XAAR Annual Report and Accounts 2006

Annual Report and Accounts 2006 WHO ARE WE? Xaar is a market-focused innovative company, developing advanced inkjet technology solutions for use in targeted industry sectors. With over 700 patents, Xaar is a technology leader with a creative and highly skilled workforce of over 300 people who design, manufacture and distribute its state-of-the-art products. Xaar’s core business is to manufacture and sell its wide range of products to leading international OEM companies, in addition to licensing the Xaar technology to global brand companies. WHAT DO WE DO? Xaar develops and manufactures industrial printheads based on a patented and innovative drop-on-demand piezoelectric design. The Xaar 126, 128 and 500 binary drop printheads are the foundation on which Xaar has grown and command substantial market share in the Wide Format Graphics and Coding & Marking markets. In 2006 Xaar introduced a new range of printheads based on the Xaar patented “multi-pulse greyscale technology”. The Xaar 760 and 1001 products offer unique characteristics, enabling OEM partners in the Graphics and Industrial markets to develop innovative and ground breaking solutions. OUR OPPORTUNITY Driving the technology more widely into print-related applications and developing the broad array of industrial applications is the catalyst for growth and opportunity. Who are we? IFC What do we do? Our opportunity Where do we do it? 01 Chairman’s statement 02 Review of operations 04 Financial review 10 Board of directors 14 Directors’ report 16 Corporate governance statement 22 Directors’ remuneration report 26 Statement of directors’ responsibilities 31 Independent auditors’ report (group) 32 Consolidated income statement 34 Consolidated statement of recognised income and expense 34 Consolidated balance sheet 35 Consolidated cash flow statement 36 Notes to the consolidated financial statements 37 Independent auditors’ report (company) 57 Company balance sheet (UK GAAP) 58 Notes to the (UK GAAP) company balance sheet 59 Five year record 62 Notice of Annual General Meeting 63 Advisors IBC The wide number of technologies adopted for printing, in combination with the extensive range of applications, positions the printing industry as one of the largest in the world. Today inkjet technology has captured a substantial market share in the Wide Format Graphics and Coding & Marking markets, but overall only a small proportion of the total available print market. The rapid advancements in inkjet technology, coupled with the benefits of digital technology will drive a high rate of adoption into other segments over the coming years. A wide array of industrial markets are preparing to transform to digital processes. Leading brand companies are adopting inkjet as the technology of choice for the production of electronic, mechanical and pharmaceutical products. Xaar plc Annual Report and Accounts 2006 01 WHERE DO WE DO IT? Americas Xaar North America, based in Marrietta Georgia, has been successful in developing new OEM relationships throughout the Americas. The proportion of revenue from the region now stands at 8% of Xaar’s total. In 2006 Xaar South America was established in Sao Paulo, Brazil. The use and demand for Xaar products in the region has grown substantially and Xaar has developed a number of new OEM relationships with leading companies there. Europe Growing 7% from 2005 and representing 35% of total revenue, Xaar has a strong sales and support network to service over 70 OEM customers operating in a wide variety of markets. With 50% of companies in the traditional Wide Format Graphics and Coding & Marking sectors, the remaining 50% are developing innovative applications and solutions in a diverse range of Graphics and Industrial applications. Asia China continues to be Xaar’s largest sales area, representing 51% of turnover. Xaar sales into China are exclusively for use in the manufacture of wide and grand format graphics printers. The Chinese are dominant in the world’s supply of large format printers, with 70% of capacity consumed in the domestic market and 30% sold overseas. In the Chinese domestic market 90% of printers are supplied with Xaar printheads. Our operation in India supports the growth of the Xaar business in the region, whilst Xaar Japan is dedicated to providing local support to a number of leading brand companies who license the technology. Total sales in Americas 8% Total sales in Europe 35% Total sales in Asia 57% 02 Chairman’s statement Xaar plc Annual Report and Accounts 2006 Arie Rosenfeld Chairman Introduction I am pleased to report on a year with two significant achievements for Xaar: we commissioned a new factory on time and on budget and we saw a strong recovery in sales in the closing months following a setback in China in the middle of the year (see below). With volume sales of our new Platform 2 and Platform 3 products (the Xaar 760 and Xaar 1001 printheads) to look forward to, we go into 2007 confident about our prospects for the future. Results and finance Revenues for the year were marginally below those for 2005 at £42.2m (2005: £42.8m). Product sales remained in line with the prior year at £39.9m (2005: £39.9m), royalty revenues increased to £1.5m (2005: £1.3m) but development fees were reduced to £0.8m (2005: £1.6m) as a result of a reduction in fees from Agfa, following the successful launch of the co-developed Xaar 760 product, and the sale of Vivid Print Innovations Inc. in March of 2006. Adjusted profit before tax for the year was in line with expectations at £7.9m (2005: £10.5m). This is stated before accounting for the cost of share options and non-recurring costs relating to the approach by Danaher Corporation. After providing for the cost of share options of £0.7m (2005: £0.5m) and non-recurring costs of £0.3m (2005: £nil), the profit before tax was £6.9m (2005: £10.0m) and earnings per share were 7.9p (2005: 11.6p). Cash balances at the end of the year were £12.4m, a reduction of £2.0m from the previous year end. This reflects the investment of £7.3m made in the year in capital equipment, including the company’s newest manufacturing plant in Huntingdon, UK. Dividend policy and dividend With the major investment in the new plant in Huntingdon mostly complete and having been funded from our own resources, the board is able to recognise the importance of dividend payments to shareholders. Going forward, while taking care to maintain a reasonable level of dividend cover in order to retain cash for future investment in the business, there is now scope to increase the proposed level of payment. Accordingly, the board is pleased to recommend payment of an annual dividend for 2006 of 2.0p, an increase of 33% over the payment for 2005. China As highlighted in previous statements, trading in China during the third quarter was affected adversely by the Chinese customs authorities’ investigation into three of Xaar’s customers for alleged non-payment of import duties. Within China, the impact of the investigation spread beyond those directly involved, causing a general reduction in order levels leading to lower sales in the second half of the year. At no time was Xaar itself implicated in the investigation. We reacted swiftly to the situation by implementing new logistics arrangements for the China market. Sterling pricing has also been introduced in this market, significantly reducing Xaar’s currency exposure to the US dollar. These new arrangements have now been working well for some months and are detailed in the Financial review. I am pleased to say that since the nadir in sales in July, we have seen a sustained recovery and that we do not believe that we have lost market share as a result of the issues, nor that the long term prospects for the China market have diminished. We believe the end user markets for printing equipment incorporating Xaar printheads remain robust. Xaar plc Annual Report and Accounts 2006 03 “... with volume sales of our new Platform 2 and Platform 3 products... to look forward to, we go into 2007 confident about our prospects for the future” Approach for the company In October, whilst the company’s share price was recovering from the issues referred to above, we received an unsolicited approach from Danaher Corporation of the USA with a possible offer for the company in the range of 200–220p per share. After due consideration, the board rejected this approach as being opportunistic and significantly undervaluing the company, its prospects and its technology. After further discussions, Danaher outlined a second, informal, offer which the board decided was not sufficiently different from the earlier offer for it to be worthwhile continuing discussions. Accordingly, on 14 February 2007 the company announced that talks had been ended. Both of Danaher’s offers were highly preliminary and subject to certain conditions, including due diligence. As a result of the approach, we incurred professional fees of £0.3m which have been reported as a non-recurring item. Market trends Momentum continues to grow in digital printing applications in general and in industrial inkjet in particular. The interest of large global companies in the industrial inkjet market (as opposed to the desktop market, already dominated by multinational businesses) intensified with Fuji Photo Film, of Japan, acquiring Dimatix Inc., one of Xaar’s competitors, and EFI Inc., of the US, acquiring both Vutek – a manufacturer of large format graphics printers – and Jetrion Inc., a smaller integrator using Xaar technology for the packaging market. In the coming months and years, Xaar’s growth will come from our latest technology Platform 2 and Platform 3 printheads. These will significantly broaden the number of end market applications which we address and strengthen our overall competitiveness in the industry. Although some inkjet technologies are now becoming proprietary, particularly for the desktop, overall the commercial printing and industrial inkjet markets are still in their infancy. As these expand and diversify, system developers will look increasingly to dedicated inkjet suppliers for their key technologies and solution components. We therefore continue to work with a number of partners to enable entry into these new markets. Second manufacturing plant I am pleased to report that Xaar’s second manufacturing plant, based in Huntingdon, UK has been completed on schedule and on budget. Production commenced in January as planned, with volumes expected to grow through 2007 and into 2008. Initially this plant will produce the Platform 3 product, Xaar 1001. Senior management Andrew Taylor, currently Company Secretary and Group Financial Controller, has been appointed Deputy Finance Director to allow Nigel Berry, Finance Director, to devote more of his time to business and corporate development. Outlook We continue to see industrial inkjet as a key enabling technology in both printing and industrial markets and, as a market leader, we intend to remain at the forefront of that development and growth. The actions we have taken during the past year have created a robust platform for future growth for your company. Sales of our established products provide Xaar with a sound and profitable base on which to build incremental sales of Platform 2 and Platform 3 products in the years to come. Arie Rosenfeld Chairman 14 March 2007 04 Review of operations Xaar plc Annual Report and Accounts 2006 Ian Dinwoodie Chief Executive 95% of total group sales generated from printhead and ink revenues Introduction After a strong year in 2005, progress in the current year was interrupted by the events described in the Chairman’s statement. We are confident that these problems are behind us; sales in China have recovered fully and we can now look forward to resumed growth in this market. Our underlying business continues to develop well with three discrete platforms of products, each targeted at a different end market. Whilst Platform 1, particularly the Xaar 128, continues to dominate current sales, we expect significant incremental business to be generated over the coming years by both Platform 2 and Platform 3 products. These products will bring with them a broader spread of business and will expand both market and geographic opportunities. As referred to in the Chairman’s statement, during the year our second manufacturing plant in Huntingdon, UK was completed on time and on budget; production began as planned in January 2007 and, although production volumes will begin modestly, we expect volumes to increase as we go through the year. Product sales Printheads and inks were once again the largest part of our business, representing 95% of total group sales. Within this, our established Platform 1 products continue to represent the majority of revenues, with new and updated versions of existing printheads gaining strong acceptance in the market. Solvent-based inkjet printing for external advertising, digital UV printing for sign-making and oil-based printing of outer case coding for packaging all continue to develop and to establish themselves as mainstream printing processes. Future revenues from Platform 2 and Platform 3 products are dependent upon customers launching machines incorporating these printheads; we look forward to such launches over the next one to two years. Xaar’s ink business continues to contribute positively to the group’s results, albeit modestly. To date, the largest market for the company’s printhead sales has been Asia and, in particular, China where its printheads are used for printing solvent-based inks onto vinyl for the outdoor advertising market. Solvent inks in Asia have now become commodity items, with prices falling significantly over the last few years. As a result, our ability to generate profitable revenue from ink in these circumstances is limited. As UV ink applications become more widespread and customers launch higher resolution UV printers for these markets – based on the Xaar 760 and Xaar 1001 printheads – the opportunity to generate sustainable ink revenues from these applications should increase. Royalties and development fees As expected, royalty receipts from our licensees continue to increase steadily. Toshiba TEC, Konica Minolta and Seiko Printek are each growing their piezo inkjet businesses, based on Xaar’s technology. During the year these licensees won a number of new supply contracts, increasing the volume of heads they produce and, consequently, the royalties payable to Xaar. On the other hand, development fees reduced in the year for two reasons; firstly, the Xaar 760 product successfully moved into production and hence the co-development fees from Agfa for this initial stage of the project ended; secondly, Vivid Print Innovations Inc., whose sales have previously been reported under development fees, was sold to Xennia Technology Ltd, one of our integration partners, in March 2006. Xaar plc Annual Report and Accounts 2006 05 “... our second manufacturing plant... was completed on time and on budget; production began as planned in January 2007 and... we expect volumes to increase as we go through the year” 06 Review of operations continued Xaar plc Annual Report and Accounts 2006 Xaar plc Annual Report and Accounts 2006 07 Geographic markets The geographic split of sales reflects sales to our customers who are equipment manufacturers. It does not detail where that equipment is finally sold and used. For that reason, Asia remains our largest market, generating 57% of turnover. Asia is now the world’s leading centre for the manufacture of wide format printing equipment. It is also a major end market for such equipment, but increasing numbers of machines are now exported from Asia into other regions. In the current year, due to the issues in China referred to above, sales to Asia were down 6% compared to sales in 2005; we believe this to be only a temporary downturn and expect growth to resume in 2007. Europe and the Middle East is our second largest regional market, accounting for 35% of turnover in 2006 and recording growth of 7% over 2005. Growth was tempered by one of our customers transferring production from Europe to the USA during the year. Sales to the Americas were flat year-on-year, despite the transfer of production by one of our customers, referred to above. This is due to revenue of £0.5m included in the 2005 comparative figure relating to Vivid Print Innovations Inc., which was sold in early 2006. Excluding sales by Vivid, revenue from the Americas grew by 18%. This figure includes good growth from South America, where our office in Brazil has successfully enabled a number of South American manufacturers to enter the wide and grand format printer market during 2006. Looking forward, we expect growth in 2007 in all regions; Asian manufacturers are likely to continue to gain market share in the existing grand format market (served by our Platform 1 products), whilst in Europe and the Americas growth will come from new printing applications based on Platform 2 and Platform 3 products. End user markets The graphic arts market was again the largest market for Xaar’s technology during 2006. Sales to the graphics market represented 74% of total revenues. Grand format digital printing, particularly for external advertising, continues to grow. Faster turnover of advertising campaigns has become economically viable due to the proliferation of lower cost solvent inks, especially in Asia. With lower costs per square metre of print, campaigns are being changed more frequently. Outer case coding accounted for 18% of sales, with growth of 21% in the year. Industrial markets, where revenues are at an early stage, accounted for £1.1m, or 3%, of total sales, up 22% over the previous year. With Platform 2 and Platform 3 products now available, we expect to see incremental revenues being generated in 2007 and 2008 from the high resolution wide format market (posters and internal advertising), the narrow format web and sheet fed market (labels and primary packaging) and from functional printing (including printed electronics and 3D modelling). Operations Investment in research and development during the year totalled £5.4m or 13% of revenue. Our spending on research and development covers all three product platforms, as well as peripheral products and an ongoing level of pure research into our core technology. 08 Review of operations continued Xaar plc Annual Report and Accounts 2006 A major focus in the year has been the second manufacturing plant in Huntingdon, UK. The first Platform 3 product, the Xaar 1001, was produced by the new plant in January 2007 and volumes will be increased during the year as demand from development partners and equipment launches begins to build. In addition to the plant being delivered and commissioned on time, it was also accredited the international quality systems standard BS EN ISO9001:2000 during January 2007. Volume sales of the Xaar 760 to Agfa also began during the year. Although these sales generate a lower gross margin than sales of other products, it should be remembered that Agfa funded the development of the Xaar 760 and has also paid for some of the production equipment used in its manufacture at our plant in Sweden. Overall, sales of Platform 1 and Platform 2 products, both of which are produced in Sweden, grew during the year, but not by as much as we had initially planned due to the issues in China. This resulted in a lower level of overhead recovery than planned which, when combined with the commencement of lower margin sales to Agfa, resulted in a lower gross margin for the year of 57% compared to 62% in the previous year. Priorities for the future We have renewed confidence in the ongoing potential for our Platform 1 business. Our newer Platform 2 and Platform 3 products provide the gateway to additional markets and better geographic diversity. We now have a range of products which allow us to develop a broader base to the business; our priority now is to convert this potential into solid financial returns. We will be working closely with our customers and development partners to achieve this and look forward to seeing them launch printing equipment incorporating our new products during 2007 and 2008. People A special note of thanks to all our staff who, once again, have shown skill, dedication and flexibility throughout a year which has at times been difficult. Ian Dinwoodie Chief Executive 14 March 2007 Xaar plc Annual Report and Accounts 2006 09 invested in research and development 13% of revenues 10 Financial review Xaar plc Annual Report and Accounts 2006 Nigel Berry Finance Director Trading for 2006 After a good start to the year, with sales in the first half up 12% over the first half of 2005, sales in the second half of the year were affected adversely by the investigation in China referred to in the Chairman’s statement, although at no time was Xaar itself implicated in the investigation. As a result of the customs investigation, other customers in China took the opportunity to review their own importation procedures and the level of orders from China fell whilst these reviews were being undertaken. The impact of this slowdown was to reduce sales in the second half of the year by 13% when compared to the second half of 2005. For the year as a whole, sales of printheads were flat compared to the prior year, but the reduction in development fees referred to in the Chairman’s statement left total revenue down marginally at £42.2m (2005: £42.8m). Sales to China have now recovered fully and the new trading arrangements introduced towards the end of the year will reduce the likelihood of the same issue occurring again in the future. Under these new arrangements, customers in China now have two methods of purchasing from Xaar; they can buy direct and, after payment of all applicable duties, collect their shipments from a bonded warehouse in Shanghai run by an international logistics company; or, again after payment of all appropriate duties, they can purchase products within China from a provincial government backed distribution company based in Nanjing. Both these new methods of supply are working well. As part of the new arrangements, Xaar has implemented Sterling invoicing for sales to China and in the first half of the year also moved customers for direct sales back to cash trading terms. The effect of these actions has been to reduce the company’s exposure to the US dollar and to improve working capital. Gross margin for the year was lower than the prior year at 57% (2005: 62%). This was due largely to reduced production levels and correspondingly lower overhead recovery, together with the commencement of lower Xaar plc Annual Report and Accounts 2006 11 “... the board is recommending an increased annual dividend for the year of 2.0p per share... an increase of 33%” margin shipments to Agfa. Increased volumes of production in future periods should recover this situation. However, with effect from January 2007 we will begin to incur costs for the new plant in Huntingdon; the annual fixed cost of the plant is £2.5m. For the year ahead, this cost will be only partially covered by sales of the Xaar 1001 in what will be its first year of commercial release. These costs will be reported in ‘cost of sales’ which in the short term will hold back recovery in gross margin. Overheads, excluding the cost of share options and non-recurring items, increased by 5% during the year to £16.5m (2005: £15.7m). Adjusted profit before tax for the year (before the cost of share options and non-recurring items), was £7.9m (2005: £10.5m). After providing for the cost of share options of £0.7m (2005: £0.5m), and for non-recurring items of £0.3m (2005: £nil), profit before tax was £6.9m (2005: £10.0m). The inter-company loan between the UK and Sweden was fully repaid during the year with no material impact on profit (2005: loss of £1.0m) and no effect on cash. Taxation for the year was £2.1m (30%) (2005: £3.0m, 30%), resulting in earnings per share for the year of 7.9p (2005: 11.6p). Foreign currency The move away from US dollar invoicing for sales to China has removed the majority of the group’s exposure to the US dollar, although some exposure remains on sales to the US. The group has an exposure to the Swedish kronor due to the need to fund its production operations in Sweden. The company hedges this exposure using forward exchange contracts, usually on a rolling twelve month basis; these contracts are fully IFRS compliant. Cash and capital expenditure Cash at the end of the year was £12.4m (2005: £14.4m). Cash is stated after higher than usual capital expenditure on assets and investments of 30% increase in cash generated by operations 12 Financial review continued Xaar plc Annual Report and Accounts 2006 £11.1m (2005: £5.2m). The major part of the capital expenditure in the year related to the group’s new manufacturing plant in Huntingdon, in which an investment of £4.7m has been made. The total value of capitalised research and development costs on the balance sheet at the end of the year was £6.5m. This balance will be amortised over the next five years. Additional financing in the year of £1.0m was taken out relating to certain equipment in the new Huntingdon plant, bringing the outstanding balance on equipment financing at the end of the year to £1.8m (2005: £1.2m). This represents the group’s only debt. Working capital improved by £1.2m during the year due largely to the return to cash trading terms for direct sales to China. 