas for improvement. Every employee in the company takes part in the annual Personal Development Programme, which reviews skills and performance and identifies opportunities for recognition and advancement. The Personal Development Programme is also the primary tool for assessing and planning employee training. Reed Elsevier’s remuneration policies are designed to attract, retain and motivate employees of the highest calibre and experience needed to shape and execute strategy. The remuneration packages of the directors and senior executives comprise a balance between “fixed” remuneration and “variable performance related” incentives, including a variable annual cash bonus based on achievement of financial performance measures and individual key performance objectives, and longer term incentive schemes. Pension scheme membership is offered to all employees in the United Kingdom, the Netherlands, the United States and a number of other countries. 159711 Reed Report 01-27 7/3/06 12:03 Page 10 10 Operating and financial review Risks The key risks facing Reed Elsevier arise from the highly competitive and rapidly changing nature of our markets, the increasingly technological nature of our products and services, the international nature of our operations, and legal and regulatory uncertainties. Certain businesses are also affected by the impact on publicly funded customers of changes in funding and by cyclical pressures on advertising and promotional spending. Reed Elsevier has an established risk management procedure that is embedded into the operations of the businesses and is reviewed by the Boards and Audit Committees. Important specific risks that have been identified and are being addressed include: • Reed Elsevier’s businesses are dependent on the continued acceptance by our customers of our products and services and the prices which we charge for them. We cannot predict whether there will be changes in the future which will affect the acceptability of products, services and prices to our customers. • We are investing significant amounts to develop and promote electronic products and platforms. The provision of these products and services is very competitive and is to some extent subject to factors outside our control such as competition from new technologies and changes in regulation. There is no assurance that this investment will produce satisfactory long term returns. • Reed Elsevier’s businesses are increasingly dependent on electronic platforms and networks, primarily the internet, for delivery of their products and services. Although plans and procedures are in place to reduce such risks, our businesses could be adversely affected if their electronic delivery platforms and networks experience a significant failure, interruption, or security breach. • Our products and services are largely comprised of intellectual property content delivered through a variety of media. We rely on trademark, copyright, patent and other intellectual property laws to establish and protect our proprietary rights in these products and services. However, there is a risk that our proprietary rights could be challenged, limited, invalidated or circumvented. • Our businesses operate in over 100 locations worldwide and our earnings are subject to taxation in many differing jurisdictions and at differing rates. We seek to organise our affairs in a tax efficient manner, taking account of the jurisdictions in which we operate. However, tax laws that apply to Reed Elsevier businesses may be amended by the relevant authorities. Such amendments, or their application to Reed Elsevier businesses, could adversely affect our reported results. Our financial statements are expressed in pounds sterling and euros and are, therefore, subject to movements in exchange rates on the translation of the financial information of businesses whose operational currencies are other than our reporting currencies. The United States is our most important market and, accordingly, significant fluctuations in US dollar exchange rates could significantly affect our reported results. Further details on risk management and internal control procedures are set out in the Structure and Corporate Governance report on pages 28 to 33. We recognise that Reed Elsevier and its businesses have a direct impact on the environment, principally through the use of energy and water and waste generation and in our supply chain through paper use and print and production technologies. We are committed to reducing these impacts, whenever possible, by limiting resource use and by efficiently employing sustainable materials and technologies. We require our suppliers and contractors to meet the same objectives. We seek to ensure that Reed Elsevier’s businesses are compliant with all relevant environmental legislation and, accordingly, whilst environmental issues are important, we do not consider that they constitute a significant risk for Reed Elsevier. 159711 Reed Report 01-27 7/3/06 12:03 Page 11 Operating review Revenue Elsevier LexisNexis Harcourt Education Reed Business Total Adjusted operating profit Elsevier LexisNexis Harcourt Education Reed Business Unallocated items Total Reed Elsevier Annual Reports and Financial Statements 2005 11 £ 2004 £m 1,363 1,292 868 1,289 4,812 445 287 157 194 (17) 1,066 2005 £m 1,436 1,466 901 1,363 5,166 449 338 161 214 (20) 1,142 e 2004 am 2,004 1,899 1,276 1,895 7,074 654 422 231 285 (25) 1,567 2005 em 2,097 2,140 1,315 1,990 7,542 655 493 235 313 (29) 1,667 % Change at constant currencies +8% +13% +3% +5% +7% +5% +17% +2% +9% +8% Adjusted figures and constant currency growth rates are used by Reed Elsevier as additional performance measures. Adjusted operating profit is stated before the amortisation of acquired intangible assets and acquisition integration costs. Constant currency growth rates are based on 2004 full year average and hedged rates. Unless otherwise indicated, all percentage movements in the following commentary refer to performance at constant exchange rates and are stated before the amortisation of acquired intangible assets and acquisition integration costs. Key performance measures referred to in the commentary are further explained at the end of the Operating and Financial Review on page 27. Reported operating results, including amortisation of acquired intangible assets and acquisition integration costs, are analysed in note 1 to the combined financial statements and discussed further below in the Financial Review, and are reconciled to the adjusted figures in note 9 to the combined financial statements. The comparative 2004 figures have been restated to conform to the IFRS accounting basis now adopted. Unallocated items comprise corporate costs, return on pension scheme assets and interest on pension scheme liabilities. 159711 Reed Report 01-27 7/3/06 12:03 Page 12 12 Operating and financial review Elsevier Revenue Science & Technology Health Sciences Adjusted operating profit Adjusted operating margin £ 2004 £m 779 584 1,363 445 32.6% 2005 £m 785 651 1,436 449 31.3% e 2004 am 1,145 859 2,004 654 32.6% 2005 em 1,146 951 2,097 655 31.3% % Change at constant currencies +5% +11% +8% +5% -0.8pts Elsevier has had a successful year with strong demand for scientific research and medical information within a more supportive funding environment, particularly for online product and in the expanding health professions. Revenue and adjusted operating profits were ahead by 8% and 5% respectively at constant exchange rates including a part year contribution from the MediMedia MAP business acquired in August. Underlying revenue growth was on target at 5% and adjusted operating profits also grew 5%, with underlying margins similar to the prior year despite the significant costs of the newly launched Scopus product ahead of revenues building and other new product launches. Overall adjusted operating margins, at 31.3%, were 0.8 percentage points lower at constant currencies reflecting the lower margin of MediMedia MAP and other acquired businesses. The Science & Technology division saw underlying revenue growth of 5% at constant exchange rates. Subscription renewals were strong at 97%, slightly higher than in the prior year, and good online growth was seen in widening distribution through ScienceDirect and in secondary databases including initial sales of Scopus. There has been continued good take up of e-only contracts which now account for over 40% of journal subscriptions by value, and ScienceDirect continues to see strong growth in usage, up over 20% year on year. The MDL software business saw only modest growth as a result of the extended sales cycle as pharmaceutical companies migrate to the new platform. The books business performed well with a strong frontlist. 159711 Reed Report 01-27 7/3/06 12:03 Page 13 Elsevier revenue Reed Elsevier Annual Reports and Financial Statements 2005 13 Science & Technology £785m c1,146m Health Sciences £651m c951m Sterling £ 2004 2005 d Euro 2004 2005 £1,363m £1,436m c2,004m g2,097m Within Health Sciences, the focus has been on expanding world class content and information services, and building e-health workflow tools and applications. New online services were introduced, such as iConsult for the hospital and practitioner markets and new modules for the Evolve online platform for the US medical education market. Outside the US, we continue to build on strong positions and leverage our global network through versioning and geocloning of content and sharing electronic platforms and publishing infrastructure. In August, we acquired the MediMedia MAP business for a270m (£188m) with its leading positions in the French, Spanish and Italian medical publishing markets from which we expect strong growth from market demand and through innovation. The outlook for Elsevier is positive. Subscription renewals are strong, book publishing is expanding, new electronic product is developing well in the market, and distribution is widening. Organic revenue growth of 5% is targeted for 2006 with underlying margin improvement from good revenue growth and further cost efficiency. The Health Sciences division saw underlying growth of 6%, with good growth in US book sales, particularly for the expanding nursing and allied healthcare sectors, and in journals and pharma communications. 2005 saw accelerating online revenue growth with new product and platform releases, and growing and attractive opportunities to expand our business online. Outside the US, strong growth was seen in continental Europe and in Asia Pacific and Latin America with the UK held back by comparison with a particularly strong prior year. Total revenue growth at constant currencies was 11% including MediMedia MAP and other smaller acquisitions. Across Elsevier, the focus has been on execution. In Science & Technology, we have expanded content with an increase of more than 4% in the number of new research articles accepted, and new online services and features have been introduced to improve customer productivity. The Scopus database service, developed in close cooperation with the scientific community, continues to be well received in the market with well over 1,000 trial customers. We are expanding distribution of our electronic products globally in areas such as China as well as securing major new contracts and renewals, such as the contract to provide all our scientific content online to universities across the Netherlands. We are also developing more flexible customised offerings to expand further into corporate research markets and smaller and mid-sized institutions. A major reorganisation is nearing completion to move from a product-centric to a more market- focused organisation, with a real drive to improve customer relations and service levels, and to focus on under-penetrated and higher growth market segments. 159711 Reed Report 01-27 7/3/06 12:03 Page 14 14 Operating and financial review LexisNexis Revenue North America International Adjusted operating profit Adjusted operating margin £ 2004 £m 949 343 1,292 287 22.2% 2005 £m 1,095 371 1,466 338 23.1% e 2004 am 1,395 504 1,899 422 22.2% 2005 em 1,599 541 2,140 493 23.1% % Change at constant currencies +15% +7% +13% +17% +0.9pts LexisNexis had a very successful year with revenue growth continuing to build with strong demand for online information and related productivity tools, and further improvement in operating margins. Revenues and adjusted operating profits were up 13% and 17% respectively at constant exchange rates, including a full year contribution from Seisint and other recent acquisitions. Organic revenue growth excluding these acquisitions and minor disposals was 6%, against a target for the year of 5% and compares with the 4% growth achieved in the prior year, with underlying adjusted operating profits up 9%. Overall adjusted operating margins improved by 0.9 percentage points to 23.1% reflecting the good revenue growth and firm cost management. In North America, LexisNexis saw revenue growth of 15%, or 6% underlying. In North American Legal Markets, stronger demand was seen from law firms for online information and workflow tools as the total practice solutions strategy gains traction, to deliver organic revenue growth of 5%. In Corporate and Federal Markets, organic revenue growth was 8% with continued recovery in online news and business, higher volumes for the US patent and trademark office and strong demand in risk management. Additionally, the Seisint business acquired in September 2004 achieved 20% pro-forma year on year sales growth and strong profit growth despite higher security and other costs following the unauthorised access to its databases reported earlier in the year. Adjusted operating profits for LexisNexis North America were up 20%, or 11% underlying, with a 1.1 percentage point increase in adjusted operating margins due to the strong revenue growth and the gearing in the business. 159711 Reed Report 01-27 7/3/06 12:03 Page 15 LexisNexis revenue Reed Elsevier Annual Reports and Financial Statements 2005 15 North America £1,095m c1,599m International £371m c541m Sterling £ 2004 2005 d Euro 2004 2005 £1,292m £1,466m c1,899m g2,140m The outlook for LexisNexis is good. Revenue momentum is building in the business as organic and acquisition investment expands market opportunities and enhances value added and differentiated offerings. Organic revenue growth of 6–7% is targeted for 2006 and further margin improvement. The International business outside North America saw excellent growth in demand for online information and from new publishing with particularly strong performances in Europe and Africa. Organic revenue growth was 7%, driven by a 16% increase in online revenues, with underlying adjusted operating profits up 5% after further investment in Germany, Asia Pacific and Latin America. In LexisNexis, the focus in 2005 has been on combining content with online workflow tools to build total practice solutions, expanding online services internationally, and integrating Seisint within our risk management business. The success of our strategy is seen in the acceleration of growth in LexisNexis. There is significantly growing demand for practice solutions from law firms and businesses: Total Litigator, just launched, combines relevant research materials with advanced tools covering electronic discovery, court docket tracking, e-filing, expert identification, legal document preparation and many other litigator tasks, in one integrated online service; Totalsearch provides customers with a single interface to combine searches of their data with our materials; and client development tools help law firms identify business development opportunities and market themselves more effectively to existing and potential clients. Internationally, the roll out of the global legal platform has brought compelling functionalities to market. The integration of Seisint is well progressed, with product integration on the Seisint platform expected to be completed this year and the product development and sales and marketing activities now combined. The return on capital invested in Seisint is building quickly and is expected to get close to a 10% post tax return in only the second full year of ownership, and to continue to grow thereafter. 159711 Reed Report 01-27 7/3/06 12:03 Page 16 16 Operating and financial review Harcourt Education Revenue US Schools & Testing International Adjusted operating profit Adjusted operating margin £ 2004 £m 774 94 868 157 18.1% 2005 £m 806 95 901 161 17.9% e 2004 am 1,138 138 1,276 231 18.1% 2005 em 1,177 138 1,315 235 17.9% % Change at constant currencies +4% – +3% +2% -0.2pts Harcourt Education had a disappointing year with modest revenue growth, well behind target. Strong growth in the US basal business, driven by success in an expanded state textbook adoption market, was to a large part offset by a below market performance in supplemental and assessment. Revenues and adjusted operating profits were up 3% and 2% respectively at constant exchange rates. Organic revenue growth excluding acquisitions and disposals was 2%, against a target for the year of 9-10%, with underlying profits flat. Adjusted operating margins were only slightly lower by 0.2 percentage points to 17.9%, as the revenue shortfall was mostly mitigated by sales mix and firm cost management throughout the year. The Harcourt US Schools & Testing business saw underlying revenues and operating profits up 2% at constant currencies, with a strong performance in the K-12 basal business undermined by a weak supplemental market and significant underperformance in the supplemental and assessment business. The Harcourt US K-12 basal business saw strong revenue growth of 9% despite a lower than 75% implementation rate in relevant Texas adoptions due to the funding delays. Harcourt won a leading market share in new state textbook adoptions in the core curriculum subjects in which we compete, coming no.1 in Elementary with a 33% share and no. 2 in Secondary with a 23% share. Particular adoption successes were seen in Texas health and Florida social studies in Elementary and in literature and language arts and in Texas health and world languages in Secondary. 159711 Reed Report 01-27 7/3/06 12:03 Page 17 Harcourt Education revenue Reed Elsevier Annual Reports and Financial Statements 2005 17 US Schools & Testing £806m c1,177m International £95m c138m Sterling £ 2004 2005 d Euro 2004 2005 £868m £901m c1,276m g1,315m The Harcourt Education International business saw underlying revenues 1% lower, reflecting a weak UK instructional materials market as schools held back spending in the face of considerable funding uncertainties surrounding government initiatives. Adjusted operating profits were down 10% underlying, due to the revenue decline and investment in new assessment product. Despite the disappointment of 2005, we believe the outlook for Harcourt Education is positive. Although the addressable adoption market for Harcourt in 2006 is smaller than in 2005, the early market response to the 2006 adoption programme is encouraging and, as stated above, progress is expected in restoring growth to the supplemental and assessment businesses. Overall, organic revenue growth of 2–4% is targeted for 2006, whilst adjusted operating profits are expected to be lower due to the significant sales and marketing investment ahead of 2007 adoptions. In 2007–2009, the textbook adoption cycle sees a strong growth phase. Harcourt has a strong programme in development to capitalise on this opportunity, and also expects to see improved momentum in the supplemental and assessment businesses. The supplemental business saw revenue decline of 11% excluding acquisitions and disposals. This resulted from sharply reduced sales of the literacy backlist titles not aligned to the approaches prompted by the No Child Left Behind Act, and tighter budgets at the school level, partly caused by funds moving to large scale intervention programmes sold at the district level. Firm remedial action has been taken: a major repositioning of the frontlist publishing programmes to fit with NCLB orientation; a new product line under development to address the more comprehensive intervention need at district level; and significant upgrading and re-staffing of the sales force. Some positive impact from this will be seen in 2006, with revenue expected to return to growth, but the major effect will be in 2007. Harcourt Assessment saw underlying revenue decline of 1% reflecting the failure to win a satisfactory share of significant state testing contracts, limited new clinical frontlist publishing, and an unexpected cut back on school spending on traditional catalogue product. Again, significant action is being implemented to address the issues. Changes are being made at a senior management level, a major upgrade in sales management and in programme servicing is underway, the clinical publishing frontlist is being strengthened, and a step change is targeted in margin through an extensive cost reduction and efficiency programme. We expect a meaningful impact from these initiatives in 2006, with revenue returning to growth and margin improvement. Results will also benefit from the continuing rollout of the Stanford Learning First online interim assessment product in 2006. The early modules of Stanford Learning First and the Unison platform on which it is based have both been well received in the market and the prospects look promising. 159711 Reed Report 01-27 7/3/06 12:03 Page 18 18 Operating and financial review Reed Business Revenue Reed Business Information US UK Continental Europe Asia Pacific Reed Exhibitions Adjusted operating profit Adjusted operating margin £ 2004 £m 323 244 268 33 421 1,289 194 15.0% 2005 £m 324 259 270 39 471 1,363 214 15.7% e 2004 am 475 359 394 48 619 1,895 285 15.0% 2005 em 473 378 394 57 688 1,990 313 15.7% % Change at constant currencies – +6% – +14% +11% +5% +9% +0.7pts Reed Business had a successful year with stronger revenue growth, driven by rapidly growing online services and excellent growth in exhibitions. Margins improved further through revenue growth and firm cost management. Revenues and adjusted operating profits were up 5% and 9% respectively at constant exchange rates. Organic revenue growth was 5%, against a target for the year of 4-5% and compares with 2% in the prior year. Adjusted operating profit excluding acquisitions and disposals was 10%. The exhibitions business grew underlying revenues 11% whilst the magazines and information publishing businesses saw underlying revenue growth of 2%, which compares with a flat performance in the prior year. Adjusted operating margins increased by 0.7 percentage points to 15.7% despite the net cycling out of contribution from biennial joint venture exhibitions. The Reed Business Information magazine and information publishing businesses saw continued strong growth in online services whilst print advertising remains variable by geography and sector, in part reflecting migration to strongly growing online services. In the US, revenues were up 1% from continuing titles, i.e. excluding the manufacturing product news titles which are currently being sold, with adjusted operating profits up 20% through continuing cost actions. The Media division continues to perform well with other divisions broadly flat as print advertising migrates online. In the UK, organic revenue growth was 7% driven by strong growth in online recruitment and paid search. The property, science, aerospace and agriculture sectors performed well with weakness in the social care market. Adjusted operating profits were 15% ahead underlying due to strong revenue growth and firm cost control. In Continental Europe, underlying revenues and adjusted operating profits were 1% and 6% lower respectively, with a continuing depressed market environment in The Netherlands in particular. Focus on new online services, market share performance and yield management largely mitigated the weakness in the advertising market. Asia Pacific saw 8% underlying revenue growth with strong performances in Japan and Singapore. 159711 Reed Report 01-27 7/3/06 12:03 Page 19 Reed Elsevier Annual Reports and Financial Statements 2005 19 Reed Business revenue Reed Exhibitions £471m c688m Continental Europe £270m c394m Sterling £ 2004 2005 d Euro 2004 2005 US £324m c473m Asia Pacific £39m c57m UK £259m c378m £1,289m £1,363m c1,895m g1,990m The outlook for Reed Business is positive. Exhibition demand remains good, although the exceptional growth of 2005 is not expected to be repeated in 2006, and the growing online business is delivering growth in the magazine and information publishing business. Organic revenue growth of 4–5% and further margin improvement is targeted for 2006. Reed Exhibitions had a very successful year, with underlying revenue growth of 11% whilst adjusted operating profits grew 7%, or 15% before the cycling out of the contribution from a number of biennial joint venture exhibitions. Good growth was seen across the business, in the US, Europe and Asia- Pacific, with strong demand, new launches and a turnaround in some underperforming sectors. Particularly strong performances were seen in Japan and in the international entertainment and property shows. In Reed Business, the focus in 2005 has been on expanding our online services to the business communities we serve, through webzines, recruitment sites, search and subscription information and data services. Reed Business Information online revenues grew over 30% in the year to more than $300m and now account for nearly 20% of RBI revenues. This follows several years of sustained investment in online services, anticipating the shift from print to online in business market growth. The most developed territory, where we started investing first, is the UK and well illustrates the potential for our online services. Online revenues grew by over 30% in the UK in 2005 and now account for 35% of total revenues. Further continued development is underway of sector specific recruitment sites, expansion of the Kellysearch service for sourcing industrial components, and in providing more specialised search offerings. In addition to online, Reed Business has continued to invest in new titles and exhibitions and in upgrading formats. Growth is accelerating in China and other developing markets through launch and alliance, such as the exhibitions joint venture in China with Sinopharm announced in August. 159711 Reed Report 01-27 7/3/06 12:03 Page 20 20 Operating and financial review Financial review Reed Elsevier combined businesses Reported figures Revenue Operating profit Profit before tax Net borrowings Adjusted figures Operating profit Profit before tax Operating cash flow Operating margin Operating cash flow conversion £ 2004 £m 4,812 766 631 2,532 1,066 934 1,013 22% 95% 2005 £m 5,166 839 701 2,694 1,142 1,002 1,080 22% 95% e 2004 em 7,074 1,126 928 3,570 1,567 1,373 1,490 22% 95% 2005 em 7,542 1,225 1,023 3,933 1,667 1,463 1,577 22% 95% % Change at constant currencies +7% +12% +14% +8% +9% +8% Adjusted figures are presented as additional performance measures and are stated before the amortisation of acquired intangible assets, acquisition integration costs, gains on disposals and investments, related tax effects and movements on deferred tax balances not expected to crystallise in the near term. Reconciliations between the reported and adjusted figures are provided in the notes to the combined financial statements. Income statement Revenue, at £5,166m/a7,542m, increased by 7% expressed both in sterling and euros, and at constant exchange rates. Excluding acquisitions and disposals, underlying revenue growth was 5%. Reported figures Reported operating profits, after amortisation of acquired intangible assets and acquisition integration costs, at £839m/a1,225m were up 10% expressed in sterling and 9% expressed in euros against the £766m/a1,126m reported in 2004 restated under IFRS. The increase reflects the strong underlying operating performance and the contribution from acquisitions. The amortisation charge in respect of acquired intangible assets amounted to £276m/a403m, up £21m/a28m on the prior year, principally as a result of a full year’s amortisation for the Seisint and Saxon acquisitions made in 2004 and the MediMedia MAP acquisition from August 2005. Acquisition integration costs were £21m/a30m against £38m/a56m in the prior year. The reported profit before tax for the Reed Elsevier combined businesses, including amortisation of acquired intangible assets, acquisition integration costs and net gains on disposals and investments, was £701m/a1,023m, which is up 11% expressed in sterling and 10% expressed in euros. Revenue by business segment Revenue by geographical market Revenue by source Elsevier 28% LexisNexis 28% Harcourt Education 18% Reed Business 26% North America 57% United Kingdom 11% The Netherlands 4% Rest of Europe 16% Rest of world 12% Subscriptions 38% Circulation 33% Advertising 13% Exhibitions 9% Other 7% 159711 Reed Report 01-27 7/3/06 12:03 Page 21 Reed Elsevier Annual Reports and Financial Statements 2005 21 The reported tax charge of £237m/a346m compares with a charge of £170m/a250m in the prior year. The increase principally reflects movements in deferred tax balances, arising on unrealised exchange differences on long term inter-affiliate lending, that are recognised in the income statement under IFRS but are not expected to be realised in the foreseeable future. The reported profit attributable to shareholders of £462m/a675m is broadly flat against the £459m/a675m reported in the prior year, reflecting the strong operating performance of the business offset by the swing in non cash deferred tax balances referred to above. Adjusted figures Adjusted figures are used by Reed Elsevier as additional performance measures and are stated before amortisation of acquired intangible assets and acquisition integration costs, and, in respect of earnings, reflect a tax rate that excludes the effects of movements in deferred taxation assets and liabilities that are not expected to crystallise in the near term. Profit and loss on disposals and other non operating items are also excluded from the adjusted figures. Comparison at constant exchange rates uses 2004 full year average and hedged exchange rates. Adjusted operating profits, at £1,142m/a1,667m, were up 7% expressed in sterling and 6% in euros. At constant exchange rates, adjusted operating profits were up 8%, or 6% underlying excluding acquisitions and disposals. Underlying operating margins improved by 0.2 percentage points from the stronger revenue growth and through firm cost management. The overall adjusted operating margin, at 22.1%, was 0.1 percentage point lower than in the prior year reflecting the inclusion of lower margin acquisitions and currency effects, most particularly the year on year movement in hedge rates in Elsevier journal subscriptions. (The net benefit of the Elsevier science journal hedging programme is lower in 2005 than in 2004 as the effect of the weaker US dollar is systematically incorporated within the three year rolling hedging programme.) Within adjusted operating profits, the net pension expense (including the net pension financing items included within operating profit) was £100m/a146m, up £11m/a15m on the prior year principally reflecting the market decline in real corporate bond yields used to calculate pension service costs. The charge for share based payments was £57m/a83m, down from £59m/a87m in the prior year due principally to expiry of the 2000 long term incentive plan service period. Restructuring costs, other than in respect of acquisition integration, were £25m/a37m, increasing £7m/a11m on the prior year as the businesses are reorganised to improve cost efficiency and to better align behind the online growth opportunity. Net finance costs, at £140m/a204m, were £8m/a10m higher than in the prior year and included a £8m/a12m net credit on the mark-to-market of non-qualifying instruments and undesignated hedges under IAS 39 which applies from 1 January 2005. The increase in costs reflects higher interest rates and the financing of prior year and 2005 acquisitions, partly offset by the benefit of strong free cashflow. Adjusted profits before tax were £1,002m/a1,463m, up 7% expressed in both sterling and euros. At constant exchange rates, adjusted profits before tax were up 9%. The effective tax rate on adjusted earnings, at 24.6%, was lower than the 26.2% effective rate in the prior year, reflecting non recurrence of one off costs and a reduction in the corporation tax rate in the Netherlands. The effective tax rate on adjusted earnings excludes the effect of movements in deferred taxation assets and liabilities that are not Use of adjusted operating cash flow Currency profile 2005 adjusted pre-tax profit Currency profile 2005 net borrowings Net interest £142m/c207m Free cash flow after dividends £428m/c625m Taxation £174m/c254m Dividends £336m/c491m Sterling 19% Euro 29% US Dollar 46% Other 6% £2,355m c3,437m US Dollar £108m/c158m Sterling £413m/c604m £34m/c50m Euro Other 159711 Reed Report 01-27 7/3/06 12:03 Page 22 22 Operating and financial review expected to crystallise in the near term, and more closely aligns with cash tax costs. Adjusted operating profits and taxation are also grossed up for the equity share of taxes in joint ventures. The adjusted profit attributable to shareholders of £754m/a1,101m was up 10% expressed in sterling and up 9% expressed in euros. At constant exchange rates, adjusted profit attributable to shareholders was up 11%. Cash flows and debt Adjusted operating cashflow was £1,080m/a1,577m, up 7% expressed in sterling and 6% in euros on the prior year, and 8% at constant currencies. The conversion rate of adjusted operating profits into cashflow was strong at 95% (2004: 95%), reflecting the continuing focus on managing working capital as the business expands. Capital expenditure on fixed assets, included within adjusted operating cashflow, was £195m/a285m (2004: £192m/a282m) as investment levelled off, and included £102m/a149m (2004: £110m/a162m) in respect of capitalised development costs within intangible assets. Depreciation/amortisation of tangible fixed assets and capitalised development costs was £144m/a210m (2004: £126m/a185m). Net working capital excluding fixed assets and financing items (i.e. principally trade debtors, inventories and pre-publication costs, less trade creditors, deferred revenues and provisions) was £107m/a156m negative (2004: £177m/a250m negative), with the increase of £70m/a94m principally reflecting the growth of the business and currency translation effects. Net interest paid in the year of £142m/a207m (2004: £130m/a191m) was similar to the net finance costs. Tax paid of £171m/a250m (2004: £209m/a307m) was lower than the effective tax charge on adjusted earnings and the prior year due to refunds of tax paid on earlier assessments. Free cashflow – after interest and taxation – was £764m/a1,116m (2004: £656m/a966m), up £108m/a150m reflecting the strong operating cashflow performance and lower taxes paid. Dividends paid to shareholders in the year amounted to £336m/a491m (2004: £309m/a454m), the increase reflecting the more progressive dividend policy announced in February 2005. After dividends, free cashflow was £428m/a625m (2004: £347m/a512m), up 23% in sterling and 22% in euros. Acquisitions in 2005 were made for a total consideration of £307m/a448m, including £14m/a20m deferred to future years, and after taking account of net cash acquired of £8m/a12m. The amounts capitalised in respect of goodwill and intangible assets were £182m/a266m and £149m/a218m respectively, the principal intangible assets acquired being the MediMedia MAP journal titles and other brands, imprints and subscriber relationships. £9m/a13m was paid in respect of prior year acquisitions. Acquisition integration related spend in respect of the 2005 and other recent acquisitions amounted to £28m/a41m. The 2005 acquisitions contributed £7m/a10m to adjusted operating profit in the year and added £8m/a12m to net cash inflow from operating activities for the part year under Reed Elsevier ownership. Net borrowings at 31 December 2005 were £2,694m/a3,933m (2004: £2,532m/a3,570m), an increase of £162m in sterling and a363m in euros since 31 December 2004 due to foreign exchange translation effects following the significant strengthening of the US dollar between the beginning and end of the year. These translation effects increase net debt expressed in sterling by £268m and in euros by a518m, more than offsetting the benefit of free cashflow less dividend and acquisition spend. Net debt is stated including a fair value adjustment to increase gross debt by £175m/a256m under IFRS which is largely offset by the corresponding fair value of derivatives used to hedge the related debt instruments. Gross borrowings after fair value adjustments at 31 December 2005 amounted to £3,164m/a4,619m, denominated mostly in US dollars, and were partly offset by the fair value of related derivatives of £174m/a254m and cash balances totalling £296m/a432m invested in short term deposits and marketable securities. After taking into account interest rate derivatives, a total of 75% of Reed Elsevier’s gross borrowings were at fixed rates and had a weighted average interest coupon of 5.1% and an average remaining life of 4.0 years. Capital employed and returns The capital employed in the business at 31 December 2005 was £9,705m/a14,169m (2004: £8,579m/a12,096m), after adding back accumulated amortisation of acquired intangible assets and goodwill. The increase of £1,126m/a2,073m principally arises from currency translation effects (£767m/a1,549m), most particularly from the strengthening of the US dollar between 1 January and 31 December 2005, and from acquisitions (£318m/a464m). The return on average capital employed in the year was 9.4% (2004: 9.0%), and compares with an estimated weighted average cost of capital for Reed Elsevier of 7.5%. This return is based on adjusted operating profits, less tax at the 25% effective rate, and the average of the capital employed at the beginning and end of the year retranslated at average exchange rates. The improvement in the year reflects the good underlying profit growth and management of working capital. Acquisitions typically dilute the overall return initially, but build quickly to deliver longer term returns well over Reed Elsevier’s average for the business. The recent acquisitions made in the years 2002 to 2004 are delivering post tax returns in 2005 of 12%, 12% and 6% respectively and continue to grow well. 159711 Reed Report 01-27 7/3/06 12:03 Page 23 Reed Elsevier Annual Reports and Financial Statements 2005 23 Accounting policies Introduction The accounting policies of the Reed Elsevier combined businesses are described in the combined financial statements. The Reed Elsevier combined financial statements and the consolidated financial statements of Reed Elsevier PLC and Reed Elsevier NV are presented in accordance with International Financial Reporting Standards (IFRS). The most significant accounting policies in determining the financial condition and results of the combined businesses, and those requiring the most subjective or complex judgement, relate to the valuation of goodwill and intangible assets, share based remuneration, pensions and taxation. Revenue recognition policies, while an area of management focus, are generally straightforward in application as the timing of product or service delivery and customer acceptance for the various revenue types can be readily determined. Allowances for product returns are deducted from revenues based on historical return rates. Where sales consist of two or more components that operate independently, revenue is recognised as each component is completed by performance, based on attribution of relative value. Pre-publication costs incurred in the creation of content prior to production and publication are deferred and expensed over their estimated useful lives based on sales profiles. Such costs typically comprise direct internal labour costs and externally commissioned editorial and other fees. Estimated useful lives generally do not exceed five years. Annual reviews are carried out to assess the recoverability of carrying amounts. Development spend embraces investment in new product and other initiatives, ranging from the building of new online delivery platforms, to launch costs of new services, to building new infrastructure applications. Launch costs and other operating expenses of new products and services are expensed as incurred. The costs of building product applications and infrastructure are capitalised as intangible fixed assets and amortised over their estimated useful lives. Impairment reviews are carried out annually. estimated useful lives, subject to annual impairment review. Appropriate amortisation periods are selected based on assessments of the longevity of the brands and imprints, the market positions of the acquired assets and the technological and competitive risks that they face. Certain intangible assets, more particularly in relation to acquired science and medical publishing businesses, have been determined to have indefinite lives. The longevity of these assets is evidenced by their long established and well regarded brands and imprints, and their characteristically stable market positions. The carrying amounts of goodwill and intangible assets are regularly reviewed, at least twice a year. The carrying amounts of goodwill and intangible assets, including amounts arising on all significant acquisitions, on all acquisitions made in the previous financial year, and on any acquisitions for which there are indications of possible impairment, are compared with estimated values in use based on latest management cash flow projections. Key areas of judgement in estimating the values in use of businesses are the forecast long term growth rates and the appropriate discount rates to be applied to forecast cash flows. Based on the latest value in use calculations, no goodwill or intangible assets were impaired as at 31 December 2005. Share based remuneration Share based remuneration is accounted for in accordance with IFRS 2 – Share Based Payment and is determined based on the fair value of an award at the date of grant, and is spread over the vesting period on a straight line basis, taking into account the number of shares that are expected to vest. The fair value of awards is determined at the date of grant by use of a binomial model, which requires judgements to be made regarding share price volatility, dividend yield, risk free rate of return and expected option lives. The number of awards that are expected to vest requires judgements to be made regarding forfeiture rates and the extent to which performance conditions will be met. These assumptions are determined in conjunction with independent actuaries based on historical data and trends. Pensions Pension costs are accounted for in accordance with IAS19 – Employee Benefits. Goodwill and intangible assets Reed Elsevier’s accounting policy is that, on acquisition of a subsidiary or business, the purchase consideration is allocated between the net tangible and intangible assets other than goodwill on a fair value basis, with any excess purchase consideration representing goodwill. The valuation of intangible assets represents the estimated economic value in use, using standard valuation methodologies, including as appropriate, discounted cash flow, relief from royalty and comparable market transactions. Acquired intangible assets are capitalised and amortised systematically over their Accounting for defined benefit pension schemes involves judgement about uncertain events, including the life expectancy of the members, salary and pension increases, inflation, the return on scheme assets and the rate at which the future pension payments are discounted. Estimates for all of these factors are used in determining the pension cost and liabilities reported in the financial statements. These best estimates of future developments are made in conjunction with independent actuaries. Each scheme is subject to a periodic review by the independent actuaries. 