Meggitt
Annual Report 2014

Plain-text annual report

Company information Meggitt PLC Atlantic House Aviation Park West Bournemouth International Airport Christchurch Dorset BH23 6EW United Kingdom T +44 (0) 1202 597 597 F +44 (0) 1202 597 555 www.meggitt.com Registered in England and Wales Company number 432989 M E G G I T T P L C A N N U A L R E P O R T A N D A C C O U N T S | 2 0 1 4 Smart engineering is second nature to us. ANNUAL REPORT AND ACCOUNTS 2014 93987_Cover.indd 1 04/03/2015 16:10 Quick reference Contents What is Meggitt? How did we perform in 2014? 02 04 31 What is our strategy and business model? 06 08 What are our markets and what drives them? 10 How do we manage risk? What are our key performance indicators? 24 27 How do we perform as corporate citizens? 38 Who runs Meggitt and how do we reward them? 01-41 Strategic report 01 02 03 04 05 06-07 08-09 10-12 13-17 18-19 20-21 22-23 24-26 27-30 31-37 38-41 Introduction Group overview Capabilities Financial highlights Chairman’s statement Chief Executive’s review Group strategy Market review Meggitt divisions The Meggitt Production System Talent Technology Principal risks and uncertainties Key performance indicators Chief Financial Officer’s review Corporate responsibility 42-79 Governance reports Chairman’s introduction 43 Board of directors 44-45 Corporate governance report 46-50 Audit Committee report 51-53 Nominations Committee report 54 Directors’ remuneration report 55-75 Directors’ report 76-79 80-140 Financial statements 80-84 Group financial statements Independent auditors’ report to the members of Meggitt PLC Consolidated income statement 85 Consolidated statement of comprehensive income 86 Consolidated balance sheet 87 Consolidated statement of changes in equity 88 89 Consolidated cash flow statement 90-132 Notes to the consolidated financial statements 44 55 133 Company financial statements Independent auditors’ report to the members of Meggitt PLC Company balance sheet 134 135-140 Notes to the financial statements of the Company Smart engineering is second nature to us High pressure air travelling through the geometry of bleed air valves cast or machined in the traditional way is extremely noisy, something that will be familiar to those who live near airports. In future, air could flow more quietly through a radical new concept from Meggitt based on a fir-cone design, an organic structure made possible through additive layer manufacturing. The bold use of innovative processes forms part of Meggitt’s centrally coordinated and highly focused technology strategy. 141-144 Supplementary information 141 142 143-144 Glossary Five-year record Investor information Download the 2014 Meggitt PLC annual report and accounts from www.meggitt.com Designed by Hybrid Creative Typeset by Whitehouse Associates Printed by Pureprint The papers used for the production of this report are certified by the Forestry Stewardship Council® and are elemental chlorine free. They are produced at paper mills certified to ISO 14001 and registered to EMAS. 93987_Cover.indd 2 04/03/2015 16:10  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 1 Meggitt’s smart engineering for extreme environments attracted an unprecedented number of programme wins in the current civil aerospace cycle of new platform launches, making 2014 a year of accelerating new product introduction ready to meet the manufacturing ramp-up that will drive financial returns for the next decade and more. We will continue to focus on the industrialisation of new products in 2015, supported by the widening implementation of the Meggitt Production System (MPS). This combination of tried-and-tested business improvement methodologies tailored to Meggitt is fundamental to defining how we work throughout the Group. The system consists of six demanding phases, with the final Silver and Gold certifications delineating operations excellence as a defining, sustainable competitive advantage. While achieving gains in productivity and employee engagement wherever MPS has been introduced, we are at the beginning of a journey that will extend from the factory floor into every function and that will touch every Meggitt employee. Operations excellence at the core Across the Group, MPS has strengthened the foundations for greater operations excellence, giving us a comprehensive but flexible framework for continuous improvement. On-time-delivery and quality are up in many of our businesses as a result. MPS’ new global standards make our core stronger, creating a secure platform for growth. (See page 18). Making more of our talent MPS is also reshaping our culture. Our new operating system has renewed employee confidence and commitment. Increasing numbers of operators, supervisors and managers have the tools and processes they need to make a very personal contribution to improving the business and leaders now have more time to lead, spotting opportunities for growth and innovation. (See page 20). A new wave of technology The operational savings and productivity improvements won by MPS will allow us to invest more in innovation—what we make and how we make it. We’re looking ahead not only to product innovation but advances in how we make products. We are already investigating a new approach to manufacturing engineering, taking the first steps toward developing the factories of the future. (See page 22). 93987_p01-04.indd 1 04/03/2015 16:21 2 MEGGITT PLC REPORT AND ACCOUNTS 2014 Group overview Headquartered in the UK, Meggitt PLC is a global engineering group specialising in smart engineering for extreme environments— components and sub-systems providing critical functionality in challenging applications within civil aerospace, military and energy markets. Over 10,500 people are employed across manufacturing facilities in Asia, Europe and North America and in sales offices in Brazil, India and the Middle East. Our civil aerospace interests cover large commercial jets, regional aircraft, business jets, helicopters and general aviation. Our military markets encompass all aircraft types, land systems, naval platforms and aerial, land- based and marine threat simulation for personnel training and weapons systems development. Training extends to law enforcement and security organisations. The Group’s growing presence in energy is driven by core capabilities in control valves for industrial gas turbines; heat transfer engineering for oil and gas platforms and offshore gas processing and storage; and sensing and monitoring capabilities deployed in rotating power generation equipment. These promote safety and reduce maintenance costs, fuel consumption and carbon emissions. The transfer of Meggitt’s core technologies to other markets includes sensing materials for breakthrough medical devices and the test and measurement industry worldwide. Revenue by market Total revenue (£ millions) 1,553.7  Civil aerospace 741.2 | 48%  Military 539.4 | 34%  Energy and other 273.1 | 18% Revenue by destination Total revenue (£ millions) 1,553.7  USA 771.1 | 49%  UK 152.4 | 10%  Rest of Europe 338.1 | 22%  Rest of World 292.1 | 19% Employees by region Number of employees 10,823  USA 5,385 | 50%  UK 2,847 | 26%  Mainland Europe 1,554 | 14%  Rest of World 1,037 | 10% Total R&D as a % of revenue 14 13 12 11 10 9.5 8.2 7.6 7.6 7.2 93987_p01-04.indd 2 04/03/2015 16:21  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 3 Capabilities Just some of the smart sub-systems and critical components created by Meggitt. For the full picture, take our Meggitt-in-a-Minute e-tour. www.meggitt.com/e-tour  USA 771.1 | 49%  UK 152.4 | 10%  Rest of Europe 338.1 | 22%  Rest of World 292.1 | 19% PR TECT Aircraft safety and security Avionics Combat support BULLET Composites Fire protection Fuel containment Pressure up to Heat transfer engineering Ice protection Polymer seals Power products Precision micro metal engineering Sensing and health monitoring STRUCTURAL DESIGN MATERIALS TECHNOLOGY THERMAL MANAGEMENT Small arms training systems Thermal management and fluid control Wheels, brakes and brake control 93987_p01-04.indd 3 04/03/2015 16:21 4 MEGGITT PLC REPORT AND ACCOUNTS 2014 Financial highlights Meggitt’s 2014 results continued to demonstrate the breadth and resilience of its portfolio during a period when our suite of products is being substantially refreshed. Our equipment is installed on over 63,000 aircraft worldwide—a growing fleet— with a predictable aftermarket revenue stream stretching out for many decades. Our excellent win rate on the many new aircraft programmes entering service, which drove our investment in research and development of £148.3m (9.5% of revenue), gives us confidence in making good progress in the years to come. Revenue (£ millions) 1,553.7 Underlying profit before tax (£ millions)1 Free cash flow (£ millions) 328.7 146.8 14 13 12 11 10 1,553.7 1,637.3 1,605.8 1,455.3 1,162.0 14 13 12 11 10 328.7 377.8 366.0 325.3 263.7 14 13 12 11 10 146.8 110.4 182.4 193.0 163.0 i See page 31 i See page 32 i See page 35 Underlying earnings per share (pence)1 Dividends per share (pence) Return on trading assets (%) 32.4 13.75 26.5 14 13 12 11 10 i See page 34 32.4 37.5 36.5 32.1 28.6 14 13 12 11 10 i See page 34 13.75 12.75 11.80 10.50 9.20 14 13 12 11 10 i See page 28 26.5 36.0 40.8 39.4 35.4 1 The definition of ‘underlying’ is provided in notes 10 and 15 to the consolidated financial statements on pages 103 and 106 respectively. 93987_p01-04.indd 4 04/03/2015 16:21  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 5 Chairman’s statement “ Meggitt was one of the first UK companies to commit to comprehensive ethics policies. As Chairman of the Group’s Ethics and Trade Compliance Committee, I take great pride in the strength of our programmes. ” Growing the Group It’s been over a decade since I joined Meggitt as a non-executive director, becoming Chairman in 2004. During that time, Meggitt has evolved from a group of individually-run industrial businesses into an increasingly integrated international enterprise focusing on aerospace, defence and energy. We have grown revenue threefold, organically and by acquisition, increased our market capitalisation five-fold and doubled our workforce to over 10,500. A brand-new braking systems business has emerged from two significant acquisitions, both of which also boosted our existing thermal management and polymers and composites capabilities. An industry leader in aircraft fire protection and control emerged from another. In 2009, we restructured our business into capability-based divisions with streamlined management that made us easier to do business with. In 2013, we launched our continuous improvement initiative, the Meggitt Production System (MPS), which is already having a marked impact on our operational performance with much more to come. Talent Meggitt has a strong focus on talent development, sponsoring aspiring engineers through successive Arkwright Scholarship Trust awards; entering into a long-term partnership with the Institution of Mechanical Engineers to provide training, management and leadership development for Meggitt engineers; appointing technical fellows; and creating a world-class biannual executive training programme with Oxford University’s Saïd Business School. In the last three years we have launched a hugely successful graduate training programme. We have attracted the best recruits from leading engineering faculties worldwide. Participants have been given the time and resources to focus on specific projects with excellent results, exemplified most recently by development work on a critical component for a major engine manufacturer using Meggitt’s growing capability in additive layer manufacturing. Doing business the right way Meggitt’s growth has been based on fair and impartial conduct of business, fully compliant with applicable laws and regulations worldwide and integrity in every business relationship. Meggitt was one of the first UK companies to commit to comprehensive ethics policies, programmes and practice when we signed the Statement of Adherence to the Global Principles of Business Ethics for the Aerospace and Defense Industry. As Chairman of the Group’s Ethics and Trade Compliance Committee, I take great pride in the strength of our programmes. Capital deployment Meggitt’s capital allocation policy focuses on investing in organic growth, increasing ordinary dividends in line with earnings through the cycle and, where appropriate, enhancing capability in its core markets through targeted, accretive acquisitions. As the year closed, we acquired Precision Engine Controls Corporation (PECC). This leading supplier of actuation systems and fuel metering valves to manufacturers of small-frame gas turbines complements Meggitt Control Systems’ capability, further extending its reach in the oil and gas and power generation sectors. Demonstrating our commitment to maintaining an efficient balance sheet, we launched a share buyback programme for the first time in 2014. This is already improving shareholder returns and will deliver gearing at or slightly above 1.5 times net debt to EBITDA (earnings before interest, taxes, depreciation and amortisation) by the end of 2015. Board of directors Alison Goligher was appointed non-executive director to the Board in October. Alison, an Executive Vice President in Shell’s Upstream International Division, brings a wealth of experience in technology deployment and integrated project management in the energy sector. In December, non-executive director, Philip Cox resigned to take up a new role as chairman of Drax Group plc. We thank Philip for his outstanding contribution to the Board. I will be retiring at April’s AGM and will be succeeded by Sir Nigel Rudd, whose extensive international business and boardroom experience spans many industries including those in which we specialise. I have enjoyed my time at Meggitt immensely and I am proud to have played my part in its transformation into a FTSE-100 global engineering group delivering critical products and solutions in its chosen markets. I look forward to seeing even greater success as Meggitt continues to evolve and grow. I would like to take this opportunity to extend my heartfelt thanks to all Meggitt employees for their outstanding work during my tenure as Chairman, particularly after a challenging year in some of our key markets. Sir Colin Terry Chairman 93987_p05.indd 5 04/03/2015 16:23 6 MEGGITT PLC REPORT AND ACCOUNTS 2014 Chief Executive’s review “ Superior performance, defined by quality, cost and on-time delivery, is key to realising our growth potential and we are determined to make operations excellence a core competitive strength. ” Group strategy Meggitt aims to be a leading provider of smart engineering for extreme environments. We invest in developing high-technology components and sub- systems which play mission or safety- critical roles over long operating lives. We seek to improve our operational performance continuously to offer industry-leading levels of quality, on-time delivery and competitiveness, enabling us to reinvest in new capabilities and technologies while generating attractive returns for shareholders. Technology We focus on targeted investment to drive future growth. We seek to grow organically by investing in the product and manufacturing technologies that count across a broad range of platforms and customers. To secure positions on specific platforms, we align our development focus with our customers’ technology roadmaps. We look to supplement organic growth with acquisitions that enhance our capabilities and routes to market. In 2014, we continued to refine our complete ATA26 fire protection systems for aircraft as we progressed our development of innovative environmentally-sound suppression technology. We continued to invest in fluid control and thermal management products capable of operating at the ever-higher temperatures required to enable the latest generation of jet engines to deliver the efficiencies demanded by their operators. To deliver these and many other capabilities competitively, we maintained our investment in cutting-edge manufacturing technologies such as additive layer manufacturing, which we now employ in the production of some in-service components, and Meggitt Modular Modifiable Manufacturing (M4), our pioneering approach to the factories of the future. M4 is designed to enable operators to manufacture a broader range of low-volume, highly complex components through greater deployment of technology through the factory. This includes the real-time monitoring of key parameters including product weight and touch-time and the provision of instant-access support to the operator if required. The result is greater optimisation of all aspects of the manufacturing process from machining and assembly to machine utilisation and traceability, enabling our businesses to invest in state-of-the-art equipment in the knowledge that it will be fully utilised in ‘smart’ facilities. Our acquisition of Precision Engine Controls Corporation (PECC) in December 2014 exemplifies targeted, value-added portfolio enhancement. PECC, now a Meggitt Control Systems product range, builds on our existing thermal management and fluid control capabilities in the aero-derivative gas turbine market, broadening our reach into small-frame gas turbines in the 1-30MW power range and widening our actuation technology offering for the combined customer base. Operations excellence Superior performance, defined by quality, cost and on-time delivery, is another key to realising our growth potential and we are determined to make operations excellence a core competitive strength. With meaningful improvements in operating performance such as Defective Parts Per Million down 84% and on-time delivery up 10%, the Meggitt Production System—our single, global approach to continuous improvement—has progressed well since its inception. We have launched the system across two thirds of our manufacturing estate and expect to see it adopted at all primary sites by the end of 2015. Several sites have entered the second phase in the six-phase programme, extending the reach of the system beyond the factory floor and supply chain into functions and leadership. We have undertaken considerable work optimising our manufacturing footprint over the last few years, consolidating six sites into three and investing in low-cost manufacturing centres in China, Vietnam and Mexico. In 2014, we made good progress in enhancing the level of manufacturing capability of our facility in Querétaro, Mexico, with the start of a substantial transfer of product lines from our Control Systems businesses in North America. In China, we increased the scope of our Xiamen facility, responding to customers’ global sourcing requirements with the successful replication of a high-tech process from one of our European facilities involving the printing of sensors onto printed circuit boards. We will continue to evolve our manufacturing estate in response to the requirements of our customer base. 93987_p06-07.indd 6 04/03/2015 16:52  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 7 decline than in recent years and even some suggestion of growth in the all-important US budget from 2016. Order intake in 2014 has been strong, with book to bill of 1.03 covering a number of short-term and multi-year contracts. On this basis we expect a return to modest growth in 2015 driven by good growth in military training, partially offset by a decline in MABS following the completion of the B1-B and Taiwanese upgrade programmes. We maintain our medium-term expectation of an average of 2% growth per annum excluding the effects of sequestration. Our energy businesses, driven by heightened demand for our printed circuit heat exchangers and increasing market share in condition-monitoring equipment, should continue to deliver revenue growth averaging greater than 10% over the medium term. However, in 2015 we expect good organic growth in energy control valves and condition monitoring to be largely offset by a decline at Heatric reflecting the impact of capital expenditure deferrals by our major oil and gas customers. On the basis of the above, the Group continues to expect organic revenue growth in 2015 of low to mid-single digit percentage points, in line with the guidance given in our interim management statement in November 2014. Stephen Young Chief Executive Renewing our customer focus Making ourselves easy to do business with while responding to the dynamic markets in which we operate is core to our business philosophy for original equipment (OE) and aftermarket customers alike. To enhance our customer focus, we have recently appointed two senior executives dedicated to the requirements of our OE customers and the aftermarket respectively. The manufacturers of aircraft and engines will see a renewed focus on their interests as we strengthen key account relationship management and bring together cross-group product packages that simplify their supply chains. The aftermarket is central to the Meggitt business model. We will improve service through the Meggitt Production System and focus on the development of innovative support solutions for our OE customers as they seek to maintain more of their products in service. Cradle-to-grave programme management underpins Original equipment manufacturer (OEM) and aftermarket relationships. We are strengthening this function, shortening the lines of communication between OEMs and operators, championing their interests inside Meggitt and allowing closer collaboration than ever before. This is how we will achieve specific programme success, insights into customer’s technology aspirations over the longer term and opportunities to create better products from our existing portfolio. Performance in 2014 Performance in our end-markets was mixed. Good growth in civil aerospace was driven by a rise in aircraft deliveries from the major manufacturers, greater Meggitt content on newer platforms and a continued recovery in aftermarket revenues. There were, however, challenges in our military market, particularly during the first half of the year. The effect of the US military drawdown from Afghanistan was compounded by the completion of two large retrofit contracts in the first half of the prior year. Both issues constituted a significant headwind to military aftermarket performance, although our overall military revenues stabilised on an organic basis in the second half of 2014. In energy, we continued to make good progress on the issue highlighted in 2013 concerning the lack of availability of tourmaline, a key raw material. This is now behind us—we have migrated a number of customers onto alternative in-house materials and we are receiving positive customer feedback on product performance. Energy performance in the second half was hampered by lower revenues at Heatric, our printed circuit heat exchanger business. Its local content provider in Brazil is experiencing financial challenges, causing revenue to be deferred from 2014. Against this background, we have delivered flat organic revenues in 2014, with a decrease in underlying earnings per share of 5.1p to 32.4p reflecting currency movements, business mix, disposals and the investment being made in new aircraft programmes. Net debt to EBITDA at the end of the year was 1.2x. In November we announced a share buyback with the intention of increasing this ratio to 1.5x by the end of 2015 to maintain an efficient balance sheet. Outlook The outlook for our civil aerospace markets remains encouraging. Production rates of large jets are expected to continue to grow and the relatively high shipset values we enjoy on the latest generation of widebody aircraft, together with our positions on the re-engined narrowbodies, should underpin organic civil OE revenue growth of 7 to 8% over the medium term. Reflecting recent inventory build at aircraft manufacturers ahead of new product launches and production rate increases, 2015 will be moderately below this level. Available seat kilometres, the key driver of our large and regional jet aftermarket, are growing at above the long-term trend, and lower oil prices should see this continue. However, we are seeing month-to-month volatility in revenues and a continuing impact from surplus parts. We therefore expect civil aftermarket growth in mid-single digits for 2015. In the military market, we look to be entering a more benign phase, with military budgets seeing lower rates of 93987_p06-07.indd 7 04/03/2015 16:52 8 8 MEGGITT PLC REPORT AND ACCOUNTS 2014 Group strategy Strategy We select high-growth markets where we can deploy our smart engineering for extreme environments and ability to navigate the complex regulatory and certification environment associated with safety- and mission-critical products. These markets must deliver long-term, predictable revenue streams in line with our business model. We set strategic priorities according to the dynamics of this business model. Today, we are addressing core technology, consolidating our resources and sharpening our focus to extend our intellectual property; operations excellence from the factory floor to every function based on the Meggitt Production System; and renewed focus on customers, with dedicated management responsibility for OEM and aftermarket customer relations, underpinned by strong programme management. Meggitt’s strategy by market and capability is outlined in the Market review (see page 10) and under Meggitt divisions (see page 13). Customer focus GRowTH operations excellence Technology Business model We deliver strong and sustainable shareholder returns through leading positions in aerospace, defence and energy markets. Throughout the business cycle, revenue comes from successfully executing original equipment programmes (often sole-source) and the aftermarket that flows from them. Aftermarket demand is driven by condition-based demand caused by the wear and tear associated with the harsh environments in which our products operate. T N E M T S E V N E R I Technology operations Installed base KNowLEdGE Field knowledge enhances our intellectual property. Aftermarket Shareholders Returns Airframers, turbine manufacturers, oil and gas platforms and processing vessels— 60,000-plus platforms carry Meggitt products Airlines, militaries, distributors, MRO integrators Winning new programmes, often on a sole-source basis, through technology and operations excellence. Selling Meggitt content onto new platforms provides aftermarket access. Supporting end-users through sales of spares and repairs for the life of programmes is a significant driver of returns. 93987_p08-09.indd 8 04/03/2015 16:24  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 9 Investment cycle We develop technology for applications involving product life-cycles measured in decades. Products must perform without fail in environmental extremes, requiring replacement or overhaul, generating strong returns from our initial investment over many years. Our business model requires significant cash investment in the development phase of programmes. For our wheels and brakes business, this includes production. We make strong positive cashflow within our civil aerospace and military end-markets during the in-service phase, resulting in cash break-even between years 11 and 18 typically, with a shorter cash break-even in the energy market. As our products are developed in line with our customers’ technology goals, we have performed strongly in recent bid cycles, securing positions on key platforms and refreshing the long-term aftermarket pipeline. Our near-term business is weighted therefore towards investment in new development programmes and the transition of new products to full run-rate manufacturing, the source of sustainable growth over the long term. Cumulative cash flow £ 0 5 10 15 20 25 30 35 40 Typical product lifecycle (years) Development In production Mature Wheels and brakes Civil Military Energy 93987_p08-09.indd 9 04/03/2015 16:24 10 MEGGITT PLC REPORT AND ACCOUNTS 2014 Market review Market matrix Meggitt benefits from a balanced portfolio. Capability-based business units deploy technological know-how and intellectual property across all our markets so we are not dependent on single customers, individual programmes or market segments. Meggitt Aircraft Braking Systems Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Civil Original equipment Aftermarket Military Original equipment Aftermarket Energy Other >10% of Group revenue 3—10% of Group revenue 1 —3% of Group revenue Market review Meggitt’s core civil aerospace, military and energy markets share a common requirement for smart engineering for extreme environments: mission- and safety-critical components and sub-systems that function without fail for many years in highly demanding operating conditions, from suppliers capable of meeting rigorous certification requirements. Civil aerospace Civil aerospace accounts for 48% of Group revenue, with products and sub-systems installed on almost every jet airliner, regional aircraft and business jet in service. This fleet has grown recently, totalling over 43,000 aircraft today versus 31,000 a decade ago. New aircraft deliveries drive sales of original equipment (OE) and aircraft utilisation generates demand for spare parts and repairs over many decades, so the growth of our fleet is a strong indication of future aftermarket revenue growth. Original equipment We classify civil aircraft deliveries by seat capacity: large jets (>100 seats), regional aircraft (<100 seats) and business jets. Large jet deliveries in 2014 stood at a record 1,380, 8% higher than in 2013. Growth is underpinned by the order books of Boeing and Airbus, the two major civil aircraft manufacturers, which extend over seven years at current production levels, plus other manufacturers investing in the large jet market including Bombardier, Sukhoi and AVIC. The high level of demand for new aircraft deliveries in recent years has been driven primarily by high oil prices, the relatively low cost of debt and the wave of newer, more fuel-efficient aircraft coming to market including Boeing’s 787 and 737MAX and Airbus’ A350XWB and A320neo. Despite the recent decrease in oil prices, we expect no significant changes to new aircraft demand in the short term. Regional aircraft deliveries of 269 in 2014 represented a 2% increase on 2013, with growth driven by 70-plus seat aircraft. Growth looks set to continue over the medium term, mirroring the increasing internationalisation of the regional aircraft fleet. Regional fleets outside North America account for 55% of the global fleet, up from 44% a decade ago. Business jet deliveries totalled 675, a 6% increase on 2013, although deliveries remain around 40% below the peak in 2008. Inventories are continuing to decline, however, and rising corporate profitability, a good driver of business jet demand historically, is forecast to continue. As with regional aircraft, the fleet is becoming increasingly global—customers in the Americas currently comprise 75% of the global business jet fleet but order trends suggest this will move to around 60% over the next decade. Ten years ago, the Americas represented 85% of the global fleet. Over the medium term, we see deliveries continuing to recover, particularly at the smaller end of the market, driven by an improved economic growth outlook in developed economies and the large number of new aircraft models. Meggitt performance Meggitt’s OE revenue grew organically by 6% in 2014, with significant contributions from the ramp-up of the Boeing 787 and initial production revenue from the A350XWB. Large jet deliveries drive the majority of our OE revenues, involving the supply of products and sub-systems on engines and airframes covering thermal management and fluid control, fire protection, condition-monitoring and high-integrity electronics. Our largest exposure to regional aircraft and business jets is through our wheels and brakes business, which provides most original equipment free of charge to civil aircraft manufacturers. Strong OE performance is also driven by higher shipset values on new aircraft programmes, whose order books and delivery forecasts lend confidence in growth prospects averaging 7 to 8% per annum for the medium term. 93987_p10-12.indd 10 04/03/2015 16:24  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 11 Large jet delivery forecast 1,640 1,701 1,603 1,513 1,417 1,380 1,279 1,800 1,500 1,200 900 600 300 2013 2014 2015 2016 2017 2018 2019  Source: Meggitt management estimates Regional aircraft delivery forecast 288 291 297 320 306 400 300 263 269 200 100 2013 2014 2015 2016 2017 2018 2019  Source: Meggitt management estimates Business jet delivery forecast 881 932 811 835 757 675 637 1,200 1,000 800 600 400 200 2013 2014 2015 2016 2017 2018 2019  Source: Meggitt management estimates Aftermarket The civil aerospace aftermarket is driven primarily by aircraft utilisation which, for large jets and regional aircraft, is measured using available seat kilometres (ASKs). We use take-offs and landings as a proxy for business jet utilisation. ASKs in the commercial aircraft fleet grew 5.5% in 2014, above the 5% long- term average. The Middle East and Asia saw particularly strong growth, with the US market showing a steady recovery. Regional aircraft utilisation picked up noticeably driven by the recovery in North America. Business jet utilisation in the US and Europe continued to exhibit the gradual improvement seen for the last two years, with take-offs and landings in 2014 up 3% versus 2013. We would normally expect our aftermarket revenues to follow these leading indicators after a lag of a few months. However, revenue can be impacted by short-term perturbations including destocking or restocking cycles and excess spare part inventory arising from the retirement of old aircraft and subsequent harvesting of serviceable components from these aircraft. Meggitt performance Meggitt’s organic aftermarket revenue was up 5% for the year, with 2% growth in the first half accelerating to 7% growth in the second half. The growth rate in the final quarter was 10%, above our medium-term expectation of 8 to 9%. Air traffic was good given the previously referenced 5.5% ASK growth. However, aftermarket revenue growth overall was held back to a degree by the parting out of old aircraft resulting from the high delivery rates of new, more fuel-efficient aircraft. Regional aircraft and business jets are important contributors to the Group’s aftermarket revenue. The continued increase in fleet size and recovery in regional aircraft utilisation in 2014 boosted overall aftermarket growth. Our regional aircraft aftermarket grew 4% in the year, with business jet aircraft up an impressive 13%. Aircraft utilisation remains very encouraging, with ASKs now tracking above the long-term average. A reduction in some of the current cyclical factors such as retirement rates and the subsequent parting out of aircraft would drive confidence in our medium-term aftermarket revenue growth expectation of 8 to 9% on average. Military Military accounts for 34% of Group revenue. Meggitt has equipment on over 20,000 aircraft and a variety of ground vehicles, naval vessels and training installations worldwide. Defence budgets in some key markets remained under pressure in 2014, notably in the US where the effect of the drawdown from Afghanistan and absence of equipment reset affected Available seat kilometres (ASKs) (billions) 7 6 5 4 3 2 1 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 2014 Source: Meggitt management estimates 1983 1976 1979 1974 1981 1973 1971 1978 1977 1982 1972 1984 1986 1987 1988 1989 1991 1992 1993 1994 1996 1997 1998 1999 2001 2002 2003 2004 2006 2007 2008 2009 2011 2012 93987_p10-12.indd 11 04/03/2015 16:24 12 MEGGITT PLC REPORT AND ACCOUNTS 2014 Market review continued Military revenue by region Total revenue (£ millions) 539.4  USA  319.5 | 59% Europe 137.3 | 26%  Rest of World 82.6 | 15% Meggitt performance Meggitt’s energy revenue declined 3% on an organic basis in 2014. Sales to power generation customers declined modestly, particularly in the first half of the year, as a shortage of tourmaline impacted our ability to fulfil customer requirements. We have, however, seen a considerable improvement as a result of migrating customers onto alternative technologies and we anticipate a return to growth from 2015. Revenue at our Heatric printed circuit heat exchanger business also declined as a result of the deferral of revenue out of 2014 driven by financial difficulties at our local content provider in Brazil. Heightened demand for our printed circuit heat exchangers from an identified project pipeline totalling nearly £600 million and increasing market share in condition- monitoring equipment should continue to deliver revenue growth averaging greater than 10% over the medium term. However, in the short term we anticipate good growth in energy control valves and condition monitoring to be largely offset by a decline at Heatric, reflecting the impact of project deferrals resulting from the recent decline in the oil price. spending levels and the Continuing Resolution in the early part of the year impacted the timing and size of orders. However, European markets were stable and parts of the Middle East and Asia saw budget growth. The US defence budget remains subject to ongoing fiscal pressures, although industry forecasts suggest we are moving into a more benign budgetary environment in US and international markets. While we do not expect significant growth in military expenditure in the near term, opportunities remain for the reset and upgrade of repatriated equipment and the supply of new products as a significant tranche of military assets reach the end of their service lives. Meggitt performance Meggitt’s military revenue declined organically by 7% in 2014. The first half decline was particularly affected by the completion of two substantial retrofit programmes in 2013 and a reduction in the sale of spares and repairs on some helicopter and heavy-lift platforms following the withdrawal of US equipment from Afghanistan. Military revenues were flat in the second half. Our exposure to a broad range of fixed and rotary wing aircraft, ground vehicles, training facilities and naval vessels across original equipment and aftermarket spares and repairs has enabled us to demonstrate resilience in a challenging environment over the last few years. We expect to continue to do so over the medium term. We have enjoyed considerable success, for example, securing retrofit programmes for blast-proof fuel tanks for the Bradley fighting vehicle fleet and fuel bladders for the KC135 tanker aircraft. While we have now completed these retrofit programmes, further opportunities exist in the reset of recently repatriated equipment from Afghanistan, and we are engaged with US military customers on further ground vehicle fuel tank retrofits. Further revenue growth is supported by continuing expansion of the fleet of platforms on which we have good content such as the F-35 Joint Strike Fighter and A400M. Accordingly, we are targeting an average of 2% per annum organic revenue growth in the medium term, excluding the impact of sequestration. Energy Our energy business accounted for 11% of Group revenue in 2014. We target power generation and oil and gas markets with condition-monitoring hardware and software, control valves and printed circuit heat exchanger technology. The market for condition monitoring and control valves has continued to grow, as high input costs, particularly in the first half of 2014, drove operators to extract greater efficiency from their assets. As newer, more capable monitoring technologies come to market, operators will maximise their asset utilisation and minimise unplanned downtime by retrofitting new condition- monitoring systems onto existing plant and machinery. The oil and gas heat transfer market remained robust through 2014. Exploration and production companies have been increasingly turning to extraction sites which are further offshore and in deeper water, necessitating the commissioning of new equipment designed to operate in these increasingly harsh environments. These factors have resulted in good growth in demand for floating, production, storage and offload (FPSO) and floating liquefied natural gas (FLNG) vessels. However, the sharp decline in the global oil price over the last few months of the year is likely to significantly dampen oil producers’ appetite for new capital projects in the short term, resulting in the deferral and possible cancellation of projects. 93987_p10-12.indd 12 04/03/2015 16:24  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 13 Meggitt divisions Meggitt Aircraft Braking Systems A leading supplier of aircraft wheels, brakes and brake control systems. Markets Revenue (£ millions) % of Group revenue Underlying operating profit (£ millions) 327.0 21.1 127.5 Revenue by end market 327.0  Civil OE 6%  Civil AM 64%  Military 30%  Energy and other 0% Civil aerospace Fixed wing military aircraft Rotary wing military aircraft Capabilities Growth strategy • Wheels and brakes • Control systems—brake, nose wheel steering and landing gear • Monitoring systems • Extend core landing gear sub-systems technologies • Secure sole-source positions on new aircraft programmes • Expand share of maintenance, repair and overhaul market Controlling more critical systems creating an effective anti-skid system is amongst the greatest challenges a braking systems provider can overcome. Since 1948, we have accomplished this for over 90 aircraft programmes, which is why customers are awarding more responsibility for aircraft safety to us. With leading-edge developments including the landing gear control and monitoring unit, nose wheel steering and aircraft hydraulics for Dassault’s all new Falcon 5X business jet, advanced braking and monitoring systems for the Gulfstream G500 and G600 and pioneering large-jet style autobrakes for the G650 and G650 Extended Range aircraft, we remain the large cabin business jet manufacturers’ preferred supplier. 93987_p13-17.indd 13 04/03/2015 16:28 14 MEGGITT PLC REPORT AND ACCOUNTS 2014 Meggitt divisions continued Meggitt Control Systems A leading supplier of pneumatic, fluid control, thermal management and electro-mechanical equipment and sub-systems, and complete fire protection solutions. Revenue (£ millions) % of Group revenue Underlying operating profit (£ millions) 348.7 22.4 91.8 Revenue by end market 348.7  Civil OE 26%  Civil AM 39%  Military 25%  Energy and other 10% Markets Civil aerospace Military aircraft Military ground vehicles Energy, industrial Marine Ground fuelling Capabilities Growth strategy • Heat exchangers • Control valves and sub-systems • Electro-mechanical controls • Environmental control • Fuel handling • Aircraft fire protection and control systems • Develop lightweight control systems for extreme temperature and pressure environments to improve aircraft performance • Diversify product range to a wider range of energy and industrial turbines • Deploy full fire protection systems to secure sole-source positions on new platforms • Develop ‘green’ fire suppressants to meet changing regulations and gain competitive advantage by being first to market Maximising aircraft take-off readiness turning an aircraft back on a false alarm can cost up to US$1 million which is why our goal is to maximise aircraft take-off readiness without compromising safety. Our complete fire protection and control systems are highly discriminating, with our latest smoke detectors reaching the state-of-the-art in particulate recognition. What’s more, we have the largest range of components in the industry and world-class integration expertise, which is why our systems, from detectors and controllers to fire extinguishers, are carried by the latest generation of narrowbody aircraft including A320neo and 737 MAX. 93987_p13-17.indd 14 04/03/2015 16:28  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 15 Meggitt Polymers & Composites A leading specialist in fuel containment, engineered aircraft sealing solutions and technical polymers, electro-thermal ice protection and complex composite structures and assemblies. Markets Revenue (£ millions) % of Group revenue Underlying operating profit (£ millions) 162.3 10.5 20.2 Revenue by end market 162.3  Civil OE 27%  Civil AM 18%  Military 54%  Energy and other 1% Civil aerospace Military aircraft and ground vehicles Missile systems and UAVs Nuclear, marine, heavy transportation and oil and gas sectors Capabilities Growth strategy • Flexible fuel tanks for military and civil aircraft and military ground vehicles • Smart electro-thermal ice protection with energy-saving • Expand our industry-leading operational performance in polymers with further investment in manufacturing technology • Invest in advanced polymer materials to enter attractive proportional control • Complex composites • Airframe, engine and oil and gas sealing solutions adjacent markets • Expand capabilities in complex composites • Complete fuel management systems Components to systems we made our mark in flexible, ballistically-resistant, crashworthy fuel cells for a range of aerospace applications, recently launching an IED-resistant design for land vehicles. Now we are leveraging this expertise with capabilities from other Meggitt divisions to deliver a fully-certified fuel containment system for Sikorsky’s advanced S-92® helicopter in a multi-million dollar contract extending to 2030. Our design significantly reduces manufacturing risk and the cost of field repairs, an investment in line with our strategy to move into total fuel management systems. 93987_p13-17.indd 15 12/03/2015 03:03 16 MEGGITT PLC REPORT AND ACCOUNTS 2014 Meggitt divisions continued Meggitt Sensing Systems A leading provider of high-performance sensing and condition-monitoring solutions for high-value rotating machinery and other assets. Revenue (£ millions) % of Group revenue Underlying operating profit (£ millions) 398.2 25.6 58.4 Revenue by end market 398.2  Civil OE 35%  Civil AM 16%  Military 21%  Energy and other 28% Markets Civil aerospace Military: fixed wing and rotary aircraft, ships, missiles Energy Test and measurement Capabilities Growth strategy • High-performance sensing in extreme environments • Condition monitoring for air and land-based machinery • Power electronics • Real-time remote aircraft surveillance • Aircraft ground manoeuvring collision prevention • Wireless emergency systems • Develop leading-edge sensing and condition-monitoring technologies to minimise emissions, conserve fuel, optimise engine performance and manage maintenance economically • Accelerate growth in energy segment, launching innovative new products and expanding sales and aftermarket services in high-growth markets • Exploit capabilities in power generation, conversion and storage for more electric aircraft • Deploy advanced sensing knowledge and intellectual property for high-growth medical ultrasound applications Improving aircraft operating economics our latest on-engine condition monitoring system enters service in 2015 on the Airbus A350, the latest widebody. The system, which has already been adopted by the Airbus A380 and Boeing 787, plays a critical role in an aircraft’s economics, enabling maintainers not only to diagnose problems but anticipate wear and tear to prevent schedule disruption and expensive unscheduled maintenance. On-engine monitors are of particular interest to engine-makers who provide total care packages to operators. 