33% dividend increase in Dividend The board is recommending an increased annual dividend for the year of 2.0p per share (2005: 1.5p), an increase of 33%. The payment is covered four times, against eight times for the prior year. Subject to the approval of shareholders at the Annual General Meeting (AGM), the annual dividend will be paid on 15 June 2007 to shareholders on the register at the close of business on 18 May 2007. Business development We continue to develop new markets for Xaar’s technology. Some are already generating early commercial revenues, but will only ramp significantly once the Xaar 1001 solution becomes widely available. Whilst early feasibility testing has used other Xaar printheads, the Xaar 1001 will provide the performance which our development partners in sheet and web fed applications require to progress further. With the 1001 now beginning commercial shipments, we expect to see several of these projects come to fruition over the next twelve months. Xaar plc Annual Report and Accounts 2006 13 “we...offer potential Xaar customers a global network of integration partners” Packaging Interest in inkjet from the packaging printing market is initially focused on labelling and the short run requirements for cans, aerosols and other rigid packages. We have active projects in all these areas involving both multinational brand owners, web and sheet fed equipment suppliers and, increasingly, the major analogue ink companies. This latter group are keen to find digital inkjet equipment to distribute, bundled together with their new digital inks. Xaar’s integration partners are playing an increasing role in this area and now have distribution agreements in place with ink companies covering web-based label printing systems and CD printers. We look forward to their continued success in the year to come. Interest in the use of Radio Frequency Identification (RFID) for packaging applications remains strong, and one company already offering a digital RFID printing system is Conductive Inkjet Technology Ltd. (CIT), based in Cambridge. CIT offers a commercial roll-to-roll direct write system for printing conductive metals onto non-porous substrates. Printed electronics Inkjet has already made inroads into this market in the area of coatings and colour filters for LCD production, and the early stage printing of OLED materials. In addition, inkjet manufactured printed circuit boards (PCBs) are moving closer to commercial reality but the exact timing of adoption by the PCB industry, however, remains unclear. Other In North America, PAT Technology Systems Inc. has become the first company to launch a Xaar 1001-based piece of equipment with its range of UV coating machines for pre-printed sheet or web fed substrates. This unique equipment offers a commercial printer the opportunity to apply a variety of print-enhancing finishes to pre-printed matter from any printing process – be it traditional analogue, inkjet or toner-based electro-photography. We are also aware that at least one European country has begun to produce its passports on an inkjet printer supplied by another of our integrator partners, utilising the greyscale Xaar 318 printhead. Integrators We continue to work closely with a range of integrators of inkjet technology and can offer potential Xaar customers a global network of integration partners with whom to discuss their equipment requirements, whether that requirement is for a bespoke system or a standard off-the-shelf product. Nigel Berry Finance Director and Deputy Chief Executive 14 March 2007 14 Board of directors Xaar plc Annual Report and Accounts 2006 1 2 3 4 5 6 7 8 Xaar plc Annual Report and Accounts 2006 15 1. Arie Rosenfeld Chairman Aged 63 – was until 1995 President of Scitex, which he joined shortly after its formation in 1968. Scitex is a world leader in graphic arts, digital printing and digital video products. He currently holds the post of managing partner at DOR Ventures, a venture capital fund. He joined the Xaar board in February 1997 and was appointed Chairman in June 1997. 2. Richard King CBE Deputy Chairman Aged 77 – was Chairman of Aveva Group plc until April 2006, is currently Chairman of Sentec Ltd and is a director of a number of other Cambridge hi-tech companies. An Emeritus Fellow of Darwin College, he was a founding member of Xaar and has been a director since 1990. He was appointed Deputy Chairman of the company in September 1997. 3. Ian Dinwoodie Chief Executive Aged 46 – joined Xaar in September 2001 as Group Operations Director and was appointed Chief Executive in July 2003. With over 20 years’ experience in hi-tech operations, he has held a variety of roles in engineering, quality assurance and manufacturing within the semiconductor, electronics and electronic imaging industries. Immediately prior to joining Xaar, he held the position of director of manufacturing for Fujifilm Electronic Imaging Ltd. 4. Nigel Berry Finance Director and Deputy Chief Executive Aged 47 – joined Xaar in May 2002. He qualified as a chartered accountant with Coopers & Lybrand, and has lived and worked in the US and Asia, both while at Wassall plc. More recently he was Finance Director of Rexam Printing Ltd and Cambridge Display Technology Ltd. He brings manufacturing and licensing experience to the group gained in international fast-growth businesses. 5. Stephen Temple Technical Director Aged 59 – is one of the original inventors of the Xaar technology. His inventions and joint inventions have led to more than 90 patents covering the technology. His primary role, aside from leading the technical team, is to focus on future development. He has been a director since 1991. 6. Phil Eaves Sales and Marketing Director Aged 53 – was previously marketing manager, Europe at Dainippon Screen, a world leader in electronic equipment for the graphic arts, flat panel display, printed circuit board and semiconductor markets. He brings over 20 years of sales and marketing expertise across many sectors of imaging and printing industries, and has held senior management positions at Scitex, Crosfield and Xeikon. 7. Robert Ecklemann Non-executive Director Aged 50 – started his career with the US Government’s International Trade Administration, where he was involved in the global trade policy for the science and electronics sector. In 1988 he joined Intel Corporation, starting in the Office of then President Andy Grove, before moving to Asia to launch Intel’s business into China, India, and the ASEAN region. He later became Intel VP and general manager for Europe, Middle East and Africa. Mr Eckelmann, a US citizen, holds several European non-executive directorships including Wolfson Microelectronics plc. 8. John Scott Senior Independent Director Aged 54 – until 2001 an executive director of Lazard Brothers & Co., Limited and currently a director of a range of quoted and private companies, including Scottish Mortgage Investment Trust PLC, Miller Insurance Services Ltd, Martin Currie Pacific Trust plc and JP Morgan Fleming Claverhouse Investment Trust plc; he is also Chairman of Dunedin Income Growth Investment Trust PLC and Endace Ltd. He joined the Xaar board in April 2001 and was appointed the Senior Independent Director in February 2002. 16 Directors’ report for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 The directors present their annual report on the affairs of the group together with the financial statements and auditors’ report for the year ended 31 December 2006. Principal activity and business review The principal activity of the group continues to be the development and commercial exploitation of a patented inkjet printing technology. A detailed review of the group’s operations during the year and of its plans for the future is given in the Chairman’s statement, the Review of operations and Financial review. The subsidiary undertakings of the group are listed in Note 9 to the Company balance sheet. Results and dividends Revenue for the year was £42.2m (2005: £42.8m) and comprised the sale of printheads and related products, development fees and licence fees and royalties. The profit after tax for the year was £4.8m (2005: £7.0m). The directors recommend the payment of a final dividend of 2.0p per ordinary share (2005: 1.5p). If approved at the forthcoming AGM, the final dividend will be paid on 15 June 2007 to shareholders on the register at close of business on 18 May 2007. Research and development £5.4m (2005: £5.5m) was spent on research and development in the year. Treasury During the year the group moved from having 65% of its sales in US dollars to less than 20%. This was a result of a change in the trading currency with the group’s customers in China from US dollars to Sterling. The group’s policy is to use financial instruments to hedge sufficient amounts of Sterling inflows into Swedish kronor in order to fund running costs of the group’s manufacturing facility in Sweden. The group’s use of financial instruments and the related risks are discussed further in Notes 19, 20 and 23. Directors and their interests The directors who served during the year were as follows: I Dinwoodie N Berry S Temple P Eaves A Rosenfeld R King J Scott R Eckelmann Brief biographical descriptions of the directors are set out on page 15. Full details of their interests in shares of the company and its subsidiary undertakings are included in the Directors’ remuneration report on pages 26 to 30. The interests of the directors in the shares of the company and its subsidiaries (all of which are beneficial) as at 31 December 2006 are as follows: Shareholdings in the company Number of ordinary shares of 10.0p each 31 December 2006 Number of ordinary shares of 10.0p each 31 December 2005 I Dinwoodie N Berry S Temple P Eaves A Rosenfeld R King J Scott R Eckelmann 96,757 350,000 385,499 — 50,000 150,000 69,000 — 96,757 350,000 435,499 — 200,000 150,000 72,100 — There have been no changes in the directors’ interests in shares of the company between 31 December 2006 and 14 March 2007. Directors interests in options over shares in the company are shown in the Directors’ remuneration report. In accordance with the company’s articles of association, at the AGM referred to in more detail on page 17, S Temple and P Eaves will retire from the board by rotation and offer themselves for re-election. Additionally R King, in accordance with best practice for directors over the age of 70, offers himself for re-election. Xaar plc Annual Report and Accounts 2006 17 Directors’ liabilities The company has granted an indemnity to one or more of its directors against liability in respect of any potential proceedings that may be brought by third parties, subject to the conditions set out in the Companies Act 1985. Such qualifying third party indemnity provision remains in force as at the date of approving the Directors’ report. Share capital As at 5 March 2007 the company had been notified in accordance with sections 198 to 208 of the Companies Act 1985, of the following material interests in its share capital: Number of ordinary shares held Percentage of issued share capital M&G Investment Management Limited AXA Investment Managers UK Limited Legal & General Investment Management Limited Barclays plc Artemis Investment Management Limited 9,057,134 6,911,597 5,950,859 2,883,886 2,460,042 14.6% 11.1% 9.6% 4.7% 4.0% Annual General Meeting The notice convening the AGM is set out on page 63. Resolutions 1 to 6 set out in the notice of the meeting deal with the ordinary business to be transacted at the meeting. The special business at the meeting (Resolutions 7 to 12) is explained on page 26 (in relation to Resolution 7) and below (in relation to Resolutions 8 to 12). Authority to purchase own shares Resolution 8 It is proposed by Resolution 8 to, by Special Resolution, authorise the company generally and unconditionally to purchase its own shares at a price of not less than the par value of the shares and not more than 5% above the average of the middle market quotations of the shares as derived from the Daily Official List of the London Stock Exchange for the five dealing days immediately preceding the day on which the purchase is made. The authority will be for a maximum of 14.9% of the company’s issued share capital and will expire at the earlier of the next AGM of the company or within 15 months from the date of the passing of this Resolution. The directors currently have no intention to exercise the authority and will only purchase shares if it is in the best interests of shareholders as a whole. The total number of options to subscribe for ordinary shares outstanding at 31 December 2006 was 4,077,822. This represents 7% of the issued ordinary share capital at that date. If Xaar plc was to buy back the maximum number of ordinary shares permitted pursuant to the passing of this Resolution, then the total number of options to subscribe for ordinary shares outstanding at 31 December 2006 would represent 8% of the reduced issued ordinary share capital. The Xaar 2007 Share Save Plan (the “Share Save Plan”) Resolution 9 This Resolution, to be proposed as an Ordinary Resolution, authorises the company to adopt a new Share Save Plan to replace the Xaar plc 1997 Share Save Scheme that expires in 2007. The Share Save Plan is a Save-As-You-Earn share option scheme designed to be approved by HM Revenue & Customs (HMRC). The following is a summary of the main features of the Share Save Plan: Administration The Share Save Plan shall be administrated by the board or a duly authorised committee. Approval The Share Save Plan has been designed for approval by HMRC as a savings-related share option scheme under Schedule 3 to the Income Tax (Earnings and Pensions) Act 2003 (ITEPA). Eligibility An individual must be an employee or full-time director of the company or a participating subsidiary of the company on the date that options are granted and must have been such an employee or full-time director for such qualifying service period (not exceeding five years) as the board may determine. An individual is a full-time director if he is obliged to devote not less than 25 hours per week to his duties with the company concerned. The board has a discretion to nominate employees who do not satisfy the above conditions to participate in the Share Save Plan. 18 Directors’ report continued for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 The Xaar 2007 Share Save Plan (the “Share Save Plan”) continued Grant of options The board may invite all eligible employees to apply for options during the six week period after the Share Save Plan has received HMRC approval. Thereafter, invitations may normally be issued only in the six weeks beginning on the dealing day next following the date on which the company announces its results for any period or at any other time when the board considers that exceptional circumstances exist to justify the issue of invitations. No options may be granted after 23 April 2017, being ten years after the date of adoption of the Share Save Plan. Options granted under the Share Save Plan are personal to the optionholder and, except on the death of the optionholder, may not be transferred. Options granted under the Share Save Plan are not pensionable. Savings contracts An eligible employee who applies for an option under the Share Save Plan must also enter into a HMRC approved savings related contract for a specified period of three, five or seven years. The board has discretion to determine which of the savings contracts will be available in respect of any invitation to apply for options. Under this contract, the employee will agree to make monthly savings contributions of a fixed amount (currently not less than £5 and not more than £250 per month). Shares may only be acquired under the Share Save Plan on the exercise of the option using the payments under this contract. Payment will be taken as including the bonus payable under the savings contract, unless otherwise decided by the board. Price The price payable for each share under option shall be determined by the board, provided that it shall not be less than 80% of the market value of a share when invitations are issued to eligible employees (or at any other time agreed with HMRC). Limit The number of shares which may be issued on the exercise of options or awards granted in any period of ten years under all the company’s employee share schemes may not exceed such number of shares as represents 10% of the company’s ordinary share capital in issue on the date of grant of such options or awards. Scaling back Applications to participate in the Share Save Plan may be scaled back by the board if applications exceed the number of shares available for the grant of options. Such scaling back may include: (i) restricting the level of bonus to be used to acquire shares; (ii) reducing monthly contributions above a certain level pro-rata; or (iii) reducing the length of the savings contract. Exercise of options An option granted may not normally be exercised until the optionholder has completed his savings contract (which will normally be three, five or seven years from the date of commencement of the savings contract) and then not more than six months thereafter. Special provisions allow early exercise in the case of death, injury, disability, redundancy, retirement or because the company or business which employs the optionholder is transferred out of the group. If an optionholder ceases employment before the third anniversary of the grant of the option for any other reason, his option will lapse. If he ceases for any other reason after the third anniversary of the grant, he may exercise his option unless he is dismissed for misconduct, in which case his option will lapse. Special provisions also allow early exercise in the event of a change of control, reconstruction or winding-up of the company. Internal reorganisations do not trigger the early exercise of options. Variation of capital In the event of an increase or variation of the share capital of the company, the board may make such adjustments as it considers appropriate to the number of shares under option and the price at which they may be required. Adjustments to the terms of options must be approved by HMRC. Amendments The board may at any time amend or add to all or any of the provisions of the Share Save Plan in any respect, provided that no amendment to a feature of the Share Save Plan that is necessary for it to be approved under Schedule 3 to ITEPA may be made without the prior approval of HMRC. In addition, the prior approval of the company in general meeting is required for any amendment to the advantage of optionholders to the provisions relating to eligibility, individual and overall limits, the basis for determining a participant’s entitlement to shares, the terms of such shares and variations of capital (unless the amendment is a minor one to benefit the administration of the Share Save Plan, to take account of a change in legislation or to obtain or maintain favourable tax, exchange control or regulatory treatment for an optionholder or any member of the group). Any