159711 Reed Report 01-27 7/3/06 12:03 Page 24 24 Operating and financial review For defined contribution schemes, the net cost represents contributions payable. Taxation The Reed Elsevier combined businesses seek to organise their affairs in a tax efficient manner, taking account of the jurisdictions in which they operate. Reed Elsevier’s policy is to make prudent provision for tax uncertainties. Reed Elsevier’s policy in respect of deferred taxation is to provide in full for all taxable temporary differences using the balance sheet liability method. Deferred tax assets are only recognised to the extent that they are considered recoverable based on forecasts of available taxable profits against which they can be utilised over the near term. Treasury policies The boards of Reed Elsevier PLC and Reed Elsevier NV have requested that Reed Elsevier Group plc and Elsevier Reed Finance BV have due regard to the best interests of Reed Elsevier PLC and Reed Elsevier NV shareholders in the formulation of treasury policies. Financial instruments are used to finance the Reed Elsevier businesses and to hedge transactions. Reed Elsevier’s businesses do not enter into speculative transactions. The main treasury risks faced by Reed Elsevier are liquidity risk, interest rate risk and foreign currency risk. The boards of the parent companies agree overall policy guidelines for managing each of these risks and the boards of Reed Elsevier Group plc and Elsevier Finance SA agree policies (in conformity with parent company guidelines) for their respective business and treasury centres. These policies are summarised below. Liquidity Reed Elsevier maintains a range of borrowing facilities and debt programmes to fund its requirements, at short notice and at competitive rates. The significance of Reed Elsevier Group plc’s US operations means that the majority of debt is denominated in US dollars and is raised in the US debt markets. A mixture of short term and long term debt is utilised and Reed Elsevier maintains a maturity profile to facilitate refinancing. Reed Elsevier’s policy is that no more than US$1,000m of term debt issues should mature in any 12-month period. In addition, minimum levels of net debt with maturities over three years and five years are specified, depending on the level of the total borrowings. After taking account of the maturity of committed bank facilities that back short term borrowing, at 31 December 2005 and after utilising available cash resources, no borrowings mature in the next two years, 46% of borrowings mature in the third year, 11% in the fourth and fifth years, 29% in the sixth to tenth years, and 14% beyond the tenth year. In April 2005 Reed Elsevier renegotiated and amended the terms of its US$3,000m committed credit facility. At 31 December 2005, Reed Elsevier had access to US$3,000m (2004: US$3,000m) of committed bank facilities, of which US$115m was drawn. These facilities principally provide back up for short term debt but also security of funding for future acquisition spend in the event that commercial paper markets are not available. Of the total committed facilities, US$nil expires within one year (2004: US$750m), US$3,000m within two to three years (2004: US$nil), and US$nil within three to four years (2004: US$2,250m). Interest rate exposure management Reed Elsevier’s interest rate exposure management policy is aimed at reducing the exposure of the combined businesses to changes in interest rates. The proportion of interest expense that is fixed on net debt is determined by reference to the level of interest cover. Reed Elsevier uses fixed rate term debt, interest rate swaps, forward rate agreements and a range of interest rate options to manage the exposure. Interest rate derivatives are used only to hedge an underlying risk and no net market positions are held. At 31 December 2005, after taking account of interest rate and currency derivatives in a designated hedging relationship, US$4,063m of Reed Elsevier’s net debt was denominated in US dollars and net interest expense was fixed or capped on approximately US$3,080m of forecast US dollar net debt for the next 12 months. This fixed or capped net debt reduces to approximately US$1,730m by the end of the third year and reduces further thereafter with all designated interest rate derivatives which fix or cap expense and all but US$113m of fixed rate term debt (not swapped back to floating rate) having matured by the end of 2009 and 2012 respectively. At 31 December 2005, fixed rate US dollar term debt (not swapped back to floating rate) amounted to US$1.9 billion and had a weighted average life remaining of 6.7 years (2004: 10.0 years) and a weighted average interest coupon of 6.0%. Designated interest rate derivatives in place at 31 December 2005 which fix or cap the interest cost on an additional US$0.7 billion (2004: US$2.1 billion) of variable rate US dollar debt, have a weighted average maturity of 2.2 years (2004: 1.5 years) and a weighted average interest rate of 5.2%. At 31 December 2005 there were undesignated derivatives in place which fix the interest cost on an average of US$0.2 billion of debt in 2006. Foreign currency exposure management Translation exposures arise on the earnings and net assets of business operations in countries other than those of each parent company. These exposures are hedged, to a significant extent, by a policy of denominating borrowings in currencies 159711 Reed Report 01-27 7/3/06 12:03 Page 25 Reed Elsevier Annual Reports and Financial Statements 2005 25 where significant translation exposures exist, most notably US dollars. Currency exposures on transactions denominated in a foreign currency are required to be hedged using forward contracts. In addition, recurring transactions and future investment exposures may be hedged, within defined limits, in advance of becoming contractual. The precise policy differs according to the commercial situation of the individual businesses. Expected future net cash flows may be covered for sales expected for up to the next 12 months (50 months for Elsevier science and medical subscription businesses up to limits staggered by duration). Cover takes the form of foreign exchange forward contracts. As at 31 December 2005, the amount of outstanding foreign exchange cover designated against future transactions was US$1.1 billion. Elsevier Reed Finance BV Structure Elsevier Reed Finance BV, the Dutch resident parent company of the Elsevier Reed Finance BV group (“ERF”), is directly owned by Reed Elsevier PLC and Reed Elsevier NV. ERF provides treasury, finance and insurance services to the Reed Elsevier Group plc businesses through its subsidiaries in Switzerland: Elsevier Finance SA (“EFSA”), Elsevier Properties SA (“EPSA”) and Elsevier Risks SA (“ERSA”). These three Swiss companies are organised under one Swiss holding company, which is in turn owned by Elsevier Reed Finance BV. companies regarding interest and foreign currency exposures, implementation of International Financial Reporting Standards, and electronic collections and payment solutions. The average balance of cash under management in 2005, on behalf of Reed Elsevier Group plc and its parent companies, was approximately $0.4 billion. Liabilities and assets At the end of 2005, 87% (2004: 89%) of ERF’s gross assets were held in US dollars and 12% (2004: 10%) in euros, including $8.1bn (2004: $8.4bn) and a0.9bn (2004: a0.7bn) in loans to the Reed Elsevier Group plc group. Loans made to the Reed Elsevier Group plc group are funded from equity, long term debt of $1.3bn and short term debt of $0.7bn backed by committed bank facilities. Adoption of International Financial Reporting Standards Reed Elsevier now prepares financial statements under International Financial Reporting Standards (IFRS), with effect from the 2005 financial year. The 2004 financial statements have been restated under IFRS, adopting a 1 January 2004 transition date, other than in respect of IAS39 – Financial Instruments for which the transition date is 1 January 2005, as further described in note 33 to the combined financial statements. The required changes in Reed Elsevier accounting policies in adopting IFRS were in six major areas: Activities EFSA, EPSA and ERSA each focus on their own specific area of expertise. • Goodwill and intangible assets – goodwill is no longer amortised and intangible assets are generally amortised over shorter periods. EFSA is the principal treasury centre for the combined businesses. It is responsible for all aspects of treasury advice and support for Reed Elsevier Group plc’s businesses operating in Continental Europe, South America, the Pacific Rim, China and certain other territories, and undertakes foreign exchange and derivatives dealing services for the whole of Reed Elsevier. EFSA also arranges or directly provides Reed Elsevier Group plc businesses with financing for acquisitions and product development and manages cash pools and investments on their behalf. EPSA is responsible for the exploitation of tangible and intangible property rights whilst ERSA is responsible for insurance activities relating to risk retention. Major developments The committed bank facilities available to EFSA and certain of its other term debt agreements were renegotiated in 2005. EFSA also renegotiated various banking and cash management arrangements in Continental Europe and Asia, and continued to provide advice to Reed Elsevier Group plc • Employee benefits – pension costs and defined benefit scheme assets a nd liabilities are measured based on market values; the amount of any surplus or deficit is recognised in full in the balance sheet. • Share based remuneration – the fair value of share options, determined at date of grant, is expensed over the vesting period. • Financial instruments – with effect from 1 January 2005, all derivative financial instruments are measured at fair value; hedge accounting is only permissible where effectiveness criteria are met. • Deferred taxation – full provision is made for nearly all differences between the balance sheet amounts of assets and liabilities and their corresponding tax bases. • Dividends – accrual is made for dividends only when they have been formally declared by the directors. 159711 Reed Report 01-27 7/3/06 12:03 Page 26 26 Operating and financial review Parent companies Reported profit attributable Adjusted profit attributable Average US$:£/a exchange rate Reported earnings per share Adjusted earnings per share Dividend per share Reed Elsevier PLC Reed Elsevier NV 2005 £m 235 399 1.82 18.6 31.5p 14.4p 2004 £m 235 363 1.83 18.6p 28.7p 13.0p Change % 0% +10% 0% +10% +11% 2005 em 338 551 1.25 e0.43 e0.70 e0.359 2004 am 338 505 1.24 a0.43 a0.64 a0.330 Change % 0% +9% 0% +9% +9% Change at constant currencies % +11% +11% The Reed Elsevier combined businesses encompass the businesses of Reed Elsevier Group plc and Elsevier Reed Finance BV, together with their two parent companies, Reed Elsevier PLC and Reed Elsevier NV (the “Reed Elsevier combined businesses”). The results of Reed Elsevier PLC reflect its shareholders’ 52.9% economic interest in the Reed Elsevier combined businesses. The results of Reed Elsevier NV reflect its shareholders’ 50% economic interest in the Reed Elsevier combined businesses. The respective economic interests of the Reed Elsevier PLC and Reed Elsevier NV shareholders take account of Reed Elsevier PLC’s 5.8% interest in Reed Elsevier NV. Earnings per share For the parent companies, Reed Elsevier PLC and Reed Elsevier NV, adjusted earnings per share were respectively up 10% at 31.5p (2004: 28.7p) and 9% at a0.70 (2004: a0.64). Adjusted earnings are stated before the amortisation of acquired intangible assets, acquisition integration costs, net gains on disposals and other non operating items, related tax effects and movements in deferred tax balances not expected to crystallise in the near term. The difference in percentage change is attributable to the impact of currency movements on the translation of reported results and the effects of rounding. At constant rates of exchange, the adjusted earnings per share of both companies would have shown an increase of 11% over 2004. The reported earnings per share for Reed Elsevier PLC shareholders was 18.6p (2004: 18.6p) and for Reed Elsevier NV shareholders was a0.43 (2004: a0.43). Dividends Dividends to Reed Elsevier PLC and Reed Elsevier NV shareholders are equalised at the gross level, including the benefit of the UK attributable tax credit of 10% received by certain Reed Elsevier PLC shareholders. The exchange rate used for each dividend calculation – as defined in the Reed Elsevier merger agreement – is the spot euro/sterling exchange rate, averaged over a period of five business days commencing with the tenth business day before the announcement of the proposed dividend. The Board of Reed Elsevier PLC has proposed a final dividend of 10.7p, giving a total dividend of 14.4p for the year, up 11% on 2004. The Boards of Reed Elsevier NV, in accordance with the dividend equalisation arrangements, have proposed a final dividend of a0.267, which results in a total dividend of a0.359 for the year, up 9% on 2004. The difference in dividend growth rates reflects the movement in the euro:sterling exchange rate between dividend announcement dates. Dividend cover, based on adjusted earnings per share and the total of the interim and proposed final dividend for the year, was 2.2 times for Reed Elsevier PLC and 1.9 times for Reed Elsevier NV. Measured for the combined businesses on a similar basis, dividend cover was 2.1 times. Parent company financial statements The individual parent company financial statements for Reed Elsevier PLC and Reed Elsevier NV continue to be prepared under UK GAAP. Under Article 362.1 of Book 2 Title 9 of The Netherlands Civil Code, UK GAAP may be adopted by Dutch companies with international operations for the preparation of financial statements and, accordingly, UK GAAP has been adopted by Reed Elsevier NV for its individual parent company financial statements, thereby ensuring consistency. 159711 Reed Report 01-27 7/3/06 12:03 Page 27 Reed Elsevier Annual Reports and Financial Statements 2005 27 The source data for calculating the key performance measures is obtained from the Reed Elsevier financial reporting system. The adjusted figures are adopted as key performance measures since they measure performance without reference to non cash amortisation of intangible assets, mostly acquired in prior periods, which has no operational relevance to current performance. Acquisition integration expenses are excluded since they are a direct function of the relevant acquisition activity and not a reflection of ongoing operational performance. Underlying growth, excluding current and prior year acquisitions and disposals, is measured to give a proper assessment of year on year organic growth without distortion for part year contributions. Constant currency growth is measured to give a better reflection of year on year performance before translation effects in arriving at the reported figures in the reporting currencies of the parent companies. Targets in respect of the principal key performance indicators are established each year for Reed Elsevier and its four businesses, and are set out in the Report of the Chairman and the Chief Executive Officer and the Operating Review above. The derivations of adjusted operating profit, adjusted profit before tax, adjusted profit attributable, and adjusted operating cash flow are disclosed in note 9 to the combined financial statements. The derivation of the adjusted earnings per share of the parent companies is shown in note 9 to the Reed Elsevier PLC consolidated financial statements and note 8 to the Reed Elsevier NV consolidated financial statements. Key performance measures The key financial performance measures used by Reed Elsevier and the bases of their calculation are as follows: • Revenue – as reported in the financial statements. • Adjusted operating profit – reported operating profit before amortisation of acquired intangible assets, acquisition integration costs, and share of taxation of joint ventures. • Adjusted operating margin – adjusted operating profit expressed as a percentage of revenue. • Adjusted profit before tax – reported profit before tax before amortisation of acquired intangible assets, acquisition integration costs, share of taxation of joint ventures, disposal gains and other non operating items. • Effective tax rate on adjusted profit before tax – reflects the tax rate excluding movements on deferred tax balances not expected to crystallise in the near term, more closely aligning with cash taxes payable, and includes the benefit of deductible tax amortisation on acquired goodwill and intangible assets. • Adjusted profit attributable to shareholders – reported profit attributable to shareholders before amortisation of acquired intangible assets, acquisition integration costs, disposal gains and other non operating items, related tax effects and movements on deferred tax balances not expected to crystallise in the near term. • Adjusted earnings per share – adjusted profit attributable to shareholders of each parent company divided by the respective number of ordinary shares in issue. • Adjusted operating cash flow – cash generated from operations plus dividends from joint ventures less net capital expenditure on property, plant and equipment and internally developed intangible assets, and excluding payments in relation to acquisition integration costs. • Constant currency growth – growth rates calculated using the prior year average and hedged exchange rates. • Underlying growth – growth rates calculated excluding businesses acquired or disposed (or held for sale) in the current or previous financial year. • Return on capital employed – adjusted operating profit less taxation (at the effective rate for the year) expressed as a percentage of capital employed, being the aggregate of gross goodwill and acquired intangible assets, property, plant and equipment, internally developed intangible assets, working capital, less net pension obligations and provisions. 159711 Reed Report 28-54 7/3/06 12:04 Page 28 28 Structure and corporate governance Structure and corporate governance Structure Corporate governance Corporate structure Reed Elsevier came into existence in January 1993, when Reed Elsevier PLC and Reed Elsevier NV contributed their businesses to two jointly owned companies, Reed Elsevier Group plc, a UK registered company which owns the publishing and information businesses, and Elsevier Reed Finance BV, a Dutch registered company which owns the financing activities. Reed Elsevier PLC and Reed Elsevier NV have retained their separate legal and national identities and are publicly held companies. Reed Elsevier PLC’s securities are listed in London and New York, and Reed Elsevier NV’s securities are listed in Amsterdam and New York. Equalisation arrangements Reed Elsevier PLC and Reed Elsevier NV each hold a 50% interest in Reed Elsevier Group plc. Reed Elsevier PLC holds a 39% interest in Elsevier Reed Finance BV, with Reed Elsevier NV holding a 61% interest. Reed Elsevier PLC additionally holds an indirect equity interest in Reed Elsevier NV, reflecting the arrangements entered into between the two companies at the time of the merger, which determined the equalisation ratio whereby one Reed Elsevier NV ordinary share is, in broad terms, intended to confer equivalent economic interests to 1.538 Reed Elsevier PLC ordinary shares. The equalisation ratio is subject to change to reflect share splits and similar events that affect the number of outstanding ordinary shares of either Reed Elsevier PLC or Reed Elsevier NV. Under the equalisation arrangements, Reed Elsevier PLC shareholders have a 52.9% economic interest in Reed Elsevier, and Reed Elsevier NV shareholders (other than Reed Elsevier PLC) have a 47.1% economic interest in Reed Elsevier. Holders of ordinary shares in Reed Elsevier PLC and Reed Elsevier NV enjoy substantially equivalent dividend and capital rights with respect to their ordinary shares. The boards of both Reed Elsevier PLC and Reed Elsevier NV have agreed, except in exceptional circumstances, to recommend equivalent gross dividends (including, with respect to the dividend on Reed Elsevier PLC ordinary shares, the associated UK tax credit), based on the equalisation ratio. A Reed Elsevier PLC ordinary share pays dividends in sterling and is subject to UK tax law with respect to dividend and capital rights. A Reed Elsevier NV ordinary share pays dividends in euro and is subject to Dutch tax law with respect to dividend and capital rights. Compliance with codes of best practice The boards of Reed Elsevier PLC and Reed Elsevier NV have implemented standards of corporate governance and disclosure policies applicable to companies listed on the stock exchanges of the United Kingdom, the Netherlands and the United States. The effect of this is that a standard applying to one will, where practicable and not in conflict, also be observed by the other. The boards of Reed Elsevier PLC and Reed Elsevier NV support the principles and provisions of corporate governance set out in the Combined Code on Corporate Governance issued in July 2003 (the UK Code) and the Dutch Corporate Governance Code issued in December 2003 (the Dutch Code). Save as explained below, Reed Elsevier PLC, which has its primary listing on the London Stock Exchange, has complied throughout the period under review with the UK Code and Reed Elsevier NV, which has its primary listing on Euronext in Amsterdam, has complied throughout the period under review with the Dutch Code. The ways in which the relevant principles of corporate governance are applied and complied with within Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV are described below. The boards The boards of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV each comprise a balance of executive and non-executive directors who bring a wide range of skills and experience to the deliberations of the boards. All non-executive directors are independent of management and free from any business or other relationship which could materially interfere with the exercise of their independent judgement. All directors have full and timely access to the information required to discharge their responsibilities fully and efficiently. They have access to the services of the respective company secretaries, other members of Reed Elsevier’s management and staff, and its external advisors. Directors may take independent professional advice in the furtherance of their duties, at the relevant company’s expense. The boards of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc are harmonised. All the directors of Reed Elsevier Group plc are also directors of Reed Elsevier PLC and of Reed Elsevier NV. The Reed Elsevier PLC and Reed Elsevier NV shareholders maintain their rights to appoint individuals to 159711 Reed Report 28-54 7/3/06 12:04 Page 29 Reed Elsevier Annual Reports and Financial Statements 2005 29 the respective boards, in accordance with the provisions of the Articles of Association of these companies. Subject to this, no individual may be appointed to the boards of Reed Elsevier PLC, Reed Elsevier NV (either members of the Executive Board or the Supervisory Board) or Reed Elsevier Group plc unless recommended by the joint Nominations Committee. Members of the Committee abstain when their own re-appointment is being considered. In order to safeguard the agreed board harmonisation, the Articles of Association of Reed Elsevier NV provide that appointments of board members other than in accordance with nominations by the combined board, shall require a 2/3 majority if less than 50% of the share capital is in attendance. Given the still generally low attendance rate at shareholders meetings in the Netherlands, the boards believe that this qualified majority requirement is appropriate. On appointment and at regular intervals, directors receive training appropriate to their level of previous experience. This includes the provision of a tailored induction programme, so as to provide newly appointed directors with information about the Reed Elsevier businesses and other relevant information to assist them in performing their duties. Non-executive directors are encouraged to visit the Reed Elsevier businesses to meet directors and senior executives. All Reed Elsevier PLC and Reed Elsevier NV directors are subject to retirement at least every three years, and are able then to make themselves available for re-election by shareholders at the respective Annual General Meetings. As a general rule, non-executive directors of Reed Elsevier PLC and members of the Reed Elsevier NV supervisory board serve on the respective board for two, three year terms, although the boards may invite individual directors to serve up to one additional three year term. Reed Elsevier PLC The Reed Elsevier PLC board consists of six executive directors: Sir Crispin Davis – Chief Executive Officer, Mark Armour – Chief Financial Officer, Gerard van de Aast, Erik Engstrom, Andrew Prozes and Patrick Tierney, and seven independent non-executive directors: Jan Hommen (Chairman – appointed 27 April 2005), Mark Elliott, Cees van Lede, David Reid, Lord Sharman, Rolf Stomberg – senior independent non-executive director – and Strauss Zelnick (appointed 27 April 2005). The board met six times during the year. Messrs Elliott, Reid, Stomberg and Lord Sharman were each unable to attend one meeting. Mr van Lede was unable to attend two meetings, otherwise there was full attendance. At the Reed Elsevier PLC Annual General Meeting to be held on 18 April 2006, Messrs van de Aast, Elliott, van Lede, Reid and Tierney will retire by rotation. Being eligible, they will each offer themselves for re-election. Reed Elsevier NV Reed Elsevier NV has a two-tier board structure comprising a Supervisory Board of eight members, all of whom are independent non-executives, and an Executive Board of six members. The Executive Board is responsible for the management of the company and the Supervisory Board supervises the Executive Board. The members of the Supervisory Board are Jan Hommen (Chairman – appointed 28 April 2005), Dien de Boer-Kruyt, Mark Elliott, Cees van Lede, David Reid, Lord Sharman, Rolf Stomberg and Strauss Zelnick (appointed 28 April 2005). The Executive Board comprises Sir Crispin Davis – Chief Executive Officer, Mark Armour – Chief Financial Officer, Gerard van de Aast, Erik Engstrom, Andrew Prozes and Patrick Tierney. The board met six times during the year. Mrs de Boer-Kruyt and Messrs Elliott, Reid, Stomberg and Lord Sharman were each unable to attend one meeting. Mr van Lede was unable to attend two meetings, otherwise there was full attendance. At the Reed Elsevier NV Annual General Meeting to be held on 19 April 2006, Mrs de Boer-Kruyt and Messrs Elliott, van Lede and Reid will retire by rotation as members of the Supervisory Board, and Messrs van de Aast and Tierney will retire by rotation as members of the Executive Board. Being eligible, they will each offer themselves for re-election. Reed Elsevier Group plc The Reed Elsevier Group plc board consists of six executive directors: Sir Crispin Davis – Chief Executive Officer, Mark Armour – Chief Financial Officer, Gerard van de Aast, Erik Engstrom, Andrew Prozes and Patrick Tierney, and seven independent non-executive directors: Jan Hommen (Chairman – appointed 28 April 2005), Mark Elliott, Cees van Lede, David Reid, Lord Sharman, Rolf Stomberg and Strauss Zelnick (appointed 28 April 2005). The board met seven times during the year. Messrs Elliott, Reid, Stomberg and Lord Sharman were each unable to attend one meeting. Mr van Lede was unable to attend two meetings, otherwise there was full attendance. Biographical information in respect of the current members of the boards appears on pages 26 and 27 of the Annual Review and Summary Financial Statements. Elsevier Reed Finance BV Elsevier Reed Finance BV has a two-tier board structure comprising a Supervisory Board and an Executive Board. The Supervisory Board during the year comprised Roelof 159711 Reed Report 28-54 7/3/06 12:04 Page 30 30 Structure and corporate governance Nelissen – Chairman, Mark Armour and Dien de Boer-Kruyt, with the Management Board consisting of Willem Boellaard and Jacques Billy. Appointments to the Supervisory and Management Boards are made by the shareholders, in accordance with the company’s Articles of Association. The Management Board and the Supervisory Board met three times during the year. Mrs de Boer-Kruyt was unable to attend one meeting, otherwise there was full attendance. Mr Nelissen retired from the Supervisory Board on 31 December 2005 and Mr Rudolf van den Brink was appointed a member and Chairman of the Supervisory Board at that time. Board committees In accordance with the principles of good corporate governance, the following committees, all of which have written terms of reference, have been established by the respective boards. The terms of reference of these committees are published on the Reed Elsevier website, www.reedelsevier.com. Audit Committees Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc have established Audit Committees. The Committees comprise only non-executive directors, all of whom are independent. The Committees are chaired by Lord Sharman, the other members being David Reid and Strauss Zelnick. A report of the Audit Committees, setting out the role of the Committees and their main activities during the year, appears on pages 34 to 36. The Committees met five times during the year, and there was full attendance. The functions of an audit committee in respect of the financing activities are carried out by the supervisory board of Elsevier Reed Finance BV. Corporate Governance Committee Reed Elsevier PLC and Reed Elsevier NV have established a joint Corporate Governance Committee, which comprises only non-executive directors, all of whom are independent. The Committee is chaired by Jan Hommen, the other members being Dien de Boer-Kruyt, Mark Elliott, Cees van Lede, David Reid, Lord Sharman, Rolf Stomberg and Strauss Zelnick. The Committee met once during the year. Mrs de Boer-Kruyt was unable to attend the meeting, otherwise there was full attendance. During the period the Committee reviewed ongoing developments and best practice in corporate governance. The Committee assessed the performance of individual executive directors and, led by the senior independent director, also assessed the performance of the Chairman. Using questionnaires completed by all directors, the Committee reviewed the functioning and constitution of the boards and their committees. Based on these assessments, the Committee believes that the performance of each director continues to be effective and that they demonstrate commitment to their respective roles in Reed Elsevier. The Committee is also responsible for recommending the structure and operation of the various committees of the boards and the qualifications and criteria for membership of each Committee, including the independence of members of the boards. Nominations Committee Reed Elsevier PLC and Reed Elsevier NV have established a joint Nominations Committee, which provides a formal and transparent procedure for the appointment of new directors to the boards. The Committee comprises a majority of independent non-executive directors. The Committee is chaired by Jan Hommen, the other members being Sir Crispin Davis – Chief Executive Officer, Cees van Lede, Lord Sharman and Rolf Stomberg. Although he is not independent, the boards believe that it is appropriate for the Chief Executive Officer to be a member of the Committee, since he provides a perspective which assists the Committee in nominating candidates to the board who will be able to work as a team with both the executive and non-executive directors. The Committee met six times during the year. Mr Tabaksblat, who retired in April 2005, was unable to attend one meeting and Lord Sharman was unable to attend two meetings, otherwise there was full attendance. The Committee’s terms of reference include assuring board succession and making recommendations to the boards of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc concerning the appointment or reappointment of directors to, and the retirement of directors from, those boards. In conjunction with the Chairman of the Reed Elsevier Group plc Remuneration Committee and external consultants, the Committee is also responsible for developing proposals for the remuneration and fees for new directors. Based on the assessment by the Corporate Governance Committee of the qualifications and performance of each individual director, the Nominations Committee recommends the re-appointment of the directors seeking re-election at the Annual General Meetings in 2006. Remuneration Committee Reed Elsevier Group plc has established a Remuneration Committee which comprises only independent non-executive directors. The Committee is chaired by Rolf Stomberg, the 159711 Reed Report 28-54 7/3/06 12:04 Page 31 Reed Elsevier Annual Reports and Financial Statements 2005 31 other members being Mark Elliott and Cees van Lede. The Committee met six times during the year. Mr van Lede was unable to attend one meeting, otherwise there was full attendance. The Committee is responsible for recommending to the board the remuneration in all its forms of executive directors of Reed Elsevier Group plc, and provides advice to the Chief Executive Officer on the remuneration of executives at a senior level below the board. It also makes recommendations to the board of Reed Elsevier PLC and to the Supervisory Board of Reed Elsevier NV regarding the remuneration of the executive directors of these companies. The fees of non-executive directors of Reed Elsevier PLC and of the Supervisory Board members of Reed Elsevier NV are determined by the Board of Directors, within the limits set out in the Articles of Association, as approved by shareholders. A Directors’ Remuneration Report, which has been approved by the boards of Reed Elsevier Group plc, Reed Elsevier PLC and Reed Elsevier NV, appears on pages 37 to 53. This report also serves as disclosure of the directors’ remuneration policy, and the remuneration and interests in shares of the directors of two parent companies, Reed Elsevier PLC and Reed Elsevier NV. Relations with shareholders Reed Elsevier PLC and Reed Elsevier NV participate in regular dialogue with institutional shareholders, and presentations on the Reed Elsevier combined businesses are made after the announcement of the interim and full year results. The boards of Reed Elsevier PLC and Reed Elsevier NV commission periodic reports on the attitudes and views of the companies’ institutional shareholders and the results are the subject of formal presentations to the respective boards. A trading update is provided at the respective Annual General Meetings of the two companies, and near the end of the financial year. The Annual General Meetings provide an opportunity for the boards to communicate with individual shareholders. The Chairman, the Chief Executive Officer, the Chief Financial Officer, the Chairmen of the board committees, other directors and a representative of the external auditors are available to answer questions from shareholders. The interim and annual results announcements and presentations, together with the trading updates and other important announcements and corporate governance documents concerning Reed Elsevier, are published on the Reed Elsevier website, www.reedelsevier.com. The Combined Board of Reed Elsevier NV has adopted rules governing the functioning of the boards and the relationship with shareholders, reflecting the requirements of the Dutch Code. Internal control Parent companies The boards of Reed Elsevier PLC and Reed Elsevier NV exercise independent supervisory roles over the activities and systems of internal control of Reed Elsevier Group plc and Elsevier Reed Finance BV. The boards of Reed Elsevier PLC and Reed Elsevier NV have each adopted a schedule of matters which are required to be brought to them for decision. In relation to Reed Elsevier Group plc and Elsevier Reed Finance BV, the boards of Reed Elsevier PLC and Reed Elsevier NV approve the strategy and the annual budgets, and receive regular reports on the operations, including the treasury and risk management activities, of the two companies. Major transactions proposed by the boards of Reed Elsevier Group plc or Elsevier Reed Finance BV require the approval of the boards of both Reed Elsevier PLC and Reed Elsevier NV. The Reed Elsevier PLC and Reed Elsevier NV Audit Committees meet on a regular basis to review the systems of internal control and risk management of Reed Elsevier Group plc and Elsevier Reed Finance BV. Operating companies The board of Reed Elsevier Group plc is responsible for the system of internal control of the Reed Elsevier publishing and information businesses, while the boards of Elsevier Reed Finance BV are responsible for the system of internal control in respect of the finance group activities. The boards of Reed Elsevier Group plc and Elsevier Reed Finance BV are also responsible for reviewing the effectiveness of their system of internal control. The boards of Reed Elsevier Group plc and Elsevier Reed Finance BV have implemented an ongoing process for identifying, evaluating, monitoring and managing the more significant risks faced by their respective businesses. This process has been in place throughout the year ended 31 December 2005 and up to the date of the approvals of the Annual Reports and Financial Statements 2005. Reed Elsevier Group plc Reed Elsevier Group plc has an established framework of procedures and internal controls, and with which the management of each business is required to comply. Group businesses are required to maintain systems of internal control, which are appropriate to the nature and scale of their activities and address all significant operational and financial risks that they face. The board of Reed Elsevier Group plc 159711 Reed Report 28-54 7/3/06 12:04 Page 32 32 Structure and corporate governance has adopted a schedule of matters that are required to be brought to it for decision. of the Elsevier Reed Finance BV group is reviewed each year by its external auditors. Reed Elsevier Group plc has a Code of Ethics and Business Conduct that provides a guide for achieving its business goals and requires officers and employees to behave in an open, honest, ethical and principled manner. The Code also outlines confidential procedures enabling employees to report any concerns about compliance, or about Reed Elsevier’s financial reporting practice. Each Business Group has identified and evaluated its major risks, the controls in place to manage those risks and the level of residual risk accepted. Risk management and control procedures are embedded into the operations of the business and include the monitoring of progress in areas for improvement that come to management and board attention. The major risks identified include business continuity, protection of IT systems and data, challenges to intellectual property rights, management of strategic and operational change, evaluation and integration of acquisitions, and recruitment and retention of personnel. The major strategic risks facing the Reed Elsevier Group plc businesses are considered by the board. Litigation and other legal and regulatory matters are managed by legal directors in Europe and the United States. The Reed Elsevier Group plc Audit Committee receives regular reports on the management of material risks and reviews these reports. The Audit Committee also receives regular reports from both internal and external auditors on internal control matters. In addition, each Business Group is required, at the end of the financial year, to review the effectiveness of its internal controls and report its findings on a detailed basis to the management of Reed Elsevier Group plc. These reports are summarised and, as part of the annual review of effectiveness, submitted to the Audit Committee of Reed Elsevier Group plc. The Chairman of the Audit Committee reports to the board on any significant internal control matters arising. Elsevier Reed Finance BV Elsevier Reed Finance BV has established policy guidelines, which are applied for all Elsevier Reed Finance BV companies. The boards of Elsevier Reed Finance BV have adopted schedules of matters that are required to be brought to them for decision. Procedures are in place for monitoring the activities of the finance group, including a comprehensive treasury reporting system. The major risks affecting the finance group have been identified and evaluated and are subject to regular review. The controls in place to manage these risks and the level of residual risk accepted are monitored by the boards. The internal control system Annual review As part of the year end procedures, the boards of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV have reviewed the effectiveness of the systems of internal control and risk management during the last financial year. The objective of these systems is to manage, rather than eliminate, the risk of failure to achieve business objectives. Accordingly, they can only provide reasonable, but not absolute, assurance against material misstatement or loss. In accordance with the Dutch Code, the boards have confirmed, subject to the above, that the respective risk management and control systems as regards financial reporting risks provide reasonable assurance that the financial reporting does not contain material inaccuracies and have functioned properly during the year. With effect from the 2006 financial year, the Reed Elsevier combined businesses will be required to report on the reporting and audit requirements of Section 404 of the US Sarbanes-Oxley Act, and are on track to do so. Responsibilities in respect of the financial statements The directors of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc and Elsevier Reed Finance BV are required to prepare financial statements as at the end of each financial period, which give a true and fair view of the state of affairs, and of the profit or loss, of the respective companies and their subsidiaries, joint ventures and associates. They are responsible for maintaining proper accounting records, for safeguarding assets, and for taking reasonable steps to prevent and detect fraud and other irregularities. The directors are also responsible for selecting suitable accounting policies and applying them on a consistent basis, making judgments and estimates that are prudent and reasonable. Applicable accounting standards have been followed and the Reed Elsevier combined financial statements, which are the responsibility of the directors of Reed Elsevier PLC and Reed Elsevier NV, are prepared using accounting policies which comply with International Financial Reporting Standards. 159711 Reed Report 28-54 7/3/06 12:04 Page 33 Reed Elsevier Annual Reports and Financial Statements 2005 33 US certifications Going concern The directors of Reed Elsevier PLC and Reed Elsevier NV, having made appropriate enquiries, consider that adequate resources exist for the combined businesses to continue in operational existence for the foreseeable future and that, therefore, it is appropriate to adopt the going concern basis in preparing the financial statements. As required by Section 302 of the US Sarbanes-Oxley Act 2002 and by related rules issued by the US Securities and Exchange Commission, the Chief Executive Officer and Chief Financial Officer of Reed Elsevier PLC and of Reed Elsevier NV certify in the respective Annual Reports 2005 on Form 20-F filed with the Commission that they are responsible for establishing and maintaining disclosure controls and procedures and that they have: • designed such disclosure controls and procedures to ensure that material information relating to Reed Elsevier is made known to them; • evaluated the effectiveness of Reed Elsevier’s disclosure controls and procedures; • based on their evaluation, disclosed to the Audit Committees and the external auditors all significant deficiencies in the design or operation of disclosure controls and procedures and any frauds, whether or not material, that involve management or other employees who have a significant role in Reed Elsevier internal controls; and • presented in the Reed Elsevier Annual Report 2005 on Form 20-F their conclusions about the effectiveness of the disclosure controls and procedures. A Disclosure Committee, comprising the company secretaries of Reed Elsevier PLC and Reed Elsevier NV and other senior Reed Elsevier managers, provides assurance to the Chief Executive Officer and Chief Financial Officer regarding their certifications. 