93987_p13-17.indd 16 04/03/2015 16:28  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 17 Meggitt Equipment Group Created to enable a set of strong, technologically- distinct businesses to market their offerings to specialist customers, while benefiting from the wider Meggitt Group’s investment in shared services and common processes. Revenue (£ millions) % of Group revenue Underlying operating profit (£ millions) 317.5 20.4 48.1 Revenue by end market 317.5  Civil OE 3%  Civil AM 1%  Military 58%  Energy and other 38% Markets Civil aerospace Fixed and rotary wing military aircraft Defence and security Energy Automotive and industrial Capabilities Growth strategy • Combat support (ammunition-handling, military electronics cooling and countermeasure launch and recovery systems) • Live-fire and virtual training systems • Heat transfer equipment for offshore oil and gas • Standby flight displays and air data systems • Linear motion control • Automotive and industrial control electronics • Build on market-leading position in compact and high-pressure heat exchangers for high-growth energy markets • Leverage growing US military system-of-record status in live and virtual training systems for international customers in defence and law enforcement markets • Provide smart thermal management solutions for military electronics systems and extend automatic ammunition handling capability into larger calibre weapons System-of-record status grows business and influence meggitt’s next generation small arms trainer will become the system-of-record for the US Army and US Marine Corps—an unprecedented dual win worth around US$130 million. Both contracts, won for Best Value, optimise the cost of personnel training through technology. Meggitt’s significant investment in software architecture and military training expertise provides a virtual product that will not only improve the quality of training to soldiers but the efficiency and effectiveness of training instructors. 93987_p13-17.indd 17 04/03/2015 16:28 18 MEGGITT PLC REPORT AND ACCOUNTS 2014 The aim of the Meggitt Production System (MPS) is to transform performance at our sites around the world, day in, day out. New global standards of excellence will strengthen our core, creating a solid platform for growth and innovation. Individual improvements are sometimes small. Together, however, they will reshape our future. The Meggitt Production System Excellence as standard 1 Singapore: outpacing the industry With a brand-new facility designed on Lean manufacturing principles, Meggitt Aerospace Asia Pacific (MAAP) already had very high standards of operational performance. In the seven months it took to implement the first stage of the MPS, however, standards rose even higher. “We believe MPS is leading the industry,” says James Mariadass, Director of Operations & Continuous Improvement in Singapore. “And it looks like the industry does too: we won Silver in the ‘Singapore Aerospace Industry Excellence Award’ for outpacing the industry. Now we’re aiming for Gold next time round.” Everyone accountable, every day Daily Layered Accountability is a key concept within the MPS. It starts with factory floor meetings that take place at the same time every day. Issues that cannot be solved by operators or supervisors are escalated same day to functional leaders, site leaders, general managers and even divisional presidents. Issues are visited daily through this process until they are solved. Above: The Meggitt Aerospace Asia Pacific Aftermarket team holds its daily functional review. L-R: James Mariadass, Director of Operations & Continuous Improvement, Sharon Fan, Head of Customer Service, Trebas Kwek, Regional Financial Controller, Adrian Plevin, General Manager, Roland Thia, Head of Quality & EHS, Dior Ang, Materials Manager, Mango Tan, Inside Sales Manager and Jeanali Wu, HR Manager. MPS boosting performance in our Singapore facility Safety—number of lost time accidents 0 0 2014 2013 Quality—DPPM2 (External – All) 243 1,854 Quality—number of MRO3 escapes (workmanship) 0 4 Delivery—MRO OTD4 performance 95% 84% 2 Defective Parts Per Million 3 Maintenance, repair and overhaul 4 On-time delivery 1 See page 8 for a full description of our strategy, articulated within three themes: Technology; Operations excellence; and Customer focus. 93987_p18-23.indd 18 04/03/2015 16:33  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 19 California: closer analysis, shop floor know-how saves US$50,000 In 2013 the main cause of internal scrap at Meggitt Control Systems’ Corona site was stator failure on a motor production line. About two a week were failing the final test, amounting to a loss of about US$50,000 a year. A cross-functional team ran a root cause investigation using a range of MPS tools, revealing that shorting thermostats were a major cause of stator failure. Based on an idea from Judy Bunch, leader of the motor-winding cell, one of the engineers on the line solved the problem by pre-impregnating the thermostats. Judy also observed that when the stators were fitted into the motor housing, the wires would occasionally get damaged and later short. Working with her, a manufacturing engineer developed a replica of the motor housing. Assemblers now check for clearance issues without damaging the wires prior to fitting. The failure rate has dropped to zero. “These are typical examples of how more ideas are coming up from the floor,” says Site Operations Director, Garret Mertz. “With MPS, we start the day with a set of short, interlocking meetings which cascade information up and down the business, escalating problems and potential solutions so they get the attention they need.” “It’s not ‘Get it done’ anymore,” says Judy. “It’s ‘How can we help you get it done’. That’s a huge difference.” Model planning: Helge Huerkamp, General Manager, Meggitt Sensing Systems Switzerland, has confidence in data run through MPS’s more reliable planning and simulation models. Creativity on the factory floor: Garrett Mertz, Site Director, Business operations, Judy Bunch, Lead Assembly Technician and Derek Harris, Lead Test Technician eliminating scrap at Meggitt’s control systems facility in Corona, California. Switzerland: better planning means higher productivity, lower inventory For the last 18 months, Helge Huerkamp, General Manager, Meggitt Sensing Systems Switzerland, has been using MPS to drive more accurate sales, inventory and operations planning. As well as driving efficiencies throughout the business cycle, the revamped process allows managers to simulate the impact of new business more accurately. At the end of 2014, a key customer asked for 120 additional engine monitoring units, each one consisting of thousands of components. Running the data through a more reliable planning and simulation model highlighted potential bottlenecks. But just as important, because key people are now used to a more rigorous step-by- step process of discussion, forecasting and sign-off, there’s a much more accurate picture of what new business can be taken on and when. “That information is invaluable in customer discussions,” says Helge. “We know we can trust it and, of course, the customer picks up on that too. We were able to confirm this additional order, plus we’ve been able to ramp up production in other areas: productivity has increased by 8% over the last two years and inventory has improved by 10 days.” 93987_p18-23.indd 19 04/03/2015 16:33 20 MEGGITT PLC REPORT AND ACCOUNTS 2014 To be the best in your field, you need the best people. Our senior leadership programme ensures we have a strong global leadership team. Our graduate programme attracts talent from the world’s top universities, adding cutting-edge technical knowledge to the Group today and engaging technology thinking for the longer term We continue to broaden the range of training for all employees. A recent Meggitt Production System (MPS) initiative, for example, funnels expertise right through the business via a network of subject matter experts. Talent More power to our people 1 Flying higher Ensuring we have the right talent to lead the organisation today and tomorrow is a key priority. MPS continues to strengthen training at site level with leadership ‘standard work’ and a set of four competencies, such as leading by example and coaching. Daily, weekly and monthly, leaders are held accountable for ensuring their people are equipped to hit performance goals. We have also developed a bespoke executive leadership programme with Oxford University’s Saïd Business School. Taught by external experts from academia and business, the one- year Oxford Leadership Programme focuses on strategy, operations and personal skills. “Since 2008, it’s helped our brightest and best develop a greater understanding of Meggitt as a whole, helping them to develop systemic thinking beyond their functional areas,” explains Robin Young, Group Organisation & Development Director. Participants attend three off-site intensives, carrying out assignments in between on live strategic issues. Participants develop their ideas in small teams, presenting recommendations and implementation plans to our Executive Board. “Each year the programme brings together a peer group of very diverse talent, new joiners and old Meggitt hands. It’s a powerful networking tool,” says Young. The people who have taken the programme so far create the core of a strong global leadership team, with a shared sense of priorities and values. We gather round and help should the going get tough and we make sure everyone in our respective teams understands their role in the bigger picture.” The next generation Now in its third year, the Meggitt Graduate Programme has a dual purpose; creating a group of future leaders in the key disciplines of engineering, operations and procurement; and bringing new insight into cutting- edge technology from the world’s leading universities. “A lot of research into areas such as additive layer manufacturing and nanotechnology is happening at places like Georgia Tech, Cal Tech and MIT,” says Chief Technology Officer, Keith Jackson. “The best graduates are ready to apply that knowledge to new and existing products.” In his first assignment, Blaise Guélat, who has a PhD in microsystems, was part of the team who produced a prototype for a next generation inclinometer. It replaces electromechanical technology with a micro-electro-mechanical system (MEMS) sensor. In his second assignment, he is developing a new algorithm for secondary flight displays to improve attitude and heading accuracy. “It uses a statistical approach known as Kalman filtering to generate a more accurate estimate than you get with a single measurement,” explains Blaise. “And it’ll be able to use other data sources such as magnetic data and GPS when they come online.” Elsewhere, we have been working with local schools and universities to develop skills and create a pipeline of talent for tomorrow. In the UK, Meggitt sponsored Sheffield University’s Formula Student team. Thousands of young engineers from more than 100 universities all over the world compete to design and manufacture a single-seat racing car to run at Silverstone. “It gets our name as a top graduate choice out into the fast lane,” says Jackson, “And it helps us get a good look at talent from all over the world.” Learn, teach, learn, teach— the smart way to embed new knowledge As part of the second phase of MPS implementation, subject matter experts in many of our sites around the world are training to become experts in one of 10 critical subjects, from statistical analysis to project leadership. Engineer Paul Thomson has spent this year becoming one of the first 2 problem-solving experts at Securaplane, our aircraft security and battery specialists in Tucson, Arizona. 1 See page 8 for a full description of our strategy, articulated within three themes: Technology; Operations excellence; and Customer focus. 93987_p18-23.indd 20 04/03/2015 16:33  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 21 (Left) Tomorrow’s leaders, refreshing our technologies today: Dr Blaise Guélat, front, with fellow graduate programme participants, back L-R: Dr Yair Korenblit, John Borton, Stefan Lespezeanu and Dr Jeff LeHew. (Below) First among experts: As part of the Meggitt Production System implementation, Paul Thompson (Sustaining Engineering Manager) is the first in a cadre of experts being developed at every Meggitt site in ten core disciplines ranging from problem-solving to project management. “We started with offsite training in Six Sigma and presentation skills—you need to get people on your side when it comes to solving complex problems,” he says. “After that came two assignments designed to put what we’d learned into practice.” The first assignment focused on quality issues with an emergency lighting system. Some 30 possible issues were revealed, 80% of recommendations were implemented within two weeks and after one month, there was a 30% improvement in the First Pass Yield (FPY). FPY shows how well standard work is undertaken, minimising deviation from plans and the introduction of rework into our production processes. Paul is now passing on his learning in a train-the-trainer programme that will take all 180 people at the site up to the first tier of expertise in the subject by the end of 2015. “We start with around six people, they train up another four or five and on it goes.” Once the training is complete, Meggitt experts continuously develop their own understanding, sharing best practice and benchmarking across the sector in order to champion their subject within the business. Model scores: Teri Samsel, Buyer/Planner, reviews production scorecards for Meggitt’s emergency back-up battery line with Paul Thompson in Securaplane’s brand-new model factory. 93987_p18-23.indd 21 04/03/2015 16:33 22 MEGGITT PLC REPORT AND ACCOUNTS 2014 To continue leading the world in our chosen fields, we must become even better innovators. By empowering people at every level to drive change themselves, the Meggitt Production System (MPS) is improving the way we innovate, freeing up capital to reinvest in technology. We are not only focusing on developing greater maturity in next generation technologies, we are looking at the advanced manufacturing capabilities needed to industrialise them. Technology Smarter engineering, generation after generation 1 Factories of the future Our focus on manufacturing high-value complex parts requires great expertise in assembling sub-components. That makes conventional automation difficult. But, as the volume, variety and complexity of these parts grows, we need to take performance optimisation up to the next level. Our pioneering approach, known as Meggitt Modular Modifiable Manufacturing (M4), will do just that, giving operators the right tools, parts, and information at the right time so they can radically improve performance. At site level, it will enable us to reconfigure our factories in real time, adjusting plans to satisfy customer requirements and optimise inventory. In 2014, we started this journey in partnership with the UK’s Advanced Manufacturing Research Centre (AMRC), creating a prototype workstation. Laser and video projected guides, plus sensor- enabled smart assembly fixtures, allow operators to build a wider variety of products, faster and more accurately. Automatic cameras keep detailed records throughout, enhancing traceability, while capturing ideas for improvement. Starting in 2015, we will develop the other technologies M4 requires in partnership with the AMRC, the Manufacturing Technology Centre (MTC) and a leading software provider. We have also attracted significant interest from Innovate UK, the UK’s innovation agency and Britain’s Aerospace Technology Institute. “M4 will optimise factory performance by responding to changes at the micro level, such as late customer demand, and at the macro level, such as buying more efficient equipment,” says Steve Parker, Director of Engineering. “It supports investment in people and equipment by maximising our resources: advanced workstations enable individual operators to work on the widest range of products.” Although the full programme will take three years, M4 will initially run alongside existing factory operations, using a combination of simulated and actual environments. “We’re already looking at introducing findings from the scoping phase to some of our other facilities and that will continue throughout the programme,” says Parker. “M4 isn’t just a one-off improvement. It’s giving us the tools we need to drive improvements, year on year.” Lighter, quieter, more reliable and faster to manufacture New manufacturing techniques are enabling us to improve existing product designs and create totally new ones. Take compressor bleed valves, for example. They’re used to prevent stalling by controlling engine pressure. High pressure air makes a huge amount of noise as it travels through the valve geometry that has been cast or machined in a traditional way. A team of Meggitt engineers on our Group graduate programme have used additive layer manufacturing (ALM) to create a radical new component design for our engine customers. The valve will significantly cut noise over residential areas surrounding major airports, an important regulatory requirement for almost all existing jet-engined planes. Scott Lathrope, Matt Scovell and David Skolnik, have led work on the new control valve concept which aims to be 25% lighter as well as quieter, more reliable and quicker to manufacture. “Air flows much more quietly around the kind of organic designs you can create with ALM,” explains Lathrope. “And our model is simpler to assemble as there are fewer parts. That means less potential error and an increase in reliability.” Group Engineering and Strategy Director, Chris Allen says, “We hope to use optimisation techniques developed on this project to create a wide range of advanced components for next- generation aero platforms, as well as products for the medical and energy sectors.” 1 See page 8 for a full description of our strategy, articulated within three themes: Technology; Operations excellence; and Customer focus. 93987_p18-23.indd 22 04/03/2015 16:33  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 23 Intelligent workbench (above and right): AMRC Technician, John Hall examines a flexible fixturing solution, a product of Meggitt’s Closed Loop Adaptive Assembly Workbench (CLAAW) project, the aim of which is to achieve a quantum leap not only in production output but quality, repeatability and traceability using guidance via lasers and display screens and ‘smart’ tools. The sample part is Meggitt’s electric brake. Below right: CLAAW’s fixture includes targets to guide the calibration of an overhead laser. A shaft is encoded to enable precise rotation measurements. A power-on brake provides stability for torque operations. Product assemblies can be mounted and removed swiftly using a pneumatic easy-click clamp. Revolution: low-noise aero-engine valve, a concept enabled by Meggitt additive layer manufacturing. 93987_p18-23.indd 23 04/03/2015 16:33 24 MEGGITT PLC REPORT AND ACCOUNTS 2014 Principal risks and uncertainties Meggitt’s risk management framework includes a formal process for identifying, assessing and responding to risk, supporting the delivery of the Group’s strategy and business objectives. reports and the Group Risk Register. This was supported by process and guidance documentation detailing the revised Group-wide framework. These processes were in place throughout 2014. During 2014, we enhanced our risk management process further. The Board approved a Group risk appetite statement and related financial risk tolerances to ensure that identified risks are managed within acceptable limits. These risk tolerance levels are flowed down to divisional and functional levels for incorporation in the process described below. We started a risk maturity exercise to capture the improvements which had been made to the Group’s risk management culture following the implementation of the new processes. Change in risk in year No change ← → Higher risk ↑ Lower risk ↓ Risk management operates at all levels throughout Meggitt. However, the Board takes overall responsibility, determining the nature and extent of the principal risks it is willing to take in achieving Meggitt’s strategic objectives, and maintaining the Group’s risk governance structure and an appropriate internal control framework. Willis Risk Advisory Services, supported by Alvarez & Marsal, have been assisting in the implementation of the Group’s risk management framework. During 2013, the Board approved an updated Risk Management Policy, a Group risk management strategy and updated formats for regular Board Types of risk Risk disclosure We monitor risk across strategic, operational, business environment and financial categories. • Strategic Includes, for example, risk arising from making poor business decisions or sub-standard execution of business objectives. • Operational Covers business processes and the technical, quality and project management or organisational risk associated with programmes. • Business environment Arises when external forces could significantly change the fundamentals driving our overall objectives and strategies. • Financial Encompasses key financial functions including the provision of adequate liquidity to meet our obligations and management of currency, interest rate, credit and other financial risks. In accordance with the Group’s enhanced risk management policy and process, we have evaluated our risk disclosure and focused this report on our most significant risks. General financial risks including foreign exchange and tax risks are not disclosed here but are described in the Chief Financial Officer’s review on pages 31 to 37. The risks outlined overleaf, which are not presented in order of priority, are those the Group believes are the principal ones it currently faces. However, additional risks, of which the Group is unaware, or risks the Group currently considers to be less significant, could have an adverse impact. The process requires each risk to have an individual owner who is responsible for regular review of that risk (and consideration of new risks in that area). Risk identification is embedded in other processes, for example project and programme management, bid approvals and other operational activities. After identification, each risk is reviewed at a site level and then aggregated and reviewed at divisional and functional level, and during the business review process. At the end of this process there is a detailed review and discussion of the Group Risk Register at the Executive Board. The Board of Directors review the output of this process. The senior executives also meet to discuss risks which may not have been identified through the normal channels. 93987_p24-26.indd 24 04/03/2015 16:36  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 25 Risk Description and impact How we manage it Strategic Business model → Technology strategy New Operational Quality escape/ equipment failure → Customer satisfaction ← → IT/systems failure ← → Failure to respond to fundamental changes in the aerospace business model, such as the accelerated pace of OE deliveries leading to earlier retirement of older aircraft and the continued development of an indigenous Chinese aerospace manufacturing industry. Impact: decreased revenue and profit Failure to develop and implement meaningful technology strategies to meet customers’ needs. Impact: restriction of ability of Group to compete on new programmes with consequent decrease in revenue and profit Defective product leading to in-service failure, accidents, the grounding of aircraft and prolonged production shut-downs for Meggitt and its customers. Impact: decreased revenue and profit, damage to reputation and operational performance Failure to meet customers’ cost, quality and delivery standards or qualify as preferred suppliers. Impact: failure to win future programmes, decreased revenue and profit Prolonged lack of availability of critical systems such as SAP due to badly-executed implementation, poor maintenance, change control, business continuity and back-up procedures; the failure of third-parties to meet service level agreements; cyber attack. Impact: decreased revenue and profits, damage to operational performance • Long-term customer agreements in place • Customer-facing organisation restructured and strengthened • Investing in research and development to maintain and enhance Meggitt’s intellectual property • Ongoing strategic review of aftermarket including evaluation of operational model • Meggitt Production System (MPS) implementation and facilities investment in our aftermarket businesses • Maintaining a pricing strategy • Development of strategy for manufacture of non-aerospace products in China • Build relationships with Chinese aerospace customers • Creation of technology roadmaps • Investing in advanced research and technology • Focus on technology during the Group strategy process • Recruiting top calibre engineers with appropriate technology skills • Ring-fenced budgets focused on longer-term technology developments • Well-developed verification, validation and system safety analysis policy and processes in place • Quality and customer audits and industry certifications • Implementing MPS across the Group • Implementing an enhanced supplier quality assurance process • Implemented supplier excellence framework through risk-based intervention following risk analysis and on-site assessments • Step change in performance enabled through ongoing implementation of MPS • Implementation of programme lifecycle management process • Programme management reorganised to increase capability and focus on programme delivery and governance • Developing our commercial function and engineering capability • Increased utilisation of low-cost manufacturing base • Rolling programme of system upgrades (including SAP implementation) to replace legacy systems • Ongoing programme of IT security enhancements • Reviewing existing systems, third-party service providers and risks, including resilience and disaster recovery processes, taking mitigating action where appropriate • Roll-out of deployment and architectural review processes Group strategy Technology Operations excellence Customer focus Meggitt’s corporate strategy is designed to optimise our business model and mitigate the risk inherent in it. See page 8 for a full description of our strategy and business model. 93987_p24-26.indd 25 04/03/2015 16:36 26 MEGGITT PLC REPORT AND ACCOUNTS 2014 Principal risks and uncertainties continued Risk Description and impact How we manage it Failure or inability of critical suppliers to supply unique products, capabilities or services which causes the Group to be unable to satisfy customers or meet contractual requirements. Impact: decreased revenue and profit, damage to reputation Failure to meet new product development and programme milestones and certification requirements, and successfully transition new products into manufacturing. Impact: significant financial penalties leading to decreased profit, damage to reputation • Implementation of supplier excellence framework • Buffer inventory maintained for critical and sole-source suppliers • Counterfeit and fraudulent parts policy implemented at high-risk facilities • Implementing integrated commercial and procurement approach to contractual terms and conditions including the development of long-term agreements • Implementation of programme lifecycle management process and a range of engineering support applications • Implementation of improved technology readiness and bid approval diligence methodology • Delivering applied research and technology objectives in line with Group strategy • Programme management reorganised to increase capability and focus on programme delivery and governance • Step change in performance enabled by the MPS implementation • Enhanced internal review process to stress-test readiness to proceed at each stage of key programmes Significant breach of increasingly complex trade compliance, bribery and corruption and ethics laws and violating the terms of Meggitt’s 2013 Consent Agreement with the US Department of State. Impact: damage to reputation, loss of supplier accreditations, suspension of activity, fines from civil and criminal proceedings • Substantial investment in measures to ensure compliance with 2013 US Department of State Consent Agreement and continuing investment in other compliance programmes • Board-approved trade compliance, ethics and anti-corruption policies • Implementing a trade compliance global IT solution • Regular monitoring by the Ethics and Trade Compliance Committee • Ongoing trade compliance programme including external audits and comprehensive ethics programme including training, anti-corruption policy, external audits and Ethics line • Implementing import compliance programme Failure to protect intellectual property or other sensitive information arising from cyber attack and physical theft of IT and business assets. Impact: compromised market position, damage to reputation, financial or contractual liabilities Significant variation in demand for products should military and civil business downcycles coincide, a serious political, economic or terrorist event taking place or an industry consolidation materially changing the competitive landscape. Impact: volatility in underlying profitability • Ongoing implementation of IT security strategy and enhancing IT security infrastructure, policies and procedures • Group-wide intellectual property protection programme in place • Implementing physical security strategy, including self-assessment and audits, prioritising higher risk environments and regions • Monitoring external economic and commercial environment and long-lead indicators • Focusing on balanced portfolio including expansion of energy-related businesses • Regularly communicating strategy to shareholders • Maintaining sufficient headroom in committed bank facilities and against bank covenants • Maintaining appropriate cost-base contingency plans Supply chain ← → Project/programme management → Legal and regulatory ← → IT and physical security ← → Business environment Product demand ← → Group strategy Technology Operations excellence Customer focus Meggitt’s corporate strategy is designed to optimise our business model and mitigate the risk inherent in it. See page 8 for a full description of our strategy and business model. 93987_p24-26.indd 26 04/03/2015 16:36  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 27 Key performance indicators The Group uses a mix of financial and non-financial key performance indicators (KPIs) to measure execution against its strategic objectives. To ensure we deliver value to our shareholders over the cycle, financial KPIs balance short-term measures (underlying profit before tax and free cash flow in the year) with longer-term measures (organic revenue growth, return on trading assets and underlying EPS growth). Non- financial KPIs focus on investment in R&D to drive future revenues, the health and safety of our employees and raising standards of operational performance to satisfy our customers. There have been no changes to the KPIs used in the year or to how they are calculated. Strategic objectives Technology Operations excellence Customer focus Organic revenue growth % 14 400 12 10 8 6 4 2 0 -2 Definition and basis of calculation Revenue growth calculated by measuring current and prior year revenue at constant currency, excluding revenue from any businesses acquired or disposed of in those periods. To measure revenue at constant currency, current year revenue is restated using translation and transaction exchange rates prevailing in the prior year. See page 32 for a reconciliation of organic revenue to statutory revenue. Target Low to mid-single digit in 2015. 6 to 7% over the medium term. Result 2014: 0.0% (2013: 1.4%). Average achieved over last five years: 3.6%. Average achieved over four years since target was set: 4.8%. See page 31 for details. 2010 2011 2012 2013 2014 Directors’ incentive plans Organic revenue growth is a performance measure for the 2014 and 2015 Long Term Incentive Plan (LTIP). See pages 68 and 71 for details. Underlying PBT Definition and basis of calculation Underlying PBT is reconciled to statutory measures in note 10 of the Group consolidated financial statements on page 103. 400.0 400 350.0 300.0 250.0 £’m 200.0 150.0 100.0 50.0 0 2010 2011 2012 2013 2014 Target We do not publish profit targets. Result 2014: £328.7 million (2013: £377.8 million). See page 32 for details. Directors’ incentive plans Underlying PBT is a performance measure in the 2014 Short Term Incentive Plan (STIP). For the purpose of this plan, underlying PBT is measured at constant currency. See page 66 for details. Underlying operating profit is the new profit measure to be used in the 2015 STIP, for the reasons described on page 71. In 2015, the Group will therefore replace the existing KPI based on underlying PBT with one based on underlying operating profit. 93987_p27-30.indd 27 04/03/2015 16:37 28 MEGGITT PLC REPORT AND ACCOUNTS 2014 Key performance indicators continued Definition and basis of calculation Underlying operating profit after tax expressed as a percentage of average trading assets. Underlying operating profit is defined and reconciled to statutory measures in note 10 of the Group consolidated financial statements on page 103. Underlying operating profit after tax applies the Group’s underlying tax rate to underlying operating profit. Trading assets are defined as net assets adjusted to exclude goodwill, other intangible assets arising on the acquisition of businesses, net debt, share buyback commitment, retirement benefit obligations, derivative financial instruments and deferred tax. Average trading assets are calculated as the average of trading assets at the start and end of the year. Return on trading assets measures performance by linking operating performance to the amount of operating capital deployed. Target Target is to achieve an average return on trading assets of 25.4% over the next three years. The target has been reduced from that set in prior years, recognising the need to continue to invest in trading assets during this elevated investment period in the aerospace cycle. Result 2014: 26.5% (2013: 36.0%). Average achieved over last five years: 35.6%. See page 32 for details of the Group’s operating profit performance in the year. See page 34 for details of the current high levels of investment to support future growth. Directors’ incentive plans Return on trading assets is a performance measure for the 2014 and 2015 LTIP. For the purpose of these plans, underlying operating profit after tax and trading assets are measured at constant currency. See pages 68 and 71 for details. Definition and basis of calculation The percentage change in underlying earnings per share (EPS) from the previous year. Underlying EPS is reconciled to statutory measures in note 15 of the Group consolidated financial statements on page 106. Target We do not publish profit targets. However, the proposed 2015 LTIP includes EPS targets equivalent to growth ranging from 5.5 to 10.0% per annum over the next three years. Return on trading assets 50 40 30 20 10 0 2010 2011 2012 2013 2014 Underlying EPS growth % % 20 15 10 5 0 -5 -10 -15 -20 2010 2011 2012 2013 2014 Result 2014: -13.6% (2013: 2.7%). Average achieved over last five years: 4.7%. See page 34 for details. Directors’ incentive plans Underlying EPS is a performance measure for the 2014 and 2015 LTIP. For the purpose of these plans, underlying EPS is adjusted to exclude the impact of any scrip dividends. See pages 68 and 71 for details. 93987_p27-30.indd 28 04/03/2015 16:37  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 29 Free cash flow 250 200 150 £’m 100 50 0 2010 2011 2012 2013 2014 R&D investment % 10 8 6 4 2 0 2010 2011 2012 2013 2014 Accident/incident rate 500 400 300 % 200 100 0 2011 2012 2013 2014 Definition and basis of calculation Cash generated excluding amounts in respect of acquisition of businesses, disposal of businesses and paid to shareholders. See page 35 for a reconciliation of free cash flow to statutory measures. Target We do not publish free cash flow targets. Result 2014: £146.8 million (2013: £110.4 million). See page 35 for details. Directors’ incentive plans Free cash flow is a performance measure in the 2014 and 2015 STIP. For the purpose of these plans, actual and target free cash flow figures are measured at constant currency. See pages 66 and 71 for details. Definition and basis of calculation Investment in research and development (R&D) expressed as a percentage of revenue. Investment is measured as total expenditure in the year and is not adjusted for amounts capitalised or amortised. Investment is measured gross of funding received from customers. Target Investment of 6 to 8% per annum. This range reflects typical investment fluctuation within the industry cycle. Result 2014: 9.5% (2013: 8.2%). Average achieved over last five years: 8.0%. See page 34 for details. Directors’ incentive plans R&D investment is not a specific measure used in directors’ incentive plans. However, the 2014 and 2015 LTIP include measures focused on delivery of R&D programmes. See pages 68 and 71 for details. Definition and basis of calculation The number of injuries reportable under local laws and regulations multiplied by 100,000 and then divided by the average employee headcount during the year. Target Year-on-year improvement with an ultimate goal of nil. Result 2014: 337 (2013: 317). See page 40 for details. Directors’ incentive plans Health and safety performance is included in the personal objectives of the Chief Executive. 93987_p27-30.indd 29 04/03/2015 16:37 30 MEGGITT PLC REPORT AND ACCOUNTS 2014 Key performance indicators continued Reduction in defective parts per million (DPPM) 2012 2013 2014 0 -20 -40 % -60 -80 -100 On-time delivery improvement % 15 12 9 6 3 0 2012 2013 2014 Definition and basis of calculation Defective parts per million (DPPM) for the year expressed as a percentage improvement from that achieved at 31 December 2011, the date at which the Meggitt Production System introduced this consistent method of measurement. DPPM is defined as the number of defective parts returned by customers in the year multiplied by 1,000,000 and then divided by the total number of parts delivered. Figures include the results of disposed businesses up to the date of sale and include the results of acquired businesses from the later of the start of the financial year following acquisition and the date the information is first available. This KPI monitors the success of the Meggitt Production System. Target To achieve the levels of performance excellence (e.g. sometimes referred to as ‘Supplier Gold’) expected by our customers. We use simple on-time delivery and DPPM measures, aggregated at a Group level, to track overall progress towards these objectives. Given the complexity and variety of customer metrics, driven by the large number of customers we serve, we also track performance as reported by our customers through their own supplier scorecards. Result Cumulative improvement since 31 December 2011: 84% (2013: 54%). See page 34 for details. Directors’ incentive plans DPPM is a performance measure for the 2014 and 2015 LTIP. For the purpose of these plans, it is measured by reference to the number of sites achieving individual targeted reductions in DPPM. See pages 68 and 71 for details. Definition and basis of calculation Average on-time delivery achieved in the year expressed as a percentage improvement from that achieved at 31 December 2011, the date at which the Meggitt Production System introduced this consistent method of measurement. Calculated as the 12-month average of the number of parts delivered on delivery dates agreed with customers, divided by the total number of parts delivered. Figures include the results of disposed businesses up to the date of sale and include the results of acquired businesses from the later of the start of the financial year following acquisition and the date the information is first available. This KPI monitors the success of the Meggitt Production System. Target To achieve the levels of performance excellence (e.g. sometimes referred to as ‘Supplier Gold’) expected by our customers. We use simple on-time delivery and DPPM measures, aggregated at a Group level, to track overall progress towards these objectives. Given the complexity and variety of customer metrics, driven by the large number of customers we serve, we also track performance as reported by our customers through their own supplier scorecards. Result Cumulative improvement since 31 December 2011: 10% (2013: 10%). See page 34 for details. Directors’ incentive plans On-time delivery is a performance measure for the 2014 and 2015 LTIP. For the purpose of these plans, it is measured by reference to the number of sites achieving individual targeted improvements in on-time delivery figures. See pages 68 and 71 for details. 93987_p27-30.indd 30 04/03/2015 16:37  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 31 Chief Financial Officer’s review Overall performance Good growth in civil aerospace original equipment (OE) and the accelerating recovery in civil aftermarket (AM) was tempered by softness in military and energy markets. Organic revenue was flat, and underlying profit before tax decreased by 11% resulting in a 14% decrease in underlying EPS to 32.4 pence. However, with a strong order book and 3% organic revenue growth in the second half of the year, there is good momentum going into 2015. Financial highlights (Table 1) 2014 £’m 2013 £’m Reported change % Organic change % Revenue 1,553.7 1,637.3 -5 0 Underlying 1: EBITDA 2 Operating profit Profit before tax Earnings per share (EPS) Statutory: Operating profit Profit before tax EPS Free cash flow3 Net debt 429.6 346.0 328.7 32.4p 236.2 208.9 22.0p 146.8 575.5 479.3 397.2 377.8 37.5p 300.3 269.4 29.4p 110.4 564.6 -10 -13 -13 -14 -21 -22 -25 +33 +2 -8 -11 -11 +38 1 Underlying profit and EPS are defined and reconciled to statutory measures in notes 10 and 15 respectively of the Group financial statements. 2 Underlying EBITDA represents underlying operating profit adjusted to add back depreciation, amortisation and impairment losses. 3 Free cash flow is defined and reconciled to statutory measures in note 40 of the Group financial statements. Revenue Reported revenue declined by 5% to £1,553.7 million. Table 2 details the revenue performance by end market. As expected, currency and disposals had a significant adverse impact on revenue. Currency movements, reflecting the strength of Sterling against the Group’s major operating currencies of US Dollar, Swiss Franc and Euro, contributed £57 million, or 3% to the decline, of which £43 million is attributable to Sterling/US Dollar. Net disposals represented an additional net headwind of £26 million, primarily reflecting the 2013 disposals of the Addison and Sunbank businesses. Good organic growth in civil in 2014 was offset by declines in military and energy, resulting in a flat overall organic revenue performance. Encouragingly, the trajectory within the year was positive with second half organic revenue growth of 3%. Total civil aerospace revenues grew 6% on an organic basis. Large jet OE, the most significant driver of our OE revenues, grew 7% driven principally by the 787 ramp-up and some initial A350XWB revenues, with regional aircraft up 10% and business jets up 4%. The aftermarket recovery seen in the latter half of 2013 continued through 2014, although we still experienced significant monthly variations. Nevertheless, the trend was positive with total civil aftermarket growing 5% organically for the full year and 7% in the second half. Business jets were the most significant contributor to the overall aftermarket performance, delivering growth of 13% for the year, while large jet grew 3% and regional aircraft grew 4%. The parting out of older aircraft continued, fuelled by the increased retirement rate in recent years, although quantification of the impact is difficult. Aftermarket order intake was positive, with orders for the year up 13% on an organic basis and a book to bill of 1.08. Military revenues declined by 7% on an organic basis, with a substantial decline in the first half of the year contrasting with a flat performance in the second half. The full-year decline was in part due to the previously announced wind-down of two retrofit programmes in the first half of 2013, with the remainder driven by the larger than expected impact of the drawdown in Afghanistan on military spares sales. 93987_p31-37.indd 31 04/03/2015 16:38 32 MEGGITT PLC REPORT AND ACCOUNTS 2014 Chief Financial Officer’s review continued Energy revenue declined by 3% on an organic basis. The tourmaline shortage impacted growth in our condition monitoring business for the majority of the year, although the situation is now resolved and we expect a return to growth in 2015. Heatric, our printed circuit heat exchanger business, saw a modest revenue decline largely due to the financial difficulties being experienced by our local content provider in Brazil which resulted in the deferral of revenue from 2014. We continue to anticipate headwinds in this business in the short term, largely driven by the decline in the oil price which is causing a number of our customers to delay capital expenditure on new gas projects. Some contracts we expected to be awarded in 2015 have been deferred for a year, and it is possible that we will see further deferrals in the near future, though we have not seen any project cancellations. Meggitt’s other specialist markets saw organic growth of 5%, with growth in medical and automotive products offsetting weakness in the test and measurement market. with OE growth outpacing that of aftermarket in both civil and military markets, combined with a further increase in investment in research and development and new product introduction and the previously disclosed lower profitability on legacy contracts, partially offset by operational improvements and a one-time benefit of a new arrangement for our US retiree healthcare provision. We also took a £6 million provision against our investment on the Learjet 85 following Bombardier’s announcement in January 2015 that they were pausing the development programme. Underlying net finance costs decreased to £17.3 million (2013: £19.4 million) as a result of lower average debt and lower interest rates following the repayment of $180 million of US private placement debt in June 2013, partly offset by a non-recurring £1.8 million charge relating to the cost of refinancing the Group’s debt in September. Underlying profit before tax was £328.7 million (2013: £377.8 million). Revenue growth (Table 2) Civil OE Civil AM Total civil aerospace Military Energy Other Total Organic growth (Table 3) Revenue 2014 £’m 2013 £’m Growth % 1,553.7 1,637.3 -5.1 Reported (8.9) 56.8 (35.4) - Impact of M&A1 Impact of currency2 2014 Revenue Growth % Organic growth % 301.6 439.6 741.2 539.4 163.1 110.0 1,553.7 +0 +1 +1 -12 -6 -1 -5 +6 +5 +6 -7 -3 +5 0 Underlying profit before tax 2014 £’m 328.7 (0.6) 5.1 2013 £’m 377.8 (2.1) - Growth % -13.0 1,601.6 1,601.9 0.0 Organic 333.2 375.7 -11.3 1 Excludes the results of businesses acquired or disposed of during the current and prior year. 2 Restates the current year using 2013 translation and transaction exchange rates. Profit The Board’s preferred measure of the Group’s trading performance is underlying profit. Underlying operating profit for the year was £346.0 million (2013: £397.2 million), representing a margin of 22.3% (2013: 24.3%). The principal drivers included adverse mix, The underlying tax rate was 21% (2013: 21%), lower than our forecast 22% due to a change in the geographical mix of profit delivery. Underlying earnings per share was 32.4 pence (2013: 37.5 pence). On a statutory basis, profit before tax was £208.9 million (2013: £269.4 million), with the year-on-year decline driven by the fall in underlying operating profit and the marking to market of forward currency contracts. Earnings per share was 22.0 pence (2013: 29.4 pence). Operational performance Meggitt Aircraft Braking Systems (MABS) provides wheels, brakes and brake control systems for over 34,000 in-service aircraft. It continues to develop innovative technology for new programmes allowing the business to retain its leading position in its target markets, underscored by the recent programme awards on the Dassault Falcon 8X business jet and Gulfstream 500/600 family of aircraft. The division targets sole-source programmes and is particularly strong in regional aircraft, large business jets and military aircraft. The division represents 21% of Group revenue, generating 86% of its revenue from the aftermarket and 14% from OE sales. MABS’ revenue grew by 3% on an organic basis, with growth in civil aftermarket and military. Regional aftermarket grew 4% driven by increases in fleet size and utilisation, and business jet aftermarket grew by 7%. These were partially offset by a 9% decline in large jet aftermarket. Total military revenue grew 8% with aftermarket benefiting from upgrade contracts for the US B1-B fleet and the Taiwanese Air Force which were completed at the end of the year. Operating margins grew from 37.0% to 39.0%, benefiting from positive mix and operating efficiencies. Meggitt Control Systems (MCS) designs and manufactures products which manage the flow of liquids and gases around aero and industrial turbines, and control the temperature of oil, fuel and air in aircraft engines. The division, which also provides fire protection equipment to engines and airframes, represents 22% of Group revenue, generating 46% of its revenue from OE and 54% from the aftermarket. For MCS, revenue was up 1% on an organic basis, with 7% growth in civil aerospace, spread across both OE and aftermarket, being partly offset by an 11% decline in military, primarily aftermarket. The most significant contributor to the military performance was a marked reduction in military spares, largely related to the drawdown from Afghanistan. Unfavourable mix within military, the provision against our investment in the Learjet 85 programme and increased costs related to new product introduction saw operating margins decrease from 29.6% to 26.3%. PECC will be reported as part of MCS in 2015. 