amendment that is to the disadvantage of optionholders requires the consent of a majority of them. Xaar plc Annual Report and Accounts 2006 19 The Xaar 2007 Long Term Incentive Plan (“LTIP”) Resolution 10 This Resolution, to be proposed as an Ordinary Resolution, authorises the company to adopt a LTIP The following is a summary of the main features . of the LTIP . Administration The remuneration committee of the board of the company (the “committee”) will be responsible for the operation of the LTIP . Eligibility The committee may select any employee (including executive directors) of the company or any of its subsidiaries (together the “group”) to participate in the LTIP . Awards An award takes the form of an option with a nil exercise price or an allocation, being a deferred right to acquire shares in the future at no cost to the participant. The committee may also decide that an award should take the form of forfeitable shares if it would be advantageous for tax or other reasons for a participant to hold forfeitable shares in a particular jurisdiction rather than holding an option or allocation. If forfeitable shares are awarded under the LTIP a participant holding forfeitable shares will not receive dividends unless the committee determines , otherwise. Neither will a participant be able to vote the forfeitable shares until they have vested. There are two types of award that the committee may make under the LTIP: Performance Share Awards The committee may select employees to receive Performance Share Awards. All Performance Share Awards will be subject to performance conditions and the performance conditions stated below will apply to awards made in 2007. For 2007, the value of shares subject to a Performance Share Award cannot exceed 100% of an employees’s annual base salary as at the award date. Matching Share Awards The committee may invite employees to invest part or all of their cash bonus in shares in the company. An employee shall be granted an award of shares (“Matching Share Award”) in respects of the shares that he has purchased using his annual cash bonus as if the bonus has been invested on a pre-tax basis. All Matching Share Awards will be subject to performance conditions and the performance conditions stated below will apply to awards made in 2007. The maximum number of shares subject to a Matching Share Award will be equal to 100% of the grossed-up (for tax) number of shares purchased by the employee. If the employee disposes of the shares that he has purchased, the number of shares subject to his Matching Share Award will be reduced proportionately. Grant of awards Awards will in the first instance be made during the six weeks following the approval of the LTIP by shareholders and thereafter normally during the period of six weeks from the announcement by the company of its results for any period (and at other times in exceptional circumstances). No awards may be made more than ten years after the LTIP is adopted. Awards are personal to a participant and, except on death, may not be transferred. Awards are not pensionable. Plan limit The number of shares that may be issued or placed under award in any period of ten years under the LTIP and any other employee share scheme established by the company may not exceed 10% of the company’s issued share capital from time to time. Shares may be transferred out of treasury to satisfy awards under the LTIP but any shares so transferred will be treated as issued for the purposes of this limit. The LTIP may also operate in , conjunction with shares purchased in the market. Performance conditions Performance Share Awards and Matching Share Awards granted under the LTIP in 2007 will be subject to two separate conditions, the first condition applying to 50% of the shares subject to each award and the second condition applying to the remaining 50%. The Total Shareholder Return (“TSR”) condition In respect of the first 50% of each 2007 award (the “TSR Awards”), the number of shares that will vest will depend on the company’s TSR performance over the three financial years of the company ending in 2009 against the TSR performance of the TechMARK All Share Index (the “Comparator group”). (1) If the company’s TSR performance is below the median performance of the Comparator group, none of the TSR Awards will vest. (2) For TSR performance which is equal to the median performance of the Comparator group, 35% of the TSR Awards will vest. (3) All of the TSR Awards will vest for TSR performance at upper quartile and above. (4) For TSR performance between median and upper quartile, the proportion of the TSR Awards that will vest will be calculated on a straight-line basis. 20 Directors’ report continued for the year ended 31 December 2006 The Xaar 2007 Long Term Incentive Plan (“LTIP”) continued The Earnings Per Share (“EPS”) condition Xaar plc Annual Report and Accounts 2006 In respect of the second 50% of each 2007 award (the “EPS Awards”), the number of shares that vest will depend on the EPS growth of the company for the three financial years of the company ending in 2009. (1) None of the EPS Awards will vest if the company’s EPS growth does not exceed growth in the Retail Prices Index (“RPI”) by at least 4% compound p.a. (2) 35% of the EPS Awards will vest if the company’s EPS growth exceeds growth in the RPI by at least 4% compound p.a. (3) All of the EPS Awards will vest if the company’s EPS growth exceeds growth in the RPI by at least 10% compound p.a. (4) EPS Awards will vest on a straight-line basis for EPS growth in excess of growth in the RPI of between 4% and 10% compound p.a. Cash alternative The Committee may decide at their discretion that, when awards are due to vest, a participant may be paid the cash equivalent of the market value of the shares at that time, instead of receiving the actual shares. Cessation of employment A participant who ceases employment with the group before the third anniversary of the grant of an award will normally forfeit any award to which he would otherwise have been entitled. If the participant’s service with the group ceases through ill health, injury, disability, redundancy, retirement by agreement with his employer, the employing company or business being sold out of the group, or in exceptional circumstances determined by the committee, some of the awards may vest on the third anniversary of the award date but only to the extent that the performance conditions have been met over the performance period. The number of shares in respect of which an award vests will be reduced pro-rata to take into account the length of time that the participant was employed during the performance period, unless the committee determines otherwise. Alternatively, the committee may allow shares to be released shortly after termination of employment, based on performance up to that time, but with a pro-rata time reduction unless the committee decides otherwise. This latter treatment of awards will also apply in the case of the death of a participant. Change of control In the event of a takeover, reconstruction or winding-up of the company, awards may vest early to the extent that the performance conditions are met at that time. The number of shares in relation to which an award vests will be reduced on a pro-rata time basis unless the committee decides otherwise. Variation of capital In the event of a variation of share capital, the committee may make such adjustments to outstanding awards as they consider appropriate. Alterations The committee has the right to alter the rules of the LTIP The prior approval of the company in general meeting must be obtained in the case of any . amendment to the advantage of participants which is made to the provisions relating to eligibility, individual and overall limits, the basis for determining a participant’s entitlement to, and the terms of, shares or cash provided under the LTIP and variations of capital (unless the amendment is a minor one to benefit the administration of the LTIP or, to take account of a change in legislation or to obtain or maintain favourable tax, exchange control or regulatory treatment for participants or any member of the group). Any amendment that is to the disadvantage of participants requires the consent of the majority of them. Xaar plc Annual Report and Accounts 2006 21 Power to issue securities Resolution 11 Under the Companies Act 1985 the directors of the company may only allot shares (whether for cash or otherwise) with the authority of shareholders given at a general meeting of the company. Under Resolution 11, to be proposed as an Ordinary Resolution, authority is sought to allot shares up to an aggregate nominal amount of £798,843, which is equal to the whole of the unissued share capital as at 14 March 2007 and which represented 13% of the company’s ordinary share capital in issue as at 14 March 2007 and is an amount within the maximum amount permitted under institutional guidelines. The directors do not currently have an intention to exercise the authority. Resolution 12 This Resolution, to be proposed as a Special Resolution, will give the directors power to allot shares for cash on a non pre-emptive basis up to a maximum aggregate nominal value of £310,058, representing 5% of the issued ordinary share capital of the company as at 14 March 2007. The directors do not currently have an intention to exercise any power given to them by shareholders to allot shares for cash on a non-pre-emptive basis, and in any event, the directors will not allot any shares for cash on a non-pre-emptive basis if such allotment would exceed the limits established by the guidance published by the investment committees of the ABI and the NAPF. The authorities contained in Resolutions 11 and 12 will expire no later than 15 months after the passing of those Resolutions. Charitable contributions The group made charitable contributions to children’s charities during the year totalling £3,344 (2005: £25,385). No political donations were made (2005: £nil). Supplier payment policy The group’s and the company’s policy is to settle terms of payment with suppliers when agreeing the terms of each transaction, ensure that suppliers are made aware of the terms of payment and abide by the terms of payment. Trade creditor days of the company at 31 December 2006 were 56 days (2005: 15 days). Auditors Ernst & Young LLP were appointed as auditors during the year, and have expressed their willingness to continue in office as auditors and a Resolution to reappoint them will be proposed at the forthcoming AGM. Directors’ statement as to disclosure of information to auditors The directors who were members of the board at the time of approving the directors’ report are listed on page 15. Having made enquiries of fellow directors and the company’s auditors, each of these directors confirm that:  to the best of each director’s knowledge and belief, there is no information relevant to the preparation of their report of which the group’s auditors are unaware; and  each director has taken all the steps a director might reasonably be expected to have taken to be aware of relevant audit information and to establish that the group’s auditors are aware of that information. By order of the board A Taylor Secretary 14 March 2007 Science Park Cambridge CB4 0XR Registered number: 3320972 22 Corporate governance statement Xaar plc Annual Report and Accounts 2006 The company is committed to the principles of corporate governance contained in the Combined Code on Corporate Governance which is appended to the Listing Rules of the Financial Services Authority (‘the 2003 FRC Code’) and for which the board is accountable to shareholders. Statement of compliance with the Code of Best Practice Throughout the year ended 31 December 2006 the company has been in compliance with the Code provisions set out in section 1 of the 2003 FRC code except for the following matters: A7.2 A Rosenfeld, R King and J Scott do not have contracts of employment for a specific period due to their appointment being prior to the 2003 FRC code. R Eckelmann is, and any non-executive director appointed in the future will be, appointed for an initial period of three years with provision for two further periods of three years subject to satisfactory performance. B2.1 Neither R King, Chairman of the remuneration committee, nor A Rosenfeld, Chairman of the company, is considered independent. The other two committee members are independent non-executive directors. The board believes that given the current board structure the composition of the committee is appropriate at this time. C3.1 Neither R King, a member of the audit committee, nor A Rosenfeld, Chairman of the company, is considered independent. The other two committee members, including the committee Chairman, are independent non-executive directors. The board believes that given the current board structure the composition of the committee is appropriate at this time. D1.1 The company’s formal investor relations and shareholder communication programmes do not routinely involve either the Chairman or the Senior Independent Director. The board considers that the Chairman has a good understanding of the issues and concerns of major shareholders, and does not consider formal inclusion in the programme beneficial. Both the Chairman and the Senior Independent Director, and any other member of the board, are available to meet any shareholder as appropriate. Statement about applying the Principles of Good Governance The company has applied the Principles of Good Governance set out in section 1 of the Combined Code, including both the main Principles and the Supporting Principles, by complying with the 2003 FRC Code as reported above. Further explanation of how the Principles and Supporting Principles have been applied is set out below and, in connection with directors’ remuneration, in the Directors’ remuneration report. Board of directors The board of directors comprises the Chairman, four executive directors and three non-executive directors. Brief biographical details of all members of the board are set out on page 15. The board considers J Scott and R Eckelmann to be independent within the meaning of the 2003 FRC Code. Neither A Rosenfeld, as Chairman of the company, nor R King, due to length of service, are considered to be independent. The board does however support both A Rosenfeld’s and R King’s membership of both the audit and the remuneration committees. The board is responsible for the formulation of strategy, the monitoring of financial and non-financial performance, and the approval of major transactions, financial statements and operating and capital expenditure budgets. Comprehensive board papers, dealing with all aspects of the business, are distributed by the Company Secretary one week in advance of each board meeting. The board met ten times during 2006, including once at the company’s manufacturing facility in Stockholm. There exists a clear division of responsibilities between the Chairman and the Chief Executive. The Chairman’s primary role includes ensuring that the board functions properly, that it meets its obligations and responsibilities and that its organisation and mechanisms are in place and are working effectively. The Chief Executive’s primary role is to provide overall leadership and vision in developing, with the board, the strategic direction of the company. Additionally the Chief Executive is responsible for the management of the overall business to ensure strategic and business plans are effectively implemented, the results are monitored and reported to the board and financial and operational objectives are attained. Xaar plc Annual Report and Accounts 2006 23 Board of directors continued The board delegates management of the business to the executive team, headed by the Chief Executive (I Dinwoodie) and consisting of the three other executive directors (N Berry, P Eaves and S Temple), the Company Secretary and Deputy Finance Director (A Taylor), the Director of Manufacturing (G Lockett), the Director of Engineering (R Welford), the Director of Marketing (M Alexander) and the Director of HR (T Bick). The executive team meets weekly and is responsible for implementing group strategy, monitoring business performance, preparing the operating and capital expenditure budgets for recommendation to the board and ensuring efficient management of the group. Back row from left to right: P Eaves, A Taylor, T Bick, R Welford, N Berry and G Lockett. Front row from left to right: I Dinwoodie and S Temple. Not in picture: M Alexander. Summary of board meeting attendance in 2006 Ten board meetings were held in 2006. Meetings attended A Rosenfeld R King J Scott R Eckelmann I Dinwoodie N Berry S Temple P Eaves Board committees Summary of committee membership Name Audit committee Remuneration committee 10 9 10 9 10 10 10 10 Nomination committee A Rosenfeld R King J Scott R Eckelmann I Dinwoodie Summary of committee meeting attendance in 2006 Name Yes Yes Chairman Yes No Audit committee Yes Chairman Yes Yes No Remuneration committee Chairman No Yes Yes Yes Nomination committee Number of meetings held A Rosenfeld R King J Scott R Eckelmann I Dinwoodie 2 2 2 2 2 n/a 2 2 2 2 2 n/a 2 2 n/a 2 2 2 24 Xaar plc Annual Report and Accounts 2006 Corporate governance statement continued Audit committee The audit committee’s role includes the examination and review of, on behalf of the board, internal financial controls, financial and accounting policies and practices, the form and content of financial reports and statements and the financial judgements therein, and the work of the external auditors. The committee ensures that arrangements are in place for staff of the company to raise, confidentially or publicly, concerns about any possible improprieties. The written terms of reference of the committee are available on request from the Company Secretary. The committee meets with the company’s auditors twice a year. The Chief Executive, Finance Director and the Company Secretary attend by invitation, except for a period of each meeting where the committee members meet with the auditors without any member of the company management present. The Chairman of the committee, J Scott, is deemed by the board to have recent and relevant financial experience as he was, until 2001, an executive director of Lazard Brothers and is currently a fellow of the FSI. The committee reviews the type of work, effectiveness of and level of fees charged by the auditors on an annual basis and recommends to the board the appointment, remuneration and terms of engagement of the external auditor. The committee monitors fees paid to the auditors in respect of non-audit work. All additional work performed by the auditors is approved by the audit committee. During the year the committee, with the board’s approval, invited three audit firms (including the incumbent) to tender for the group audit. All three firms were invited to present their proposal to the audit committee. After careful consideration of all three proposals the committee recommended to the board that Ernst & Young LLP be appointed group auditors. The independence and objectivity of the auditors is regularly considered by the committee. The committee receives an annual statement from the auditors detailing their independence policies and safeguards and confirming their independence. The committee reviews the need for an internal audit function on an annual basis and has concluded that, due to the current size and structure of the group and the level of control exercised by the executive team, an internal audit function is neither necessary nor cost effective at this time. Remuneration committee The remuneration committee makes recommendations to the board on the group’s policy for executive remuneration and determines the individual remuneration packages on behalf of the board for the executive directors of the group. The Chief Executive attends meetings by invitation, except when the Chief Executive’s own remuneration package is being discussed. The committee has access to professional advice, both inside and outside the company, in the furtherance of its duties. The Directors’ remuneration report sets out in more detail the committee’s policies and practices on executive remuneration. The written terms of reference of the committee are available on request from the Company Secretary. Nomination committee The nomination committee is responsible for reviewing the size and composition of the board, for making recommendations to the board on the appointment of new executive and non-executive directors and their re-appointment following retirement by rotation. The committee meets as required, but at least twice a year. The written terms of reference of the committee are available on request from the Company Secretary. The process adopted by the committee to identify a candidate for a specific vacancy is, in the first instance, to determine whether any individuals known to the committee would be suitable for the role. If no candidates can be identified through this process then an external search consultancy will be approached. Short listed candidates are interviewed by all members of the committee and other executive and non-executive directors as the committee deems appropriate. Once a suitable candidate has been identified, the Chairman of the committee will recommend to the board that the company make a formal offer of employment to the candidate. All directors are required to submit themselves for re-appointment at least every three years and directors appointed during the year are required to seek re-appointment at the first AGM following their appointment. In accordance with best practice it is also group policy that all directors over the age of 70 submit themselves for re-appointment on an annual basis. It is the committee’s view that R King be put forward for re-appointment on the basis of his continued contribution to the board. Performance evaluation A full board effectiveness review was undertaken in the year by ICSA. This involved one to one interviews with all members of the board and the Company Secretary and a board discussion of the conclusions facilitated by ICSA. The board’s policy for individual director performance reviews is for a formal and rigorous appraisal process