159711 Reed Report 28-54 7/3/06 12:04 Page 34 34 Report of the Audit Committees Report of the Audit Committees This report has been prepared by the Audit Committees of Reed Elsevier PLC and Reed Elsevier NV, in conjunction with the Audit Committee of Reed Elsevier Group plc, (the Committees) and has been approved by the respective boards. The report meets the requirements of the Combined Code of Corporate Governance, issued by the UK Financial Services Authority. Audit Committees The main role and responsibilities of the Committees in relation to the respective companies are set out in written terms of reference and include: (i) to monitor the integrity of the financial statements of the company, and any formal announcements relating to the company’s financial performance, reviewing significant financial reporting judgements contained in them; (ii) to review the company’s internal financial controls and the company’s internal control and risk management systems; (iii) to monitor and review the effectiveness of the company’s internal audit function; (iv) to make recommendations to the board, for it to put to the shareholders for their approval in general meetings, in relation to the appointment, re-appointment and removal of the external auditor and to approve the remuneration and terms of engagement of the external auditor; (v) to review and monitor the external auditor’s independence and objectivity and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements; and (vi) to develop and recommend policy on the engagement of the external auditor to supply non audit services, taking into account relevant ethical guidance regarding the provision of non audit services by the external audit firm, and to monitor compliance. The Committees report to the respective boards on their activities identifying any matters in respect of which they consider that action or improvement is needed and making recommendations as to the steps to be taken. The Reed Elsevier Group plc Audit Committee fulfils this role in respect of the publishing and information operating business. The functions of an audit committee in respect of the financing activities are carried out by the Supervisory Board of Elsevier Reed Finance BV. The Reed Elsevier PLC and Reed Elsevier NV Audit Committees fulfil their roles from the perspective of the parent companies and both Committees have access to the reports to and the work of the Reed Elsevier Group plc Audit Committee and the Elsevier Reed Finance BV Supervisory Board in this respect. The Committees have explicit authority to investigate any matters within their terms of reference and have access to all resources and information that they may require for this purpose. The Committees are entitled to obtain legal and other independent professional advice and have the authority to approve all fees payable to such advisers. A copy of the terms of reference of each Audit Committee is published on the Reed Elsevier website, www.reedelsevier.com. Committee membership The Committees each comprise at least three independent non-executive directors. The current members of each of the Committees are: Lord Sharman (Chairman of the Committees), David Reid and Strauss Zelnick. Lord Sharman and David Reid are considered to have significant, recent and relevant financial experience. Lord Sharman (63), a chartered accountant, spent his professional career at KPMG and now serves as non- executive Chairman of Aviva PLC and Aegis Group plc. He is a member of the Supervisory Board of ABN-AMRO NV and a non-executive director of BG Group plc. He was elected UK senior partner of KPMG in 1994 and served as Chairman of KPMG Worldwide between 1997 and 1999. David Reid (59), a chartered accountant, was appointed non-executive Chairman of Tesco PLC in April 2004. Prior to this appointment, he was executive Deputy Chairman, with responsibility for strategy, business development and international operations; he was previously the finance director of Tesco PLC. Strauss Zelnick (48) is the founder of Zelnick Media Corporation. He is Chairman of Columbia Music Entertainment Inc and OTX Corporation. Prior to founding Zelnick Media he was President and Chief Executive Officer of BMG Entertainment. Appointments to the Committees are made on the recommendation of the Nominations Committee and are for periods of up to three years, extendable by no more than two additional three-year periods, so long as the member continues to be independent. Details of the remuneration policy in respect of members of the Committees and the 159711 Reed Report 28-54 7/3/06 12:04 Page 35 Reed Elsevier Annual Reports and Financial Statements 2005 35 remuneration paid to members for the year ended 31 December 2005 are set out in the Directors’ Remuneration Report on pages 37 to 53. In discharging their principal responsibilities in respect of the 2005 financial year, the Committees have: Committee activities The Committees typically hold meetings five times a year: around January, February, June, August and December, and report on these meetings to the respective boards at the next board meetings. The principal business of these meetings includes: • January: review of critical accounting policies and practices, and significant financial reporting issues and judgements made in connection with the annual financial statements; review of internal control effectiveness; reviewing and approving the internal audit plan; review of internal audit findings • February: review and approval of annual financial statements, results announcement and related formal statements; review of external audit findings • June: monitoring and assessing the qualification, performance, expertise, resources, objectivity and independence of the external auditors and the effectiveness of the external and internal audit process; agreeing the external audit plan; reviewing significant financial reporting issues and judgements arising in connection with the interim financial statements; review of risk management activities; review of report from external auditors on control matters; review of internal audit findings • August: review and approval of the interim financial statements, results announcement and related formal statements; review of external audit findings; review of internal audit findings • December: review of year end financial reporting and accounting issues; review of significant external financial reporting and regulatory developments; review of external audit findings to date; review of internal audit findings. The Audit Committee meetings are typically attended by the chief financial officer, group chief accountant, director of internal audit and senior representatives of the external auditors. Additionally, the managing director and senior representatives of the external auditors of Elsevier Reed Finance BV attend the August and February meetings of the parent company Audit Committees. At two or more of the meetings each year, the Committees additionally meet separately with the external auditors without management present, and also with the director of internal audit. (i) received and discussed reports from the Reed Elsevier Group plc group chief accountant that set out areas of significance in the preparation of the financial statements, including: review of the carrying values of goodwill and intangible assets for possible impairment, review of estimated useful lives of intangible assets, accounting for pensions and related assumptions, accounting for share based remuneration and related assumptions, accounting treatment for acquisitions and disposals, application of revenue recognition and cost capitalisation, accounting for derivatives, review of tax reserves and provisions for lease obligations. Discussion of reporting matters has focused on the adoption of International Financial Reporting Standards with effect from the 2005 financial year and the related disclosures. (ii) reviewed the critical accounting policies and compliance with applicable accounting standards and other disclosure requirements and have received regular update reports on accounting and regulatory developments. (iii) received and discussed regular reports on the management of material risks and reviewed the effectiveness of the systems of internal control. As part of this review, detailed internal control evaluation and certification is obtained from management across the operating businesses, reviewed by internal audit and discussed with the Committees. (iv) received and discussed regular reports from the director of internal audit summarising the status of the Reed Elsevier risk management activities and the findings from internal audit reviews and the actions agreed with management. An area of focus in 2005 has been to review the progress in implementing plans to meet the requirements of Section 404 of the US Sarbanes-Oxley Act relating to the documentation and testing of internal financial controls. (v) reviewed and approved the internal audit plan for 2005 and monitored execution. Reviewed the resources and budget of the internal audit function. 159711 Reed Report 28-54 7/3/06 12:04 Page 36 36 Report of the Audit Committees The external auditors have attended all meetings of the Committees. They have provided written reports at the June, August, December and February meetings summarising the most significant findings from their audit work. These reports have been discussed by the Committees and actions agreed where necessary. The external auditors have confirmed their independence from management and compliance with the Reed Elsevier policy on auditor independence. This policy sets out inter alia the requirements for rotation of the lead, review and other senior partners, as well as guidelines for the provision of permitted non audit services. The Committees have reviewed and agreed the non audit services provided by the external auditors, together with the associated fees. The external auditors’ fees for audit services have been reviewed and approved by the Committees. At their meeting in June 2005, the Committees conducted a formal review of the performance of the external auditors and the effectiveness of the audit process for both the external and internal audit activities. Based on this review, and on their subsequent observations on the planning and execution of the external audit for the year ended 31 December 2005, the Committees have recommended to the respective boards that resolutions for the re-appointment of the external auditors be proposed at the forthcoming Annual General Meetings. Lord Sharman of Redlynch Chairman of the Audit Committees 15 February 2006 159711 Reed Report 28-54 7/3/06 12:04 Page 37 Directors’ remuneration report Reed Elsevier Annual Reports and Financial Statements 2005 37 This report provides Reed Elsevier’s statement of how it has applied the principles of good governance relating to Directors’ remuneration and communicates its policies and practices on executive remuneration to shareholders. It has been prepared by the Remuneration Committee (the Committee) of Reed Elsevier Group plc and approved by the boards of Reed Elsevier Group plc, Reed Elsevier PLC and Reed Elsevier NV. In accordance with UK Directors’ Remuneration Report Regulations 2002 (the UK Regulations) and the Dutch Corporate Governance Code issued in December 2003 (the Dutch Code), resolutions will be submitted to the respective Annual General Meetings of Reed Elsevier PLC and Reed Elsevier NV to approve this report and the remuneration policy as set out below. Membership of the Remuneration Committee Throughout 2005, the Committee consisted wholly of independent non-executive directors; Rolf Stomberg (Chairman), Mark Elliott and Cees van Lede. At the invitation of the Chairman, the Chief Executive Officer attends the meetings of the Committee except when his own remuneration is under consideration. The contents of this report For greater clarity, the main body of this report is focused on pay policy and practice for executive directors (pages 37 to 43) and non-executive directors (page 43). Pages 44 to 53 forming part of this report deal with the auditable disclosures and other regulatory requirements. The contents of the report are as follows: A. Executive directors a. Remuneration policy and objectives b. Remuneration in practice c. 2005 payments d. 2005 awards e. Shareholding requirement f. Service contracts g. Policy on external appointments B. Non-executive directors a. Policy b. Fee levels C. Statutory disclosures A. Executive directors (a) Remuneration policy and objectives Our remuneration policy has been designed to meet the needs of a group of global business divisions, each of which operates internationally by line of business. In order to support this business structure, it is essential to have a remuneration policy which: • aids the attraction and retention of the best executive talent from anywhere in the world; and • underpins Reed Elsevier’s demanding performance standards. The challenges and demands created by the need for global market competitiveness as well as for internal consistency have led the Committee to apply a more global approach to the design and operation of its incentive plans. The Committee believes that in order to meet its remuneration objectives, the remuneration of executive directors should comprise a balance between fixed and variable (performance-related) pay elements with the greater proportion of potential reward being linked to performance. For superior performance, some 60% of total target remuneration is performance-related. The Committee constantly reviews remuneration policy to ensure that it is sufficiently flexible to take account both of future changes in Reed Elsevier’s business operations and environment and of key developments in remuneration practice. Consequently, the policy set out in this report has applied during 2005 and will apply in 2006 subject to any necessary changes. Any changes will be described in full in future reports. Remuneration objectives The principal objectives of the policy are to attract and motivate executives of the highest calibre and experience needed to shape and execute strategy and deliver shareholder value in an ever more competitive and increasingly global employment market. The Committee believes that this requires the following: • A pay and benefits package which is competitive with packages offered by other leading multinational companies operating in global markets, and is capable of providing upper quartile total remuneration for the sustained delivery of the clearly superior levels of performance required by our challenging business objectives. • A reward structure that links individual performance, company performance and share price performance so as to align the interests of the directors with those of Reed Elsevier and the shareholders of the parent companies. • An approach to performance management that stimulates enhanced performance by directors, recognises their individual contribution to the attainment of our short term and longer term results and also encourages the teamwork which is essential to achieve the long term strategic objectives. 159711 Reed Report 28-54 7/3/06 12:04 Page 38 38 Directors’ remuneration report Base salary and the annual incentive plan (AIP) aim to position the executive within the relevant market for executive talent and to provide a focus on the delivery of our shorter term strategic objectives. The Executive Share Option (ESOS) and Long Term Incentive Scheme (LTIS) encourage a focus on longer term earnings growth and increases executives’ alignment with shareholders’ interests. The Committee believes that the primary engine for the creation of long term shareholder value is sustained growth in profitability. In relation to shareholders, the primary measure of profitability is growth in adjusted earnings per share which is supported, at an operational level, by the measures of revenue growth, profitability and cash generation. Accordingly, these measures are integrated into our reward structure. In all cases payments are made against a sliding scale of performance achievement because this is the fairest and simplest way to relate incentives to business targets. Recognising shareholder preference for longer term incentive arrangements to include a performance measure based on shareholder return, it is proposed that a secondary measure of total shareholder return relative to a focused peer group will apply to awards made under the LTIS from 2006. (b) Remuneration in practice The Committee’s practice is to review the market competitiveness of base salary on the following basis: • UK-based directors against FTSE 50 companies (excluding financial services); and • US-based directors (or directors on US-market based reward packages) against US Media Industry companies. Benefits, including medical and retirement benefits, are positioned to reflect local country practice. UK directors are eligible to participate in the all-employee SAYE (savings related) share option scheme. Recognising the more global approach to the design of its incentive plans, referred to earlier, the annual and longer term incentive plans for executive directors are operated with common incentive opportunity levels, irrespective of geographical location. In relation to long term incentives, the performance measures are tested once at the end of the specific performance period and are not subsequently re-tested; (i.e. there is no re-testing of any performance condition). This overall approach is set out in greater detail below with reference to the individual elements of the reward package for executive directors: Base salary • Salaries are reviewed annually to take account of two factors, Firstly, market movement and individual performance during the previous year. Secondly, the increased and sustainable contribution of the individual to the group which may position the individual at a higher value relative to the market. Annual Incentive Plan (AIP) • Based on achievement of financial performance targets set against the critical measures of revenue growth, profit, cash generation and Key Performance Objectives (KPOs). • Targets are approved by the Committee at the beginning of the year and are aligned with the annual budget and strategic business objectives. • Payment against each financial performance measure is only made if a threshold of 94% of the target is achieved. • Up to 90% of salary is payable for the achievement of highly stretching financial targets which align with the Company’s double digit adjusted EPS growth objective. This 90% bonus opportunity is allocated as follows, as a percentage of salary: – Revenue – Profit – Cash Flow Conversion Rate – KPOs 27% 27% 9% 27% The four elements are measured separately, such that there could be a pay-out on one element and not on others. • A maximum of 110% of salary could be paid for exceptional performance. (This degree of upside potential in our AIP is low by market standards and it reflects the demanding nature of the initial targets). Bonus Investment Plan (BIP) • Designed to encourage increased personal shareholding by the participant. • Directors and other designated key senior executives may invest up to half of any payment they receive under the AIP in shares of Reed Elsevier PLC or Reed Elsevier NV. • Subject to continued employment, and to their retaining these investment shares during a three-year performance period, they will be awarded an equivalent number of matching shares. 159711 Reed Report 28-54 7/3/06 12:04 Page 39 Reed Elsevier Annual Reports and Financial Statements 2005 39 • The award of matching shares is wholly dependent on the achievement of a performance condition. In 2005, this was the achievement of at least 6% per annum compound growth in the average of Reed Elsevier PLC and Reed Elsevier NV adjusted EPS – measured at constant exchange rates (adjusted EPS) over the three year vesting period. Executive Share Options (ESOS) • Annual grants of options are made over shares in Reed Elsevier PLC and Reed Elsevier NV at the market price at date of grant. • The level of option grant and the performance conditions are determined and reviewed by the Committee annually. • The standard performance condition, which governs the size of grant for all participants, relates to the compound annual growth in adjusted EPS over the three years prior to grant. The Target Grant Pool for all participants is defined with reference to share usage during the base year of 2003, as follows: Adjusted EPS Growth per annum Less than 6% 6% or more 8% or more 10% or more 12% or more Target Grant Pool (as a % of 2003 Grant) 50% 75% 100% 125% 150% • The awards made to executive directors are subject to an annual maximum of up to three times base salary. The awards are subject to the following three performance criteria: • On grant – corporate performance as measured by adjusted EPS growth in accordance with the criteria above, and – individual performance over the three year period prior to grant; • On vesting – a further performance condition such that the compound growth in adjusted EPS during the three years following grant must be at least 6% per annum. There is no retesting of the performance condition. • The combination of the above tests requires sustained high level profit growth over a continuous six year period in respect of each individual grant to executive directors. • Options are normally exercisable between three and ten years from the date of grant. Long term Incentive (LTIS) – 2004–2006 cycle • For the current performance period 2004-06, awards to Directors under the LTIS were made in February 2004 over 5.5 times salary in conventional market price options and 2.5 times salary in performance shares. • The awards will vest at the end of the 2004-06 performance period, to the extent that the performance condition has been achieved: • at 8% compound annual growth in adjusted EPS, 25% of the awards will vest; • at 10%, 100% will vest; • at 12%, 125% of the award will vest; and • awards will vest on a straight line basis between each of these points. There is no retesting of the performance condition. • Even if the adjusted EPS target is met, the Remuneration Committee retains full discretion to reduce or cancel awards under the Plan based on its assessment as to whether the adjusted EPS growth achieved is a fair reflection of the progress of the business having regard to underlying revenue growth, cash generation, return on capital and any significant changes in inflation as well as on individual performance. • Acceptance of an award under the LTIS (for the 2004-06 cycle) by any individual automatically terminated their award under the previous Senior Executive Long Term Incentive Plan introduced in 2000. No payments were therefore made under the 2000 Plan. Long term Incentive (LTIS) – 2006 and future cycles The Committee has reviewed the operation of the LTIS in line with its commitment to shareholders and is proposing the following changes to the operation of the LTIS with effect from 2006: • Grants will be made annually: from 2006, all executive directors will be eligible to receive an annual grant of performance shares with a target value of around 135% of salary. (Lower levels of grant will apply to other senior executives invited to participate in the LTIS). • Awards will consist solely of performance shares (rather than a mix of performance shares and conventional market price options). • Relative Total Shareholder Return (TSR) will be introduced as a performance measure in addition to the EPS target. From 2006, in addition to achieving a demanding EPS performance target over a three year performance period, an additional TSR performance target over the same three year period will also be taken into account. 159711 Reed Report 28-54 7/3/06 12:04 Page 40 40 Directors’ remuneration report The threshold level of compound adjusted EPS growth will continue to be 8% per annum, with maximum vesting being achieved for growth of 12% per annum. Any award earned through EPS performance may then be increased in line with Reed Elsevier’s TSR performance against a comparator group over the three year period, to a maximum of around 270% of salary (depending on dividend payments). No increase will be applied for TSR performance which is below median, and the maximum increase will be applied at upper quartile or higher levels of TSR achievement. No award will be made to participants if Reed Elsevier fails to achieve the adjusted EPS growth threshold irrespective of the associated TSR performance. The effect of this revised structure is that the vesting levels based on adjusted EPS growth will, in isolation, generate a lower reward than currently. However, in combination with strong relative TSR performance, there will be scope for better reward. The Committee considers the proposed mechanism to be tougher than normal UK practice because the TSR element can improve the reward to participants if, but only if, the adjusted EPS test has first been achieved. • Reed Elsevier’s TSR will be tested against a selected international group of competitor companies over a three year period. For awards in 2006, it is proposed that these companies will be as follows: The Thomson Corporation United Business Media McGraw Hill Reuters Group Pearson VNU Wolters Kluwer ChoicePoint EMAP Informa Fair Isaac John Wiley & Sons DMGT Dow Jones Lagardere Dun & Bradstreet WPP Taylor Nelson • Any shares which vest will be treated as attracting dividends during the performance period. The value of awards granted to participants will be reduced to take into account a reasonable expectation of the value of dividends over the performance period. • As currently, the Committee will have full discretion to reduce or cancel awards granted to participants in 2006 and thereafter based on its assessment as to whether the EPS and TSR performance fairly reflects the progress of the business having regard to underlying revenue growth, cash generation, return on capital and any significant changes in currency and inflation as well as individual performance. These changes require the approval of shareholders, and further information is contained in the circular dated 10 March 2006, which contains the notices of Annual General Meeting for Reed Elsevier PLC and Reed Elsevier NV, respectively. Retirement benefits • The Committee reviews retirement benefit provision in the context of the total remuneration package for each director, bearing in mind their age and service and against the background of evolving legislation and practice in the group’s major countries of operation. • Base salary is the only pensionable element of remuneration. • The three UK-based executive directors are provided with conventional UK defined benefit pension arrangements targeting two thirds (Sir Crispin Davis 45%) of salary at a normal retirement age of 60. • The Committee has considered the Government changes to UK taxation of pension schemes introduced from 6 April 2006 (“A” Day). The Committee currently intends to continue its existing practice of providing the targeted pension through a combination of: – the main UK Reed Elsevier Pension Scheme for salary restricted to a cap, determined annually on the same basis as the pre-April 2006 Inland Revenue earnings cap, and – Reed Elsevier’s unfunded unapproved pension arrangement for salary above the cap. • P Tierney and A Prozes are covered by a mix of defined benefit and defined contribution arrangements. Reed Elsevier pays a contribution of 19.5% of salary to E Engstrom’s personal pension plan. In accordance with US legislation, these directors have no defined retirement age. • These arrangements are set out in further detail on pages 45 and 46. (c) 2005 payments In this section, we set out the payments made to executive directors and any gains which they have made during 2005 under any of the long term incentive plans. (i) Base Salary for 2005 The annual salary increases made to executive directors with effect from 1 January 2005 were consistent with UK and US norms, respectively, for increases paid to senior executives during 2005. The increases to UK-based executives were in a range from 4.9% to 6.2%, and to US-based executives were at 4%. Because of the many countries in which we operate, there is no practical basis on which to compare directors’ pay increases with those of other employees. However, the same factors, in terms of market, personal contribution and performance determine the level of increase across all employee populations globally. 159711 Reed Report 28-54 7/3/06 12:04 Page 41 Reed Elsevier Annual Reports and Financial Statements 2005 41 G J A van de Aast M H Armour Sir Crispin Davis E Engstrom A Prozes P Tierney (i) Mr Engstrom joined in August 2004 and the salary shown for 2004 was pro-rated. (ii) Annual Incentive Plan Payments for 2005 G J A van de Aast M H Armour Sir Crispin Davis E Engstrom A Prozes P Tierney Annual Salary 2005 £430,000 £535,000 £1,040,000 $1,040,000 $1,040,000 $1,040,000 Payments made in 2006 (in respect of 2005) £408,741 £474,989 £923,343 $846,404 $1,013,958 $312,021 Annual Salary 2004 £405,900 £503,970 £991,725 $1,000,000(i) $997,500 $997,500 % of salary 95.1% 88.8% 88.8% 81.4% 97.5% 30.0% In setting the levels of payments under the AIP for directors, the Committee took into account a number of factors including; strong organic revenue growth in the majority of the businesses, continued improvement in underlying operating margin, overall improvement in capital efficiency and strong cash generation when compared to stretching internal targets. Harcourt Education’s disappointing performance in supplemental and assessment was considered against the strong basal performance. In addition, the directors were generally assessed as performing well against their KPOs, resulting in positive business momentum and an overall promising business outlook. (iii) Gains made under Long term Incentive Plans during 2005 The first cycle under the current Long term Incentive Scheme (LTIS) was launched for the performance period 2004–06 and the first grant does not therefore vest until early 2007, subject to the performance condition. Similarly, the first cycle under the Bonus Investment Plan (BIP) was launched in 2003 and therefore, subject to the performance condition, the first matching shares do not vest until 2006. The following gains were made by Executive Directors in relation to share incentives during 2005: Mr Armour made a gain of £50,985 in respect of executive share options awarded in 1995. Sir Crispin Davis made a gain of £9,576 under the UK Save-As-You-Earn (SAYE) Scheme granted in 2000. Mr Engstrom made a gain of £410,921 on vesting of restricted shares awarded to him in 2004 as part of his initial recruitment arrangements, which were disclosed in the Annual Reports and Financial Statements 2004. These gains are set out in further detail on pages 48 to 52. 159711 Reed Report 28-54 7/3/06 12:04 Page 42 42 Directors’ remuneration report (d) 2005 awards In this section, we set out the awards made to executive directors during 2005 under the terms of our long term incentive plans. LTIS awards – 2005 was the second year of the 2004–06 performance cycle under the LTIS, for which a single block grant was made in 2004. ESOS grants made in the year and executive directors’ elections under the Bonus Investment Plan (BIP) are shown in the following table: G J A van de Aast M H Armour Sir Crispin Davis E Engstrom A Prozes P Tierney Share Options BIP Matching Shares Share Type No. of Shares Option Price No. of shares PLC NV PLC NV PLC NV PLC NV PLC NV PLC NV 120,900 82,478 150,422 102,618 292,409 199,481 154,517 105,412 154,517 105,412 154,517 105,412 533.50p a11.31 533.50p a11.31 533.50p a11.31 533.50p a11.31 533.50p a11.31 533.50p a11.31 Nil 26,347 21,861 15,098 86,042 Nil 14,020 Nil 23,756 16,522 24,156 16,800 (e) Shareholding requirement Participants in the LTIS are required to build up a significant personal shareholding in Reed Elsevier PLC and/or Reed Elsevier NV. At executive director level, the current requirement is that they should own shares equivalent to 1.5 times salary and that this shareholding should be acquired prior to any payout being made under the LTIS in February 2007. Under the proposed terms of the revised LTIS, the shareholding requirement for the Group Chief Executive Officer will (subject to shareholders’ approval) increase from 1.5 times to three times salary and for other Executive Directors from 1.5 times to two times salary (the revised shareholding requirements to be met by February 2009). Details of directors’ shareholdings, as at 31 December 2005, are set out on page 53. (f) Service contracts Executive directors are employed under service contracts which generally provide for one year’s notice and neither specify severance payments nor contain specific provisions in respect of change in control. The service contracts for executive directors (and for approximately 130 other senior executives) contain the following provisions: • covenants which prevent them from working with specified competitors, recruiting Reed Elsevier employees and soliciting Reed Elsevier customers for a period of 12 months after leaving employment; • in the event of their resigning, they will immediately lose all rights to any awards under the LTIS, ESOS and BIP granted from 2004 onwards, whether or not such awards have vested; and • in the event that they join a specified competitor within 12 months of termination, any gains made in the six months prior to termination on the exercise of an LTIS, ESOS and BIP award made from 2004 onwards shall be repayable. 159711 Reed Report 28-54 7/3/06 12:04 Page 43 Reed Elsevier Annual Reports and Financial Statements 2005 43 (g) Policy on external appointments The Committee believes that the experience gained by allowing executive directors to serve as non-executive directors on the boards of other organisations is of benefit to Reed Elsevier. Accordingly, executive directors may, subject to the approval of the Chairman and the Chief Executive Officer, serve as non-executive directors on the boards of up to two non-associated companies (of which only one may be to the board of a major company) and they may retain remuneration arising from such appointments. • Sir Crispin Davis is a non-executive director of GlaxoSmithKline plc and received a fee of £70,000/a102,200 during 2005. • Erik Engstrom is a non-executive director of Eniro AB and received a fee of £22,108/a32,277 during 2005. • Andrew Prozes is a non-executive director of the Cott Corporation and received a fee of £27,377/a39,971 during 2005. B. Non-executive directors (a) Policy Reed Elsevier seeks to recruit non-executive directors with the experience to contribute to the board of a dual-listed global business and with a balance of personal skills which will make a major contribution to the boards and their committee structures. With the exception of G J de Boer-Kruyt, who serves only on the supervisory board of Reed Elsevier NV, non-executive directors, including the Chairman, are appointed to the boards of Reed Elsevier Group plc, Reed Elsevier PLC and the supervisory board of Reed Elsevier NV. Non-executive directors’ remuneration is determined by the three boards as appropriate to the director concerned. The primary source for comparative market data is the practice of FTSE50 companies, although reference is also made to AEX companies. Non-executive directors, including the Chairman, serve under letters of appointment, do not have contracts of service and are not entitled to notice of, or payments following, termination. During the year the Reed Elsevier Group plc board introduced a charity donation matching programme for non-executive directors. Under the policy, where a non-executive director donates all or part of their fees to a registered charity, the company may, at its sole discretion, make a matching donation to any charity, provided the charity’s objectives are judged to be appropriate and are not political or religious in nature. Messrs Reid and Zelnick each donated a proportion of their fees in respect of 2005 to charity and, in accordance with the programme the company made matching charitable donations of £22,500/a32,850 and £30,000/a43,800, respectively. (b) Fee levels Non-executive directors receive one annual fee in respect of their memberships of the boards of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc. The fee paid to G J de Boer-Kruyt, who serves only on the supervisory board of Reed Elsevier NV, reflects her time commitment to that company and to other companies within the Reed Elsevier combined businesses. Non-executive directors are reimbursed for expenses incurred in attending meetings. They do not receive any performance related bonuses, pension provisions, share options or other forms of benefit. Fees may be reviewed annually, although in practice they have changed on a less frequent basis and were last reviewed with effect from 1 May 2003. The fee for Mrs de Boer-Kruyt was last reviewed with effect from 1 January 2004. Annual fee rates applicable to non-executive directors and to the Chairman are set out in the following table: Chairman J Hommen (from April 2005) M Tabaksblat (until April 2005) Non-executive directors Chairman of: • Audit Committee • Remuneration Committee Annual fee 2005 Annual fee 2004 g350,000(i) g280,000(i) £45,000/g65,000 – a280,000 £45,000/a65,000 £7,000/g12,000 £7,000/g12,000 £7,000/a12,000 £7,000/a12,000 (i) Mr Hommen was appointed in April 2005, when Mr Tabaksblat retired. Their fees for 2005 were pro-rated. 159711 Reed Report 28-54 7/3/06 12:04 Page 44 44 Directors’ remuneration report C. Statutory disclosures (a) Report authorship This report has been prepared by the Remuneration Committee of Reed Elsevier Group plc. It has been prepared in accordance with the UK Regulations and the Dutch Code issued in December 2003 in order to meet the requirements of the UK Combined Code of Corporate Governance issued in July 2003, the Dutch Code and the Netherlands Civil code. (b) Remuneration committee constitution and terms of reference The Committee is responsible for: • recommending to the boards the remuneration (in all its forms) of the Chairman and the executive directors, including terms of service contracts and all other terms and conditions of employment; • providing advice to the Board and to the Chief Executive Officer on major policy issues affecting the remuneration of executives at a senior level below the board; and • the operation of all share-based plans. A copy of the Terms of Reference of the Committee can be found on the Reed Elsevier website www.reedelsevier.com. The Remuneration Committee met six times during the year. Mr van Lede was unable to attend one meeting, otherwise there was full attendance. (c) Advisors The Committee has appointed Towers Perrin, an external consultancy which has wide experience of executive remuneration in multinational companies, to advise in developing its performance-related remuneration policy. Towers Perrin also provide actuarial and other Human Resources consultancy services directly to some Reed Elsevier companies. The following individuals also provided material advice or services to the Committee during the year: • Sir Crispin Davis (Chief Executive Officer); • Ian Fraser (Group HR Director); and • Philip Wills (Director, Compensation and Benefits). (d) Total Shareholder Return (TSR) As required by the Directors’ Remuneration Report Regulations 2002, the following graphs show the Reed Elsevier PLC and Reed Elsevier NV total shareholder return performance, assuming dividends were reinvested. They compare the Reed Elsevier PLC performance with that achieved by the FTSE 100, and the Reed Elsevier NV performance with the performance achieved by the Euronext Amsterdam (AEX) Index, over the five year period from 2001–2005. For the five year period since 1 January 2001, the TSR for Reed Elsevier PLC was a negative 13%, against a FTSE 100 return of 4%. For Reed Elsevier NV during the same period, TSR was a negative 16%, against an AEX Index return of negative 22%. As Reed Elsevier PLC and Reed Elsevier NV are members of the FTSE 100 and AEX Index respectively, the Committee considers these indices to be appropriate for comparison purposes. Reed Elsevier PLC total shareholder return v FTSE 100 2001–2005 (cid:6)(cid:6)(cid:1) (cid:6)(cid:1)(cid:1) (cid:5)(cid:1) (cid:4)(cid:1) (cid:3)(cid:1) (cid:0)(cid:1) (cid:2)(cid:1) Reed Elsevier PLC FTSE 100 Reed Elsevier NV total shareholder return v AEX Index 2001–2005 (cid:6)(cid:6)(cid:1) (cid:6)(cid:1)(cid:1) (cid:5)(cid:1) (cid:4)(cid:1) (cid:3)(cid:1) (cid:0)(cid:1) (cid:2)(cid:1) Reed Elsevier NV AEX Index (cid:7)(cid:8)(cid:9) (cid:1)(cid:1) (cid:7)(cid:8)(cid:9) (cid:1)(cid:6) (cid:7)(cid:8)(cid:9) (cid:1)(cid:11) (cid:7)(cid:8)(cid:9) (cid:1)(cid:12) (cid:7)(cid:8)(cid:9) (cid:1)(cid:13) (cid:7)(cid:8)(cid:9) (cid:1)(cid:2) (cid:14)(cid:15)(cid:16)(cid:17)(cid:9)(cid:8)(cid:18) (cid:7)(cid:19)(cid:20)(cid:19)(cid:21)(cid:20)(cid:17)(cid:8)(cid:19)(cid:22) (cid:7)(cid:8)(cid:9) (cid:1)(cid:1) (cid:7)(cid:8)(cid:9) (cid:1)(cid:6) (cid:7)(cid:8)(cid:9) (cid:1)(cid:11) (cid:7)(cid:8)(cid:9) (cid:1)(cid:12) (cid:7)(cid:8)(cid:9) (cid:1)(cid:13) (cid:7)(cid:8)(cid:9) (cid:1)(cid:2) (cid:14)(cid:15)(cid:16)(cid:17)(cid:9)(cid:8)(cid:18) (cid:7)(cid:19)(cid:20)(cid:19)(cid:21)(cid:20)(cid:17)(cid:8)(cid:19)(cid:22) The total shareholder return set out above is calculated on the basis of the average share price in the 30 trading days prior to the respective year ends and on the assumption that dividends were reinvested. 159711 Reed Report 28-54 7/3/06 12:04 Page 45 Reed Elsevier Annual Reports and Financial Statements 2005 45 (e) Service contracts Each of the executive directors has a service contract, as summarised below: G J A van de Aast(i) M H Armour(i) Sir Crispin Davis(i) E Engstrom(i) A Prozes(ii) Contract Date 15 November 2000 7 October 1996 19 July 1999 25 June 2004 5 July 2000 Expiry date (subject to notice period) 17 July 2017 29 July 2014 19 March 2009 14 June 2025 Indefinite P Tierney(ii) 19 November 2002 Indefinite (i) Employed by Reed Elsevier Group plc (ii) Employed by Reed Elsevier Inc Notice period Subject to: 12 months 12 months 12 months 12 months 12 months base salary payable for termination without cause 12 months base salary payable for termination without cause English law English law English law English law New York law New York law The Committee believes that as a general rule, notice periods should be twelve months and that the directors should, subject to practice within their base country, be required to mitigate their damages in the event of termination. The Committee will, however, note local market conditions so as to ensure that the terms offered are appropriate to attract and retain top executives operating in global businesses. No loans, advances or guarantees have been provided on behalf of any director. (f) Auditable disclosures (i) Pensions in more detail The target pension for Sir Crispin Davis at normal retirement age of 60 is 45% of base salary in the 12 months prior to retirement. Other executive directors based in the UK are provided with pension benefits at a normal retirement age of 60, equivalent to two thirds of base salary in the 12 months prior to retirement, provided they have completed 20 years service with Reed Elsevier or at an accrual rate of 1/30th of pensionable salary per annum if employment is for less than 20 years. The target pension for A Prozes, a US-based director, is US$300,000 per annum, which becomes payable on retirement only if he completes a minimum of seven years service. The pension will be reduced in amount by the value of any other retirement benefits payable by Reed Elsevier or which become payable by any former employer, other than those attributable to employee contributions. The target pension for P Tierney, a US-based director, after completion of five years pensionable service is US$440,000 per annum, inclusive of any other retirement benefits from any former employer. In the event of termination of employment before completion of five years pensionable service, the pension payable will be reduced proportionately. As US employees Messrs Prozes and Tierney also are eligible to participate in Reed Elsevier’s 401k plan, to which Reed Elsevier contributed £3,588/a5,239 and £4,031/a5,885, respectively for the year. The pension arrangements for the above directors include life assurance cover whilst in employment, an entitlement to a pension in the event of ill health or disability and a spouse’s and/or dependents’ pension on death. E Engstrom is not a member of a company pension scheme and Reed Elsevier made a contribution to Mr Engstrom’s designated retirement account of £111,429/a162,686, equivalent to 19.5% of his annual salary. In addition, Mr Engstrom is provided with life assurance cover whilst in employment. 159711 Reed Report 28-54 7/3/06 12:04 Page 46 46 Directors’ remuneration report The increase in the transfer value of the directors’ pensions, after deduction of contributions, is shown below: Transfer Transfer value value of accrued of accrued pension pension Directors’ 31 December 31 December Age 31 December 2004 510,134 2005 contributions) 2005 contributions 206,437 721,552 4,980 48 4,980 1,722,165 2,259,816 51 532,670 4,980 3,961,740 5,563,704 1,596,984 56 59 – 381,816 60 – – – – 1,556,726 1,938,541 Increase in transfer value during the period (net of Accrued annual pension directors’ 31 December 2005 72,884 194,644 310,475 – 170,308 Transfer Transfer value value of accrued of accrued pension pension Directors’ 31 December 31 December 2004 2005 contributions) contributions 300,927 7,259 743,633 1,051,821 7,259 2,510,434 3,294,179 776,484 7,259 5,775,108 8,110,323 2,327,956 – 556,580 – – – – 2,269,270 2,825,850 Increase in transfer value during the period (net of Accrued annual pension directors’ 31 December 2005 106,244 283,736 452,586 – 248,261 G J A van de Aast M H Armour Sir Crispin Davis A Prozes P Tierney G J A van de Aast M H Armour Sir Crispin Davis A Prozes P Tierney £ Increase in accrued annual pension during the period Transfer value of increase in accrued annual pension during the period (net of inflation (net of and directors’ inflation) contributions) 150,257 15,680 253,598 22,272 934,483 52,425 – – 288,412 25,500 d Increase in accrued annual pension during the period Transfer value of increase in accrued annual pension during the period (net of inflation (net of and directors’ inflation) contributions) 219,033 22,857 32,466 369,675 76,421 1,362,215 – 420,424 – 37,172 Increase in accrued annual pension during the period 17,615 28,090 61,152 – 25,500 Increase in accrued annual pension during the period 25,678 40,947 89,142 – 37,172 Transfer values have been calculated in accordance with the guidance note GN11 published by the UK Institute of Actuaries and Faculty of Actuaries. The transfer value in respect of individual directors represents a liability in respect of directors’ pensions entitlement, and is not an amount paid or payable to the director. 