93987_p31-37.indd 32 04/03/2015 16:38  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 33 Meggitt Polymers & Composites (MPC) has a bias towards military, representing 54% of its revenue. It supplies flexible bladder fuel tanks, ice protection products and composite assemblies for a range of fixed wing and rotorcraft platforms and complex seals packages for civil and military platforms. These products are linked by their dependence on similar materials technology and manufacturing processes. It supplies over 80% of the US military requirements for fuel bladders and ballistically- resistant and crashworthy fuel tanks. MPC represents 11% of Group revenue and generated 55% of its revenue from OE and 45% from the aftermarket. MPC revenue declined by 7% on an organic basis, largely reflecting the impact of the Bradley and KC135 retrofit programmes completed in 2013. Overall military revenue reduced by 17%, partially offset by growth in civil aerospace of 9%. Operating margins declined from 16.7% to 12.4% due to lower volumes in the fuel bladder facility and high levels of up-front new product introduction costs ahead of production ramp-up on upcoming aircraft programmes over the next few years. Meggitt Sensing Systems (MSS) designs and manufactures highly engineered sensors to measure a variety of parameters such as vibration, temperature, pressure, fluid level and flow as well as power storage, conversion and distribution systems for aerospace applications. Its products are designed to operate effectively in the extreme conditions of temperature, vibration and contamination that exist in an aircraft or ground-based turbine engine. Sensors are combined into broader electronics packages, providing condition data to operators and maintainers of engines, contributing to improved safety and lower operating costs. MSS has migrated these products into other specialist markets requiring similar capabilities, such as test and measurement, automotive crash test and medical. Combining its capabilities with MABS, it is currently developing a number of civil aerospace tyre pressure monitoring systems, having secured positions for this technology on 10 aircraft platforms. MSS represents 26% of Group revenue and generated 81% of its revenue from OE and 19% from the aftermarket. MSS revenue grew 4% on an organic basis, with 8% growth in civil offsetting a 6% decline in military, largely aftermarket, and a 3% decline in energy. The military decline reflected the Afghanistan drawdown and disruption linked to the US site consolidation in 2013, as well as the shortage of tourmaline which impacted both military and energy growth. Operating margins decreased from 17.6% to 14.7% reflecting adverse mix in the lower margin civil OE revenue stream and additional costs incurred as a result of the tourmaline shortage, offset by the renegotiation of a loss- making contract against which provision had previously been held. Operating margin in  the second half showed good improvement versus the first half. Meggitt Equipment Group (MEG) comprises principally our avionics, non-engine actuation, dedicated military and Heatric businesses. The division represents 20% of Group revenue and generates 81% of its revenue from OE and 19% from the aftermarket. With effect from 1 January 2015, Meggitt Avionics will be reported as part of Meggitt Sensing Systems. Revenue in MEG declined by 3% on an organic basis. Good growth in civil, largely avionics, was more than offset by a modest decline in Heatric revenue and strong comparators in our training business. Operating margins decreased from 18.4% to 15.1% driven by lower volumes, adverse mix and the provision against our investment in the Learjet 85 programme, in addition to the previously disclosed investment in the Heatric business for future growth and lower profitability on three contracts. Taxation Meggitt’s underlying tax rate remained at 21% (2013: 21%), lower than our forecast 22% due to a change in the mix of profit delivery. Our medium-term guidance is unchanged at 22%, based on our current business mix and barring any material changes in the tax legislation in the main countries in which we operate. Cash tax paid as a percentage of underlying profit was 6% (2013: 12%). The rate of cash tax paid is typically lower than our underlying tax rate due to tax deductible items which do not affect underlying profit, including goodwill amortisation and tax relief on retirement benefit deficit reduction payments. It is lower than normal in 2014 due to excess payments on account in prior years. Our statutory tax rate, which includes items reported below underlying profit before tax, was 15% (2013: 14%). Cash tax paid as a percentage of statutory profit was 9% (2013: 16%) and is lower than normal for 2014 for the reasons described above. The Group is committed to complying fully with the laws in the countries in which it operates. It seeks to achieve a competitive tax rate by maintaining appropriate levels of debt in high tax jurisdictions, claiming available tax credits and incentives and utilising common financing structures where appropriate. We are rated as low risk by HM Revenue and Customs. As for all companies, the Group is exposed to changing tax legislation in the territories in which we operate, including as an international business changes that may arise due to local legislation arising from the OECD’s current Base Erosion and Operational performance (Table 4) Revenue 2014 £’m 327.0 348.7 162.3 398.2 317.5 20131 £’m 330.4 364.3 181.0 397.5 364.1 1,553.7 1,637.3 Growth % -1.0 -4.3 -10.3 +0.2 -12.8 -5.1 Organic growth2 % +2.5 +0.6 -7.3 +3.5 -3.3 0.0 Aircraft Braking Systems Control Systems Polymers & Composites Sensing Systems Equipment Group Underlying operating profit 2014 £’m 127.5 91.8 20.2 58.4 48.1 346.0 20131 £’m 122.4 107.7 30.2 69.9 67.0 397.2 Growth % +4.2 -14.8 -33.1 -16.5 -28.2 -12.9 Organic growth2 % +5.6 -12.3 -33.3 -11.0 -29.3 -11.0 1 Restated for the change in segmental structure announced on 7 May 2014 and as described in note 6 of the Group financial statements. 2 Organic growth excludes the impact of M&A and currency and is reconciled in Table 3. 93987_p31-37.indd 33 04/03/2015 16:38 34 MEGGITT PLC REPORT AND ACCOUNTS 2014 Chief Financial Officer’s review continued Profit Shifting project. We manage these risks by monitoring international developments, participating in pre-legislative consultations where appropriate and adapting our approach where necessary and practical. Earnings per share (EPS) Underlying EPS declined by 14% to 32.4 pence (2013: 37.5 pence). An increase in shares in issue, which includes the 51% take up of scrip dividend on 2014 dividend payments, resulted in the EPS reduction being slightly greater than the reduction in underlying profit before tax. The timing of the commencement of the share buyback programme in November 2014 meant it had no significant impact on reported underlying EPS this year but the programme will be accretive in 2015 as the issued share capital reduces. In 2015, the scrip dividend plan will be replaced by a dividend reinvestment plan. The dividend reinvestment plan provides an efficient reinvestment option for shareholders, without the need for new shares to be issued. Statutory EPS declined by 25% to 22.0 pence (2013: 29.4 pence). The decline is higher than in statutory profit before tax due to the increase in statutory tax rate and the higher issued share capital. Dividends The Board has recommended a final dividend of 9.50 pence (2013: 8.80 pence) which would result in an 8% increase in the full-year dividend to 13.75 pence (2013: 12.75 pence). The Company has a balance on its profit and loss reserve at 31 December 2014 of £1.2 billion, the substantial majority of which relates to reserves which can be distributed as a dividend or used for share buybacks, and accordingly we have a comfortable level of headroom. We are monitoring the FRC’s Financial Reporting Lab project on dividend policy and capacity and will consider their final recommendations on future disclosures in this area. Investing for the future Targeted investment in technology development remains critical to our long-term organic growth. Total R&D expenditure in 2014 of £148.3 million was 9.5% of revenues (2013: £134.9 million, 8.2%), of which 19% (2013: 18%) was funded by customers. The net charge to operating costs including amortisation and impairment increased by 5% on an organic basis to £58.5 million (2013: £57.1 million). Growth in R&D largely reflects our impressive win rate on new programmes, as well as our ongoing investment in new technology aligned to our customers’ future technology requirements. About 30% of the expenditure was on new wheels and brakes programmes and over 50% focused on products for engines and engine accessories, including working towards meeting the long-term requirement of the aerospace industry to eliminate the use of halon gas in on-board fire protection systems. The balance was spread across a range of civil, military and energy applications including the initial investment resulting from the strong order intake in the period, notably in military training. This investment in R&D supports our medium-term revenue growth assumptions and increases revenue security, particularly as the majority of the investment is on platforms where we have won sole-source positions. The record number of programmes entering service in the next few years will also drive new product introduction costs higher. In 2014 we industrialised new products at three times our historical average rate, which is good for future revenues but which impacts profitability in the short term. Our investment in programme participation costs including the supply of equipment free of charge to new aircraft, mostly in MABS, increased by 33% organically. The pace of deliveries on programmes equipped with our wheels and brakes including the Gulfstream 280 and 650 platforms is expected to grow further over the medium term. These programmes will drive aftermarket revenue for decades. Our market share of wheels and brakes on the fleet of super- mid size and large business jets in 2014 was 64%, supportive of our expectation that we will have a market share on the overall fleet in excess of 70% by 2020. Capital expenditure on property, plant and equipment and intangible assets was £42.2 million (2013: £66.9 million), with 2013 expenditure inflated by site consolidations and expansions. We expect growth in expenditure in 2015 driven by increased investment in manufacturing equipment, including new carbon furnaces in MABS and further movement of production to low-cost manufacturing locations. Analysis of R&D expenditure (Table 5) Total R&D expenditure % of revenue Customer-funded R&D Capitalised Amortisation/ impairment Charge to net operating costs 2014 £’m 148.3 9.5% (28.9) (77.7) 16.8 2013 £’m 134.9 8.2% (24.5) (70.2) 16.9 58.5 57.1 Driving organic growth through operational excellence The Meggitt Production System (MPS), our single, global approach to continuous improvement, was launched during 2013. MPS will create the sustainable quality and delivery culture that confers competitive advantage beyond our technical expertise, enabling the Group to deliver a higher rate of organic growth over the long term. It will also enable us to become more cost competitive through the reduction of working capital and the elimination of the cost of poor quality. MPS, a six-phase programme which will take five to seven years to become fully embedded, has been launched at 29 sites in total, representing 71% of our manufacturing footprint, with sixteen sites having successfully exited the first phase and one site having exited the second, more demanding phase. The launch of the programme at the remainder of the Group’s primary facilities will be complete by the end of 2015. We have already seen some significant improvements in quality and delivery since inception, with defective parts per million down 84% and on-time delivery up by 10%. The quality performance in the year improved significantly, and the stable year-on-year on-time delivery metric reflects good underlying performance in reducing production arrears. Given the demonstrable success we have seen internally, we have accelerated the planned deployment of the key tools and competencies to long-term partners in our supply chain. Our culture of continuous improvement has resulted in the expansion of our footprint in low-cost manufacturing locations, notably a 30% increase in activity in our Mexican operations and an 8% increase in our Chinese facility in 2014. 93987_p31-37.indd 34 04/03/2015 16:38  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 35 These activities will drive consistently high levels of quality and delivery performance across all of our businesses, while retaining our focus on cost control. In turn, this will help us fund future technology development programmes and respond to changing customer requirements. Cash flow and borrowings Free cash flow of £146.8 million (2013: £110.4 million) represents a substantial year-on-year improvement despite the reduction in profit and continued high levels of investment to support future growth. This was driven by better working capital management and lower tax payments reflecting the unwinding of excess payments on account in prior years. Net cash flow reduced to £21.1 million (2013: £63.2 million), largely driven by the £28.3 million acquisition of Precision Engine Controls Corporation (PECC) and a £33.7 million outflow (2013: Nil) from the purchase of shares as part of the share buyback programme implemented in November 2014. Dividend payments for the year reduced to £51.4 million (2013: £75.6 million) as a result of higher take-up of the scrip dividend. The scrip dividend option has been replaced by a dividend reinvestment plan for future dividend payments. Debt structure and financing The Group’s borrowings comprise a combination of US private placement debt and syndicated bank credit facilities. During the year, the Group took the opportunity to refinance its bank facilities, agreeing a new USD900 million committed revolving credit facility, from 13 international banks. The new facility has a five year term with one-year extension options at the end of the first and second years. It replaces existing facilities of USD700 million and USD400 million which were due to expire in 2016 and 2017 respectively. The early refinancing resulted in £1.8 million accelerated amortisation of debt issue costs, relating to the old facilities, being recorded within finance costs in 2014. The terms of the new facility are substantially unchanged from those which it replaced, except for a relaxation of the net debt/EBITDA covenant to allow it to rise to 4.0x for two six month reporting periods after a significant acquisition. There were no other changes in facilities available to the Group in the year. At 31 December, 2014, the Group had undrawn committed credit facilities of £431 million after taking account of surplus cash (2013: £504 million). With the exception of USD70 million private placement notes, which mature in June 2015 and will be repaid out of existing facilities, the Group has no committed facilities which expire before 2017. Facility headroom (£’m) (Table 6) Headroom £431 million Net debt £576 million 1,500 1,200 900 600 300 00 2014 2015 2016 2017 2018 2019 Floating rate Fixed rate Share buyback programme The Group has a strong track record of cash generation and net debt reduction, even in periods of the aerospace cycle, as we are currently experiencing, that drive elevated organic investment. In addition to supporting our regular dividend, we seek to deploy this cash by investing in the acquisition of complementary businesses that will enhance our offering to customers, accelerate the Group’s growth and deliver good returns to shareholders. Whilst we continue to actively evaluate acquisition opportunities, there is currently a relative lack of sizeable acquisition opportunities meeting our strict investment criteria. The Board believes that in maintaining an efficient balance sheet, a net debt/ EBITDA ratio of between 1.5x and 2.5x is appropriate, whilst retaining the flexibility to move outside the range if appropriate. The Group had a net debt/EBITDA ratio of 1.3x at 30 June 2014 and accordingly in November 2014, announced the introduction of a share buyback programme with the intention of delivering a net debt/EBITDA ratio at, or slightly above, 1.5x (as measured under the Group’s committed credit facilities) by the end of 2015. A share buyback programme was chosen as the most appropriate way to return excess capital to shareholders because the Board wish to retain flexibility to evaluate future organic growth and acquisition opportunities. At 31 December 2014, the Group had purchased 6.8 million shares at an average share price of 490.49 pence and a cost of £33.7 million under the buyback programme. The programme has continued in 2015 with a further 2.9 million shares purchased at an average share price of 522.64 pence and a cost of £15.2 million as at 13 February 2015. These shares have all been cancelled. Debt financing risks The Group seeks to minimise debt financing risk as follows: Movements in net debt (£’m) (Table 7) Cash flow from operations before exceptional operating costs Exceptional operating costs excluding M&A costs Interest and tax Capitalised development costs/programme participation costs Capital expenditure Free cash flow Net (investment in)/proceeds from M&A Dividends (Purchase)/issue of own shares Share buyback Net cash generated Currency movements Other non-cash movements Opening net debt Closing net debt 2014 364.0 (16.6) (34.7) (123.7) (42.2) 146.8 (29.1) (51.4) (11.5) (33.7) 21.1 (24.7) (7.3) (564.6) (575.5) 2013 361.9 (15.3) (63.4) (105.9) (66.9) 110.4 25.9 (75.6) 2.5 – 63.2 2.7 12.0 (642.5) (564.6) 93987_p31-37.indd 35 04/03/2015 16:38 36 MEGGITT PLC REPORT AND ACCOUNTS 2014 Chief Financial Officer’s review continued a. Concentration of risk We raise funds through private placement issuances and committed bank facilities to reduce reliance on any one market. Bank financing is sourced from 13 international institutions spread across North America, Europe and Asia. No single bank accounts for more than 6% of the Group’s total credit facilities and the credit rating of lenders is monitored by our treasury department. Our largest lenders are Bank of America, Bank of China, Barclays, BNP Paribas, Crédit Industriel et Commercial, HSBC, JP Morgan, Bank of Tokyo-Mitsubishi and Sumitomo Mitsui Banking Corporation. We seek to maintain at least £200 million of undrawn committed facilities, net of cash, as a buffer. b. Set-off arrangements The Group utilises set-off and netting arrangements where possible to reduce the potential effect of counterparty defaults. All treasury transactions are settled on a net basis where possible and surplus cash is generally deposited with our lenders up to the level of their current exposure to us. c. Refinancing risk We seek to ensure the maturity of our facilities is staggered and any refinancing is concluded in good time, typically more than 12 months before expiry. d. Currency risk To ensure we mitigate headroom erosion due to currency movements our credit facilities are denominated in US Dollars, the currency in which most of our borrowings are held. Net debt by drawn currency (£’m) (Table 8) 2014 2013 Sterling US Dollar Euro Swiss Franc Other Net debt (17.7) 545.8 42.4 12.0 (7.0) (21.2) 462.9 53.9 78.9 (9.9) 575.5 564.6 e. Covenant risk Our committed credit facilities contain two financial ratio covenants—interest cover and net debt to EBITDA. The covenant calculations are drafted to protect us from potential volatility caused by accounting standard changes, sudden movements in exchange rates and exceptional items. This is achieved by measuring EBITDA on a frozen GAAP basis, retranslating net debt and EBITDA at similar average exchange rates for the year and excluding exceptional items from the definition of EBITDA. We continue to have considerable headroom on both key financial covenant measures. Covenant ratios (£’m) (Table 9) Covenant 2014 2013 Net debt/EBITDA ≤3.5x1 1.2x 1.2x Interest cover ≥3.0x 20.8x 22.0x 1 A ratio of 4.0x applies in the two six month reporting periods following a significant acquisition. Interest risk The Group seeks to reduce the volatility caused by interest rate fluctuations on net debt. Our US private placements are subject to fixed interest rates, whereas borrowings under our syndicated bank credit facilities are at floating rates. To manage interest rate volatility, we use interest rate derivatives to either convert floating rate interest into fixed rate or vice versa. Our policy is to maintain at least 25% of net debt at fixed rates with a weighted average maturity of two years or more. At 31 December 2014, the percentage of net debt at fixed rates was 48% (2013: 46%) and the weighted average period to maturity of the first 25% was 4.5 years (2013: 5.4 years). Foreign exchange risk The Group is exposed to both translation and transaction risk due to changes in foreign exchange rates. These risks principally relate to the US Dollar/ Sterling rate, although exposure also exists in relation to other currency pairs including translation risk for the Sterling/ Euro and Sterling/Swiss Franc and transaction risk for the US Dollar/Euro and US Dollar/Swiss Franc. Exchange rates (Table 10) 2014 2013 Average translation rates against Sterling: US Dollar Euro Swiss Franc Average transaction rates: US Dollar/Sterling US Dollar/Euro US Dollar/Swiss Franc 1.63 1.24 1.51 1.54 1.30 1.08 Year-end rates against Sterling: US Dollar Euro Swiss Franc 1.56 1.29 1.55 1.57 1.18 1.45 1.62 1.29 1.06 1.66 1.20 1.47 The results of overseas businesses are translated into Sterling at weighted average exchange rates. Compared to 2013, the Group’s underlying profit before tax for the year was adversely affected by £9.6 million from currency translation, of which £7.8 million arose on US Dollar denominated profits with the balance on other currencies. Translation currency sensitivity (£’m) (Table 11) Revenue PBT1 Impact of 10 cent movement2 : US Dollar Euro Swiss Franc 55.0 10.0 7.0 12.0 1.0 2.0 1 Underlying profit before tax as defined and reconciled to statutory measures in note 10 of the Group financial statements. 2 As measured against the 2014 average translation rates against Sterling set out in Table 10. The net assets of overseas businesses are translated into Sterling at year end exchange rates. The resultant exchange rate exposure is mitigated through holding our net debt in the currencies of those net assets, principally the US Dollar. Transaction risk arises where revenues and/or costs of our businesses are denominated in a currency other than their own. We hedge known and some anticipated transaction currency exposures based on historical experience and projections. Our policy is to hedge at least 70% of the next 12 months’ anticipated exposure and to permit the placing of cover up to five years ahead. Compared to 2013, the Group’s underlying profit before tax for the year benefited by £4.5 million from currency transaction movements, including a favourable impact of £5.6 million relating to US Dollar/Sterling exposure and adverse impacts from other currency pairs. Each ten cent movement in the US Dollar against the average hedge rates achieved in 2014, would affect underlying profit before tax by approximately £8.0 million in respect of US Dollar/Sterling exposure, £3.0 million in respect of US Dollar/Euro exposure and £4.0 million in respect of US Dollar/Swiss Franc exposure. At 31 December 2014, US Dollar/Sterling cover for our estimated 2015 exposure is 96% hedged at an average rate of $1.57 and we have covered approximately 80% of our exposure for the four subsequent years at an average rate of $1.54. We have 93987_p31-37.indd 36 04/03/2015 16:38  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 37 due to remeasurement gains on scheme assets, principally driven by the continued global recovery in equity markets. following which the Group continues to provide comparable benefits, resulted in a past service credit being recognised of £8.4 million (2013: Nil). also hedged 96% of our estimated 2015 US Dollar/Euro exposure at a rate of 1.36 and 100% of our estimated 2015 US Dollar/ Swiss Franc exposure at a rate of 1.08. Further hedging of approximately 80% of our US Dollar/Euro exposure for the four subsequent years is in place at an average rate of 1.21. We do not have any hedging in place for 2016 or subsequent years in respect of US Dollar/Swiss Franc exposure. • Post-retirement benefit schemes The Group’s principal defined benefit pension schemes are in the UK and US and are closed to new members. Total pension scheme deficits increased to £271.0 million (2013: £189.8 million). The main drivers of the movement were: • An increase in the deficit of £124.6 million (2013: Reduction of £10.6 million) due to remeasurement losses on scheme liabilities. The main cause of the increase was a significant reduction in the rates used to discount scheme liabilities. Accounting standards require these liabilities to be discounted using the yields on high quality AA corporate bonds, with a maturity that reflects the duration of the scheme liabilities. These yields, reflecting the falls seen in gilt markets, have reduced in 2014 by 100 basis points in the UK and 70 basis points in the US to levels not seen in the last 10 years. There has also been a modest increase in US liabilities following the adoption of new life expectancy tables which were published during the year. • A reduction in the deficit of £30.9 million (2013: £25.5 million) Net deficit reduction payments of £27.8 million (2013: £26.7 million). Regulations in the UK and US require repayment of deficits over time. In the UK, the Group is making deficit payments in accordance with an agreement reached with the trustees following the last actuarial valuation in 2012. This agreement provides for payments to gradually increase over the period to 2024. The next actuarial valuation date is April 2015. In the US, the level of deficit payments is principally driven by regulations. Amounts required to be paid in the US decreased slightly in the year reflecting the impact of new legislation regarding funding payments and are expected to reduce further in 2015 due to the full year impact of these changes. Overall, the Group expects deficit contributions to reduce to £25.7 million in 2015 based on the existing deficit reduction agreement with the UK trustees and absent further regulatory changes in the US. Meggitt has two other principal post- retirement benefit schemes providing medical and life assurance benefits to certain US employees. The Group’s exposure to increases in future medical costs provided under these plans is capped. Both schemes are unfunded and have a combined deficit of £46.8 million (2013: £48.3 million). Deficit payments during the year were £1.5 million (2013: £0.7 million). During the year, the Group made changes to the way in which medical benefits are provided. These changes, Defined benefit pension scheme summary (£’m) (Table 12) Opening net deficit Service cost Group cash contributions Deficit reduction payments Other amounts charged to income statement1 Remeasurement gains—schemes’ assets Remeasurement losses/(gains)—schemes’ liabilities Currency movements Closing net deficit Assets Liabilities Closing net deficit Funding status 2014 189.8 11.9 (39.7) (27.8) 10.3 (30.9) 124.6 5.0 271.0 761.1 1,032.1 271.0 74% 2013 241.2 12.7 (39.4) (26.7) 11.4 (25.5) (10.6) – 189.8 688.4 878.2 189.8 78% 1 Comprises past service amounts, administration expenses borne directly by schemes and net finance costs. Going concern The Group’s business activities are described on pages 10 to 17 which include those factors most likely to affect its future development, performance and position. The financial position of the Group is set out in this report and additional information is provided in the financial statements including note 3 (Financial risk management), note 28 (Bank and other borrowings) and note 30 (Derivative financial instruments). Details of the principal risks and uncertainties to which the Group is exposed, and the mitigation plans in place, are set out on pages 24 to 26. The Group describes in the Strategic Report on pages 8 to 9 its cash generative business model designed to deliver organic revenue growth of 6–7% in the medium-term and its resilience to one-off global shock events. The Group continues to be cash generative even at the current elevated level in the aerospace investment cycle, has considerable headroom against existing bank facilities and covenants and there is no material facility expiry before 2017. Accordingly, after making enquiries, the directors have formed a judgement, at the time of approving the financial statements, that there is a reasonable expectation that the Group and the Company have adequate resources to continue in operational existence for the foreseeable future. For this reason, the directors continue to adopt the going concern basis in preparing the Group and Company financial statements. Doug Webb Chief Financial Officer 93987_p31-37.indd 37 04/03/2015 16:38 38 MEGGITT PLC REPORT AND ACCOUNTS 2014 Corporate responsibility We recognise our responsibility to shareholders, employees, customers, suppliers and the wider community to conduct our operations in a safe, responsible and sustainable manner. We believe that our focus on corporate responsibility creates value for Meggitt and our stakeholders. It helps us manage our businesses more efficiently, which in turn helps us mitigate risks, reduce costs and protect the communities in which we operate. We are also committed to ensuring compliance with all relevant national laws and regulations and aim to continually improve our financial, social and environmental performance. Policy We are committed to: • • • Upholding sound corporate governance principles; Providing a supportive, rewarding and safe working environment with modern operational practices; Conducting business relationships in an ethical and responsible manner; Minimising the environmental impact of products and processes and maintaining internationally-accredited environmental management systems; Acting as a responsible supplier and encouraging our contractors and suppliers to do the same; • Independent audits in key • • compliance areas; • Supporting our local communities; and • Professional and comprehensive employee training programmes. Governance and compliance Health, safety and environment (HSE), ethics and business conduct and trade compliance are managed by a highly experienced team of functional specialists, under the leadership of the Corporate Affairs Director. Divisional presidents and site directors are responsible for implementing policies and programmes locally. Board-approved policies on corporate responsibility, health and safety, environment, ethics and business conduct and trade compliance are published on the policies section of our website. The Board’s Ethics and Trade Compliance Committee meets quarterly to discuss these programmes in detail. HSE matters are reviewed and discussed at every Board meeting. Sustainability Meggitt appreciates the importance of conducting business in a sustainable manner and we will continue to incorporate this principle into the way we carry out our operations. During 2014, we held initial discussions with Business in the Community, a leading charitable organisation in this field, to help develop our thinking further. Activity in 2014 Environment Meggitt strives to achieve high levels of environmental performance throughout our businesses based on standards and procedures set by Group leadership. To achieve the goals of our Environmental Policy, Meggitt’s environmental management programme includes setting environmental targets, communicating regulatory developments, training and information-sharing, data analysis and internal and external auditing of environmental management systems and practices. Our global environmental audit programme, supported by external consultants, includes a comprehensive review of applicable regulatory requirements and best practice standards at all manufacturing facilities every three years. In total, 16 sites were audited in 2014. Some 86% of our manufacturing facilities had achieved ISO 14001 standard certification by the end of 2014. The remaining facilities are targeting certification in 2015. Performance Table 1 shows our performance for key environmental metrics and Table 2 shows our progress on achieving internally set targets. Our performance is on track to meet targets for most metrics, but facility consolidations and increased production of carbon brakes has impacted our progress on electricity and waste recycled in 2014. Although we had already achieved our five-year target on CO2 emissions relative to revenue as at the end of last year, our performance slipped in 2014 to a 7% reduction compared to our baseline year which means that we did not reach our five-year CO2 reduction target by the end of 2014. The increase in CO2 emissions in 2014 was primarily due to a significant increase in electricity and gas consumption in our US carbon manufacturing operations because of an increase in production as new aircraft programmes enter service. We recycle an estimated average of 87,000 cubic metres of water each year through closed-loop water recycling systems installed at several facilities. Other water conservation measures include installation of thermostatically controlled water circulation systems on process tanks reducing evaporative losses. In 2014, despite an increase in cooling water used in our carbon manufacturing operations, our closed-loop recycling systems and other water conservation efforts resulted in a decrease in absolute water consumption and consumption relative to revenue and we remain on track to meet our five-year target of reducing water consumption relative to revenue. We were able to realise the benefits of integrating the waste minimisation ideals of the Meggitt Production System (MPS) by reducing the environmental impact of waste at many facilities within the Group and were able to decrease the absolute amount of waste generated by 13%. An example of the progress made in 2014 is at one of our US braking systems facilities, which found a way to recycle carbon dust from carbon brake disk machining into electrically conductive plastic. This facility also identified a recycling method for waste carbon insulation as an oxygen scavenger in third-party metal recovery Environmental metrics1 (Table 1) Utilities Electricity—gWh MWh per £m revenue Natural gas—gWh MWh per £m revenue GHG Emissions (CO2e)1—tonnes Tonnes per £m revenue Waste—tonnes Tonnes per £m revenue Water—cubic metres Cubic metres per £m revenue 2014 Change 201 127 190 120 131,897 83.5 12,200 7.72 722,200 457 +6% +4% +5% -13% -2% 2013 192 120 183 115 126,720 79.3 14,182 8.87 744,196 466 1 Metrics per £m are calculated using revenue converted at constant exchange rates. Greenhouse gas emissions are calculated using conversion factors published in the 2013 and 2014 Guidelines to DEFRA/ DECC’s GHG Conversion Factors for Company Reporting. Emissions from overseas electricity are in CO2 only (not CO2e). The 2013 reported GHG emissions have been restated to reflect the change in using the updated conversion factors. 93987_p38-41.indd 38 04/03/2015 16:40  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 39 furnaces. In total, these efforts have resulted in the facility diverting 35 tonnes of waste away from landfill. Since 2007, we have been a participant in the Carbon Disclosure Project (CDP) detailing our approach and performance in managing climate change. In 2014, we increased our score by 60% and our submission can be viewed on the CDP website. Greenhouse gas emissions (GHG) Table 3 shows the GHG emissions data for the Large and Medium-Sized Companies and Groups (Accounts and Reports) Regulation 2013 (the Regulations). The sites reporting GHG data are the same as those consolidated in the Group’s financial statements. We had an absolute increase in our GHG emissions in 2014 and our GHG emissions relative to revenue increased slightly due to an increase in electricity and natural gas consumed in our US carbon manufacturing operations as described above. Notwithstanding, this increase was partially offset by reductions in electricity and gas consumption and associated GHG emissions elsewhere due to site consolidations and energy efficiency measures as well as an increase in carbon recycling and reuse under our carbon refurbishment initiative described below. To align the Group’s emissions targets with the Regulations, we will be setting new five-year GHG emission reduction targets from 2016 using 2015 as the baseline year. We will set separate GHG reduction targets for our carbon manufacturing operations due to the unique and complex process involved. Saving energy In 2014, we achieved reductions in key sustainability metrics through investments in several energy efficiency projects. These are exemplified by upgrading compressed air plants, improving furnace controls and installing high efficiency lighting and controls at our facilities as follows: • Recladding of roofing insulation at a UK facility resulted in improved heating and cooling efficiencies. Significant lighting upgrade projects at several facilities, saving around 300 tonnes of CO2 per annum. • • Replacement of fluorescent lighting with more efficient LED lighting and replacement of two inefficient boilers with higher efficiency rated gas boilers at another of our UK facilities saving 25 tonnes of CO2 per annum. The same facility made insulation upgrades to improve heating and cooling efficiencies. Targets (Table 2) CO2 emissions Gas Electricity Water consumption Waste to landfill Waste recycled Baseline year 2009 2011 2011 2011 2011 2011 Five year performance period (financial years) Target improvement over performance period Achieved during performance period up to 31 December 2014 To 31 December 2014 To 31 December 2016 To 31 December 2016 To 31 December 2016 To 31 December 2016 To 31 December 2016 -15% -15% -15% -10% -10% +10% -7% -11% +10% -6% -6% 0% • The carbon refurbishment programme at our braking systems facility in Akron, US continued to expand in 2014 with a 59% increase in carbon discs recovered and refurbished from 2013. Reductions in processing time and associated energy consumption of around 81% resulted in savings of approximately 2,300 tonnes of CO2 that would have otherwise been emitted in 2014. Meggitt UK facilities will be required to comply with the Energy Savings Opportunity Scheme (ESOS) in 2015. As a result, the facilities comprising at least 90% of our energy consumption in the UK will undergo energy assessments. Conducted by certified lead assessors, these will assist us in identifying additional energy conservation opportunities. The ESOS is derived from European Union (EU) legislation and it is likely that EU member countries will implement similar schemes requiring energy assessments for other EU Meggitt facilities. We recognise the need to reduce our dependence on fossil fuels and are actively investigating cleaner energy technologies including fuel cell power generation systems and solar energy throughout the Group. (REACH) is managed by the Group’s REACH Steering Committee which continues to address the risks associated with the potential obsolescence of chemicals used by aerospace manufacturers. We continuously track substances regulated under REACH and work closely with our chemical suppliers to ensure substances are registered and will be approved for continued use, or a suitable alternative identified. We participate in an aerospace industry group involved in researching the replacement of hexavalent chromium used in common applications impacting aerospace manufacturing. Obsolescence The Obsolescence Review Board (ORB) continued to identify and define a coordinated response to issues potentially affecting our business including conflict minerals, counterfeit and fraudulent materials and chemical obsolescence. Working with our customers and suppliers, we continue to strive for the reduction and substitution of materials and substances impacted by regulatory developments, performing material assessments, surveying our suppliers and undertaking reliability and qualification testing of alternatives. REACH Compliance with the European Community regulation on Registration, Evaluation, Authorisation and Restriction of Chemicals Health and safety We want our employees to work in safe and secure environments and believe that occupational injuries and illnesses are GHG emissions1 data (Table 3) Combustion of fuel and operation of facilities3 Electricity, heat, steam and cooling purchased for own use Intensity measurement: Emissions reported above, normalised to tonnes per £m revenue 2014 Tonnes of CO2e 35,693 96,204 131,897 20132 Tonnes of CO2e 34,239 92,480 126,719 83.5 79.3 1 Global GHG emissions are calculated using conversion factors published in the Guidelines to DEFRA/ DECC’s GHG Conversion Factors for Company Reporting. Emissions factors from overseas electricity are in CO2 only (not CO2e). 2 2013 numbers have been restated to the updated 2013 conversion factors. 3 Does not include GHG emissions generated from Meggitt-owned and operated vehicles or refrigerant gases as these emissions are not material to the Group’s emissions. 93987_p38-41.indd 39 04/03/2015 16:40 40 MEGGITT PLC REPORT AND ACCOUNTS 2014 Corporate responsibility continued Reportable accidents and incidents (Table 4) Reportable accidents and incidents1 Reportable accident/incident rate2 2014 36 337 Change +3% +6% 2013 35 317 1 Directly reportable to a regulatory authority. 2 The number of reportable accidents/incidents per 100,000 employees. preventable. Our health and safety policy makes clear that we do not tolerate unsafe behaviours or conditions in our workplaces and that we seek to continuously improve our safety culture and performance with an ultimate goal of zero injuries and illnesses. In 2014, we continued to implement measures to improve safety in the workplace. These included: • • • • • Group-wide online health and safety awareness training for all employees; Implementation of a behavioural health and safety programme at five facilities in 2014, with plans to roll it out at another ten facilities in 2015; Development of a health and safety maturity index and a revision of the Meggitt Safety Star recognition programme to focus on proactive health and safety leading indicators. This will emphasise the importance of preventative actions to reduce incidents and injuries occurring in the workplace; Integration of the reporting and investigation of near-miss accidents and unsafe conditions with MPS; Continued dissemination of information and best practice through intra-Group HSE conferences, health and safety alerts and all-employee safety bulletins. • Roll out of a further three new Meggitt health and safety procedures across the Group. As a result of these measures we have made good progress on some of our safety metrics across the Group, most notably a 25% decrease in the US Occupational Safety and Health Administration (OSHA) recordable frequency rate for our US operations compared to the prior year. However, due to a substantial increase in the number of reported incidents at a small number of our sites, the Group overall experienced a slight increase in reportable incidents and associated incident rates, as shown in Table 4. In 2014, 80% (2013: 80%) of our manufacturing facilities achieved at least a Bronze Meggitt Safety Star award reflecting a 25% improvement in health and safety performance over the three- year average performance for years 2009 to 2011. Of those, 23 facilities will receive a Platinum Safety Star award for outstanding performance in 2014. As reported in last year’s annual report, we continue to cooperate fully with regulatory authorities in the investigation of the fatal accident that occurred at our Rockmart, US facility last year and we expect the investigation to conclude in 2015. Ethics and business conduct and trade compliance Our ethics and business conduct programme commits us to conducting business fairly, impartially and in compliance with laws and regulations and acting with integrity and honesty in our business relationships. In 2014, we provided training across the Group, on our Code of Conduct, ‘Reporting Concerns—Someone Else’s Problem’, and Global Anti-Corruption. We held two in-house ethics conferences, one in the UK and one in the USA, where facility-based ethics coordinators reviewed and provided feedback on the Ethics Programme. As a result of this feedback, we are redesigning our Ethics Guide, which will be available to all staff in printed form and on our website. Meggitt is a charter member of the International Forum on Business Ethical Conduct for the aerospace and defence industries and Barney Rosenberg, our Vice President, Ethics and Business Conduct, serves on the Steering Committee that runs this global organisation. The Board revised the Trade Compliance Policy (which is available on our website) in 2014. We have a highly-developed trade compliance programme, based on the Nunn-Wolfowitz Task Force Report of 2000 (the influential report on export compliance best practice) and guidelines issued by the regulatory authorities. During 2014, we continued to implement our global trade management software solution to enhance our trade compliance programme, and continued implementation of our enhanced import compliance programme at a number of facilities in the US and the UK. We also implemented Phases 2 to 5 of the US Government’s Export Control Reform programme. Local communities and charitable donations We are committed to being good corporate citizens, and continue to support the communities in which we operate. Our businesses and employees give back to our communities through volunteerism, educational business partnerships and charitable donations as demonstrated by the following: • • • Since 2007, we have continued to sponsor the Arkwright Engineering Scholarship Trust, an independent, charity that identifies, inspires and nurtures future leaders in engineering and technical design. The scholarship supports Science, Technology, Engineering and Mathematics (STEM) initiatives that grant an annual financial award to young scholars and their schools. The 2014 scholar will benefit from mentoring by an experienced member of the Meggitt Global Engineering Group and valuable work experience over the next two years. Meggitt US businesses and employees have donated over USD 1 million in the past five years to the United Way, a US-based non-profit organisation focusing on resolving local community issues through partnerships with local schools, government agencies and voluntary and neighbourhood associations. Several Meggitt US businesses hold annual United Way drives to encourage employee engagement in local community activities and initiatives designed to improve education, financial stability and health care for local families. Our McMinnville Oregon facility partnered with local businesses, community leaders and the McMinnville Economic Development Partnership to establish a manufacturing training programme at a local high school to address a shortage of skilled local labour. Meggitt donated equipment and materials for student training and assisted in developing the syllabus. Local congressional officials who visited the high school and Meggitt facility acknowledged the importance of innovative partnerships between the private sector and local schools to provide training leading to well-paid local manufacturing jobs. Some 260 of the school’s 400 students enrolled. 