centred on periodic discussion between the Chairman, Senior Independent Director and the Chief Executive. These discussions are not minuted. Appropriate feedback is given to the Chairman and individual directors as required. Xaar plc Annual Report and Accounts 2006 25 Company structure The company has three main locations. The head office functions, research and development, European sales and the marketing function are based in Cambridge, England. The company has two manufacturing facilities, one in Stockholm, Sweden and the other in Huntingdon, England. The company has representative offices in Shanghai (China), New Delhi (India), São Paulo (Brazil), Shin-Yokohama (Japan) and Atlanta (USA). The company’s applications division, Vivid Print Innovations Inc. based in San Antonio, USA was sold out of the group during the year. Environment The company manufactures product in both Sweden and England and undertakes research and development in England. The company complies with all local and European legislation relevant to the respective territories. The company’s manufacturing facility in Sweden is both ISO9001 and ISO14001 certified and the manufacturing facility in England is ISO9001 certified with a plan to gain ISO14001 certification during 2007. It is the company’s policy to maintain this level of certification for all its manufacturing facilities both current and future and to comply at all times with all relevant environmental and other legislation of the territories in which the company operates. With regard to the WEEE (Waste Electrical and Electronic Equipment) and RoHS (Restriction of the use of certain Hazardous Substances) directives Xaar understands the environmental aims of these directives and, although Xaar’s product portfolio is not directly covered by these directives, will ensure its products comply wherever practicable and allow our OEM customers to fulfil these environmental policies more readily. In addition it is the company’s aim to:  improve performance in areas which have a significant impact on the environment such as energy usage, chemical usage, transportation, pollution and waste disposal;  where possible source products from suppliers who provide product information relating to the environmental impact of their products and the steps they have taken to mitigate any environmental impact;  communicate with staff on environmental issues and any changes to environmental legislation; and  monitor technical developments within the industry to ensure that the company can take advantage of opportunities that reduce the environmental impact of the company’s activities. Dialogue with institutional shareholders The directors seek to build on a mutual understanding of objectives between the company and its institutional shareholders by meeting at least twice per year, following interim and annual results, to provide an update on trading and obtain feedback. Additionally, the company has hosted institutional investors at both the company’s headquarters in Cambridge and the manufacturing facility in Stockholm during 2006. The company’s financial public relations advisors give all investors and potential investors, who have met with the company’s investor relations team, the opportunity to provide feedback on the meetings. The feedback is co-ordinated by the PR advisors into a single document which is circulated to all members of the board. Additionally the Chief Executive and Finance Director provide feedback to the board at the meeting following shareholder meetings. Constructive use of the Annual General Meeting The board use the AGM to communicate with investors and to encourage their participation. Internal control The board has applied Principle C2.1 of the Combined Code by establishing a continuous process for identifying, evaluating and managing the significant risks the group faces. The board regularly reviews the process, which has been in place from the start of the year to the date of approval of this report and which is in accordance with Internal Control: Guidance for directors on the Combined Code published in September 1999 and updated in 2005. The board is responsible for the group’s system of internal control and for reviewing its effectiveness. Such a system is designed to manage rather than eliminate the risk of failure to achieve business objectives and can only provide reasonable and not absolute assurance with respect to the preparation of financial information and the safeguarding of assets and against material misstatement or loss. In compliance with Provision C2.1 of the Combined Code, the board regularly reviews the effectiveness of the group’s system of internal control. The board’s monitoring covers all controls, including financial, operational and compliance controls and risk management systems. It is based principally on reviewing reports from management to consider whether significant risks are identified, evaluated, managed and controlled and whether any significant weaknesses are promptly remedied and indicate a need for more extensive monitoring. The board has also performed a specific assessment for the purpose of this annual report. This assessment considers all significant aspects of internal control arising during the period covered by the report. The audit committee assists the board in discharging its review responsibilities. 26 Directors’ remuneration report Xaar plc Annual Report and Accounts 2006 This report has been prepared in accordance with Schedule 7A to the Companies Act 1985. The report also meets the relevant requirements of the Listing Rules of the Financial Services Authority and describes how the board has applied the Principles of Good Governance relating to directors’ remuneration. As required by the Act, Resolution 7 to approve the report will be proposed at the AGM of the company at which the financial statements of the company will be approved. The Act requires the auditors to report to the company’s members on certain parts of the Directors’ remuneration report and to state whether in their opinion that part of the report has been properly prepared in accordance with the Companies Act 1985. The report has therefore been divided into separate sections for audited and unaudited information. Unaudited information Remuneration committee The principal function of the remuneration committee (the membership of which is outlined in the Corporate governance statement) is to determine, on behalf of the board, the specific remuneration and other benefits of all executive directors, including pension contributions, bonus payments, share options and service contracts. The fees paid to the non-executive directors are determined by the board. Additionally, the remuneration committee makes recommendations to the board on the framework of executive remuneration. The committee has access to professional advice, both inside and outside the company, in the furtherance of its duties. Total level of remuneration The remuneration committee’s policy is to attract and retain individuals of the highest calibre by offering remuneration competitive with comparable publicly listed companies and fairly and responsibly reward individuals for their contribution to the success of the company. A substantial proportion of remuneration, representing bonuses and share options, of executive directors is performance related. Executive directors are entitled to accept appointments outside the company providing that the Chairman’s permission is sought and fees in excess of £20,000 from all such appointments are accounted for to the company. Basic salaries An executive director’s basic salary is reviewed by the committee prior to the beginning of each year and when an individual changes position or responsibility. In deciding appropriate levels, the committee considers the group as a whole, as well as the individual’s performance. Benefits in kind Benefits in kind represent company cars and private medical insurance. Bonus payments Bonuses are non-pensionable and based on a percentage of basic salary. Bonuses are paid each six months, following the interim and annual results, in recognition of each executive director’s contribution to the success of the company and upon achievement of certain predetermined corporate targets. The maximum potential bonus payment as a percentage of basic salary for directors depends on the individual director’s role and responsibility. For the year commencing 1 January 2007 the potential amount payable under the annual bonus scheme ranges between 0% and 100% of basic salary. Non-executive directors do not receive a bonus. Xaar plc Annual Report and Accounts 2006 27 Unaudited information continued Share options All executive directors are entitled to participate in the company’s share option schemes, including the company’s SAYE scheme. Any options granted thereunder are approved by the remuneration committee. Performance criteria for all share option schemes are intended to deliver increased shareholder value. Non-executive directors do not participate in the company’s share option schemes. It is the policy of the company to grant share options to employees and executive directors as a means of encouraging ownership and providing incentives for performance. Certain options granted to directors are subject to vesting criteria as summarised below. Options held at 31 December 2006 granted prior to 2004 under the Xaar plc 1997 share option scheme: I Dinwoodie: 100,000 options with an exercise price of 68.5p where, as long as the share price remains above the relevant threshold for at least 20 consecutive days after the earliest date of exercise, 33% vest at a share price of 110.0p, 66% vest at 125.0p and 100% vest at 140.0p. N Berry: 250,000 options with an exercise price of 71.5p where, as long as the share price remains above the relevant threshold for at least 20 consecutive days after the earliest date of exercise, 33% vest at a share price of 110.0p, 66% vest at 125.0p and 100% vest at 140.0p. S Temple: 100,000 options with an exercise price of 74.0p where, as long as the share price remains above the relevant threshold for at least 20 days after the earliest date of exercise, 33% vest at a share price of 110.0p, 66% vest at 125.0p and 100% vest at 140.0p. All options detailed above additionally require earnings per share (EPS) growth over the three year vesting period to be more than RPI + 5% per annum compound. Options held at 31 December 2006 granted during 2003 under the Xaar plc 1997 share option scheme: Number Exercise price I Dinwoodie N Berry S Temple Options held at 31 December 2006 granted under the Xaar plc 2004 share option plan: Date of grant 200,000 200,000 200,000 36.0p 36.0p 36.0p These options will vest as long as the share price remains above 76.0p for at least 20 consecutive days after the earliest date of exercise. Number Exercise price I Dinwoodie N Berry I Dinwoodie N Berry S Temple P Eaves I Dinwoodie N Berry S Temple I Dinwoodie N Berry P Eaves 20.05.04 20.05.04 28.10.04 28.10.04 28.10.04 15.03.05 15.09.05 15.09.05 15.09.05 03.04.06 03.04.06 03.04.06 100,000 100,000 50,000 50,000 50,000 119,791 98,540 91,240 50,000 101,460 8,760 85,106 84.0p 84.0p 109.0p 109.0p 109.0p 192.0p 274.0p 274.0p 274.0p 294.0p 294.0p 294.0p Additionally, P Eaves was granted a further 130,209 options on 15 March 2005 at an exercise price of 192.0p. This grant was made on P Eaves’ joining the company in accordance with Rule 9.4.2 (2) of the Listing Rules. These options are subject to a separate agreement between P Eaves and the company, with the terms of this agreement being the provisions of the Xaar plc 2004 share option plan in all respects except as to the limit of options allowed in relation to an individual’s salary. An option granted under the Xaar plc 2004 share option plan will be exercisable over shares with a market value at the date of grant not exceeding a person’s annual salary if at the third anniversary of grant the EPS growth of the company since grant has exceeded the growth in the RPI over the same period by at least 12%. To the extent that an option relates to shares with a market value as at the date of grant in excess of a person’s annual salary, the option will be exercisable over all of the excess shares if EPS growth over this period has exceeded RPI growth by at least 15%. For EPS performance between these two points, options will be exercisable over the excess shares on a sliding scale. In addition, options can only be exercised if EPS is at least 5.5p for the financial year preceding the third anniversary of grant. Performance may be retested once only from the date of grant to the fourth or fifth anniversary of grant (at the discretion of the remuneration committee), but the original EPS growth targets will be increased from 12/15% to 16/20% and 20/25% respectively. The 5.5p target will apply for the final financial year in the extended period. 28 Directors’ remuneration report continued Xaar plc Annual Report and Accounts 2006 Unaudited information continued Retesting of performance criteria under the rules of the Xaar plc 2004 share option plan In accordance with best practice the remuneration committee has indicated that performance criteria will not be retested with regard to share options issued to directors under the Xaar plc 2004 share option plan. Options exercised during 2006 I Dinwoodie exercised 50,000 options with an exercise price of 88.0p on 14 March 2006 and a further 50,000 options with an exercise price of 88.0p on 25 April 2006. Pension scheme The company operates a self-administered, defined contribution, HMRC approved pension scheme. All current executive directors participate in this scheme. Non-executive directors do not receive pension contributions. Performance graph The following graph shows the company’s performance, measured by total shareholder return, compared with the performance of the TechMARK All Share Index. ����������������������������������������������������������������������������������������������������������� ����� ����� ����� ���������� ����� ����� ���� ��� ����� ������ The TechMARK All Share Index has been selected for this comparison because the Index includes Xaar plc. For the purposes of this comparison the TechMARK All Share Index is based on the constituent companies in the index at a point in time. �������� ������������������ Xaar plc Annual Report and Accounts 2006 29 Unaudited information continued Terms of appointment Executive directors’ appointments are terminable by twelve months’ written notice. Non-executive directors’ appointments are terminable by six months’ written notice. The details of directors’ contracts are summarised below: Date of contract I Dinwoodie N Berry S Temple P Eaves A Rosenfeld R King J Scott R Eckelmann 13.11.01 20.05.02 08.10.97 04.02.05 08.10.97 08.10.97 10.04.01 01.10.05 Other directorships S Temple served as a non-executive director of Global Graphics SA, a company registered in France until 20 April 2006. S Temple received no fees during 2006 from the company. Audited information Directors’ remuneration The remuneration of directors who served during the year was as follows (total remuneration for all directors who served during 2005 was £1,164,000): Total Money (excluding purchase Bonus pension pension payments contributions) contributions £’000 £’000 £’000 Total Money (including purchase pension pension contributions) contributions 2005 2005 £’000 £’000 Basic salary £’000 Fees £’000 Benefits in kind £’000 Total 2006 £’000 Executive I Dinwoodie N Berry S Temple P Eaves Non-executive A Rosenfeld R King J Scott R Eckelmann 155 142 120 125 — — — — 542 — — — — 48 33 33 50 164 12 20 16 17 — — — — 65 17 13 8 10 — — — — 48 184 175 144 152 48 33 33 50 819 17 16 14 13 — — — — 60 201 191 158 165 48 33 33 50 879 283 247 197 180 40 27 27 8 1,009 15 14 12 11 — — — — 52 30 Directors’ remuneration report continued Xaar plc Annual Report and Accounts 2006 Directors’ share options Directors’ emoluments disclosed above do not include any amounts for the value of options to acquire ordinary shares in the company granted or held by the directors. Details of the options are as follows: As at 1 January 2006 As at 31 December Exercised 2006 Gain on exercise 2006 £ Exercise price p Earliest date of exercise Name Granted Expiry date I Dinwoodie N Berry S Temple P Eaves 100,0002 100,0002 200,0002 26,0843 100,0002 50,0002 1,7223 98,5401,2 — 676,346 250,0002 200,0002 26,0843 100,0002 50,0002 1,7223 91,2401, 2 — 719,046 100,0002 200,0002 50,0002 50,0002 400,000 119,7912 130,2092 —1 — 250,000 — — — — — — — — 101,4602 101,460 — — — — — — — 8,7602 8,760 — — — — — — — — 85,1062 85,106 (100,000) — — — — — — — — (100,000) — — — — — — — — — — — — — — — — — — — — 100,000 200,000 26,084 100,000 50,000 1,722 98,540 101,460 677,806 250,000 200,000 26,084 100,000 50,000 1,722 91,240 8,760 727,806 100,000 200,000 50,000 50,000 400,000 119,791 130,209 — 85,106 335,106 234,5004 — — — — — — — — — — — — — — — — — — — — — — — — — — 88.0p 68.5p 36.0p 29.0p 84.0p 109.0p 99.0p 274.0p 294.0p 71.5p 36.0p 29.0p 84.0p 109.0p 99.0p 274.0p 294.0p 74.0p 36.0p 109.0p 274.0p 192.0p 192.0p 274.0p 294.0p 22.11.04 12.06.05 06.10.06 01.12.06 20.05.07 20.10.07 01.11.07 15.09.08 03.04.09 21.05.05 06.10.06 01.12.06 20.05.07 20.10.07 01.11.07 15.09.08 03.04.09 22.02.05 06.10.06 28.10.07 15.09.08 15.03.08 15.03.08 15.09.08 03.04.09 22.11.11 12.06.12 06.10.13 01.06.07 20.05.14 20.10.14 01.05.08 15.09.15 03.04.16 21.05.12 06.10.13 01.06.07 20.05.14 20.10.14 01.05.08 15.09.15 03.04.16 22.02.12 06.10.13 28.10.14 15.09.15 15.05.15 15.05.15 15.09.15 03.04.16 1. 2. 3. 4. The option grants on these dates were incorrectly reported in the 2005 remuneration report. The options shown as at 1 January 2006 reflect the actual grants made on 15 September 2005. These options carry certain specific performance criteria which must be achieved prior to vesting. Details are shown in the unaudited section of the Directors’ remuneration report. These options were granted under the Xaar plc 1997 Share Save Scheme (SAYE). The market price of these shares was 330.0p at the date of exercise for the first 50,000 options exercised and 315.0p for the second 50,000 options exercised. I Dinwoodie made a gain of £86,500 on the exercise of share options during 2005. The performance conditions relating to the above share options are given on page 27. The market value of the ordinary shares of the company as at 31 December 2006 was 240.0p per share. The closing mid range price ranged from 117.0p to 338.0p per share during the year. Approval This report was approved by the board of directors on 14 March 2007 and signed on its behalf by: I Dinwoodie Chief Executive 14 March 2007 Xaar plc Annual Report and Accounts 2006 31 Statement of directors’ responsibilities The directors are responsible for preparing the annual report and the financial statements in accordance with applicable law and regulations. The directors are required to prepare financial statements for the group in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union. The directors have elected to prepare financial statements for the company in accordance with United Kingdom Generally Accepted Accounting Practice (UK GAAP). In the case of UK GAAP accounts, the directors are required to prepare financial statements for each financial year which give a true and fair view of the state of affairs of the company and of the profit or loss of the company for that period. In preparing these financial statements, the directors are required to:  select suitable accounting policies and then apply them consistently;  make judgements and estimates that are reasonable and prudent;  state whether applicable UK accounting standards have been followed, subject to any material departures disclosed and explained in the financial statements; and  prepare the accounts on a going concern basis unless, having assessed the ability of the company to continue as a going concern, management intends to either liquidate the entity or to cease trading, or have no realistic alternative but to do so. In the case of the group financial statements, International Accounting Standard 1 requires that financial statements present fairly for each financial year the group’s financial position, financial performance and cash flows. This requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the International Accounting Standards Board’s ‘Framework for the Preparation and Presentation of Financial Statements’. In virtually all circumstances, a fair presentation will be achieved by compliance with all applicable International Financial Reporting Standards. Directors are also required to:  properly select and consistently apply accounting policies in accordance with IAS 8;  present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;  provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance;  state that the group has complied with IFRS, subject to any material departures disclosed and explained in the financial statements; and  prepare the accounts on a going concern basis unless, having assessed the ability of the group to continue as a going concern, management either intends to liquidate the entity or to cease trading, or have no realistic alternative but to do so. The directors are responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the group, for safeguarding the assets, for taking reasonable steps for the prevention and detection of fraud and other irregularities and enable them to ensure that the group financial statements comply with the requirements of the Companies Act 1985 and Article 4 of the IAS Regulation. 