159711 Reed Report 28-54 7/3/06 12:04 Page 47 Reed Elsevier Annual Reports and Financial Statements 2005 47 (ii) Aggregate emoluments The emoluments of the directors of Reed Elsevier PLC and Reed Elsevier NV (including any entitlement to fees or emoluments from either Reed Elsevier Group plc or Elsevier Reed Finance BV) were as follows: Aggregate emoluments Salaries and fees Benefits Annual performance-related bonuses Pension contributions Pension to former director Payment to former director Total £ 2004 £000 3,684 475 3,027 54 190 10 7,440 2005 £000 4,234 111 3,001 135 223 10 7,714 d 2005 g000 6,182 162 4,381 197 326 15 2004 a000 5,416 698 4,450 79 279 15 11,263 10,937 No compensation payments have been made for loss of office or termination in 2004 and 2005. Details of share options exercised by the directors over shares in Reed Elsevier PLC and Reed Elsevier NV during the year are shown on pages 48 to 52. The aggregate notional pre-tax gain made by the directors on the exercise of share options during the year was £471,482/a688,364 (2004: £2,001/a2,942). (iii) Individual emoluments of executive directors Salary 430,000 535,000 1,040,000 Benefits 16,462 19,372 28,173 £ Total 2005 Bonus Total 2004 408,741 855,203 835,222 998,402 474,989 1,029,361 923,343 1,991,516 1,949,435 571,429 571,429 571,429 465,057 1,050,436 739,732 557,120 1,148,440 1,080,352 755,878 1,087,071 171.440 3,719,287 110,857 3,000,690 6,830,834 6,690,214 13,950 19,891 13,009 d Bonus Salary Benefits 627,800 24,034 781,100 28,283 Total 2005 Total 2004 596,762 1,248,596 1,227,776 693,484 1,502,867 1,467,652 1,518,400 41,133 1,348,081 2,907,614 2,865,670 834,286 20,367 834,286 29,040 834,286 18,993 678,983 1,533,636 1,087,404 813,395 1,676,721 1,588,117 250,303 1,103,582 1,597,993 5,430,158 161,850 4,381,008 9,973,016 9,834,612 G J A van de Aast M H Armour Sir Crispin Davis E Engstrom (from 23 August 2004) A Prozes P Tierney Total Benefits principally comprise the provision of a company car, medical insurance and life assurance. Sir Crispin Davis was the highest paid director in 2005. He exercised a SAYE share option during 2005 over 5,019 Reed Elsevier PLC ordinary shares, at an option price of 336.2p. The notional gain on the exercise amounted to £9,576/a13,981. (iv) Individual emoluments of non-executive directors G J de Boer-Kruyt J F Brock (until 28 April 2005) M W Elliott C J A van Lede J Hommen (from 27 April 2005) D E Reid Lord Sharman R W H Stomberg M Tabaksblat (until 28 April 2005) S Zelnick (from 27 April 2005) Total £ 2005 159,817 2004 23,151 22,993 11,130 44,218 45,000 45,000 44,521 44,218 – 45,000 45,000 52,000 52,000 52,740 52,381 47,945 190,476 – 33,750 515,054 496,286 d 2005 233,333 2004 33,800 33,800 16,250 65,000 65,700 66,150 65,000 65,000 – 65,700 66,150 75,920 76,440 77,000 77,000 70,000 280,000 – 49,275 751,978 729,540 159711 Reed Report 28-54 7/3/06 12:04 Page 48 48 Directors’ remuneration report R J Nelissen, a former director of Reed Elsevier PLC, Reed Elsevier NV and Reed Elsevier Group plc served as Chairman of the Supervisory Board of Elsevier Reed Finance BV throughout 2005. During the period he received fees of £10,274/a15,000 in such capacity. (v) Share Options and Interests in Shares Details of options and restricted shares held by directors in Reed Elsevier PLC and Reed Elsevier NV during the period are shown below. There have been no changes in the options or restricted shares held by directors since 31 December 2005. (a) Options in Reed Elsevier PLC G J A van de Aast – ESOS – BIP – LTIS (options) – LTIS (shares) Total M H Armour – ESOS – BIP – LTIS (options) – LTIS (shares) – SAYE Granted during the year 120,900 120,900 150,422 21,861 1 January 2005 50,940 49,317 58,000 81,728 124,956 31,217 229,087 104,130 729,375 39,600 30,000 52,000 66,900 33,600 88,202 62,974 74,000 104,319 155,147 11,327 19,225 284,437 129,289 4,329 Option price 638.00p 659.00p 600.00p 451.50p 487.25p 533.50p Nil 487.25p Nil 400.75p 585.25p 565.75p 523.00p 537.50p 436.50p 659.00p 600.00p 451.50p 487.25p 533.50p Nil Nil Nil 487.25p Nil 377.60p Exercised during the year Market price at exercise date 31 December 2005 Exercisable from Exercisable until 50,940 1 Dec 2003 1 Dec 2010 49,317 23 Feb 2004 23 Feb 2011 58,000 22 Feb 2005 22 Feb 2012 81,728 21 Feb 2006 21 Feb 2013 124,956 19 Feb 2007 19 Feb 2014 120,900 17 Feb 2008 17 Feb 2015 31,217 26 Mar 2007 26 Mar 2007 229,087 19 Feb 2007 19 Feb 2014 104,130 19 Feb 2007 19 Feb 2007 850,275 39,600(i) 529.50p – 30,000 23 Apr 1999 23 Apr 2006 52,000 21 Apr 2000 21 Apr 2007 66,900 17 Aug 2001 17 Aug 2008 33,600 21 Feb 2003 19 Apr 2009 88,202 2 May 2003 2 May 2010 62,974 23 Feb 2004 23 Feb 2011 74,000 22 Feb 2005 22 Feb 2012 104,319 21 Feb 2006 21 Feb 2013 155,147 19 Feb 2007 19 Feb 2014 150,422 17 Feb 2008 17 Feb 2015 11,327 21 Mar 2006 21 Mar 2006 19,225 26 Mar 2007 26 Mar 2007 21,861 14 Apr 2008 14 Apr 2008 284,437 19 Feb 2007 19 Feb 2014 129,289 19 Feb 2007 19 Feb 2007 4,329 1 Aug 2009 31 Jan 2010 Total 1,155,349 172,283 39,600 1,288,032 159711 Reed Report 28-54 7/3/06 12:04 Page 49 Reed Elsevier Annual Reports and Financial Statements 2005 49 (a) Options in Reed Elsevier PLC continued Sir Crispin Davis – ESOS – BIP – LTIS (options) – LTIS (shares) – SAYE Granted during the year 292,409 86,042 1 January 2005 160,599 80,300 80,300 171,821 122,914 148,500 209,192 305,303 22,731 39,554 559,722 254,419 5,019 Total 2,160,374 378,451 154,517 14,020 E Engstrom – ESOS – BIP – LTIS (options) – LTIS (shares) – Restricted shares Total A Prozes – ESOS – BIP – LTIS (options) – LTIS (shares) 63,460 318,398 144,726 115,781 642,365 188,281 83,785 103,722 132,142 162,666 20,040 20,104 298,221 135,555 Exercised during the year Market price at exercise date 31 December 2005 Exercisable from Exercisable until 160,599 21 Feb 2003 1 Sept 2009 80,300 1 Sept 2003 1 Sept 2009 80,300 1 Sept 2004 1 Sept 2009 171,821 2 May 2003 2 May 2010 122,914 23 Feb 2004 23 Feb 2011 148,500 22 Feb 2005 22 Feb 2012 209,192 21 Feb 2006 21 Feb 2013 305,303 19 Feb 2007 19 Feb 2014 292,409 17 Feb 2008 17 Feb 2015 22,731 21 Mar 2006 21 Mar 2006 39,554 26 Mar 2007 26 Apr 2007 86,042 14 Apr 2008 14 Apr 2008 559,722 19 Feb 2007 19 Feb 2014 254,419 19 Feb 2007 19 Feb 2007 5,019(i) 5,019 527.00p – 2,533,806 63,460 23 Aug 2007 23 Aug 2014 154,517 17 Feb 2008 17 Feb 2015 14,020 14 Apr 2008 14 Apr 2008 318,398 23 Aug 2007 23 Aug 2014 144,726 23 Aug 2007 23 Aug 2007 77,186 23 Aug 2005 23 Aug 2007 38,595(ii) 524.50p Option price 467.00p 467.00p 467.00p 436.50p 659.00p 600.00p 451.50p 487.25p 533.50p Nil Nil Nil 487.25p Nil 336.20p 478.00p 533.50p Nil 478.00p Nil Nil 168,537 38,595 772,307 566.00p 659.00p 600.00p 451.50p 487.25p 533.50p Nil Nil Nil 487.25p Nil 154,517 23,756 188,281 9 Aug 2003 9 Aug 2010 83,785 23 Feb 2004 23 Feb 2011 103,722 22 Feb 2005 22 Feb 2012 132,142 21 Feb 2006 21 Feb 2013 162,666 19 Feb 2007 19 Feb 2014 154,517 17 Feb 2008 17 Feb 2015 20,040 21 Mar 2006 21 Mar 2006 20,104 26 Mar 2007 26 Mar 2007 23,756 14 Apr 2008 14 Apr 2008 298,221 19 Feb 2007 19 Feb 2014 135,555 19 Feb 2007 19 Feb 2007 Total 1,144,516 178,273 1,322,789 159711 Reed Report 28-54 7/3/06 12:04 Page 50 50 Directors’ remuneration report (a) Options in Reed Elsevier PLC continued P Tierney – ESOS – BIP – LTIS (options) – LTIS (shares) Granted during the year 154,517 24,156 1 January 2005 396,426 162,666 19,572 298,221 135,555 Option price 451.50p 487.25p 533.50p Nil Nil 487.25p Nil Exercised during the year Market price at exercise date 31 December 2005 Exercisable from Exercisable until 396,426 21 Feb 2006 21 Feb 2013 162,666 19 Feb 2007 19 Feb 2014 154,517 17 Feb 2008 17 Feb 2015 19,572 26 Mar 2007 26 Mar 2007 24,156 14 Apr 2008 14 Apr 2008 298,221 19 Feb 2007 19 Feb 2014 135,555 19 Feb 2007 19 Feb 2007 Total 1,012,440 178,673 1,191,113 (i) Retained an interest in all of the shares (ii) Retained an interest in 10,169 shares Awards granted under ESOS and BIP which become exercisable from 2007 onwards are subject to post-grant performance conditions, as set out on page 39. The proportion of the award that may vest under LTIS is subject to the annual growth in adjusted EPS during the performance period. The numbers of LTIS options and shares included in the above table are calculated by reference to an assumed annual growth rate of 10%, which would result in 100% of the award vesting. Depending on actual adjusted EPS growth, the proportion of the award that may vest could be lower or higher, as outlined on page 39. Options under the SAYE scheme, in which all eligible UK employees are invited to participate, are granted at a maximum discount of 20% to the market price at time of grant. They are normally exercisable after the expiry of 3 to 5 years from the date of grant. No performance targets are attached to this scheme as it is an all-employee scheme. The middle market price of a Reed Elsevier PLC ordinary share on the date of the 2005 award under BIP was 536.50p. The middle market price of a Reed Elsevier PLC ordinary share during the year was in the range 474.50p to 553.50p and at 31 December 2005 was 546.00p. (b) Options in Reed Elsevier NV G J A van de Aast – ESOS – BIP – LTIS (options) – LTIS (shares) Total 1 January 2005 35,866 35,148 40,699 58,191 85,805 12,057 157,309 71,504 496,579 Granted during the year 82,478 26,347 108,825 Option price a14.87 a14.75 a13.94 a9.34 a10.57 a11.31 Nil Nil a10.57 Nil Exercised during the year Market price at exercise date 31 December 2005 Exercisable from Exercisable until 35,866 1 Dec 2003 1 Dec 2010 35,148 23 Feb 2004 23 Feb 2011 40,699 22 Feb 2005 22 Feb 2012 58,191 21 Feb 2006 21 Feb 2013 85,805 19 Feb 2007 19 Feb 2014 82,478 17 Feb 2008 17 Feb 2015 12,057 21 Mar 2006 21 Mar 2006 26,347 14 Apr 2008 14 Apr 2008 157,309 19 Feb 2007 19 Feb 2014 71,504 19 Feb 2007 19 Feb 2007 605,404 159711 Reed Report 28-54 7/3/06 12:04 Page 51 Reed Elsevier Annual Reports and Financial Statements 2005 51 (b) Options in Reed Elsevier NV continued M H Armour – ESOS – BIP – LTIS (options) – LTIS (shares) Total Sir Crispin Davis – ESOS – BIP – LTIS (options) – LTIS (shares) Total E Engstrom – ESOS – LTIS (options) – LTIS (shares) – Restricted shares Total Granted during the year 102,618 15,098 117,716 199,481 1 January 2005 20,244 61,726 44,882 51,926 74,276 106,536 8,030 12,842 195,317 88,780 664,559 95,774 47,888 47,888 120,245 87,601 104,204 148,946 209,645 16,115 26,421 384,349 174,704 1,463,780 199,481 43,866 220,090 100,040 80,032 444,028 105,412 105,412 Option price a13.55 a10.73 a14.75 a13.94 a9.34 a10.57 a11.31 Nil Nil Nil a10.57 Nil a12.00 a12.00 a12.00 a10.73 a14.75 a13.94 a9.34 a10.57 a11.31 Nil Nil a10.57 Nil a10.30 a11.31 a10.30 Nil Nil Exercised during the year Market price at exercise date 31 December 2005 Exercisable from Exercisable until 20,244 21 Feb 2003 19 Apr 2009 2 May 2010 61,726 2 May 2003 44,882 23 Feb 2004 23 Feb 2011 51,926 22 Feb 2005 22 Feb 2012 74,276 21 Feb 2006 21 Feb 2013 106,536 19 Feb 2007 19 Feb 2014 102,618 17 Feb 2008 17 Feb 2015 8,030 21 Mar 2006 21 Mar 2006 12,842 26 Mar 2007 26 Mar 2007 15,098 14 Apr 2008 14 Apr 2008 195,317 19 Feb 2007 19 Feb 2014 88,780 19 Feb 2007 19 Feb 2007 782,275 120,245 2 May 2003 95,774 21 Feb 2003 1 Sept 2009 47,888 1 Sept 2003 1 Sept 2009 47,888 1 Sept 2004 1 Sept 2009 2 May 2010 87,601 23 Feb 2004 23 Feb 2011 104,204 22 Feb 2005 22 Feb 2012 148,946 21 Feb 2006 21 Feb 2013 209,645 19 Feb 2007 19 Feb 2014 199,481 17 Feb 2008 17 Feb 2015 16,115 21 Mar 2006 21 Mar 2006 26,421 26 Mar 2007 26 Mar 2007 384,349 19 Feb 2007 19 Feb 2014 174,704 19 Feb 2007 19 Feb 2007 1,663,261 43,866 23 Aug 2007 23 Aug 2014 105,412 17 Feb 2008 17 Feb 2015 220,090 23 Aug 2007 23 Aug 2014 100,040 23 Aug 2007 23 Aug 2007 53,354 23 Aug 2005 23 Aug 2007 522,762 26,678(i) 26,678 a11.41 159711 Reed Report 28-54 7/3/06 12:04 Page 52 52 Directors’ remuneration report (b) Options in Reed Elsevier NV continued A Prozes – ESOS – BIP – LTIS (options) – LTIS (shares) Total P Tierney – ESOS – BIP – LTIS (options) – LTIS (shares) Total 1 January 2005 131,062 59,714 72,783 94,086 111,699 14,552 13,612 204,782 93,083 795,373 282,258 111,699 13,252 204,782 93,083 705,074 Granted during the year 105,412 16,522 121,934 105,412 16,800 122,212 Option price a13.60 a14.75 a13.94 a9.34 a10.57 a11.31 Nil Nil Nil a10.57 Nil a9.34 a10.57 a11.31 Nil Nil a10.57 Nil Exercised during the year Market price at exercise date 31 December 2005 Exercisable from Exercisable until 131,062 9 Aug 2003 9 Aug 2010 59,714 23 Feb 2004 23 Feb 2011 72,783 22 Feb 2005 22 Feb 2012 94,086 21 Feb 2006 21 Feb 2013 111,699 19 Feb 2007 19 Feb 2014 105,412 17 Feb 2008 17 Feb 2015 14,552 21 Mar 2006 21 Mar 2006 13,612 26 Mar 2007 26 Mar 2007 16,522 14 Apr 2008 14 Apr 2008 204,782 19 Feb 2007 19 Feb 2014 93,083 19 Feb 2007 19 Feb 2007 917,307 282,258 21 Feb 2006 21 Feb 2013 111,699 19 Feb 2007 19 Feb 2014 105,412 17 Feb 2008 17 Feb 2015 13,252 26 Mar 2007 26 Mar 2007 16,800 14 Apr 2008 14 Apr 2008 204,782 19 Feb 2007 19 Feb 2014 93,083 19 Feb 2007 19 Feb 2007 827,286 (i) Retained an interest in all of the shares Awards granted under ESOS and BIP which become exercisable from 2007 onwards are subject to post-grant performance conditions, as set out on page 39. The proportion of the award that may vest under LTIS is subject to the annual growth in adjusted EPS during the performance period. The numbers of LTIS options and shares included in the above table are calculated by reference to an assumed annual growth rate of 10%, which would result in 100% of the award vesting. Depending on actual adjusted EPS growth, the proportion of the award that may vest could be lower or higher, as outlined on page 39. The market price of a Reed Elsevier NV ordinary share on the date of the 2005 award under BIP was a11.35. The market price of a Reed Elsevier NV ordinary share during the year was in the range a10.09 to a11.91 and at 31 December 2005 was a11.80. 159711 Reed Report 28-54 7/3/06 12:04 Page 53 Reed Elsevier Annual Reports and Financial Statements 2005 53 (c) Shareholdings in Reed Elsevier PLC and Reed Elsevier NV G J A van de Aast M H Armour G J de Boer-Kruyt Sir Crispin Davis M W Elliott E Engstrom J Hommen C J A van Lede A Prozes D E Reid Lord Sharman R W H Stomberg P Tierney S Zelnick Reed Elsevier PLC ordinary shares Reed Elsevier NV ordinary shares 1 January 31 December 2005 18,600 99,321 – 528,847 – 19,253 – – 91,444 – – – 42,440 – 2005(i) 18,600 46,926 – 473,467 – – – – 76,808 – – – 26,692 – 1 January 31 December 2005 35,445 38,727 – 298,261 – 26,678 – 11,100 73,632 – – – 28,902 – 2005(i) 19,684 29,846 – 298,261 – – – 11,100 63,454 – – – 17,952 – (i) Or date of appointment as a director, if subsequent to 1 January 2005 Any ordinary shares required to fulfil entitlements under nil cost restricted share awards are provided by the Employee Benefit Trust (EBT) from market purchases. As a potential beneficiary under the EBT in the same way as other employees of Reed Elsevier, each executive director is deemed to be interested in all the shares held by the EBT which, at 31 December 2005, amounted to 10,780,776 Reed Elsevier PLC ordinary shares and 5,539,922 Reed Elsevier NV ordinary shares. Approved by the board of Reed Elsevier Group plc on 15 February 2006 Rolf Stomberg Chairman of the Remuneration Committee Approved by the board of Reed Elsevier PLC on 15 February 2006 Approved by the Combined Board of Reed Elsevier NV on 15 February 2006 Rolf Stomberg Non-executive director Rolf Stomberg Member of the Supervisory Board 159711 Reed Report 28-54 7/3/06 12:04 Page 54 159711 Reed Report 55-102 7/3/06 12:04 Page 55 Reed Elsevier Combined financial statements Combined income statement Combined cash flow statement Combined balance sheet Combined statement of recognised income and expense Combined shareholders’ equity reconciliation Accounting policies Notes to the combined financial statements Independent auditors’ report > 56 > 57 > 58 > 59 > 59 > 60 > 65 > 101 159711 Reed Report 55-102 7/3/06 12:04 Page 56 56 Combined financial statements Combined income statement For the year ended 31 December Revenue Cost of sales Gross profit Selling and distribution costs Administration and other expenses Operating profit before joint ventures Share of results of joint ventures Operating profit Finance income Finance costs Net finance costs Disposals and other non operating items Profit before tax Taxation Net profit for the year Attributable to: Parent companies’ shareholders Minority interests Net profit for the year Note 1 2 6 6 7 8 £ 2004 £m 4,812 (1,733) 3,079 (1,065) (1,265) 749 17 766 16 (148) (132) (3) 631 (170) 461 2005 £m 5,166 (1,890) 3,276 (1,120) (1,333) 823 16 839 36 (176) (140) 2 701 (237) 464 d 2004 am 7,074 (2,548) 4,526 (1,566) (1,860) 1,100 26 1,126 23 (217) (194) (4) 928 (250) 678 2005 gm 7,542 (2,759) 4,783 (1,635) (1,946) 1,202 23 1,225 52 (256) (204) 2 1,023 (346) 677 462 2 464 459 2 461 675 2 677 675 3 678 159711 Reed Report 55-102 7/3/06 12:04 Page 57 Combined cash flow statement Reed Elsevier Annual Reports and Financial Statements 2005 57 Note 10 10 For the year ended 31 December Cash flow from operating activities Cash generated from operations Interest paid Interest received Tax paid Net cash from operating activities Cash flows from investing activities Acquisitions Purchases of property, plant and equipment Expenditure on internally developed intangible assets Purchases of investments Proceeds on disposals of property, plant and equipment Proceeds from other disposals Dividends received from joint ventures Net cash used in investing activities Cash flows from financing activities Dividends paid to shareholders of the parent companies Net movement in bank loans, overdrafts and commercial paper Issuance of other loans Repayment of other loans Repayment of finance leases Proceeds on issue of ordinary shares Purchase of treasury shares Net cash used in financing activities £ 2004 £m 1,154 (146) 16 (209) 815 (647) (82) (110) (13) 4 12 17 (819) (309) (162) 102 (3) (19) 21 (29) (399) 2005 £m 1,223 (153) 11 (171) 910 (317) (93) (102) (3) 8 36 16 (455) (336) (492) 544 (90) (13) 25 (27) (389) d 2004 am 1,696 (215) 24 (307) 1,198 (951) (120) (162) (19) 7 18 25 (1,202) (454) (237) 149 (4) (28) 31 (43) (586) 2005 gm 1,786 (223) 16 (250) 1,329 (463) (136) (149) (4) 12 52 23 (665) (491) (718) 794 (132) (19) 37 (39) (568) Increase/(decrease) in cash and cash equivalents 10 66 (403) 96 (590) Movement in cash and cash equivalents At start of year Increase/(decrease) in cash and cash equivalents Exchange translation differences At end of year 225 66 5 296 638 (403) (10) 225 317 96 19 432 906 (590) 1 317 159711 Reed Report 55-102 7/3/06 12:04 Page 58 58 Combined financial statements Combined balance sheet As at 31 December Non-current assets Goodwill Intangible assets Investments Property, plant and equipment Deferred tax assets Current assets Inventories and pre-publication costs Trade and other receivables Cash and cash equivalents Assets held for sale Total assets Current liabilities Trade and other payables Borrowings Taxation Non-current liabilities Borrowings Taxation Deferred tax liabilities Net pension obligations Provisions Liabilities associated with assets held for sale Total liabilities Net assets Capital and reserves Combined share capitals Combined share premiums Combined shares held in treasury Translation reserve Other combined reserves Combined shareholders’ equity Minority interests Total equity Note 13 14 15 16 18 19 20 21 22 23 23 18 4 25 21 27 28 29 30 31 £ 2004 £m 2,611 2,835 110 292 235 6,083 541 1,103 225 1,869 – 7,952 1,791 1,051 299 3,141 1,706 198 857 321 52 3,134 – 6,275 1,677 2005 £m 3,030 2,979 115 314 266 6,704 630 1,437 296 2,363 60 9,127 1,982 900 269 3,151 2,264 287 980 405 44 3,980 11 7,142 1,985 190 1,805 (93) 89 (21) 1,970 15 1,985 191 1,805 (66) (122) (144) 1,664 13 1,677 d 2004 am 3,682 3,997 157 411 331 8,578 763 1,555 317 2,635 – 11,213 2,525 1,482 422 4,429 2,405 279 1,208 453 73 4,418 – 8,847 2,366 269 2,545 (93) (175) (200) 2,346 20 2,366 2005 gm 4,424 4,349 168 458 388 9,787 920 2,098 432 3,450 88 13,325 2,893 1,314 393 4,600 3,305 420 1,431 591 64 5,811 16 10,427 2,898 277 2,635 (136) 130 (30) 2,876 22 2,898 159711 Reed Report 55-102 7/3/06 12:04 Page 59 Combined statement of recognised income and expense Reed Elsevier Annual Reports and Financial Statements 2005 59 For the year ended 31 December Net profit for the year Exchange differences on translation of foreign operations Actuarial losses on defined benefit pension schemes Fair value movements on available for sale investments Fair value movements on cash flow hedges Tax on actuarial losses on defined benefit pension schemes Tax on fair value movements on cash flow hedges Net income/(expense) recognised directly in equity Note 4 Transfer to net profit from hedge reserve Total recognised income and expense for the year Attributable to: Parent companies’ shareholders Minority interests Total recognised income and expense for the year Transition adjustment on adoption of IAS39 attributable to: Parent companies’ shareholders Minority interests Transition adjustment on adoption of IAS39 Combined shareholders’ equity reconciliation For the year ended 31 December Total recognised net income attributable to the parent companies’ shareholders Dividends declared Issue of ordinary shares, net of expenses Increase in shares held in treasury Recognition of share based remuneration reserve Net increase in combined shareholders’ equity Combined shareholders’ equity at start of year Transition adjustment on adoption of IAS39 Combined shareholders’ equity at end of year Note 12 29 £ 2004 £m 461 (121) (74) – – 12 – (183) – 278 276 2 278 – – – £ 2004 £m 276 (309) 21 (29) 59 18 1,646 – 1,664 2005 £m 464 180 (37) 3 (10) 10 (13) 133 (19) 578 576 2 578 11 – 11 2005 £m 576 (336) 25 (27) 57 295 1,664 11 1,970 d 2004 am 678 (196) (109) – – 18 – (287) – 391 388 3 391 – – – d 2004 am 388 (454) 31 (43) 87 9 2,337 – 2,346 2005 gm 677 346 (54) 4 (15) 15 (19) 277 (28) 926 924 2 926 16 – 16 2005 gm 924 (491) 37 (39) 83 514 2,346 16 2,876 159711 Reed Report 55-102 7/3/06 12:04 Page 60 60 Combined financial statements Accounting policies Under a regulation adopted by the European Parliament, the Reed Elsevier combined financial statements are prepared in accordance with International Financial Reporting Standards (IFRS) with effect from the 2005 financial year. The transition date for the application of IFRS is 1 January 2004 and the comparative figures for the year ended 31 December 2004 have been restated accordingly. Reconciliations of net income and equity for the comparative period from previously applied UK GAAP to IFRS are presented in note 33. IAS39 – Financial Instruments: Recognition and Measurement is applicable from the 2005 financial year with a transition date of 1 January 2005 and accordingly no restatement of prior period comparatives has been made in respect of IAS39. non operating items, related tax effects and movements in deferred taxation assets and liabilities that are not expected to crystallise in the near term. Adjusted operating profits are also grossed up to exclude the equity share of taxes in joint ventures. Adjusted operating cash flow is measured after dividends from joint ventures and net capital expenditure, but before payments in relation to acquisition integration costs. Foreign exchange translation The combined financial statements are presented in both pounds sterling and euros, being the respective functional currencies of the two parent companies, Reed Elsevier PLC and Reed Elsevier NV. The Reed Elsevier combined financial statements are prepared under IFRS as endorsed by the European Union, including the early adoption of an amendment to IAS19 – Employee Benefits which allows actuarial gains and losses to be recognised in full in the statement of recognised income and expense in the period in which they occur. The Reed Elsevier accounting policies under IFRS are set out below. Basis of preparation The equalisation agreement between Reed Elsevier PLC and Reed Elsevier NV has the effect that their shareholders can be regarded as having the interests of a single economic group. The Reed Elsevier combined financial statements (“the combined financial statements”) represent the combined interests of both sets of shareholders and encompass the businesses of Reed Elsevier Group plc and Elsevier Reed Finance BV and their respective subsidiaries, associates and joint ventures, together with the parent companies, Reed Elsevier PLC and Reed Elsevier NV (“the combined businesses”). These financial statements form part of the statutory information to be provided by Reed Elsevier NV, but are not for a legal entity and do not include all the information required to be disclosed by a company in its financial statements under the UK Companies Act 1985 or the Dutch Civil Code. Additional information is given in the Annual Reports and Financial Statements of the parent companies set out on pages 104 to 142. A list of principal businesses is set out on page 153. In addition to the figures required to be reported by applicable accounting standards, adjusted profit and operating cash flow figures have been presented as additional performance measures. Adjusted figures are shown before the amortisation of acquired intangible assets, acquisition integration costs, disposals and other Transactions in foreign currencies are recorded at the rate of exchange prevailing on the date of the transaction. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are retranslated at the rate prevailing on the balance sheet date. Exchange differences arising are recorded in the income statement other than where hedge accounting applied (see Financial Instruments). Assets and liabilities of foreign operations are translated at exchange rates prevailing on the balance sheet date. Income and expense items of foreign operations are translated at the average exchange rate for the period. Exchange differences arising are classified as equity and transferred to the translation reserve. When operations are disposed of, the related cumulative translation differences are recognised within the income statement in the period. As permitted under the transition rules of IFRS1 – First Time Adoption of International Financial Reporting Standards, cumulative translation differences in respect of foreign operations have been deemed to be nil at the date of transition to IFRS. Reed Elsevier uses derivative financial instruments, primarily forward contracts, to hedge its exposure to certain foreign exchange risks. Details of Reed Elsevier’s accounting policies in respect of derivative financial instruments are set out below. Revenue Revenue represents the invoiced value of sales less anticipated returns on transactions completed by performance, excluding customer sales taxes and sales between the combined businesses. Revenues are recognised for the various categories of turnover as follows: subscriptions – on periodic despatch of subscribed product or rateably over the period of the 159711 Reed Report 55-102 7/3/06 12:04 Page 61 Reed Elsevier Annual Reports and Financial Statements 2005 61 subscription where performance is not measurable by despatch; circulation – on despatch; advertising – on publication or over the period of online display; exhibitions – on occurrence of the exhibition; educational testing contracts – over the term of the contract on percentage completed against contract milestones. Where sales consist of two or more independent components, revenue is recognised on each component, as it is completed by performance, based on attribution of relative value. Employee benefits The expense of defined benefit pension schemes and other post-retirement employee benefits is determined using the projected unit credit method and charged in the income statement as an operating expense, based on actuarial assumptions reflecting market conditions at the beginning of the financial year. Actuarial gains and losses are recognised in full in the statement of recognised income and expense in the period in which they occur. Past service costs are recognised immediately to the extent that benefits have vested, or, if not vested, on a straight line basis over the period until the benefits vest. Net pension obligations in respect of defined benefit schemes are included in the balance sheet at the present value of scheme liabilities, less the fair value of scheme assets. Where assets exceed liabilities, any net pension asset is limited to the extent that the asset is not recoverable through reductions in future contributions. The expense of defined contribution pension schemes and other employee benefits is charged in the income statement as incurred. Share based remuneration The fair value of share based remuneration is determined at the date of grant and recognised as an expense in the income statement on a straight line basis over the vesting period, taking account of the estimated number of shares that are expected to vest. Market based performance criteria are taken into account when determining the fair value at the date of grant. Non-market based performance criteria are taken into account when estimating the number of shares expected to vest. The fair value of share based remuneration is determined by use of a binomial model. All Reed Elsevier’s share based remuneration is equity settled. In accordance with the transitional provisions of IFRS2 – Share Based Payment, the expense recognised in the income statement relates to grants made during the financial period and all grants made before the transition date that had not fully vested at that date. Borrowing costs All borrowing costs are expensed as incurred unless hedge accounting applies (see Financial Instruments). Taxation The tax expense represents the sum of the tax payable on the current year taxable profits and the movements on deferred tax that are recognised in the income statement. The tax payable on current year taxable profits is calculated using the applicable tax rates that have been enacted, or substantively enacted, by the balance sheet date. Deferred tax is the tax arising on differences between the carrying amounts of assets and liabilities in the financial statements and their corresponding tax bases used in the computation of taxable profit, and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Deferred tax is not recognised on temporary differences arising in respect of goodwill that is not deductible for tax purposes. Deferred tax is calculated using tax rates that are expected to apply in the period when the liability is expected to be settled or the asset realised. Full provision is made for deferred tax which would become payable on the distribution of retained profits from foreign subsidiaries, associates or joint ventures. Movements in deferred tax are charged or credited in the income statement, except when they relate to items charged or credited directly to equity, in which case the deferred tax is also dealt with in equity. Goodwill On the acquisition of a subsidiary or business, the purchase consideration is allocated between the net tangible and intangible assets on a fair value basis, with any excess purchase consideration representing goodwill. Goodwill arising on acquisitions also includes amounts corresponding to deferred tax liabilities recognised in respect of acquired intangible assets. Goodwill is recognised as an asset and reviewed for impairment at least annually. Any impairment is recognised immediately in the income statement and not subsequently reversed. On disposal of a subsidiary or business, the attributable amount of goodwill is included in the determination of the profit or loss on disposal. 159711 Reed Report 55-102 7/3/06 12:04 Page 62 62 Combined financial statements Accounting policies In accordance with the IFRS transition rules, goodwill arising on acquisitions before the 1 January 2004 date of transition to IFRS is included in the balance sheet at the net book amount previously stated under UK GAAP. An impairment review was carried out as at the transition date and no impairment identified. Deferred tax liabilities recognised in respect of acquired intangible assets acquired prior to the transition date were taken directly to equity on transition. leases are depreciated over their estimated useful lives up to a maximum of 50 years. Short leases are written off over the duration of the lease. Depreciation is provided on other assets on a straight line basis over their estimated useful lives as follows: leasehold improvements – shorter of life of lease and 10 years; plant – 3 to 20 years; office furniture, fixtures and fittings – 5 to 10 years; computer systems, communication networks and equipment – 3 to 7 years. Intangible assets Intangible assets acquired as part of a business combination are stated in the balance sheet at their fair value as at the date of acquisition, less accumulated amortisation. Internally generated intangible assets are stated in the balance sheet at the directly attributable cost of creation of the asset, less accumulated amortisation. Intangible assets acquired as part of business combinations comprise: market related assets (e.g. trade marks, imprints, brands); customer related assets (e.g. subscription bases, customer lists, customer relationships); editorial content; software and systems (e.g. application infrastructure, product delivery platforms, in-process research and development); contract based assets (e.g. publishing rights, exhibition rights, supply contracts); and other intangible assets. Internally generated intangible assets typically comprise software and systems development where an identifiable asset is created that is probable to generate future economic benefits. All other development expenditure is recognised as an expense in the period in which it is incurred. Intangible assets, other than brands and imprints determined to have indefinite lives, are amortised systematically over their estimated useful lives. The estimated useful lives of intangible assets with finite lives are as follows: market related assets – 3 to 40 years; customer related assets – 3 to 16 years; content, software and other acquired intangible assets – 3 to 20 years; and internally developed intangible assets – 3 to 10 years. Brands and imprints determined to have indefinite lives are not amortised and are subject to impairment review at least annually. Intangible assets recognised on acquisitions made before the 1 January 2004 date of transition to IFRS have been included in the balance sheet at their previously stated UK GAAP cost less amortisation as at that date. An impairment review was carried out as at the transition date and no impairment identified. Property, plant and equipment Property, plant and equipment are stated in the balance sheet at cost less accumulated depreciation. No depreciation is provided on freehold land. Freehold buildings and long Investments Investments, other than investments in joint ventures and associates, are stated in the balance sheet at fair value. Investments held as part of the venture capital portfolio are classified as held for trading, with changes in fair value reported through the income statement. All other investments are classified as available for sale with changes in fair value recognised directly in equity until the investment is disposed of or is determined to be impaired, at which time the cumulative gain or loss previously recognised in equity is brought into the net profit or loss for the period. All items recognised in the income statement related to investments, other than investments in joint ventures and associates, are reported as non operating items. Available for sale investments and venture capital investments held for trading represent investments in listed and unlisted securities. The fair value of listed securities is determined based on quoted market prices, and of unlisted securities on management’s estimate of fair value based on standard valuation techniques. Investments in joint ventures and associates are accounted for under the equity method and stated in the balance sheet at cost as adjusted for post-acquisition changes in Reed Elsevier’s share of net assets, less any impairment in value. Impairment At each balance sheet date, reviews are carried out of the carrying amounts of tangible and intangible assets and goodwill to determine whether there is any indication that those assets have suffered an impairment loss. If any such indication exists, the recoverable amount of the asset is estimated in order to determine the extent, if any, of the impairment loss. Where the asset does not generate cash flows that are independent from other assets, estimates are made based on the cash flows of the cash generating unit to which the asset belongs. Intangible assets with an indefinite useful life are tested for impairment at least annually and whenever there is any indication that the asset may be impaired. Recoverable amount is the higher of fair value, less costs to sell, and value in use. In assessing value in use, estimated future cash flows are discounted to their present value using 159711 Reed Report 55-102 7/3/06 12:04 Page 63 Reed Elsevier Annual Reports and Financial Statements 2005 63 a discount rate appropriate to the specific asset or cash generating unit. Pre-tax discount rates of 10–12% have been applied. Estimated future cashflows are based on latest forecasts and estimates for the next five years, and a long term growth rate of 3% is assumed thereafter. If the recoverable amount of an asset or cash generating unit is estimated to be less than its net carrying amount, the net carrying amount of the asset or cash generating unit is reduced to its recoverable amount. Impairment losses are recognised immediately in the income statement. Inventories and pre-publication costs Inventories and pre-publication costs are stated at the lower of cost, including appropriate attributable overhead, and estimated net realisable value. Pre-publication costs, representing costs incurred in the origination of content prior to publication, are expensed systematically reflecting the expected sales profile over the estimated economic lives of the related products, generally up to five years. Leases Assets held under leases which confer rights and obligations similar to those attaching to owned assets are classified as assets held under finance leases and capitalised within property, plant and equipment and the corresponding liability to pay rentals is shown net of interest in the balance sheet as obligations under finance leases. The capitalised value of the assets is depreciated on a straight line basis over the shorter of the periods of the leases or the useful lives of the assets concerned. The interest element of the lease payments is allocated so as to produce a constant periodic rate of charge. Operating lease rentals are charged to the income statement on a straight line basis over the period of the leases. Rental income from operating leases is recognised on a straight line basis over the term of the relevant lease. Cash and cash equivalents Cash and cash equivalents comprise cash balances, call deposits and other short term highly liquid investments and are held in the balance sheet at fair value. Assets held for sale Assets of businesses that are held for sale, rather than for continuing use by Reed Elsevier, are classified as assets held for sale. Such assets are carried at the lower of amortised cost and fair value less costs to sell. Similarly, liabilities of businesses held for sale are also separately classified on the balance sheet. Financial instruments Financial instruments comprise investments (other than investments in joint ventures or associates), trade receivables, cash and cash equivalents, payables and accruals, borrowings and derivative financial instruments. Financial instruments that are classified as held to maturity are recorded in the balance sheet at amortised cost. Investments are classified as either held for trading or available for sale, as described above. Other financial instruments that are classified as held for trading are recorded in the balance sheet at fair value, with changes in fair value reported through the income statement. In accordance with the transitional provisions of IFRS1 – First Time Adoption of International Financial Reporting Standards, financial instruments have been accounted for and presented on the UK GAAP basis for the year ended 31 December 2004. Under IAS39 – Financial Instruments, with effect from 1 January 2005, financial instruments are stated in the balance sheet at fair value. Derivative financial instruments are used to hedge interest rate and foreign exchange risks. Changes in the fair value of derivative financial instruments that are designated and effective as hedges of future cash flows are recognised directly in equity in the hedge reserve. If a hedged firm commitment or forecasted transaction results in the recognition of a non financial asset or liability, then, at the time that the asset or liability is recognised, the associated gains or losses on the derivative that had previously been recognised in equity are included in the initial measurement of the asset or liability. For hedges that do not result in the recognition of an asset or a liability, amounts deferred in equity are recognised in the income statement in the same period in which the hedged item affects net profit or loss. Any ineffective portion of hedges is recognised immediately in the income statement. Where an effective hedge is in place against changes in the fair value of fixed rate borrowings, the hedged borrowings are adjusted for changes in fair value attributable to the risk being hedged with a corresponding income or expense included in the income statement. The offsetting gains or losses from remeasuring the fair value of the related derivatives are also recognised in the income statement. Changes in the fair value of derivative financial instruments that do not qualify for hedge accounting are recognised in the income statement as they arise. Hedge accounting is discontinued when a hedging instrument expires or is sold, terminated or exercised, or no longer qualifies for hedge accounting. At that time, any cumulative gain or loss on the hedging instrument recognised in equity is either retained in equity until the firm commitment or forecasted transaction occurs, or, where a hedged transaction is no longer expected to occur, is immediately credited or expensed in the income statement. 159711 Reed Report 55-102 7/3/06 12:04 Page 64 64 Combined financial statements Accounting policies As at 1 January 2005, adjustments have been made either to the carrying value of hedged items or to equity, as appropriate, to reflect the differences between the UK GAAP carrying values of financial instruments and their carrying values required to be reported under IAS39. Any transition gains or losses on financial instruments that qualify for hedge accounting and are reflected in equity will remain in equity until either the forecasted transaction occurs or is no longer expected to occur. Critical judgements and key sources of estimation uncertainty A description of critical judgements made by management of Reed Elsevier and key sources of estimation uncertainty in the preparation of the combined financial statements is included in the description of accounting policies on pages 23 and 24 of the Operating and Financial Review. 159711 Reed Report 55-102 7/3/06 12:04 Page 65 Notes to the combined financial statements For the year ended 31 December 2005 Reed Elsevier Annual Reports and Financial Statements 2005 65 1 Segment analysis Reed Elsevier is a publisher and information provider organised as four business segments: Elsevier, comprising scientific, technical and medical publishing and communication businesses; LexisNexis, providing legal, tax, regulatory and business information to professional, business and government customers; Harcourt Education, publishing school textbooks and related instructional and assessment materials; and Reed Business, providing information and marketing solutions to business professionals. Internal reporting is consistent with this organisational structure. Adjusted operating profit figures are presented as an additional performance measure. They are stated before the amortisation of acquired intangible assets and acquisition integration costs and are grossed up to exclude the equity share of taxes in joint ventures. Adjusted operating profit is reconciled to operating profit in note 9. Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Corporate costs Unallocated net pension credit Total Geographical origin North America United Kingdom The Netherlands Rest of Europe Rest of world Total Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Corporate costs Unallocated net pension credit Total Geographical origin North America United Kingdom The Netherlands Rest of Europe Rest of world Total Revenue Operating profit 2005 £m 2004 £m 1,436 1,466 901 1,363 5,166 – – 5,166 2,888 870 500 601 307 5,166 1,363 1,292 868 1,289 4,812 – – 4,812 2,656 846 503 545 262 4,812 2005 £m 396 218 87 158 859 (32) 12 839 364 158 161 106 50 839 2004 £m 402 188 67 126 783 (29) 12 766 315 129 182 102 38 766 Adjusted operating profit 2005 £m 2004 £m 449 338 161 214 1,162 (32) 12 1,142 595 186 166 141 54 1,142 445 287 157 194 1,083 (29) 12 1,066 539 159 189 138 41 1,066 Revenue 2005 gm 2004 am Operating profit 2005 gm 2004 am Adjusted operating profit 2005 gm 2004 am 2,097 2,140 1,315 1,990 7,542 – – 7,542 4,216 1,270 730 878 448 7,542 2,004 1,899 1,276 1,895 7,074 – – 7,074 3,904 1,244 739 801 386 7,074 578 318 127 231 1,254 (47) 18 1,225 531 231 235 155 73 1,225 591 276 99 185 1,151 (43) 18 1,126 462 190 268 150 56 1,126 655 493 235 313 1,696 (47) 18 1,667 869 271 242 206 79 1,667 654 422 231 285 1,592 (43) 18 1,567 792 234 278 203 60 1,567 159711 Reed Report 55-102 7/3/06 12:04 Page 66 66 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 1 Segment analysis continued Revenue is analysed before the £91m/a133m (2004: £94m/a138m) share of joint ventures' revenue, of which £20m/a29m (2004: £19m/a28m) relates to LexisNexis, principally to Giuffrè, and £71m/a104m (2004: £75m/a110m) relates to Reed Business, principally to exhibition joint ventures. Share of post-tax results of joint ventures of £16m/a23m (2004: £17m/a26m) included in operating profit comprises £3m/a4m (2004: £3m/a5m) relating to LexisNexis and £13m/a19m (2004: £14m/a21m) relating to Reed Business. The unallocated net pension credit of £12m/a18m (2004: £12m/a18m) comprises the expected return on pension scheme assets of £149m/a218m (2004: £139m/a204m) less interest on pension scheme liabilities of £137m/a200m (2004: £127m/a186m). Analysis of revenue by geographical market North America United Kingdom The Netherlands Rest of Europe Rest of world Total 2005 £m 2,974 568 202 804 618 5,166 2004 £m 2,779 545 202 725 561 4,812 2005 gm 4,342 829 295 1,174 902 7,542 2004 am 4,085 801 297 1,066 825 7,074 Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Corporate Total Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Corporate Total Acquired intangible assets Capital expenditure Amortisation of acquired intangible assets Depreciation and other amortisation 2005 £m 97 27 3 22 149 – 149 2004 £m 3 215 72 20 310 – 310 2005 £m 60 95 22 27 204 3 207 Acquired intangible assets Capital expenditure 2005 gm 143 39 4 32 218 – 218 2004 am 5 316 106 29 456 – 456 2005 gm 88 139 32 39 298 4 302 2004 £m 65 93 27 27 212 4 216 2004 am 95 137 40 40 312 6 318 2005 £m 49 102 73 52 276 – 276 2004 £m 39 82 74 60 255 – 255 2005 £m 38 65 14 25 142 2 144 2004 £m 28 57 12 25 122 4 126 Amortisation of acquired intangible assets Depreciation and other amortisation 2005 gm 71 149 107 76 403 – 403 2004 am 57 121 109 88 375 – 375 2005 gm 55 95 20 37 207 3 210 2004 am 40 84 18 37 179 6 185 Capital expenditure comprises additions to property, plant and equipment and internally developed intangible assets. In addition to the depreciation and amortisation above, other non cash items relate to the recognition of share based remuneration and comprise £11m/a16m (2004: £9m/a14m) in Elsevier, £16m/a23m (2004: £15m/a22m) in LexisNexis, £9m/a13m (2004: £9m/a13m) in Harcourt Education, £14m/a21m (2004: £17m/a25m) in Reed Business and £7m/a10m (2004: 9m/a13m) in Corporate. 