93987_p38-41.indd 40 04/03/2015 16:40  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 41 Analysis of employees (Table 5)1 Employees by division Number of employees 10,823 Employees by length of service (years) Number of employees Employees by region Number of employees 10,823 10,823  Aircraft Braking Systems  Control Systems  Polymers & Composites  Sensing Systems  Equipment Group  Cross-group facilities 1,267 1,902 1,827 3,120 1,995 712 12% 17% 17% 29% 18% 7%  Less than 5  Between 5 and 10  Between 10 and 15  Between 15 and 20  Between 20 and 25  Over 25 4,841 2,252 1,211 976 350 1,193 45% 21% 11% 9% 3% 11%  USA  UK  Mainland Europe  Rest of World 5,385 2,847 1,554 1,037 50% 26% 14% 10% 1 As at 31 December 2014. • • • Our Poole UK facility partnered with the local Bournemouth and Poole College to develop an apprenticeship and training programme. An annual charitable golf outing sponsored by our Saginaw, Michigan facility is held in June, donating funds to the local amyotrophic lateral sclerosis association and the Saginaw YMCA. In the UK, our Birmingham facility commemorated the 100-year anniversary of the start of World War 1 with support for the Help for Heroes military charity. Our employees Learning, career development, employee engagement, strong leadership and effective teamwork are vital components of Meggitt’s performance culture. Various initiatives are underway, many of which have overt goals to improve or sustain engagement. Investment in learning and development is one. We continue to increase corporate training enabling employees from different businesses to learn together and create a common culture. The most significant investment is in MPS, our single, global approach to the application of ‘lean’ tools and other continuous improvement practices. The purpose of MPS is to ensure that everything we do and everyone who does it supports the front line of our business. Table 6 Level Board of Directors Executive Board Senior executives All employees % of females at 31 December 2014 Number of females Number of males 20% 13% 9% 29% 2 1 22 3,111 8 7 236 7,712 Equal opportunities The Group supports equal employment opportunities and opposes all forms of unlawful or unfair discrimination. It is Group policy to give full and fair consideration to job applications from disabled people, to provide opportunities for their training, career development and promotion and to continue wherever possible to employ staff who become disabled. We require all Meggitt employees, reinforced through our ethics training programme and its values, to treat all colleagues fairly and with respect. We recognise the value of diversity amongst our employees. Table 6 shows the number of women employed at all levels of the workforce. The Board’s approach to diversity is discussed in the Nominations Committee report (see page 54). Human rights We confirm our commitment to the human rights of our employees in our Corporate Responsibility Policy, which we apply across all our businesses. all-employee ‘Town Hall’ meetings, team briefings and works councils. We respect all employee relations regulations. Corporate communications take a variety of forms, including presentations from the Chief Executive via audio-visual media, global web-enabled conferences, publications such as the Meggitt Review and a variety of electronically-distributed newsletters. Results presentations are disseminated across the Group, which enhance our employees’ understanding of the financial and economic factors affecting its performance. The directors encourage employees to become shareholders to improve active participation in, and commitment to, the Group’s success. This policy has been pursued for all UK employees through the Share Incentive Plan and the Sharesave Scheme. Strategic report This 2014 Strategic report on pages 1 to 41 is hereby signed on behalf of the Board of Directors. Our very successful graduate training scheme continues with a third generation of graduates and post-graduates from some of the world’s best engineering institutions. Our next executive leadership programme begins in 2015, tailored for Meggitt by the Saïd Business School (see page 20). Employee consultation The Group regards employee communication as a vital business function. Communication and consultation is carried out at facilities by operations directors and other line managers using a variety of forums including daily meetings on shop floors, monthly Stephen Young Chief Executive 23 February 2015 93987_p38-41.indd 41 04/03/2015 16:40 42 MEGGITT PLC REPORT AND ACCOUNTS 2014 Who runs Meggitt and how do we reward them? 44 55 42-79 Governance reports 43 Chairman’s introduction 44-45 Board of directors 46-50 Corporate governance report 51-53 Audit Committee report 54 Nominations Committee report 55-75 Directors’ remuneration report 76-79 Directors’ report 93987_p42-45.indd 42 11/03/2015 10:34 STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 43 Corporate governance report Chairman’s introduction Throughout the financial year ended 31 December 2014 and to the date of this report, we have complied with the provisions set out in the UK Corporate Governance Code 2012 (the Code) published by the Financial Reporting Council (FRC). The Company has applied the main and supporting principles set out in the Code. An explanation of how the main principles have been applied is set out in this report and in the Audit Committee report, the Nominations Committee report (including a report from the Chairman Succession Sub-Committee) and in the Directors’ remuneration report. The FRC published a revised UK Corporate Governance Code on 17 September 2014, applicable to reporting periods beginning on or after 1 October 2014 (the 2014 Code), although the Board has adopted some of the new provisions in the 2014 Code earlier than required. In December 2014, we announced that as a result of the additional time commitments required for his new appointment as non-executive director and chairman designate of Drax Group plc, Phil Cox had decided to resign as a non-executive director with effect from 31 January 2015. On behalf of the Board I would like to thank David and Phil for their significant contributions to the Board and to wish them well for the future. Effectiveness As reported last year, the main findings from our 2013 internal evaluation were to enhance our strategy reviews and risk management process and continue to improve the annual Board schedule. In 2014, the Board engaged in additional strategy presentations and discussions and we continued to enhance our risk management process. We have since conducted our 2014 internal evaluation and a report is included on page 49. The Board is committed to maintaining high standards of corporate governance, which are fundamental to discharging our responsibilities. As Chairman, I encourage open and transparent discussion and constructive challenge. It is my responsibility to ensure that Meggitt is governed and managed in the best interests of shareholders and wider stakeholders. In this report, we set out our governance framework and explain how sound and effective corporate governance practices support our strategy of creating long-term, sustainable shareholder value. Accountability The Board considered the 2014 Code, and assessed our current processes and reporting of risk management and internal control against the associated guidance issued by the Financial Reporting Council in September 2014. In 2015, we will start preparing for the new long-term viability statement which is first required for our 2015 Annual Report. Our shareholders can read about our most significant risks and uncertainties and our risk management process on pages 24 to 26. Leadership At our AGM in May 2014, I announced my intention to retire following the appointment of a suitable successor, having had the privilege of chairing the Board of Directors for nearly 11 years. I have thoroughly enjoyed my time as the Chairman of Meggitt and am delighted to hand over to Sir Nigel Rudd, a highly experienced and successful director and chairman. With his prior role as a non-executive director of BAE Systems, and current exposure to the industry at BBA Aviation, Sir Nigel has exceptional knowledge of the aerospace sector. I know that his experience across a wide range of businesses will be of significant benefit to the Group. In terms of other Board changes, in May 2014, David Robins retired from the Board and in October 2014 we appointed Alison Goligher as a non-executive director. Alison introduces specific oil and gas experience to our Board, which will be of great value to Meggitt’s energy businesses. At the same time, her technology management expertise and experience running a wide range of functions within globally significant corporations will benefit the Group as a whole. The Board have confirmed that this Annual Report is fair, balanced and understandable, and you will find an explanation of the process we have used to make this determination on page 51. Remuneration At our AGM in 2014, we received 98.95% votes in favour of our Remuneration Policy. Shareholders also overwhelmingly approved our Directors’ remuneration report and a new long-term incentive plan. The Directors’ remuneration report (pages 55 to 75) provides a detailed review of the Remuneration Committee’s 2014 activities and bonus and share scheme performance in 2014. For ease of reference, we have also included the Remuneration Policy approved at our AGM in 2014 (which is valid until the AGM held in 2017). Sir Colin Terry Chairman of the Board of Directors 23 February 2015 93987_p42-45.indd 43 04/03/2015 17:00 44 44 MEGGITT PLC REPORT AND ACCOUNTS 2014 MEGGITT PLC REPORT AND ACCOUNTS 2014 Board of directors Board of directors Meggitt’s Board is characterised by world-class experience of UK, mainland European and North American businesses spanning multiple sectors—many with global reach. Stephen Young Alison Goligher Sir Colin Terry Guy Berruyer Philip Green Sir Colin Terry KBE CB DL FREng Non-Executive Chairman + § Appointed: 2004 | Nationality: British Retiring at the conclusion of the 2015 AGM Skills and experience Chartered engineer with extensive civil and military aerospace, logistics and industrial experience. Qualified military and civilian pilot. Current appointments Chairman of the UK Military Aviation Authority Safety Advisory Committee, Non-Executive Director and Chairman of the Audit Committee of Fox Marble Holdings PLC, Non-Executive Chairman of AviaMedia Tech Limited and Non-Executive Director and Chairman of the Remuneration Committee of Aveillant Limited. President of Soldiers, Sailors, Airmen and Families Association in Buckinghamshire, of which he is Deputy Lieutenant. Previous appointments 37 years in Royal Air Force, reaching rank of Air Marshal, where he was Chief Engineer (RAF), a Commander in Chief and the Air Force Board Member for Logistics. Since retiring from the regular RAF, was Group Managing Director of Inflite Engineering Services, Chairman of the Engineering Council (UK), President of the Royal Aeronautical Society and the Council of European Aerospace Societies. Served for several years as an RAF Volunteer Reserve Pilot. Committee membership * Audit Committee + Nominations Committee ‡ Remuneration Committee § Ethics and Trade Compliance Committee ◊ Finance Committee Stephen Young Chief Executive + § ◊ Appointed: 2013 | Nationality: British Appointed to the Board as Group Finance Director in 2004, prior to appointment as Chief Executive Skills and experience Chartered management accountant with wide experience in all financial disciplines gained from national and multi-national businesses across multiple sectors. Current appointments Non-Executive Director, Audit Committee Chairman and member of Risk and Remuneration committees of Derwent London plc. Previous appointments Senior financial positions held previously include Group Finance Director, Thistle Hotels plc and Group Finance Director of the Automobile Association. Guy Berruyer Non-Executive Director * + ‡ Appointed: 2012 | Nationality: French Skills and experience Trained as electrical engineer at the École Polytechnique Fédérale de Lausanne and holds Harvard Business School MBA. Brings significant experience to the Board as a recently serving FTSE-100 Chief Executive. Current appointments None. Previous appointments Group Chief Executive of The Sage Group plc until 5 November 2014. Chief Executive of Sage Group plc’s Europe and Asia division. Early career spent with software and hardware vendors in French and European management roles. Alison Goligher OBE Non-Executive Director * + ‡ Appointed: 2014 | Nationality: British Skills and experience MEng Petroleum Engineering. Brings specific oil and gas experience to the Board, including technology management expertise and experience running diverse functions and businesses within globally significant energy corporations. Current appointments Joined Royal Dutch Shell in 2006; appointed Executive Vice President, Upstream International Unconventionals in 2013. Previous appointments 17 years at Schlumberger, a leading supplier of technology, integrated project management and information solutions to oil and gas customers worldwide. Philip Green Group Corporate Affairs Director § ◊ Appointed: 2001 | Nationality: British Skills and experience Fellow of the Institute of Chartered Secretaries and Administrators, with significant legal and compliance experience. Current Appointments Member of the GC100 and the Dorset Employment and Skills Board. To be appointed as Non-Executive Director of Poole Hospital NHS Foundation Trust from 25 April 2015. Previous appointments Meggitt’s Company Secretary from 1994 to 2006, after 14 years at British Aerospace in company secretarial roles. 93987_p42-45.indd 44 11/03/2015 10:34 STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 45 Paul Heiden Doug Webb Brenda Reichelderfer David Williams Sir Nigel Rudd Sir Nigel Rudd DL To be appointed as Non-Executive Director and Deputy Chairman on 1 March 2015 Assuming the role of Non-Executive Chairman at the conclusion of the AGM on 23 April 2015 | Nationality: British Skills and experience Chartered accountant with extensive Board experience spanning multiple sectors including aerospace, retail and financial services. Current appointments Non-Executive Chairman of BBA Aviation plc and Heathrow Airport Holdings Limited, Chairman of Aquarius Platinum Ltd, Non-Executive Director of Sappi Limited and Chancellor of Loughborough University. Previous appointments Chief Executive of Williams Holdings plc. Chairman of Kidde plc, BAA Limited, The Boots Company, Pilkington PLC, Pendragon PLC and Invensys plc. Deputy Chairman of Barclays PLC and Non-Executive Director of BAE Systems plc. Paul Heiden Non-Executive Director * + ‡ Appointed: 2010 | Nationality: British Doug Webb Chief Financial Officer § ◊ Appointed: 2013 | Nationality: British Skills and experience Chartered accountant, with considerable experience in senior executive and financial roles in aerospace. Current appointments Non-Executive Director and Chairman of the Audit Committee of London Stock Exchange Group plc and Chairman of Intelligent Energy Holdings plc. Previous appointments Chief Executive of FKI Plc from 2003 to 2008, senior positions, including Director, Industrial Business and Finance Director of Rolls-Royce plc and senior financial positions with Peat Marwick, Mitchell and Co, Hanson Plc and Mercury Communications. Non-Executive Director of UU Plc, Bunzl plc, Essentra PLC (formerly Filtrona PLC) and Chairman of Talaris Topco Limited. Brenda Reichelderfer Non-Executive Director * + ‡ § Appointed: 2011 | Nationality: American Skills and experience Skilled engineer and business leader with considerable US aerospace and industrial experience. Current appointments Senior Vice President and Managing Director of private equity sector consulting firm TriVista and Non-Executive Director of Federal Signal Corporation. Previous appointments Senior roles at ITT Industries Corporation including Senior Vice President, Director of Engineering, Chief Technology Officer and Group President of two operating divisions. Non-Executive Director of Wencor Aerospace. Skills and experience Chartered accountant who has held senior international financial positions in defence, aerospace, engineering, technology and financial services. Current appointments Non-Executive Director of SEGRO Plc and Chairman of their Audit Committee and member of the Hundred Group of Financial Directors. Previous appointments Chief Financial Officer, London Stock Exchange Group Plc, Chief Financial Officer, QinetiQ Group Plc and various senior financial roles in the UK and US for Logica (now CGI). David Williams Non-Executive Director * + ‡ Senior Independent Director Appointed: 2006 | Nationality: British Skills and experience Chartered accountant with significant experience in senior financial roles. Current appointments Joint Chairman of Mondi plc and Mondi Limited. Previous appointments Senior financial roles including 15 years as Finance Director of Bunzl plc. Non-Executive Director and Audit Committee Chairman of Tullow Oil plc until May 2012. Non-Executive Director and Audit Committee Chairman of DP World Limited until his retirement in April 2014. 93987_p42-45.indd 45 10/03/2015 16:51 46 MEGGITT PLC REPORT AND ACCOUNTS 2014 Corporate governance report continued LEADERSHIP Our governance framework as at 31 December 2014: Board of directors Sir Colin Terry (Chairman) Three executive directors Six independent non-executive directors Creating and delivering sustainable shareholder value Board committees Remuneration Audit Nominations Six independent non-executive directors Six independent non-executive directors Chairman, Chief Executive and six independent non-executive directors Determines the reward strategy for the executive directors and senior management, to align their interests with those of the shareholders Monitors the integrity of the Group’s financial statements and the effectiveness of the external and internal auditors Ensures the Board and senior management team have the appropriate skills, knowledge and experience to operate effectively and to deliver the Group’s strategy Ethics and trade compliance Finance Chairman Succession Chairman, one non-executive director and three executive directors Three executive directors and Chief Operating Officer Ensures the implementation and application of the Ethics and Business Conduct and Trade Compliance policies and programmes Approves treasury-related activity, insurance, and other matters delegated to it by the Board This committee existed during 2014 but not at the year end Independent non-executive directors Select and interview candidates and recommend candidate to the Board Management committees Executive Board Operations Board Commercial Committee Three executive directors, the Chief Operating Officer and four senior functional executives The Chief Operating Officer and five divisional presidents Assists the Chief Executive with the development and implementation of the Group’s strategy, the management of the business and the discharge of responsibilities delegated by the Board Assists the Chief Operating Officer to manage the Group’s operations and discharge the responsibilities delegated by the Executive Board Three executive directors, Chief Operating Officer and two Executive Board members Reviews/approves bids and proposals and any other commercial activity 93987_p46-54.indd 46 04/03/2015 17:02  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 47 The role of the Board The Board retains full and effective control of the Group and is collectively responsible for its success. It sets the Group’s strategy, ensures appropriate resources are in place to achieve the Group’s objectives and reviews performance regularly. The Board is responsible for setting the Group’s values and standards and for ensuring obligations to shareholders, employees and other stakeholders are met. A Schedule of Matters Reserved for the Board (updated in 2012) sets out the matters on which the Board must make the final decisions. These include, for example, changes to the Group’s capital structure and capital allocation policy, acquisitions and disposals above a certain threshold and approval of results announcements, annual reports and dividends. If a decision is not reserved for the Board, authority lies, in accordance with authorisation policies and terms of reference, with a Board committee, a management committee, the Chief Executive or other executive director, Chief Operating Officer, divisional president or site director. Board membership and attendance during 2014 The Board met eight times in 2014, attendance for which is shown in the table below. Name Title Chairman Sir Colin Terry Non-executive director Mr G S Berruyer Mr P G Cox1 Non-executive director Ms A J P Goligher2 Non-executive director Corporate Affairs Director Mr P E Green Mr P Heiden Non-executive director Ms B L Reichelderfer Non-executive director Mr D A Robins3 Non-executive director Chief Financial Officer Mr D R Webb Non-executive director Mr D M Williams Chief Executive Mr S G Young 1 Resigned 31 January 2015 2 Appointed 30 October 2014 3 Resigned 7 May 2014 Meetings eligible to attend Meetings attended 8 8 8 2 8 8 8 2 8 8 8 8 8 8 2 8 8 8 2 8 8 8 Chairman • Sir Colin Terry met the independence criteria on appointment as Chairman on 1 July 2004. Sir Nigel Rudd will join the Board on 1 March 2015, initially as a non-executive director and Deputy Chairman, becoming Chairman at the end of the Annual General Meeting (AGM) on 23 April 2015 upon Sir Colin Terry’s retirement from the Board and as Chairman. Sir Nigel Rudd will meet the independence criteria on appointment as Chairman. • • The roles of the Chairman and Chief Executive are separate and a clear division of responsibilities has been approved and agreed in writing by the Board. These were reviewed and updated by the Board in 2013. The Chairman is responsible for (i) setting the Board’s agenda; (ii) ensuring that adequate time is available for discussion of agenda items, including strategic issues; (iii) leading the Board; and (iv) ensuring its effectiveness. • The Chairman facilitates the contribution of non-executive directors and oversees the relationship between them and the executive directors. The Chairman holds meetings with other non-executive directors without executive directors present. • The Chairman is responsible for ensuring directors receive accurate, timely and clear information and is satisfied that effective communication, principally by the Chief Executive and Chief Financial Officer, is undertaken with shareholders. • The Chairman agrees a personalised approach to the training and development of each director and reviews this regularly. Senior Independent Director The role of Mr Williams, as Senior Independent Director, is to: • Make himself available to shareholders if they have concerns that cannot be resolved through normal channels; • Chair the Nominations Committee when it is considering the Chairman of the Board’s succession, however Mr Williams did not Chair the Nominations Committee for the recent Chairman succession process because he was a candidate for the role. The chairman selection process employed in 2014 is outlined in more detail on page 54; and • Meet with the non-executive directors at least once a year to appraise the Chairman’s performance. Non-executive directors • The non-executive directors play a full part by challenging executive management and contributing to the development of the Group’s strategy. • • • The non-executive directors scrutinise the performance of executive management and monitor the reporting of the Group’s performance, the integrity of financial information and the effectiveness of financial controls and risk management systems. The non-executive directors are responsible for determining appropriate levels of remuneration for executive directors and participating in the selection and recruitment of new directors and succession planning. The terms and conditions of appointment of non-executive directors are available for inspection at the Company’s registered office during normal business hours. Company Secretary The appointment and removal of the Company Secretary is a matter for the Board. The work of the Board in 2014 The Board approved the appointment of Ms Goligher as a non- executive director and Sir Nigel Rudd as non-executive director and Deputy Chairman (to become Chairman at the conclusion of the AGM on 23 April 2015). The Board visited several facilities and received regular reports from executive management on strategy and business performance, financial performance (including treasury activity) and corporate affairs (including risk, legal and compliance). The Board implemented enhancements to its 2014 programme as a result of the evaluation of the Board undertaken in 2013, including: • An update and Board discussion on Group strategy, focusing on technology, aftermarket and operations; 93987_p46-54.indd 47 04/03/2015 17:02 48 MEGGITT PLC REPORT AND ACCOUNTS 2014 Corporate governance report continued • Greater focus on risk, including a session to review and approve the Group’s risk appetite. The Board received and discussed: • The Group’s budget for 2015; • Business unit and functional updates and presentations on senior executive succession, operations, IT security, and investor relations; • Reports on internal control, risk management and going concern; and • Reports on the activities of its committees. The Board reviewed and approved: • • • The 2013 Annual Report and Accounts, the 2013 full-year results announcement and the 2014 interim results announcement; Interim management statements released in May and November 2014; Recommendations to shareholders on the final dividend payment for the year ended 31 December 2013 and approved the interim dividend payment for the year ended 31 December 2014; • The Group’s risk appetite and risk register; • The appointment of a second corporate broker; • The decision to commence a share buyback programme; • Fees payable to the Group’s auditors and a recommendation to shareholders on their reappointment; • Amended terms of reference for all Board committees; and • Revisions to the Group’s share dealing rules, health and safety and trade compliance policies. Since the year-end, up to the date of the Annual Report, the Board has approved the 2014 Annual Report and Accounts, the 2014 full-year results announcement and the proposed final dividend for the year ended 31 December 2014. During the year, no unresolved concerns were recorded in the Board’s minutes. Effectiveness Composition The Board considers it has a good balance of executive and non-executive directors, is of an appropriate size and includes the independence, skills, experience and knowledge to enable the directors to discharge their respective duties and responsibilities effectively. All non-executive directors are considered independent under the Code. All non-executive directors (other than the Chairman) are members of the Audit and Remuneration Committees on appointment. All non-executive directors are asked to join the Nominations Committee on appointment. Chairmanship of Committees is considered during discussions on composition and succession. No one other than Committee chairmen and members are entitled to attend the meetings, although others can be invited. Committee chairmen, members and regular meeting invitees are noted in the respective Committee reports below. Each of these Committees’ written terms of reference were reviewed and updated in 2014 by the Board. These are available on our website. All Committee chairmen report orally on the proceedings of their Committees at the next meeting of the Board. Where appropriate, the Committee chairmen make recommendations to the Board on appropriate matters, for example, the fairness, balance and understandability of the Annual Report. Further details of the composition and operation of these Committees are set out in the Audit Committee, Nominations Committee and Directors’ remuneration reports. Appointments to the Board There is a formal, rigorous and transparent procedure for the appointment of new directors. Full details of the process for appointments made during the year are available in the Nominations Committee report set out on page 54. Commitment The letters of appointment for the Chairman and non-executive directors set out the expected time commitment required of them and are available for inspection during normal business hours at the Company’s registered office and at the AGM. Other significant commitments of the Chairman and non- executive directors are disclosed on appointment and require approval thereafter. In 2014, the Chairman became a non-executive director of Aveillant Limited. Sir Colin confirmed that he continues to have sufficient time to discharge his role as Chairman of the Board. Mr Philip Cox was appointed as non-executive director and chairman designate of Drax Group plc with effect from 1 January 2015 and, as a result of the additional time commitments required, resigned as a non-executive director of the Company with effect from 31 January 2015. Development The Board is supplied with the information it needs to discharge its duties. In 2014, Ms Alison Goligher joined the Board and has since had meetings with other directors, senior management, auditors, brokers and other professional advisors, as well as site visits and a comprehensive induction pack. Sir Nigel Rudd will commence a similar induction process in March 2015 following his appointment to the Board. The Board will continue to enhance the induction process as feedback is received and incorporated from the recently recruited directors. The Company Secretary facilitates the induction of new directors and assists with professional development where required. Directors are encouraged to update their skills regularly and their training needs are assessed as part of the Board evaluation process. Their knowledge and familiarity with the Group is facilitated by access to senior management, reports on the business and site visits. Resources are available to all directors for the purposes of developing and updating their knowledge and capabilities. Information and support The Chairman is responsible for ensuring the directors receive accurate, timely and clear information. The Company Secretary is responsible for ensuring good information flows within the Board and Committees and between senior management and non-executive directors. The Board members have regular 93987_p46-54.indd 48 04/03/2015 17:02  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 49 discussions about their information and support requirements, and are involved in setting the annual Board schedule. • The Board and its Committees have been provided with sufficient resources to undertake their duties. All directors have had access to the advice and services of the Company Secretary who is responsible to the Board for advising on all governance matters. The Board allows all directors to take external independent professional advice at the Group’s expense. Process controls—for example financial controls including the Group Financial Policies and Procedures Manual, bid approvals, programme management and execution, IT security and risk management. The risk management process enables the Group to identify, evaluate and manage the principal risks faced by the Group and this process was in place for 2014 and up to the date of approval of the Annual Report and has been regularly reviewed by the Board; and Board performance evaluation In 2014, the Board evaluated its own effectiveness, together with the effectiveness of the Chairman, individual directors, its Committees, auditors and remuneration advisers and agreed its objectives for 2015. The effectiveness reviews covered strategy, risk management, the annual Board schedule, composition, succession, the appointment process, diversity, remuneration, audit and open channels of communication. The 2014 evaluation of the Board and its Committees was undertaken internally, using questionnaires and group and individual discussions. The Board continues to be thoroughly engaged with the review process, and the main findings and recommendations of the 2014 evaluation relate to further developing our succession planning and administrative matters relating to the issue of papers. The Board noted that progress had been made in areas selected for improvement in 2013. It is anticipated that the 2015 evaluation will be externally facilitated. Accountability Financial and business reporting The financial statements contain an explanation of the directors’ responsibilities in preparing the Annual Report and the financial statements (pages 78 to 79) and a statement by the auditors concerning their responsibilities (page 84). The directors also report that the business is a going concern (page 37) and detail how the Group generates and preserves value over the longer term (the business model) and the Group’s strategy for delivering its objectives in the Strategic report (pages 1 to 41). Risk management and internal control The Board is responsible for the Group’s system of internal control and for maintaining and reviewing its financial and operational effectiveness. The Board has taken into account the guidance provided by the FRC on Risk Management, Internal Control and Related Financial and Business Reporting in 2014 in reviewing the effectiveness of the Group’s risk management and internal control systems. The system of internal control is designed to manage, but not to eliminate, the risk of failure to achieve business objectives and to provide reasonable, but not absolute, assurance against material misstatement or loss. The Group’s functions are responsible for determining Group policies and processes, and businesses are responsible for implementing them, with internal and/or external audits to confirm business unit compliance. The key features of the risk management and internal control system are described below, including those relating to the financial reporting process, as required under the Disclosure and Transparency Rules: • Group policies—key policies are approved by the Board and most other policies are approved by Group functions; • The forecasting, budget and strategic plan processes. The Group has programmes for insurance and business continuity which form part of the risk management and internal control framework. The following features of the internal control framework allow the Group to monitor the effective implementation of policy and process controls by business units: • • • • A business performance review process (including financial, operational and compliance performance); Annual business unit and divisional sign-off of compliance with Group policies and processes; Compliance programmes and external audits (including trade compliance, ethics, anti-corruption, health, safety and environmental); An effective internal audit function which, primarily, performs business unit reviews by rotation (including finance, IT, HR, ethics and the bid process); and • A whistleblowing line to enable employees to raise concerns. The Board and Audit Committee applied the following processes in 2014 and up to the date of approval of the Annual Report in order to review the effectiveness of the system of internal controls: • • • • • • Reviews of the risk management process, risk register and risk appetite; Written and verbal reports to the Audit Committee from internal and external audit on progress with internal control activities, including: – reviews of business processes and activities, including action plans to address any identified control weaknesses and recommendations for improvements to controls or processes; – the results of internal audits; – internal control recommendations made by the external auditors; and – follow-up actions from previous internal control recommendations; Regular compliance reports from the Corporate Affairs Director; Regular reports on the state of the business from the Chief Executive and Chief Financial Officer; A presentation on IT security activities and plans; Strategy reviews, review of the ten year financial plan and review and approval of the 2015 budget; Written report to the Ethics and Trade Compliance Committee on the effectiveness of whistleblowing procedures; and • Reports on insurance coverage and uninsured risks. 93987_p46-54.indd 49 04/03/2015 17:02 50 MEGGITT PLC REPORT AND ACCOUNTS 2014 Corporate governance report continued The risk management and internal control systems have been in place for the year under review and up to the date of approval of the Annual Report, and are regularly reviewed by the Board. The Board monitors executive management’s action plans to implement improvements in internal controls that have been identified following the above-mentioned reviews and reports. The Board confirms that it has not been advised of any significant failings or weaknesses in the Group’s internal controls. Remuneration The Directors’ remuneration report is set out on pages 55 to 75 and provides details of our remuneration policy which was approved at our AGM in 2014, and how it has been implemented in 2014, together with the activities of the Remuneration Committee. Relations with shareholders The Group values its dialogue with institutional and private investors. The Board communicates with private investors via direct communication with our Group Head of Investor Relations and the Company Secretary, material distributed or made available on the investor relations section of our website and at the AGM (see below). Effective communication with fund managers, institutional investors and analysts about the Group’s strategy, performance and policies is promoted by meetings involving, principally, the Chief Executive and Chief Financial Officer. The Board receives reports from the Chief Executive and Chief Financial Officer and the Head of Investor Relations on the views of shareholders, which are discussed. The Chairman and other non-executive directors are available to attend meetings with shareholders, and a specific letter was issued to major shareholders after the AGM in 2014, offering a meeting with the Chairman and Senior Independent Director. A number of such meetings on corporate governance took place in 2014. We also received a number of requests from shareholders to have meetings with the Chairman Succession sub-committee, which were held before and after the announcement of our chosen candidate. Directors’ understanding of major shareholders’ views is enhanced by reports from the Head of Investor Relations, our brokers and attending analysts’ briefings. Analysts’ notes on the Group are made available to all directors. We provide annual reports and other documents to shareholders in their elected format under the electronic communications provisions, which were approved by shareholders at our AGM in 2007. Electronic copies of this Annual Report and Accounts 2014 and the Notice of AGM will be posted on our website, where our announcements, press releases and other investor information are also available. An analysis of ordinary shareholders by size of holdings and shareholder type is also available on our website. Constructive use of the Annual General Meeting The Board uses the AGM to communicate with its shareholders. Proxy appointment forms for each resolution provide shareholders with the option to direct their proxy to vote for or against resolutions or to withhold their vote. All proxy votes for, against and withheld are counted by the Company’s Registrars and the level of voting for, against and withheld on each resolution is made available after the meeting and on the Group’s website. The proxy form and the voting results announcement make it clear that a vote withheld is not a vote in law and will not be counted in the calculation of the proportion of votes for and against the resolution. Separate resolutions are proposed at the AGM on substantially separate issues and there is a resolution relating to the financial statements. The Notice of AGM and related papers are sent to shareholders at least 20 working days before the meeting. Meggitt encourages shareholders to vote at the AGM and provides a facility for electronic proxy voting. Shareholders who are not CREST members can vote online on resolutions proposed at the AGM via our website, after voting has opened. Proxy cards contain further details on how and when to vote and further information for CREST members. The respective Chairmen of the Audit, Remuneration and Nominations Committees are available at the AGM to respond to questions. It is usual for all other directors to also attend. At the AGM to be held on 23 April 2015, shareholders’ consent will be sought on the following item of special business, in addition to the routine business: on the authority to convene general meetings on 14 clear days’ notice in accordance with the Articles (on the terms set out in the Notice of Meeting). All directors are subject to election by shareholders at the first AGM after their appointment and have been subject to re-election annually since 2012 in compliance with the Code. All directors in office at the date of the AGM (23 April 2015) will be subject to election or re-election except for Sir Colin Terry, who will retire from the Board as Chairman and non-executive director at the conclusion of the AGM. By order of the Board M L Thomas Company Secretary 23 February 2015 93987_p46-54.indd 50 04/03/2015 17:02  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 51 Audit Committee report policies and the methods used to account for significant or unusual transactions; (ii) whether appropriate accounting standards have been followed; (iii) whether appropriate estimates and judgements have been made, taking into account the views of the external auditor; and (iv) the clarity and completeness of disclosure in the Group’s financial reports and the context in which the statements are made; Reviewing the content of the annual report and advising the Board on whether, taken as a whole, it is fair, balanced and understandable; Reviewing the adequacy and effectiveness of the Group’s internal financial controls and financial risk management system, reviewing and approving the statements to be included in the annual report concerning internal financial controls and financial risk management and reviewing the Group’s procedures for detecting fraud; Overseeing the internal audit function, including assessing the annual work plan, receiving reports on a periodic basis and monitoring the effectiveness of the internal audit function; Overseeing the relationship with the external auditor, including the decision to tender external audit services, the approval of fees paid to external auditors and their terms of engagement, and recommending to the Board, to be put to shareholders for approval at the AGM, the appointment, re-appointment and removal of the external auditor; and • • • • • Reviewing the Committee’s own effectiveness. Work of the committee The Audit Committee reviewed: • The financial information contained in the 2013 Annual Report and 2013 full-year and 2014 interim results announcements and recommended them to the Board for approval; • • • 2014 external audit fees, and recommended them to the Board for approval; The external audit strategy memorandum and interim audit clearance report for 2014; The independence, effectiveness and reappointment of the external auditors; • The internal audit plan for 2015 and regular update reports; • • Their own terms of reference and agreed to transfer the responsibility for reviewing whistleblowing procedures to the Ethics and Trade Compliance Committee; Technical accounting and governance updates provided by the Group Financial Controller, Company Secretary and the external auditors; • A treasury update from the Head of Tax and Treasury; and • The effectiveness of the Committee and internal audit. Since the year end, the Committee has approved the 2014 Annual Report and Accounts and full-year results announcement and recommended them to the Board for approval and provided advice to the Board that the 2014 Annual Report and Accounts, taken as a whole, is fair, balanced and understandable. The Committee provided this advice having approved and monitored an enhanced review and verification process of the Annual Report undertaken by management and provided confirmation to the Board that this process was both followed and effective. Chairman’s introduction I am pleased to present the report of the Audit Committee for 2014. I chair the Audit Committee and as a Fellow of the ICAEW, former Audit Committee Chairman of DP World Limited and Finance Director at Bunzl plc, I bring recent and relevant financial experience to the Committee. My fellow committee members throughout 2014 were Guy Berruyer, Philip Cox, Paul Heiden and Brenda Reichelderfer, who attended all three Committee meetings during the year. Alison Goligher joined the Committee for her first meeting in December 2014 (which was the last meeting for Philip Cox before stepping down from the Board in January 2015). By invitation, there were a number of other regular attendees including the Chief Financial Officer, the Group Financial Controller and the internal and external auditors. The Chairman of the Board, the Chief Executive, the Corporate Affairs Director and David Robins (for the February 2014 meeting) also attended by invitation. The key role of the Audit Committee is to provide confidence in the integrity of our processes and procedures relating to internal financial control and corporate reporting. The Board relies on the Committee to review financial reporting and to appoint and oversee the work of the internal and external auditors. The work of the Committee in 2014 is described below in detail and included providing advice to the Board on whether these accounts are fair, balanced and understandable. Committee membership and attendance Name Mr D M Williams (Committee chairman) Mr G S Berruyer Mr P G Cox Ms A J P Goligher Mr P Heiden Ms B L Reichelderfer Meetings eligible to attend Meetings attended 3 3 3 1 3 3 3 3 3 1 3 3 Terms of Reference The Committee operates within agreed terms of reference, which were updated in 2014 and are available on our website. Responsibilities The responsibilities of the Audit Committee include: • Monitoring the integrity of the financial statements of the Group, including its annual and half-yearly reports, and any other formal announcement relating to its financial performance, reviewing and reporting to the Board on significant financial reporting issues and judgements having regard to matters communicated to it by the external auditor; • Reviewing and challenging where necessary: (i) the consistency of and any changes to significant accounting 93987_p46-54.indd 51 04/03/2015 17:02 52 MEGGITT PLC REPORT AND ACCOUNTS 2014 Audit Committee report continued Significant judgements relating to the financial statements The table below summarises the significant judgements reviewed by the Committee in respect of the Group’s financial statements: Significant judgements Action Goodwill and other intangible assets arising on an acquisition Development costs and programme participation costs The principal judgements are management’s determination of the level at which impairment testing should be performed, the achievability of CGU business plans (and therefore future cash flows) and the appropriateness of the discount rates applied to future cash flows. The Committee addressed this through consideration of a report from management setting out the basis for the assumptions, confirmation that the cash flows used were derived from the 2015 budget and strategic plan (which in their role as members of the Board, committee members had previously reviewed), a sensitivity analysis on key assumptions and an analysis of the headroom for each CGU. The Committee agreed the assumptions made by management were appropriate and that no impairment was required. The Committee considered the method of testing for potential impairment used by management, the reasonableness of assumptions used on specific programmes with limited headroom, the aggregation of related intangible assets at an aircraft platform level and the appropriateness of the estimated useful lives assigned to the assets. The Committee addressed this through consideration of a report from management covering these areas, exposure to different platforms and a sensitivity analysis on specific programmes. The Committee concluded that the assumptions made by management were reasonable and the carrying value and estimated useful lives of the assets appropriate. Provision for environmental matters relating to historic sites The Committee considered a report from management setting out the basis for the judgements made and the extent to which these were supported by third party specialist advice. The Committee discussed with management, the sensitivity of the estimates to increases in cost estimates and changes in discount rates applied to future cash flows. The Committee agreed with the judgements made by management. Provision for onerous contracts and other matters Retirement benefit obligations Income taxes The key areas reviewed by the Committee were the provision held for the supply from a vendor of non-conforming raw material identified in the prior year, judgements made by management relating to selling prices, product quantities and unit costs on a small number of onerous production contracts and the impact of Heatric’s local content provider in Brazil having filed for creditor protection. The Committee considered a report from management setting out the bases for the judgements made on each of these items. The Committee agreed with the accounting treatment adopted. Assumptions on mortality, inflation and the rates at which scheme liabilities are discounted can have a significant impact on the value at which retirement benefit obligations are included in the financial statements. The Committee considered a report from management setting out the basis on which the 2014 assumptions had been determined, including the revised mortality tables used for the Group’s US schemes. Additionally, the Committee reviewed a benchmarking, they had requested, of the Group’s assumptions used in the 2013 consolidated financial statements against those disclosed by other large corporate entities. The Committee concluded that the assumptions recommended, which were supported by third party actuarial advice, were appropriate. Judgements have to be made by management on the tax treatment of a number of transactions in advance of the ultimate tax determination being known. In determining the appropriateness of the estimates made, the Committee considered a report from management setting out the basis for the judgements. The Committee concluded that the position taken was appropriate. Contract accounting revenue The Committee considered a report from management setting out the key judgements made by management in recognising revenue under contract accounting principles, focusing on the process by which amounts recognised were determined using estimates of total contract costs and the historical reliability of such estimates. The Committee concluded that the basis of revenue recognition was appropriate. Treatment of exceptional operating items The Committee discussed the treatment and disclosure of items included within exceptional operating items. The Committee noted items were treated appropriately and consistently year on year. The Committee also discussed each of the above judgements with the external auditors in reaching their conclusions. 