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Report on remuneration

Introduction

This report has been prepared in accordance with the Accounting Regulations of the Companies Act 2006 (the "Act") and complies with the Combined Code on Corporate Governance. 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 relating to Directors’ remuneration under the Directors’ Remuneration Report Regulations 2002. As required by the Act, a resolution to approve this report will be proposed at the Annual General Meeting of the Group at which the financial statements will be approved.

The Act requires the auditors to report to the Group’s members on certain parts of the Report on remuneration and state whether in their opinion those parts of the report have been properly prepared in accordance with the Companies Act 2006. The report has, therefore, been divided into separate sections for unaudited and audited information.

Unaudited information

Remuneration Committee

The Remuneration Committee (the "Committee") consists entirely of NEDs and is constituted in accordance with the recommendations of the Combined Code. The Committee is formally constituted with written terms of reference and its main responsibilities are detailed below. Its members for the year ended 31 March 2011 were Dr Foden (Chair), Dr Brown, Mr Cashman, Dr Richards and Mr Warner with effect from 1 February 2011.

The Committee is responsible for:

• setting a remuneration strategy that ensures that talented executives are recruited, retained and motivated to deliver results;
• ensuring that the remuneration for the Executive Directors and other senior executives reflects both their individual performance and their contribution to the overall Company results;
• determining the terms of employment and remuneration for the Executive Directors and senior executives including recruitment and retention terms;
• approving the design and targets for any annual incentive schemes that include the Executive Directors and senior executives;
• agreeing the design and targets, where applicable, of all share incentive plans requiring shareholder approval;
• assessing the appropriateness and subsequent achievement of the performance targets related to any share incentive plans;
• recommending to the Board the fees paid to the Chairman. The Chairman is excluded from this process; and
• the selection and appointment of the external advisors to the Committee to provide independent remuneration advice where necessary.

The Committee members have no personal financial interests other than as shareholders in matters to be decided, no potential conflicts of interests arising from cross directorships and no day-to-day involvement in running the business. No Director plays a part in any discussion about his or her own remuneration.

The fees of the Non-Executive Directors are determined by the Board on the joint recommendation of the Chairman and the Chief Executive.

The Committee met formally four times during the year ended 31 March 2011.

A summary of the matters considered at each of those meetings is set out below.

Current approach to remuneration policy

When determining the structure and level of the Executive Directors’ remuneration, the Committee has regard to compensation packages in the UK pharmaceutical and biotech sectors.

In determining the Group’s current policy, and in constructing the remuneration arrangements of each Executive Director and senior employee, the Board, advised by the Committee, aims to provide remuneration packages that are competitive and designed to attract, retain and motivate Executive Directors and senior employees of the highest calibre. To achieve this objective, the Committee takes account of information from both internal and independent sources including Hay Group. Hay Group do not provide any other services to the Group. Since the year end date, the Committee has appointed Hewitt New Bridge Street to provide it with advice on executive remuneration.

The total remuneration of each individual Executive Director and senior employee is benchmarked against the relevant sector. Vectura’s policy is to provide remuneration generally at levels that are broadly aligned with the mid-points for equivalent roles in comparable companies in the UK.

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The Group’s policy is that a substantial proportion of the remuneration of Executive Directors and senior employees should be performance-related. Performance measures are balanced between internal measures and sector-comparative measures to achieve maximum alignment between executive and shareholder objectives. Base salaries are supplemented by bonuses based on the achievement of corporate goals set at the start of each year.

The diagram below shows the components of the remuneration package as a percentage of total remuneration. 56% of the Executive Directors’ total remuneration is performance-related.

Components of the current remuneration package

The principal components of remuneration packages are base salary, short and long-term incentives and pension benefits. The policy in relation to each of these components, and key terms of the various incentive and benefit programmes, is explained further below.

Basic salary

Basic salaries are reviewed annually, taking into account recommendations on individual performance against objectives and levels of responsibility, together with salary levels in comparable companies and other indicators as described above. The Committee also took into consideration pay and conditions throughout the Company in setting salary levels.