159711 Reed Report 55-102 7/3/06 12:04 Page 67 Reed Elsevier Annual Reports and Financial Statements 2005 67 1 Segment analysis continued Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Taxation Cash/borrowings Net pension obligations Other assets and liabilities Total Geographical location North America United Kingdom The Netherlands Rest of Europe Rest of world Total Total assets Total liabilities Net assets/(liabilities) 2005 £m 2004 £m 2005 £m 2004 £m 2005 £m 2004 £m 2,545 2,881 1,667 1,225 8,318 266 296 – 247 9,127 6,433 899 513 1,089 193 9,127 2,099 2,616 1,542 1,194 7,451 235 225 – 41 7,952 5,622 927 417 841 145 7,952 759 386 181 544 1,870 1,536 3,164 405 167 7,142 4,075 611 651 1,647 158 7,142 704 329 177 515 1,725 1,354 2,757 321 118 6,275 3,403 581 623 1,531 137 6,275 1,786 2,495 1,486 681 6,448 (1,270) (2,868) (405) 80 1,985 2,358 288 (138) (558) 35 1,985 1,395 2,287 1,365 679 5,726 (1,119) (2,532) (321) (77) 1,677 2,219 346 (206) (690) 8 1,677 Total assets Total liabilities Net assets/(liabilities) 2005 gm 2004 am 2005 gm 2004 am 2005 gm 2004 am 2,960 3,689 2,174 1,683 10,506 331 317 – 59 11,213 3,716 4,206 2,434 1,788 12,144 388 432 – 361 13,325 Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Taxation Cash/borrowings Net pension obligations Other assets and liabilities Total Geographical location North America 9,391 United Kingdom 1,313 The Netherlands 749 Rest of Europe 1,590 Rest of world 282 Total 13,325 Investments in joint ventures of £71m/a104m (2004: £60m/a86m) included in segment assets above comprise £28m/a41m (2004: £26m/a37m) relating to LexisNexis and £43m/a63m (2004: £34m/a49m) relating to Reed Business. 2,608 3,643 2,170 993 9,414 (1,856) (4,187) (591) 118 2,898 1,108 563 264 795 2,730 2,244 4,619 591 243 10,427 993 464 249 726 2,432 1,909 3,887 453 166 8,847 5,948 893 950 2,405 231 10,427 7,927 1,307 588 1,186 205 11,213 3,443 420 (201) (815) 51 2,898 4,798 819 878 2,159 193 8,847 1,967 3,225 1,925 957 8,074 (1,578) (3,570) (453) (107) 2,366 3,129 488 (290) (973) 12 2,366 159711 Reed Report 55-102 7/3/06 12:04 Page 68 68 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 1 Segment analysis continued Business segment Elsevier LexisNexis Harcourt Education Reed Business Total Goodwill Intangible assets 2005 £m 821 1,304 467 438 3,030 2004 £m 629 1,147 415 420 2,611 2005 £m 1,050 924 632 373 2,979 2004 £m 919 886 629 401 2,835 Goodwill 2005 gm 2004 am Intangible assets 2005 gm 2004 am Business segment 1,296 Elsevier 1,249 LexisNexis 887 Harcourt Education 565 Reed Business 3,997 Total Included in intangible assets within the Elsevier segment are £333m/a486m (2004: £298m/a420m) of intangible assets which have been determined to have indefinite lives. 1,533 1,349 923 544 4,349 1,199 1,904 682 639 4,424 887 1,618 585 592 3,682 2 Operating profit Operating profit is stated after charging/(crediting) the following: Note 2005 £m 4 5 1,318 136 100 57 1,611 Staff costs Wages and salaries Social security costs Pensions Share based remuneration Total staff costs Depreciation and amortisation Amortisation of acquired intangible assets Amortisation of internally developed intangible assets Depreciation of property, plant and equipment Total depreciation and amortisation Auditors' remuneration For audit services For non audit services Total auditors’ remuneration Other expenses and income Pre-publication costs, inventory expenses and other cost of sales Operating lease rentals expense Operating lease rentals income Depreciation and amortisation charges are included within administration and other expenses. 1,890 115 (14) 276 57 87 420 3.2 1.6 4.8 14 14 16 2004 £m 1,216 125 89 59 1,489 255 55 71 381 3.0 1.2 4.2 1,733 105 (12) 2005 gm 1,924 199 146 83 2,352 403 83 127 613 4.7 2.3 7.0 2004 am 1,787 184 131 87 2,189 375 81 104 560 4.4 1.8 6.2 2,759 168 (20) 2,548 154 (18) Auditors’ remuneration for non audit services comprises: £0.4m/a0.6m (2004: £0.4m/a0.6m) for audit related services, £0.4m/a0.6m (2004: £0.2m/a0.3m) for due diligence and other transaction related services, £0.7m/a1.0m (2004: £0.6m/a0.9m) for tax compliance and advisory work and £0.1m/a0.1m (2004: £nil/anil) for other non audit services. 159711 Reed Report 55-102 7/3/06 12:04 Page 69 Reed Elsevier Annual Reports and Financial Statements 2005 69 3 Personnel Number of people employed Business segment Elsevier LexisNexis Harcourt Education Reed Business Sub-total Corporate/shared functions Total Geographical location North America United Kingdom The Netherlands Rest of Europe Rest of world Total At 31 December Average during the year 2005 2004 2005 2004 7,300 13,400 5,400 10,200 36,300 200 36,500 20,200 5,800 2,500 4,600 3,400 36,500 6,800 13,100 5,400 10,100 35,400 200 35,600 20,000 5,700 2,600 4,100 3,200 35,600 7,100 13,200 5,400 10,200 35,900 200 36,100 20,100 5,800 2,500 4,300 3,400 36,100 6,700 12,800 5,300 10,100 34,900 200 35,100 19,800 5,700 2,600 4,000 3,000 35,100 4 Pension schemes A number of pension schemes are operated around the world. The major schemes are of the defined benefit type with assets held in separate trustee administered funds. The largest schemes, which cover the majority of employees, are in the UK, the US and the Netherlands. Under these plans, employees are entitled to retirement benefits normally dependent on the number of years service. The principal assumptions used for the purpose of valuation under IAS19 – Employee Benefits are presented below as the weighted average of the various defined benefit pension schemes: Discount rate Expected return on scheme assets Expected rate of salary increases Future pension increases 2005 4.9% 7.0% 4.0% 2.8% 2004 5.4% 6.8% 4.4% 2.8% The expected rates of return on individual categories of scheme assets are determined by reference to relevant market indices. The overall expected rate of return on scheme assets is based on the weighted average of each asset category. The defined benefit pension cost, recognised within operating expenses in the income statement, comprises: 2004 am Service cost 122 Interest on pension scheme liabilities 186 Expected return on scheme assets (204) Net defined benefit pension cost 104 A total of £21m/a31m (2004: £18m/a27m) was recognised as an expense in relation to defined contribution pension schemes. 2005 £m 91 137 (149) 79 2005 gm 133 200 (218) 115 2004 £m 83 127 (139) 71 159711 Reed Report 55-102 7/3/06 12:04 Page 70 70 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 4 Pension schemes continued The amount recognised in the balance sheet in respect of defined benefit pension schemes at the start and end of the year and the movements during the year were as follows: 2005 Defined benefit obligations £m Fair value of scheme assets £m Net pension obligations £m Defined benefit obligations £m 2004 Fair value of scheme assets £m Net pension obligations £m At start of year Service cost Interest on pension scheme liabilities Expected return on scheme assets Actuarial (loss)/gain Contributions by employer Contributions by employees Benefits paid Exchange translation differences At end of year At start of year Service cost Interest on pension scheme liabilities Expected return on scheme assets Actuarial (loss)/gain Contributions by employer Contributions by employees Benefits paid Exchange translation differences At end of year (2,525) (91) (137) – (267) – (13) 94 (41) (2,980) 2,204 – – 149 230 47 13 (94) 26 2,575 2005 (321) (91) (137) 149 (37) 47 – – (15) (405) Defined benefit obligations gm Fair value of scheme assets gm Net pension obligations gm (3,561) (133) (200) – (390) – (19) 137 (183) (4,349) 3,108 – – 218 336 68 19 (137) 146 3,758 (453) (133) (200) 218 (54) 68 – – (37) (591) The proportion of scheme assets held as equities, bonds and other assets is shown below: (2,281) (83) (127) – (140) – (10) 89 27 (2,525) 2,030 – – 139 66 68 10 (89) (20) 2,204 (251) (83) (127) 139 (74) 68 – – 7 (321) Defined benefit obligations am 2004 Fair value of scheme assets am Net pension obligations am (3,239) (122) (186) – (206) – (15) 131 76 (3,561) 2,883 – – 204 97 100 15 (131) (60) 3,108 2005 (356) (122) (186) 204 (109) 100 – – 16 (453) 2004 64% 32% 4% 100% Equities Bonds Other Total The actual return on scheme assets for the year ended 31 December 2005 was £379m/a553m (2004: £205m/a301m). 66% 30% 4% 100% As at 31 December 2005 the defined benefit obligations comprise £2,890m/a4,218m (2004: £2,458m/a3,466m) in relation to funded schemes and £90m/a131m (2004: £67m/a95m) in relation to unfunded schemes. Deferred tax assets of £133m/a194m (2004: £109m/a154m) are recognised in respect of the net pension obligations. 159711 Reed Report 55-102 7/3/06 12:04 Page 71 Reed Elsevier Annual Reports and Financial Statements 2005 71 4 Pension schemes continued As at 31 December 2005 the net cumulative actuarial losses recognised in the statement of recognised income and expense, since transition to IFRS effective from 1 January 2004 was £111m/a163m, comprising: Experience losses on scheme liabilities Experience gains on scheme assets Actuarial losses arising on the present value of scheme liabilities due to changes in: – discount rates – other actuarial assumptions 2005 £m (25) 230 2004 £m (18) 66 2005 gm (37) 336 2004 am (26) 97 (217) (25) (37) (113) (9) (74) (317) (36) (54) (166) (14) (109) Total actuarial losses charged directly to equity The combined businesses expect to contribute approximately £70m/a102m to their defined benefit pension schemes in 2006. 5 Share based remuneration Reed Elsevier offers a number of share based remuneration schemes to directors and employees. The principal share based remuneration schemes comprise share options, under the Executive Share Option Schemes (ESOS) and the Long Term Incentive Scheme (LTIS), and conditional shares under LTIS, the Retention Share Plan (RSP) and the Bonus Investment Plan (BIP), in relation to Reed Elsevier PLC and Reed Elsevier NV ordinary shares. Share options granted under ESOS and LTIS are exercisable after three years and up to ten years from the date of grant at a price equivalent to the market value of the respective shares at the date of grant. Conditional shares granted under LTIS, RSP and BIP are exercisable after three years for nil consideration. All share based remuneration awards are subject to the condition that the employee remains in employment at the time of exercise. Share options and conditional shares granted under LTIS, RSP, certain ESOS and BIP are further subject to the achievement of growth targets of Reed Elsevier PLC and Reed Elsevier NV adjusted earnings per share measured at constant exchange rates. The estimated fair value of grants made in the year ended 31 December 2005 and in the prior year, and the main assumptions used, which have been established with advice from and data provided by independent actuaries, are set out below. The fair value of grants made in any year is recognised in the income statement over the vesting period, typically 3 years. In respect of Reed Elsevier PLC ordinary shares In respect of Reed Elsevier NV ordinary shares Total fair value Weighted average fair value per award £ £1.05 £4.87 Number of shares ‘000 11,520 951 Fair value £m 12 5 17 Weighted average fair value per award g g1.91 g10.27 Number of shares ‘000 7,471 406 Fair value gm 14 4 18 £m 22 8 30 gm 32 11 43 2005 grants Share options Conditional shares Total 159711 Reed Report 55-102 7/3/06 12:04 Page 72 72 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 5 Share based remuneration continued In respect of Reed Elsevier PLC ordinary shares In respect of Reed Elsevier NV ordinary shares Total fair value Weighted average fair value per award £ £1.35 £4.59 Number of shares ‘000 22,532 5,141 Fair value £m 30 24 54 Weighted average fair value per award a a2.63 a9.96 Number of shares ‘000 15,235 3,391 Fair value am 40 34 74 £m 57 47 104 am 84 69 153 2004 grants Share options Conditional shares Total Assumptions for grants made during the year Share options Weighted average share price at date of grant Expected volatility Expected option life Expected dividend yield Risk free interest rate Expected lapse rate Conditional shares Weighted average share price at date of grant Expected dividend yield Risk free interest rate Expected lapse rate In respect of Reed Elsevier PLC ordinary shares In respect of Reed Elsevier NV ordinary shares 2005 2004 2005 2004 £5.24 22% 4 years 2.6% 5.1% 3-5% £4.86 32% 4 years 2.0% 5.1% 3-5% £5.26 2.6% 5.1% 3% £4.87 2.0% 5.1% 3% g11.30 22% 4 years 2.6% 3.4% 3-5% a10.57 32% 4 years 2.0% 3.4% 3-5% g11.05 2.6% 3.4% 3% a10.57 2.0% 3.4% 3% Expected volatility has been estimated based on relevant historic data in respect of the Reed Elsevier PLC and Reed Elsevier NV ordinary share prices. The share based remuneration awards outstanding as at 31 December 2005, in respect of both Reed Elsevier PLC and Reed Elsevier NV ordinary shares, are set out below. In respect of Reed Elsevier PLC ordinary shares In respect of Reed Elsevier NV ordinary shares 2005 Number of shares '000 63,655 11,520 (3,629) (4,915) (92) 66,539 2005 Weighted average exercise price (pence) 500p 524p 426p 519p 439p 507p 2004 Number of shares '000 63,780 22,532 (2,913) (19,446) (298) 63,655 2004 Weighted average exercise price (pence) 501p 482p 428p 494p 494p 500p 2005 Number of shares '000 42,103 7,471 (1,892) (2,812) (111) 44,759 2005 Weighted average exercise price (g) g11.30 g11.30 g10.37 g11.85 g10.16 g11.30 2004 Number of shares '000 41,966 15,235 (1,377) (13,448) (273) 42,103 2004 Weighted average exercise price (a) a11.67 a10.57 a10.19 a11.65 a17.07 a11.30 Share options Outstanding at start of year Granted Exercised Forfeited Expired Outstanding at end of year Exercisable at end of year 22,747 552p 19,660 525p 16,557 g12.81 13,873 a12.37 The weighted average share price at the date of exercise of share options during 2005 was 533p (2004: 513p) for Reed Elsevier PLC ordinary shares and a11.31 (2004: a11.31) for Reed Elsevier NV ordinary shares. 159711 Reed Report 55-102 7/3/06 12:04 Page 73 Reed Elsevier Annual Reports and Financial Statements 2005 73 5 Share based remuneration continued Conditional shares Outstanding at start of year Granted Exercised Forfeited Outstanding at end of year Range of exercise prices for outstanding share options Reed Elsevier PLC ordinary shares (pence) 301-350 351-400 401-450 451-500 501-550 551-600 601-650 651-700 Total Reed Elsevier NV ordinary shares (euro) 8.01-9.00 9.01-10.00 10.01-11.00 11.01-12.00 12.01-13.00 13.01-14.00 14.01-15.00 15.01-16.00 Total In respect of Reed Elsevier PLC ordinary shares 2005 Number of shares ‘000 2004 Number of shares ‘000 5,341 951 (51) (317) 5,924 232 5,141 – (32) 5,341 2005 Number of shares Weighted average remaining under period until expiry option (years) ‘000 38 2,161 6,110 31,858 12,981 8,283 1,019 4,089 66,539 9 8,034 17,919 8,774 356 5,808 3,223 636 44,759 0.1 2.3 4.0 6.6 8.1 5.2 3.6 5.1 6.2 7.2 7.0 5.9 8.0 3.3 5.4 4.7 2.6 6.3 In respect of Reed Elsevier NV ordinary shares 2005 Number of shares ‘000 2004 Number of shares ‘000 3,483 406 (32) (222) 3,635 109 3,391 – (17) 3,483 2004 Number of shares under option ‘000 Weighted average remaining period until expiry (years) 578 2,516 7,357 34,920 3,147 9,518 1,133 4,486 63,655 9 9,084 19,917 1,845 407 6,619 3,530 692 42,103 1.1 3.3 4.7 7.6 5.0 6.2 4.6 6.1 6.5 8.2 7.9 6.8 5.0 4.0 6.4 5.7 3.4 6.7 Share options are expected, upon exercise, to be met principally by the issue of new ordinary shares but may also be met from shares held by the Reed Elsevier Group plc Employee Benefit Trust (EBT) (see note 29). Conditional shares will be met from shares held by the EBT. 159711 Reed Report 55-102 7/3/06 12:04 Page 74 74 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 6 Net finance costs Interest on bank loans, overdrafts and commercial paper Interest on other loans Interest on obligations under finance leases Interest on undesignated derivatives Total borrowing costs Losses on derivatives not designated as hedges Fair value losses on interest rate derivatives formerly designated as cash flow hedges transferred from equity Finance costs Interest on bank deposits Gains on loans and derivatives not designated as hedges Finance income Net finance costs 7 Disposals and other non operating items Revaluation of held for trading investments Loss on disposal of businesses and other assets Net gain/(loss) on disposals and other non operating items 2005 £m (44) (105) (1) (8) (158) (12) (6) (176) 10 26 36 (140) 2005 £m 3 (1) 2 2004 £m (41) (106) (1) – (148) – – (148) 16 – 16 (132) 2004 £m – (3) (3) 2005 gm (64) (153) (1) (12) (230) (17) (9) (256) 14 38 52 (204) 2005 gm 4 (2) 2 2004 am (60) (156) (1) – (217) – – (217) 23 – 23 (194) 2004 am – (4) (4) 159711 Reed Report 55-102 7/3/06 12:04 Page 75 Reed Elsevier Annual Reports and Financial Statements 2005 75 8 Taxation Current tax United Kingdom The Netherlands Rest of world Total current tax Deferred tax Origination and reversal of timing differences Total 2005 £m 85 48 83 216 21 237 2004 £m 73 52 60 185 (15) 170 2005 gm 124 70 121 315 31 346 A reconciliation of the notional tax charge based on average applicable rates of tax (weighted in proportion to accounting profits) to the actual total tax expense is set out below. Profit before tax Tax at average applicable rates Tax included in share of results of joint ventures Deferred tax on unrealised exchange differences on long term inter-affiliate lending Non deductible amounts and other items Tax expense Tax expense as a percentage of profit before tax A net deferred tax charge of £3m/a4m (2004: £12m/a18m credit) has been recognised directly in equity during the year in relation to income or expense recognised directly in equity. 44 45 237 34% (31) 66 170 27% 64 66 346 34% 2005 £m 701 154 (6) 2004 £m 631 142 (7) 2005 gm 1,023 225 (9) 2004 am 107 77 88 272 (22) 250 2004 am 928 209 (10) (46) 97 250 27% 159711 Reed Report 55-102 7/3/06 12:04 Page 76 76 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 9 Adjusted figures Reed Elsevier uses adjusted figures as additional performance measures. Adjusted figures are stated before amortisation of acquired intangible assets, acquisition integration costs, disposals and other non operating items, related tax effects and movements in deferred taxation assets and liabilities that are not expected to crystallise in the near term. Adjusted operating profit is also grossed up to exclude the equity share of taxes in joint ventures. Adjusted operating cash flow is measured after net capital expenditure and dividends from joint ventures but before payments in relation to acquisition integration costs. Operating profit Adjustments: Amortisation of acquired intangible assets Acquisition integration costs Reclassification of tax in joint ventures Adjusted operating profit Profit before tax Adjustments: Amortisation of acquired intangible assets Acquisition integration costs Reclassification of tax in joint ventures Disposals and other non operating items Adjusted profit before tax Profit attributable to parent companies' shareholders Adjustments: Amortisation of acquired intangible assets Acquisition integration costs Disposals and other non operating items Deferred tax adjustment Adjusted profit attributable to parent companies’ shareholders 2005 £m 839 276 21 6 1,142 701 276 21 6 (2) 1,002 462 310 17 (2) (33) 754 2004 £m 766 255 38 7 1,066 631 255 38 7 3 934 459 288 29 2 (91) 687 2005 gm 2004 am 1,225 1,126 403 30 9 1,667 375 56 10 1,567 1,023 928 403 30 9 (2) 1,463 375 56 10 4 1,373 675 675 452 24 (2) (48) 1,101 423 43 3 (134) 1,010 Cash generated from operations 1,696 Dividends received from joint ventures 25 Purchases of property, plant and equipment (120) Proceeds on disposals of property, plant and equipment 7 Expenditure on internally developed intangible assets (162) Payments in relation to acquisition integration costs 44 Adjusted operating cash flow 1,490 Tax cash flow benefits of £3m/a4m (2004: £18m/a26m) were obtained in relation to acquisition integration costs and disposals and other non operating items. 1,786 23 (136) 12 (149) 41 1,577 1,223 16 (93) 8 (102) 28 1,080 1,154 17 (82) 4 (110) 30 1,013 159711 Reed Report 55-102 7/3/06 12:04 Page 77 Reed Elsevier Annual Reports and Financial Statements 2005 77 10 Cash flow statement Reconciliation of operating profit before joint ventures to cash generated from operations Operating profit before joint ventures Amortisation of acquired intangible assets Amortisation of internally developed intangible assets Depreciation of property, plant and equipment Share based remuneration Total non cash items Increase in inventories and pre-publication costs Increase in receivables Increase in payables Increase in working capital Cash generated from operations Cash flow on acquisitions Purchase of businesses Investment in joint ventures Deferred payments relating to prior acquisitions Total Note 11 2005 £m 823 276 57 87 57 477 (56) (92) 71 (77) 1,223 2005 £m (293) (15) (9) (317) 2004 £m 749 255 55 71 59 440 (39) (69) 73 (35) 1,154 2004 £m (640) – (7) (647) Reconciliation of net borrowings At start of year Transition adjustment on adoption of IAS39 At start of year as restated Increase/(decrease) in cash and cash equivalents Net movement in bank loans, overdrafts and commercial paper Issuance of other loans Repayment of other loans Repayment of finance leases Change in net borrowings resulting from cash flows Borrowings in acquired businesses Inception of finance leases Fair value adjustments to borrowings and related derivatives Exchange translation differences At end of year Related derivative Cash & cash financial equivalents Borrowings instruments £m £m £m 225 – 225 66 – – – – 66 – – – 5 296 (2,757) (250) (3,007) – 492 (544) 90 13 51 – (10) 99 (297) (3,164) – 244 244 – – – – – – – – (94) 24 174 2005 gm 2004 am 1,202 1,100 403 83 127 83 696 (82) (134) 104 (112) 1,786 2005 gm (428) (22) (13) (463) 2005 £m (2,532) (6) (2,538) 66 492 (544) 90 13 117 – (10) 5 (268) (2,694) 375 81 104 87 647 (58) (100) 107 (51) 1,696 2004 am (941) – (10) (951) 2004 £m (2,372) – (2,372) (403) 162 (102) 3 19 (321) (2) (11) – 174 (2,532) 159711 Reed Report 55-102 7/3/06 12:04 Page 78 78 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 10 Cash flow statement continued Reconciliation of net borrowings At start of year Transition adjustment on adoption of IAS39 At start of year as restated Increase/(decrease) in cash and cash equivalents Net movement in bank loans, overdrafts and commercial paper Issuance of other loans Repayment of other loans Repayment of finance leases Change in net borrowings resulting from cash flows Borrowings in acquired businesses Inception of finance leases Fair value adjustments to borrowings and related derivatives Exchange translation differences At end of year Related derivative Cash & cash financial equivalents Borrowings instruments gm gm gm 317 – 317 96 – – – – 96 – – – 19 432 (3,887) (352) (4,239) – 718 (794) 132 19 75 – (15) 144 (584) (4,619) – 344 344 – – – – – – – – (137) 47 254 2005 gm (3,570) (8) (3,578) 96 718 (794) 132 19 171 – (15) 7 (518) (3,933) 2004 am (3,368) – (3,368) (590) 237 (149) 4 28 (470) (3) (16) – 287 (3,570) Net borrowings comprise cash and cash equivalents, loan capital, finance leases, promissory notes, bank and other loans, and those derivative financial instruments that are used to hedge the fair value of fixed rate borrowings. 11 Acquisitions During the year a number of acquisitions were made for a total consideration amounting to £307m/a448m, after taking account of net cash acquired of £8m/a12m. The net assets of the businesses acquired are incorporated at their fair value to the combined businesses. The fair values of the consideration given and the assets and liabilities acquired are summarised below. Book value on Fair value acquisition adjustments £m £m Goodwill Intangible assets Property, plant and equipment Current assets Current liabilities Deferred tax Net assets acquired Consideration (after taking account of £8m net cash acquired) Less: consideration deferred to future years Net cash flow – 12 3 36 (46) – 5 182 137 (1) (4) (1) (11) 302 Fair value £m 182 149 2 32 (47) (11) 307 307 (14) 293 159711 Reed Report 55-102 7/3/06 12:04 Page 79 Reed Elsevier Annual Reports and Financial Statements 2005 79 11 Acquisitions continued Goodwill Intangible assets Property, plant and equipment Current assets Current liabilities Deferred tax Net assets acquired Consideration (after taking account of g12m net cash acquired) Less: consideration deferred to future years Net cash flow Book value on Fair value acquisition adjustments gm gm – 18 4 52 (67) – 7 266 200 (1) (6) (2) (16) 441 Fair value gm 266 218 3 46 (69) (16) 448 448 (20) 428 The fair value adjustments in relation to the acquisitions made in 2005 relate principally to the valuation of intangible assets and inventories. Goodwill represents the excess of the consideration over the net tangible and intangible assets acquired. The businesses acquired in 2005 contributed £52m/a76m to revenue, £7m/a10m to adjusted operating profit, reduced net profit by £4m/a6m and contributed £8m/a12m to net cash inflow from operating activities for the part year under Reed Elsevier ownership. Had the businesses been acquired at the beginning of the year, on a proforma basis, the Reed Elsevier combined revenues, adjusted operating profit and net profit for the year would have been £5,230m/a7,636m, £1,151m/a1,680m and £464m/a677m respectively. 12 Equity dividends Dividends declared in the year Reed Elsevier PLC Reed Elsevier NV Total 2005 £m 168 168 336 2004 £m 153 156 309 2005 gm 246 245 491 2004 am 225 229 454 Dividends declared in the year, in amounts per ordinary share, comprise: a 2004 final dividend of 9.6p and 2005 interim dividend of 3.7p giving a total of 13.3p (2004: 12.1p) for Reed Elsevier PLC; and a 2004 final dividend of a0.240 and 2005 interim dividend of a0.092 giving a total of a0.332 (2004: a0.310) for Reed Elsevier NV. The directors of Reed Elsevier PLC have proposed a final dividend of 10.7p (2004: 9.6p). The directors of Reed Elsevier NV have proposed a final dividend of a0.267 (2004: a0.240). The total cost of funding the proposed final dividends is £273m/a399m, for which no liability has been recognised at the date of the balance sheet. Dividends paid to Reed Elsevier PLC and Reed Elsevier NV shareholders are equalised at the gross level inclusive of the UK tax credit of 10% received by certain Reed Elsevier PLC shareholders. The cost of funding the Reed Elsevier PLC dividends, is therefore, similar to that of Reed Elsevier NV. 159711 Reed Report 55-102 7/3/06 12:04 Page 80 80 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 13 Goodwill At start of year Acquisitions Disposals/transfers Exchange translation differences At end of year 2005 £m 2,611 182 (14) 251 3,030 2004 £m 2,437 345 – (171) 2,611 2005 gm 3,682 266 (21) 497 4,424 2004 am 3,461 507 – (286) 3,682 The net carrying amount of goodwill under previous GAAP is deemed under IFRS to be the cost of goodwill on transition to IFRS at 1 January 2004. The cumulative amortisation deducted in arriving at the net carrying amount under previous GAAP was £1,813m/a2,574m. The equivalent amount at 31 December 2005, after taking account of foreign exchange movements, would have been £1,847m/a2,697m (2004: £1,721m/a2,427m). 14 Intangible assets Cost At 1 January 2004 Acquisitions Additions Disposals Exchange translation differences At 1 January 2005 Acquisitions Additions Disposals/transfers Exchange translation differences At 31 December 2005 Amortisation At 1 January 2004 Charge for the year Disposals/write off on acquisitions Exchange translation differences At 1 January 2005 Charge for the year Disposals/transfers Exchange translation differences At 31 December 2005 Net book amount At 31 December 2004 At 31 December 2005 Market and customer related £m Content, software and other £m Total acquired intangible assets £m Internally developed intangible assets £m 1,208 144 – – (100) 1,252 88 – – 149 1,489 35 71 – (6) 100 85 – 16 201 2,842 166 – (13) (131) 2,864 61 – (29) 187 3,083 1,299 184 (13) (62) 1,408 191 (9) 92 1,682 4,050 310 – (13) (231) 4,116 149 – (29) 336 4,572 1,334 255 (13) (68) 1,508 276 (9) 108 1,883 419 – 110 – (17) 512 – 102 – 33 647 229 55 10 (9) 285 57 – 15 357 Total £m 4,469 310 110 (13) (248) 4,628 149 102 (29) 369 5,219 1,563 310 (3) (77) 1,793 333 (9) 123 2,240 1,152 1,288 1,456 1,401 2,608 2,689 227 290 2,835 2,979 159711 Reed Report 55-102 7/3/06 12:04 Page 81 Reed Elsevier Annual Reports and Financial Statements 2005 81 14 Intangible assets continued Cost At 1 January 2004 Acquisitions Additions Disposals Exchange translation differences At 1 January 2005 Acquisitions Additions Disposals/transfers Exchange translation differences At 31 December 2005 Amortisation At 1 January 2004 Charge for the year Disposals/write off on acquisitions Exchange translation differences At 1 January 2005 Charge for the year Disposals/transfers Exchange translation differences At 31 December 2005 Net book amount At 31 December 2004 At 31 December 2005 Market and customer related gm Content, software and other gm Total acquired intangible assets gm Internally developed intangible assets gm 1,716 212 – – (162) 1,766 129 – – 279 2,174 50 105 – (13) 142 124 – 27 293 4,035 244 – (19) (222) 4,038 89 – (43) 417 4,501 1,844 270 (19) (110) 1,985 279 (13) 205 2,456 5,751 456 – (19) (384) 5,804 218 – (43) 696 6,675 1,894 375 (19) (123) 2,127 403 (13) 232 2,749 1,624 1,881 2,053 2,045 3,677 3,926 595 – 162 – (36) 721 – 149 – 75 945 325 81 15 (20) 401 83 – 38 522 320 423 Total gm 6,346 456 162 (19) (420) 6,525 218 149 (43) 771 7,620 2,219 456 (4) (143) 2,528 486 (13) 270 3,271 3,997 4,349 Intangible assets acquired as part of business combinations comprise: market related assets (e.g. trade marks, imprints, brands); customer related assets (e.g. subscription bases, customer lists, customer relationships); and content, software and other intangible assets (e.g. editorial content, software and product delivery systems, other publishing rights, exhibition rights and supply contracts). Included in content, software and other acquired intangible assets are certain assets with a net book value of £1,154m/a1,685m (2004: £1,240m/a1,748m) that arose on acquisitions completed prior to the transition to IFRS with effect from 1 January 2004 that have not been allocated to specific categories of intangible assets. Internally developed intangible assets typically comprise software and systems development where an identifiable asset is created that is probable to generate future economic benefits. Included in market and customer related intangible assets are £333m/a486m (2004: £298m/a420m) of brands and imprints with indefinite lives. These assets are determined to have an indefinite life based on an assessment of their historical longevity and stable market positions. 159711 Reed Report 55-102 7/3/06 12:04 Page 82 82 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 15 Investments Investments in joint ventures Available for sale investments Venture capital investments held for trading Total 2005 £m 71 22 22 115 An analysis of changes in the carrying value of investments in joint ventures is given below. At start of year Share of results of joint ventures Dividends received from joint ventures Additions Transfers Exchange translation differences At end of year 2005 £m 60 16 (16) 15 (3) (1) 71 2004 £m 60 32 18 110 2004 £m 60 17 (17) – – – 60 2005 gm 104 32 32 168 2005 gm 86 23 (23) 22 (4) – 104 2004 am 86 45 26 157 2004 am 85 26 (25) – – – 86 The principal joint venture at 31 December 2005 is Giuffrè (an Italian legal publisher in which Reed Elsevier has a 40% shareholding). In addition there are a number of exhibition joint ventures within Reed Business. Summarised information showing total amounts in respect of joint ventures and Reed Elsevier’s share is set out below. Revenue Net profit for the year Total assets Total liabilities Net assets Goodwill Total Total joint ventures Reed Elsevier share Total joint ventures Reed Elsevier share 2005 £m 194 33 220 (137) 83 2004 £m 209 37 199 (112) 87 2005 £m 91 16 103 (63) 40 31 71 2004 £m 94 17 98 (57) 41 19 60 2005 gm 283 48 321 (200) 121 2004 am 307 54 281 (158) 123 2005 gm 133 23 151 (92) 59 45 104 2004 am 138 26 138 (79) 59 27 86 159711 Reed Report 55-102 7/3/06 12:04 Page 83 Reed Elsevier Annual Reports and Financial Statements 2005 83 16 Property, plant and equipment Cost At start of year Acquisitions Capital expenditure Disposals Exchange translation differences At end of year Accumulated depreciation At start of year Acquisitions Disposals Charge for the year Exchange translation differences At end of year 2005 Land and Fixtures and equipment buildings £m £m 182 – 5 (10) 15 192 72 – (3) 8 7 84 627 6 98 (86) 50 695 445 4 (76) 79 37 489 Total £m 809 6 103 (96) 65 887 517 4 (79) 87 44 573 2004 Land and Fixtures and equipment buildings £m £m 185 7 14 (13) (11) 182 72 1 (3) 7 (5) 72 646 11 79 (70) (39) 627 477 4 (70) 64 (30) 445 Total £m 831 18 93 (83) (50) 809 549 5 (73) 71 (35) 517 Net book amount 108 206 314 110 182 292 Cost At start of year Acquisitions Capital expenditure Disposals Exchange translation differences At end of year Accumulated depreciation At start of year Acquisitions Disposals Charge for the year Exchange translation differences At end of year 2005 Land and Fixtures and equipment buildings gm gm 257 – 7 (15) 31 280 102 – (4) 12 12 122 884 9 143 (125) 104 1,015 627 6 (111) 115 78 715 Total gm 1,141 9 150 (140) 135 1,295 729 6 (115) 127 90 837 2004 Land and Fixtures and equipment buildings am am 263 10 21 (19) (18) 257 103 1 (4) 10 (8) 102 917 16 116 (103) (62) 884 677 6 (103) 94 (46) 628 Total am 1,180 26 137 (122) (80) 1,141 780 7 (107) 104 (54) 730 Net book amount 158 300 458 155 256 411 No depreciation is provided on freehold land. The net book amount of property, plant and equipment at 31 December 2005 includes £20m/a29m (2004: £19m/a27m) in respect of assets held under finance leases relating to fixtures and equipment. 159711 Reed Report 55-102 7/3/06 12:04 Page 84 84 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 17 Financial instruments Details of the objectives, policies and strategies pursued by Reed Elsevier in relation to financial instruments are set out on pages 24 and 25 of the Operating and Financial Review. The main financial risks faced by Reed Elsevier are liquidity risk and market risk – comprising interest rate risk and foreign exchange risk. Financial instruments are used to finance the Reed Elsevier businesses and to hedge interest rate and foreign exchange risks. Reed Elsevier’s businesses do not enter into speculative derivative transactions. Details of financial instruments subject to liquidity, market and credit risks are described below. Liquidity risk Fixed and floating rate borrowings analysed by maturity are summarised below. Borrowings are shown after taking account of related interest rate derivatives in designated hedging relationships. Within 1 year Within 1 to 2 years Within 2 to 3 years Within 3 to 4 years Within 4 to 5 years After 5 years Total Fixed rate borrowings £m 2005 Floating rate borrowings £m 710 77 – – 2 687 1,476 191 242 254 – 304 523 1,514 Fixed rate borrowings gm 2005 Floating rate borrowings gm Total £m 901 319 254 – 306 1,210 2,990 Total gm Fixed rate borrowings £m 2004 Floating rate borrowings £m 1,010 291 75 – – 349 1,725 41 32 295 312 – 352 1,032 Fixed rate borrowings am 2004 Floating rate borrowings am Total £m 1,051 323 370 312 – 701 2,757 Total am Within 1 year Within 1 to 2 years Within 2 to 3 years Within 3 to 4 years Within 4 to 5 years After 5 years Total At 31 December 2005, £290m/a423m of borrowings were designated in fair value hedging relationships whereby the interest payments are fixed for the next one to three years and swapped to floating thereafter. These borrowings have been included above as floating rate borrowings due after 5 years. 1,037 112 – – 3 1,003 2,155 1,316 465 371 – 447 1,766 4,365 279 353 371 – 444 763 2,210 58 45 416 440 – 496 1,455 1,424 410 106 – – 492 2,432 1,482 455 522 440 – 988 3,887 At 31 December 2005, Reed Elsevier had access to £1,739m/a2,539m (2004: £1,555m/a2,193m) of committed bank facilities that expire in two to three years, of which £67m/a98m (2004: £41m/a58m) was drawn. These facilities principally provide back up for short term borrowings. After taking account of the maturity of committed bank facilities that back short term borrowings at 31 December 2005, and after utilising available cash resources, no borrowings mature in the next two years (2004: nil); 46% of borrowings mature in the third year (2004: 14%); 11% in the fourth and fifth years (2004: 58%); 29% in the sixth to tenth years (2004: 16%); and 14% beyond the tenth year (2004: 12%). 159711 Reed Report 55-102 7/3/06 12:04 Page 85 Reed Elsevier Annual Reports and Financial Statements 2005 85 17 Financial instruments continued Market Risk Reed Elsevier’s primary market risks are to interest rate fluctuations and exchange rate movements. Derivatives are used to hedge or reduce the risks of interest rate and exchange rate movements and are not entered into unless such risks exist. Derivatives used by Reed Elsevier for hedging a particular risk are not specialised and are generally available from numerous sources. The fair values of interest rate swaps, interest rate options, forward rate agreements and forward foreign exchange contracts set out below represent the replacement costs calculated using market rates of interest and exchange at 31 December 2005. The fair value of long term borrowings has been calculated by discounting expected future cash flows at market rates. Interest rate risk Reed Elsevier’s interest rate exposure management policy is aimed at reducing the exposure of the combined businesses to changes in interest rates. The following sensitivity analysis of borrowings and derivative financial instruments to interest rate movements assumes an immediate 100 basis point change in interest rates for all currencies and maturities from their levels at 31 December 2005, with all other variables held constant. The range of changes represents Reed Elsevier’s view of the changes that are reasonably possible over a one year period based on these assumptions. At 31 December 2005, the majority of net borrowings are either fixed rate or have been fixed through the use of interest rate swaps, forward rate agreements and options. A 100 basis point reduction in interest rates would result in an estimated decrease in net interest expense of £5m/a7m, based on the composition of financial instruments including cash, cash equivalents, bank loans and commercial paper borrowings at 31 December 2005. A 100 basis point rise in interest rates would result in an estimated increase in net interest expense of £5m/a7m. The sensitivity of the fair value of financial instruments at 31 December 2005 to changes in interest rates is set out in the table below. Fair value change Short term borrowings Long term borrowings (including current portion) Interest rate swaps (swapping fixed rate debt to floating) Interest rate swaps (swapping floating rate debt to fixed) Interest rate options Forward rate agreements Short term borrowings Long term borrowings (including current portion) Interest rate swaps (swapping fixed rate debt to floating) Interest rate swaps (swapping floating rate debt to fixed) Interest rate options Forward rate agreements Carrying value £m (536) (2,628) 175 (1) (1) 1 Carrying value gm (782) (3,837) 256 (1) (1) 1 Fair value £m (536) (2,685) 175 (1) (1) 1 Fair value gm (782) (3,920) 256 (1) (1) 1 +100 -100 basis points basis points £m £m – 110 (56) 17 – – – (125) 64 (17) – – Fair value change +100 -100 basis points basis points gm gm – 161 (82) 25 – – – (183) 93 (25) – – Short term borrowings comprise bank loans, overdrafts and commercial paper due within one year. Long term borrowings (including current portion) comprise other loans and finance leases. A 100 basis point change in interest rates would not result in a material change to the fair value of any other financial instrument. 159711 Reed Report 55-102 7/3/06 12:04 Page 86 86 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 17 Financial instruments continued Foreign exchange rate risk Translation exposures arise on the earnings and net assets of business operations in countries with currencies other than those of each of the parent companies, most particularly in respect of the US businesses. These exposures are hedged, to a significant extent, by a policy of denominating borrowings in currencies where significant translation exposures exist, most notably US dollars (see note 23). The following sensitivity analysis of net borrowings and derivative financial instruments to foreign exchange rate movements assumes an immediate 10% change in all foreign exchange rates against sterling or euros as appropriate from their levels at 31 December 2005, with all other variables held constant. A +10% change indicates a strengthening of the currency against sterling/euro and a -10% change indicates a weakening of the currency against sterling/euro. The range of changes represents Reed Elsevier’s view of the changes that are reasonably possible over a one year period based on these assumptions. Cash and cash equivalents Short term borrowings Long term borrowings (including current portion) Interest rate swaps (including cross currency interest rate swaps) Forward foreign exchange contracts Cash and cash equivalents Short term borrowings Long term borrowings (including current portion) Interest rate swaps (including cross currency interest rate swaps) Forward foreign exchange contracts Carrying value £m 296 (536) (2,628) 174 5 Carrying value gm 432 (782) (3,837) 255 7 Fair value £m 296 (536) (2,685) 174 5 Fair value gm 432 (782) (3,920) 255 7 Fair value change +10% £m 20 (59) (298) 19 (38) -10% £m (17) 49 244 (16) 37 Fair value change +10% gm 35 (35) (407) 29 (4) -10% gm (29) 30 333 (24) 4 A 10% change in foreign currency exchange rates would not result in a material change to the fair value of any other financial instrument. Credit risk Reed Elsevier seeks to limit interest rate and foreign exchange risks described above by the use of financial instruments and as a result has a credit risk from the potential non performance by the counterparties to these financial instruments, which are unsecured. The amount of this credit risk is normally restricted to the amounts of any hedge gain and not the principal amount being hedged. Reed Elsevier also has a credit exposure to counterparties for the full principal amount of cash and cash equivalents. Credit risks are controlled by monitoring the credit quality of these counterparties, principally licensed commercial banks and investment banks with strong long term credit ratings, and of the amounts outstanding with each of them. Reed Elsevier has treasury policies in place which do not allow concentrations of risk with individual counterparties and do not allow significant treasury exposures with counterparties which are rated lower than A by Standard and Poor’s, Moody’s or Fitch. 159711 Reed Report 55-102 7/3/06 12:04 Page 87 Reed Elsevier Annual Reports and Financial Statements 2005 87 17 Financial instruments continued Transition to IAS39 – Financial Instruments Reed Elsevier adopted IAS39 – Financial Instruments with effect from 1 January 2005. On adoption of IAS39, all derivatives and fixed rate debt in hedging relationships were recorded at fair value. Borrowings and related hedging derivatives were grossed up by £250m/a352m, leaving net debt broadly unchanged. The fair value of derivatives used to hedge forecasted transactions (such as forward exchange contracts and floating-to-fixed interest rate swaps) was recorded in the balance sheet and the corresponding net gain of £40m/a56m deferred within the hedge reserve. The fair value of derivatives used to swap fixed rate debt to floating rate was recognised in the balance sheet and, together with differences on restatement at spot rates of certain foreign currency working capital balances which were reported under previous GAAP at hedged rates and other working capital restatements, the corresponding net gain recorded directly in other reserves. Including related deferred tax, other reserves were accordingly reduced by £29m/a40m. Taken together with the hedge reserve of £40m/a56m, shareholders’ equity at 1 January 2005 was increased by a net IAS39 transition adjustment of £11m/a16m. In respect of currency risk, Reed Elsevier hedges cross border transactions in foreign currencies, the most significant of which relate to the Elsevier global scientific journals business. Hedge accounting treatment continues to be applied to these transactions under IAS39. However, whereas under previous GAAP hedge accounting applied to both revenues and costs where the net exchange risk is hedged in the market, under IAS39 there is no grossing up of the hedge for the foreign currency revenues and the offsetting costs and a portion of the revenues and the costs are therefore treated as if unhedged and reported at spot rates. 