93987_p46-54.indd 52 04/03/2015 17:02  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 53 Key areas of oversight External audit The external auditors are PricewaterhouseCoopers LLP (PwC) who were appointed as Group auditors for the financial year commencing 1 January 2003 on 2 October 2003 after a competitive tender. There are no contractual obligations restricting the Committee’s choice of external auditors. The lead audit partner is Mr Paynter whose appointment in this role commenced with the audit for the financial year ended 31 December 2013. Mr Paynter has had no previous involvement with the Group in any capacity. The Committee assessed the effectiveness of PwC and the external audit process using a questionnaire and a Committee discussion on the responses to the questionnaire. The Committee was satisfied with PwC’s performance and the external audit process and that they had employed an appropriate level of professional challenge in fulfilling their role. The Committee has determined, on the basis of the satisfactory outcome of the evaluation, that the external audit will not be subject to tender in 2015. It has recommended that the Board submit the re-appointment of PwC to shareholders for approval at the AGM in 2015. The Committee has reviewed the tendering and rotation provisions from the EU, Competition and Markets Authority (CMA) and those contained in the UK Corporate Governance Code. The Committee does not expect to put the external audit services out for tender before the end of the current audit partner rotation period i.e. after the audit for the financial year ending 31 December 2017. This is subject to (i) any clarifications or changes issued by the CMA relating to their transitional provisions; (ii) the detailed implementation of the EU auditor rotation rules in UK law, scheduled for later in 2015; (iii) any other changes to the regulatory regime; and (iv) the Committee continuing to be satisfied with the effectiveness of the auditors which is considered annually. The Committee routinely meet with PwC without executive management present and there were no concerns raised at that meeting. It was confirmed that the external auditors had been able to offer rigorous and constructive challenge to executive management during the year. Non-audit services The Group places great importance on the independence of its external auditors and is careful to ensure their objectivity is not compromised. The Committee agrees the fees paid to external auditors for their services as auditors and is required to approve, in advance, any fees to the external auditors for non-audit services in excess of £0.1 million. Details of the fees paid for audit services, audit-related services and non-audit services can be found in note 7 to the financial statements. The fees paid for non-audit services in 2014 were less than £0.1 million (Nil% of the total audit fee) and the average fees paid for non-audit services for the last three years to 2014 was £0.1 million (4% of the total audit fee over that period). Fees paid in prior years related to services permitted to be provided by PwC under the Group’s policy on non-audit services. The Group’s policy on non-audit services covers which services can be provided and which generally cannot be provided (for example internal audit services and tax planning). The full policy is disclosed on our website. On balance, the Committee is satisfied that the overall levels of audit-related and non-audit fees are not material relative to the income of the office of PwC conducting the audit or PwC as a whole and therefore the objectivity and independence of the external auditors was not compromised. Internal audit The Committee agrees the annual internal audit plan which is developed according to a risk assessment process and ensures that adequate resources are available to execute the plan. In 2014, the risk assessment process was reviewed. It was agreed that businesses would be split into three tiers based on their significance to the Group’s results, prior year audit findings, a self-assessment questionnaire and discussions with key stakeholders throughout the Group. Tier 1 businesses are visited annually, with Tier 2 businesses visited every other year and Tier 3 every third year. At each meeting, the Committee receives a status update on the audit programme and reviews, discusses and challenges any significant issues arising and monitors implementation by the business of the recommendations made. In 2014, internal audits were carried out at a number of Group sites, including post-SAP implementation audits and the annual audit of the finance shared service centres. IT was added to the scope of internal audit in 2014, using the services of Grant Thornton UK LLP. The 2014 IT audit scope included reviews of IT strategy and risk management, IT security, a data centre which has been established in the UK, and the global template utilised on SAP, our ERP system. The Committee routinely meet internal audit without executive management present. No concerns were raised at the meeting and it was confirmed that internal audit had been able to carry out their work and offer constructive challenge to executive management during the year. The Committee considered the effectiveness of internal audit and confirmed that they were satisfied. Whistleblowing During the year, the Committee transferred responsibility for reviewing the process for handling allegations from whistleblowers to the Ethics and Trade Compliance Committee. In January 2015, the Ethics and Trade Compliance Committee confirmed that it was satisfied with the Group’s process for handling whistleblowing allegations. Whistleblowing is covered under our Ethics and Business Conduct Policy and Code of Conduct, which are available on our website. The Group sponsors an independently operated and monitored Ethics Line, enabling employees to report concerns about possible misconduct, with proportionate and independent investigation and appropriate follow-up action. Whistleblowing reports are reviewed regularly by the Ethics and Trade Compliance Committee of the Board. On behalf of the Audit Committee David Williams Chairman of the Audit Committee 23 February 2015 93987_p46-54.indd 53 04/03/2015 17:02 54 MEGGITT PLC REPORT AND ACCOUNTS 2014 Nominations Committee report Chairman’s introduction The Nominations Committee plays a leading role in assessing the balance of skills and experience on the Board and the Group’s principal committees. The Committee identifies the roles and capabilities required to meet the demands of the business and, with due regard to diversity, ensures that a succession plan is in place. Candidates continue to be considered on merit against specific criteria determined by the Committee. David Robins retired from the Board at the end of the 2014 AGM. Following a rigorous search process using search firm Zygos Associates, a number of candidates for the position of non- executive director were interviewed by the Board. The Nominations Committee recommended the appointment of Ms Alison Goligher as a non-executive director, as her career in the energy sector in a wide range of functional and operational roles would be of great value to Meggitt’s energy businesses. In December 2014, we announced the appointment of Sir Nigel Rudd as a non-executive director and Deputy Chairman effective from 1 March 2015 (becoming Chairman at the conclusion of the AGM in April 2015). He is a highly experienced and successful director and chairman and with his prior role as a non-executive director of BAE Systems, and current exposure to the industry at BBA Aviation, Sir Nigel has exceptional knowledge of the aerospace sector. His experience across a wide range of businesses and expertise will be of significant benefit to the Group and make him ideally positioned to be the next Chairman of Meggitt PLC. We announced in December 2014 that Mr Philip Cox has resigned from the Board to concentrate on his new role as non-executive director and chairman designate of Drax Group plc. In 2015, the Committee will continue to review the composition of the Board and succession plans for executive and non-executive directors, and is considering succession plans for Mr David Williams as he approaches his ninth year as a non-executive director during 2016. • • Committee membership and attendance during 2014 Sub-Committee of the Board be formed, for the purpose of running the Chairman selection process. Sir Colin Terry was not involved in the selection of his successor and Ms Reichelderfer chaired the Sub-Committee, which was formed entirely of non-executive directors. Advisers (including Russell Reynolds Associates acting as search adviser), the Chief Executive and other executive directors were consulted during the process. The role of Chairman was defined in writing and approved by the Board. The selection process for the role included consideration of prior successful FTSE 100 chair experience, solid experience in aerospace and defence or engineering/industrial, as well as broad international experience, time availability and preferably previous experience of being a Chief Executive. Just over 30 candidate profiles were initially reviewed in the long list, from which a short list was identified and around ten candidates (including external and internal) were interviewed. Taking into account the requirements of the role and the structure, size and composition (including the skills, knowledge, experience and diversity) of the Board, the Chairman Succession Sub-Committee decided to recommend to the Board that Sir Nigel Rudd be appointed as Chairman. It was the view of the Board who approved his appointment, that Meggitt would benefit from the counsel and governance of Sir Nigel Rudd, a seasoned chairman with extensive international business experience spanning many industries, including aerospace. Board diversity The Board confirms a strong commitment to diversity (including, but not limited to, gender diversity) at all levels of the Group. The Board’s policy on diversity commits Meggitt to: • Ensuring the selection and appointment process for employees and directors includes a diverse range of candidates; Disclosing statistics on gender diversity in every Annual Report (see page 41); and Reviewing this policy from time to time and continuing to disclose this policy in the Annual Report. Name Sir Colin Terry (Chairman) Mr S G Young Mr G S Berruyer Mr P G Cox Ms A J P Goligher Mr P Heiden Ms B L Reichelderfer Mr D M Williams Meetings eligible to attend Meetings attended 3 3 3 3 1 3 3 3 3 3 3 3 1 3 3 3 Terms of reference The Committee operates within agreed Terms of Reference which were reviewed and updated in 2014 and are on our website. Responsibilities The Committee reviews the structure, size and composition (including the skills, knowledge, experience and diversity) of the Board and, in consultation with the directors, makes recommendations to the Board on any proposed changes. Decisions on Board changes are taken by the Board as a whole. In performing its duties, the Committee has access to the services of the Company Secretary and may seek external professional advice at the Group’s expense. Based on the current size and composition of the Board and taking into account current succession plans, the Board has determined that there should be a minimum of two female directors, which is currently the case (for gender diversity statistics, see page 41). The Board remains committed to ensuring that the directors bring a wide range of skills, knowledge, experience, backgrounds and perspectives. Our directors are from the UK, US and France, and have a range of different skills and experience, from energy to aerospace, financial and technology backgrounds to an electrical engineer. External search consultancies During 2014, the Committee used Russell Reynolds Associates to assist in the search for the Chairman (and assist the Group with searches for other senior management posts from time to time). Zygos Associates were used to assist in the search for the non-executive director. Neither Russell Reynolds Associates nor Zygos Associates have any other connection with the Group. On behalf of the Nominations Committee Chairman Succession Sub-Committee of the Board In 2014, after a number of internal applications were received for the role of Chairman, it was agreed that a Chairman Succession Sir Colin Terry Chairman of the Nominations Committee 23 February 2015 93987_p46-54.indd 54 04/03/2015 17:02  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 55 Directors’ remuneration report Chairman’s introduction and annual statement It is my pleasure to present the Directors’ remuneration report for the year ended 31 December 2014. Pay philosophy Executive remuneration packages at Meggitt are designed to attract, motivate and retain directors of a high calibre, to recognise the international nature of the Group’s business and to reward the directors for delivering value to shareholders. The package targets fixed pay at market competitive levels to companies of a similar size and with similar operating characteristics, supplemented by performance-related annual bonuses and an equity-based long term incentive plan designed to reward and incentivise growth, and provide a strong link to Group and individual performance. 2014 activity In 2014, we finalised the review of the remuneration package (which commenced last year and was extensively reported on in our 2013 report) and submitted the Directors’ remuneration report and remuneration policy (Policy) to shareholders for approval at our AGM. 98.95% of those shareholders who voted at the AGM approved our Policy and 99.79% voted for the Directors’ remuneration report. We also finalised the effectiveness review of the Committee and Kepler Associates (Kepler), our advisers, which was carried out using questionnaires and Committee discussion. Overall the ratings for the Committee and Kepler were satisfactory; there was a valuable discussion about effectiveness but no significant areas highlighted for improvement. Since May, we have approved awards under the new shareholder-approved Long Term Incentive Plan (LTIP), updated our terms of reference to reflect the new remuneration reporting and policy regime and confirmed the Equity Participation Plan (EPP) vesting outcome (see page 67). We also discussed performance targets for 2015 and agreed the fees for Sir Nigel Rudd, who will become Chairman at the conclusion of the AGM on 23 April 2015. The intended remuneration arrangements for 2015, outlined in this report, are in line with the Policy approved by shareholders at our 2014 AGM. 2014 performance Civil original equipment revenue enjoyed another year of strong growth, and the civil aftermarket gained momentum through the year resulting in full year organic growth in civil aerospace of 6%. However, this was offset by declines in military and energy resulting in flat organic Group revenue for the year. Underlying organic profit before tax declined by 11% reflecting adverse product mix and increased investment in new product introduction costs, with a 14% decline in underlying EPS reflecting also adverse movements in foreign exchange and the disposal of non-core businesses. This has resulted in the earnings per share (EPS) and cash elements of the awards granted in 2012 under the Executive Share Option Scheme (ESOS) and EPP failing to meet their performance conditions (the total shareholder return outcome on the EPP will be confirmed at the vesting date). Under our Short Term Incentive Plan (STIP), we did not hit our financial targets which account for two thirds of the award, but the targets for personal performance objectives were met and vesting outcomes for 2014 are as a result of this personal performance element. With growing order intake and building aftermarket momentum, we anticipate a return to organic growth in 2015. This Directors’ remuneration report has been prepared in accordance with the provisions of the Companies Act 2006 and Schedule 8 of the Large and Medium sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013. The report meets the requirements of the UK Listing Authority’s Listing Rules and the Disclosure and Transparency Rules. In this report we describe how the principles relating to directors’ remuneration, as set out in the UK Corporate Governance Code 2012 (the Code), are applied in practice. The FRC published a revised UK Corporate Governance Code on 17 September 2014, applicable to reporting periods beginning on or after 1 October 2014 (the 2014 Code), although the Board has adopted some of the new provisions in the 2014 Code earlier than required. Paul Heiden Chairman of the Remuneration Committee 93987_p55-75.indd 55 04/03/2015 17:06 56 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued The Policy report This section of the report sets out the Policy for the directors, which shareholders approved at the 2014 AGM and is effective for a period of three years from the date of the 2014 AGM. The only amendments to the Policy from the version approved by shareholders are to update the data used in the pay-for-performance scenario analysis from 2014 to 2015 and to remove references to future approval of the Long Term Incentive Plan (which was approved at the AGM in 2014). Executive Director Remuneration Policy Table Base salary Function Operation To attract and retain talent by ensuring base salaries are competitive in the relevant talent market. Salary will be reviewed by the Committee annually, in February, with changes effective from 1 April of that year. Salaries for the year under review are disclosed in the annual report on remuneration. In deciding salary levels, the Committee considers personal performance including how the individual has helped to support the strategic objectives of the Group. The Committee will also consider employment conditions and salary levels across the Group, and prevailing market conditions. Salaries are paid to existing directors in GBP; however the Committee reserves the right to pay future and existing directors in any other currency (converted at the prevailing market rate when a change is agreed). Opportunity It is not anticipated that percentage salary increases for executive directors will exceed those of the wider workforce over the period this Policy will apply. Where increases are awarded in excess of the wider employee population, for example if there is a material change in the responsibility, size or complexity of the role, the Committee will provide the rationale in the relevant year’s annual report on remuneration. Performance metrics None explicitly, but salaries are independently benchmarked periodically against FTSE companies in similar industries and those with similar market capitalisation. Personal performance is also taken into account when considering salary increases. Pension Function Operation Opportunity To provide post-retirement benefits for executive directors in a cost-efficient manner. The pension plans operated by the Group which executive directors are, or could be, members of are: —Meggitt Pension Plan (defined benefit pension plan, closed to new members). —Meggitt Workplace Savings Plan (defined contribution personal pension scheme, open to new members). Salary is the only element of remuneration that is pensionable. There are no unfunded pension promises or similar arrangements for directors. From 2013, it has been our Policy that new executive director external appointments are eligible for a pension allowance of 25% of salary, payable either as pension contribution up to any limit set in current regulations or, above such limits, in cash. Where agreements have been made prior to the approval of this Policy which entitle an executive to receive a pension allowance higher than 25% of salary, pension allowances up to a maximum of 50% of salary, will be paid; Mr Young and Mr Green had agreements prior to the approval of this Policy which entitle them to receive a pension allowance of 50% of salary and this arrangement will continue for these directors. Performance metrics None. 93987_p55-75.indd 56 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 57 Benefits Function Operation Opportunity To provide non-cash benefits which are competitive in the market in which the executive director is employed. The Group may provide benefits including, but not limited to, a company car or car allowance, private medical insurance, permanent health insurance, life assurance, a fuel allowance, a mobile phone, relocation costs and any other future benefits made available either to all employees globally or all employees in the region in which the executive director is employed. Benefits vary by role and individual circumstances; eligibility and cost is reviewed periodically. Benefits in respect of the year under review are disclosed in the annual report on remuneration. It is not anticipated that the costs of benefits provided will increase significantly in the financial years over which this Policy will apply, although the Committee retains discretion to approve a higher cost in exceptional circumstances (e.g. to facilitate recruitment, relocation, expatriation etc) or in circumstances where factors outside the Group’s control have changed materially (e.g. market increases in insurance costs). Performance metrics None. Annual bonus (Short Term Incentive Plan—STIP) Function Operation To incentivise executive directors on delivering annual financial and personal targets. Performance measures, targets and weightings are set at the start of the year. The performance period of the STIP is a financial year. After the end of the financial year, to the extent that the performance criteria have been met, 75% of the STIP award is paid in cash to the director. The remaining 25% of the award will be deferred into shares and released (with no further performance conditions attached, and no matching shares provided) after a further period of two years. Under the STIP 2014 rules as approved by the Committee, the Committee may decide to apply malus and/or clawback to STIP awards and deferred STIP awards to reduce the vesting of awards and/or require repayment of awards in the event of a review of the conduct, capability or performance of the director where there has been misconduct by the director or material misstatement of the Company’s or a Group members financial results for any period. Deferred STIP awards may lapse in certain leaver circumstances (see page 62). Opportunity The STIP provides for a maximum award opportunity of up to 150% of salary in normal circumstances with an on-target opportunity of 100% of salary and an opportunity of 50% of salary at threshold. Performance metrics The Committee has discretion to make a STIP award of up to 200% of salary in exceptional circumstances (e.g. a substantial contract win which has a significant positive financial impact in the long term but which has no, or negative, short term financial impact). Dividends accrue on unvested deferred STIP awards over the vesting period and are released on the vesting date. STIP awards are based on the achievement of financial and personal performance targets. For the executive directors, two-thirds of the STIP will be weighted to financial performance, with the remainder subject to personal performance. The relative weightings of the financial and personal elements for any STIP period, and the measures used to assess financial and non-financial performance, will be set by the Committee in its absolute discretion to align with the Group’s operating and strategic priorities for that year. The award for performance under each element of the STIP will be calculated independently. The Committee will have discretion to review the consistency of the pay-out of the financial and personal elements and adjust the total up or down (within the levels specified above) if it does not consider this to be a fair reflection of the underlying performance of the Group or the individual. The personal performance element will typically be based on three to five objectives relevant to the executive’s role. Details of the measures, weightings and targets applicable to the STIP for each year, including a description of how they were chosen and whether they were met, will be disclosed retrospectively in the annual report on remuneration for the following year (subject to commercial sensitivity). 93987_p55-75.indd 57 04/03/2015 17:06 58 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Long Term Incentive Plan (LTIP) Function Operation To align the interests of executive directors with shareholders in growing the value of the Group over the long term. The LTIP replaced the ESOS and EPP in 2014. Under the LTIP, executive directors are eligible to receive annual awards over Meggitt shares vesting after three years, subject to the achievement of stretching performance targets. Whilst it is the current intention that LTIP awards will be in the form of nil cost options, the LTIP provides, at the absolute discretion of the Committee, for awards over conditional shares, market value share options and phantom awards. Under the LTIP 2014 rules as approved by shareholders at the AGM in 2014, the Committee may decide to apply malus and/or clawback to awards to reduce the vesting of awards and/or require repayment of awards in the event of a review of the conduct, capability or performance of the director where there has been misconduct by the director or material misstatement of the Company’s or a Group members financial results for any period. Opportunity Executive directors will normally be eligible for annual LTIP awards of 220% of salary. Awards up to a maximum of 300% of salary may be granted in exceptional circumstances (e.g. to support the recruitment of a key executive or to recognise exceptional individual performance). Performance metrics 30% of an award will vest if performance against each performance condition is at threshold and 100% if it is at maximum, with straight line vesting in between. Dividends accrue on unvested LTIP awards over the vesting period and are released, to the extent the LTIP award vests, on the vesting/exercise date. Vesting of LTIP awards is subject to continued employment and performance against three measures, which are intended to be as follows: • Earnings per Share (EPS); • Return on Trading Assets (ROTA), which is underlying operating profit after tax divided by net trading assets, measured at constant currency. Net trading assets are adjusted to exclude goodwill and other intangible assets arising on the acquisition of a business, derivative financial instruments, retirement benefit obligations, deferred tax and net debt; and • Strategic goals (typically to be based on three strategic priorities around execution, growth and innovation). The way these measures link to our KPIs can be seen on pages 27 to 30. It is the current intention that the weighting of the measures will be equal (i.e. one third each) but that the Committee will consider, and adjust if deemed appropriate, the weighting at the start of each LTIP cycle. Any commercially-sensitive information on measures, targets and performance will be disclosed retrospectively. Awards made under the LTIP will have a performance period of three financial years, starting from 1 January of the year in which the award is made and ending on 31 December of the third year. If no entitlement has been earned at the end of the relevant performance period, awards will lapse. Vesting of the strategic element will also be subject to a discretionary assessment by the Committee of the extent to which achievement of the strategic objectives is consistent with the underlying financial performance over the three-year period. The measures and targets in operation for grants made under the LTIP in the current year, and which are not deemed commercially sensitive are disclosed in the annual report on remuneration. Sharesave Scheme and Share Incentive Plan (SIP) Function Operation To align the interests of employees and shareholders by encouraging all employees to own Meggitt shares. Sharesave Scheme—All employee scheme under which all UK employees (including executive directors) may save up to the maximum monthly savings limit (as determined by legislation) over a period of three or five years. Options under the Sharesave Scheme are granted at a discount of up to 20% to the market value of shares at the date of grant. SIP—All employee scheme under which (i) all UK employees (including executive directors) may contribute up to the monthly maximum (as determined by legislation) to purchase shares monthly from pre-tax pay; and (ii) all UK employees (including executive directors) may receive free shares up to the annual maximum value (as determined by legislation). Opportunity Savings, contributions and free shares are capped at the prevailing legislative limit at the time UK employees are invited to participate. Performance metrics None. 93987_p55-75.indd 58 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 59 Notes to the Policy table The Committee is satisfied that the above Policy is in the best interests of shareholders and does not promote excessive risk-taking. The Committee retains discretion to make minor, non-significant changes to the Policy without reverting to shareholders. Payments from outstanding awards Outstanding awards are currently held by the directors under the EPP and the ESOS, the Group’s long term incentives operated prior to the introduction of the LTIP in 2014. These awards will continue to vest (subject to performance conditions being met) and be capable of exercise during the period over which this Policy applies. The tables on pages 74 to 75 highlight outstanding and vested awards. Approach to target setting and performance measure selection Targets applying to the STIP and LTIP are reviewed annually, based on a number of internal and external reference points, including the Group’s strategic plan, analyst forecasts for Meggitt and its sector comparators, historical growth achieved by Meggitt and its sector comparators and external expectations for growth in Meggitt’s markets. STIP The performance measures used under the STIP reflect financial targets for the year and non-financial performance objectives. The Policy provides the Committee with flexibility to select appropriate measures on an annual basis. STIP performance targets are set to be stretching but achievable, with regard to the particular personal performance objectives and the economic environment in a given year. For financial measures, ‘target’ is based around the annual budget approved by the Board. Prior to the start of the financial year, the Committee sets an appropriate performance range around target, which it considers provides an appropriate degree of ‘stretch’ challenge and an incentive to outperform. LTIP The vesting of LTIP awards is linked to EPS, ROTA and the achievement of long-term strategic goals. EPS is considered by the Board to be the most important measure of Meggitt’s financial performance. It is highly visible internally, is regularly monitored and reported, and is strongly motivational for participants. EPS targets will continue to be set on a nominal cumulative (pence) basis to incentivise consistent performance and reflect the fact that Meggitt’s profits are generated to a large degree outside the UK and not significantly influenced by UK retail price inflation. ROTA helps to balance the achievement of growth and returns. The Committee believes ROTA is a good internal proxy for total shareholder return (TSR) which focuses executives on managing the balance sheet and Meggitt’s operational performance, whilst also being less remote for participants below Board level. The definition of net trading assets for ROTA excludes goodwill and other intangible assets arising when a business is acquired, to reflect that acquisitions are not within the control of the majority of participants. In order to safeguard against poor acquisitions, the Committee has overall discretion to reduce the outcome under the ROTA element if in its opinion the outcome does not reflect the underlying financial performance of the Group. The performance of acquisitions against Board approved targets is also monitored separately. The Committee believes that the strategic goals component will help reinforce the realisation of Group strategy and the achievement of key non-financial and strategic goals over long product cycles which drive long-term value at Meggitt. The element will typically comprise a scorecard of three-year targets across a maximum of three core strategic areas for the Group. The Committee believes that this approach will enable it to reflect the Group’s long-term nature and shifting strategic priorities in the LTIP to ensure executives’ interests remain closely aligned with those of our shareholders over time. Specific measures and targets for each area will be developed and clearly defined at the start of each three-year cycle to balance leading and lagging indicators of performance. Vesting of this element is subject to a discretionary assessment by the Committee of the extent to which achievement of the strategic objectives is consistent with Meggitt’s underlying financial performance over the performance period. Remuneration policy for other employees The remuneration policy for other employees is based on broadly consistent principles as that for executive directors. Annual salary reviews take into account Group performance, local pay and market conditions, and salary levels for similar roles in comparable companies. Some employees below executive level are eligible to participate in annual bonus schemes; opportunities and performance measures vary by organisational level, geographical region and an individual’s role. Senior executives are eligible for LTIP on similar terms as the executive directors, although award opportunities are lower and vary by organisational level. All UK employees are eligible to participate in the Sharesave Scheme and SIP on identical terms. Share ownership guidelines In 2013, the Committee increased the minimum shareholding guidelines for executive directors from 100% to 300% of base salary for the Chief Executive and from 100% to 200% of base salary for each of the other executive directors. There is no set time frame within which directors have to meet the guideline, however until they meet the guideline they are not permitted to sell more than 50% of the after-tax value of a vested share award. The shareholding requirement ceases when a director leaves the Group. Further information on the shareholding requirement is in the annual remuneration report (see page 73). 93987_p55-75.indd 59 04/03/2015 17:06 60 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Pay-for-performance: scenario analysis The charts below provide an estimate of the potential future reward opportunities for the executive directors, and the potential split between the different elements of remuneration under three different performance scenarios: ‘Maximum’, ‘On-target’ and ‘Minimum’. S G Young (£’000) D R Webb (£’000) P E Green (£’000) 29% 29% 42% 26% 30% 44% 29% 29% 42% Maximum £3,546 Maximum £2,236 Maximum £1,892 48% 31% 21% 44% 34% 22% 48% 31% 21% On-target £2,164 On-target £1,320 On-target £1,155 100% 100% Minimum £1,040 Minimum £575 100% Minimum £556 Salary and benefits Pension STIP LTIP Potential reward opportunities are based on the Policy, applied to 2015 base salaries and 2015 incentive opportunities. Note that the LTIP awards granted in a year will not normally vest until the third anniversary of the date of grant, and the projected value excludes the impact of share price movement or dividend accrual. The ‘Maximum’ scenario reflects fixed remuneration (salary and benefits and pension), plus maximum payout under all incentives (150% of salary under the STIP, and full vesting of LTIP awards). The ‘On-target’ scenario reflects fixed remuneration as above, plus target STIP (based on two-thirds of maximum opportunity) and LTIP threshold vesting (30% vesting). The ‘Minimum’ scenario reflects fixed remuneration only, being the only elements of the executive directors’ remuneration package not linked to performance. Non-Executive Directors’—Remuneration Policy Table Non-Executive Directors are submitted for re-election annually, do not have a contract of service and are not eligible to join the Group’s pension or share schemes. Details of the Policy on fees paid to our non-executive directors are set out in the table below: Fees Function Operation To attract and retain non-executive directors of the highest calibre with broad commercial and other experience relevant to the Group. Fee levels are reviewed annually, with any adjustments effective 1 April each year. The fees paid to the Chairman of the Board are determined by the Committee, while the fees for all other non-executive directors are reviewed by a committee of the Board formed of executive directors. Fees for the year under review and for the current year are disclosed in the annual report on remuneration. Additional fees are paid to the chairmen of the Remuneration and Audit Committee and to the Senior Independent Director, to reflect the additional time commitment of these roles. In deciding fee increases, the committees consider employment conditions and salary increases across the Group, and prevailing market conditions. Currently, all fees are paid in GBP, however the committees reserve the right to pay future and existing non- executive directors in any other currency (converted at the prevailing market rate when a change is agreed) . Opportunity Fee increases will be applied taking into account the outcome of the annual review. The maximum aggregate annual fee for all non-executive directors (including the Chairman) as provided in the Company’s Articles of Association is £1,000,000. Performance metrics None. 93987_p55-75.indd 60 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 61 Recruitment External appointments In cases of hiring or appointing a new executive director from outside the Group, the Committee may make use of all existing components of remuneration, as follows: Component Approach Maximum annual grant value Base salary The base salaries of new appointees will be determined based on the experience and skills of the individual, internal comparisons, employment conditions and salary levels across the Group, and prevailing market conditions. Initial salaries may be set below market and consideration given to phasing any increases over two or three years subject to development in the role. Pension In line with the Policy, new appointees will be entitled to become members of the Meggitt Workplace Savings Plan (defined contribution plan) or receive a cash pension allowance of 25% of salary in lieu. Benefits/ Sharesave/SIP New appointees will be eligible to receive benefits in line with the Policy, and will be eligible to participate in all-employee share schemes. N/A N/A N/A STIP LTIP The structure described in the Policy table will apply to new appointees with the relevant maximum being pro-rated to reflect the proportion of employment over the year. Targets for the personal element will be tailored to the appointee. 150% of salary (200% in exceptional circumstances) New appointees will be granted awards under the LTIP on similar terms as other executive directors, as described in the Policy table. 220% of salary (300% in exceptional circumstances) In determining the appropriate remuneration structure and levels, the Committee will take into consideration all relevant factors to ensure that arrangements are in the best interests of Meggitt and its shareholders. The Committee may make an award in respect of a new appointment to ‘buy out’ incentive arrangements forfeited on leaving a previous employer, i.e. over and above the approach outlined in the table above. Any such compensatory awards will be made under existing share schemes, where appropriate, and will be subject to the normal performance conditions of those schemes. The Committee may also consider it appropriate to structure ‘buy-out’ awards differently to the structure described in the Policy table, exercising the discretion available under UKLA Listing Rule 9.4.2 R where necessary to make a one-off award to an executive director in the context of recruitment. In doing so, the Committee will consider relevant factors including any performance conditions attached to these awards, the likelihood of those conditions being met and the proportion of the vesting period remaining. The value of any such ‘buy-out’ will be fully disclosed. Internal promotion Where a new executive director is appointed by way of internal promotion, the Policy will be consistent with that for external appointees, as detailed above. Any commitments made prior to an individual’s promotion will continue to be honoured even if they would not otherwise be consistent with the Policy prevailing when the commitment is fulfilled, although the Group may, where appropriate, seek to revise an individual’s existing service contract on promotion to ensure it aligns with other executive directors and prevailing market best practice. Disclosure on the remuneration structure of any new executive director, including details of any exceptional payments, will be disclosed in the RIS notification made at the time of appointment and in the annual report on remuneration for the year in which the recruitment occurred. Non-executive directors In recruiting a new non-executive director, the Committee will use the Policy as set out in the table on page 60. 