Each Executive Director’s base salary was broadly aligned with the mid-points of the chosen UK pharmaceutical sector comparator group and adjusted to reflect company size and complexity. Based on this data, for the year ended 31 March 2011 the Committee considered that Dr Blackwell and Ms Hyland could receive basic salary increases (2009/10: nil and nil). However, given the Company’s share price performance over the year to 31 March 2010, the Committee together with the Executive Directors agreed not to implement any increases to their salaries for the year to 31 March 2011.

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Performance-related cash bonuses

All employees are eligible for an annual discretionary cash bonus, whereby performance objectives are established at the beginning of the financial year by reference to suitably challenging corporate goals. Goals typically include revenue generation, development pipeline progress, partnering successes and control of cash expenditure, and are weighted towards goals with the highest corporate significance. Performance-related payments may be paid annually, dependent upon achievements measured against corporate goals. Bonus payments are not pensionable. The scheme is offered to all staff below board level with bonus award entitlements ranging between 10% and 50% of salary depending on grade. Cash bonuses are limited to a maximum of 100% of basic salary for each Executive Director.

For the year ended 31 March 2011 the performance objectives against which bonus payments were calculated were as follows:

The Committee also assessed that a bonus in the order of 62% of salary was appropriate when judged by the achievement of the above metrics and when looking at a broader picture of the Company’s corporate performance over the period.

Given the number of shares acquired for cash by the Executive Directors during the year ended 31 March 2011, the Remuneration Committee has not required any of the bonus payment for this year to be deferred into shares.

Long-Term Incentive Plan

Annually, Executive Directors and certain senior executives have been granted an award in the form of nil-cost options under the Vectura Group plc 2005 Long-Term Incentive Plan ("LTIP"). These awards are dependent on the achievement of a rigorous, predetermined set of performance conditions.

Performance conditions

At the end of a three-year performance period, a percentage of the shares so awarded is made available to the participating executives, dependent upon the Group’s Total Shareholder Return ("TSR") as compared to those of a comparator group of similar quoted UK pharmaceutical and biotechnology companies. Awards are released in accordance with the following table:

* Linear vesting between points

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In addition, the Committee is required to ensure that the underlying financial performance of the Group is consistent with its TSR performance, by considering the Group’s performance against a range of objective financial measures. These measures include revenue and cash generation. If the Committee believes that the underlying corporate financial performance is not consistent with its TSR performance, then no LTIP awards will be released.

PricewaterhouseCoopers report to the Committee annually on the TSR performance measurement.

These performance conditions have been selected for the following reasons:

• the Committee is keen that Executives are encouraged to focus on ensuring that the Company’s return to shareholders is competitive compared to comparable companies;
• participants will be rewarded only if the Company’s comparative performance is better than its competitors; even if the absolute value of the Company increases over the measurement period; and
• comparative total shareholder return is a measure operated in conjunction with the majority of LTIP schemes.

The current comparator group of companies to which the performance of Vectura Group plc is compared, valid for the awards made in 2008 and 2009 that have not yet reached the end of their holding periods, is as follows:

On 8 June 2010, shares were awarded to Dr Blackwell and Ms Hyland under the LTIP scheme, as further detailed in this report, below. Awards to each Executive Director are up to a maximum of 200% of salary with effect from May 2009 (previous maximum 100%) as approved by shareholders at the September 2008 AGM. The market price of the shares on 8 June 2010 was 38p. In addition to the performance decisions listed above, the following conditions apply to this award:

• the Company’s performance will be measured against the FTSE SmallCap Index rather than a comparator group of companies;
• the first 50% of the award will not vest if the average price of the Company’s shares for a three-month period before the date of vesting is less than £1.00. The second 50% of the award will not vest if the average price of the Company’s shares for the three-month period before the date of vesting is less than £1.27, and
• 50% of the award will vest after a performance period of three years. The second 50% will vest after a performance period of four years.

For the 2009 awards, made on 21 May 2009, the LTIP awards will not vest if the average price of the Company’s shares over the three-month period before the date of vesting is less than £1. The approach adopted in respect of the 2009 and 2010 awards ensures that even if the comparative TSR measure has been achieved, the Executive Directors will benefit from an LTIP award only if share price performance is strong.