32 Independent auditors’ report (group) to the members of Xaar plc Xaar plc Annual Report and Accounts 2006 We have audited the group financial statements of Xaar plc for the year ended 31 December 2006 which comprise the Consolidated income statement, the Consolidated statement of recognised income and expense, the Consolidated balance sheet, the Consolidated cash flow statement and the related Notes 1 to 35. These group financial statements have been prepared under the accounting policies set out therein. We have reported separately on the parent company financial statements of Xaar plc for the year ended 31 December 2006 and on the information in the Directors’ remuneration report that is described as having been audited. This report is made solely to the company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors The directors are responsible for preparing the annual report and the group financial statements in accordance with applicable United Kingdom law and IFRS as adopted by the European Union as set out in the Statement of directors’ responsibilities. Our responsibility is to audit the group financial statements in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). We report to you our opinion as to whether the group financial statements give a true and fair view, the group financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation and whether the information given in the Directors’ report is consistent with the financial statements. The information given in the Directors’ report includes that specific information presented in the Chairman’s statement, the Review of operations and the Financial review that is cross referred from the Principal activity and business review section of the Directors’ report. We also report to you if, in our opinion, we have not received all the information and explanations we require for our audit, or if information specified by law regarding director’s remuneration and other transactions 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 statements on internal control cover all risks and controls, or form an opinion on the effectiveness of the group’s corporate governance procedures or its risk and control procedures. We read other information contained in the annual report and consider whether it is consistent with the audited group financial statements. The other information comprises only the Chairman’s statement, the Review of operations, the Financial review, the Corporate governance statement and the unaudited part of the Directors’ remuneration report. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the group financial statements. Our responsibilities do not extend to any other information. Xaar plc Annual Report and Accounts 2006 33 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 group financial statements. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the group financial statements, and of whether the accounting policies are appropriate to the group’s circumstances, consistently applied and adequately disclosed. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary in order to provide us with sufficient evidence to give reasonable assurance that the group 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 group financial statements. Opinion In our opinion :  the group financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union, of the state of the group’s affairs as at 31 December 2006 and of its profit for the year then ended;  the group financial statements have been properly prepared in accordance with the Companies Act 1985 and Article 4 of the IAS Regulation; and  the information given in the Directors’ report is consistent with the group financial statements. Ernst & Young LLP Registered auditor Cambridge 14 March 2007 Notes 1. The maintenance and integrity of the Xaar plc web site is the responsibility of the directors; the work carried out by the auditors does not involve consideration of these matter and, accordingly, the auditors accept no responsibility for any changes that may have occurred to the financial statements since they were initially presented on the web site. 2. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. 34 Consolidated income statement for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes 2006 £’000 2005 £’000 Continuing operations Revenue Cost of sales Gross profit Distribution costs Administrative expenses Operating profit Investment income Finance costs Foreign exchange loss on inter-company loan Profit before tax before abortive deal costs and share-based payments Abortive deal costs Share-based payments Profit before tax Tax Profit for the year attributable to shareholders Earnings per share from continuing operations Basic Diluted 4 8 9 10 6 12 12 42,207 (18,096) 24,111 (4,108) (13,426) 6,577 451 (116) — 7,921 (298) (711) 6,912 (2,068) 4,844 7.9p 7.6p 42,772 (16,123) 26,649 (4,038) (12,132) 10,479 576 (63) (977) 10,517 — (502) 10,015 (2,966) 7,049 11.6p 11.1p Dividends paid in the year amounted to £903,000 (2005: £604,000). Further disclosures are given in Note 11. Consolidated statement of recognised income and expense for the year ended 31 December 2006 2006 £’000 2005 £’000 Exchange differences on translation of foreign operations Gains/(losses) on cash flow hedges taken to equity Tax on items taken directly to equity Net income/(loss) recognised directly in equity Profit for the year Total recognised income and expense for the year (113) 1,197 (415) 669 4,844 5,513 842 (2,545) 1,690 (13) 7,049 7,036 Xaar plc Annual Report and Accounts 2006 35 Consolidated balance sheet as at 31 December 2006 2006 £’000 2005 £’000 Notes Non-current assets Property, plant and equipment Goodwill Other intangible assets Investments Deferred tax asset Current assets Inventories Trade and other receivables Cash and cash equivalents Assets held for sale Total assets Current liabilities Trade and other payables Other financial liabilities Current tax liabilities Obligations under finance leases Provisions Derivative financial instruments Liabilities directly associated with assets classified as held for sale Net current assets Non-current liabilities Deferred tax liabilities Other financial liabilities Obligations under finance leases Total liabilities Net assets Equity Share capital Share premium Own shares Other reserves Hedging and translation reserves Retained earnings Equity attributable to shareholders Total equity They were signed on its behalf by: 15 13 14 17 21 11,990 720 7,030 1,931 1,383 23,054 3,690 6,135 12,438 22,263 — 45,317 (7,928) (185) (507) (468) (209) — — (9,297) 12,966 (1,635) (865) (267) (2,767) (12,064) 33,253 6,201 9,669 (3,420) 3,097 593 17,113 33,253 33,253 6,436 720 3,773 1,377 2,916 15,222 2,835 9,142 14,395 26,372 265 41,859 (7,875) — (2,916) (556) (120) (1,197) (15) (12,679) 13,693 (946) — (681) (1,627) (14,306) 27,553 6,115 9,376 (3,420) 2,386 (131) 13,227 27,553 27,553 18 19 31 23 24 10 22 25 20 21 24 22 26 27 28 30 29 30 The financial statements were approved by the board of directors and authorised for issue on 14 March 2007. I Dinwoodie Director 14 March 2007 N Berry Director 36 Consolidated cash flow statement for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes 2006 £’000 2005 £’000 Net cash from operating activities Investing activities Interest received Purchases of property, plant and equipment Proceeds on disposal of property, plant and equipment Purchases of trading investments Expenditure on capitalised product development Net cash used in investing activities Financing activities Dividends paid Proceeds from issue of ordinary share capital New borrowings Repayments of obligations under finance leases Purchase of own shares Net cash inflow/(outflow) from financing activities Net decrease in cash and cash equivalents Effect of foreign exchange rate changes Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year 31 8,692 450 (7,274) 5 (427) (3,420) (10,666) (903) 384 1,050 (520) — 11 (1,963) 6 14,395 12,438 7,862 577 (2,579) 1 (1,377) (1,220) (4,598) (604) 754 — (553) (3,400) (3,803) (539) (382) 15,316 14,395 Xaar plc Annual Report and Accounts 2006 37 Notes to the consolidated financial statements for the year ended 31 December 2006 1. General information Xaar plc (the company) is incorporated in the United Kingdom under the Companies Act 1985. The address of the registered office is given on the inside back cover. The nature of the group’s operations and its principal activities are set out in the Directors’ report on page 16. 2. Key sources of estimation uncertainty The key assumptions concerning the future and other sources of estimation uncertainty at the balance sheet date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year, are as follows: Provisions Throughout the year, management considers the carrying value of both debtors and inventory balances. Provisions against both balances are made on the basis of past losses, current trading patterns and anticipated future events. Impairment of goodwill The group determines whether goodwill is impaired at least on an annual basis. This requires an estimation of the ‘value in use’ of the cash-generating units to which the goodwill is allocated. Estimating a value in use amount requires management to make an estimate of the expected future cash flows from the cash-generating unit and also to choose a suitable discount rate in order to calculate the present value of those cash flows. The carrying amount of goodwill at 31 December 2006 was £720,000 (2005: £720,000). Further details are given in Note 13. 3. Significant accounting policies Basis of accounting The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), as adopted for use in the European Union and therefore comply with Article 4 of the EU IAS Regulation. The financial information has been prepared on the basis of all applicable IFRS, including all International Accounting Standards (IAS), Standing Interpretations Committee (SIC) interpretations and International Financial Reporting Interpretations Committee (IFRIC) interpretations issued by the International Accounting Standards Board (IASB) before 31 December 2006. These include IFRS endorsed by the EU and those awaiting formal endorsement. The financial statements have been prepared on the historical cost basis, except for the revaluation of financial instruments. The principal accounting policies adopted are set out below. Basis of consolidation The Consolidated financial statements incorporate the financial statements of the company (Xaar plc) and entities controlled by the company (its subsidiaries) made up to 31 December each year. Control is achieved where the company has the power to govern the financial and operating policies of an investee entity so as to obtain benefits from its activities. The results of subsidiaries acquired or disposed of during the year are included in the Consolidated income statement from the effective date of acquisition or up to the effective date of disposal, as appropriate. Where necessary, adjustments are made to the financial statements of subsidiaries to bring the accounting policies used in line with those used by the group. All intra-group transactions, balances, income and expenses are eliminated on consolidation. Business combinations The acquisition of subsidiaries is accounted for using the purchase method. Goodwill arising on acquisition is recognised as an asset and initially measured at cost, being the excess of the cost of the business combination over the group’s interest in the net fair value of the identifiable assets, liabilities and contingent liabilities recognised. If, after reassessment, the group’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities exceeds the cost of the business combination, the excess is recognised immediately in the income statement. Non-current assets held for sale Non-current assets (and disposal groups) classified as held for sale are measured at the lower of carrying amount and fair value less costs to sell. Non-current assets and disposal groups are classified as held for sale if their carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is regarded as met only when the sale is highly probable and the asset (or disposal group) is available for immediate sale in its present condition. Management must be committed to the sale which should be expected to qualify for recognition as a completed sale within one year from the date of classification. 38 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 3. Significant accounting policies continued Goodwill Goodwill arising on consolidation is initially recognised as an asset at cost and is subsequently measured at cost less any accumulated impairment losses. Goodwill which is recognised as an asset is reviewed for impairment at least annually. Any impairment is recognised immediately in the income statement and is not subsequently reversed. For the purposes of impairment testing, goodwill is allocated to each of the group’s cash-generating units expected to benefit from the synergies of the combination. Cash-generating units to which goodwill has been allocated are tested for impairment annually, or more frequently when there is an indication that the unit may be impaired. If the recoverable amount of the cash-generating unit is less than the carrying amount of the unit, the impairment loss is allocated first to reduce the carrying amount of any goodwill allocated to the unit and then to the other assets of the unit pro-rata on the basis of the carrying amount of each asset in the unit. An impairment loss recognised for goodwill is not reversed in a subsequent period. On disposal of the cash-generating unit, the attributable amount of goodwill is included in the determination of the profit or loss on disposal. Goodwill arising on acquisitions before the date of transition to IFRS has been retained at the previous UK GAAP amounts subject to being tested for impairment at that date. Goodwill written off to reserves under UK GAAP prior to 1998 has not been reinstated and is not included in determining any subsequent profit or loss on disposal. Revenue recognition Revenue is measured at the fair value of the consideration received or receivable and represents amounts receivable for goods and services provided in the normal course of business, net of discounts, VAT and other sales related taxes, but gross of any tax withheld. Sales of goods are recognised when goods are delivered and title has passed. Development fees gained from joint development agreements are treated as income over the periods necessary to match them with the related costs. Funding received for internally-generated intangible assets is recognised on a straight-line basis to match the amortisation period of the related intangible fixed asset. Royalties are recognised on an accruals basis in accordance with the actual revenue trend in the most recent quarterly statements received from each licensee. Interest income is accrued on a time basis, by reference to the principal outstanding and at the effective interest rate applicable, which is the rate that discounts estimated future cash receipts through the expected life of the financial asset to that asset’s net carrying amount. Leasing Leases are classified as finance leases whenever the terms of the lease transfer substantially all the risks and rewards of ownership to the lessee. All other leases are classified as operating leases. Assets held under finance leases are recognised as assets of the group at their fair value or, if lower, at the present value of the minimum lease payments, each determined at the inception of the lease. The corresponding liability to the lessor is included in the balance sheet as a finance lease obligation. Lease payments are apportioned between finance charges and reduction of the lease obligation so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged directly against income. Rentals payable under operating leases are charged to income on a straight-line basis over the term of the relevant lease, even if the payments are not made on such a basis. Foreign currencies The individual financial statements of each group company are presented in the currency of the primary economic environment in which it operates (its functional currency). For the purpose of the Consolidated financial statements, the results and financial position of each group company are expressed in Sterling, which is the functional currency of the company, and the presentation currency for the Consolidated financial statements. Exchange differences arising on the settlement of monetary items, and on the retranslation of monetary items, are included in the income statement for the period. Exchange differences arising on the retranslation of non-monetary items carried at fair value are included in the income statement for the period except for differences arising on the retranslation of non-monetary items in respect of which gains and losses are recognised directly in equity. For such non-monetary items, any exchange component of that gain or loss is also recognised directly in equity. Xaar plc Annual Report and Accounts 2006 39 In order to hedge its exposure to certain foreign exchange risks, the group enters into forward contracts (see below for details of the group’s accounting policies in respect of such derivative financial instruments). For the purposes of presenting Consolidated financial statements, the assets and liabilities of the group’s foreign operations are translated at the exchange rates prevailing on the balance sheet date. Income and expense items are translated at the average exchange rates for the period. Exchange differences arising, if any, are classified as equity and transferred to the group’s translation reserve. Such translation differences are recognised as income or as expenses in the period in which the operation is disposed of. Goodwill and fair value adjustments arising on the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate. The group has elected to treat goodwill and fair value adjustments arising on acquisitions before the date of transition to IFRS as Sterling denominated assets and liabilities. Government grants Government grants relating to research and development are treated as income over the periods necessary to match them with the related costs. Government grants relating to property, plant and equipment are treated as deferred income and released to profit or loss over the expected useful lives of the assets concerned. Operating profit Operating profit is stated before investment income and finance costs. Retirement benefit costs Payments to defined contribution retirement benefit schemes are charged as an expense as they fall due. Payments made to state-managed retirement benefit schemes are dealt with as payments to defined contribution schemes where the group’s obligations under the schemes are equivalent to those arising in a defined contribution retirement benefit scheme. Taxation The tax expense represents the sum of the tax currently payable and deferred tax, including UK corporation tax and foreign tax. The tax currently payable is based on taxable profit for the year. Taxable profit differs from net profit as reported in the income statement because it excludes items of income or expense that are taxable or deductible in other years and it further excludes items that are never taxable or deductible. The group’s liability for current tax is calculated using tax rates that have been enacted or substantively enacted by the balance sheet date. Deferred tax is the tax expected to be payable or recoverable on differences between the carrying amounts of assets and liabilities in the financial statements and the 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. Such assets and liabilities are not recognised if the temporary difference arises from the initial recognition of goodwill or from the initial recognition (other than in a business combination) of other assets and liabilities in a transaction that affects neither the tax profit nor the accounting profit. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries, except where the group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profits will be available to allow all or part of the asset to be recovered. Deferred tax is calculated at the tax rates that are expected to apply in the period when the liability is settled or the asset is realised. Deferred tax is charged or credited in the income statement, except when it relates to items charged or credited directly to equity, in which case the deferred tax is also dealt with in equity. Deferred tax assets and liabilities are measured on an un-discounted basis and are offset when there is a legally enforceable right to set off current tax assets against current tax liabilities and when they relate to income taxes levied by the same taxation authority and the group intends to settle its current tax assets and liabilities on a net basis. 