159711 Reed Report 55-102 7/3/06 12:04 Page 88 88 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 17 Financial instruments continued Hedge accounting The hedging relationships that are designated under IAS39 – Financial Instruments, effective from 1 January 2005 are described below: Fair value hedges Reed Elsevier has entered into interest rate swaps and cross currency interest rate swaps to hedge the exposure to changes in the fair value of fixed rate borrowings due to interest rate and foreign currency movements which could affect the income statement. Interest rate derivatives (including cross currency interest rate swaps) with a principal amount of £954m/a1,393m were in place at 31 December 2005 swapping fixed rate term debt issues denominated in United States dollars (USD), euros and Swiss francs (CHF) to floating rate USD debt for the whole or part of their term. The gains and losses on the borrowings and related derivatives designated as fair value hedges for the year ended 31 December 2005, which are included in the income statement, were: USD interest rate swaps USD debt Euro to USD cross currency interest rate swaps Euro debt CHF to USD cross currency interest rate swaps CHF debt Total USD interest rate swaps USD debt Euro to USD cross currency interest rate swaps Euro debt CHF to USD cross currency interest rate swaps CHF debt Total Fair value 1 January movement gain/(loss) £m 9 (9) – (62) 62 – (41) 41 – – 2005 £m 5 (5) – 152 (151) 1 87 (86) 1 2 Fair value 1 January movement gain/(loss) gm 13 (13) – (90) 90 – (60) 60 – – 2005 gm 7 (7) – 214 (213) 1 123 (121) 2 3 Exchange 31 December 2005 gain/(loss) £m £m 15 1 (15) (1) – – 105 15 (104) (15) – 1 54 8 (53) (8) 1 – 2 – Exchange 31 December 2005 gain/(loss) gm gm 21 1 (21) (1) – – 154 30 (152) (29) 1 2 79 16 (78) (17) 1 (1) 3 – All fair value hedges were highly effective throughout the year ended 31 December 2005. At 31 December 2005 there were fair value losses of £3m/a4m (on transition to IAS39 at 1 January 2005: £8m/a11m losses) included within borrowings which relate to debt de-designated from a fair value hedge relationship. During 2005, £5m/a7m of the fair value losses recognised on transition to IAS39 was included in finance income. 159711 Reed Report 55-102 7/3/06 12:04 Page 89 Reed Elsevier Annual Reports and Financial Statements 2005 89 17 Financial instruments continued Cash flow hedges Reed Elsevier enters into two types of cash flow hedge: (1) Interest rate derivatives which fix the interest expense on a portion of forecast floating rate USD denominated debt (including commercial paper, short term bank loans and floating rate term debt). (2) Foreign exchange derivatives which fix the exchange rate on a portion of future foreign currency subscription revenues forecast by the Elsevier science and medical businesses for up to 50 months. Movements in the hedge reserve in 2005, including gains and losses on cash flow hedging instruments, were as follows: Hedge reserve at start of year: gains/(losses) deferred Gains/(losses) arising in 2005 Amounts recognised in income statement Exchange translation differences Hedge reserve at end of year: gains/(losses) deferred Hedge reserve at start of year: gains/(losses) deferred Gains/(losses) arising in 2005 Amounts recognised in income statement Exchange translation differences Hedge reserve at end of year: gains/(losses) deferred Transition loss £m Interest rate hedges £m (10) – 6 (1) (5) (15) 11 5 (1) – Transition loss gm Interest rate hedges gm (15) – 9 (1) (7) (22) 16 7 (1) – Foreign exchange hedges £m 65 (21) (30) (2) 12 Foreign exchange hedges gm 95 (31) (44) (3) 17 Total hedge reserve £m 40 (10) (19) (4) 7 Total hedge reserve gm 58 (15) (28) (5) 10 All cash flow hedges were highly effective throughout the year ended 31 December 2005. The transition loss relates to interest rate derivatives held on 1 January 2005, which were formerly treated as hedging instruments under UK GAAP but which are not designated as such under IAS39. The deferred gains and losses on cash flow hedges at 31 December 2005 are currently expected to be recognised in the income statement in future years as follows: 2006 2007 2008 2009 Gains/(losses) deferred in hedge reserve at end of year Transition loss £m Interest rate hedges £m Foreign exchange hedges £m Total hedge reserve £m (3) (2) – – (5) – 1 – (1) – 12 2 (2) – 12 9 1 (2) (1) 7 159711 Reed Report 55-102 7/3/06 12:04 Page 90 90 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 17 Financial instruments continued 2006 2007 2008 2009 Gains/(losses) deferred in hedge reserve at end of year Transition loss gm Interest rate hedges gm Foreign exchange hedges gm Total hedge reserve gm (4) (3) – – (7) – 1 – (1) – 17 3 (3) – 17 13 1 (3) (1) 10 The cash flows for these hedges are expected to occur in line with the recognition of the gains and losses in the income statement, other than in respect of certain forward foreign exchange hedges on subscriptions, where cash flows may be expected to occur in advance of the subscription year. 18 Deferred tax Deferred tax assets Deferred tax liabilities Total 2005 £m 266 (980) (714) 2004 £m 235 (857) (622) 2005 gm 388 (1,431) (1,043) 2004 am 331 (1,208) (877) Movements in deferred tax liabilities and assets are summarised as follows: Excess of tax allowances over amortisation £m Other Acquired temporary intangible differences- liabilities £m assets £m Tax losses carried forward £m Other temporary differences- assets £m Pensions £m Deferred tax asset/(liability) at 1 January 2004 (Charge)/credit to profit Credit to equity Transfers Acquisitions Exchange translation differences Deferred tax asset/(liability) at 1 January 2005 Transition adjustment on adoption of IAS39 (Charge)/credit to profit Credit/(charge) to equity Transfers Acquisitions Exchange translation differences Deferred tax asset/(liability) at 31 December 2005 (43) (33) – – – 5 (71) – (34) – – – (10) (830) 62 – – (68) 51 (785) – 65 – – (11) (68) (18) (18) – 34 – 1 (1) – (52) – (5) (3) (5) 18 (27) – 47 25 (4) 59 – (6) – – – 1 (115) (799) (66) 54 84 13 12 – – – 109 – 8 10 – – 6 133 Total £m (681) 15 12 28 (43) 47 (622) 6 (21) (3) 8 (11) (71) 108 18 – (53) – (6) 67 6 (2) (13) 13 3 5 79 (714) 159711 Reed Report 55-102 7/3/06 12:04 Page 91 Reed Elsevier Annual Reports and Financial Statements 2005 91 18 Deferred tax continued Deferred tax asset/(liability) at 1 January 2004 (Charge)/credit to profit Credit to equity Transfers Acquisitions Exchange translation differences Deferred tax asset/(liability) at 1 January 2005 Transition adjustment on adoption of IAS39 (Charge)/credit to profit Credit/(charge) to equity Transfers Acquisitions Exchange translation differences Deferred tax asset/(liability) at 31 December 2005 Excess of tax allowances over amortisation gm Other Acquired temporary intangible differences- liabilities gm assets gm Tax losses carried forward gm Other temporary differences- assets gm Pensions gm (61) (49) – – – 10 (100) – (49) – – – (19) (1,179) 91 – – (100) 81 (1,107) – 95 – – (16) (139) (26) (26) – 50 – 1 (1) – (77) – (7) (4) (7) 26 (40) – 69 37 (9) 83 – (9) – – – 5 119 19 18 – – (2) 154 – 12 15 – – 13 153 27 – (78) – (8) 94 9 (3) (19) 19 4 11 Total gm (968) 22 18 41 (63) 73 (877) 9 (31) (4) 12 (16) (136) (168) (1,167) (96) 79 194 115 (1,043) At 31 December 2005, potential deferred tax assets not recognised due to uncertainties over availability and timing of relevant taxable income amounted to £211m/a308m (2004: £168m/a237m) in relation to tax deductions carried forward of £528m/a769m (2004: £419m/a593m). No time limitation currently applies on utilisation of the tax deductions. 19 Inventories and pre-publication costs Raw materials Pre-publication costs Finished goods Total 20 Trade and other receivables Trade receivables Prepayments and accrued income Derivative financial instruments Total 2005 £m 12 394 224 630 2004 £m 12 340 189 541 2005 gm 18 575 327 920 2004 am 17 479 267 763 2005 £m 1,086 151 200 1,437 2004 £m 978 125 – 1,103 2005 gm 1,586 220 292 2,098 2004 am 1,379 176 – 1,555 159711 Reed Report 55-102 7/3/06 12:04 Page 92 92 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 21 Assets and liabilities held for sale The major classes of assets and liabilities of operations classified as held for sale are as follows: Goodwill Intangible assets Investments in joint ventures Inventories and pre-publication costs Trade and other receivables Total assets held for sale Trade and other payables Total liabilities associated with assets held for sale 22 Trade and other payables Payables and accruals Deferred income Derivative financial instruments Total 23 Borrowings Analysis by year of repayment 2005 £m 2004 £m 2005 gm 2004 am 16 14 3 19 8 60 11 11 – – – – – – – – 23 21 4 28 12 88 16 16 – – – – – – – – 2005 £m 982 979 21 1,982 2004 £m 844 947 – 1,791 2005 gm 1,434 1,429 30 2,893 2004 am 1,190 1,335 – 2,525 2005 2004 Bank loans, overdrafts and commercial paper £m 536 – – – – – – 536 Other loans £m 353 369 359 – 304 1,228 2,260 2,613 Finance leases £m 11 3 – – 1 – 4 15 Total £m 900 372 359 – 305 1,228 2,264 3,164 Bank loans, overdrafts and commercial paper £m 965 – – – – – – 965 Other loans £m 78 317 368 312 – 701 1,698 1,776 Finance leases £m 8 6 2 – – – 8 16 Total £m 1,051 323 370 312 – 701 1,706 2,757 Within 1 year Within 1 to 2 years Within 2 to 3 years Within 3 to 4 years Within 4 to 5 years After 5 years Total 159711 Reed Report 55-102 7/3/06 12:04 Page 93 Reed Elsevier Annual Reports and Financial Statements 2005 93 23 Borrowings continued Within 1 year Within 1 to 2 years Within 2 to 3 years Within 3 to 4 years Within 4 to 5 years After 5 years Total Analysis by currency US Dollars £ Sterling Euro Other Total Bank loans, overdrafts and commercial paper gm 782 – – – – – – 782 Bank loans, overdrafts and commercial paper £m 149 – 312 75 536 Bank loans, overdrafts and commercial paper gm 2005 Other loans gm 516 538 524 – 444 1,793 3,299 3,815 2005 Other loans £m 2,436 – 177 – 2,613 2005 Finance leases gm 16 5 – – 1 – 6 22 Total gm 1,314 543 524 – 445 1,793 3,305 4,619 Finance leases £m 15 – – – 15 Total £m 2,600 – 489 75 3,164 Other loans gm Finance leases gm Total gm Bank loans, overdrafts and commercial paper am 1,360 – – – – – – 1,360 Bank loans, overdrafts and commercial paper £m 606 – 305 54 965 Bank loans, overdrafts and commercial paper am 2004 Other loans am 110 447 519 440 – 988 2,394 2,504 2004 Other loans £m 1,594 – 182 – 1,776 2004 Finance leases am 12 8 3 – – – 11 23 Finance leases £m 16 – – – 16 Total am 1,482 455 522 440 – 988 2,405 3,887 Total £m 2,216 – 487 54 2,757 Other loans am Finance leases am Total am US Dollars £ Sterling Euro Other Total Included in the US dollar amounts for other loans above is £586m/a856m of debt denominated in euros (a500m) and Swiss francs (CHF 500m) that was swapped into US dollars on issuance and against which there are related derivative financial instruments included within trade and other receivables, which, as at 31 December 2005, had a fair value of £159m/a233m. 3,557 – 258 – 3,815 3,795 – 714 110 4,619 2,248 – 256 – 2,504 854 – 430 76 1,360 216 – 456 110 782 22 – – – 22 23 – – – 23 3,125 – 686 76 3,887 159711 Reed Report 55-102 7/3/06 12:04 Page 94 94 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 24 Lease arrangements Finance leases At 31 December 2005 future finance lease obligations fall due as follows: Within one year In the second to fifth years inclusive Less future finance charges Total Present value of future finance lease obligations payable: Within one year In the second to fifth years inclusive Total 2005 £m 11 5 16 (1) 15 11 4 15 2004 £m 9 8 17 (1) 16 8 8 16 2005 gm 16 7 23 (1) 22 16 6 22 Operating leases At 31 December 2005 outstanding commitments under non-cancellable operating leases fall due as follows: 2005 £m 2004 £m 2005 gm Within one year In the second to fifth years inclusive After five years Total Of the above outstanding commitments, £783m/a1,143m (2004: £785m/a1,107m) relate to land and buildings. 113 335 352 800 105 330 367 802 165 489 514 1,168 2004 am 13 11 24 (1) 23 11 12 23 2004 am 148 465 518 1,131 Reed Elsevier has a number of properties that are sub-leased. The future lease receivables contracted with sub-tenants fall as follows: Within one year In the second to fifth years inclusive After five years Total 2005 £m 12 39 21 72 2004 £m 11 38 22 71 2005 gm 18 57 30 105 2004 am 15 54 31 100 159711 Reed Report 55-102 7/3/06 12:04 Page 95 Reed Elsevier Annual Reports and Financial Statements 2005 95 25 Provisions At start of year Utilised Exchange translation differences At end of year 2005 £m 52 (13) 5 44 2004 £m 75 (19) (4) 52 2005 gm 73 (19) 10 64 2004 am 107 (28) (6) 73 The provisions are for property lease obligations which relate to estimated sub-lease shortfalls and guarantees given by Harcourt General, Inc. in favour of a former subsidiary for certain property leases for various periods up to 2016. 26 Contingent liabilities There are contingent liabilities amounting to £46m/a67m (2004: £57m/a80m) in respect of property lease guarantees given by Harcourt General, Inc. in favour of a former subsidiary. 27 Combined share capitals At start of year Issue of ordinary shares Exchange translation differences At end of year 2005 £m 191 1 (2) 190 2004 £m 190 1 – 191 2005 gm 269 2 6 277 2004 am 270 1 (2) 269 Combined share capitals exclude the shares of Reed Elsevier NV held by Reed Elsevier PLC. 28 Combined share premiums At start of year Issue of ordinary shares, net of expenses Exchange translation differences At end of year 2005 £m 1,805 24 (24) 1,805 2004 £m 1,784 20 1 1,805 2005 gm 2,545 35 55 2,635 2004 am 2,533 30 (18) 2,545 Combined share premiums exclude the share premium in respect of shares of Reed Elsevier NV held by Reed Elsevier PLC. 159711 Reed Report 55-102 7/3/06 12:04 Page 96 96 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 29 Combined shares held in treasury At start of year Purchase of shares Exchange translation differences At end of year 2005 £m 66 27 – 93 2004 £m 37 29 – 66 2005 gm 93 39 4 136 2004 am 53 43 (3) 93 At 31 December 2005, shares held in treasury related to 10,780,776 (2004: 8,313,746) Reed Elsevier PLC ordinary shares and 5,539,922 (2004: 3,708,599) Reed Elsevier NV ordinary shares held by the Reed Elsevier Group plc Employee Benefit Trust (EBT). The aggregate market value of these shares at 31 December 2005 was £104m/a152m (2004: £66m/a93m). The EBT purchases Reed Elsevier PLC and Reed Elsevier NV shares which, at the trustees' discretion, can be used in respect of the exercise of share options and to meet commitments under conditional share awards. 30 Translation reserve At start of year Exchange differences on translation of foreign operations Other exchange translation differences At end of year 31 Other combined reserves At start of year Transition adjustment on adoption of IAS39 At start of year as restated Profit attributable to parent companies’ shareholders Dividends declared Actuarial losses on defined benefit pension schemes Fair value movements on available for sale investments Fair value movements on cash flow hedges Tax on actuarial losses on defined benefit pension schemes Tax on fair value movements on cash flow hedges Recognition of share based remuneration reserve Transfers from hedge reserve to net profit Exchange translation differences At end of year 2005 £m (122) 180 31 89 2004 £m – (121) (1) (122) Hedge reserve 2005 £m Other reserves 2005 £m – 40 40 – – – – (10) – – – (19) (4) 7 (144) (29) (173) 462 (336) (37) 3 – 10 (13) 57 – (1) (28) 2005 gm (175) 346 (41) 130 Total 2005 £m (144) 11 (133) 462 (336) (37) 3 (10) 10 (13) 57 (19) (5) (21) 2004 am – (196) 21 (175) Total 2004 £m (291) – (291) 459 (309) (74) – – 12 – 59 – – (144) 159711 Reed Report 55-102 7/3/06 12:04 Page 97 Reed Elsevier Annual Reports and Financial Statements 2005 97 31 Other combined reserves continued At start of year Transition adjustment on adoption of IAS39 At start of year as restated Profit attributable to parent companies’ shareholders Dividends declared Actuarial losses on defined benefit pension schemes Fair value movements on available-for-sale investments Fair value movements on cash flow hedges Tax on actuarial losses on defined benefit pension schemes Tax on fair value movements on cash flow hedges Recognition of share based remuneration reserve Transfers from hedge reserve to net profit Exchange translation differences At end of year 32 Related party transactions Hedge reserve 2005 gm Other reserves 2005 gm – 56 56 – – – – (15) – – – (28) (3) 10 (200) (40) (240) 675 (491) (54) 4 – 15 (19) 83 – (13) (40) Total 2005 gm (200) 16 (184) 675 (491) (54) 4 (15) 15 (19) 83 (28) (16) (30) Total 2004 am (413) – (413) 675 (454) (109) – – 18 – 87 – (4) (200) Transactions between the Reed Elsevier combined businesses have been eliminated within the combined financial statements. Transactions with joint ventures were made on normal market terms of trading and comprise sales of goods and services of £6m/a8m (2004: £6m/a8m). As at 31 December 2005, amounts owed by joint ventures were £3m/a4m (2004: £2m/a3m). Transactions with key management personnel, being the directors, relate to remuneration which is disclosed in the Directors' Remuneration Report on pages 37 to 53. 159711 Reed Report 55-102 7/3/06 12:04 Page 98 98 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 33 Reconciliations to previous GAAP The combined financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). The adoption of these standards has resulted in changes to the accounting policies previously applied under UK GAAP for the 2004 financial year (“previous GAAP”). The effects of differences to previous GAAP on net profit for the year ended 31 December 2004 and combined shareholders’ equity as at that date, are summarised below. Year ended 31 December Net profit under previous GAAP Adjustments Acquired goodwill and intangible assets Pensions Share based remuneration Deferred taxation Net profit under IFRS As at 31 December Shareholders' equity under previous GAAP Adjustments Acquired goodwill and intangible assets Pensions Deferred taxation Equity dividends Other Shareholders' equity under IFRS (i) Acquired goodwill and intangible assets Note (i) (ii) (iii) (iv) Note (i) (ii) (iv) (v) 2004 £m 305 151 (27) (48) 80 461 2004 am 448 223 (40) (71) 118 678 2004 £m 2004 am 2,267 3,196 215 (405) (643) 248 (18) 1,664 303 (571) (907) 350 (25) 2,346 IFRS3 – Business Combinations prohibits the amortisation of acquired goodwill. Goodwill amortisation of £206m/a304m charged under previous GAAP in 2004 is therefore reversed under IFRS. On the balance sheet, the net book amount of goodwill under IFRS was £262m/a370m higher as at 31 December 2004 than under previous GAAP. This higher amount reflects the reversal of the previous GAAP amortisation charge for 2004, together with an increase of £68m/a96m in the amount of goodwill arising on 2004 acquisitions under IFRS due to the recognition of additional deferred taxation liabilities (see below), less the effects of currency translation on adjustments. IAS38 – Intangible Assets requires more detailed evaluations to be made of acquired intangible assets and their estimated useful lives than under previous GAAP. Estimated useful lives of acquired intangible assets under IFRS are typically shorter than under previous GAAP, although in certain cases may be considered indefinite. The adoption of IAS38 gives rise to a net increase in the amortisation charge in respect of acquired intangible assets of £55m/a81m. Other adjustments to goodwill and intangible assets on the balance sheet at 31 December 2004 are due to the effects of currency translations on the adjustments described above. There is no retrospective restatements of the acquired goodwill and intangible asset values as at the 1 January 2004 transition date. (ii) Pensions The accounting for the costs of defined benefit pension schemes and other post-retirement employee benefits under IFRS is governed by IAS19 – Employee Benefits, which differs from previous GAAP in that the net expense is determined using assumptions that are based on market conditions at the start of each financial year, principally in relation to salary 159711 Reed Report 55-102 7/3/06 12:04 Page 99 Reed Elsevier Annual Reports and Financial Statements 2005 99 33 Reconciliations to previous GAAP continued inflation, investment returns and discount rates. Similarly, the assets and liabilities of defined benefit pension schemes and other employee benefit schemes are determined based on market conditions at the balance sheet date. Under previous GAAP, determinations were made based on long run actuarial assumptions. The adoption of IAS19 valuation methodologies increases the expense for employee benefits in 2004 by £27m/a40m compared to the amount reported under previous GAAP. Net pension obligations calculated using the IAS19 valuation methodologies were £321m/a453m as at 31 December 2004, which compares with a net pension prepayment less accrued liabilities under previous GAAP of £84m/a118m. Reed Elsevier is adopting the approach available under IAS19 to reflect all actuarial gains and losses in the balance sheet in full and to report the amounts of such gains and losses arising each year through the Statement of Recognised Income and Expense. Actuarial losses of £74m/a109m arising in the year ended 31 December 2004 are reflected in the amount of net pension obligations at the balance sheet date. (iii) Share based remuneration For share based remuneration, the expense under IFRS2 – Share Based Payment is determined based on the fair value of such payments at the date of grant, spread over the vesting period taking account of the number of shares that are expected to vest. Under previous GAAP, only the intrinsic value was expensed, i.e. where options are granted over shares with an exercise price below the market price of the shares at the date of grant. The charge under IFRS2 in 2004 is £48m/a71m higher than the £11m/a16m charge under previous GAAP. There is no effect on net assets as the expense is offset by an equivalent amount credited to reserves. (iv) Deferred taxation IAS12 – Income Taxes requires deferred taxation to be provided for nearly all differences between the balance sheet amounts of assets and liabilities and their corresponding tax bases. Under previous GAAP, deferred tax was provided for timing differences only and deferred tax assets were not recognised unless realisable in the near term. Net deferred tax liabilities as at 31 December 2004 are £643m/a907m higher under IFRS than under previous GAAP. This relates principally to deferred tax of £785m/a1,107m on the difference between the balance sheet amount of acquired intangible assets and the historic tax bases of the underlying assets, partly offset by deferred tax assets in respect of net pension obligations. The goodwill on acquisition is grossed up by the amount of deferred tax liabilities on acquired intangible assets, other than in respect of intangible assets acquired prior to the transition date of 1 January 2004. (Under transition rules, the deferred tax liability as at the 1 January 2004 transition date in respect of intangible assets acquired prior to that date is charged directly to reserves and not added to goodwill.) The tax charge under IFRS for 2004 is £80m/a118m lower than under previous GAAP due to the unwinding of deferred tax liabilities and the deferred tax effects of other IFRS adjustments. (v) Dividends payable Under previous GAAP, dividends were provided for in the year in respect of which they were declared or proposed by the directors. Under IAS10 – Post Balance Sheet Events, dividends are only provided for when declared. Current liabilities have been reduced by £248m/a350m as at 31 December 2004 in respect of proposed dividends not formally declared as at the balance sheet date. (vi) Joint ventures Under IFRS, the equity accounted share of joint ventures results is included within operating profit on a post-tax basis. Under previous GAAP, the equity share of the taxes in joint ventures was included in taxation and not deducted within operating profit. The effect is to reduce both the operating profit and taxation under IFRS by £7m/a10m. There is no effect on net profit and shareholders’ equity. As at the IFRS transition date of 1 January 2004, shareholders’ equity was £788m/a1,119m lower under IFRS than under previous GAAP due to additional deferred tax liabilities of £686m/a974m, additional net pension obligations of £310m/a440m and other additional liabilities of £18m/a26m, partly offset by reversal of proposed dividends of £226m/a321m. 159711 Reed Report 55-102 7/3/06 12:04 Page 100 100 Combined financial statements Notes to the combined financial statements For the year ended 31 December 2005 34 Exchange rates The following exchange rates have been applied in preparing the combined financial statements: Euro to sterling US dollars to sterling Euro to US dollars US dollars to euro Income statement Balance sheet 2005 1.46 1.82 0.80 1.25 2004 1.47 1.83 0.80 1.24 2005 1.46 1.73 0.84 1.18 2004 1.41 1.93 0.73 1.37 35 Approval of financial statements The combined financial statements were approved and authorised for issue by the boards of directors of Reed Elsevier PLC and Reed Elsevier NV on 15 February 2006. 159711 Reed Report 55-102 7/3/06 12:04 Page 101 Independent auditors’ report to the members of Reed Elsevier PLC and shareholders of Reed Elsevier NV Reed Elsevier Annual Reports and Financial Statements 2005 101 We have audited the combined financial statements of Reed Elsevier PLC, Reed Elsevier NV, Reed Elsevier Group plc, Elsevier Reed Finance BV and their respective subsidiaries, associates and joint ventures (together “the combined businesses”) for the year ended 31 December 2005 (“the combined financial statements”) which comprise the combined income statement, the combined cash flow statement, the combined balance sheet, the combined statement of recognised income and expense, the combined shareholders’ equity reconciliation, the accounting policies, and the related notes 1 to 35. These combined financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the parts of the Directors’ Remuneration Report presented in the Reed Elsevier Annual Reports and Financial Statements 2005 (“the Remuneration Report”) that are described as having been audited. Our audit work has been undertaken so that we might state to the members of Reed Elsevier PLC and shareholders of Reed Elsevier NV those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than Reed Elsevier PLC and Reed Elsevier NV, and the members of Reed Elsevier PLC as a body and the shareholders of Reed Elsevier NV as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors As described in the statement of directors’ responsibilities, the directors of Reed Elsevier PLC and Reed Elsevier NV are responsible for the preparation of the combined financial statements in accordance with International Financial Reporting Standards (“IFRS”) as adopted for use in the European Union. They are also responsible for the preparation of the other information contained in the Reed Elsevier Annual Report and Financial Statements 2005, including the Remuneration Report. Our responsibilities, as independent auditors of the combined financial statements and the parts of the Remuneration Report described as having been audited, are set out in International Standards on Auditing (UK and Ireland) issued by the United Kingdom Auditing Practices Board, and International Standards on Auditing as applied in the Netherlands, and by our respective professions’ ethical guidance. contents section, and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the combined financial statements. We are not required to consider whether the board’s statement on internal control covers all risks and controls, or form an opinion on the effectiveness of the group’s corporate governance procedures or its risk and control procedures. Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the United Kingdom Auditing Practices Board, and International Standards on Auditing as applied in the Netherlands. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the combined financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the combined financial statements, and of whether the accounting policies are appropriate to the combined businesses, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the combined financial statements and the parts of the Remuneration Report described as having been audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the combined financial statements. Opinion In our opinion: • the combined financial statements give a true and fair view, in accordance with IFRS as adopted for use in the European Union, of the state of affairs of the combined businesses as at 31 December 2005, and of their profits for the year then ended; • the combined financial statements have been properly prepared in accordance with Article 4 of the IAS Regulation; and • the parts of the Remuneration Report described as having been audited have been properly prepared in accordance with the United Kingdom Companies Act 1985. We report to you our opinion as to whether the combined financial statements give a true and fair view and whether the combined financial statements have been properly prepared in accordance with Article 4 of the IAS Regulation of European Union law. We read other information contained in the Reed Elsevier Annual Reports and Financial Statements 2005, as described in the Deloitte & Touche LLP Chartered Accountants and Registered Auditors London United Kingdom 15 February 2006 Deloitte Accountants B.V. J P M Hopmans Amsterdam The Netherlands 15 February 2006 159711 Reed Report 55-102 7/3/06 12:04 Page 102 159711 Reed Report 103-142 7/3/06 12:05 Page 103 Reed Elsevier PLC Annual report and financial statements Directors’ report Consolidated financial statements Group accounting policies Notes to the consolidated financial statements Independent auditors’ report on the consolidated financial statements Parent company financial statements Parent company accounting policies Independent auditors’ report on the parent company financial statements Company number: 77536 > 104 > 107 > 110 > 111 > 118 > 119 > 120 > 121 159711 Reed Report 103-142 7/3/06 12:05 Page 104 104 Reed Elsevier PLC Directors’ report The directors present their report, together with the financial statements of the company, for the year ended 31 December 2005. As a consequence of the merger of the company’s businesses with those of Reed Elsevier NV in 1993, described on page 28, the shareholders of Reed Elsevier PLC and Reed Elsevier NV can be regarded as having the interests of a single economic group. The Reed Elsevier combined financial statements represent the combined interests of both sets of shareholders and encompass the businesses of Reed Elsevier Group plc, Elsevier Reed Finance BV and their respective subsidiaries, associates and joint ventures, together with the parent companies, Reed Elsevier PLC and Reed Elsevier NV (“the combined businesses” or “Reed Elsevier”). This directors’ report and the financial statements of the company should be read in conjunction with the combined financial statements and other reports set out on pages 2 to 101. Principal activities The company is a holding company and its principal investments are its direct 50% shareholding in Reed Elsevier Group plc and its 39% shareholding in Elsevier Reed Finance BV, which are engaged in publishing and information activities and financing activities respectively. The remaining shareholdings in these two companies are held by Reed Elsevier NV. Reed Elsevier PLC also has an indirect equity interest in Reed Elsevier NV. Reed Elsevier PLC and Reed Elsevier NV have retained their separate legal identities and are publicly held companies. Reed Elsevier PLC’s securities are listed in London and New York and Reed Elsevier NV’s securities are listed in Amsterdam and New York. Financial statement presentation The consolidated financial statements of Reed Elsevier PLC include the 52.9% economic interest that shareholders have under the equalisation arrangements in the Reed Elsevier combined businesses, accounted for on an equity basis. Under the terms of the merger agreement, dividends paid to Reed Elsevier PLC and Reed Elsevier NV shareholders are equalised at the gross level inclusive of the UK tax credit received by certain Reed Elsevier PLC shareholders. Because of the tax credit, Reed Elsevier PLC normally requires proportionately less cash to fund its net dividend than Reed Elsevier NV does to fund its gross dividend. An adjustment is therefore required in the consolidated income statement of Reed Elsevier PLC to share this tax benefit between the two sets of shareholders in accordance with the equalisation agreement. The equalisation adjustment arises on dividends paid by Reed Elsevier PLC to its shareholders and it reduces the consolidated attributable earnings by £9m (2004: £8m), being 47.1% of the total amount of the tax credit. In addition to the reported figures, adjusted profit figures are presented as additional performance measures. These exclude the tax credit equalisation adjustment, the amortisation of acquired intangible assets, acquisition integration costs, disposals and other non operating items, related tax effects and movements in deferred taxation assets and liabilities not expected to crystallise in the near term. International Financial Reporting Standards Under a regulation adopted by the European Parliament, the consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) as endorsed by the European Union with effect from the 2005 financial year. The transition date for the application of IFRS is 1 January 2004, other than in respect of IAS39 – Financial Instruments for which the transition date is 1 January 2005, and comparative figures for 31 December 2004 have been restated accordingly. Reconciliations of net income and equity for the comparative period from previously applied UK GAAP to IFRS are presented in note 19 to the consolidated financial statements. Consolidated income statement Reed Elsevier PLC’s 52.9% share of the adjusted profit before tax of the Reed Elsevier combined businesses was £530m, up from £494m in 2004. In scientific and medical markets, demand has remained strong for scientific research and medical information within a more supportive funding environment particularly for online product and in the expanding health professions. In legal markets, good demand growth has been seen for online productivity tools and practice solutions, and in international online expansion and risk management. In education markets, strong growth in the US K-12 basal business, driven by success in an expanded state textbook adoptions market, was in large part offset by a weak supplemental market and a significant underperformance in the supplemental and assessment businesses. In business to business markets, we are now seeing a more positive overall environment. The exhibitions business grew strongly as markets recovered and, whilst print advertising remains subdued, the online services in which we have been investing over the last few years continued their rapid growth. Reed Elsevier PLC’s share of the adjusted profit attributable of the combined businesses was £399m, up from £363m in 2004. The company’s share of the post tax charge for amortisation of acquired intangible assets was £164m, up £12m from 2004, reflecting the full year impact of acquisitions made in 2004. The reported net profit for the year was £235m (2004: £235m). Adjusted earnings per share increased 10% to 31.5p (2004: 28.7p). At constant rates of exchange, the increase 159711 Reed Report 103-142 7/3/06 12:05 Page 105 Reed Elsevier Annual Reports and Financial Statements 2005 105 would have been 11%. Including the effect of the tax credit equalisation as well as the amortisation of acquired intangible assets, acquisition integration costs, non operating items and tax adjustments, the basic earnings per share was 18.6p (2004: 18.6p). Consolidated balance sheet The consolidated balance sheet of Reed Elsevier PLC reflects its 52.9% economic interest in the net assets of Reed Elsevier, which at 31 December 2005 amounted to £1,042m (2004: £880m). The £162m increase in net assets principally reflects the company’s share in the attributable profits of Reed Elsevier, exchange translation effects and dividends paid. Dividends Given the strengthening performance of the business, the strong cash generation and positive outlook, the board announced in February 2005 a more progressive dividend policy that more closely aligns dividend growth with growth in adjusted earnings. Accordingly, the board is recommending a final dividend of 10.7p per ordinary share to be paid on 12 May 2006 to shareholders on the Register on 21 April 2006. The total dividend paid on the ordinary shares for the financial year was £168m (2004: £153m). Share repurchase programme Following a review of Reed Elsevier’s financial position and outlook, the board of Reed Elsevier PLC, together with the boards of Reed Elsevier NV, has approved the introduction of an annual share repurchase programme in 2006 to further improve capital efficiency. It is expected that this new programme will enhance shareholder returns, whilst retaining the financial capability to continue to develop the business through both organic and acquisition investment. Further details are given on pages 2 and 3 of the Reed Elsevier Annual Report and Financial Statements 2005. Parent company financial statements The individual parent company financial statements of Reed Elsevier PLC are presented on pages 119 to 120, and continue to be prepared under UK generally accepted accounting principles (UK GAAP). Parent company shareholders’ funds as at 31 December 2005 were £1,886m (2004: £1,880m). Share capital During 2005, 3,339,431 ordinary shares in the company were issued in connection with share option schemes as follows: 602,343 under a UK SAYE share option scheme at prices between 336.20p and 543.20p per share. 2,737,088 under executive share option schemes at prices between 400.75p and 537.50p per share. At 15 February 2006, the company had received notification of the following substantial interests in the company’s issued ordinary share capital: The Capital Group Companies, Inc 115,904,745 shares 9.08% FMR Corporation, 66,469,992 shares 5.20% Legal & General Group plc 49,863,553 shares 3.90% Prudential plc 39,858,771 shares 3.12% Barclays plc 38,625,977 shares 3.02% At the 2005 Annual General Meeting a resolution was passed to extend the authority given to the company to purchase up to 10% of its ordinary shares by market purchase. At 31 December 2005, this authority remained unutilised. A resolution to further extend the authority is to be put to the 2006 Annual General Meeting. Directors The following served as directors during the year: J Hommen (Chairman – appointed 27 April 2005) M Tabaksblat (Chairman – retired 27 April 2005) Sir Crispin Davis (Chief Executive Officer) M H Armour (Chief Financial Officer) G J A van de Aast J F Brock (retired 27 April 2005) M W Elliott E Engstrom C J A van Lede A Prozes D E Reid Lord Sharman of Redlynch OBE R W H Stomberg (senior independent non-executive director) P Tierney S Zelnick (appointed 27 April 2005) Biographical details of the directors at the date of this report are given on pages 26 and 27 of the Annual Review and Summary Financial Statements. Messrs van de Aast, Elliott, van Lede, Reid and Tierney will retire by rotation at the forthcoming Annual General Meeting. Being eligible, they will each offer themselves for re-election. 159711 Reed Report 103-142 7/3/06 12:05 Page 106 106 Reed Elsevier PLC The notice period applicable to the service contracts of Messrs van de Aast and Tierney is set out in the Directors’ Remuneration Report on page 42. Messrs Elliott, van Lede and Reid do not have service contracts. Details of directors’ remuneration and their interests in the share capital of the company are provided in the Directors’ Remuneration Report on pages 37 to 53. In accordance with the company’s Articles of Association, directors are granted an indemnity from the company to the extent permitted by law in respect of liabilities incurred as a result of their office. Charitable and political donations Reed Elsevier companies made donations during the year for charitable purposes amounting to £2.1m of which £0.3m was in the United Kingdom. In the United States, Reed Elsevier companies contributed £48,000 to political parties. There were no donations made in the European Union for political purposes. Statement of directors’ responsibilities The directors are required by English company law to prepare financial statements for each financial period, which give a true and fair view of the state of affairs of the company and the group, and of the profit or loss for that period. In preparing those financial statements, the directors ensure that suitable accounting policies, consistently applied and supported by reasonable and prudent judgements and estimates, have been used, and accounting standards have been followed. Corporate governance Save as noted on page 28, the company has complied throughout the period under review with the provisions of the Combined Code on Corporate Governance issued in July 2003 (the “UK Code”). Details of how the principles of the UK Code have been applied and the directors’ statement on internal control are set out in the Structure and Corporate Governance report on pages 28 to 33. Details of the role and responsibilities, membership and activities of the Reed Elsevier PLC Audit Committee are set out in the Report of the Audit Committees on pages 34 to 36. Going concern After making enquiries, the directors have a reasonable expectation that the group has adequate resources to continue in operational existence for the foreseeable future and that, therefore, it is appropriate to adopt the going concern basis in preparing the financial statements. Payments to suppliers Reed Elsevier companies agree terms and conditions for business transactions with suppliers and payment is made on these terms. The average time taken to pay suppliers was between 30 and 45 days. Auditors Resolutions for the reappointment of Deloitte & Touche LLP as auditors of the company and authorising the directors to fix their remuneration will be submitted to the forthcoming Annual General Meeting. The directors are responsible for keeping proper accounting records, which disclose with reasonable accuracy at any time the financial position of the company and enable them to ensure that the financial statements comply with the law. By order of the Board Stephen J Cowden Secretary The directors have general responsibility for taking reasonable steps to safeguard the assets of the group and to prevent and detect fraud and other irregularities. 15 February 2006 Registered Office 1-3 Strand London WC2N 5JR 159711 Reed Report 103-142 7/3/06 12:05 Page 107 Consolidated income statement Reed Elsevier Annual Reports and Financial Statements 2005 107 For the year ended 31 December Administrative expenses Effect of tax credit equalisation on distributed earnings Share of results of joint ventures Operating profit Finance income Profit before tax Taxation Profit attributable to ordinary shareholders Earnings per ordinary share (“EPS”) For the year ended 31 December Basic EPS Diluted EPS Consolidated cash flow statement For the year ended 31 December Cash flow from operating activities Cash used by operations Interest received Tax paid Net cash flow from operating activities Dividends received from joint ventures Cash flows from financing activities Equity dividends paid Proceeds on issue of ordinary shares Increase in net funding balances due from joint ventures Net cash flows from financing activities Movement in cash and cash equivalents Note 1 2 11 5 6 Note 8 8 Note 10 7 10 £ 2004 £m (2) (8) 247 237 3 240 (5) 235 2005 £m (2) (9) 252 241 1 242 (7) 235 £ 2004 pence 18.6p 18.5p 2005 pence 18.6p 18.4p £ 2004 £m (2) 3 (1) – 2005 £m (2) 1 (8) (9) 168 153 (168) 14 (5) (159) (153) 11 (11) (153) – – 159711 Reed Report 103-142 7/3/06 12:05 Page 108 108 Reed Elsevier PLC Consolidated balance sheet As at 31 December Non-current assets Investments in joint ventures Current assets Amounts due from joint ventures Total assets Current liabilities Payables Taxation Non-current liabilities Amounts owed to joint ventures Total liabilities Net assets Capital and reserves Called up share capital Share premium account Shares held in treasury Capital redemption reserve Translation reserve Other reserves Total equity Note 11 12 13 14 15 16 17 2005 £m 490 600 1,090 1 11 12 36 48 1,042 160 987 (49) 4 31 (91) 1,042 £ 2004 £m 334 595 929 1 12 13 36 49 880 159 974 (35) 4 (64) (158) 880 The consolidated financial statements were approved by the board of directors, 15 February 2006. J Hommen Chairman M H Armour Chief Financial Officer 159711 Reed Report 103-142 7/3/06 12:05 Page 109 Consolidated statement of recognised income and expense Reed Elsevier Annual Reports and Financial Statements 2005 109 For the year ended 31 December Profit attributable to ordinary shareholders Share of joint ventures’ net income/(expense) recognised directly in equity Share of joint ventures’ transfer to net profit from hedge reserve Total recognised income and expense for the year Transition adjustment on adoption of IAS39 Reconciliation of shareholders’ equity For the year ended 31 December Total recognised net income Equity dividends declared Issue of ordinary shares, net of expenses Increase in shares held in treasury Share of joint ventures’ recognition of share based remuneration reserve Equalisation adjustments Net increase in shareholders’ equity Shareholders’ equity at start of year Share of joint ventures’ transition adjustment on adoption of IAS39 Shareholders’ equity at end of year Note 7 £ 2004 £m 235 (97) – 138 2005 £m 235 71 (10) 296 6 – 2005 £m 296 (168) 14 (14) 30 (2) 156 880 6 1,042 £ 2004 £m 138 (153) 11 (15) 31 (3) 9 871 – 880 159711 Reed Report 103-142 7/3/06 12:05 Page 110 110 Reed Elsevier PLC Group accounting policies These consolidated financial statements have been prepared under the historical cost convention in accordance with applicable accounting standards. and its subsidiaries. Investments in joint ventures are accounted for using the equity method. Basis of preparation These statutory consolidated financial statements report the consolidated statements of income, cash flow and financial position of Reed Elsevier PLC, and have been prepared in accordance with International Financial Reporting Standards (IFRS) as endorsed by the European Union with effect from the 2005 financial year. The transition date for the application of IFRS is 1 January 2004, other than in respect of IAS39 where the transition date is 1 January 2005, and the comparative figures for the year ended 31 December 2004 have been restated accordingly. Reconciliations of net income and equity for the comparative period from previously applied UK GAAP to IFRS are presented in note 19 to the consolidated financial statements. Unless otherwise indicated, all amounts shown in the financial statements are in millions of pounds. The basis of the merger of the businesses of Reed Elsevier PLC and Reed Elsevier NV is set out on page 28. Determination of profit The Reed Elsevier PLC share of the Reed Elsevier combined results has been calculated on the basis of the 52.9% economic interest of the Reed Elsevier PLC shareholders in the Reed Elsevier combined businesses, after taking account of results arising in Reed Elsevier PLC and its subsidiaries. Dividends paid to Reed Elsevier PLC and Reed Elsevier NV shareholders are equalised at the gross level inclusive of the UK tax credit received by certain Reed Elsevier PLC shareholders. In Reed Elsevier PLC’s consolidated financial statements, an adjustment is required to equalise the benefit of the tax credit between the two sets of shareholders in accordance with the equalisation agreement. This equalisation adjustment arises on dividends paid by Reed Elsevier PLC to its shareholders and reduces the consolidated attributable earnings by 47.1% of the total amount of the tax credit. The accounting policies adopted in the preparation of the combined financial statements are set out on pages 60 to 64. Investments Reed Elsevier PLC’s 52.9% economic interest in the net assets of the combined businesses has been shown on the balance sheet as investments in joint ventures, net of the assets and liabilities reported as part of Reed Elsevier PLC Foreign exchange translation Transactions in foreign currencies are recorded at the rate of exchange prevailing on the date of the transaction. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are retranslated at the rate prevailing on the balance sheet date. Exchange differences arising are recorded in the income statement. The gains or losses relating to the retranslation of Reed Elsevier PLC’s 52.9% economic interest in the net assets of the combined businesses are classified as equity and transferred to the translation reserve. Cumulative translation differences are recognised within the income statement in the period in which operations are disposed of. As permitted under the transition rules of IFRS1 – First Time Adoption of International Financial Reporting Standards, cumulative translation differences in respect of foreign operations have been deemed to be nil at the date of transition. Taxation The tax expense represents the sum of the tax payable on the current year taxable profits and the movements on deferred tax that are recognised in the income statement. Tax arising in joint ventures is included in the share of results of joint ventures. The tax payable on current year taxable profits is calculated using the applicable tax rate that has been enacted, or substantively enacted, by the balance sheet date. Deferred tax is the tax arising on differences between the carrying amounts of assets and liabilities in the financial statements and their corresponding tax bases used in the computation of taxable profit, and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Deferred tax is calculated using tax rates that are expected to apply in the period when the liability is settled or the asset is realised. 159711 Reed Report 103-142 7/3/06 12:05 Page 111 Notes to the consolidated financial statements For the year ended 31 December 2005 Reed Elsevier Annual Reports and Financial Statements 2005 111 1 Administrative expenses Administrative expenses include £495,000 (2004: £386,000) paid in the year to Reed Elsevier Group plc under a contract for the services of directors and administrative support. Reed Elsevier PLC has no employees (2004: nil). 2 Effect of tax credit equalisation on distributed earnings The tax credit equalisation adjustment arises on dividends paid by Reed Elsevier PLC to its shareholders and reduces the consolidated profit attributable to ordinary shareholders by 47.1% of the total amount of the tax credit, as set out in the accounting policies on page 110. 3 Auditors’ remuneration Audit fees payable by Reed Elsevier PLC were £24,000 (2004: £24,000). Further information on the audit and non-audit fees paid by the Reed Elsevier combined businesses to Deloitte & Touche LLP and its associates is set out in note 2 to the combined financial statements. 4 Related party transactions All transactions with joint ventures, which are related parties of Reed Elsevier PLC, have been disclosed in these financial statements. Key personnel are also related parties and comprise the directors of Reed Elsevier PLC. The remuneration of directors of Reed Elsevier PLC is disclosed in the Directors’ Remuneration Report on pages 37 to 53. 5 Finance income Finance income from joint ventures 6 Taxation UK corporation tax 2005 £m 1 2005 £m 7 2004 £m 3 2004 £m 5 A reconciliation of the notional tax charge based on the applicable rate of tax to the actual total tax expense is set out below. Profit before tax Tax at applicable rate (30%) Tax included in share of results of joint ventures Other Tax expense 2005 £m 242 73 (73) 7 7 2004 £m 240 72 (72) 5 5 159711 Reed Report 103-142 7/3/06 12:05 Page 112 112 Reed Elsevier PLC Notes to the consolidated financial statements For the year ended 31 December 2005 7 Equity dividends Dividends declared in the year Ordinary shares of 12.5 pence each Final for prior financial year Interim for financial year Total 2005 pence 2004 pence 9.6p 3.7p 13.3p 8.7p 3.4p 12.1p 2005 £m 120 48 168 2004 £m 110 43 153 The directors of Reed Elsevier PLC have proposed a final dividend of 10.7p (2004: 9.6p). The total cost of funding the proposed final dividends will be £137m. No liability has been recognised at the date of the balance sheet. Dividends paid and proposed relating to the financial year Ordinary shares of 12.5 pence each Interim (paid) Final (proposed) Total 8 Earnings per ordinary share (“EPS”) 2005 pence 2004 pence 3.7p 10.7p 14.4p 3.4p 9.6p 13.0p Basic EPS Diluted EPS EPS based on 52.9% economic interest in the Reed Elsevier combined businesses Weighted average number of shares (millions) 1,266.2 1,277.2 2005 Earnings £m 235 235 EPS pence 18.6p 18.4p Weighted average number of shares (millions) 1,264.6 1,273.1 1,266.2 244 19.3p 1,264.6 2004 Earnings £m 235 235 243 EPS pence 18.6p 18.5p 19.2p The diluted EPS figures are calculated after taking account of the effect of potential additional ordinary shares arising from the exercise of share options and conditional shares. The weighted average number of shares is after deducting shares held in treasury. 159711 Reed Report 103-142 7/3/06 12:05 Page 113 Reed Elsevier Annual Reports and Financial Statements 2005 113 9 Adjusted figures Adjusted profit and earnings per share figures are used as additional performance measures. The adjusted figures are derived as follows: Reported figures Effect of tax credit equalisation on distributed earnings Profit attributable to ordinary shareholders based on 52.9% economic interest in the Reed Elsevier combined businesses Share of adjustments in joint ventures: Amortisation of acquired intangible assets Acquisition integration costs Disposals and other non operating items Deferred tax adjustment Adjusted figures 10 Cash flow statement Reconciliation of administrative expenses to cash used by operations Administrative expenses Net movement in payables Cash used by operations Reconciliation of net funding balances due from joint ventures At start of year Cash flow At end of year Profit attributable to ordinary shareholders Basic earnings per share 2005 £m 235 9 244 164 9 (1) (17) 399 2004 £m 235 8 243 152 15 1 (48) 363 2005 pence 18.6p 0.7p 2004 pence 18.6p 0.6p 19.3p 19.2p 13.0p 0.7p (0.1)p (1.4)p 31.5p 12.0p 1.2p 0.1p (3.8)p 28.7p 2005 £m (2) – (2) 2005 £m 559 5 564 2004 £m (2) – (2) 2004 £m 548 11 559 159711 Reed Report 103-142 7/3/06 12:05 Page 114 114 Reed Elsevier PLC Notes to the consolidated financial statements For the year ended 31 December 2005 11 Investments in joint ventures Share of results of joint ventures Share of joint ventures’ net income/(expense) recognised directly in equity Share of joint ventures’ transfer to net profit from cash flow hedge reserve Share of joint ventures’ transition adjustment on adoption of IAS39 Dividends received from joint ventures Increase in shares held in treasury Share of joint ventures’ recognition of share based remuneration reserve Equalisation adjustments Increase in the year At start of year At end of year 2005 £m 252 71 (10) 6 (168) (14) 30 (11) 156 334 490 2004 £m 247 (97) – – (153) (15) 31 (11) 2 332 334 Summarised information showing total amounts in respect of joint ventures and Reed Elsevier PLC shareholders’ 52.9% share is set out below. Revenue Net profit for the year Total assets Total liabilities Net assets Attributable to: Joint ventures Minority interests Total Total joint ventures 2005 £m 5,166 464 2004 £m 4,812 461 Total joint ventures 2005 £m 9,127 (7,142) 1,985 1,970 15 1,985 2004 £m 7,952 (6,275) 1,677 1,664 13 1,677 Reed Elsevier PLC shareholders’ share 2005 £m 2,733 252 2004 £m 2,546 247 Reed Elsevier PLC shareholders’ share 2005 £m 4,864 (4,374) 490 2004 £m 4,243 (3,909) 334 490 – 490 334 – 334 The above amounts exclude assets and liabilities held directly by Reed Elsevier PLC and include the counterparty balances of amounts owed to and by other Reed Elsevier businesses. Included within Reed Elsevier PLC’s share of assets and liabilities are cash and cash equivalents of £157m (2004: £119m) and borrowings of £1,674m (2004: £1,458m) respectively. 12 Share capital Authorised Ordinary shares of 12.5p each Unclassified shares of 12.5p each Total No. of shares 1,277,013,440 194,439,736 £m 160 24 184 159711 Reed Report 103-142 7/3/06 12:05 Page 115 Reed Elsevier Annual Reports and Financial Statements 2005 115 12 Share capital continued Called up share capital – issued and fully paid At start of year Issue of ordinary shares At end of year 2005 No. of shares 1,273,674,009 3,339,431 1,277,013,440 £m 159 1 160 2004 No. of shares 1,271,111,509 2,562,500 1,273,674,009 £m 159 – 159 The issue of ordinary shares relates to the exercise of share options. Details of share option and conditional share schemes are set out in note 5 to the Reed Elsevier combined financial statements. 13 Share premium At start of year Issue of ordinary shares At end of year 14 Shares held in treasury At start of year Purchase of shares At end of year Details of shares held in treasury are provided in note 29 to the Reed Elsevier combined financial statements. 15 Capital redemption reserve At start and end of year 16 Translation reserve At start of year Share of joint ventures’ exchange differences on translation of foreign operations At end of year 2005 £m 974 13 987 2005 £m 35 14 49 2004 £m 963 11 974 2004 £m 20 15 35 2005 £m 4 2004 £m 4 2005 £m (64) 95 31 2004 £m – (64) (64) 159711 Reed Report 103-142 7/3/06 12:05 Page 116 116 Reed Elsevier PLC Notes to the consolidated financial statements For the year ended 31 December 2005 17 Other reserves At start of year Share of joint ventures’ transition adjustment on adoption of IAS39 At start of year restated Profit attributable to ordinary shareholders Share of joint ventures’ actuarial losses on defined benefit pension schemes Share of joint ventures’ fair value movements on available for sale investments Share of joint ventures’ fair value movements on cash flow hedges Share of joint ventures’ tax on actuarial losses on defined benefit pension schemes Share of joint ventures’ tax on fair value movements on cash flow hedges Share of joint ventures’ transfer to net profit from hedge reserve Share of joint ventures’ recognition of share based remuneration reserve Equalisation adjustments Equity dividends declared At end of year 2005 £m (158) 6 (152) 235 (19) 2 (5) 5 (7) (10) 30 (2) (168) (91) 2004 £m (235) – (235) 235 (39) – – 6 – – 31 (3) (153) (158) 18 Contingent liabilities There are contingent liabilities in respect of borrowings of joint ventures guaranteed by Reed Elsevier PLC as follows: Guaranteed jointly and severally with Reed Elsevier NV 2005 £m 2004 £m 2,705 2,487 Financial instruments disclosures in respect of the borrowings covered by the above guarantees are given in note 17 to the Reed Elsevier combined financial statements. 19 Reconciliations to previous GAAP The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). The adoption of these standards has resulted in changes to the accounting policies previously applied under UK GAAP (“previous GAAP”) for the year ended 31 December 2004. The effects of differences to previous GAAP on net profit for the year ended 31 December 2004 and shareholders’ equity as at that date are summarised below. Year ended 31 December Profit attributable to ordinary shareholders under previous GAAP Adjustments: Share of IFRS adjustments in joint ventures Profit attributable to ordinary shareholders under IFRS Note (i) 2004 £m 152 83 235 159711 Reed Report 103-142 7/3/06 12:05 Page 117 Reed Elsevier Annual Reports and Financial Statements 2005 117 19 Reconciliations to previous GAAP continued As at 31 December Shareholders’ equity under previous GAAP Adjustments: Share of IFRS adjustments in joint ventures Dividends Shareholders’ equity under IFRS Note (i) (ii) 2004 £m 1,199 (439) 120 880 (i) Details of the IFRS adjustments made to the Reed Elsevier combined figures are presented in note 33 to the combined financial statements. (ii) Reversal of proposed dividends not declared by 31 December 2004. Under IFRS the carrying value of investments in joint ventures and external payables at 31 December 2004 were £439m and £120m lower respectively, compared to the figures reported under previous GAAP. As at the IFRS transition date of 1 January 2004, shareholders’ equity was £417m lower under IFRS than under previous GAAP due to the share of IFRS adjustments in joint ventures of £527m and the reversal of proposed dividends of £110m. 20 Post balance sheet event On 14 February 2006, Reed Elsevier’s Group plc declared a dividend to Reed Elsevier PLC of £150m. 21 Principal joint ventures Reed Elsevier Group plc Incorporated and operating in Great Britain 1-3 Strand London WC2N 5JR Holding company for operating businesses involved in science & medical, legal, educational and business publishing Elsevier Reed Finance BV Incorporated in the Netherlands Radarweg 29 1043 NX Amsterdam, The Netherlands Holding company for financing businesses £10,000 ordinary “R” shares £10,000 ordinary “E” shares £100,000 7.5% cumulative preference non voting shares Equivalent to a 50% equity interest 133 ordinary “R” shares 205 ordinary “E” shares Equivalent to a 39% equity interest The “E” shares in Reed Elsevier Group plc and Elsevier Reed Finance BV are owned by Reed Elsevier NV. 22 Principal subsidiary Reed Holding BV Incorporated in the Netherlands Radarweg 29 1043 NX Amsterdam, The Netherlands 41 ordinary shares % holding 100% – 100% 100% – % holding 100% Reed Holding BV owns 4,679,249 shares of a separate class in Reed Elsevier NV, giving Reed Elsevier PLC a 5.8% indirect equity interest in Reed Elsevier NV. 159711 Reed Report 103-142 7/3/06 12:05 Page 118 118 Reed Elsevier PLC Independent auditors’ report on the consolidated financial statements to the members of Reed Elsevier PLC We have audited the consolidated financial statements of Reed Elsevier PLC for the year ended 31 December 2005 (“the consolidated financial statements”), which comprise the group accounting policies, the consolidated income statement, the consolidated cash flow statement, the consolidated balance sheet, the consolidated statement of recognised income and expense, the reconciliation of shareholders’ equity and the related notes 1 to 22. These consolidated financial statements have been prepared under the accounting policies set out therein. We have reported separately on the individual parent company financial statements of Reed Elsevier PLC for the year ended 31 December 2005 and on the information in the parts of the Directors’ Remuneration Report presented in the Annual Reports and Financial Statements 2005 (“the Remuneration Report”) included in the individual parent company annual report that are described as having been audited. This report is made solely to the company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors As described in the statement of directors’ responsibilities, the company’s directors are responsible for preparing the consolidated financial statements in accordance with applicable United Kingdom law and International Financial Reporting Standards (“IFRS”), as adopted for use in the European Union. Our responsibility is to audit the consolidated financial statements in accordance with relevant United Kingdom legal and regulatory requirements and International Standards on Auditing (UK and Ireland). We report to you our opinion as to whether the consolidated financial statements give a true and fair view in accordance with the relevant framework and whether the consolidated financial statements have been properly prepared in accordance with the United Kingdom Companies Act 1985 and Article 4 of the IAS Regulation of European Union law. We report to you if, in our opinion, the directors’ report is not consistent with the consolidated financial statements. We also report to you if the company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and transactions with the company and other members of the group is not disclosed. We review whether the corporate governance statement reflects the company’s compliance with the nine provisions of the 2003 FRC Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the board’s statement on internal control covers all risks and controls, or form an opinion on the effectiveness of the group’s corporate governance procedures or its risk and control procedures. We read the directors’ report and the other information contained in the Reed Elsevier Annual Reports and Financial Statements 2005 for the above year as described in the contents section and we consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the consolidated financial statements. Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the consolidated financial statements, and of whether the accounting policies are appropriate to the company’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the consolidated financial statements are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the consolidated financial statements. Opinion In our opinion: • the consolidated financial statements give a true and fair view in accordance with IFRS, as adopted for use in the European Union, of the state of the group’s affairs as at 31 December 2005 and of its profit for the year then ended; and • the consolidated financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation. Deloitte & Touche LLP Chartered Accountants and Registered Auditors London United Kingdom 15 February 2006 159711 Reed Report 103-142 7/3/06 12:05 Page 119 Parent company balance sheet Reed Elsevier Annual Reports and Financial Statements 2005 119 As at 31 December Fixed assets Investments in subsidiary undertakings Investments in joint ventures Current assets Debtors: amounts due from joint ventures Creditors: amounts falling due within one year Other creditors Taxation Amounts owed to subsidiary undertakings Net current assets Creditors: amounts falling due after one year Amounts owed to joint ventures Net assets Capital and reserves Called up share capital Share premium account Capital redemption reserve Profit and loss reserve Shareholders’ funds Note 2005 £m 2004 £m (i) 303 1,108 1,411 600 600 (1) (11) (77) (89) 511 303 1,108 1,411 595 595 (1) (12) (77) (90) 505 (36) 1,886 (36) 1,880 160 987 4 735 1,886 159 974 4 743 1,880 (i) Following adoption of FRS21 – Events after the Balance Sheet Date, creditors: amounts falling due within one year as at 31 December 2004 have been restated to remove the accrual for the proposed dividend of £120m with the profit and loss reserve restated correspondingly. (ii) Subsequent to the balance sheet date, on 14 February 2006, Reed Elsevier’s Group plc declared a dividend payable to Reed Elsevier PLC of £150m. The parent company financial statements were approved by the board of directors, 15 February 2006. J Hommen Chairman M H Armour Chief Financial Officer 159711 Reed Report 103-142 7/3/06 12:05 Page 120 120 Reed Elsevier PLC Parent company reconciliation of shareholders’ funds Note Share capital £m account £m Share Capital premium redemption Profit and reserve loss reserve £m £m At 1 January 2004 Prior year adjustment At 1 January 2004 as restated Profit attributable to ordinary shareholders Equity dividends paid Issue of ordinary shares, net of expenses At 1 January 2005 As originally reported Prior year adjustment Profit attributable to ordinary shareholders Equity dividends paid Issue of ordinary shares, net of expenses At 31 December 2005 (i) (i) 159 – 159 – – – 159 159 – – – 1 160 963 – 963 – – 11 974 974 – – 13 987 4 – 4 – – – 4 4 – – – – 4 637 110 747 149 (153) – 743 623 120 160 (168) – 735 Total £m 1,763 110 1,873 149 (153) 11 1,880 1,760 120 160 (168) 14 1,886 (i) The prior year adjustment represents the reversal of the final dividend accrual following the change in accounting policy required by the adoption of FRS21 – Events after the Balance Sheet Date. Foreign exchange translation Transactions entered into in foreign currencies are recorded at the exchange rates applicable at the time of the transaction. Taxation Deferred taxation is provided in full for timing differences using the liability method. Deferred tax assets are only recognised to the extent that they are considered recoverable in the short term. Deferred taxation balances are not discounted. Parent company accounting policies Basis of preparation The parent company financial statements have been prepared under the historical cost convention in accordance with UK Generally Accepted Accounting Principles (UK GAAP). Unless otherwise indicated, all amounts in the financial statements are in millions of pounds. As permitted by Section 230 of the Companies Act 1985, the company has not presented its own profit and loss account. Reed Elsevier PLC adopted FRS21 – Events after the Balance Sheet Date with effect from the 2005 financial year. Comparative figures have been restated accordingly. The Reed Elsevier PLC accounting policies under UK GAAP are set out below. Investments Fixed asset investments in the combined businesses are stated at cost, less provision, if appropriate, for any impairment in value. Principal joint ventures and subsidiaries are set out in notes 21 and 22 of the Reed Elsevier PLC consolidated financial statements. 159711 Reed Report 103-142 7/3/06 12:05 Page 121 Independent auditors’ report on the parent company financial statements to the members of Reed Elsevier PLC Reed Elsevier Annual Reports and Financial Statements 2005 121 We have audited the individual parent company financial statements of Reed Elsevier PLC for the year ended 31 December 2005 (“the company financial statements”) which comprise the parent company balance sheet, the parent company reconciliation of shareholders’ funds and the parent company accounting policies. These company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the parts of the Directors’ Remuneration Report presented in the Reed Elsevier Annual Reports and Financial Statements 2005 (“the Remuneration Report”) that are described as having been audited. We have reported separately on the consolidated financial statements of Reed Elsevier PLC for the year ended 31 December 2005. This report is made solely to the company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors As described in the statement of directors’ responsibilities, the company’s directors are responsible for the preparation of the company financial statements in accordance with applicable United Kingdom law and United Kingdom Generally Accepted Accounting Principles. They are also responsible for the preparation of the other information contained in the Reed Elsevier Annual Reports and Financial Statements 2005 including, together with the directors of Reed Elsevier NV, the Remuneration Report. Our responsibility is to audit the company financial statements and the parts of the Remuneration Report described as having been audited in accordance with relevant United Kingdom legal and regulatory requirements and International Standards on Auditing (UK and Ireland). We report to you our opinion as to whether the company financial statements give a true and fair view in accordance with the relevant framework and whether the company financial statements and the parts of the Remuneration Report to be audited have been properly prepared in accordance with the Companies Act 1985. We report to you if, in our opinion, the directors’ report is not consistent with the company financial statements, if the company has not kept proper accounting records, if we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and transactions with the company is not disclosed. We also report to you if, in our opinion, the company has not complied with any of the four directors’ remuneration disclosure requirements specified for our review by the Listing Rules of the Financial Services Authority. These comprise the amount of each element in the remuneration package and information on share options, details of long term incentive schemes, and money purchase and defined benefit schemes. We give a statement, to the extent possible, of details of any non-compliance. We review whether the corporate governance statement reflects the company’s compliance with the nine provisions of the 2003 FRC Combined Code specified for our review by the Listing Rules of the Financial Services Authority, and we report if it does not. We are not required to consider whether the board’s statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the company’s corporate governance procedures or its risk and control procedures. We read the directors’ report and the other information contained in the Reed Elsevier Annual Reports and Financial Statements 2005 for the above year and described in the contents section including the unaudited parts of the Remuneration Report and consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the company financial statements. Basis of audit opinion We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) issued by the Auditing Practices Board. An audit includes examination, on a test basis, of evidence relevant to the amounts and disclosures in the company financial statements and the part of the Remuneration Report described as having been audited. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the company financial statements, and of whether the accounting policies are appropriate to the company’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the company financial statements and the parts of the Remuneration Report described as having been audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy 159711 Reed Report 103-142 7/3/06 12:05 Page 122 122 Reed Elsevier PLC of the presentation of information in the company financial statements and the parts of the Remuneration Report described as having been audited. Opinion In our opinion: • The company financial statements give a true and fair view, in accordance with United Kingdom Generally Accepted Accounting Principles, of the state of the company’s affairs as at 31 December 2005; and • the company financial statements and the parts of the Remuneration Report described as having been audited have been properly prepared in accordance with the Companies Act 1985. Deloitte & Touche LLP Chartered Accountants and Registered Auditors London United Kingdom 15 February 2006 159711 Reed Report 103-142 7/3/06 12:05 Page 123 Reed Elsevier NV Annual report and financial statements The Supervisory Board’s report The Executive Board’s report Consolidated financial statements Group accounting policies Notes to the consolidated financial statements Independent auditors’ report on the consolidated financial statements Additional information Parent company financial statements Parent company accounting policies Notes to the parent company financial statements Independent auditors’ report on the parent company financial statements Additional information > 124 > 125 > 126 > 129 > 131 > 138 > 138 > 139 > 140 > 141 > 142 > 142 159711 Reed Report 103-142 7/3/06 12:05 Page 124 124 Reed Elsevier NV The Supervisory Board’s report J Hommen, Chairman G J de Boer-Kruyt M W Elliott C J A van Lede D E Reid Lord Sharman of Redlynch OBE R W H Stomberg S Zelnick Together with the Executive Board, we herewith submit Reed Elsevier NV’s annual report and financial statements, comprising the consolidated financial statements and the parent company financial statements for the financial year ended 31 December 2005, to the shareholders’ meeting for adoption. The financial statements have been drawn up in accordance with the accounting principles explained on pages 129, 130 and 140 of this document and have been examined by Deloitte Accountants BV, Amsterdam. Their reports and opinions are set out on pages 138 and 142. The combined financial statements on pages 56 to 100 are part of the notes to and form an integral part of these statutory financial statements. We refer to the Report of the Chairman and the Chief Executive Officer and to the other reports contained within the Reed Elsevier Annual Review and Summary Financial Statements 2005 and the Reed Elsevier Annual Reports and Financial Statements 2005. These reports explain the business results of 2005, the financial state of the company as at 31 December 2005, and contain disclosures in respect of corporate governance, systems of internal control and risk management, corporate responsibility, remuneration of board members and key strategic issues. The equalisation agreement between Reed Elsevier NV and Reed Elsevier PLC has the effect that the respective shareholders can be regarded as having the interests of a single economic group and provides that Reed Elsevier NV shall declare dividends such that the dividend on one Reed Elsevier NV ordinary share, which shall be payable in euros, will equal 1.538 times the cash dividend, including the related UK tax credit, paid on one Reed Elsevier PLC ordinary share. In that context, the combined meeting of the Supervisory and Executive Boards (the Combined Board) determines the amounts of the company’s profit to be retained. The ordinary shares and the R-shares are entitled to receive distribution in proportion to their nominal value. The Combined Board may resolve to pay less per R-share, but not less than 1% of their nominal value. Details of dividends are contained in note 6 to the consolidated financial statements. Following a review of Reed Elsevier’s financial position and outlook, the Combined Board of Reed Elsevier NV, together with the board of Reed Elsevier PLC, has approved the introduction of an annual share repurchase programme in 2006 to further improve capital efficiency. With Reed Elsevier’s stronger free cash flow and positive growth outlook, it is expected that this new programme will enhance shareholder returns, whilst retaining the financial capability to continue to develop the business through both organic and acquisition investment. Further details are given on pages 2 and 3 of the Reed Elsevier Annual Reports and Financial Statements 2005. Reed Elsevier’s policies, practices and disclosures, and an explanation of the way in which Reed Elsevier has complied with the Dutch Corporate Governance Code, are set out in pages 28 to 33 of the Reed Elsevier Annual Reports and Financial Statements 2005. Reed Elsevier’s corporate governance policies, practices and disclosures were explained and accepted by the shareholders of Reed Elsevier NV at the Annual General Meeting in April 2005. At the forthcoming Reed Elsevier NV Annual General Meeting on 19 April 2006, Mrs de Boer-Kruyt, Mr Elliott, Mr van Lede and Mr Reid will retire by rotation as members of the Supervisory Board and, being eligible, will offer themselves for re-election. Furthermore Mr van de Aast and Mr Tierney will retire by rotation as members of the Executive Board and, being eligible, will offer themselves for re-election. A recommendation will be made at the Annual General Meeting for the reappointment of these directors. The Supervisory Board 15 February 2006 Registered office Radarweg 29 1043 NX Amsterdam 159711 Reed Report 103-142 7/3/06 12:05 Page 125 Reed Elsevier Annual Reports and Financial Statements 2005 125 The Executive Board’s report Sir Crispin Davis, Chairman M H Armour, Chief Financial Officer G J A van de Aast E Engstrom A Prozes P Tierney We refer to the Report of the Chairman and the Chief Executive Officer and to the other reports contained within the Reed Elsevier Annual Review and Summary Financial Statements 2005 and the Reed Elsevier Annual Reports and Financial Statements 2005. These reports explain the business results of 2005, the financial state of the company as at 31 December 2005, and the key operational and strategic issues. As explained in the financial statements on pages 126 to 142, Reed Elsevier NV now prepares its consolidated financial statements in accordance with International Financial Reporting Standards and its parent company financial statements, as previously, in accordance with generally accepted accounting principles in the UK. In the consolidated financial statements, the profit attributable to the shareholders of Reed Elsevier NV was a338m (2004: a338m) and net assets as at 31 December 2005, principally representing the investments in Reed Elsevier Group plc and Elsevier Reed Finance BV under the equity method, were a1,438m (2004: a1,173m). In the parent company financial statements, the profit attributable to the shareholders of Reed Elsevier NV was a188m (2004: a219m) and net assets as at 31 December 2005, principally representing the investments in Reed Elsevier Group plc and Elsevier Reed Finance BV under the historical cost method, were a2,112m (2004: a2,151m). Free reserves as at 31 December 2005 were a570m (2004: a627m). Following the declaration by Reed Elsevier Group plc of a dividend payable to Reed Elsevier NV, the free reserves of the company as at 14 February 2006, after taking account of other income and expenses in the period from 1 January 2006 to 14 February 2006, were a788m. The Executive Board 15 February 2006 Registered office Radarweg 29 1043 NX Amsterdam 159711 Reed Report 103-142 7/3/06 12:05 Page 126 126 Reed Elsevier NV Consolidated income statement For the year ended 31 December Administrative expenses Share of results of joint ventures Operating profit Finance income Profit before tax Taxation Profit attributable to ordinary shareholders Earnings per ordinary share (EPS) For the year ended 31 December Basic EPS Diluted EPS Consolidated cash flow statement For the year ended 31 December Cash flows from operating activities Cash used by operations Interest received Tax received/(paid) Net cash flow from operating activities Dividends received from joint ventures Cash flows from financing activities Equity dividends paid Proceeds on issue of ordinary shares Decrease in net funding balances due from joint ventures Net cash flow from financing activities (Decrease)/increase in cash and cash equivalents Note 1 10 4 5 Note 7 7 Note 9 6 9 d 2004 am (3) 339 336 2 338 – 338 2005 gm (3) 339 336 2 338 – 338 d 2004 a a0.43 a0.43 2005 g d0.43 d0.43 d 2004 am (3) 1 (5) (7) 2005 gm (5) 1 2 (2) 189 220 (245) 18 16 (211) (229) 14 20 (195) (24) 18 159711 Reed Report 103-142 7/3/06 12:05 Page 127 Consolidated balance sheet Reed Elsevier Annual Reports and Financial Statements 2005 127 As at 31 December Non-current assets Investments in joint ventures Current assets Amounts due from joint ventures: Funding Other Cash and cash equivalents Total assets Current liabilities Payables Taxation Non-current liabilities Taxation Total liabilities Net assets Capital and reserves Share capital issued Paid-in surplus Shares held in treasury Translation reserve Other reserves Total equity d 2004 am 2005 gm 1,487 1,183 Note 10 14 8 1 23 1,510 8 6 14 58 72 1,438 47 1,495 (68) 76 (112) 1,438 30 7 25 62 1,245 10 4 14 58 72 1,173 47 1,477 (47) (98) (206) 1,173 11 12 13 14 15 16 159711 Reed Report 103-142 7/3/06 12:05 Page 128 128 Reed Elsevier NV Consolidated statement of recognised income and expense For the year ended 31 December Profit attributable to ordinary shareholders Share of joint ventures’ net income/(expense) recognised directly in equity Share of joint ventures’ transfer to net profit from hedge reserve Total recognised income and expense for the year d 2004 am 338 (144) – 194 2005 gm 338 138 (14) 462 Share of joint ventures’ transition adjustment on adoption of IAS39 8 – Reconciliation of shareholders’ equity For the year ended 31 December Total recognised net income Equity dividends declared Issue of ordinary shares, net of expenses Increase in shares held in treasury Share of joint ventures’ recognition of share based remuneration reserve Equalisation adjustments Net increase in shareholders’ equity Shareholders’ equity at start of year Share of joint ventures’ transition adjustment on adoption of IAS39 Shareholders’ equity at end of year Note 6 d 2004 am 194 (229) 14 (22) 44 3 4 1,169 – 1,173 2005 gm 462 (245) 18 (20) 42 – 257 1,173 8 1,438 159711 Reed Report 103-142 7/3/06 12:05 Page 129 Group accounting policies Reed Elsevier Annual Reports and Financial Statements 2005 129 These consolidated financial statements report the statements of income, cash flow and financial position of Reed Elsevier NV. Unless otherwise indicated, all amounts shown in the financial statements are in millions of euros. The statutory consolidated financial statements have been prepared under the historical cost convention. As required by a regulation adopted by the European Parliament, the consolidated financial statements have been prepared, with effect from the 2005 financial year, in accordance with International Financial Reporting Standards (IFRS) as endorsed by the European Union. The transition date for the application of IFRS is 1 January 2004, other than in respect of IAS39 where the transition date is 1 January 2005, and the comparative figures for 31 December 2004 have been restated accordingly. Reconciliations of net income and equity for the comparative period from previously applied UK GAAP to IFRS are presented in note 18 to the consolidated financial statements. The Reed Elsevier combined financial statements on pages 56 to 100 form an integral part of the notes to Reed Elsevier NV’s statutory financial statements. The basis of the merger of the businesses of Reed Elsevier NV and Reed Elsevier PLC is set out on page 28. As a consequence of the merger of the company’s businesses with those of Reed Elsevier PLC, described on page 28, the shareholders of Reed Elsevier NV and Reed Elsevier PLC can be regarded as having the interests of a single economic group, enjoying substantially equivalent ordinary dividend and capital rights in the earnings and net assets of the Reed Elsevier combined businesses. Reed Elsevier NV consolidated financial statements are presented incorporating Reed Elsevier NV’s investments in the Reed Elsevier combined businesses accounted for using the equity method, as adjusted for the effects of the equalisation arrangement between Reed Elsevier NV and Reed Elsevier PLC. The arrangement lays down the distribution of dividends and net assets in such a way that Reed Elsevier NV’s share in the profit and net assets of the Reed Elsevier combined businesses equals 50%, with all settlements accruing to shareholders from the equalisation arrangements taken directly to reserves. Because the dividend paid to shareholders by Reed Elsevier NV is equivalent to the Reed Elsevier PLC dividend plus the UK tax credit received by certain Reed Elsevier PLC shareholders, Reed Elsevier NV normally distributes a higher proportion of the combined profit attributable than Reed Elsevier PLC. Reed Elsevier PLC’s share in this difference in dividend distributions is settled with Reed Elsevier NV and is credited directly to consolidated reserves under equalisation. Reed Elsevier NV can pay a nominal dividend on its R-shares held by Reed Elsevier PLC that is lower than the dividend on the ordinary shares. Equally, Reed Elsevier NV has the possibility to receive dividends directly from Dutch affiliates. Reed Elsevier PLC is compensated by direct dividend payments by Reed Elsevier Group plc. The settlements flowing from these arrangements are also taken directly to consolidated reserves under equalisation. Combined financial statements The accounting policies adopted in the preparation of the combined financial statements are set out on pages 60 to 64. These include policies in relation to intangible assets. Such assets are amortised over their estimated useful economic lives which, due to their longevity, may be for periods in excess of five years. Basis of valuation of assets and liabilities Reed Elsevier NV’s 50% economic interest in the net assets of the combined businesses has been shown on the consolidated balance sheet as investments in joint ventures, net of the assets and liabilities reported as part of Reed Elsevier NV. Joint ventures are accounted for using the equity method. Cash and cash equivalents are stated at fair value. Other assets and liabilities are stated at historical cost, less provision, if appropriate, for any impairment in value. Foreign exchange translation Transactions in foreign currencies are recorded at the rate of exchange prevailing on the date of the transaction. At each balance sheet date, monetary assets and liabilities that are denominated in foreign currencies are retranslated at the rate prevailing on the balance sheet date. Exchange differences arising are recorded in the income statement. The gains or losses relating to the retranslation of Reed Elsevier NV’s 50% interest in the net assets of the combined businesses are classified as equity and transferred to the translation reserve. Cumulative translation differences are recognised within the income statement in the period in which operations are disposed of. As permitted under the transition rules of IFRS1 – First Time Adoption of International Financial Reporting Standards, cumulative translation differences in respect of foreign operations have been deemed to be nil at the date of transition. 159711 Reed Report 103-142 7/3/06 12:05 Page 130 130 Reed Elsevier NV Taxation The tax expense represents the sum of the tax payable on the current year taxable profits and the movements on deferred tax that are recognised in the income statement. Tax arising in joint ventures is included in the share of results of joint ventures. The tax payable on current year taxable profits is calculated using the applicable tax rate that has been enacted, or substantively enacted, by the balance sheet date. Deferred tax is the tax arising on differences between the carrying amounts of assets and liabilities in the financial statements and their corresponding tax bases used in the computation of taxable profit, and is accounted for using the balance sheet liability method. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Deferred tax is calculated using tax rates that are expected to apply in the period when the liability is settled or the asset is realised. 159711 Reed Report 103-142 7/3/06 12:05 Page 131 Notes to the consolidated financial statements For the year ended 31 December 2005 Reed Elsevier Annual Reports and Financial Statements 2005 131 1 Administrative expenses Administrative expenses are stated after the gross remuneration for present and former directors of Reed Elsevier NV in respect of services rendered to Reed Elsevier NV and the combined businesses. Fees for members of the Supervisory Board of Reed Elsevier NV of a0.2m (2004: a0.2m) are included in gross remuneration. In so far as gross remuneration is related to services rendered to Reed Elsevier Group plc group and Elsevier Reed Finance BV group, it is borne by these groups. Reed Elsevier NV has no employees (2004: Nil). 2 Auditors’ remuneration Audit fees payable by Reed Elsevier NV were a46,000 (2004: a46,000). Further information on the audit and non-audit fees paid by the Reed Elsevier combined businesses to Deloitte Accountants, B.V. and its associates is set out in note 2 to the combined financial statements. 3 Related party transactions All transactions with joint ventures, which are related parties of Reed Elsevier NV, have been disclosed in these financial statements. Key personnel are also related parties and comprise the directors of Reed Elsevier NV. The remuneration of directors of Reed Elsevier NV is disclosed in the Directors’ Remuneration Report on pages 37 to 53. 