93987_p55-75.indd 61 04/03/2015 17:06 62 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Service contracts and exit payment policy Executive director service contracts, including arrangements for early termination, are carefully considered by the Committee and are designed to recruit, retain and motivate directors of the quality required to manage the Group. The Committee’s Policy is that executive directors’ service contracts should be terminable on no more than 12 months’ notice. The Committee’s approach to payments in the event of termination of employment of an executive director is to take account of the particular circumstances, including the reasons for termination, individual performance, contractual obligations and the rules of the Group’s applicable incentive plans which apply to share awards held by the executive directors: • Compensation for loss of office in service contracts Except as set out in the table on page 63, under the terms of their service contracts, the executive directors may be required to work during their notice period or may, if the Group decides, be paid in lieu of notice if not required to work the full notice period. Payment in lieu of notice will be equal to base salary plus the cost to the Group of providing the contractual benefits (pensions allowance, health insurance and company car or car allowance) that would otherwise have been paid or provided during the notice period. Payments will be in equal monthly instalments and will be subject to mitigation such that payments will either reduce, or stop completely, if the executive director obtains alternative employment. An executive director’s employment can be terminated by the Company without notice or payment in lieu of notice in specific circumstances including summary dismissal, bankruptcy or resignation. • Treatment of STIP Executive directors have no automatic entitlement to any bonus on termination of employment under the STIP, but the Committee may use its discretion to award a bonus (normally pro-rated). Where any bonus is deferred into shares, the award will normally lapse if an executive director’s employment terminates unless the executive director leaves for specified ‘good leaver’ reasons. The ‘good leaver’ reasons are death, redundancy, retirement, injury, disability, the business or company which employs the executive director ceasing to be part of the Group, any other circumstances in which the Committee exercises discretion to treat the executive director as a ‘good leaver’ or on a change of control. If the executive director is a ‘good leaver’ their award will vest on the normal vesting date, or earlier on a change of control, and would not be subject to pro-rating. • Treatment of long term incentive plan awards The treatment of awards under the ESOS, EPP and LTIP is governed by the rules of the plans which have been approved by shareholders and is described below. Awards will normally lapse if an executive director’s employment terminates unless the executive director leaves for specified ‘good leaver’ reasons. The ‘good leaver’ reasons are the same as described above. If the executive director is a ‘good leaver’, awards will vest to the extent that the attached performance conditions are met, but on a time pro-rated basis, with Committee discretion to allow early vesting. Under the EPP and ESOS, awards vest as soon as practicable after an employee has left. Under the LTIP, awards vest on the normal vesting date. 93987_p55-75.indd 62 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 63 A summary of the key terms of the executive directors’ service contracts on termination of employment or change of control is set out below: Name Position Notice period from employer Notice period from employee Mr S G Young Service contract dated 1 May 2013 Chief Executive 12 months 6 months Compensation payable on termination of employment or change of control As set out in the Policy, but service contract includes an obligation for the Committee to allow Mr Young to exercise awards under the Group’s share plans that have already vested at the point of termination. No change of control provisions. Mr D R Webb Service contract dated 6 June 2013 Mr P E Green Service contract dated 26 February 2001 Chief Financial Officer Group Corporate Affairs Director 12 months 6 months As set out in the Policy. No change of control provisions. 12 months 6 months Mr Green’s service contract was entered into before 27 June 2012 and has not been modified or renewed after that date. As such, remuneration or payments for loss of office that are required to be made under Mr Green’s service contract are not required to be consistent with the Policy. Payments to Mr Green under his service contract differ from the Policy in the following respects: On termination of employment, Mr Green is entitled to a liquidated damages payment equal to his salary and the value of his contractual benefits (bonus, pension allowance, insurance and company car or car allowance) at the date of termination, pro-rated to the remaining notice period less an amount equal to 5% of the aggregate sum and the Committee shall exercise its discretion under the Group’s share plans to treat Mr Green as a ‘good leaver’. On change of control, Mr Green may give notice to terminate his employment within six months of the event and upon such termination he shall become entitled to the liquidated damages payment summarised above. External appointments held by executive directors The Board believes that the Group can benefit from experience gained when executive directors hold external non-executive directorships. Executive directors are allowed to hold external appointments and to receive payment provided such appointments are agreed by the Board or Committee in advance, there are no conflicts of interests and the appointment does not lead to deterioration in the individual’s performance. Details of external appointments and the associated fees received are included in the annual report on remuneration on page 72. Consideration of conditions elsewhere in the Company The Committee does not consult with employees specifically on executive remuneration policy and framework but does seek to promote and maintain good relations with employee representative bodies—including trade unions and works councils—as part of its broader employee engagement strategy and consults on matters affecting employees and business performance as required in each case by law and regulation in the jurisdictions in which the Group operates. Salary increases made elsewhere in the Group are amongst the data that the Committee considers in determining salaries for executive directors. Consideration of shareholder views The Committee considers shareholder views received during the year and at the AGM each year, as well as guidance from shareholder representative bodies more broadly. The majority of shareholders continue to express support of remuneration arrangements at Meggitt. 93987_p55-75.indd 63 04/03/2015 17:06 64 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Annual report on remuneration The following report provides details of how our Policy was implemented during the year ended 31 December 2014. Remuneration Committee—2014 membership and attendance Name Mr P Heiden (Chairman) Mr G S Berruyer Mr P G Cox Ms A J P Goligher Ms B L Reichelderfer Mr D M Williams Meetings eligible to attend Meetings attended 3 3 3 1 3 3 3 3 3 1 3 3 Mr Cox resigned from the Committee on 31 January 2015 on his departure from the Board. There was one meeting between the end of the financial year and the date of signing of this report on 16 February 2015, which all current members of the Committee attended. The Committee operates within agreed Terms of Reference, which are available on our website and were updated in 2014. The Committee is responsible for determining the remuneration policy and packages for all executive directors and Executive Board members (covering five of the next most senior executives across the Group) and for agreeing the fees for the Chairman. The Chairman, Chief Executive and Organisational Development Director attend meetings of the Committee by invitation; they are absent when their own remuneration is under consideration. None of the non-executive directors has, or has had, any personal financial interests or conflicts of interest arising from cross- directorships or day-to-day involvement in running the business. Advisers to the Committee During the year, the Committee’s independent remuneration advisor was Kepler Associates (Kepler). Kepler, appointed in 2010, was selected by the Committee as a result of a competitive tender process. The Committee evaluates the support provided by Kepler annually and is comfortable that they provide independent remuneration advice to the Committee. Kepler provide guidance on remuneration matters at Board level and below. Kepler do not have any other connection with the Group. Kepler is a member of the Remuneration Consultants Group and adheres to its code of conduct (www.remunerationconsultantsgroup.com). Their total fees in 2014 were £88,000 (2013: £87,000). 2014 AGM voting The following table shows the results of the AGM votes on the 2013 Directors’ Remuneration Policy and Directors’ remuneration report at the 2014 AGM: Resolution text Votes withheld (abstentions)1 Approval of Directors’ Remuneration Policy Approval of Directors’ remuneration report Votes for 623,092,269 654,155,733 % of votes cast for 98.95 99.79 Votes against 6,598,635 1,368,456 % of votes cast against 1.05 0.21 Total votes cast 629,690,904 655,524,189 Votes withheld (abstentions) 1 30,502,072 4,668,787 1 A withheld vote is not a vote in law and is not counted in the calculation of the proportion of votes cast for and against a resolution. 93987_p55-75.indd 64 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 65 Single total figure of remuneration for executive directors (audited) The table below sets out a single figure for the total remuneration received by each executive director for the year ended 31 December 2014 and the prior year: Base salary Taxable benefits2 Pension STIP3 EPP basic4 EPP matching4 ESOS5 Total Mr S G Young1 Mr D R Webb1 Mr P E Green 2014 £’000 658 24 329 221 – – – 2013 £’000 554 21 277 250 136 96 244 1,232 1,578 2014 £’000 436 14 118 198 – – – 766 2013 £’000 240 8 57 93 – – – 398 2014 £’000 339 14 170 166 – – – 689 2013 £’000 325 14 163 126 106 74 190 998 4 5 1 Mr Young was promoted to Chief Executive on 1 May 2013. Mr Webb was appointed on 6 June 2013. 2 3 Taxable benefits consist primarily of company car or car allowance, fuel allowance and private health care insurance. STIP paid for performance over the relevant financial year. Further details of the 2014 STIP, including performance measures, actual performance and bonus payouts, can be found on page 66. EPP is calculated as the number of shares vesting based on performance measures substantially completed during the year, valued at the market value of the shares. For 2014, the figure represents the actual vesting outcome of the EPS and cash elements of the 2012 award (the performance period ended on 31 December 2014) and an estimate of the outcome of the TSR element of the 2012 award (the performance period of which will end in August 2015) based on performance to 31 December 2014. The market value of vested shares is based on the average share price over the last quarter of 2014 of 474.07 pence. The valuation of the 2012 award will be amended for the actual vesting outcome of the TSR element in August 2015 and the share price on the date of vesting (22 August 2015) in next year’s annual report on remuneration. For 2013, the figure represents the actual vesting outcome of the 2011 award, which has been trued up, compared to that reported last year, to reflect the final vesting outcome of the TSR element (Nil%) and the share price on the date of vesting (467.80p). Further details on performance criteria, achievement and resulting vesting levels can be found on page 67. ESOS is calculated as the number of shares vesting based on performance measures substantially completed during the year, valued at the difference between the market value of the shares and the exercise price of the award. For 2014, the figure represents the actual vesting outcome of the 2012 award. The market value of vested shares is based on the average share price over the last quarter of 2014 of 474.07 pence and an exercise price of 397.20p. For 2013, the figure represents the actual vesting outcome of the 2011 award, trued up, compared to that reported last year, to reflect the embedded gain based on the actual share price at vesting (504.00p). Further details on performance criteria, achievement and resulting vesting levels can be found on page 67. Single total figure of remuneration for non-executive directors (audited) The table below sets out a single figure for the total remuneration received by each non-executive director for the year ended 31 December 2014 and the prior year: Sir Colin Terry Mr D M Williams Mr G S Berruyer Mr P G Cox Ms A J P Goligher1 Mr P Heiden Ms B L Reichelderfer Mr D A Robins2 Appointed on 30 October 2014. 1 2 Retired on 7 May 2014. 2014 £’000 175 74 53 53 9 63 53 18 2013 £’000 170 72 52 52 – 62 52 52 93987_p55-75.indd 65 04/03/2015 17:06 66 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Incentive outcomes for the year ended 31 December 2014 STIP in respect of 2014 performance The Board set stretching financial and strategic targets for the STIP at the start of the 2014 financial year. These targets, and our performance against these, are summarised in the table below. Measure Underlying profit before tax (Weighting: one-third of the award) Performance targets Threshold Target £370m £390m Stretch £410m Free cash flow1 (Weighting: one-third of the award) £195m £228m £260m Actual performance Below threshold Below threshold Personal performance2 (Weighting: one third of the award) Mr S G Young Mr D R Webb Mr P E Green 2 2 2 3 3 3 4 4 Target Between target and stretch 4 At stretch 1 Adjusted to exclude capital expenditure. 2 Individual personal performance is measured on a scale of 1 to 5. The average of all ratings drives the STIP outcome, where 2 indicates expectations are partially met, 3 is fully met and 4 exceeds expectations. Details of the personal performance measures are provided below. It is the view of the Committee that notwithstanding that 2014 has been a challenging year and that the STIP financial targets have not been met, the personal performance objectives of the executive directors have been satisfied to the extent shown above, and STIP awards should vest on this basis. A full listing of personal performance objectives has not been provided owing to commercial sensitivity, however, the following is a summary of the conditions applying to each executive director. Mr Young’s personal performance objectives related to transforming execution capability (e.g. through successful implementation of the Meggitt Production System), shaping the business for competitive advantage, positioning for future growth (e.g. progressing technology projects) and ensuring best practice governance (e.g. health and safety improvements at sites). Mr Webb’s personal objectives related to assessing the Group’s strategic financial planning and capital allocation priorities, delivering sustainable cost improvements, implementing a mid-life ERP effectiveness programme, delivering a cyber-security risk reduction programme and shaping the business for competitive advantage. Mr Green’s personal objectives related to continued enhancement of the risk management programme, continued improvement of health, safety and environment standards, implementation of the US Department of State’s Consent Agreement and enhancing the import compliance and ethics programmes. The following STIP awards were received by directors in respect of 2014 performance: Mr S G Young Mr D R Webb Mr P E Green % salary 33 45 48 £’000 221 198 166 STIP—deferral into shares As a result of the 2014 performance STIP vesting outcome described above, 25% of the STIP bonus will be deferred into shares and released (with no further performance conditions attached) after a further period of two years, per the Policy. 93987_p55-75.indd 66 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 67 2012 EPP The EPP award made in August 2012 vests 50% on cumulative underlying EPS performance, 25% on cash conversion over three financial years and 25% on the Group’s relative TSR performance over a three-year period commencing on the date of grant, as follows: Measure EPS Weighting % Period ending Vesting schedule 50 31.12.14 Cash conversion 25 31.12.14 TSR 25 22.08.15 0% vesting below 110p 30% vesting for 110p per share 100% vesting for 122p or more; Straight line vesting between these points 0% vesting below 87% 30% vesting at 87% 100% vesting at 95% and above; Straight line vesting between these points 0% vesting for performance below median TSR 30% vesting for performance in line with median TSR 100% vesting for outperformance of median TSR by 8% per annum; Straight line vesting between these points Outcome Vesting % Below 110p Nil Below 87% Nil N/A1 N/A1 1 The vesting outcome will be confirmed at the end of the three-year performance period ending on 22 August 2015. For the purposes of the single figure of remuneration table, the estimated vesting of this element of the 2012 award is Nil%, based on Meggitt’s relative TSR performance to 31 December 2014. 2012 ESOS The ESOS award made in April 2012 did not vest, based on three-year cumulative underlying EPS performance to 31 December 2014. Measure EPS Weighting % Period ending Vesting schedule 100 31.12.14 0% vesting below 110p 30% vesting for 110p per share 100% vesting for 122p or more; Straight line vesting between these points Outcome Vesting % Below 110p 0% 2011 EPP As disclosed in the 2013 annual report on remuneration, the Committee determined that 50% of the 2011 EPP award subject to the three-year cumulative underlying EPS performance condition and the 25% subject to the cash conversion performance condition vested in full based on performance to 31 December 2013. The remaining 25% of the award was dependent on the Group’s TSR performance compared to a group of 17 international aerospace and defence companies over the three-year period to 17 August 2014. TSR for all comparator companies is measured on a common currency basis. Measure TSR Weighting % Period ending Vesting schedule 25 17.08.14 0% vesting for performance below median TSR 30% vesting for performance in line with median TSR 100% vesting for outperformance of median TSR by 8% per annum; Straight line vesting between these points Outcome Vesting % Below median TSR 0% Following confirmation of the vesting outcome of the TSR element, the overall vesting outcome for the 2011 EPP award (taking into consideration the outcome of both the EPS and TSR elements) was 38% of maximum. To allow for comparability going forward, the Committee has elected to capture the vesting of the entire 2011 EPP award in the financial year ending 31 December 2013 for the purposes of the single figure, as follows: Executive Mr S G Young Basic award Matching award Mr P E Green Basic award Matching award Interests held 76,663 53,768 59,719 41,884 Vesting % 38 38 38 38 Interests vested 29,131 20,431 22,693 15,915 Date vested Market price at vesting Value £’000 17.08.14 17.08.14 17.08.14 17.08.14 467.80p 467.80p 467.80p 467.80p £136 £96 £106 £74 93987_p55-75.indd 67 04/03/2015 17:06 68 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Scheme interests awarded in the year ended 31 December 2014 (audited) 2014 LTIP Executive Mr S G Young Mr D R Webb Mr P E Green Form of award Date of grant Nil cost option Nil cost option Nil cost option 22.05.14 22.05.14 22.05.14 Shares over which awards granted 312,443 207,041 161,868 Face value 1 Award price £’000 % of salary1 Date of vesting 467.54p 467.54p 467.54p £1,460 £968 £757 220 220 220 22.05.17 22.05.17 22.05.17 1 The award price is the average of the last five days close prices before the award date. The face value has been calculated using the award price for each award. 2 Based on 2014 salary at the date of award. Vesting is dependent on the achievement of three-year targets based on the following performance measures: Weighting Measure 33.3% 33.3% Underlying EPS (pence) three-year aggregate (equivalent to CAGR range of 5 to 10%) ROTA average over three years Quality % sites on target2 Threshold Mid-point 124.0 33.0% 57.0% 130.5 34.5% 71.0% Stretch 137.0 36.0% 86.0% 33.3% Strategic measures1 average over three years Execution Growth Delivery % sites on target2 43.0% 57.0% 71.0% Meggitt Production System Average status per schedule Organic revenue growth Programme management % organic revenue growth (CAGR over three years) Average status per reviews Average status per schedule 2.0 3.0 4.0 5.0% 6.5% 8.0% 2.0 2.0 3.0 3.0 4.0 4.0 Innovation Schedule 1 2 Performance against each strategic measure will be assessed at the end of the three-year period against a scale of: • 1.0 —threshold objective not met • 2.0—threshold met • 3.0—on target • 4.0—stretch objective met • 5.0—stretch objective exceeded The targets for quality and delivery are for year 1 of the 2014 LTIP award. Please refer to the 2015 LTIP award performance measures for the targets which also apply to year 2 of the 2014 LTIP award. 93987_p55-75.indd 68 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 69 Total pension entitlements (audited) The table below sets out details of the pension entitlements under the Meggitt Pension Plan (MPP) for Mr Young and Mr Green. Under the MPP, Mr Young and Mr Green accrued defined benefits at 3% of salary per annum up to the Scheme Cap and were entitled to a cash supplement equivalent to 50% of salary above the Scheme Cap. Since reaching the government’s Lifetime Allowance in April 2012, Mr Young and Mr Green ceased accruing further benefit under the MPP and received a 50% pension allowance on their full salary. Mr Young and Mr Green’s dependants remain eligible for dependants’ pensions and the payment of a lump sum on death in service. Mr Webb receives a pension allowance of 25% of base salary, but is not a member of any defined benefit or defined contribution pension scheme operated by the Group. The pension allowance payments made in 2014 are included in the single total figure of remuneration table. Accrued benefit Date benefit receivable Total value of additional benefit if director retires early Mr S G Young1 Mr P E Green2 2014 £’000 27 2013 £’000 27 2014 £’000 75 2013 £’000 73 05.04.2012 05.04.2012 26.10.2018 26.10.2018 Left MPP and taken benefits Left MPP and taken benefits Nil. Early retirement factors cost neutral Nil. Early retirement factors cost neutral 1 Mr Young opted to leave the MPP and take his pension benefits with effect from 5 April 2012. 2 Mr Green opted to leave the MPP with effect from 31 March 2012. He has not drawn his pension. Percentage change in CEO cash remuneration The table below shows the percentage change in CEO remuneration from the prior year compared to the average percentage change in remuneration for all executive employees. We have selected our executive population (around 300 people) for this comparison because it is considered to be the most relevant, due to the structure of total remuneration; most of our senior executives receive benefits under the same STIP and LTIP structure as our CEO. Base salary Taxable benefits STIP Total 20141 £’000 658 24 221 903 CEO % change 2013-2014 Executive employees% change 2013-2014 +1.7 Nil -9.4 -1.3 +3.52 +2.03 Nil4 +3.0 20131 £’000 647 24 244 915 1 2 3 4 The CEO’s remuneration includes base salary, taxable benefits and STIP. For 2013, the figures comprise elements paid to Mr T Twigger before his retirement from the Board in May 2013 and payments made to Mr S G Young from his appointment as CEO since May 2013. The base salary for executive employees is calculated using the increase in the earnings of full-time executive employees using a consistent set of employees. For benefits, this information is not collected for the executive employee population and is therefore estimated from a sample of executive employees, using a consistent set of employees. For STIP, the increase is estimated as at 13 February 2015 as the validation processes for personal performance ratings for executive employees below the level of the Board and Executive/Operations Boards is not yet complete. To the extent there is a significant variation between the actual outcome and the estimate, this will be declared in the 2015 Directors’ remuneration report. 93987_p55-75.indd 69 04/03/2015 17:06 70 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Relative importance of spend on pay The table below shows shareholder distributions (i.e. dividends and share buybacks) and total employee expenditure for 2014 and the prior year, along with the percentage change in both. Shareholder distributions—dividends1 Shareholder distributions—buybacks1 Total employee expenditure2 2014 £’m 110.4 33.7 461.3 2013 £’m 101.4 – 475.1 % change 2013-2014 +8.9 N/A -2.9 1 See notes 16 and 40 respectively of the Group consolidated financial statements. 2 Comprises wages and salaries and retirement benefit costs. See note 9 of the Group consolidated financial statements. Exit payments made in the year No exit payments have been made in 2014. Payments to past directors (audited) There were no payments to past directors in 2014. A de minimis of £10,000 applies to all disclosures under this note. Review of past performance The remuneration package is structured to help ensure alignment with shareholders. There is no direct correlation between share price movement and the change in the value of the pay package in any one year (as the remuneration package comprises several components, some fixed, and others based on non-financial measures). The graph and table below show how the CEO’s pay has been sensitive to the share price over the last six years. This graph illustrates the Group’s performance compared to the FTSE100 Index, which is considered the most appropriate broad equity market index against which the Group’s performance should be measured. Performance, as required by legislation, is measured by TSR over the six-year period from 1 January 2009 to 31 December 2014: Meggitt FTSE 100 £ 450 400 350 300 250 200 150 100 50 8 0 0 2 r e b m e c e D 1 3 n o d e t s e v n i 0 0 1 £ f o e u l a V Year 31 Dec 2008 31 Dec 2009 31 Dec 2010 31 Dec 2011 31 Dec 2012 31 Dec 2013 31 Dec 2014 The table below details the CEO’s single total figure of remuneration over the same period: Mr S G Young Single total figure of remuneration (£’000) STIP outcome1 (% of maximum) EPP vesting1 (% of maximum) ESOS vesting1 (% of maximum) Mr T Twigger Single total figure of remuneration (£’000) STIP outcome1 (% of maximum) EPP vesting1 (% of maximum) ESOS vesting1 (% of maximum) 2009 2010 2011 2012 20132 2014 – – – – 1,758 86% 0% 100% – – – – 2,947 86% 50% 100% – – – – 4,252 100% 69% 100% – – – – 3,812 80% 88% 100% 1,296 39% 38% 76% 1,845 35% 56% 98% 1,232 33% 0% 0% 1 The outcomes are for those awards which are included in the single figure of remuneration for that year. For 2014, this represents the outcome of ESOS and EPP awards vesting in 2015. The final vesting of the EPP award will not be confirmed until the vesting date in 2015 because of the TSR performance condition. 2 Figures are provided for Mr T Twigger for the period up to 1 May 2013, and Mr S G Young for the period from his appointment as CEO on 1 May 2013. 93987_p55-75.indd 70 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 71 Implementation of Remuneration Policy for 2015 Base salary Base salaries are reviewed taking into account personal performance, employment conditions and salary levels across the Group and prevailing market conditions. Base salaries were reviewed in early 2015 and, effective 1 April 2015, will be as follows for the executive directors: Mr S G Young Mr D R Webb Mr P E Green 2015 £’000 677 449 361 % change +2.0 +2.0 +5.0 2014 £’000 664 440 344 For context, salary adjustments across the Group vary from region to region according to local salary inflation; in the UK and the US the average salary adjustment will be 2%. Mr Green assumes additional responsibilities in 2015, including for the commercial contracts function. The Committee therefore agreed to increase his salary by 5% in recognition of this change in role and in view of his salary continuing to be below competitive levels. Pension and benefits There were no changes in pension contribution rates or benefit provision. 2015 STIP measures STIP measures for 2015 are based on underlying operating profit (one third), free cash flow (one third) and personal performance (one third). The definition of profit for the purposes of this target has been changed for 2015 from underlying profit before tax to underlying operating profit because it is considered by the Committee to be more aligned to the metrics used to monitor our business units and therefore more relevant to STIP participants. The STIP targets for 2015, together with details of whether they have been met, will be disclosed (subject to commercial sensitivity) in the 2015 Directors’ remuneration report. The opportunity is in line with the Policy disclosed on page 57. 2015 LTIP measures The executive directors will be granted awards under the LTIP in 2015, the vesting of which will be subject to the measures and targets set out in the table below. A number of the strategic measures have agreed annual schedules and, to ensure that the LTIP targets for these measures remain relevant and stretching over the entire three-year performance period, targets for these measures will be set as three sets of annual targets (i.e. at the start of each year and measured over a 12-month period). Therefore, the quality and delivery targets shown below are effective for year 1 of the 2015 LTIP award, and also for year 2 of the 2014 LTIP award. In determining the final vesting outcome at the end of each LTIP cycle, the Committee will consider performance over the three-year performance period for each strategic measure. Vesting of the LTIP awards will be subject to the following measures and targets: Weighting Measure 33.3% 33.3% Underlying EPS (pence) three-year aggregate (equivalent to CAGR range of 5.5 to 10%) ROTA average over three years Quality % sites on target2 Threshold Mid-point 108.3 23.4% 57.0% 113.6 25.4% 71.0% Stretch 119.1 27.4% 86.0% 33.3% Strategic measures1 average over three years Execution Growth Delivery % sites on target2 36.0% 50.0% 65.0% Meggitt Production System Average status per schedule Organic revenue growth Programme management % organic revenue growth (CAGR over 3 years) Average status per reviews Average status per schedule 2.0 3.0 4.0 5.0% 6.5% 8.0% 2.0 2.0 3.0 3.0 4.0 4.0 Innovation Schedule 1 Performance aga inst each strategic measure will be assessed at the end of the three-year period against a scale of: • 1.0 —threshold objective not met • 2.0—threshold met • 3.0—on target • 4.0—stretch objective met • 5.0—stretch objective exceeded 2 The targets set out above on quality and delivery apply to year 1 of the 2015 LTIP award and year 2 of the 2014 LTIP award. 93987_p55-75.indd 71 04/03/2015 17:06 72 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Chairman and non-executive director fees The remuneration of the Chairman and non-executive directors has been in line with our Policy in 2014. Chairman fee2 Non-executive director base fee Additional fee for chairing Audit or Remuneration Committee Additional fee for Senior Independent Director 20151 £’000 350 55 11 11 20141 £’000 176 54 10 10 1 2 Fees shown here are effective for a year from 1 April. On 23 April 2015, Sir Nigel Rudd will assume the role of Chairman. As part of the selection process, the Chairman’s fee was reviewed and it was agreed that it would be appropriate to review the fee against a benchmark based on Chairman fees at other FTSE 100 companies, and for the fee to reflect Sir Nigel Rudd’s extensive experience at Board level across multiple industries. With his prior role as a non-executive director of BAE Systems, and current exposure to the industry at BBA Aviation, Sir Nigel has exceptional knowledge of the aerospace sector. His experience across a wide range of businesses and expertise will be of significant benefit to the Group and make him ideally positioned to be the next Chairman. It was also agreed that Sir Nigel Rudd will receive additional benefits of £20,000 per annum for secretarial and car services needed for business purposes. Directors’ beneficial interests (audited) The beneficial interests of the directors and their connected persons in the ordinary shares of the Company at 31 December 2014, as notified under the Disclosure and Transparency Rules of the Financial Conduct Authority (DTR) (including shares held beneficially in the Share Incentive Plan by executive directors), were as follows: Sir Colin Terry Mr S G Young Mr G S Berruyer Mr P G Cox1 Ms A J P Goligher2 Mr P E Green Mr P Heiden Ms B L Reichelderfer Mr D A Robins3 Mr D R Webb4 Mr D M Williams 1 2 3 4 Resigned on 31 January 2015. Appointed on 30 October 2014. Retired on 7 May 2014. Appointed on 6 June 2013. Shareholding Ordinary shares of 5p each 2013 2014 12,274 431,501 3,000 6,162 3,000 558,928 6,008 6,000 – 26,488 5,000 12,041 413,351 3,000 6,824 – 557,978 5,841 6,000 73,008 25,648 5,000 Between 1 January 2015 and 13 February 2015, the only changes to the beneficial interests of the directors in the ordinary shares of the Company are that Mr Young, Mr Webb and Mr Green each acquired 47 shares through the Meggitt PLC Share Incentive Plan. External appointments held by executive directors Executive Director Company Role Mr S G Young Derwent London plc Mr D R Webb SEGRO plc Non-executive director Chairman of Audit Committee Member of Remuneration Committee Total Non-executive director Chairman of Audit Committee Total Fees retained 2014 £’000 40 9 4 53 53 10 63 93987_p55-75.indd 72 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 73 Directors’ shareholding requirements (audited) Shares which are included within the shareholding requirement are: Source of shares Description ESOS, EPP and LTIP Investment shares Deferred Bonus Ordinary shares Share dividend plan SIP Sharesave Scheme Share awards exercised and retained. Shares purchased as investment shares in respect of matching awards held under the EPP. Shares released and retained after the two-year deferral period. Shares purchased directly in the market. Shares acquired through the share dividend plan. Shares acquired via the SIP. Shares exercised and retained. The table below shows the shareholding of each executive director against their respective shareholding requirement as at 31 December 2014: Name Mr S G Young Mr D R Webb Mr P E Green Shareholding guideline (% 2014 salary) 300 200 200 Current shareholding (% 2014 salary)2 337 31 843 Shares owned outright1 431,501 26,488 558,928 Guideline met? Met Building Met Includes shares invested to be eligible for outstanding EPP matching awards. 1 2 Assessment of shareholding is based on a share price of 519.00 pence (the value of a Meggitt share on 31 December 2014). 93987_p55-75.indd 73 04/03/2015 17:06 74 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration report continued Directors’ interests in share schemes (audited) All of the ESOS, EPP and LTIP awards have performance conditions attached (as detailed in the Directors remuneration report in the year of grant and in this report for those awards made in 2014): • The awards made up to and including 2011 have already vested to the extent detailed in this and previous reports and the figures shown in the table below for those years are the vested share award amounts. • The awards made in 2012, 2013 and 2014 were unvested as at 31 December 2014. Sharesave awards are not subject to performance conditions. Mr S G Young 1996 ESOS No1 (options) ESOS 2005, Part B (stock SARs) EPP—Basic (nil cost options) EPP—Match (nil cost options) LTIP (nil cost options) Sharesave (options) Total Number of shares under award Date of award At 1 Jan 2014 Awarded/ (exercised/ lapsed) At 31 Dec 2014 Exercise price Market price at date of exercise Date exercisable from Expiry date 01.04.04 10.10.05 27.09.06 29.03.07 25.03.08 30.04.09 12.03.10 02.03.11 10.04.12 05.09.13 05.08.09 21.04.11 17.08.11 22.08.12 18.03.13 12.08.09 21.04.11 17.08.11 22.08.12 18.03.13 22.05.14 12.09.14 17,200 186,615 210,871 192,642 285,149 297,345 251,660 210,975 288,520 243,114 115,418 77,729 76,663 73,236 114,556 64,359 57,630 53,768 47,547 66,946 – – (17,200) – – – – – – (50,634) – – – – (47,532) – – – – (33,337) – – 312,443 2,405 – 186,615 210,871 192,642 285,149 297,345 251,660 160,341 288,520 243,114 115,418 77,729 29,131 73,236 114,556 64,359 57,630 20,431 47,547 66,946 312,443 2,405 174.40p 278.65p 263.67p 299.00p 252.50p 169.50p 286.10p 351.70p 397.20p 526.50p – – – – – – – – – – – 374.19p 2,931,943 166,145 3,098,088 449.50p – – – – – – – – – – – – – – – – – – – – – 01.04.07 10.10.08 27.09.09 29.03.10 25.03.11 30.04.12 12.03.13 02.03.14 10.04.15 05.09.16 21.08.12 21.08.13 17.08.14 22.08.15 18.03.16 21.08.12 21.08.13 17.08.14 22.08.15 18.03.16 22.05.17 01.11.17 31.03.14 09.10.15 26.09.16 28.03.17 24.03.18 29.04.19 11.03.20 01.03.21 09.04.22 04.09.23 04.08.19 20.04.21 16.08.21 21.08.22 17.03.23 04.08.19 20.04.21 16.08.21 21.08.22 17.03.23 21.05.19 01.05.18 93987_p55-75.indd 74 04/03/2015 17:06  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 75 Mr P E Green ESOS 2005, Part A (options) ESOS 2005, Part B (stock SARs) EPP – Basic (nil cost options) EPP – Match (nil cost options) LTIP (nil cost options) Sharesave (options) Number of shares under award Date of award At 1 Jan 2014 Awarded/ (exercised/ lapsed) At 31 Dec 2014 Exercise price Market price at date of exercise Date exercisable from Expiry date 29.03.07 30.04.09 10.10.05 27.09.06 25.03.08 30.04.09 12.03.10 02.03.11 10.04.12 05.09.13 05.08.09 21.04.11 17.08.11 22.08.12 18.03.13 12.08.09 21.04.11 17.08.11 22.08.12 18.03.13 22.05.14 06.09.10 14.09.12 12.09.14 2,759 12,832 20,662 23,365 217,822 214,306 192,240 164,345 233,384 123,456 88,167 59,377 59,719 59,240 58,173 49,163 44,022 41,884 38,461 33,996 – 1,389 1,835 – – – – – – – – (39,443) – – – – (37,026) – – – – (25,969) – – 161,868 – – 1,619 2,759 12,832 20,662 23,365 217,822 214,306 192,240 124,902 233,384 123,456 88,167 59,377 22,693 59,240 58,173 49,163 44,022 15,915 38,461 33,996 161,868 1,389 1,835 1,619 299.00p 169.50p 278.65p 263.67p 252.50p 169.50p 286.10p 351.70p 397.20p 526.50p – – – – – – – – – – 222.35p 326.94p 374.19p – – – – – – – – – – – – – – – – – – – – – – – – 29.03.10 30.04.12 10.10.08 27.09.09 25.03.11 30.04.12 12.03.13 02.03.14 10.04.15 05.09.16 21.08.12 21.08.13 17.08.14 22.08.15 18.03.16 21.08.12 21.08.13 17.08.14 22.08.15 18.03.16 22.05.17 01.11.15 01.11.17 01.11.19 28.03.17 29.04.19 09.10.15 26.09.16 24.03.18 29.04.19 11.03.20 01.03.21 09.04.22 04.09.23 04.08.19 20.04.21 16.08.21 21.08.22 17.03.23 04.08.19 20.04.21 16.08.21 21.08.22 17.03.23 21.05.19 01.05.16 01.05.18 01.05.20 Total 1,740,597 61,049 1,801,646 Number of shares under award Date of award At 1 Jan 2014 Awarded/ (exercised/ lapsed) At 31 Dec 2014 Exercise price Market price at date of exercise Date exercisable from Expiry date 05.09.13 05.09.13 05.09.13 05.09.13 22.05.14 13.09.13 5,698 155,745 60,281 39,868 – 3,517 – – – – 207,041 – 5,698 155,745 60,281 39,868 207,041 3,517 526.50p 526.50p 526.50p 526.50p – 426.40p 265,109 207,041 472,150 – – – – – – 05.09.16 05.09.16 05.09.16 05.09.16 22.05.17 01.11.18 04.09.23 04.09.23 04.09.23 04.09.23 21.05.19 01.05.19 Mr D R Webb ESOS 2005, Part A (options) ESOS 2005, Part B (stock SARs) EPP-Basic (nil cost options) EPP-Match (nil cost options) LTIP (nil cost options) Sharesave (options) Total By order of the Board Paul Heiden Chairman, Remuneration Committee 23 February 2015 93987_p55-75.indd 75 04/03/2015 17:06 76 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ report The directors present their report together with the audited consolidated financial statements of the Group (prepared in accordance with International Financial Reporting Standards (IFRSs as adopted by the European Union and the Companies Act 2006) and Company audited financial statements (prepared in accordance with UK Generally Accepted Accounting Practice (UK GAAP) and the Companies Act 2006) for the year ended 31 December 2014. There are no significant events affecting the Group since the end of the year requiring disclosure. Incorporation by reference Certain laws and regulations require that specific information should be included in the Directors’ report. The table below shows the items which are incorporated into this Directors’ report by reference: Information incorporated into the Directors’ report by reference Location and page Likely future developments in the Group’s business Strategic report (page 1 to 41) The Corporate governance report Research and development activities Board of Directors and Corporate governance report (pages 43 to 50) Note 8 of the Group’s consolidated financial statements (page 102) and Chief Financial Officer’s review (page 34) Policies on financial risk management, including the extent to which financial instruments are utilised to mitigate any significant risks to which the Group is exposed Note 3 of the Group’s consolidated financial statements (page 95) Greenhouse gas emissions Employee information Employee involvement Employment of disabled persons Corporate responsibility report (page 39) Corporate responsibility report (page 41) Independent auditors—disclosure of relevant audit information Statement of directors responsibilities (page 79) Statement of the amount of interest capitalised by the Group during the year with an indication of the amount and treatment of any related tax relief Note 19 of the Group’s consolidated financial statements (page 109) Details of long term incentive plans Directors’ remuneration report (pages 58 to 59) Details of any arrangements under which a director of the Company has waived or agreed to waive any emoluments from the Company or any subsidiary undertaking. Nothing to disclose Details of allotments for cash of ordinary shares made during the period under review. Note 34 of the Group’s consolidated financial statements (page 125) Contracts of significance to which the Company is a party and in which a director is materially interested. Nothing to disclose Contracts of significance between a Company and a controlling shareholder. Contracts for the provision of services to the Company by a controlling shareholder. Not applicable, as the Company does not have a controlling shareholder Not applicable, as the Company does not have a controlling shareholder Details of any arrangement under which a shareholder has waived or agreed to waive dividends. Nothing to disclose Agreements related to controlling shareholder requirements under LR 9.2.2 A Not applicable, as the Company does not have a controlling shareholder Statement of directors interests Interests disclosed by shareholders under DTR 5 Going concern disclosure Directors’ remuneration report (page 72) Substantial shareholdings (page 78) Chief Financial Officer’s review (page 37) Details of shareholder authority for the purchase of the Company’s own shares Share capital and control (page 77) A statement of how the Company has complied with the Code and details of any non- compliance. Corporate governance report (page 43) Details of directors service contracts Share capital and control (page 78) and Directors’ remuneration report (pages 62 to 63) Share buyback disclosures Chief Financial Officer’s review (page 35) 93987_p76-79.indd 76 04/03/2015 17:07  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 77 Dividends The directors recommend the payment of a final dividend of 9.50p net per ordinary 5p share (2013: 8.80p), to be paid on 8 May 2015 to those members on the register at close of business on 20 March 2015. An interim dividend of 4.25p (2013: 3.95p) was paid on 3 October 2014. If the final dividend as recommended is approved the total ordinary dividend for the year will amount to 13.75p net per ordinary 5p share (2013: 12.75p). Dividends are paid to shareholders net of a non-refundable tax credit of 10%. Shareholders liable to higher rates of income tax will have additional tax to pay. Conflicts of interest The Company has a procedure for the disclosure, review, authorisation and management of directors’ conflicts of interest and potential conflicts of interest, in accordance with the provisions of the Companies Act 2006. In deciding whether to authorise a conflict or potential conflict the directors must have regard to their general duties under the Companies Act 2006. The authorisation of any conflict matter, and the terms of authorisation, are regularly reviewed by the Board. Political donations No political donations were made during the year (2013: None). Share dividend plan During 2014, the Company made a share dividend plan available for the dividends paid in May 2014 (the final dividend for 2013) and in October 2014 (the interim dividend for 2014). The cash dividend necessary to give an entitlement to one new ordinary share was fixed at 454.54p and 467.40p respectively. A share buyback programme was announced on 5 November 2014. Consistent with introducing a share buyback programme, the Board determined that a dividend reinvestment plan would be offered instead of a scrip dividend in 2015. Further details of the share buyback programme are contained in the Chief Financial Officer’s review (page 35). Directors The directors of the Company who were in office during the year and up to the date of signing the financial statements were: Sir Colin Terry (Chairman), Mr S G Young (Chief Executive), Mr G S Berruyer, Mr P G Cox (resigned 31 January 2015), Ms A J P Goligher (appointed 30 October 2014), Mr P E Green, Mr P Heiden, Ms B L Reichelderfer, Mr D A Robins (retired 7 May 2014), Mr D R Webb and Mr D M Williams (Senior Independent Director). Since the year end and up to the date of this Directors’ report, Mr Philip Cox resigned as a director on 31 January 2015. Additionally, the Board announced in December 2014 that on 1 March 2015, Sir Nigel Rudd will join the Board, initially as a non-executive director and Deputy Chairman, and then as Non-Executive Chairman at the conclusion of the Annual General Meeting (AGM) being held on 23 April 2015, following the retirement of Sir Colin Terry. All directors will be submitted for election or re-election at the AGM, except Sir Colin Terry who is due to retire at its conclusion. Details of any unexpired terms of the directors’ service contracts are in the Directors’ remuneration report. Membership of committees and biographical information is disclosed on pages 44 to 45 and in the notice of AGM. The directors have the benefit of qualifying third-party indemnity provisions for the purposes of Section 236 of the Companies Act 2006 pursuant to the Articles which were in effect throughout the financial year and up to the date of this Directors’ report. The Company also purchased and maintained throughout the year Directors’ and Officers’ liability insurance. No indemnity is provided for the Company’s auditors. Share capital and control The issued share capital of the Company at 31 December 2014 and details of shares issued and cancelled during the financial year are shown in note 34 of the Group’s consolidated financial statements. On 31 December 2014 there were 802,330,037 ordinary shares in issue. A further 2,916,114 ordinary shares were bought back and cancelled between 1 January 2015 and 13 February 2015 with an aggregate amount paid of £15.2m, all of which were cancelled as a result of the share buyback programme, and 1,031 shares have been allotted under the Sharesave Scheme. The ordinary shares are listed on the London Stock Exchange. The rights and obligations attaching to the Company’s ordinary shares are set out in the Articles. A copy of the Articles is available for inspection at the registered office. The holders of ordinary shares are entitled to receive the Company’s report and accounts, to attend and speak at general meetings of the Company, to appoint proxies to exercise full voting rights and to participate in any distribution of income or capital. There are no restrictions on transfer, or limitations on holding ordinary shares and no requirements for prior approval of any transfers. There are no known arrangements under which financial rights are held by persons other than holders of the shares and no known agreements or restrictions on share transfers or on voting rights. Shares acquired through Company share plans rank pari passu (on an equal footing) with the shares in issue and have no special rights. Rules about the appointment and replacement of Company directors are contained in the Articles which provide that a director may be appointed by ordinary resolution of the shareholders or by the existing directors, either to fill a vacancy or as an additional director. Changes to the Articles must be submitted to the shareholders for approval by way of special resolution. The directors may exercise all the powers of the Company subject to the provisions of relevant legislation, the Articles and any directions given by the Company in general meeting. The powers of the directors include those in relation to the issue and buyback of shares. At each AGM, the shareholders are requested to renew the directors’ powers to allot securities in the Company up to the value specified in the notice of meeting and to renew the directors’ powers to allot securities, without the application of pre-emption rights, up to the value specified in the notice of meeting in accordance with the Articles. The Company can seek authority from the shareholders at the AGM to purchase its own shares. 