40 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 3. Significant accounting policies continued Property, plant and equipment All fixed assets are shown at original historical cost less accumulated depreciation and any recognised impairment loss. Assets in the course of construction for production or administrative purposes are carried at cost, less any recognised impairment loss. Depreciation of these assets, on the same basis as other assets in the same class, commences when the assets are ready for their intended use. Depreciation is charged so as to write off the cost or valuation of assets, other than assets in the course of construction, over their estimated useful lives, using the straight-line method, on the following bases: Leasehold improvements Plant and machinery Furniture, fittings and equipment Motor vehicles ten years three–five years three–five years three years Assets held under finance leases are depreciated over their expected useful lives on the same basis as owned assets or, where shorter, over the term of the relevant lease. The gain or loss arising on the disposal of an asset is determined as the difference between the sales proceeds and the carrying amount of the asset and is recognised in income. Internally-generated intangible assets – research and development expenditure Expenditure on research activities is recognised as an expense in the period in which it is incurred. An internally-generated intangible asset arising from the group’s development of new products is recognised only if all of the following conditions are met:  an asset is created that can be identified (such as software and new processes);  it is probable that the asset created will generate future economic benefits; and  the development cost of the asset can be measured reliably. Internally-generated intangible assets are amortised on a straight-line basis over their useful lives. Where no internally-generated intangible asset can be recognised, development expenditure is recognised as an expense in the period in which it is incurred. Other intangible assets Costs incurred in maintaining the patent and trademark portfolio are written off to the income statement as incurred. Payments in respect of software, external product development costs and licence rights acquired are capitalised at cost and amortised on a straight-line basis over their estimated useful lives. Impairment of tangible and intangible assets excluding goodwill At each balance sheet date, the group reviews the carrying amounts of its tangible and intangible assets 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 of the impairment loss (if any). Where the asset does not generate cash flows that are independent from other assets, the group estimates the recoverable amount of the cash-generating unit to which the asset belongs. An intangible asset with an indefinite useful life is tested for impairment annually and whenever there is an 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, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset for which the estimates of future cash flows have not been adjusted. If the recoverable amount of an asset (or cash-generating unit) is estimated to be less than its carrying amount, the carrying amount of the asset (cash-generating unit) is reduced to its recoverable amount. An impairment loss is recognised as an expense immediately, unless the relevant asset is carried at a revalued amount, in which case the impairment loss is treated as a revaluation decrease. Where an impairment loss subsequently reverses, the carrying amount of the asset (or cash-generating unit) is increased to the revised estimate of its recoverable amount, but so that the increased carrying amount does not exceed the carrying amount that would have been determined had no impairment loss been recognised for the asset (or cash-generating unit) in prior years. A reversal of an impairment loss is recognised as income immediately. Xaar plc Annual Report and Accounts 2006 41 Inventories Inventories are stated at the lower of cost and net realisable value. Cost comprises direct materials, direct labour costs and an attributable proportion of manufacturing overheads based on normal levels of activity that have been incurred in bringing the inventories to their present location and condition. Cost is calculated using the weighted average method. Net realisable value represents the estimated selling price less all estimated costs of completion and costs to be incurred in marketing, selling and distribution. Provision is made for obsolete, slow-moving or defective items where applicable. Financial instruments Financial assets and financial liabilities are recognised on the group’s balance sheet when the group becomes a party to the contractual provisions of the instrument. Trade receivables Trade receivables are measured at initial recognition at fair value. Appropriate allowances for estimated irrecoverable amounts are recognised in profit or loss when there is objective evidence that the asset is impaired. The allowance recognised is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the effective interest rate computed at initial recognition. Investments Investments are recognised and derecognised on a trade date where a purchase or sale of an investment is under a contract whose terms require delivery of the investment within the timeframe established by the market concerned, and are initially measured at fair value, equating to cost, including transaction costs. Investments are classified as available-for-sale, and on the basis that the investments have no active market and their fair values cannot be reliably determined using valuation techniques, the investments are carried at cost. If there is objective evidence that an impairment loss on an unquoted equity investment that is not carried at fair value because its fair value cannot be reliably measured, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset. Cash and cash equivalents Cash and cash equivalents comprise cash on hand and demand deposits, and other short term highly liquid investments that are readily convertible to a known amount of cash and are subject to an insignificant risk of changes in value. Financial liabilities and equity Financial liabilities and equity instruments are classified according to the substance of the contractual arrangements entered into. An equity instrument is any contract that evidences a residual interest in the assets of the group after deducting all of its liabilities. The accounting policies adopted for specific financial liabilities and equity instruments are set out below. Interest-bearing loans and borrowings Interest-bearing loans and bank overdrafts are measured initially at fair value, net of direct issue costs. Finance charges, including premiums payable on settlement or redemption and direct issue costs, are accounted for on an accrual basis in the income statement using the effective interest rate method and are added to the carrying amount of the instrument to the extent that they are not settled in the period in which they arise. Trade payables Trade payables are measured at original cost. Equity instruments Equity instruments issued by the company are recorded at the proceeds received, net of direct issue costs. Derivative financial instruments and hedge accounting The group’s activities expose it primarily to the financial risks of changes in foreign currency exchange rates and interest rates and liquidity risk. The group uses derivative financial instruments (primarily foreign currency forward contracts) to hedge its risks associated with foreign currency fluctuations relating to certain firm commitments and forecasted transactions. The group’s interest rate risk arises mainly from its funds invested in short term bank deposits. To mitigate these risks, limits have been set by the board in relation to maturity period and maximum deposits with any one institution. In order to mitigate the group’s liquidity risks, the policy is to fund significant fixed asset purchases by finance leases repayable over a period of three to five years dependent on the individual asset being financed and interest-bearing loans. The use of financial derivatives is governed by the group’s policies approved by the board of directors, which provides written principles on the use of financial derivatives consistent with the group’s risk management strategy. The group does not use derivative financial instruments for speculative purposes. Derivative financial instruments are initially measured at fair value on the contract date and are remeasured to fair value at subsequent reporting dates. 42 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 3. Significant accounting policies continued Derivative financial instruments and hedge accounting 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 and the ineffective portion is recognised immediately in the income statement. If the cash flow hedge of a firm commitment or forecasted transaction results in the recognition of an asset or a liability, then, at the time 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. Changes in 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 the 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 retained in equity until the forecasted transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss recognised in equity is transferred to net profit or loss for the period. Derivatives embedded in other financial instruments or other host contracts are treated as separate derivatives when their risks and characteristics are not closely related to those of host contracts and the host contracts are not carried at fair value, with gains or losses reported in the income statement. Provisions Provisions are recognised when the group has a present obligation as a result of a past event and it is probable that the group will be required to settle that obligation. Provisions are measured at the directors’ best estimate of the expenditure required to settle the obligation at the balance sheet date and are discounted where the effect of the time value of money is material. Share-based payments The group has applied the requirements of IFRS 2 “Share-based payment”. In accordance with the transitional provisions, IFRS 2 has been applied to all grants of equity instruments after 7 November 2002 that were unvested at 1 January 2005. The group issues equity-settled share-based payments to certain employees. These payments are measured at fair value (excluding the effect of non market-based vesting conditions) at the date of grant. The fair value determined at the grant date of the equity-settled share-based payments is expensed on a straight-line basis over the vesting period, based on the group’s estimate of the shares that will eventually vest and adjusted for the effect of non market-based vesting conditions. Fair value is measured using the Black-Scholes pricing model. The expected life used in the model has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations. Own shares Own shares are deducted from equity. No gain or loss is recognised in the income statement on the purchase, sale, issue or cancellation of the group’s own shares. New Standards and Interpretations not applied During the year, the IASB and IFRIC have issued the following Standards and Interpretations with an effective date after the date of these financial statements: International Accounting Standards (IAS/IFRS) Accounting periods beginning on or after IFRS7 IFRS8 IAS1 Financial Instruments: Disclosures Operating Segments Amendment - Presentation of Financial Statement; Capital Disclosures 01.01.07 01.01.09 01.01.07 International Financial Reporting Interpretations Committee (IFRIC) IFRIC7 IFRIC8 IFRIC9 IFRIC10 IFRIC11 IFRIC12 Applying the Restatement Approach under IAS29 Financial Reporting in Hyperinflationary Economies Scope of IFRS2 Reassessment of Embedded Derivatives Interim Financial Reporting and Impairment IFRS2 – Group and Treasury Share Transactions Service Concession Arrangements 01.03.06 01.05.06 01.06.06 01.11.06 01.03.07 01.01.08 The directors do not anticipate that the adoption of these Standards and Interpretations will have a material impact on the group’s financial statements in the period of initial application. Xaar plc Annual Report and Accounts 2006 43 4. Revenue An analysis of the group’s revenue is as follows: 2006 £’000 2005 £’000 Sales of goods Development fees Licence fees and royalties Investment income (Note 8) 39,918 748 1,541 42,207 451 42,658 39,872 1,587 1,313 42,772 576 43,348 5. Business and geographical segments Business segments For management reporting purposes, the group’s operations are currently analysed according to product type. These product groups are the basis on which the group reports its primary segment information. Principal product groups are as follows: Printheads and related products Development fees Licence fees and royalties Segment information about these product types is presented below. 2006 £’000 2005 £’000 Revenue Printheads and related products Development fees Licence fees and royalties Total revenue 39,918 748 1,541 42,207 2006 £’000 39,872 1,587 1,313 42,772 2005 £’000 Result Printheads and related products Development fees Licence fees and royalties Total segment results Unallocated corporate expenses Profit from operations Investment income Finance costs Foreign exchange loss on inter-company loan Profit before tax Tax Profit after tax 16,198 (442) 1,247 17,003 (10,426) 6,577 451 (116) — 6,912 (2,068) 4,844 20,062 464 1,049 21,575 (11,096) 10,479 576 (63) (977) 10,015 (2,966) 7,049 Unallocated corporate expenses relate to administrative expenses which cannot be directly attributed to any of the principal product groups. 44 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 5. Business and geographical segments continued Other information Printheads and related products 2006 £’000 Development fees 2006 £’000 Licence fees and royalties 2006 £’000 Consolidated 2006 £’000 Capital additions Depreciation and amortisation Balance sheet Assets Segment assets Unallocated corporate assets Consolidated total assets Liabilities Segment liabilities Unallocated corporate liabilities Consolidated total liabilities 11,147 1,531 — 616 — 59 11,147 2,206 24,440 1,378 635 26,453 18,864 45,317 (7,025) (5,039) (12,064) (5,781) (1,162) (82) Printheads and related products 2005 £’000 Development fees 2005 £’000 Licence fees and royalties 2005 £’000 Consolidated 2005 £’000 Capital additions Depreciation and amortisation Balance sheet Assets Segment assets Unallocated corporate assets Consolidated total assets Liabilities Segment liabilities Unallocated corporate liabilities Consolidated total liabilities 3,913 1,454 46 273 — 57 3,959 1,784 17,209 2,274 525 20,008 20,905 40,913 (6,552) (6,808) (13,360) (4,934) (1,549) (69) The comparative capital additions and segment assets disclosures for 2005 have been amended since the prior year financial statements in order to provide a more accurate reflection of the assets attributed to the printheads and related products and development fees business segments. Unallocated corporate assets include £449,000 (2005: £401,000) of capital additions, and depreciation and amortisation of £577,000 (2005: £556,000). Geographical segments The group’s operations are located in Europe, Asia and North and South America. The following table provides an analysis of the group’s sales by geographical market, which is considered to be the group’s secondary segment, irrespective of the origin of the goods: 2006 £’000 2005 £’000 Europe and Middle East Asia Americas 14,997 23,937 3,273 42,207 14,025 25,440 3,307 42,772 Substantially, all assets and additions to property, plant and equipment and intangible assets are located in Europe and the Middle East. Xaar plc Annual Report and Accounts 2006 45 6. Profit for the year Profit for the year has been arrived at after charging/(crediting): 2006 £’000 2005 £’000 Net foreign exchange losses Research and development costs Government grants towards research and development Depreciation of property, plant and equipment Amortisation of internally-generated intangible assets included in administrative expenses Amortisation of other intangible assets included in administrative expenses Loss on disposal of property, plant and equipment Impairment of inventories Impairment of other financial assets Auditors’ remuneration for audit services (see below) 91 3,843 (122) 1,998 461 324 15 134 765 88 752 4,613 (502) 1,936 103 301 103 65 182 130 No amounts were paid to Ernst & Young LLP and their associates by the company and its UK subsidiary undertakings in respect of non-audit services (2005: £222,000 payable to Deloitte & Touche LLP the previous auditors). , A more detailed analysis of auditors’ remuneration on a worldwide basis is provided below: 2006 Ernst & Young LLP £’000 2005 Deloitte & Touche LLP £’000 2006 % 2005 % Audit services – statutory audit – audit-related regulatory reporting Further assurance services Tax services – compliance services – advisory services Other services – employee related tax advice 80 8 88 — 88 — — — — 88 91 9 100 — 100 — — — — 100 105 25 130 7 137 52 177 229 19 385 27 6 33 2 35 14 46 60 5 100 A description of the work of the audit committee is set out in the audit committee report on page 24 and includes an explanation of how auditor objectivity and independence is safeguarded when non-audit services are provided by the auditors. The audit fee for Xaar plc in 2006 was £17,000 (2005: £17,000). 7. Staff costs The average monthly number of persons employed by the group including executive directors was as follows: 2006 Number 2005 Number Research and development Sales and marketing Manufacturing and engineering Administration 68 40 165 27 300 59 33 142 26 260 46 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 7. Staff costs continued Their aggregate remuneration comprised: 2006 £’000 2005 £’000 Wages and salaries Social security costs Other pension costs (see Note 34) Share-based payments 9,664 2,290 506 711 13,171 8,874 1,923 549 502 11,848 8. Investment income 2006 £’000 2005 £’000 Interest receivable on short term deposits 9. Finance costs 451 576 2006 £’000 2005 £’000 Interest on bank loans and overdrafts Interest on obligations under finance leases 60 56 116 10 53 63 10. Tax Note 2006 £’000 2005 £’000 Current tax Amounts overprovided in previous years Total current income tax Deferred tax Adjustment in respect of prior years Total deferred tax charge/(credit) Total tax expense for the year 557 (296) 261 1,599 208 1,807 2,068 3,346 — 3,346 (380) — (380) 2,966 21 The standard rate of tax for the year, based on the UK standard rate of corporation tax is 30%. Taxation for other jurisdictions is calculated at the rates prevailing in the respective jurisdictions. The charge for the year can be reconciled to the profit per the income statement as follows: 2006 £’000 2005 £’000 Profit on ordinary activities before tax Tax on ordinary activities at standard rate of 30% (2005: 30%) Effect of: Expenses not deductible for tax purposes Effect of foreign tax rates Unrelieved foreign tax suffered Enhanced tax deduction for research and development expenditure Deferred tax liability/(asset) not previously recognised Prior period adjustments Total tax expense for the year The effective tax rate for the year is 29.9% (2005: 29.6%). 6,912 2,074 76 (33) 187 (197) 49 (88) 2,068 10,015 3,004 2,695 (102) 114 (146) (2,599) — 2,966 Xaar plc Annual Report and Accounts 2006 47 11. Dividends 2006 £’000 2005 £’000 Amounts recognised as distributions to equity holders in the period: Final dividend for the year ended 31 December 2005 of 1.5p (2004: 1.0p) per share Proposed final dividend for the year ended 31 December 2006 of 2.0p (2005: 1.5p) per share 903 1,240 604 909 The proposed final dividend is subject to approval by shareholders at the AGM and has not been included as a liability in these financial statements. 12. Earnings per ordinary share – basic and diluted The calculation of basic and diluted earnings per share is based on the following data: 2006 £’000 2005 £’000 Earnings Earnings for the purposes of basic earnings per share being net profit attributable to equity holders of the parent 4,844 7,049 Number of shares Weighted average number of ordinary shares for the purposes of basic earnings per share Effect of dilutive potential ordinary shares: Share options Weighted average number of ordinary shares for the purposes of diluted earnings per share 61,447,492 2,221,595 63,669,087 60,578,422 2,921,181 63,499,603 Adjusted earnings per share The calculation of earnings per share excluding abortive deal costs, share-based payments and foreign exchange loss on the inter-company loan is based on earnings of: 2006 £’000 2005 £’000 Earnings for the purposes of basic earnings per share being net profit attributable to equity holders of the parent Abortive deal costs Share-based payments Foreign exchange loss on the inter-company loan Tax effect of adjusting items Profit after tax excluding abortive deal costs, share-based payments and foreign exchange loss on the inter-company loan The denominators used are the same as those detailed above for both basic and diluted earnings per share. 4,844 298 711 — (303) 5,550 7,049 — 502 977 (444) 8,084 Earnings per share excluding abortive deal costs, share-based payments and foreign exchange loss on the inter-company loan: 2006 £’000 2005 £’000 Basic Diluted 9.0p 8.7p 13.3p 12.7p This adjusted earnings per share information is considered to provide a fairer representation of the group’s trading performance year on year. 48 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 13. Goodwill The carrying amount of goodwill at 31 December 2006 was £720,000 (2005: £720,000). There were no accumulated impairment losses at the end of either period. Goodwill acquired in a business combination is allocated, at acquisition, to the cash-generating units (CGUs) that are expected to benefit from that business combination. The carrying amount of goodwill had been allocated as follows: 2006 £’000 2005 £’000 Printheads and related products (a single CGU) 720 720 The group tests goodwill annually for impairment, or more frequently if there are indications that goodwill might be impaired. The recoverable amount of the CGU is determined from a value in use calculation. The key assumptions to which the value in use calculation is most sensitive are those regarding the discount rates, growth rates and expected changes to selling prices and direct costs during the period. Management estimates discount rates using pre-tax rates that reflect current market assessments of the time value of money and the risks specific to the CGU. The growth rates are based on industry growth forecasts. Changes in selling prices and direct costs are based on past practices and expectations of future changes in the market. Management believes that no reasonably possible change in any of the above key assumptions would cause the carrying value of the unit to exceed its recoverable amount. The group prepares cash flow forecasts derived from the most recent financial budgets approved by management for the next five years. The rate used to discount the forecast cash flows from the group’s printheads and related products activities is 12%. This rate reflects management’s estimate of return on capital employed, and does not exceed the average long term growth rate for the relevant markets. Having performed impairment testing, no impairment has been identified, and therefore no impairment loss has been recognised in either period. 