4 Finance income Finance income from joint ventures 5 Taxation 2005 em 2 2004 am 2 A reconciliation of the notional tax charge based on the applicable rate of tax to the actual total tax expense is set out below. Profit before tax Tax at applicable rate 31.5% (2004: 34.5%) Tax included in share of results of joint ventures Tax expense 2005 em 338 106 (106) – 2004 am 338 117 (117) – 159711 Reed Report 103-142 7/3/06 12:05 Page 132 132 Reed Elsevier NV Notes to the consolidated financial statements For the year ended 31 December 2005 6 Equity dividends Dividends declared in the year Ordinary shares of a0.06 each Final for prior financial year Interim for financial year 2005 g 2004 a 2005 gm g0.240 g0.092 – g0.332 a0.220 a0.090 – a0.310 177 68 – 245 2004 am 162 67 – 229 R-shares of a0.60 each Total The directors of Reed Elsevier NV have proposed a final dividend of a0.267 (2004: a0.240). The total cost of funding the proposed final dividends will be a198m. No liability has been recognised at the date of the balance sheet. Dividends paid and proposed relating to the financial year Ordinary shares of a0.06 each Interim (paid) Final (proposed) R-shares of a0.60 each Total 7 Earnings per ordinary share (EPS) 2005 g 2004 a g0.092 g0.267 – g0.359 a0.090 a0.240 – a0.330 Basic EPS Diluted EPS 2005 Weighted average number of shares (millions) 783.3 789.9 Earnings gm 338 338 EPS g g0.43 g0.43 2004 Weighted average number of shares (millions) 783.3 787.9 Earnings am 338 338 EPS a a0.43 a0.43 The diluted EPS figures are calculated after taking account of the effect of potential ordinary shares arising from share options and conditional shares. The weighted average number of shares is after deducting shares held in treasury. 159711 Reed Report 103-142 7/3/06 12:05 Page 133 Reed Elsevier Annual Reports and Financial Statements 2005 133 8 Adjusted figures Adjusted profit and earnings per share figures are used as additional performance measures. The adjusted figures are derived as follows: Reported figures Share of adjustments in joint ventures: Amortisation of acquired intangible assets Acquisition integration costs Disposals and other non operating items Deferred tax adjustment Adjusted figures 9 Cash flow statement Reconciliation of administrative expenses to cash used by operations Administrative expenses Decrease in payables Cash used by operations Reconciliation of net funding balances due from joint ventures At start of year Cash flow At end of year 10 Investments in joint ventures Share of results of joint ventures Share of joint ventures’ net income/(expense) recognised directly in equity Share of joint ventures’ transfer to net profit from cash flow hedge reserve Share of joint ventures’ transition adjustment on adoption of IAS39 Dividends received from joint ventures Increase in shares held in treasury Share of joint ventures’ recognition of share based remuneration reserve Equalisation adjustments Increase in the year At start of year At end of year Profit attributable to ordinary shareholders Basic earnings per share 2005 gm 338 226 12 (1) (24) 551 2004 am 338 212 21 1 (67) 505 2005 g g0.43 g0.29 g0.02 – g(0.04) g0.70 2004 a a0.43 a0.27 a0.03 – a(0.09) a0.64 2005 em (3) (2) (5) 2005 em 30 (16) 14 2005 em 339 138 (14) 8 (189) (20) 42 – 304 1,183 1,487 2004 am (3) – (3) 2004 am 50 (20) 30 2004 am 339 (144) – – (220) (22) 44 3 – 1,183 1,183 159711 Reed Report 103-142 7/3/06 12:05 Page 134 134 Reed Elsevier NV Notes to the consolidated financial statements For the year ended 31 December 2005 10 Investments in joint ventures continued Summarised information showing total amounts in respect of joint ventures and Reed Elsevier NV’s 50% share is set out below: Revenue Net profit for the year Total assets Total liabilities Net assets Attributable to: Joint ventures Minority interests Total Total joint ventures Reed Elsevier NV share 2005 gm 7,542 677 2004 am 7,074 678 2005 gm 3,771 339 2004 am 3,537 339 Total joint ventures Reed Elsevier NV share 2005 gm 13,325 (10,427) 2,898 2,876 22 2,898 2004 am 11,213 (8,847) 2,366 2,346 20 2,366 2005 gm 6,662 (5,175) 1,487 1,487 – 1,487 2004 am 5,582 (4,399) 1,183 1,183 – 1,183 The above amounts exclude assets and liabilities held directly by Reed Elsevier NV and include the counterparty balances owed to and by other Reed Elsevier businesses. Included within Reed Elsevier NV’s share of assets and liabilities are cash and cash equivalents of a215m (2004: a134m) and borrowings of a2,303m (2004: a1,937m). 11 Payables Included within payables are employee convertible debenture loans of a7m (2004: a7m) with a weighted average interest rate of 4.74% (2004: 4.90%). Depending on the conversion terms, the surrender of a227 or a200 par value debenture loans qualifies for the acquisition of 50 Reed Elsevier NV ordinary shares. 12 Share capital Authorised Ordinary shares of a0.06 each Unclassified shares of a0.60 each Total Issued and fully paid At 1 January 2004 Issue of ordinary shares At 1 January 2005 Issue of ordinary shares At 31 December 2005 No. of shares 2,100,000,000 30,000,000 R-shares Ordinary shares am 44 – 44 – 44 am 3 – 3 – 3 gm 126 18 144 Total am 47 – 47 – 47 R-shares Ordinary shares Number Number 4,679,249 738,760,906 1,329,694 4,679,249 740,090,600 1,714,630 4,679,249 741,805,230 – – The R-shares are held by a subsidiary company of Reed Elsevier PLC. The R-shares are convertible at the election of the holders into ten ordinary shares each. They have otherwise the same rights as the ordinary shares, except that Reed Elsevier NV may pay a lower dividend on the R-shares. 159711 Reed Report 103-142 7/3/06 12:05 Page 135 Reed Elsevier Annual Reports and Financial Statements 2005 135 13 Paid-in surplus At start of year Issue of ordinary shares At end of year Within paid-in surplus, an amount of a1,318m (2004:a1,300m) is free of tax. 2005 gm 1,477 18 1,495 2004 am 1,463 14 1,477 The issue of ordinary shares relates to the exercise of share options. Details of share option and conditional share schemes are set out in note 5 to the Reed Elsevier combined financial statements. 14 Shares held in treasury At start of year Purchase of shares Exchange translation differences At end of year Details of shares held in treasury are provided in note 29 to the Reed Elsevier combined financial statements. 15 Translation reserve At start of year Share of joint ventures’ exchange differences on translation of foreign operations At end of year 16 Other reserves At start of year Share of joint ventures’ transition adjustment on adoption of IAS39 At start of year as restated Profit attributable to ordinary shareholders Share of joint ventures’ actuarial losses on defined benefit pension schemes Share of joint ventures’ fair value movements on available for sale investments Share of joint ventures’ fair value movements on cash flow hedges Share of joint ventures’ tax on actuarial losses on defined benefit pension schemes Share of joint ventures’ tax on fair value movements on cash flow hedges Share of joint ventures’ transfer to net profit from hedge reserve Share of joint ventures’ recognition of share based remuneration reserve Equalisation adjustments Equity dividends declared At end of year 2005 gm 47 20 1 68 2005 gm (98) 174 76 2005 gm (206) 8 (198) 338 (27) 2 (8) 8 (10) (14) 42 – (245) (112) 2004 am 27 22 (2) 47 2004 am – (98) (98) 2004 am (316) – (316) 338 (55) – – 9 – – 44 3 (229) (206) 159711 Reed Report 103-142 7/3/06 12:05 Page 136 136 Reed Elsevier NV Notes to the consolidated financial statements For the year ended 31 December 2005 17 Contingent liabilities There are contingent liabilities in respect of borrowings of joint ventures guaranteed by Reed Elsevier NV as follows: Guaranteed jointly and severally with Reed Elsevier PLC 2005 gm 2004 am 3,949 3,519 Financial instruments disclosures in respect of the borrowings covered by the above guarantees are given in note 17 to the Reed Elsevier combined financial statements. 18 Reconciliations to previous GAAP The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS). The adoption of these standards has resulted in changes to the accounting policies previously applied under UK GAAP (“previous GAAP”) for the year ended 31 December 2004. The effects of differences to previous GAAP on net profit for the year ended 31 December 2004 and shareholders’ equity as at that date are summarised below. Year ended 31 December Profit attributable to ordinary shareholders under previous GAAP Adjustments: Share of IFRS adjustments in joint ventures Profit attributable to ordinary shareholders under IFRS As at 31 December Shareholders’ equity under previous GAAP Adjustments: Share of IFRS adjustments in joint ventures Dividends Shareholders’ equity under IFRS Note (i) (i) (ii) 2004 am 223 115 338 2004 am 1,598 (602) 177 1,173 (i) Details of the IFRS adjustments made to the Reed Elsevier combined figures are presented in note 33 to the combined financial statements. (ii) Reversal of proposed dividends not declared by 31 December 2004. Under IFRS the carrying value of investments in joint ventures and external payables at 31 December 2004 were a602m and a177m lower respectively, compared to the figures reported under previous GAAP. As at the IFRS transition date of 1 January 2004, shareholders’ equity was a559m lower under IFRS than under previous GAAP due to the share of IFRS adjustments in joint ventures of a721m and the reversal of proposed dividends of a162m. 19 Post balance sheet event On 14 February 2006, Reed Elsevier Group plc declared a dividend payable to Reed Elsevier NV of a218m. 159711 Reed Report 103-142 7/3/06 12:05 Page 137 Reed Elsevier Annual Reports and Financial Statements 2005 137 20 Principal joint ventures Reed Elsevier Group plc Incorporated and operating in Great Britain 1-3 Strand London WC2N 5JR Holding company for operating businesses involved in science & medical, legal, educational and business publishing Elsevier Reed Finance BV Incorporated in the Netherlands Radarweg 29 1043 NX Amsterdam, The Netherlands Holding company for financing businesses £10,000 ordinary “R” shares £10,000 ordinary “E” shares £100,000 7.5% cumulative preference non voting shares Equivalent to a 50% equity interest 133 ordinary “R” shares 205 ordinary “E” shares Equivalent to a 61% equity interest % holding – 100% – – 100% The “R” shares in Reed Elsevier Group plc and Elsevier Reed Finance BV are owned by Reed Elsevier PLC. In addition, Reed Elsevier NV holds a0.14m par value in shares with special dividend rights in Reed Elsevier Overseas BV and Reed Elsevier Nederland BV, both with registered offices in Amsterdam. These shares are included in the amount shown under investments in joint ventures. They enable Reed Elsevier NV to receive dividends from companies within the same tax jurisdiction. A list of companies within Reed Elsevier is filed with the Amsterdam Chamber of Commerce in the Netherlands. 21 Approval of financial statements The consolidated financial statements were signed and authorised for issue by the Combined Board of directors on 15 February 2006. J Hommen Chairman M H Armour Chief Financial Officer 159711 Reed Report 103-142 7/3/06 12:05 Page 138 138 Reed Elsevier NV Independent auditors’ report on the consolidated financial statements to the shareholders of Reed Elsevier NV Introduction We have audited the consolidated financial statements, which are part of the financial statements of Reed Elsevier NV, Amsterdam, for the year ended 31 December 2005 (“the consolidated financial statements”) as set out on pages 126 to 137. These consolidated financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audit. We have reported separately on the individual parent company financial statements of Reed Elsevier NV for the year ended 31 December 2005. Scope We conducted our audit in accordance with auditing standards generally accepted in the Netherlands. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion. Opinion In our opinion, the consolidated financial statements give a true and fair view of the financial position of the company as at 31 December 2005 and of the result and the cashflows for the year then ended in accordance with International Financial Reporting Standards as adopted by the European Union and also comply with the financial reporting requirements included in Book 2 Title 9 of the Netherlands Civil Code as far as applicable. Furthermore we have established to the extent possible that the other information contained in the Reed Elsevier Annual Reports and Financial Statements 2005 is consistent with the consolidated financial statements. Deloitte Accountants B.V. J P M Hopmans Amsterdam The Netherlands 15 February 2006 Additional information As set out in the notes to the consolidated and parent company financial statements, on 14 February 2006 Reed Elsevier Group plc declared a dividend payable to Reed Elsevier NV of a218m. 159711 Reed Report 103-142 7/3/06 12:05 Page 139 Parent company profit and loss account Reed Elsevier Annual Reports and Financial Statements 2005 139 For the year ended 31 December Administrative expenses Dividends received from joint ventures Finance income from joint ventures Profit attributable to ordinary shareholders Parent company balance sheet As at 31 December Fixed assets Investments in joint ventures Current assets Amounts due from joint ventures: Funding Other Short term investments Creditors: amounts falling due within one year Taxation Other creditors Net current assets Total assets less current liabilities Creditors: amounts falling due after more than one year Taxation Net assets Capital and reserves Share capital issued Paid-in surplus Reserves Shareholders’ funds 2005 gm (3) 189 2 188 2004 am (3) 220 2 219 Note 2005 gm 2004 am 2,161 2,161 1 14 8 22 1 23 (6) (8) (14) 9 2,170 (58) 2,112 47 1,495 570 2,112 30 7 37 25 62 (4) (10) (14) 48 2,209 (58) 2,151 47 1,477 627 2,151 The parent company financial statements were signed and authorised for issue by the Combined Board of directors on 15 February 2006. J Hommen Chairman M H Armour Chief Financial Officer 159711 Reed Report 103-142 7/3/06 12:05 Page 140 140 Reed Elsevier NV Parent company reconciliation of shareholders’ funds At 1 January 2004 Prior year adjustment At 1 January 2004 as restated Profit attributable to ordinary shareholders Equity dividends paid Issue of shares, net of expenses At 1 January 2005 As originally reported Prior year adjustment Note (ii) (ii) Share capital issued gm Paid-in surplus(i) gm Reserves gm Total gm 47 – 47 – – – 47 47 – – – – 47 1,463 – 1,463 – – 14 1,477 1,477 – – – 18 1,495 475 162 637 219 (229) – 627 450 177 188 (245) – 570 1,985 162 2,147 219 (229) 14 2,151 1,974 177 188 (245) 18 2,112 Profit attributable to ordinary shareholders Equity dividends paid Issue of shares, net of expenses At 31 December 2005 (i) Within paid-in surplus, an amount of a1,318m (2004: a1,300m) is free of tax. (ii) The prior year adjustment represents the reversal of the final 2004 dividend accrual following the change in accounting policy required by the adoption of FRS21 – Events after the Balance Sheet Date. Parent company accounting policies Basis of preparation The parent company financial statements have been prepared under the historical cost convention. As permitted by Article 362.1 of Book 2 Title 9 of the Netherlands Civil Code for companies with international operations, the parent company financial statements have been prepared in accordance with UK Generally Accepted Accounting Principles (GAAP) ensuring consistency. The financial information relating to the company is recognised in the consolidated financial statements. In accordance with article 2: 402 of the Netherlands Civil Code, the parent company financial statements only contain an abridged profit and loss account. Creditors: amounts falling due within one year and reserves as at 31 December 2004 have been restated, following the adoption in 2005 of FRS21 – Events after the Balance Sheet Date, to reverse the accrual for the final dividend proposed in respect of the 2004 financial year but not declared by the balance sheet date. The Reed Elsevier NV accounting policies under UK GAAP are set out below. Investments Fixed asset investments in the combined businesses are stated at cost, less provision, if appropriate, for any impairment in value. Principal joint ventures are set out in note 20 of the Reed Elsevier NV consolidated financial statements on page 137. Short term investments are stated at the lower of cost and net realisable value. Other assets and liabilities are stated at historical cost, less provision, if appropriate, for any impairment in value. Foreign exchange translation Transactions entered into in foreign currencies are recorded at the exchange rates applicable at the time of the transaction. Taxation Deferred taxation is provided in full for timing differences using the liability method. Deferred tax assets are only recognised to the extent that they are considered recoverable in the short term. Deferred taxation balances are not discounted. 159711 Reed Report 103-142 7/3/06 12:05 Page 141 Notes to the parent company financial statements Reed Elsevier Annual Reports and Financial Statements 2005 141 1 Other creditors Other creditors include a7m (2004: a7m) of employee convertible debenture loans with a weighted average interest rate of 4.74% (2004: 4.90%). Depending on the conversion terms, the surrender of a227 or a200 par value debenture loans qualifies for the acquisition of 50 Reed Elsevier NV ordinary shares. 2 Reconciliations to consolidated financial statements A reconciliation of the parent company UK GAAP profit attributable to ordinary shareholders and the consolidated IFRS profit attributable to ordinary shareholders presented under the equity method is provided below: Year ended 31 December Parent company profit attributable to ordinary shareholders Share of results of joint ventures Dividends received from joint ventures Consolidated profit attributable to ordinary shareholders using the equity method 2005 gm 188 339 (189) 338 A reconciliation between the parent company UK GAAP shareholders’ funds and consolidated IFRS shareholders’ funds presented under the equity method is provided below: As at 31 December Parent company shareholders‘ funds Cumulative share of results of joint ventures less cumulative dividends received from joint ventures Cumulative currency translation adjustments Cumulative equalisation and other adjustments Shares held in treasury Share of IFRS adjustments in joint ventures Consolidated shareholders‘ equity using the equity method 2005 gm 2,112 6 (144) 134 (68) (602) 1,438 2004 am 219 339 (220) 338 2004 am 2,151 (144) (318) 133 (47) (602) 1,173 3 Post balance sheet event On 14 February 2006, Reed Elsevier Group plc declared a dividend payable to Reed Elsevier NV of a218m. After taking account of this dividend and the other income and expenses in the period from 1 January 2006 to 14 February 2006, the summarised parent company balance sheet of Reed Elsevier NV as at 14 February 2006 was as follows: As at 14 February 2006 Investments in joint ventures Amounts due from joint ventures: Dividend receivable Funding Other Creditors: amounts falling due within one year Creditors: amounts falling due after more than one year Net assets Share capital issued Paid-in-surplus Reserves Shareholders’ funds gm 2,161 218 16 8 (14) (58) 2,331 47 1,496 788 2,331 159711 Reed Report 103-142 7/3/06 12:05 Page 142 142 Reed Elsevier NV Independent auditors’ report on the parent company financial statements to the shareholders of Reed Elsevier NV Introduction We have audited the individual parent company financial statements, which are part of the financial statements of Reed Elsevier NV, Amsterdam, for the year ended 31 December 2005 (the “company financial statements”) as set out on pages 139 to 141. These company financial statements are the responsibility of the company’s management. Our responsibility is to express an opinion on these company financial statements based on our audit. Scope We conducted our audit in accordance with auditing standards generally accepted in the Netherlands. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the company financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the company financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the company financial statements. We believe that our audit provides a reasonable basis for our opinion. Opinion In our opinion, the company financial statements give a true and fair view of the financial position of the company as at 31 December 2005 and of the result for the year then ended in accordance with accounting principles generally accepted in the United Kingdom and also comply with the financial reporting requirements included in Book 2 Title 9 of the Netherlands Civil Code. Furthermore we have established to the extent possible that the other information contained in the Reed Elsevier Annual Reports and Financial Statements 2005 is consistent with the company financial statements. Deloitte Accountants B.V. J P M Hopmans Amsterdam The Netherlands 15 February 2006 Additional information As set out in the notes to the consolidated and parent company financial statements, on 14 February 2006 Reed Elsevier Group plc declared a dividend payable to Reed Elsevier NV of a218m. Proposal for allocation of profit Final dividend on ordinary shares for prior financial year Interim dividend on ordinary shares for financial year Dividend on R-shares Retained loss 2005 gm 177 68 – (57) 188 2004 am 162 67 – (10) 219 The combined Supervisory and Executive Board determines the part of the profit to be retained. The profit to be distributed is paid on the ordinary shares and the R-shares in proportion to their nominal value. The Combined Board may resolve to pay less per R-share, but not less than 1% of the nominal value. The company is bound by the Governing Agreement with Reed Elsevier PLC, which provides that Reed Elsevier NV shall declare dividends such that the dividend on one Reed Elsevier NV ordinary share, which shall be payable in euros, will equal 1.538 times the dividend, including the related UK tax credit, paid on one Reed Elsevier PLC ordinary share. 159711 Reed Report 143-154 8/3/06 09:10 Page 143 Additional information for US investors Reed Elsevier combined businesses Reed Elsevier PLC Reed Elsevier NV > 144 > 149 > 151 159711 Reed Report 143-154 8/3/06 09:10 Page 144 144 Additional information for US Investors Reed Elsevier combined businesses Summary financial information in US dollars Basis of preparation The summary financial information is a simple translation of the Reed Elsevier combined financial statements into US dollars at the stated rates of exchange. The financial information provided below is prepared under IFRS as used in the preparation of the Reed Elsevier combined financial statements. It does not represent a restatement under US GAAP which would be different in some significant respects. Exchange rates for translation Sterling Income statement and cash flow Balance sheet Euro Income statement and cash flow Balance sheet Combined income statement For the year ended 31 December Revenue Operating profit Profit before tax Profit attributable to parent companies’ shareholders Adjusted operating profit Adjusted profit before tax Adjusted profit attributable to parent companies’ shareholders 2005 US$ 1.82 1.73 2004 US$ 1.83 1.93 1.247 1.185 1.245 1.369 2005 US$ 9,402 1,527 1,276 841 2,078 1,824 1,372 2004 US$ 8,806 1,402 1,155 840 1,951 1,709 1,257 159711 Reed Report 143-154 8/3/06 09:10 Page 145 Reed Elsevier combined businesses Combined cash flow statement Reed Elsevier Annual Reports and Financial Statements 2005 145 For the year ended 31 December Net cash from operating activities Net cash used in investing activities Net cash used in financing activities Increase/(decrease) in cash and cash equivalents Movement in cash and cash equivalents At start of year Increase/(decrease) in cash and cash equivalents Exchange translation differences At end of year Adjusted operating cash flow Adjusted operating cash flow conversion Combined balance sheet As at 31 December Non-current assets Current assets Assets held for sale Total assets Current liabilities Non-current liabilities Liabilities associated with assets held for sale Total liabilities Net assets 2005 US$ 1,656 (828) (708) 120 434 120 (42) 512 1,966 95% 2004 US$ 1,491 (1,499) (729) (737) 1,136 (737) 35 434 1,854 95% 2005 US$ 11,598 4,088 104 15,790 5,451 6,885 20 12,356 3,434 2004 US$ 11,740 3,607 – 15,347 6,062 6,048 – 12,110 3,237 159711 Reed Report 143-154 8/3/06 09:10 Page 146 146 Additional information for US Investors Reed Elsevier combined businesses Summary of the principal differences to US GAAP The combined financial statements are prepared in accordance with IFRS, which differs in certain significant respects from US GAAP. The principal differences that affect net income and combined shareholders’ funds are explained below and their approximate effect is shown on page 148. The Reed Elsevier Annual Report 2005 on Form 20-F provides further information for US investors. Goodwill and intangible assets Under IFRS, acquired goodwill and intangible assets with indefinite lives are not amortised and are subject to at least annual impairment review. Other intangible assets with definite lives are amortised over their estimated useful economic lives. Previously, under UK GAAP, acquired goodwill and intangible assets had been amortised systematically over their estimated useful lives up to a maximum of 40 years, subject to impairment review. There is no retrospective restatement of the acquired goodwill and intangible asset values as at the 1 January 2004 transition date. Under US GAAP, acquired goodwill and intangible assets are accounted for in accordance with SFAS141 – Business Combinations and SFAS142 – Goodwill and Other Intangible Assets. In accordance with these SFASs, goodwill and intangible assets with indefinite lives are not amortised and are subject to at least annual impairment review, with effect from 1 January 2002, except in respect of 2001 acquisitions made after 1 July 2001, for which the effective date under the transitional provisions was 1 July 2001. Other intangible assets with definite lives are amortised over their estimated useful economic lives up to 20 years, subject to annual impairment review under SFAS144: Accounting for the Impairment or Disposal of Long-Lived Assets. Under IFRS, any deferred tax liability arising on acquired intangible assets in acquisitions made after the transition date of 1 January 2004, results in a corresponding grossing up of acquired goodwill. For acquisitions made prior to the transition date, any such deferred tax liabilities are written off directly to equity. Under US GAAP, goodwill has historically been grossed up for deferred tax liabilities on acquired intangible assets. This, along with the historically lower goodwill amortisation charge under US GAAP compared to previous UK GAAP, results in a higher carrying value of goodwill and intangible assets under US GAAP. Under US GAAP, as at 31 December 2005, the carrying value of goodwill is £4,470m/a6,526m (2004: £3,938m/a5,553m), the gross cost of intangible assets is £4,613m/a6,735m (2004: £4,153m/a5,856m) and the accumulated amortisation of intangible assets is £1,873m/a2,734m (2004: £1,497m/a2,111m). Pensions Under IFRS, the expense of defined benefit pension schemes and other post-retirement benefit schemes is charged to the income statement as an operating expense over the periods benefiting from the employees' services. The charge is based on actuarial assumptions reflecting market conditions at the beginning of the financial year. Variations from this expected cost are recognised in full in the statement of recognised income and expense in the period in which they occur. Net pension obligations in respect of defined benefit schemes are included in the balance sheet at the present value of scheme liabilities, less the fair value of scheme assets. Where assets exceed liabilities, any net pension asset is limited to the extent that the asset is not recoverable through reductions in future contributions. Under US GAAP, pension costs and liabilities are accounted for in accordance with SFAS87 – Employers' Accounting for Pensions, which is similar to IFRS. However, a significant difference arises in the net pension cost as variations from expected cost are recognised in the income statement under SFAS87. The total amount of variation is determined by reference to market related values of plan assets and amortised over the expected remaining service lives of plan members. SFAS87 also requires a minimum pension liability to be recognised that is at least equal to the unfunded benefit obligation (ignoring projected future salary increases). Changes in the additional minimum pension liability are recognised as other comprehensive income, a component of shareholders' equity. Derivative financial instruments Under both IFRS (IAS39 – Financial Instruments) and US GAAP (SFAS133 – Accounting for Derivative Instruments and Hedging Activities), all derivative financial instruments are required to be carried at fair value on the balance sheet. Changes in fair value are accounted for through the income statement or equity, depending on the derivative's designation and effectiveness as a hedging instrument. Derivative instruments used by Reed Elsevier as fair value hedges are designated as qualifying hedge instruments under IAS39 and SFAS133. The fixed rate loans which are swapped to floating rate and subject to this hedging treatment are set out on page 88. Amounts only impact net income, under both IFRS and US GAAP, in relation to these instruments to the extent that the hedges are not fully effective. 159711 Reed Report 143-154 8/3/06 09:10 Page 147 Reed Elsevier Annual Reports and Financial Statements 2005 147 In addition, certain forward exchange rate contracts and interest rate swaps have been designated as qualifying cash flow hedge instruments under IAS39 and SFAS133. Accordingly, to the extent that the hedges are effective, mark-to-market movements are recorded in either equity (IFRS) or other comprehensive income (US GAAP). Other derivative instruments, which act as cashflow hedges, have not been designated as qualifying hedge instruments under either IAS39 or SFAS133 and, accordingly, changes in the fair value of those derivative instruments are recorded in net income under both IFRS and US GAAP. net income. As a result of this difference, net income under US GAAP is £24m/a35m lower than reported under IFRS (2004: £6m/a9m higher), and combined shareholders’ equity is £25m/a36m higher than reported under IFRS (2004: £50m/a71m higher). Adjusted earnings In the combined financial statements adjusted profit and cash flow measures are presented, as permitted by IFRS, as additional performance measures. US GAAP does not permit the presentation of alternative earnings measures. Short term obligations expected to be refinanced Under US GAAP, where it is expected to refinance short term obligations on a long term basis and this is supported by an ability to consummate the refinancing, such short term obligations should be excluded from current liabilities and shown as long term obligations. Under IFRS, such obligations can only be excluded from current liabilities where, additionally, the debt and facility are under a single agreement or course of dealing with the same lender or group of lenders. Short term obligations at 31 December 2005 of £889m/a1,298m (2004: £1,043m/a1,471m) would be excluded from current liabilities under US GAAP and shown as long term obligations. SFAS133 was effective from 1 January 2001 resulting in a cumulative transition adjustment of which £2m/a3m was charged to US GAAP net income in 2005 (2004: £4/a6m). IAS39 was effective from 1 January 2005 resulting in a cumulative transition adjustment of £29m/a40m loss to other combined reserves and a £40m/a56m gain recognised in the hedge reserve, which included a £10m/a15m loss relating to instruments that were treated as hedges under previously applied UK GAAP, but which are not designated as hedges under IAS39. These losses will be unwound over the period to which they relate and will consequently give rise to a short term difference between net income reported under IFRS and US GAAP. Deferred taxation Under IFRS, deferred taxation is provided for nearly all differences between the balance sheet amounts of assets and liabilities and their tax bases. Deferred tax liabilities are generally recognised for all taxable temporary differences and deferred tax assets are recognised to the extent that it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Under US GAAP, deferred taxation is provided on all temporary differences under the liability method subject to a valuation allowance on deferred tax assets where applicable, in accordance with SFAS109 – Accounting for Income Taxes. The most significant deferred tax differences between IFRS and US GAAP arise from the different carrying values in respect of pensions, goodwill and acquired intangible assets as described above. The tax effect of these and other GAAP differences in carrying values is that net income under US GAAP is £27m/a39m higher than reported under IFRS (2004: £81m/a119m lower), and combined shareholders’ equity is £144m/a210m lower than reported under IFRS (2004: £174m/a246m lower). A further difference arises on the recognition of deferred tax assets for share based remuneration, which, under IFRS, is calculated based on the intrinsic value of outstanding awards and which, under US GAAP, is determined based on the cumulative charge to 159711 Reed Report 143-154 8/3/06 09:10 Page 148 148 Additional information for US Investors Reed Elsevier combined businesses Effects on net income of material differences between IFRS and US GAAP For the year ended 31 December Net income as reported under IFRS US GAAP adjustments: Intangible assets Pensions Derivative financial instruments Deferred taxation Other Net income under US GAAP 2005 £m 462 5 (78) (5) 3 (13) 374 2004 £m 459 3 6 32 (75) (7) 418 2005 gm 675 7 (114) (7) 4 (19) 546 2004 am 675 4 9 47 (110) (10) 615 Effects on combined shareholders’ equity of material differences between IFRS and US GAAP As at 31 December Combined shareholders’ equity as reported under IFRS US GAAP adjustments: Goodwill and intangible assets Pensions Derivative financial instruments Deferred taxation Other Combined shareholders’ equity under US GAAP 2005 £m 2004 £m 2005 gm 2004 am 1,970 1,664 2,876 2,346 1,491 409 5 (119) 7 3,763 1,378 485 12 (124) 16 3,431 2,177 597 7 (174) 10 5,493 1,943 684 17 (175) 22 4,837 Net income and shareholders’ equity in the 2004 financial year under US GAAP have been restated for the adoption of SFAS 123(R) – Share-Based Payment, which requires an expense to be recorded based on the fair value at the date of grant, and related deferred tax effects. Net income and shareholders’ equity under US GAAP for 2004 are therefore £31m/a45m lower and £58m/a81m higher respectively than the amounts previously reported. 159711 Reed Report 143-154 8/3/06 09:10 Page 149 Reed Elsevier PLC Summary financial information in US dollars Reed Elsevier Annual Reports and Financial Statements 2005 149 Basis of preparation The summary financial information is a simple translation of Reed Elsevier PLC’s consolidated financial statements into US dollars at the stated rates of exchange. The financial information provided below is prepared under IFRS as used in the preparation of the Reed Elsevier PLC consolidated financial statements. It does not represent a restatement under US GAAP which would be different in some significant respects. Exchange rates for translation of sterling ($:£1) Income statement Balance sheet Consolidated income statement For the year ended 31 December Profit attributable to ordinary shareholders Adjusted profit attributable to 52.9% interest in Reed Elsevier combined businesses Amortisation of acquired intangible assets Acquisition integration costs Disposals and other non operating items Deferred tax adjustment Profit attributable to 52.9% interest in Reed Elsevier combined businesses Data per American Depositary Share (ADS) Earnings per ADS based on 52.9% interest in Reed Elsevier combined businesses Adjusted Basic Net dividend per ADS declared in the year Net dividend per ADS paid and proposed in relation to the financial year Consolidated balance sheet As at 31 December Shareholders’ equity 2005 US$:£ 1.82 1.73 2004 US$:£ 1.83 1.93 2005 US$m 428 726 (299) (16) 2 31 444 2004 US$m 430 664 (278) (27) (2) 88 445 2005 US$ 2004 US$ $2.29 $1.35 $0.97 $1.05 $2.10 $1.36 $0.89 $0.95 2005 US$m 1,803 2004 US$m 1,698 Adjusted earnings per American Depositary Share is based on Reed Elsevier PLC shareholders’ 52.9% share of the adjusted profit attributable of the Reed Elsevier combined businesses, which excludes amortisation of acquired intangible assets, acquisition integration costs, disposals and other non operating items, related tax effects and movements in deferred tax assets and liabilities that are not expected to crystallise in the near term. Adjusted figures are described in note 9 to the Reed Elsevier PLC consolidated financial statements. Reed Elsevier PLC shares are quoted on the New York Stock Exchange and trading is in the form of American Depositary Shares (ADSs), evidenced by American Depositary Receipts (ADRs), representing four Reed Elsevier PLC ordinary shares of 12.5p each. (CUSIP No. 758205108; trading symbol, RUK; Bank of New York is the ADS Depositary.) 159711 Reed Report 143-154 8/3/06 09:10 Page 150 150 Additional information for US Investors Reed Elsevier PLC Summary of the principal differences between IFRS and US GAAP Reed Elsevier PLC accounts for its shareholders’ 52.9% economic interest in the Reed Elsevier combined businesses, before the effect of tax credit equalisation, using the equity method in conformity with IFRS which is similar to the equity method in US GAAP. Using the equity method to present its net income and shareholders’ equity under US GAAP, Reed Elsevier PLC reflects its shareholders’ 52.9% share of the effects of differences between IFRS and US GAAP relating to the combined businesses as a single reconciling item. The most significant differences relate to goodwill and acquired intangible assets, pensions, derivative financial instruments and deferred taxes. A more complete explanation of the accounting policies used by the Reed Elsevier combined businesses and the differences between IFRS and US GAAP is given on pages 146 and 147. The Reed Elsevier Annual Report 2005 on Form 20-F provides further information for US investors. Effects on net income of material differences between IFRS and US GAAP For the year ended 31 December Net income as reported under IFRS Impact of US GAAP adjustments to combined financial statements Net income under US GAAP Earnings per ordinary share under US GAAP 2005 £m 235 (47) 188 14.8p 2004 £m 235 (22) 213 16.8p Effects on shareholders’ equity of material differences between IFRS and US GAAP As at 31 December Shareholders’ equity as reported under IFRS Impact of US GAAP adjustments to combined financial statements Shareholders’ equity under US GAAP 2005 £m 1,042 948 1,990 2004 £m 880 935 1,815 Net income and shareholders’ equity in the 2004 financial year under US GAAP have been restated for the adoption of SFAS 123(R) – Share-Based Payment, which requires an expense to be recorded based on the fair value at the date of grant, and related deferred tax effects. Net income under US GAAP for 2004 is £16m lower than the amount previously reported. Shareholders’ equity under US GAAP for 2004 is £32m higher than the amount previously reported. 159711 Reed Report 143-154 8/3/06 09:10 Page 151 Reed Elsevier NV Summary financial information in US dollars Reed Elsevier Annual Reports and Financial Statements 2005 151 Basis of preparation The summary financial information is a simple translation of the Reed Elsevier NV consolidated financial statements into US dollars at the stated rates of exchange. The financial information provided below is prepared under IFRS as used in the preparation of the Reed Elsevier NV consolidated financial statements. It does not represent a restatement under US GAAP which would be different in some significant respects. Exchange rates for translation of euros (g:$1) Income statement Balance sheet Consolidated income statement For the year ended 31 December Adjusted profit attributable to ordinary shareholders Amortisation of acquired intangible assets Acquisition integration costs Disposals and other non operating items Deferred tax adjustment Profit attributable to ordinary shareholders Data per American Depositary Share (ADS) Earnings per ADS based on 50% interest in Reed Elsevier combined businesses Adjusted Basic Net dividend per ADS declared in the year Net dividend per ADS paid and proposed in relation to the financial year Consolidated balance sheet As at 31 December Shareholders’ equity 2005 g:US$ 0.802 0.844 2004 a:US$ 0.803 0.731 2005 US$m 687 (282) (15) 1 30 421 2004 US$m 629 (264) (26) (1) 83 421 2005 US$ 2004 US$ $1.75 $1.07 $0.83 $0.90 $1.59 $1.07 $0.77 $0.82 2005 US$m 1,704 2004 US$m 1,606 Adjusted earnings per American Depositary Share is based on Reed Elsevier NV shareholders’ 50% share of the adjusted profit attributable of the Reed Elsevier combined businesses, which excludes amortisation of acquired intangible assets, acquisition integration costs, disposals and other non operating items, related tax effects and movements in deferred tax assets and liabilities that are not expected to crystallise in the near term. Adjusted figures are described in note 8 to the Reed Elsevier NV consolidated financial statements. Reed Elsevier NV shares are quoted on the New York Stock Exchange and trading is in the form of American Depositary Shares (ADSs), evidenced by American Depositary Receipts (ADRs), representing two Reed Elsevier NV ordinary shares of a0.06 each. (CUSIP No. 758204101; trading symbol, ENL; Bank of New York is the ADS Depositary.) 159711 Reed Report 143-154 8/3/06 09:10 Page 152 152 Additional information for US Investors Reed Elsevier NV Summary of the principal differences between IFRS and US GAAP Reed Elsevier NV accounts for its 50% economic interest in the Reed Elsevier combined businesses, before the effect of tax credit equalisation, using the equity method in its consolidated financial statements. Using the equity method to present its net income and shareholders’ equity under US GAAP, Reed Elsevier NV reflects its 50% share of the effects of differences between UK and US GAAP relating to the combined businesses as a single reconciling item. The most significant differences relate to goodwill and acquired intangible assets, pensions, derivative financial instruments and deferred taxes. A more complete explanation of the accounting policies used by the Reed Elsevier combined businesses and the differences between IFRS and US GAAP is given on pages 146 and 147. The Reed Elsevier Annual Report 2005 on Form 20-F provides further information for US investors. Effects on net income of material differences between IFRS and US GAAP For the year ended 31 December Net income as reported under IFRS Impact of US GAAP adjustments to combined financial statements Net income under US GAAP Earnings per ordinary share under US GAAP 2005 gm 338 (51) 287 g0.37 2004 am 338 (18) 320 a0.41 Effects on shareholders’ equity of material differences between IFRS and US GAAP As at 31 December Shareholders’ equity as reported under IFRS Impact of US GAAP adjustments to combined financial statements Shareholders’ equity under US GAAP 2005 gm 1,438 1,309 2,747 2004 am 1,173 1,246 2,419 Net income and shareholders’ equity in the 2004 financial year under US GAAP have been restated for the adoption of SFAS 123(R) – Share-Based Payment, which requires an expense to be recorded based on the fair value at the date of grant, and related deferred tax effects. Net income under US GAAP for 2004 is a22m lower than the amount previously reported. Shareholders’ equity under US GAAP for 2004 is a43m higher than the amount previously reported. 159711 Reed Report Cover 7/3/06 12:02 Page 2 Annual Reports and Financial Statements 2005 Financial highlights Report of the Chairman and the Chief Executive Officer Operating and financial review Structure and corporate governance Report of the Audit Committees Directors’ remuneration report Reed Elsevier combined financial statements Combined financial statements Accounting policies Notes to the combined financial statements Independent auditors’ report Reed Elsevier PLC annual report and financial statements Directors’ report Consolidated financial statements Group accounting policies Notes to the consolidated financial statements Independent auditors’ report on the consolidated financial statements Parent company financial statements Parent company accounting policies Independent auditors’ report on the parent company financial statements Reed Elsevier NV annual report and financial statements The Supervisory Board’s report The Executive Board’s report Consolidated financial statements Group accounting policies Notes to the consolidated financial statements Independent auditors’ report on the consolidated financial statements Additional information Parent company financial statements Parent company accounting policies Notes to the parent company financial statements Independent auditors’ report on the parent company financial statements Additional information Additional information for US investors Reed Elsevier combined businesses Reed Elsevier PLC Reed Elsevier NV Principal operating locations > 1 > 2 > 5 > 28 > 34 > 37 > 56 > 60 > 65 > 101 > 104 > 107 > 110 > 111 > 118 > 119 > 120 > 121 > 124 > 125 > 126 > 129 > 131 > 138 > 138 > 139 > 140 > 141 > 142 > 142 > 144 > 149 > 151 > 153 This document contains Annual Reports information and the Financial Statements in respect of the Reed Elsevier combined businesses and the two parent companies, Reed Elsevier PLC and Reed Elsevier NV. This, together with the separate summary document Reed Elsevier Annual Review and Summary Financial Statements 2005, forms the Annual Reports and Financial Statements of Reed Elsevier PLC and Reed Elsevier NV for the year ended 31 December 2005 and the two documents should be read together. 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