The Remuneration Committee has determined that the award made on 8 June 2010 is the last to be made under the current scheme, which expired in September 2010. The Committee is considering introducing a new LTIP at the 2012 AGM.

For the three-year performance period ended in the year ended 31 March 2011, 63.0% of LTIP shares awarded in May 2007 were released.

In addition to the comparative TSR measures for these periods, the Committee also considered the underlying financial performance of the Group in its determination of the vesting of these LTIP awards. These included the 32% increase in revenues in the three years to 31 March 2011, and the fact that the Group increased its investment in its development activities whilst generating net cash inflow before financing activities in the same period.

Value Realisation Plan

On 31 October 2008, the shareholders approved the Vectura Group plc Value Realisation Plan ("VRP"). The VRP runs in parallel to the LTIP and provides participants with a share of a predetermined percentage of the total consideration paid for the Group in the event of a change in control. In this event, under the VRP members of the Executive Committee of the Group will be granted a one-off entitlement in the form of units, which convert into ordinary shares in Vectura Group plc, the actual number of shares that convert being linked to the offer price per share achieved. The VRP is triggered upon achievement of a minimum bid price of £1.27 per share, with a maximum number of shares available to participants if the bid price reaches or exceeds £1.77 per share. The VRP operates over a five-year period to 31 October 2013.

Share Incentive Plan

The Vectura Group plc Share Incentive Plan ("SIP") is available to all employees, including Executive Directors, for the purpose of encouraging employees to become shareholders of the Group and to retain their shares over the medium to long term. It introduces share ownership to the employee in three ways: free shares, partnership shares, and matching shares. Vectura Group plc may award free shares annually, employees may buy partnership shares out of pre-tax salary, and Vectura Group plc may match any partnership shares purchased in a year with the award of additional matching shares on a one-for-one basis. The SIP is an HMRC approved scheme through which benefits are provided in a tax efficient manner.

Sharesave Share Option Scheme

Vectura Group plc also operates a Sharesave ("SAYE") Share Option Scheme for both employees and Executive Directors. Under this Scheme all eligible employees and Executive Directors are invited to subscribe for options, which may be granted at a discount of up to 20% of market value and which vest after three years. The Sharesave Share Option Scheme is an all-employee plan to which performance conditions do not apply.

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Approved and Unapproved Share Option Plans and the EMI Plan

Executive Directors hold options under the Approved and Unapproved Share Option Plans and under Enterprise Management Incentive arrangements (the "EMI Plan").

Historically, before it was listed, Vectura Group plc granted NEDs share options as part of their remuneration package. At the early stage of the Group’s development this was considered to be essential to secure the recruitment and retention of high-calibre NEDs with the appropriate experience. This policy of granting share options to NEDs has not applied since the Group was publicly listed in 2004, and no further share option awards will be made to them. In this connection, reference should also be made to the Corporate governance statement. The options held by the NEDs have vested and are exercisable at any time. The Board does not believe that the retention of these fully vested options in any way compromises the independence of the NEDs concerned.

Historically, no performance conditions have been attached to the options granted under the above schemes. The exercise price is equal to the market value of Vectura Group plc’s shares at the time the options are granted.

Pension arrangements

All employees, including Executive Directors, are invited to participate in the Group Personal Pension Plan, which is moneypurchase in nature. The only pensionable element of remuneration is basic salary. During the year, the Group contributed 20% of basic salary to the Group Personal Pension Plan in the name of the Executive Directors.

Performance graph

The following graph shows Vectura Group plc’s performance since its initial listing in July 2004, measured by TSR, compared with the performance of the current comparator group of companies in the sector, as described above.

The following graph shows Vectura Group plc’s performance since 1 April 2010, measured by TSR, compared with the performance of the FTSE Small Cap, as described above. This index was chosen as Vectura is one of the constituent companies and the Committee feels that it is the most appropriate one against which to measure performance from June 2010.

Other information

Directors’ service contracts

It is the Group’s policy that Executive Directors should have contracts with an indefinite term and which provide for a maximum period of 12 months’ notice. This applies to the contracts of Dr Blackwell and Ms Hyland, which were effective from 25 June 2004. Executive Directors are subject to re-election at an AGM at intervals of no more than three years.