93987_p76-79.indd 77 04/03/2015 17:07 78 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ report continued Share capital and control continued The Group has significant financing agreements which include change of control provisions which, should there be a change of ownership of the Company, could result in renegotiation, withdrawal or early repayment of these financing agreements. These are a USD 900 million revolving credit agreement dated September 2014, a USD 600 million note purchase agreement dated June 2010 and a USD 250 million note purchase agreement dated June 2003. There are a number of other long-term commercial agreements that may alter or terminate upon a change of control of the Company following a successful takeover bid. These arrangements are commercially confidential and their disclosure could be seriously prejudicial to the Company. Agreements with the Company’s directors or employees providing compensation in the event of a takeover bid: Director Contractual entitlement Mr S G Young None except that provisions in the Company’s share plans may cause options and/or awards granted to employees under such plans to vest on a takeover. Mr D R Webb None except that provisions in the Company’s share plans may cause options and/or awards granted to employees under such plans to vest on a takeover. Mr P E Green Mr Green may terminate his employment within six months and would be entitled to compensation from the Company for loss of office. The compensation would be annual remuneration plus the value of benefits for the unexpired notice period less 5%. In addition, provisions in the Company’s share plans may cause options and/or awards granted to employees under such plans to vest on a takeover. Non-executive directors None. All other employees There are no agreements that would provide compensation for loss of employment resulting from a takeover except that provisions in the Company’s share plans may cause options and/or awards granted to employees under such plans to vest on a takeover. Substantial shareholdings At 13 February 2015, the Company had been notified under the Disclosure and Transparency Rules (DTR) of the following substantial interests in the issued ordinary shares of the Company requiring disclosure: Direct voting rights (m)* Indirect voting rights (m)* Percentage of total voting r ights attaching to the issued or dinary share capital of the company The Capital Group Companies, Inc. Harris Associates L.P. FMR LLC Standard Life Investments Ltd – – – 22.2 Legal & General Group plc 23.7 *One voting right per ordinary share. 120.8 15.11% 41.3 40.6 3.8 – 5.16% 5.07% 3.24% 2.97% These holdings are published on a regulatory information service and on the Company’s website. Statement of directors’ responsibilities The directors are responsible for preparing the Annual Report, the Directors’ Remuneration report and the financial statements in accordance with applicable law and regulations. Company law requires the directors to prepare financial statements for each financial year. Under that law the directors have prepared the Group financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union, and the parent company financial statements in accordance with United Kingdom Generally Accepted Accounting Practice (United Kingdom Accounting Standards and applicable law). 93987_p76-79.indd 78 04/03/2015 17:07  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 79 Each of the persons who is a director as at the date of this report confirms that: • • so far as the director is aware, there is no relevant audit information of which the Company’s auditors are unaware; and the director has taken all the necessary steps in order to make himself or herself aware of any relevant audit information and to establish that the Company’s auditors are aware of that information. This confirmation is given and should be interpreted in accordance with the provisions of section 418 of the Companies Act 2006. Fair, balanced and understandable The directors as at the date of this report consider that the Annual Report and Accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy. The Board has made this assessment on the basis of a review of the accounts process, a discussion on the content of the annual report assessing its fairness, balance and understandability, together with the confirmation from executive management that the report is fair, balanced and understandable. By order of the Board M L Thomas Company Secretary 23 February 2015 Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and the Company and of the profit or loss of the Group for that period. In preparing these financial statements, the directors are required to: • • • select suitable accounting policies and apply them consistently; make judgements and accounting estimates that are reasonable and prudent; and state whether IFRSs as adopted by the European Union and applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the Group and parent Company financial statements respectively. The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company’s transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and enable them to ensure that the financial statements and the Directors’ Remuneration report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. They are also responsible for safeguarding the assets of the Company and the Group and hence for taking reasonable steps for the prevention and detection of fraud and other irregularities. The directors are also responsible for the maintenance and integrity of the Company’s website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Each of the directors, whose names and functions are listed in the Board of Directors on page 44 to 45, confirm that to the best of their knowledge: • • the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit of the Group; and the Strategic report and this Directors’ report include a fair review of the development and performance of the business and the position of the Group, together with a description of the principal risks and uncertainties that it faces. 93987_p76-79.indd 79 04/03/2015 17:07 80 MEGGITT PLC REPORT AND ACCOUNTS 2014 Independent auditors’ report to the members of Meggitt PLC Report on the group financial statements Our opinion In our opinion, Meggitt PLC’s group financial statements (the “financial statements”): • • give a true and fair view of the state of the group’s affairs as at 31 December 2014 and of its profit and cash flows for the year then ended; have been properly prepared in accordance with International Financial Reporting Standards (“IFRSs”) as adopted by the European Union; and • have been prepared in accordance with the requirements of the Companies Act 2006 and Article 4 of the IAS Regulation. What we have audited Meggitt PLC’s financial statements comprise: • the Consolidated balance sheet as at 31 December 2014; Our audit approach Overview Materiality Audit Scope • • • Overall group materiality: £11m which represents approximately 5% of profit before tax. We conducted audit work at 17 reporting units. Business units where we performed audit work accounted for 100% of group profit before tax and 77% of group net assets. Areas of focus • Goodwill and intangible asset impairment assessments. • • Environmental and contractual provisions. Revenue recognition under long term contract accounting primarily in the group’s energy business. • Retirement benefit obligation liability. • Provision for uncertain tax positions. the Consolidated income statement and Consolidated statement of comprehensive income for the year then ended; The scope of our audit and our areas of focus We conducted our audit in accordance with International Standards on Auditing (UK and Ireland) (“ISAs (UK & Ireland)”). • • • • the Consolidated cash flow statement for the year then ended; the Consolidated statement of changes in equity for the year then ended; and the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. Certain required disclosures have been presented elsewhere in the Annual Report and Accounts (the ‘Annual Report’), rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited. The financial reporting framework that has been applied in the preparation of the financial statements is applicable law and IFRSs as adopted by the European Union. We designed our audit by determining materiality and assessing the risks of material misstatement in the financial statements. In particular, we looked at where the directors made subjective judgements, for example in respect of significant accounting estimates that involved making assumptions and considering future events that are inherently uncertain. As in all of our audits, we also addressed the risk of management override of internal controls, including evaluating whether there was evidence of bias by the directors that represented a risk of material misstatement due to fraud. The risks of material misstatement that had the greatest effect on our audit, including the allocation of our resources and effort, are identified as ‘areas of focus’ in the table below. We have also set out how we tailored our audit to address these specific areas in order to provide an opinion on the financial statements as a whole, and any comments we make on the results of our procedures should be read in this context. Each of the areas of focus below is also referred to in the Audit Committee report on page 52 and in the critical accounting estimates and judgements on pages 96 to 98. This is not a complete list of all risks identified by our audit. 93987_p80-84.indd 80 04/03/2015 17:36  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 81 Independent auditors’ report to the members of Meggitt PLC continued Area of focus How the scope of our audit addressed the area of focus Goodwill and intangible asset impairment assessments Refer also to notes 18, 19 and 20 (pages 107 to 110) The group holds significant amounts of goodwill (£1.5bn), acquired intangibles (£0.7bn), development costs (£0.3bn) and programme participation costs (£0.2bn) on the balance sheet. We focused on the risk that certain of these balances could be overstated. We focused in particular on the estimated value in use of the Meggitt Sensing Systems business as it has the lowest percentage headroom of estimated value in use over book value (headroom £53.4m) and also the Meggitt Aircraft Braking Systems business as it has the highest net book value of goodwill and intangibles at £1.5bn and has the second lowest percentage headroom of estimated value in use over net book value (headroom £313.6m). Environmental and contractual provisions Refer also to note 31 (page 119) The group has liabilities of £133.0m relating to environmental matters and £42.6m relating to other matters. We focused on these areas because certain of these provisions include significant subjective judgements as set out below. The environmental matters, which primarily relate to site remediation and clean up liabilities at legacy manufacturing sites in the US, are based on judgements as to the estimated clean-up cost and also the length of time that operation and monitoring of the site is required. In addition the group has contract related and other provisions based, for example, on estimates of the potential cost of settling any claims for damages by customers and, where appropriate, the cost of any new equipment or rework required under the contract. We evaluated and challenged the directors’ future cash flow forecasts, and the process by which they were drawn up, and tested the underlying value in use calculations. We compared the directors’ forecast to the latest Board approved five year plans and assessed the actual performance in the year against the prior year budgets to evaluate budgeting accuracy. The key assumption in the Sensing Systems business forecast is the planned level of profitability following a significant decline in profits during 2014. In assessing this assumption we evaluated in particular the likelihood of the factors that drove the decline in profits during 2014 impacting the business over the 5 year forecast period. The key assumption in the Braking Systems business forecast is the assumed level of growth. In assessing this assumption the factors we considered included the expected growth in the number of aircraft on which the braking business has its equipment (based on third party forecasts) during the forecast period, in particular the aftermarket size and whether a sole source supplier position is held. In respect of both forecasts, we also challenged: • • the directors’ assumptions for terminal growth rates in the forecasts by comparing them to economic and industry forecasts; and the discount rate by assessing the cost of capital for the company and comparable organisations. We performed sensitivity analysis in respect of the assumptions noted above to ascertain the extent of change in those assumptions which either individually or collectively would be required for the goodwill and intangible assets to be impaired and we assessed the likelihood of these changes in assumption arising. Although uncertainties exist in any long term forecasting exercise, based on the work performed we reached the view that the cash flows required to support the carrying values are achievable. Our work on the valuation of environmental liabilities comprised the following: • • • We obtained the cost estimates and reports prepared by the group’s external environmental consultants, for the most significant sites, and discussed these with the group’s internal legal counsel. We agreed the provisions recorded to the cost estimates included in these reports. In addition we assessed the consistency of the cost estimates year on year and the level of costs incurred compared to the prior year estimates. We assessed the competence of the external environmental consultants including reviewing their qualifications and we assessed the level of historical accuracy of the estimates produced by these consultants and in-house legal experts by comparing them to the actual costs or settlements. We assessed the extent of insurance coverage against the known exposures including obtaining evidence of the insurers’ financial position to assess their ability to meet the commitments in these policies. We found no material exceptions in these tests. Our work on contract related and other provisions included obtaining corroborating evidence for the directors’ cost estimates including looking at the historical level of actual costs incurred against the estimated costs and comparing the future cost estimates to the current actual costs. We also read legal and other correspondence with customers for evidence regarding claims outstanding or provided for at year end. In addition where insurance exists in respect of an exposure we read the correspondence with the insurers. We found no material exceptions in these tests. We performed sensitivity analysis in respect of the cost estimates of contractual disputes (including estimated costs of settlement and the expected cost of production of new equipment or rework), to ascertain the extent of change in those estimates that either individually or collectively would be required for the provisions to be materially misstated. We discussed the likelihood of such a change in these estimates with the directors and agreed with their conclusion that this was unlikely. 93987_p80-84.indd 81 04/03/2015 17:36 82 MEGGITT PLC REPORT AND ACCOUNTS 2014 Independent auditors’ report to the members of Meggitt PLC continued Area of focus How the scope of our audit addressed the area of focus Revenue recognition under long term contract accounting primarily in the group’s energy business Refer also to note 5 (page 98) We focused on the recognition of revenue because where long term contract accounting is used, estimates and judgements are made in determining the amount of revenue to be recorded. The group’s long term contract accounting is primarily concentrated in its energy business which contracts to manufacture printed circuit heat exchangers. These comprise the majority of the group contract accounting revenue of £98.3m. The recognition of revenue is largely dependent on the estimated stage of completion of each contract which is determined based on the proportion of contract costs incurred for work performed to date compared to the estimated total contract costs. As these contracts sometimes span a number of reporting periods, changes in the estimate of total contract costs or the inappropriate recording of costs around the year end could result in material amounts of revenue being recorded in the incorrect period. Retirement benefit obligation liability Refer also to note 33 (pages 121 to 125) The group has retirement benefit obligations with gross liabilities of £1,078.9m, which are significant in the context of the overall balance sheet of the group. The valuation of retirement benefit obligations requires significant levels of judgement and technical expertise in choosing appropriate assumptions. Small changes in a number of the key assumptions (including salary increases, inflation, discount rates and mortality) can have a material impact on the calculation of the liability. Provisions for uncertain tax positions Refer also to note 14 (page 105) Judgements have to be made by management on the tax treatment of a number of transactions in advance of the ultimate tax determination being known. These uncertain tax outcomes result from the complexity of the group’s legal structure (including multiple legal entities) and the multiple tax jurisdictions (primarily the UK and US) and the changing tax environment in which the group operates. In addition uncertainty arises from the level of tax credits claimed and the level of intergroup transactions that are recorded. We tested revenue recognised under long term contract accounting as follows: • • • • • • Tested the calculation of stage of completion including testing the costs incurred and recorded against the contract for occurrence and accuracy, assessing the basis for determining the total contract cost and reperforming the percentage of completion calculation. Agreed that the revenue recognised was consistent with the calculated stage of completion. Tested whether the work allocated to contracts had been carried out in the period in which the revenue had been recognised. For raw materials in stock at year end and allocated to contracts, tested to confirm that these were made specifically for the contract and therefore that revenue was recorded in the appropriate period. Assessed the estimates of costs to complete for major contracts and also assessed the historical accuracy of the estimates of total contract costs. Examined any loss making contracts to determine the level of provisioning required and also assessed the actual profit or loss achieved on contracts that completed in the year compared to the forecast position in the prior year. We found no instances of inappropriate revenue recognition. We evaluated the assumptions made in relation to the valuation of the liabilities. In particular: • We compared assumed mortality rates to national and industry averages. • • • We assessed the assumption for salary increases against the group’s historic trend and expected future outlook. We agreed the discount and inflation rates used to our internally developed benchmarks. We validated the census data used by the group’s actuaries to the underlying data held by the group and scheme administrators. We found no material exceptions in these tests. We evaluated the process by which management have calculated each exposure and we challenged the estimates made by management in arriving at the provision for uncertain tax positions. We also calculated our own range of outcomes in respect of each of the significant tax exposures. In addition we considered any tax opinions or other tax reports the group had received from its tax advisors in relation to the exposures identified to determine if the treatment is consistent with the advice obtained. We also tested the underlying calculation of the provision for uncertain tax positions. We found that the assumptions management have used in developing the estimated exposure provided a reasonable basis for provisioning. How we tailored the audit scope We tailored the scope of our audit to ensure that we performed enough work to be able to give an opinion on the financial statements as a whole, taking into account the geographic structure of the group, the accounting processes and controls, and the industry in which the group operates. The group’s accounting process is structured around a local finance function in each of the group’s reporting units. These functions maintain their own accounting records and controls (although transactional processing and certain controls for some reporting units are performed at the group’s shared service centres) and report to the head office finance team through an integrated consolidation system. In establishing the overall group audit strategy and plan, we determined the type of work that needed to be performed at the reporting units by the group engagement team and by 93987_p80-84.indd 82 04/03/2015 17:36  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 83 component auditors from other PwC network firms or by our shared service centre teams. Where the work was performed by component auditors or our shared service centre teams, we determined the level of involvement we needed to have in the audit work at those reporting units so as to be able to conclude whether sufficient appropriate audit evidence had been obtained as a basis for our opinion on the group financial statements as a whole. For each reporting unit we determined whether we required an audit of their complete financial information or whether specified procedures addressing parts of their financial information would be sufficient. Those where a complete audit was required included the largest reporting unit (Meggitt Aircraft Braking Systems Akron), because this makes up more than 15% of the group’s revenue and profits. We included a further 9 reporting units in 4 countries based on their size or risk and performed specified procedures on a further 7 reporting units in respect of specific balances. The group consolidation, financial statement disclosures and a number of complex items were audited by the group engagement team at the head office. These included derivative financial instruments, hedge accounting, defined benefit pension schemes, share based payments and goodwill. The group engagement team also visited 10 businesses in 3 countries (UK, USA and Switzerland) to review the work undertaken by component auditors and to assess the findings. Together these 17 reporting units accounted for 100% of Group profit before tax and 77% of net assets. This gave us the evidence we needed for our opinion on the financial statements as a whole. Materiality The scope of our audit is influenced by our application of materiality. We set certain quantitative thresholds for materiality. These, together with qualitative considerations, helped us to determine the scope of our audit and the nature, timing and extent of our audit procedures and to evaluate the effect of misstatements, both individually and on the financial statements as a whole. • Based on our professional judgement, we determined materiality for the financial statements as a whole as follows: statements using the going concern basis of accounting. The going concern basis presumes that the group has adequate resources to remain in operation, and that the directors intend it to do so, for at least one year from the date the financial statements were signed. As part of our audit we have concluded that the directors’ use of the going concern basis is appropriate. However, because not all future events or conditions can be predicted, these statements are not a guarantee as to the group’s ability to continue as a going concern. Other required reporting Consistency of other information Companies Act 2006 opinion In our opinion, the information given in the Strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. ISAs (UK & Ireland) reporting Under ISAs (UK & Ireland) we are required to report to you if, in our opinion: • information in the Annual Report is: – materially inconsistent with the information in the audited financial statements; or We have no exceptions to report arising from this responsibility. – apparently materially incorrect based on, or materially inconsistent with, our knowledge of the group acquired in the course of performing our audit; or – is otherwise misleading. the statement given by the directors on page 79, in accordance with provision C.1.1 of the UK Corporate Governance Code (“the Code”), that they consider the Annual Report taken as a whole to be fair, balanced and understandable and provides the information necessary for members to assess the group’s performance, business model and strategy is materially inconsistent with our knowledge of the group acquired in the course of performing our audit. We have no exceptions to report arising from this responsibility. Overall group materiality £11m (2013: £14m). How we determined it Approximately 5% of profit before tax. Rationale for benchmark applied Consistent with last year, we applied this benchmark, a generally accepted auditing practice, in the absence of indicators that an alternative benchmark would be more appropriate. We agreed with the Audit Committee that we would report to them misstatements identified during our audit above £500,000 (2013: £500,000) as well as misstatements below that amount that, in our view, warranted reporting for qualitative reasons. Going concern Under the Listing Rules we are required to review the directors’ statement, set out on page 37, in relation to going concern. We have nothing to report having performed our review. As noted in the directors’ statement, the directors have concluded that it is appropriate to prepare the financial • the section of the Annual Report on page 51, as required by provision C.3.8 of the Code, describing the work of the Audit Committee does not appropriately address matters communicated by us to the Audit Committee. We have no exceptions to report arising from this responsibility. Adequacy of information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion, we have not received all the information and explanations we require for our audit. We have no exceptions to report arising from this responsibility. 93987_p80-84.indd 83 04/03/2015 17:36 84 MEGGITT PLC REPORT AND ACCOUNTS 2014 Directors’ remuneration Under the Companies Act 2006 we are required to report to you if, in our opinion, certain disclosures of directors’ remuneration specified by law are not made. We have no exceptions to report arising from this responsibility. We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. Other matter We have reported separately on the company financial statements of Meggitt PLC for the year ended 31 December 2014 and on the information in the Directors’ remuneration report that is described as having been audited. Andrew Paynter (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 23 February 2015 Corporate governance statement Under the Listing Rules we are required to review the part of the Corporate Governance Statement relating to the company’s compliance with ten provisions of the UK Corporate Governance Code. We have nothing to report having performed our review. Responsibilities for the financial statements and the audit Our responsibilities and those of the directors As explained more fully in the Statement of directors’ responsibilities set out on pages 78 to 79, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and ISAs (UK & Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. What an audit of financial statements involves An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: • whether the accounting policies are appropriate to the group’s circumstances and have been consistently applied and adequately disclosed; • the reasonableness of significant accounting estimates made by the directors; and • the overall presentation of the financial statements. We primarily focus our work in these areas by assessing the directors’ judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements. 93987_p80-84.indd 84 04/03/2015 17:36  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 85 Consolidated income statement For the year ended 31 December 2014 Revenue Cost of sales Gross profit Net operating costs Operating profit1 Finance income Finance costs Net finance costs Profit before tax2 Tax Profit for the year attributable to equity owners of the Company Earnings per share: Basic3 Diluted4 1 Underlying operating profit 2 Underlying profit before tax 3 Underlying basic earnings per share 4 Underlying diluted earnings per share Notes 5 6 12 13 14 15 15 10 10 15 15 2014 £’m 2013 £’m 1,553.7 (935.9) 1,637.3 (981.1) 617.8 656.2 (381.6) (355.9) 236.2 300.3 1.2 (28.5) (27.3) 0.3 (31.2) (30.9) 208.9 269.4 (31.9) 177.0 (37.1) 232.3 22.0p 21.7p 346.0 328.7 32.4p 31.9p 29.4p 28.9p 397.2 377.8 37.5p 36.9p 93987_p85-89.indd 85 04/03/2015 17:11 86 MEGGITT PLC REPORT AND ACCOUNTS 2014 Consolidated statement of comprehensive income For the year ended 31 December 2014 Profit for the year attributable to equity owners of the Company Items that may be reclassified to the income statement in subsequent periods: Currency translation differences Cash flow hedge movements Tax effect Items that will not be reclassified to the income statement in subsequent periods: Remeasurement of retirement benefit obligations Tax effect Notes 2014 £’m 2013 £’m 177.0 232.3 14 33 14 77.4 (0.8) (0.2) 76.4 (97.7) 24.2 (73.5) (37.2) 1.9 0.1 (35.2) 46.8 (21.6) 25.2 Other comprehensive income/(expense) for the year 2.9 (10.0) Total comprehensive income for the year attributable to equity owners of the Company 179.9 222.3 93987_p85-89.indd 86 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 87 Consolidated balance sheet As at 31 December 2014 Non-current assets Goodwill Development costs Programme participation costs Other intangible assets Property, plant and equipment Trade and other receivables Derivative financial instruments Deferred tax assets Current assets Inventories Trade and other receivables Derivative financial instruments Current tax recoverable Cash and cash equivalents Total assets Current liabilities Trade and other payables Derivative financial instruments Current tax liabilities Obligations under finance leases Bank and other borrowings Provisions Net current assets Non-current liabilities Trade and other payables Derivative financial instruments Deferred tax liabilities Obligations under finance leases Bank and other borrowings Provisions Retirement benefit obligations Total liabilities Net assets Equity Share capital Share premium Other reserves Hedging and translation reserves Retained earnings Total equity attributable to owners of the Company Notes 2014 £’m 2013 £’m 18 19 19 20 21 23 30 32 22 23 30 24 1,541.1 342.9 242.4 673.0 251.1 93.4 29.6 0.9 1,457.1 270.5 210.6 707.3 245.5 89.9 35.5 9.1 3,174.4 3,025.5 327.2 331.9 1.1 3.3 105.5 769.0 299.2 328.9 11.2 2.8 116.1 758.2 6 3,943.4 3,783.7 25 30 27 28 31 26 30 32 27 28 31 33 34 (358.5) (9.6) (36.5) (0.1) (58.9) (45.1) (329.1) (0.7) (40.6) (2.4) (7.2) (44.3) (508.7) (424.3) 260.3 333.9 (5.9) (2.9) (214.8) (5.3) (616.7) (130.5) (317.8) (5.2) (0.1) (219.3) (5.1) (666.0) (149.2) (238.1) (1,293.9) (1,283.0) (1,802.6) (1,707.3) 2,140.8 2,076.4 40.1 1,218.9 14.4 159.1 708.3 39.9 1,166.3 14.1 82.7 773.4 2,140.8 2,076.4 The financial statements on pages 85 to 132 were approved by the Board of Directors on 23 February 2015 and signed on its behalf by: S G Young Director D R Webb Director 93987_p85-89.indd 87 04/03/2015 17:11 88 MEGGITT PLC REPORT AND ACCOUNTS 2014 Consolidated statement of changes in equity For the year ended 31 December 2014 Equity attributable to owners of the Company Share capital Share premium Other reserves* Hedging and translation Retained earnings Total equity Notes £’m 39.3 £’m 1,143.9 £’m 14.1 At 1 January 2013 Profit for the year Other comprehensive income for the year: Currency translation differences: Arising in the year Transferred to income statement Cash flow hedge movements: Movement in fair value Transferred to income statement Remeasurement of retirement benefit obligations Other comprehensive (expense)/income before tax Tax effect Other comprehensive (expense)/income for the year Total comprehensive (expense)/income for the year Employee share schemes: Value of services provided Issue of equity share capital Dividends At 31 December 2013 Profit for the year Other comprehensive income for the year: Currency translation differences: Arising in the year Cash flow hedge movements: Movement in fair value Transferred to income statement Remeasurement of retirement benefit obligations Other comprehensive income/(expense) before tax Tax effect Other comprehensive income/(expense) for the year Total comprehensive income for the year Employee share schemes: Value of services provided Purchase of own shares Issue of equity share capital Share buyback – purchased in year Share buyback – close period commitment Dividends At 31 December 2014 reserves** £’m 117.9 £’m 590.2 £’m 1,905.4 – 232.3 232.3 (31.9) (5.3) 1.6 0.3 – (35.3) 0.1 (35.2) – – – – 46.8 46.8 (21.6) 25.2 (31.9) (5.3) 1.6 0.3 46.8 11.5 (21.5) (10.0) (35.2) 257.5 222.3 – – – 21.8 (0.5) (95.6) 21.8 2.5 (75.6) – – – – – – – – – – – – – – – – – – – – – 0.4 0.2 – 2.6 19.8 – – – – – – – – – – – – – 39.9 1,166.3 14.1 82.7 773.4 2,076.4 – – – – – – – – – – – – – – – – – – – – – (0.3) – 0.5 – – 0.1 – – 52.5 – – – – – – – – – – – – 0.3 – – – 177.0 177.0 77.4 (1.6) 0.8 – 76.6 (0.2) 76.4 – – – (97.7) (97.7) 24.2 (73.5) 77.4 (1.6) 0.8 ( 97.7) (21.1) 24.0 2.9 76.4 103.5 179.9 – – – – – – 1.1 (11.6) – (33.7) (20.0) (104.4) 1.1 (11.6) 0.1 (33.7) (20.0) (51.4) 40.1 1,218.9 14.4 159.1 708.3 2,140.8 33 14 16 33 14 16 * Other reserves relate to capital reserves of £14.1 million (2013: £14.1 million) arising on the acquisition of businesses in 1985 and 1986 where merger accounting was applied and a capital redemption reserve of £0.3 million (2013: £Nil million) created as a result of the share buyback programme commenced during 2014. ** Hedging and translation reserves at 31 December 2014 comprise a credit balance on the hedging reserve of £2.5 million (2013: £3.2 million) and a credit balance on the translation reserve of £156.6 million (2013: £79.5 million). Amounts recycled from the hedging reserve to the income statement, in respect of cash flow hedge movements, have been recorded in net finance costs. Amounts recycled from the translation reserve to the income statement in 2013, in respect of the disposal of foreign subsidiaries, have been recorded in net operating costs. 93987_p85-89.indd 88 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 89 Consolidated cash flow statement For the year ended 31 December 2014 Cash inflow from operations before exceptional operating items Cash outflow from exceptional operating items Cash inflow from operations Interest received Interest paid Tax paid Cash inflow from operating activities Businesses acquired Businesses disposed Capitalised development costs Capitalised programme participation costs Purchase of intangible assets Purchase of property, plant and equipment Proceeds from disposal of property, plant and equipment Cash outflow from investing activities Dividends paid to Company’s shareholders Purchase of own shares Issue of equity share capital Share buyback – purchased in year Proceeds from borrowings Debt issue costs Repayments of borrowings Cash outflow from financing activities Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents at start of the year Exchange gains/(losses) on cash and cash equivalents Cash and cash equivalents at end of the year Notes 11 39 42 19 19 20 16 34 24 2014 £’m 364.0 (17.1) 346.9 0.3 (16.3) (18.7) 312.2 (28.6) – (77.7) (46.0) (12.0) (33.0) 2.8 2013 £’m 361.9 (16.2) 345.7 0.3 (19.7) (44.0) 282.3 (26.5) 53.3 (70.2) (35.7) (18.4) (52.4) 3.9 (194.5) (146.0) (51.4) (11.6) 0.1 (33.7) 218.3 (2.8) (249.9) (75.6) – 2.5 – 181.5 – (231.4) (131.0) (123.0) (13.3) 116.1 2.7 105.5 13.3 104.9 (2.1) 116.1 93987_p85-89.indd 89 04/03/2015 17:11 90 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements 1. Basis of preparation Meggitt PLC is a public limited company listed on the London Stock Exchange, domiciled in the United Kingdom and incorporated in England and Wales with the registered number 432989. Its registered office is at Atlantic House, Aviation Park West, Bournemouth International Airport, Christchurch, Dorset, BH23 6EW. Meggitt PLC is the parent company of a Group whose principal activities during the year were the design and manufacture of high performance components and sub-systems for aerospace, defence and other specialist markets, including energy, medical, industrial, test and automotive. The consolidated financial statements of the Group have been prepared in accordance with International Financial Reporting Standards (‘IFRSs’) as adopted by the European Union and the Companies Act 2006 applicable to companies reporting under IFRS. The consolidated financial statements have been prepared on a going concern basis and under the historical cost convention, as modified by the revaluation of certain financial assets and financial liabilities (including derivative instruments) at fair value. 2. Summary of significant accounting policies The principal accounting policies adopted by the Group in the preparation of the consolidated financial statements are set out below. These policies have been applied consistently to all periods presented unless stated otherwise. Basis of consolidation The Group financial statements consolidate the financial statements of the Company and all of its subsidiaries. A subsidiary is an entity over which the Group has control. The Group has control over an entity where the Group is exposed to, or has the rights to, variable returns from its involvement with the entity, and it has the power over the entity to affect those returns. The results of subsidiaries acquired are fully consolidated from the date on which control transfers to the Group. The results of subsidiaries disposed are fully consolidated up to the date on which control transfers from the Group. The cost of an acquisition is the fair value of consideration provided, including the fair value of any contingent consideration, as measured at the acquisition date. Subsequent changes to the fair value of contingent consideration are recorded in the income statement. Identifiable assets and liabilities of an acquired business meeting the conditions for recognition under IFRS 3 are recognised at fair value at the date of acquisition. To the extent the cost of an acquisition exceeds the fair value of net assets acquired, the difference is recorded as goodwill. To the extent the fair value of net assets acquired exceeds the cost of an acquisition, the difference is recorded immediately in the income statement. Costs directly attributable to an acquisition are recognised in the income statement as incurred. When a subsidiary is acquired, the fair value of its identifiable assets and liabilities are finalised within 12 months of the acquisition date. All fair value adjustments are recorded with effect from the date of acquisition and consequently may result in the restatement of previously reported financial results. When a subsidiary is disposed, the difference between the fair value of consideration received or receivable and the value at which net assets of the subsidiary were recorded, immediately prior to disposal, is recognised in the income statement. Any contingent consideration receivable is measured at fair value at the date of disposal in determining the gain or loss to be recognised. Contingent consideration is measured at fair value at each subsequent balance sheet date, with any changes in fair value recorded in the income statement. When a foreign subsidiary is disposed, the cumulative exchange differences relating to the retranslation of the net investment in the foreign subsidiary are recognised in the income statement as part of the gain or loss on disposal. This applies only to exchange differences recorded in equity after 1 January 2004. Exchange differences arising prior to 1 January 2004 remain in equity on disposal as permitted by IFRS 1 (‘First time Adoption of International Financial Reporting Standards’). Transactions between, and balances with, Group companies are eliminated together with unrealised gains on inter-group transactions. Unrealised losses are eliminated to the extent the asset transferred is not impaired. The accounting policies of acquired businesses are changed where necessary to be consistent with those of the Group. The following items in respect of the acquisition and disposal of subsidiaries are excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10): • Any amounts by which the fair value of net assets of an acquired subsidiary exceed the cost of acquisition; • Costs directly attributable to the acquisition and integration of a subsidiary; • Any gain or loss arising from the disposal of a subsidiary; and • Adjustments to the fair value of contingent consideration payable in respect of the acquisition of a subsidiary or receivable in respect of the disposal of a subsidiary. Foreign currencies Functional and presentational currency The Group’s consolidated financial statements are presented in pounds sterling. Items included in the financial statements of each of the Group’s subsidiaries are measured using the functional currency of the primary economic environment in which the subsidiary operates. Transactions and balances Transactions in foreign currencies are recorded at exchange rates prevailing on the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies are reported at exchange rates prevailing at the balance sheet date. Exchange differences on retranslating monetary assets and liabilities are recognised in the income statement except where they relate to qualifying cash flow hedges or net investment hedges in which case exchange differences are recognised in hedging and translation reserves within other comprehensive income. Foreign subsidiaries The results of foreign subsidiaries are translated at average exchange rates for the period. Assets and liabilities of foreign subsidiaries are translated at exchange rates prevailing at the balance sheet date. Exchange differences arising from the retranslation of the results and opening net assets of foreign subsidiaries are recognised as a separate component of equity in hedging and translation reserves. Exchange differences on borrowings designated as net investment hedges of foreign subsidiaries are also recognised in hedging and translation reserves. Goodwill and fair value adjustments arising from the acquisition of a foreign subsidiary are treated as assets and liabilities of the subsidiary and are retranslated at exchange rates prevailing at the balance sheet date. 93987_p90-132.indd 90 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 91 2. Summary of significant accounting policies continued Segment reporting Operating segments are those segments for which results are reviewed by the Group’s Chief Operating Decision Maker (‘CODM’) to assess performance and make decisions about resources to be allocated. The CODM has been identified as the Board (see page 46 of the Corporate governance report). The Group has determined that its segments are Meggitt Aircraft Braking Systems, Meggitt Control Systems, Meggitt Polymers & Composites, Meggitt Sensing Systems and the Meggitt Equipment Group. On 7 May 2014, the Group announced that the divisional structure had been realigned to reflect the following changes: • The fire protection business has moved from Meggitt Equipment Group to Meggitt Control Systems; and • The power businesses have moved from Meggitt Equipment Group to Meggitt Sensing Systems. Prior period comparatives have been restated to reflect this new divisional structure. The principal profit measure reviewed by the CODM is ‘underlying operating profit’ as defined in note 10. A segmental analysis of underlying operating profit is accordingly provided in the notes to the financial statements. Segmental information on assets is provided in the notes to the financial statements in respect of ‘trading assets’, which are defined to exclude from total assets amounts which the CODM does not review at a segmental level. Excluded assets comprise centrally managed trading assets, goodwill, other intangible assets (excluding software assets), derivative financial instruments, deferred tax assets, current tax recoverable and cash and cash equivalents. No segmental information on liabilities is provided in the notes to the financial statements as no such measure is reviewed by the CODM. Revenue recognition Revenue represents the fair value of consideration received or receivable in respect of goods and services provided in the normal course of business to external customers, net of trade discounts, returns and sales related taxes. Sale of goods Revenue is recognised when the significant risks and rewards of ownership have transferred to the customer, managerial involvement and control of the goods is not retained by the Group, the revenue and costs associated with the sale can be measured reliably and the collection of related receivables is probable. In the majority of instances these conditions are met when delivery to the customer takes place. In a minority of instances ‘bill and hold’ arrangements exist whereby revenue is recorded prior to delivery but only when the customer has accepted title to the goods, the goods are separately identifiable and available for delivery on terms agreed with the customer and normal credit terms apply. Contract accounting revenue The Group is usually able to reliably estimate the outcome of a contract at inception and accordingly recognises revenue and cost of sales by reference to the stage of completion of the contract. Revenue is typically measured by applying to total contract revenue, the proportion costs incurred for work performed in the period bear to total estimated contract costs. Where it is not possible to reliably estimate the outcome of a contract, revenue is recognised equal to costs incurred, provided recovery of such costs is probable. If total contract costs are forecast to exceed total contract revenue then the expected loss is recorded immediately in the income statement. Revenue from services Revenue is recognised by reference to the stage of completion of the contract. For ‘cost-plus fixed fee’ contracts, revenue is recognised equal to the costs incurred plus an appropriate proportion of the fee agreed with the customer. For other contracts, the stage of completion is typically measured by reference to contractual milestones achieved, number of aircraft flying hours or number of aircraft landings. Revenue from funded research and development Revenue is recognised according to the stage of completion of the contract. The stage of completion is typically measured by reference to contractual milestones achieved. Exceptional operating items Items which are significant by virtue of their size or nature, which are considered non-recurring and which are excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10) are classified as exceptional operating items. They include, for instance, gains or losses made on the disposal or closure of a business, adjustments to the fair value of contingent consideration payable in respect of an acquired business or receivable in respect of a disposed business, costs directly attributable to the acquisition and integration of a business, and significant site consolidation and other restructuring costs. Additionally in 2013, given its significance and non-recurring nature, the raw material supply issue described in note 11 was treated as an exceptional operating item. Exceptional operating items are included within the appropriate consolidated income statement category but are highlighted separately in the notes to the financial statements. Intangible assets Goodwill Goodwill represents the excess of the cost of an acquisition over the fair value of the Group’s share of identifiable assets acquired and liabilities and contingent liabilities assumed. Goodwill is tested annually for impairment, and also whenever events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is carried at cost less amortisation charged prior to 1 January 2004 less accumulated impairment losses. In the event the subsidiary to which goodwill relates is disposed, its attributable goodwill is included in the determination of the gain or loss on disposal. Research and development Research expenditure is recognised as an expense in the income statement as incurred. Development costs incurred on projects where the related expenditure is separately identifiable, measurable and management are satisfied as to the ultimate technical and commercial viability of the project and that the asset will generate future economic benefit based on all relevant available information are recognised as an intangible asset. Capitalised development costs are carried at cost less accumulated amortisation and impairment losses. Amortisation is charged over the periods expected to benefit, commencing with the launch of the product. During the year, the period over which amortisation is charged was reassessed and, as a result, the maximum life extended from 10 years to 15 years. The impact of this change, which has been applied prospectively, was to reduce the charge to the income statement in 2014 by approximately £7.0 million. Development costs not meeting the criteria for capitalisation are expensed as incurred. 