14. Other intangible assets Internally-generated product development costs £’000 Other product development costs £’000 Licences acquired £’000 Software £’000 Total £’000 Cost At January 2005 Additions At 1 January 2006 Additions At 31 December 2006 Amortisation At January 2005 Charge for the year At 1 January 2006 Charge for the year At 31 December 2006 Carrying amount At 31 December 2006 At 31 December 2005 2,107 867 2,974 1,591 4,565 — 103 103 461 564 4,001 2,871 460 352 812 2,120 2,932 153 153 306 154 460 2,472 506 533 — 533 — 533 245 57 302 59 361 172 231 486 — 486 331 817 230 91 321 111 432 385 165 3,586 1,219 4,805 4,042 8,847 628 404 1,032 785 1,817 7,030 3,773 The amortisation period for software and development costs incurred on the group’s product development is three years. Internally-generated product development costs relate to the Platform 2 and Platform 3 ranges of printheads. The amortisation period of these costs are three years and five years respectively. Licences acquired are amortised over their estimated useful lives, which is on average nine years. Xaar plc Annual Report and Accounts 2006 49 15. Property, plant and equipment Leasehold property £’000 Plant and machinery £’000 Furniture, fittings and equipment £’000 Assets in the course of construction £’000 Motor vehicles £’000 Total £’000 Cost At 1 January 2005 Additions Transfers Exchange movements Disposals At 1 January 2006 Additions Transfers Exchange movements Disposals At 31 December 2006 Depreciation At 1 January 2005 Charge for the year Exchange movements Disposals At 1 January 2006 Charge for the year Exchange movements Disposals At 31 December 2006 Carrying amount At 31 December 2006 At 31 December 2005 Leased assets included in the above: Carrying amount At 31 December 2006 At 31 December 2005 2,273 138 — (85) — 2,326 6 150 23 (23) 2,482 1,164 275 (43) — 1,396 319 17 — 1,732 750 930 12,808 757 147 (526) (29) 13,157 1,380 480 162 (138) 15,041 8,688 1,454 (290) (29) 9,823 1,531 109 (118) 11,345 3,696 3,334 1,274 278 — (21) (153) 1,378 99 — 5 (36) 1,446 926 207 (17) (48) 1,068 148 5 (17) 1,204 242 310 47 1,968 (147) (6) — 1,862 6,069 (630) 1 — 7,302 — — — — — — — — — 7,302 1,862 14 — — — — 14 — — — — 14 14 — — — 14 — — — 14 — — 16,416 3,141 — (638) (182) 18,737 7,554 — 191 (197) 26,285 10,792 1,936 (350) (77) 12,301 1,998 131 (135) 14,295 11,990 6,436 — — 549 1,169 1 4 — — — — 550 1,173 At 31 December 2006 the group had entered into contractual commitments for the acquisition of property, plant and equipment amounting to £138,000 (2005: £57,000). 16. Subsidiaries A list of the investments in subsidiaries, including the name, country of incorporation and proportion of ownership interest is given in Note 9 to the company’s separate financial statements. In March 2006, the group disposed of its investment in Vivid Print Innovations Inc. The consideration for the disposal was £256,000, which was satisfied through the issue of shares in a trading investment, representing a non-cash transaction. The overall loss on disposal was £4,000. 17. Investments 2006 £’000 2005 £’000 Trading investments 1,931 1,377 These unquoted investments represent the fair value of investments in companies that present the group with opportunity for return through trading gains. 50 for the year ended 31 December 2006 18. Inventories Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 2006 £’000 2005 £’000 Raw materials and consumables Work in progress Finished goods 1,703 543 1,444 3,690 1,055 533 1,247 2,835 19. Other financial assets 2006 £’000 2005 £’000 Trade and other receivables Amounts receivable for the sale of goods 6,841 9,142 The average credit period taken on sales of goods is 32 days (2005: 53 days). An allowance has been made for estimated irrecoverable amounts from the sale of goods of £614,000 (2005: £450,000). This allowance has been determined by reference to past default experience. The directors consider that the carrying amount of trade and other receivables approximates their fair value. Bank balances and cash comprise cash held by the group and short term bank deposits with an original maturity of three months or less. The carrying amount of these assets approximates their fair value. Credit risk The group’s principal financial assets are bank balances and cash and trade and other receivables. The group’s credit risk is primarily attributable to its trade receivables. The amounts presented in the balance sheet are net of allowances for doubtful receivables. An allowance for impairment is made where there is an identified loss event which, based on previous experience, is evidence of a reduction in the recoverability of the cash flows. The credit risk on liquid funds and derivative financial instruments is limited because the counterparties are banks with high credit-ratings assigned by international credit-rating agencies. The group has no significant concentration of credit risk, with exposure spread over a large number of counterparties and customers. 20. Derivative financial instruments The group utilises currency derivatives to hedge significant future transactions and cash flows. The group is party to a variety of foreign currency forward contracts and options in the management of its exchange rate exposures. The instruments purchased are primarily denominated in the currencies of the group’s principal markets. At the balance sheet date, the total notional amount of outstanding forward foreign exchange contracts that the group has committed are as below: 2006 US$’000 2005 US$’000 Forward foreign exchange contracts — 35,250 The group had no outstanding forward foreign exchange contracts at 31 December 2006. Hence, at 31 December 2006, the fair value of the group’s currency derivatives is £nil (2005: liability of £1,197,000). The liability for 2005 is based on market values of equivalent instruments at the balance sheet date. These derivatives were all designated and effective as cashflow hedges and were deferred in equity at the prior year end. The group does not currently designate its foreign currency denominated debt as a hedging instrument for the purpose of hedging the translation of its foreign operations. Xaar plc Annual Report and Accounts 2006 51 21. Deferred tax The following are the major deferred tax liabilities and assets recognised by the group and movements thereon during the current and prior reporting period. Accelerated tax depreciation £’000 Cashflow Share-based hedges payment £’000 £’000 Untaxed reserves £’000 Tax losses £’000 Other temporary difference £’000 Total £’000 At 1 January 2005 Charge/(credit) to income Credit to equity Exchange differences At 1 January 2006 Charge/(credit) to income Charge to equity At 31 December 2006 (288) 10 — 10 (268) 587 — 319 404 — (764) — (360) — 360 — (545) — (926) — (1,471) 204 55 (1,212) 689 458 — (52) 1,095 (1) — 1,094 — (1,102) — — (1,102) 380 — (722) (144) 254 — 26 136 637 — 773 116 (380) (1,690) (16) (1,970) 1,807 415 252 Certain deferred tax assets and liabilities have been offset. The following is the analysis of the deferred tax balances (after offset) for financial reporting purposes: 2006 £’000 2005 £’000 Deferred tax liabilities Deferred tax assets 1,635 (1,383) 252 946 (2,916) (1,970) At the balance sheet date, the group has unused tax losses of £2,408,000 (2005: £3,674,000) available for offset against future profits. A deferred tax asset has been recognised in respect of £2,408,000 (2005: £3,674,000) of such losses, on the basis that those entities in which the losses reside will be profitable in the future. At 31 December 2006, the aggregate amount of temporary differences associated with the undistributed earnings of overseas subsidiaries for which deferred tax liabilities have not been recognised was £15,595,000 (2005: £14,622,000). No liability has been recognised in respect of these differences because the group is in a position to control the timing of the reversal of the temporary differences and it is probable that such differences will not reverse in the foreseeable future. 22. Obligations under finance leases Minimum lease payments 2006 £’000 2005 £’000 Amounts payable under finance leases: Within one year In the second to fifth years inclusive Less: amount due for settlement within twelve months (shown under current liabilities) Amount due for settlement after twelve months 468 267 735 (468) 267 556 681 1,237 (556) 681 The amounts included above are not considered to be materially different from the present value of minimum lease payments. It is the group’s policy to lease certain of its fixtures and equipment under finance leases. The average lease term is five years. For the year ended 31 December 2006 the average effective borrowing rate was 6.1% (2005: 5.8%). Interest rates are fixed at the contract date. All leases are on a fixed repayment basis and no arrangements have been entered into for contingent rental payments. The majority of lease obligations are denominated in Swedish kronor. The fair value of the group’s lease obligations approximates their carrying amount. The group’s obligations under finance leases are secured by the lessors’ rights over the leased assets. 52 for the year ended 31 December 2006 23. Trade and other payables Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 2006 £’000 2005 £’000 Trade creditors and accruals 7,928 7,875 Trade creditors and accruals principally comprise amounts outstanding for trade purchases and ongoing costs. The average credit taken for trade purchases is 34 days (2005: 53 days). The directors consider that the carrying amount of trade payables approximates to their fair value. 24. Other financial liabilities Other financial liabilities consist of a Sterling loan of £1,050,000 (2005: £nil). The borrowings are repayable as follows: £’000 Within one year In the second year In the third to fifth years inclusive Less: amount due for settlement within twelve months (shown under current liabilities) Amount due for settlement after twelve months The amounts included above are not considered to be materially different from the present value of the loan repayments. This loan was arranged at a fixed interest rate and exposes the group to fair value interest rate risk. The directors estimate that the fair value of the group’s borrowings is not materially different from the amounts disclosed above. 185 197 668 1,050 (185) 865 The loan was taken out on 29 December 2006. Repayments commenced on 8 January 2007 and will continue until 30 November 2011, with repayments being made in 60 equal monthly instalments. The loan is secured by a charge over certain of the group’s capital equipment. The loan carries fixed interest rate at 6.2% per annum. The group had undrawn committed borrowing facilities at 31 December 2006 of £2.0m (2005: £2.0m) in respect of which all conditions precedent had been met. The facility is scheduled for review by 2 May 2007. 25. Provisions Warranty provision £’000 At 1 January 2006 Additional provision in the year Utilisation of provision At 31 December 2006 120 259 (170) 209 The warranty provision represents management’s best estimate of the group’s liability under twelve month warranties granted on printheads, based on past experience of returns for defective products. 26. Share capital 2006 £’000 2005 £’000 Authorised: 70,000,000 ordinary shares of 10.0p each Issued and fully paid: 62,011,567 (2005: 61,146,281) ordinary shares of 10.0p each The movement during the year on the company’s issued and fully paid shares was as follows: 2006 Number 7,000 6,201 2006 £’000 7,000 6,115 2005 £’000 At beginning of year Exercise of share options At end of year The company has one class of ordinary shares which carry no right to fixed income. 61,146,281 865,286 62,011,567 6,115 86 6,201 6,013 102 6,115 Xaar plc Annual Report and Accounts 2006 53 Options have been granted under separate share option schemes to subscribe for ordinary shares of the company as follows: Number of shares under option Subscription price per share Scheme Date of grant Xaar plc 1997 Share Option Scheme 20.10.99 18.04.00 18.12.00 16.02.01 22.02.02 21.05.02 12.06.02 19.11.02 06.10.03 03.11.03 20.05.04 28.10.04 15.03.05 13.04.05 15.09.05 03.04.06 09.10.06 01.11.03 01.11.04 15.03.05 Xaar plc 2004 Share Option Plan Xaar plc Share Save Scheme Options granted outside the 1997, 2004 and Share Save Schemes Total share options outstanding at 31 December 2006 20,000 50,000 25,000 20,000 100,000 250,000 100,000 48,800 600,000 50,000 1,263,800 570,000 360,000 139,791 82,962 558,356 248,788 550,000 2,509,897 101,154 72,762 173,916 130,209 4,077,822 115.0p 279.0p 142.0p 160.0p 74.0p 71.5p 68.5p 25.0p 36.0p 36.0p 84.0p 109.0p 192.0p 208.5p 274.0p 294.0p 169.0p 29.0p 99.0p 192.0p Options under the Xaar plc 1997 Share Option Scheme are exercisable within three to seven years after the date of the grant, except that approved options and unapproved options granted after 27 March 2001 are exercisable within three to ten years after the date of the grant. Options granted under the Xaar plc 2004 Share Option Plan are exercisable within three to ten years after the date of the grant. The maximum value of approved options, under the Xaar plc 1997 Share Scheme and the Xaar plc 2004 Share Option Plan, which may be granted to individual employees is £30,000. Options granted outside the 1997, 2004 and Share Save Schemes are exercisable within three to ten years after the date of grant. Options under the Xaar plc Share Save Scheme are exercisable between 36 and 42 months after the date of the grant. 27. Share premium account £’000 Balance at 1 January 2006 Premium arising on issue of equity shares Balance at 31 December 2006 28. Own shares 9,376 293 9,669 £’000 Balance at 1 January and 31 December 2006 (3,420) Of this balance, £20,000 (2005: £20,000) represents 91,250 ordinary shares in Xaar plc held in trust by Xaar Trustee Ltd. Xaar Trustee Ltd was formed in 1995 to act as trustee to the Employee Benefit Trust established in 1995 to hold shares for the benefit of the employees of the company and the group. There has been no movement in the number of shares held in trust by Xaar Trustee Ltd during the year. The remaining balance of £3,400,000 (2005: £3,400,000) represents the cost of 1,205,504 shares in Xaar plc purchased in the market at market value and held by the Xaar plc ESOP trust to satisfy options granted under the company’s share option schemes. There has been no movement in the number of shares held in trust by the Xaar plc ESOP trust during the year. 54 for the year ended 31 December 2006 29. Hedging and translation reserves Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued Hedging reserve £’000 Translation reserve £’000 Total £’000 Balance at 1 January 2005 Exchange differences on translation of overseas operations Decrease in fair value of hedging derivatives Deferred tax asset recognised Balance at 1 January 2006 Exchange differences on translation of overseas operations Movement in fair value of hedging derivatives taken to income statement Deferred tax asset released Balance at 31 December 2006 1,348 — (2,545) 360 (837) — 1,197 (360) — (136) 842 — — 706 (113) — — 593 1,212 842 (2,545) 360 (131) (113) 1,197 (360) 593 The hedging reserve at the balance sheet date represents the market value of the group’s foreign currency hedges at that date. The translation reserve represents the foreign exchange difference arising on the translation of subsidiary company results prepared in a currency other than Sterling. 30. Retained earnings and other reserves Merger Share-based reserve payments £’000 £’000 Other reserves £’000 Total other reserves £’000 Retained earnings £’000 Total £’000 Balance at 1 January 2005 Net profit for the year Dividends paid Deferred tax asset taken directly to equity Movement in valuation of share options Balance at 1 January 2006 Net profit for the year Dividends paid Deferred tax asset taken directly to equity Movement in valuation of share options Balance at 31 December 2006 1,105 — — — — 1,105 — — — — 1,105 294 — — — 502 796 — — — 711 1,507 485 — — — — 485 — — — — 485 1,884 — — — 502 2,386 — — — 711 3,097 5,452 7,049 (604) 1,330 — 13,227 4,844 (903) (55) — 17,113 7,336 7,049 (604) 1,330 502 15,613 4,844 (903) (55) 711 20,210 The merger reserve and other reserves are not distributable. The merger reserve represents the share premium account in Xaar Technology Limited. The share-based payment reserve represents the movement in valuation of share options and other reserves represent the non-distributable portion of the dividend received in Xaar plc from Xaar Digital Ltd. 31. Notes to the cash flow statement 2006 £’000 2005 £’000 Operating profit Adjustments for: Share-based payments Depreciation of property, plant and equipment Amortisation of intangible assets Loss on disposal of property, plant and equipment Increase in provisions Operating cash flows before movements in working capital Increase in inventories Decrease/(increase) in receivables Increase in payables Cash generated by operations Income taxes paid Interest paid Net cash from operating activities 6,577 711 1,998 785 15 89 10,175 (814) 1,944 77 11,382 (2,576) (114) 8,692 10,479 502 1,936 404 103 66 13,490 (556) (4,867) 681 8,748 (823) (63) 7,862 Cash and cash equivalents (which are presented as a single class of asset on the face of the balance sheet) comprise cash at bank and other short term highly liquid investments with a maturity of three months or less. Xaar plc Annual Report and Accounts 2006 55 32. Operating lease arrangements 2006 £’000 2005 £’000 Minimum lease payments under operating leases recognised in income for the year: Fixtures, fittings and equipment Land and buildings 90 1,227 1,317 108 978 1,086 At the balance sheet date, the group had outstanding commitments for future minimum lease payments under non-cancellable operating leases, which fall due as follows: Fixtures, fittings and equipment 2006 £’000 2005 £’000 Land and buildings 2006 £’000 2005 £’000 Within one year In the second to fifth years inclusive After five years 128 115 — 243 59 58 — 117 1,291 3,435 3,147 7,873 1,095 3,312 3,078 7,485 The operating leases in respect of fixtures, fittings and equipment extend over a period of up to three years. 33. Share-based payments Equity-settled share option scheme The company’s share option schemes are open to all employees of the group. Options are exercisable at a price equal to the average quoted market price of the company’s shares on the date of grant. The vesting period is three years. If the options remain unexercised after a period of ten years from the date of grant, or 42 months in the case of the Share Save Scheme, the options expire. Save as permitted in the share option scheme rules options lapse on an employee leaving the group. Details of the share options outstanding during the year are as follows: 2006 Number of share options Weighted average exercise price (£) Number of share options 2005 Weighted average exercise price (£) Outstanding at beginning of period Adjustment to options outstanding at beginning of period* Granted during the period Lapsed during the period Exercised during the period Outstanding at the end of the period Exercisable at the end of the period 4,581,492 (265,779) 800,885 (173,490) (865,286) 4,077,822 1,263,800 1.17 2.73 2.08 1.49 0.44 1.39 0.63 4,500,729 — 1,242,500 (142,872) (1,018,865) 4,581,492 833,400 0.69 — 2.51 0.75 0.75 1.17 0.76 The weighted average share price at the date of exercise for share options exercised during the period was £2.45. The options outstanding at 31 December 2006 had a weighted average remaining contractual life of seven years. In 2006, options were granted on 3 April and 9 October. The aggregate of the estimated fair values of the options granted on those dates is £0.8m. In 2005, options were granted on 15 March, 13 April and 15 September. The aggregate of the estimated fair values of the options granted on those dates is £1.1m. * This adjustment corrects a misstatement in the number of options reported as granted in 2005. The performance conditions relating to the above share options are given on page 27. 56 for the year ended 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes to the consolidated financial statements continued 33. Share-based payments continued Equity-settled share option scheme continued The inputs into the Black-Scholes model are as follows: 2006 2005 Weighted average share price Weighted average exercise price Expected volatility Expected life Risk free rate Expected dividends £2.07 £2.08 40% 6.5 years 4.8% 0.1% £2.53 £2.51 60% 6.5 years 4.8% — Expected volatility was determined by calculating the historical volatility of the group’s share price over periods ranging from the previous one to three years. The expected life used in the model has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations. The group recognised total expenses of £0.7m (2005: £0.5m) related to equity-settled share-based payment transactions in the year. 34. Retirement benefit schemes Defined contribution schemes The UK based employees of the group’s UK companies have the option to be members of a defined contribution pension scheme managed by a third party pension provider. For each employee who is a member of the scheme the company will contribute a fixed percentage of each employee’s salary to the scheme. The only obligation of the group with respect to this scheme is to make the specified contributions. The employees of the group’s subsidiaries in Sweden are members of a state-managed retirement benefit scheme operated by the government of Sweden. The subsidiaries are required to contribute a specified percentage of payroll costs to the retirement benefit scheme to fund the benefits. The only obligation of the group with respect to the retirement benefit scheme is to make the specified contributions. The total cost charged to the income statement in respect of these schemes during 2006 was £506,000 (2005: £549,000). As at 31 December 2006 contributions of £35,000 (2005: £32,000) due in respect of the current reporting period had not been paid over to the schemes. 35. Related party transactions Transactions between the company and its subsidiaries, which are related parties, have been eliminated on consolidation and are not disclosed in this Note. There were no transactions during the year with related parties who are not members of the group. Remuneration of key management personnel The remuneration of the executive team, who are the key management personnel of the group, is set out below in aggregate for each of the categories specified in IAS 24 “Related Party Disclosures”. Further information about the remuneration of individual directors is provided in the audited part of the Directors’ remuneration report on pages 29 to 30. 