Awards made under the Company’s Long-Term Incentive Plan that have not been released at the date the Executive’s employment ceases lapse, unless the Remuneration Committee in its absolute discretion determines otherwise. The Executive has no entitlement to a bonus payment in the event that he ceases to be employed by the Company.

Dr Blackwell is also a Non-Executive Director of AGI Therapeutics plc for which he received no salary in the year to 31 March 2011 (2010: €7,500).

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Non-Executive Directors

All NEDs have specific terms of engagement which are terminable on three months’ notice by either party, and their remuneration is determined by the Board within the limits set by the Articles of Association and based on a review of fees paid to NEDs of similar companies. NEDs are not eligible to join the Group’s pension scheme, nor do they receive other benefits. All NEDs are subject to re-election at an AGM at intervals of no more than three years.

The dates of appointment of each of the NEDs serving at 31 March 2011 are summarised in the table below:

All of the NEDs are considered independent, including those with service greater than nine years. This is due to the major change in the operating activities of the Group that occurred with effect from July 2004 when the Company completed its Initial Public Offering.

Directors’ interests

The Directors who held office at 31 March 2011 and their interests in the share capital of Vectura Group plc at 31 March 2011 and 31 March 2010 were as follows:

⁽¹⁾ The holdings of C P Blackwell and A P Hyland include 39,982 ordinary shares of 0.025p each, which are held in the Vectura Group plc Employee Benefit Trust (Share Incentive Plan).

⁽²⁾ The holding of J R Brown includes 8,929 ordinary shares of 0.025p each, which are held through nominees.

There was no change in the Directors’ interests between 31 March 2011 and 22 May 2011, the date of this report.

Audited information

Directors’ remuneration

The remuneration of the individual Directors who served during the year was as follows:

* Included within the NEDs’ fees are the fees for chairing committees. Dr Brown received £15,000 for chairing the Audit
and Nomination Committees. Dr Foden received £7,500 for chairing the Remuneration Committee.

Also included in the above are fees for consultancy services of £2,000 (2010: £6,000) paid to Dr Foden, for the provision of specialist advice on intellectual property matters up to the period to 30 September 2010. Dr Foden is no longer providing consultancy services to the Group.

Benefits represent payments for medical insurance.

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Options

Directors holding office at 31 March 2011 with options outstanding over ordinary shares of 0.025p were as follows:

All options were granted for nil consideration.

⁽¹⁾ Vesting in three equal annual installments from date first exercisable.

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Directors’ pension entitlements

The money-purchase pension contributions paid by the Group for Executive Directors were as follows:

Directors’ LTIP awards

Under the LTIP scheme, the grants made to Directors at 31 March 2011 were as follows:

The number of shares released to the Directors at the end of the three-year performance period is dependent upon the performance TSR of the Group during that period in comparison to that of a comparator group of companies as described in the LTIP section of this Report on remuneration.

⁽¹⁾ The award made on 12 September 2005 reached the end of its holding period on 12 September 2008. The TSR of the Group during this period compared with that of the comparator group was in the upper quartile. Accordingly, 100% of the shares awarded were released. The nil-cost options relating to this award lapse on 11 September 2015.
⁽²⁾ The award made on 22 November 2006 reached the end of its holding period on 22 November 2009. The TSR of the Group during this period compared with that of the comparator group equated to 83.32% of the shares awarded being released. The nil-cost options relating to this award lapse on 21 November 2016.
⁽³⁾ The award made on 25 May 2007 reached the end of its holding period on 25 May 2010. The TSR of the Group during this period compared with that of the comparator group equated to 62.964% of the shares awarded being released. The nil-cost options relating to this award lapse on 25 May 2017.
⁽⁴⁾ On 15 June 2010, C P Blackwell and A P Hyland each exercised 95,000 nil-cost options. On the date of exercise, the market value of the Company’s shares was 43.5p per share. The total cost for each exercise was £21,087, including taxation, and the total nominal gain was £41,301 in each case.

On behalf of the Board

Dr S E Foden
Chair of the Remuneration Committee
22 May 2011

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