2006 £’000 2005 £’000 Short term employee benefits Post-employment benefits Termination benefits Share-based payments 992 83 — 321 1,396 1,209 69 139 722 2,139 Xaar plc Annual Report and Accounts 2006 57 Independent auditors’ report (company) to the members of Xaar plc We have audited the parent company financial statements of Xaar plc for the year ended 31 December 2006 which comprise the company balance sheet and the related Notes 1 to 9. These parent company financial statements have been prepared under the accounting policies set out therein. We have also audited the information in the Directors’ remuneration report in the Consolidated financial statements that is described as having been audited. We have reported separately on the group financial statements of Xaar plc for the year ended 31 December 2006. This report is made solely to the company’s members, as a body, in accordance with section 235 of the Companies Act 1985. Our audit work has been undertaken so that we might state to the company’s members those matters we are required to state to them in an auditors’ report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the company and the company’s members as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors The directors are responsible for preparing the annual report, the Directors’ remuneration report and the parent company financial statements in accordance with applicable United Kingdom law and Accounting Standards (United Kingdom Generally Accepted Accounting Practice) as set out in the Statement of directors’ responsibilities. Our responsibility is to audit the parent company financial statements and the part of the Directors’ remuneration report to be audited in accordance with relevant legal and regulatory requirements and International Standards on Auditing (UK and Ireland). We report to you our opinion as to whether the parent company financial statements give a true and fair view, the parent company financial statements and the part of the Directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985 and whether the information given in the parent company Directors’ report is consistent with the financial statements. The information given in the Directors’ report includes that specific information presented in the Chairman’s statement, the Review of operations and the Financial review that is cross referred from the Principal activity and business review section of the Directors’ report. We also report to you if, in our opinion, 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 other transactions is not disclosed. We read other information contained in the annual report and consider whether it is consistent with the audited parent company financial statements. The other information comprises only the Chairman’s statement, the Review of operations, the Financial review, the Corporate governance statement and the unaudited part of the Directors’ remuneration report . We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the parent company financial statements. Our responsibilities do not extend to any other information. 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 parent company financial statements and the part of the Directors’ remuneration report to be audited. It also includes an assessment of the significant estimates and judgements made by the directors in the preparation of the parent 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 parent company financial statements and the part of the Directors’ remuneration report to be audited are free from material misstatement, whether caused by fraud or other irregularity or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the parent company financial statements and the part of the Directors’ remuneration report to be audited. Opinion In our opinion:  the parent company financial statements give a true and fair view, in accordance with United Kingdom Generally Accepted Accounting Practice, of the state of the company’s affairs as at 31 December 2006;  the parent company financial statements and the part of the Directors’ remuneration report to be audited have been properly prepared in accordance with the Companies Act 1985; and  the information given in the Directors’ report is consistent with the parent company financial statements. Ernst & Young LLP Registered auditor Cambridge 14 March 2007 58 Company balance sheet (UK GAAP) as at 31 December 2006 Xaar plc Annual Report and Accounts 2006 Notes 2006 £’000 As restated 2005 £’000 Fixed assets Investments in subsidiaries Trade investments Current assets Debtors – due within one year Debtors – due after one year Cash at bank and in hand Creditors: amounts falling due within one year Net current assets Creditors: amounts falling due after more than one year Net assets Capital and reserves Called-up share capital Share premium account Other reserves Own shares Share-based payment reserve Profit and loss account Equity shareholders’ funds 3 3 12,445 1,931 14,376 5,123 11,325 11,095 27,543 (1,107) 26,436 (865) 39,947 6,201 9,669 25,333 (3,400) 1,507 637 39,947 12,450 1,377 13,827 2,593 11,587 11,037 25,217 (308) 24,909 — 38,736 6,115 9,376 25,333 (3,400) 796 516 38,736 4 4 5 5 6 6 6 6 6 6 8 The financial statements were approved by the of directors on 14 March 2007 and signed on its behalf by: I Dinwoodie Director 14 March 2007 N Berry Director The accompanying Notes are an integral part of this balance sheet. Xaar plc Annual Report and Accounts 2006 59 Notes to the (UK GAAP) company balance sheet 1. Significant accounting policies Basis of accounting The separate financial statements of the company are presented as required by the Companies Act 1985. They have been prepared under the historical cost convention and in accordance with applicable United Kingdom Accounting Standards and law. The principal accounting policies are summarised below. They have all been applied consistently throughout the year and the proceeding year. Own shares Own shares are deducted from equity. No gain or loss is recognised in the income statement on the purchase, sale, issue or cancellation of the company’s own shares. Share-based payments The company has applied the requirements of FRS 20 “Share-based payment”. In accordance with the transitional provisions, FRS 20 has been applied to all grants of equity instruments after 7 November 2002 that were unvested at 1 January 2005. The company issues equity-settled share-based payments to certain employees. These payments are measured at fair value (excluding the effect of non market-based vesting conditions) at the date of grant. The fair value determined at the grant date of the equity-settled share-based payments is expensed on a straight-line basis over the vesting period, based on the company’s estimate of the shares that will eventually vest and adjusted for the effect of non market-based vesting conditions. Fair value is measured using the Black-Scholes pricing model. The expected life used in the model has been adjusted, based on management’s best estimate, for the effects of non-transferability, exercise restrictions and behavioural considerations. Taxation Current tax, including UK corporation tax and foreign tax, is provided at amounts expected to be paid (or recovered) using the tax rates and laws that have been enacted or substantively enacted by the balance sheet date. Deferred taxation is provided in full on timing differences that result in an obligation at the balance sheet date to pay more tax, or a right to pay less tax, at a future date, at rates expected to apply when the timing differences crystallise based on current tax rates and law. Timing differences arise from the inclusion of items of income and expenditure in taxation computations in periods different from those in which they are included in financial statements. Deferred tax assets and liabilities are not discounted. Investments Fixed asset investments in subsidiaries are shown at cost less provision for impairment. For investments in subsidiaries acquired for consideration, including the issue of shares qualifying for merger relief, cost is measured by reference to the nominal value only of the shares issued. Any premium is ignored. 2. Profit for the year As permitted by section 230 of the Companies Act 1985 the company has elected not to present its own profit and loss account for the year. Xaar plc reported a profit for the financial year ended 31 December 2006 of £24,000 (2005: £297,000). The average number of employees throughout 2006 was 18 (2005: 17). Staff costs amounted to £1.5m (2005: £1.1m). Information about the remuneration of directors is provided in the audited part of the Directors’ remuneration report on pages 29 to 30 of the Consolidated financial statements. The audit fee for the company in 2006 was £17,000 (2005: £17,000). 3. Fixed asset investments 2006 £’000 2005 £’000 Subsidiary undertakings At beginning of year Subsidiary undertakings disposed of in the year At end of year Trade investments At beginning of year Investments purchased in the year At end of year 12,450 (5) 12,445 1,377 554 1,931 12,450 — 12,450 — 1,377 1,377 60 Xaar plc Annual Report and Accounts 2006 Notes to the (UK GAAP) company balance sheet continued 4. Debtors 2006 £’000 2005 £’000 Amounts receivable within one year Amounts owed by group undertakings Prepayments and accrued income VAT Amounts receivable after more than one year Amounts owed by group undertakings 5,067 32 24 5,123 11,325 16,448 2,546 41 6 2,593 11,587 14,180 Amounts receivable after more than one year are in respect of a five year loan note granted to Xaar Digital Ltd, which can be repaid early at the option of Xaar Digital Ltd. 5. Creditors 2006 £’000 2005 £’000 Amounts falling due within one year Trade creditors Accruals Financial liabilities Amounts falling due after more than one year Financial liabilities For additional disclosures relating to financial liabilities, see Note 24 in the Consolidated financial statements. 6. Capital and reserves Called-up share capital £’000 Share premium account £’000 Other reserves £’000 136 786 185 1,107 865 1,972 41 267 — 308 — 308 As restated As restated Own Share-based Profit and shares payments loss account £’000 £’000 £’000 Total £’000 At 1 January 2005 Transfer to share-based payment reserve At 1 January 2005, as restated New shares issued Own shares acquired Dividends paid Profit for the financial year Share-based payments At 1 January 2006 New shares issued Dividends paid Dividends received Profit for the financial year Share-based payments At 31 December 2006 6,013 — 6,013 102 — — — — 6,115 86 — — — — 6,201 8,713 — 8,713 663 — — — — 9,376 293 — — — — 9,669 25,333 — 25,333 — — — — — 25,333 — — — — — 25,333 — — — — (3,400) — — — (3,400) — — — — — (3,400) — 294 294 — — — — 502 796 — — — — 711 1,507 1,114 (294) 820 — — (601) 297 — 516 — (903) 1,000 24 — 637 41,173 — 41,173 765 (3,400) (601) 297 502 38,736 379 (903) 1,000 24 711 39,947 Full details of movements in share capital and the share option schemes are given in Note 26 to the Consolidated financial statements. The share premium account and other reserves are non-distributable. In order to create a separate share-based payment reserve, for consistency with the Consolidated financial statements, the share-based payment charge has been transferred from the profit and loss account to a seperate reserve. Details of share-based payments are given in Note 33 of the Consolidated financial statements. Xaar plc Annual Report and Accounts 2006 61 7. Dividends 2006 £’000 2005 £’000 Amounts recognised as distributions to equity holders in the period: Final dividend for the year ended 31 December 2005 of 1.5p (2004: 1.0p) per share Proposed final dividend for the year ended 31 December 2006 of 2.0p (2005: 1.5p) per share 903 1,240 601 909 The proposed final dividend is subject to approval by shareholders at the AGM and has not been included as a liability in these financial statements. 8. Reconciliation of movements in shareholders’ funds 2006 £’000 2005 £’000 Profit for the financial year Share-based payments Dividends paid Dividends received New shares issued Own shares acquired Net addition/(reduction) to shareholders’ funds Opening shareholders’ funds Closing shareholders’ funds 9. Subsidiary undertakings The following entities are wholly-owned subsidiary undertakings of the company: Name and country of incorporation Principal activity Issued and fully paid up share capital 24 711 (903) 1,000 379 — 1,211 38,736 39,947 297 502 (601) — 765 (3,400) (2,437) 41,173 38,736 Proportion of ordinary share capital held by the company Xaar Technology Limited Great Britain XaarJet Limited Great Britain XaarJet (Overseas) Limited Great Britain Xaar Trustee Limited1 Great Britain Xaar Digital Limited Great Britain Xaar group AB Sweden XaarJet AB2 Sweden Xaar Americas Inc. USA 1. 2. Research and development Research and development & sales and marketing Sales and marketing Trustee Treasury Holding company Manufacturing Sales and marketing 4,445,322 ordinary £1 shares 2 ordinary £1 shares 1 ordinary £1 share 2 ordinary £1 shares 1 ordinary £1 share 1,137,000 ordinary shares of SEK 100 each 1,000 ordinary shares of SEK 100 each 10,000 shares of common stock US $1 each 100% 100% 100% 100% 100% 100% 100% 100% Xaar Trustee Limited shares are held by Xaar Technology Limited. XaarJet AB shares are held by Xaar group AB. 62 Five year record 2006 £’000 IFRS 2005 £’000 IFRS Xaar plc Annual Report and Accounts 2006 2004 £’000 IFRS 2003 £’000 UK GAAP 2002 £’000 UK GAAP Summarised consolidated results Results Turnover Gross profit Operating profit/(loss) Abortive deal costs Foreign exchange (loss)/gain on inter-company loan Net interest Taxation Dividends Basic earnings per share Assets employed Property, plant and equipment Cash and short term investments Net current assets Financed by Shareholders’ funds: all equity 42,207 24,111 6,577 (298) — 335 (2,068) (903) 7.9p 11,990 12,438 12,966 33,253 42,772 26,649 10,479 — (977) 513 (2,966) (604) 11.6p 6,436 14,395 13,693 27,553 34,812 19,734 6,294 — (231) 206 (1,658) — 7.7p 5,624 15,316 15,295 23,254 29,230 13,475 (1,300) — 1,791 (45) 501 — 1.6p 6,090 8,458 11,506 16,994 30,870 14,100 785 — — 140 86 — 1.7p 4,733 9,852 12,232 17,339 The amounts disclosed for 2003 and earlier periods are stated on the basis of UK GAAP because it is not practicable to restate amounts for periods prior to the date of transition to IFRS. Xaar plc Annual Report and Accounts 2006 63 Notice of Annual General Meeting Notice is hereby given that the tenth AGM of Xaar plc (the “company”) will be held at The Trinity Centre, Science Park, Milton Road, Cambridge on 23 April 2007 at 10.30am for the following purposes: Ordinary business 1. To receive the company’s annual financial statements for the financial year ended 31 December 2006, together with the Directors’ report, the Directors’ remuneration report, the Independent auditors’ report on the auditable part of the Directors’ remuneration report and the Independent auditors’ report on those financial statements. 2. To reappoint Ernst & Young LLP as auditors to hold office from the conclusion of this meeting until the conclusion of the next general meeting of the company at which financial statements are laid and to authorise the directors to fix their remuneration. 3. To declare a final dividend for the financial year ended 31 December 2006 of 2.0p per ordinary share. 4. To reappoint as a director in accordance with the company’s articles of association S Temple, who is retiring by rotation. 5. To reappoint as a director in accordance with the company’s articles of association P Eaves, who is retiring by rotation. 6. To reappoint R King as a director in accordance with corporate governance best practice for directors over the age of 70. Special business To consider and, if thought fit, pass the following Resolutions which will be proposed in the case of Resolutions 7, 9, 10 and 11 as Ordinary Resolutions and in the case of Resolutions 8 and 12 as Special Resolutions: 7. To approve the Directors’ remuneration report in accordance with section 241a of the Companies Act 1985. 8. That the company be generally and unconditionally authorised to make one or more market purchases (within the meaning of s.163(3) of the Companies Act 1985) of ordinary shares of 10.0p in the capital of the company (“ordinary shares”) provided that:  the maximum aggregate number of ordinary shares authorised to be purchased is 9,239,723 (representing 14.9% of the issued ordinary share capital);  the minimum price which may be paid for an ordinary share is the par value of the shares;  the maximum price which may be paid for an ordinary share is an amount equal to 105% of the average of the middle market quotations for an ordinary share as derived from The London Stock Exchange Daily Official List for the five business days immediately preceding the day on which that ordinary share is purchased;  this authority expires at the conclusion of the next Annual General Meeting of the company or within 15 months from the date of the passing of this Resolution whichever is earlier; and  the company may make a contract to purchase ordinary shares under this authority before the expiry of the authority which will or may be executed wholly or partly after the expiry of the authority, and may make a purchase of ordinary shares in pursuance of any such contract. 9. That the Xaar 2007 Share Save Plan (the “Share Save Plan”), the main features of which are summarised in the Directors’ report, be and is hereby approved and the directors be and are hereby authorised to establish further schemes for the benefit of employees outside the United Kingdom based on the Share Save Plan, but modified to the extent necessary or desirable to take account of non-United Kingdom tax, securities and exchange control laws and regulations, provided that such schemes must operate within the limits on individual and overall participation in the Share Save Plan. 10. That the Xaar 2007 Long Term Incentive Plan (the “LTIP”), the main features of which are summarised in the Directors’ report, be and is hereby approved and the directors be and are hereby authorised to establish further schemes for the benefit of the employees outside the United Kingdom based on the LTIP but modified to the extent necessary or desirable to take account of non-United Kingdom tax, securities and exchange control laws , and regulations, provided that such schemes must operate within the limits on individual and overall participation in the LTIP . 11. That in substitution for all existing authorities the authority conferred on the directors by article 4(B) of the company’s articles of association be renewed for the period expiring 15 months after the date of the passing of this Resolution and for that period the ”section 80 amount” is £798,843. The company may, before the expiry of this authority, make an offer or agreement which would or might require equity or other relevant securities to be allotted after the expiry of this authority and the directors may allot equity or other relevant securities in pursuance of that offer or agreement as if the power conferred by this Resolution had not expired. 64 Xaar plc Annual Report and Accounts 2006 Notice of Annual General Meeting continued 12. That subject to the passing of Resolution 11, the power conferred on the directors by article 4(C) of the company’s articles of association be renewed for the period expiring 15 months after the date of the passing of this Resolution and for that period the ”section 89 amount” is £310,058. The company may, before the expiry of this authority, make an offer or agreement which would or might require equity or other relevant securities to be allotted after the expiry of this authority and the directors may allot equity or other relevant securities in pursuance of that offer or agreement as if the power conferred by this Resolution had not expired. By order of the board A Taylor Secretary 14 March 2007 Notes 1. A member entitled to attend and vote at the meeting is also entitled to appoint one or more proxies to attend and, on a poll, vote instead of him. The proxy need not be a member of the company. 2. To be effective, the instrument appointing a proxy and any authority under which it is executed (or a notarially certified copy of such authority) must be deposited at the office of the company’s registrars not less than 48 hours before the time for holding the meeting or adjourned meeting. A form of proxy is enclosed with this notice. Completion and return of the form of proxy will not preclude ordinary shareholders from attending and voting in person. 3. In accordance with Regulation 41 of the Uncertified Securities Regulations 2001, the company specifies that only those members entered on the register of members of the company as at 10.30am on 19 April 2007 (or in the event the meeting is adjourned, on the register of members 48 hours before the time of any adjourned meeting) shall be entitled to attend or vote at the meeting in respect of the number of shares registered in their name at that time. Changes to entries on the register of members after 10.30am on 19 April 2007 (or in the event the meeting is adjourned, on the register of members less than 48 hours before the time of any adjourned meeting) shall be disregarded in determining the rights of any person to attend or vote at the meeting. 4. Copies of directors’ service agreements, the terms of appointment of non-executive directors, the register of directors’ interests and the Xaar plc 2004 Share Option Plan kept by the company under section 325 of the Companies Act 1985 will be available 15 minutes prior to the commencement of the meeting and will remain open and accessible during the continuance of the meeting to any person attending the meeting. 5. Biographical details of all directors offering themselves for re-appointment are set out on page 15. Advisors Registered office Science Park Cambridge CB4 0XR Registered number 3320972 Secretary A Taylor Financial advisor and lead broker Panmure Gordon & Co Moorgate Hall 155 Moorgate London EC2M 6XB Registered auditors Ernst & Young LLP Compass House 80 Newmarket Road Cambridge CB5 8DZ Solicitors Clifford Chance LLP 10 Upper Bank Street London E14 5JJ Mills & Reeve Francis House 112 Hills Road Cambridge CB2 1PH Bankers Barclays Bank plc 15 Bene’t Street Cambridge CB2 3PZ Registrars Capita Registrars The Registry 34 Beckenham Road Beckenham BR3 4TU Xaar plc Science Park Cambridge CB4 0XR England Tel: Fax: +44 (0) 1223 423663 +44 (0) 1223 423590 Email: info@xaar.co.uk Website: www.xaar.co.uk