93987_p90-132.indd 91 04/03/2015 17:11 92 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 2. Summary of significant accounting policies continued Borrowing costs Programme participation costs Programme participation costs consist of incentives given to Original Equipment Manufacturers in connection with their selection of the Group’s products for installation onto new aircraft where the Group has obtained principal supplier status. These incentives comprise cash payments and/or the supply of initial manufactured parts on a free of charge or deeply discounted basis. Programme participation costs are recognised as an intangible asset and carried at cost less accumulated amortisation and impairment losses. For manufactured parts supplied on a free of charge or deeply discounted basis, cost represents the cost of manufacture transferred from inventory less the value of any revenue received or receivable. Amortisation is charged over the periods expected to benefit from receiving the status of principal supplier, through the sale of replacement parts, typically up to 15 years. Other intangible assets a) Intangible assets acquired as part of a business combination For acquisitions, the Group recognises intangible assets separately from goodwill provided they are separable or arise from contractual or other legal rights and their fair value can be measured reliably. Intangible assets are initially recognised at fair value, which is regarded as their cost. Intangible assets are subsequently held at cost less accumulated amortisation and impairment losses. Where intangible assets have finite lives, their cost is amortised on a straight-line basis over those lives. The nature of intangible assets recognised and their estimated useful lives are as follows: Customer relationships .............................. Up to 25 years Technology .................................................. Up to 25 years Trade names and trademarks .................... Up to 25 years Order backlogs ............................................ Over period of backlog (typically up to 3 years) Amortisation of intangible assets acquired as part of a business combination is excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10). b) Other purchased intangible assets Purchased licences, trademarks, patents and software are carried at cost less accumulated amortisation and impairment losses. Amortisation is charged on a straight-line basis over their estimated useful economic life, typically over periods up to 10 years. Property, plant and equipment Property, plant and equipment is recorded at cost less accumulated depreciation and impairment losses, except for land which is recorded at cost less accumulated impairment losses. Cost includes expenditure directly attributable to the acquisition of the asset. Depreciation is calculated on a straight-line basis over the estimated useful lives of the assets as follows: Freehold buildings ...................................... Up to 50 years Leasehold property ..................................... Over period of lease Plant and machinery ................................... 3 to 10 years Furnaces ...................................................... Up to 20 years Fixtures and fittings .................................... 3 to 10 years Motor vehicles.............................................. 4 to 5 years Residual values and useful lives are reviewed annually and adjusted if appropriate. When property, plant and equipment is disposed, the difference between sale proceeds, net of related costs, and the carrying value of the asset is recognised in the income statement. Borrowing costs directly attributable to the construction or production of qualifying assets, are capitalised as part of the cost of those assets until such time as the assets are substantially ready for their intended use. Qualifying assets are those that necessarily take a substantial period of time to get ready for their intended use, which would generally be at least 12 months. All other borrowing costs are recognised in the income statement as incurred. Taxation Tax payable is based on taxable profit for the period, calculated using tax rates enacted or substantively enacted at the balance sheet date. Deferred tax is provided in full using the liability method on temporary differences between the tax bases of assets and liabilities and their corresponding book values as recorded in the Group’s financial statements. Deferred tax is provided on unremitted earnings of foreign subsidiaries, except where the Group can control the remittance and it is probable that the earnings will not be remitted in the foreseeable future. Deferred tax assets are recognised only to the extent it is probable that taxable profits will be available against which deductible temporary differences can be utilised. Deferred tax is calculated using tax rates enacted or substantively enacted at the balance sheet date. Current tax and deferred tax are recognised in the income statement, other comprehensive income or directly in equity depending on where the item to which they relate has been recognised. Impairment of non-current non-financial assets Assets are reviewed for impairment annually and also whenever events or changes in circumstances indicate their carrying value may not be recoverable. To the extent the carrying value exceeds the recoverable amount, the difference is recorded as an expense in the income statement. The recoverable amount used for impairment testing is the higher of the value in use and fair value less costs of disposal. For the purpose of impairment testing, assets are grouped at the lowest level for which there are separately identifiable cash inflows which are largely independent of cash inflows from other assets or groups of assets. At each balance sheet date, previously recorded impairment losses, other than any relating to goodwill, are reviewed and if no longer required reversed with a corresponding credit to the income statement. Inventories Inventories are recorded at the lower of cost and net realisable value. Cost represents materials, direct labour, other direct costs and related production overheads, based on normal operating capacity, and is determined using the first-in first-out (FIFO) method. Net realisable value is based on estimated selling price, less further costs expected to be incurred to completion and disposal. When a subsidiary is acquired, finished goods are valued at fair value, which is typically estimated selling price less costs of disposal and a reasonable profit allowance for the selling effort. Work in progress is also valued at fair value at acquisition, which is typically estimated selling price less costs to complete, costs of disposal and a reasonable profit allowance for work not yet completed. When this inventory is subsequently disposed post acquisition, the fair value is charged to the income statement. The difference between the fair value of the inventory disposed and its actual cost of manufacture is excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10). Provision is made for obsolete, slow moving or defective items where appropriate and for unrealised profits on items of inter-group manufacture. 93987_p90-132.indd 92 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 93 2. Summary of significant accounting policies continued Provisions Trade receivables Trade receivables are initially recognised at fair value and subsequently measured at amortised cost less any impairment losses. An impairment is recognised in the income statement, when there is objective evidence the Group will not be able to collect all amounts due according to the original terms of the receivables. The impairment recorded is the difference between the carrying value of the receivable and its estimated future cash flows discounted where appropriate. Cash and cash equivalents Cash and cash equivalents include cash in hand and deposits held at call with banks. Bank overdrafts are disclosed as current liabilities, within bank and other borrowings, except where the Group participates in offset arrangements with certain banks whereby cash and overdraft amounts are offset against each other. Trade payables Trade payables are initially recognised at fair value and subsequently measured at amortised cost. Trade payables are not interest bearing. Leases Leases where the Group has substantially all the risks and rewards of ownership are classified as finance leases. Finance leases are capitalised at commencement of the lease at the lower of fair value of the leased asset and present value of the minimum lease payments. Each lease payment is allocated between the liability and finance charges so as to achieve a constant rate on the finance balance outstanding. The corresponding lease obligations, net of finance charges, are included in liabilities. Assets acquired under finance leases are depreciated on a straight-line basis over the shorter of the useful life of the asset or the lease term. Leases in which a significant portion of the risks and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases, net of any incentives received from the lessor, are charged to the income statement on a straight-line basis over the period of the lease. Dividends Interim dividends are recognised as liabilities when they are approved by the Board. Final dividends are recognised as liabilities when they are approved by the shareholders. Borrowings Borrowings are initially recognised at fair value, being proceeds received less directly attributable transaction costs incurred. Borrowings are generally subsequently measured at amortised cost with any transaction costs amortised to the income statement over the period of the borrowings using the effective interest method. Certain borrowings however are designated as fair value through profit and loss at inception, if the Group has interest rate derivatives in place which have the economic effect of converting fixed rate borrowings into floating rate borrowings. Such borrowings are measured at fair value at each balance sheet date with any movement in fair value recorded in the income statement within net operating costs. Movements in fair value are excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10). Any related interest accruals are included within borrowings. Borrowings are classified as current liabilities unless the Group has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date. Provision is made for environmental liabilities, onerous contracts, product warranty claims and other liabilities when the Group has a present obligation as a result of past events, it is more likely than not that an outflow of economic benefits will be required to settle the obligation and the amount can be reliably estimated. Provisions are discounted to present value where the impact is significant, using a pre-tax rate. The discount rate used is based on current market assessments of the time value of money, adjusted to reflect any risks specific to the obligation which have not been reflected in the undiscounted provision. The impact of the unwinding of discounting is recognised in the income statement within net finance costs. Retirement benefit schemes For defined benefit schemes, pension costs and the costs of providing other post-retirement benefits, principally healthcare, are charged to the income statement in accordance with the advice of qualified independent actuaries. Past service credits and costs are recognised immediately in the income statement. Retirement benefit obligations represent, for each scheme, the difference between the fair value of the schemes’ assets and the present value of the schemes’ defined benefit obligations measured at the balance sheet date. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the defined benefit obligations using interest rates of high quality corporate bonds denominated in the currency in which the benefits will be paid and with terms to maturity comparable with the terms of the related defined benefit obligations. Where the Group has a statutory or contractual minimum funding requirement to make contributions to a scheme in respect of past service and any such contributions are not available to the Group once paid (either as a reduction in future contributions or as a refund during the life of the scheme or when the scheme liabilities are settled, to which the Group has an irrevocable right), an additional liability for such amounts is recognised. Remeasurement gains and losses are recognised in the period in which they arise in other comprehensive income. For defined contribution schemes, payments are recognised in the income statement when they fall due. The Group has no further obligations once the contributions have been paid. Share-based compensation The Group operates a number of equity-settled and cash-settled share-based compensation schemes. For equity-settled schemes, the fair value of an award is measured at the date of grant and reflects any market-based vesting conditions. Non market-based vesting conditions are excluded from the fair value of the award. At the date of grant, the Group estimates the number of awards expected to vest as a result of non market-based vesting conditions and the fair value of this estimated number of awards is recognised as an expense in the income statement on a straight-line basis over the period for which services are received. At each balance sheet date, the Group revises its estimate of the number of awards expected to vest as a result of non market-based vesting conditions and adjusts the amount recognised cumulatively in the income statement to reflect the revised estimate. When awards are exercised and the Company issues new shares, the proceeds received, net of any directly attributable transaction costs, are credited to share capital (nominal value) and share premium. For cash-settled schemes, the total amount recognised is based on the fair value of the liability incurred. The fair value of the liability is remeasured at each balance sheet date with changes in fair value recognised in the income statement for the period. 93987_p90-132.indd 93 04/03/2015 17:11 94 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 2. Summary of significant accounting policies continued Derivative financial instruments and hedging The Group uses derivative financial instruments to hedge its exposure to interest rate risk and foreign currency transactional risk. Derivative financial instruments are initially recognised at fair value on the date the derivative contract is entered into and are subsequently remeasured at fair value at each balance sheet date using values determined indirectly from quoted prices that are observable for the asset or liability. The method by which any gain or loss arising from remeasurement is recognised depends on whether the instrument is designated as a hedging instrument and if so the nature of the item hedged. The Group recognises an instrument as a hedging instrument by documenting, at inception of the instrument, the relationship between the instrument and the hedged item and the objectives and strategy for undertaking the hedging transaction. To be designated as a hedging instrument, an instrument must also be assessed, at inception and on an ongoing basis, to be highly effective in offsetting changes in fair values or cash flows of hedged items. To the extent the maturity of the financial instrument is more than 12 months from the balance sheet date, the fair value is reported as a non-current asset or non-current liability. All other derivative financial instruments are reported as current assets or current liabilities. Fair value hedges Changes in fair value of derivative financial instruments, that are designated and qualify as fair value hedges, are recognised in the income statement within net operating costs together with changes in fair value of the hedged item. Any difference between the movement in fair value of the derivatives and the hedged item is excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10). The Group currently only applies fair value hedge accounting to the hedging of fixed interest rate risk on borrowings. Cash flow hedges Changes in fair value of the effective portion of derivative financial instruments, that are designated and qualify as cash flow hedges, are initially recognised in other comprehensive income. Changes in fair value of any ineffective portion are recognised immediately in the income statement within net operating costs. To the extent changes in fair value are recognised in other comprehensive income, they are recycled to the income statement in the periods in which the hedged item affects the income statement. The Group currently only applies cash flow hedge accounting to the hedging of floating interest rate risk on borrowings. If the forecast transaction to which the cash flow hedge relates is no longer expected to occur, the cumulative gain or loss previously recognised in other comprehensive income is transferred to the income statement immediately. If the hedging instrument is sold, expires or no longer meets the criteria for hedge accounting, the cumulative gain or loss previously recognised in other comprehensive income is transferred to the income statement when the forecast transaction is recognised in the income statement. Net investment hedges Hedges of net investments of foreign subsidiaries are accounted for in a similar way to cash flow hedges. Changes in fair value of the effective portion of any hedge are recognised in other comprehensive income. Changes in fair value of any ineffective portion are recognised immediately in the income statement within net operating costs. Cumulative gains and losses previously recognised in other comprehensive income are transferred to the income statement if the foreign subsidiary to which they relate is disposed. Derivatives not meeting the criteria for hedge accounting Where derivatives do not meet the criteria for hedge accounting, changes in fair value are recognised immediately in the income statement. The Group utilises a large number of foreign currency forward contracts to mitigate against currency fluctuations. The Group has determined the additional costs of meeting the extensive documentation requirements in order to apply hedge accounting under IAS 39 ‘Financial Instruments: Recognition and Measurement’ are not merited. Gains and losses arising from measuring these contracts at fair value are excluded from the underlying profit measures used by the Board to monitor and measure the underlying performance of the Group (see note 10). Share capital Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares are deducted from the proceeds recorded in equity. Own shares represent shares in the Company that are held by an independently managed Employee Share Ownership Plan. Consideration paid for own shares, including any incremental directly attributable costs, is recorded as a deduction from retained earnings. Share buyback On 5 November 2014, the Group announced the intention to commence a share buyback programme. The total consideration payable for shares purchased is deducted from retained earnings. The shares when purchased are cancelled and the nominal value of the cancelled shares is transferred from share capital to a separate capital redemption reserve. Where the Group has entered into an irrevocable non-discretionary contract to purchase for cancellation shares on its behalf during a close period, the obligation to purchase shares is recognised in full at the inception of the contract, even when the obligation is conditional on the share price. The obligation is remeasured at each balance sheet date with changes recognised in the income statement. Adoption of new and revised accounting standards During the year, no new accounting standards became effective which had a significant impact on the Group’s consolidated financial statements. Recent accounting developments A number of new standards and amendments and revisions to existing standards have been published and are mandatory for the Group’s future accounting periods. They have not been adopted early in these consolidated financial statements. None of these are expected to have a significant impact on the consolidated financial statements when they are adopted except as disclosed below; • IFRS 9, ‘Financial instruments’. The main change is expected to relate to the way in which movements in the fair value of the Group’s fixed rate borrowings, attributable to changes in the Group’s own credit risk, are accounted for. The Group is yet to assess the full impact of IFRS 9 which becomes effective for accounting periods beginning on or after 1 January 2018. This standard is subject to endorsement by the European Union. • IFRS 15, ‘Revenue from contracts with customers’. This standard establishes principles for reporting the nature, amount and timing of revenue arising from an entity’s contracts with customers. The Group is yet to assess the full impact of IFRS 15 which becomes effective for accounting periods beginning on or after 1 January 2017. This standard is subject to endorsement by the European Union. 93987_p90-132.indd 94 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 95 3. Financial risk management Financial risk factors The Group’s operations expose it to a number of financial risks including market risk (principally foreign exchange risk and interest rate risk), credit risk and liquidity risk. These risks are managed by a centralised treasury department, in accordance with Board approved objectives, policies and authorities (see also pages 35 to 37 of the Chief Financial Officer’s review). Regular reports monitor exposures and assist in managing the associated risks. Market risk Foreign exchange risk The Group operates internationally and is subject to foreign exchange risks on future commercial transactions and the retranslation of the results of, and net investments in, foreign subsidiaries. The principal exposure arises with respect to the US dollar against the Pound sterling. To mitigate risks associated with future commercial transactions, the Group policy is to hedge known and certain forecast transaction exposure based on historical experience and projections. The Group hedges at least 70% of the next 12 months anticipated exposure and can hedge up to five years ahead. Details of hedges in place are provided in note 30. The Group does not currently hedge exposure arising from the retranslation of the results of foreign subsidiaries. The Group uses borrowings denominated in the relevant currencies to hedge its net investments in foreign subsidiaries. Interest rate risk The Group has borrowings issued at both fixed and floating rates of interest. Borrowings issued at fixed rates expose the Group to fair value interest rate risk, whereas borrowings issued at floating rates expose the Group to cash flow interest rate risk. The Group’s policy is to maintain at least 25% of its net debt at fixed rates. The Group mitigates interest rate risks through interest rate derivatives which have the economic effect of converting fixed rate borrowings into floating rate borrowings and floating rate borrowings into fixed rate borrowings. Details of hedges in place are provided in note 30. Credit risk The Group is not subject to significant concentration of credit risk with exposure spread across a large number of customers across the world. In addition, many of the Group’s principal customers are either government departments or large multinationals. Policies are maintained to ensure the Group makes sales to customers with an appropriate credit history. Letters of credit, or other appropriate instruments, are put in place to reduce credit risk where considered necessary. The Group is also subject to credit risk on the counterparties to its other financial instruments which it controls through only dealing with highly rated counterparties and netting transactions on settlement wherever possible. Liquidity risk The Group maintains sufficient committed facilities to meet projected borrowing requirements based on cash flow forecasts. Additional headroom is maintained to protect against the variability of cash flows and to accommodate small bolt-on acquisitions. Key ratios are monitored to ensure continued compliance with covenants contained in the Group’s principal credit agreements. The following table analyses the Group’s non-derivative financial liabilities and derivative assets and liabilities at the balance sheet date. The amounts disclosed in the table are the contractual undiscounted cash flows: Trade and other payables* Bank and other borrowings Interest payments on borrowings Obligations under finance leases (see note 27) Derivative financial instruments: Inflows** Outflows** Total Trade and other payables* Bank and other borrowings Interest payments on borrowings Obligations under finance leases (see note 27) Derivative financial instruments: Inflows** Outflows** Total Less than 1 year £’m 350.1 49.5 20.5 1.1 (9.1) 0.8 412.9 Less than 1 year £’m 316.6 4.1 20.6 3.4 (8.2) 0.7 337.2 2014 1-2 years 2-5 years Greater than 5 years £’m 1.7 256.8 17.3 12.4 Total £’m 356.0 650.3 102.0 17.5 (9.8) – (50.7) 2.8 £’m 2.7 343.9 45.2 3.0 (22.8) 1.2 373.2 278.4 1,077.9 £’m 1.5 0.1 19.0 1.0 (9.0) 0.8 13.4 2013 1-2 years 2-5 years £’m 1.2 42.4 19.1 1.0 (8.5) 0.7 55.9 £’m 2.2 370.4 48.2 2.8 (23.5) 1.9 402.0 Greater than 5 years £’m 1.8 241.9 28.6 12.7 (15.8) – Total £’m 321.8 658.8 116.5 19.9 (56.0) 3.3 269.2 1,064.3 * Excludes social security and other taxes of £8.4 million (2013: £12.5 million) (see note 25). ** Assumes no change in interest rates from those prevailing at year end. 93987_p90-132.indd 95 04/03/2015 17:11 96 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 3. Financial risk management continued Sensitivity analysis The Group’s principal exposure in relation to market risks are to changes in the exchange rate between the US dollar and Pound sterling and to changes in US interest rates. The table below illustrates the sensitivity of the Group’s results to changes in these key variables at the balance sheet date. The analysis covers only financial assets and liabilities held at the balance sheet date and is made on the basis of the hedge designations in place on those dates and assuming no hedge ineffectiveness. USD/GBP exchange rate +/- 10% US yield curve +/- 1% 2014 2013 Income statement £’m 28.3 4.6 Equity £’m 44.1 3.3 Income statement £’m 25.2 4.6 Equity £’m 36.1 4.1 The impact on equity from movements in the exchange rate comprises £53.2 million (2013: £46.3 million) in respect of US dollar net debt, offset by £9.1 million (2013: £10.2 million) in respect of other financial assets and liabilities. However, as all US dollar debt is designated as a net investment hedge, this element of the impact is entirely offset by the retranslation of foreign subsidiaries. The impact of a 1% movement in the US yield curve includes the effect on the Group’s forward foreign exchange contracts as well as other financial assets and liabilities. Capital risk management The Group’s objective when managing its capital structure is to minimise the cost of capital whilst maintaining adequate capital to protect against volatility in earnings and net asset values. The strategy is designed to maximise shareholder return over the long-term. The Group’s current post-tax average cost of capital is approximately 8% (2013: 8%) and its capital structure at 31 December is as follows: Net debt (see note 40) Total equity Debt/equity % 2014 £’m 2013 £’m 575.5 2,140.8 564.6 2,076.4 26.9% 27.2% The Board believes that in maintaining an efficient balance sheet, a net debt/EBITDA ratio of between 1.5x and 2.5x is appropriate, whilst retaining the flexibility to move outside the range if appropriate. Further details on the share buyback programme announced as part of the Group’s strategy for delivering net debt/EBITDA in this range can be found on page 35 of the Chief Financial Officer’s review, which also includes details on how the Group has complied with the two principle financial covenant requirements contained in its committed credit facilities for the year ended 31 December 2014. 4. Critical accounting estimates and judgements In applying the Group’s accounting policies set out in note 2, the Group is required to make certain estimates and judgements concerning the future. These estimates and judgements are regularly reviewed and revised as necessary. The estimates and judgements that have the most significant effect on the amounts included in these financial statements are as described below. Further consideration of these critical estimates and judgements can be found in the Audit Committee report on page 52. Goodwill Each year the Group carries out impairment tests of goodwill which require estimates to be made of the value in use of its cash generating units (‘CGUs’). These value in use calculations are dependent on estimates of future cash flows, long-term growth rates and appropriate discount rates to be applied to future cash flows of the CGUs. Further details on these estimates and sensitivities of the carrying value of goodwill to these estimates are provided in note 18. Fair value of intangible assets acquired in a business combination On the acquisition of a business, it is necessary to attribute fair values to any intangible assets acquired, provided they meet the criteria to be recognised. The fair values of these assets are dependent on estimates of attributable future revenues, margins, cash flows and appropriate discount rates to be applied to future cash flows. The Group takes advice from third parties in determining fair values and the estimated useful lives of intangible assets arising on significant acquisitions. Intangible assets are subject to impairment testing at least annually or if events or changes in circumstances indicate their carrying value may not be recoverable. Estimates of remaining useful lives of assets are also reviewed at least annually, and revised if appropriate (see note 20 for further details). 93987_p90-132.indd 96 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 97 4. Critical accounting estimates and judgements continued Development costs The majority of capitalised development costs relate to technology developed for aerospace programmes. In such cases, costs are typically not capitalised until a contract to develop the technology is awarded by a customer as, prior to this date, it is generally not possible to reliably estimate the point at which research activities conclude and development activities commence. Absent a contract, the Group also does not believe there is generally sufficient certainty over the future economic benefits that will be generated from the technology, to allow capitalisation of those costs. Post contract award, the Group will capitalise development costs provided it retains the intellectual property in the technology throughout the life of the aircraft or engine and it is probable that future economic benefits will flow to the Group. In making a judgement as to whether economic benefits will arise, the Group will make estimates of aircraft or engine volumes (taking into account the extent to which the Group has a sole-source position), aftermarket revenues which are dependent on aircraft utilisation, fleet lives and operator service routines, costs of manufacture and costs to complete the development activity. Capitalised development costs are subject to impairment testing at least annually and, where headroom is limited or if events or changes in circumstances indicate the carrying value may not be recoverable, more frequently. Estimates of remaining useful lives of assets are also reviewed at least annually, and revised if appropriate. At 31 December 2014, the programme with the largest capitalised development balance has a net book value of £44.5 million. Fleet volumes would need to reduce by approximately 60% from management estimates, without any mitigation actions taken by the Group, before any impairment would need to be recognised. Programme participation costs Approximately 80% of capitalised programme participation costs relate to free of charge or deeply discounted manufactured parts (‘FOC’), with the balance relating to cash payments. All amounts relate to aerospace programmes. FOC costs are typically incurred just prior to individual aircraft entering service and only where the Group is satisfied the incremental aftermarket revenues that will be generated over the life of the part are sufficient, will amounts be capitalised. In making this judgement, the Group makes estimates of aircraft utilisation rates and fleet lives and operator service routines. The capitalisation of cash payments is subject to similar judgements to those described in development costs above. Capitalised programme participation costs are subject to impairment testing at least annually and, where headroom is limited or if events or changes in circumstances indicate the carrying value may not be recoverable, more frequently. Estimates of remaining useful lives of assets are also reviewed at least annually, and revised if appropriate. At 31 December 2014, the programme with the largest capitalised programme participation balance has a net book value of £29.0 million. No reasonably foreseeable change in assumptions would cause an impairment to be recognised. Environmental matters The Group is involved in the investigation and remediation of certain sites for which it has been identified as a potentially responsible party under US law. Advice is received by the Group from its environmental consultants and legal advisors to assist in the determination of the timing and estimation of the costs the Group may incur in respect of such claims and appropriate provisions are made. The Group has extensive insurance arrangements in place to mitigate the impact of historical environmental events on the Group. To the extent estimates in respect of claims change as more information becomes available, adjustments are made to the carrying value of these provisions and, if the costs are determined to be covered by insurance, to the amounts recoverable from insurers. However, actual losses incurred could differ from the original estimates (see note 31 for further details). Onerous contracts The Group makes provision for any expected losses arising from onerous contracts which require estimates to be made of future contract revenues, margins, potential claims from third parties and cash flows. These estimates are dependent on a number of factors including anticipated sales volumes, future pricing, production costs and the outcome of negotiations with third parties. To the extent these estimates change as more information becomes available, adjustments are made to the carrying value of these provisions. However, actual losses incurred could differ from the original estimates (see note 31 for further details). Legal, regulatory and other similar matters The Group is subject to legal proceedings and other claims arising in the ordinary course of business. The Group is required to assess the likelihood of any adverse judgements or outcomes, as well as potential ranges of probable losses. A determination of any provisions required and any impairment of related receivables for these matters is based on a careful analysis of each individual issue with the assistance of outside legal counsel. However, actual losses incurred could differ from the original estimates (see note 31 for further details). 93987_p90-132.indd 97 04/03/2015 17:11 98 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 4. Critical accounting estimates and judgements continued Retirement benefit obligations The liability recognised in respect of retirement benefit obligations is dependent on a number of estimates including those relating to mortality, inflation, salary increases and the rate at which liabilities are discounted. External actuarial advice is taken with regard to the most appropriate assumptions to use. During 2014, a number of new mortality tables were published in the US. Advice was taken from the Group’s third party US actuary as to the most appropriate tables to use to reflect current and future improvements in life expectancy for each of the Group’s US schemes. Further details on these estimates and sensitivities of the retirement benefit obligations to these estimates are provided in note 33. Contract accounting revenue In determining amounts to be recognised as revenue under long-term contracts, the Group makes an assessment of the stage of completion of each contract and its expected profit at completion based on an estimate of total contract costs. Contract cost estimates are based on an internal evaluation taking into account the specific nature of the contract, including its level of technical risk, together with the historical accuracy of previous contract estimates. Estimates are reviewed and updated regularly throughout the life of the contract, which typically will span more than one accounting period. The total amount of revenue recognised under long-term contracts in the year is disclosed in note 5. Income taxes In determining the Group’s provisions for income tax and deferred tax, it is necessary to consider transactions in a small number of key tax jurisdictions for which the ultimate tax determination is uncertain. To the extent the final outcome differs from the tax that has been provided, adjustments will be made to income tax and deferred tax balances held in the period the determination is made. If the actual outcome of events differed by 10% from the estimates made at 31 December 2014, the impact on the tax charge would be approximately £5.0 million. Judgements also need to be made as to the extent to which deferred tax assets and liabilities can be offset against one another (see note 32 for further details). 5. Revenue The Group’s revenue is analysed as follows: Sale of goods Contract accounting revenue Revenue from services Revenue from funded research and development Total 6. Segmental analysis Analysis by operating segment 2014 £’m 1,351.7 98.3 75.0 28.7 2013 £’m 1,428.8 110.1 73.9 24.5 1,553.7 1,637.3 The Group manages its businesses under the key segments of Meggitt Aircraft Braking Systems, Meggitt Control Systems, Meggitt Polymers & Composites, Meggitt Sensing Systems and the Meggitt Equipment Group. On 7 May 2014, the Group announced that the divisional structure had been realigned to reflect the following changes: • The fire protection business has moved from Meggitt Equipment Group to Meggitt Control Systems; and • The power businesses have moved from Meggitt Equipment Group to Meggitt Sensing Systems. Prior year comparatives have been restated to reflect this new divisional structure. Details of the Group’s divisions can be found on pages 13 to 17 of the Strategic report. 93987_p90-132.indd 98 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 99 6. Segmental analysis continued Year ended 31 December 2014 The key performance measure reviewed by the CODM is underlying operating profit. A detailed reconciliation of operating profit to underlying operating profit is provided in note 10. Gross segment revenue Inter-segment revenue Meggitt Aircraft Braking Systems £’m 327.1 (0.1) Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Total £’m 349.7 (1.0) £’m 163.2 (0.9) £’m 402.4 (4.2) £’m 320.1 (2.6) £’m 1,562.5 (8.8) Revenue from external customers 327.0 348.7 162.3 398.2 317.5 1,553.7 Underlying operating profit (see note 10)* Items not affecting underlying operating profit (see note 10) 127.5 91.8 20.2 58.4 48.1 Operating profit (see note 10) Finance income (see note 12) Finance costs (see note 13) Net finance costs Profit before tax Tax (see note 14) Profit for the year Exceptional operating items (see note 11) Amortisation of intangible assets (see notes 19 and 20)** Impairment loss (see note 19) Depreciation (see note 21)*** 0.5 70.9 – 6.7 3.0 12.2 4.0 6.1 0.3 6.4 – 3.3 6.9 15.0 3.1 9.0 1.8 8.1 0.9 6.1 * Central costs are allocated using a variety of bases designed to reflect the beneficial relationship between the costs and the segments. Bases include headcount, payroll costs, gross assets and revenue. ** Of the total amortisation in the year, £44.5 million has been charged to underlying operating profit as defined in note 10. *** Of the total depreciation in the year, £31.1 million has been charged to underlying operating profit as defined in note 10. The Group’s largest customer accounts for 6.2% of revenue (£96.3 million). Revenue from this customer arises across all segments. 346.0 (109.8) 236.2 1.2 (28.5) (27.3) 208.9 (31.9) 177.0 12.5 112.6 8.0 31.2 Additions to non-current assets* Development costs (see note 19) Programme participation costs (see note 19) Other purchased intangible assets Property, plant and equipment Total Meggitt Aircraft Braking Systems £’m 30.1 40.4 0.3 6.1 76.9 Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Total £’m £’m £’m £’m £’m 16.5 5.6 1.3 4.5 27.9 4.1 – 0.5 5.9 10.5 21.7 – 1.1 9.1 31.9 5.3 – 1.0 7.7 77.7 46.0 4.2 33.3 14.0 161.2 * Relate to those non-current assets included within segmental trading assets reviewed by the CODM. 93987_p90-132.indd 99 04/03/2015 17:11 100 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 6. Segmental analysis continued As at 31 December 2014 Meggitt Aircraft Braking Systems Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Total segmental trading assets Centrally managed trading assets* Goodwill (see note 18) Other intangible assets Derivative financial instruments – non-current (see note 30) Deferred tax assets (see note 32) Derivative financial instruments – current (see note 30) Current tax recoverable Cash and cash equivalents (see note 24) Total assets Total £’m 568.3 295.0 94.0 325.2 200.6 1,483.1 181.4 1,541.1 597.4 29.6 0.9 1.1 3.3 105.5 3,943.4 * Centrally managed trading assets principally include amounts recoverable from insurers in respect of environmental issues relating to former sites, other receivables and property, plant and equipment of central companies. Year ended 31 December 2013 (Restated) The key performance measure reviewed by the CODM is underlying operating profit. A detailed reconciliation of operating profit to underlying operating profit is provided in note 10. Gross segment revenue Inter-segment revenue Revenue from external customers Meggitt Aircraft Braking Systems £’m 330.4 – 330.4 Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Total £’m 365.2 (0.9) 364.3 £’m 182.9 (1.9) 181.0 £’m 399.5 (2.0) 397.5 £’m 365.2 (1.1) £’m 1,643.2 (5.9) 364.1 1,637.3 Underlying operating profit (see note 10)* Items not affecting underlying operating profit (see note 10) 122.4 107.7 30.2 69.9 67.0 Operating profit (see note 10) Finance income (see note 12) Finance costs (see note 13) Net finance costs Profit before tax Tax (see note 14) Profit for the year Exceptional operating items (see note 11) Amortisation of intangible assets (see notes 19 and 20)** Impairment loss (see note 19) Depreciation (see note 21)*** 1.5 74.5 – 8.1 8.6 13.4 3.2 4.8 – 6.7 – 3.2 8.9 16.3 – 9.4 9.4 12.3 – 6.7 * Central costs are allocated using a variety of bases designed to reflect the beneficial relationship between the costs and the segments. Bases include headcount, payroll costs, gross assets and revenue. ** Of the total amortisation in the year, £47.5 million has been charged to underlying operating profit as defined in note 10. *** Of the total depreciation in the year, £31.4 million has been charged to underlying operating profit as defined in note 10. The Group’s largest customer accounts for 6.6% of revenue (£108.3 million). Revenue from this customer arises across all segments. 397.2 (96.9) 300.3 0.3 (31.2) (30.9) 269.4 (37.1) 232.3 28.4 123.2 3.2 32.2 93987_p90-132.indd 100 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 101 6. Segmental analysis continued Additions to non-current assets* Development costs (see note 19) Programme participation costs (see note 19) Other purchased intangible assets Property, plant and equipment Total Meggitt Aircraft Braking Systems £’m 24.8 31.5 0.4 4.0 60.7 Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Total £’m 16.8 3.2 5.1 14.4 39.5 £’m 2.5 – 0.8 2.7 6.0 £’m £’m £’m 21.4 1.0 2.3 18.6 43.3 4.7 – 0.9 10.2 15.8 70.2 35.7 9.5 49.9 165.3 * Relate to those non-current assets included within segmental trading assets reviewed by the CODM. As at 31 December 2013 (Restated) Meggitt Aircraft Braking Systems Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Total segmental trading assets Centrally managed trading assets* Goodwill (see note 18) Other intangible assets Derivative financial instruments – non-current (see note 30) Deferred tax assets (see note 32) Derivative financial instruments – current (see note 30) Current tax recoverable Cash and cash equivalents (see note 24) Total assets Total £’m 502.2 241.9 87.8 314.5 194.9 1,341.3 176.5 1,457.1 634.1 35.5 9.1 11.2 2.8 116.1 3,783.7 * Centrally managed trading assets principally include amounts recoverable from insurers in respect of environmental issues relating to former sites, other receivables and property, plant and equipment of central companies. Analysis by geography Revenue UK Rest of Europe United States of America Rest of World Total Revenue is based on the location of the customer. Non-current assets UK Rest of Europe United States of America Rest of World Total 2014 £’m 152.4 338.1 771.1 292.1 2013 £’m 165.8 365.1 811.7 294.7 1,553.7 1,637.3 2014 £’m 2013 £’m 602.0 203.6 2,235.4 9.5 714.4 215.6 1,953.0 8.0 3,050.5 2,891.0 Segmental non-current assets are based on the location of the assets. They exclude trade and other receivables, derivative financial instruments and deferred tax. 93987_p90-132.indd 101 04/03/2015 17:11 102 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 7. Auditor’s remuneration Payable to PricewaterhouseCoopers LLP and its associates: For the audit of the Company and consolidated financial statements in respect of the current year For the audit of the Company and consolidated financial statements in respect of the prior year For the audit of the accounts of any subsidiary of the Company in respect of the current year For audit related assurance services Total 8. Operating profit Operating profit is stated after charging/(crediting): Raw materials and consumables used Changes in inventories of finished goods and work in progress Employee costs (see note 9) Research and development costs* Amortisation of capitalised development costs (see note 19) Amortisation of programme participation costs (see note 19) Amortisation of other purchased intangible assets (see note 20) Amortisation of intangible assets acquired in business combinations (see note 10) Impairment loss on capitalised development costs (see note 19) Depreciation (see note 21) Loss/(gain) on disposal of property, plant and equipment Exceptional operating items (see note 11) Financial instruments (see note 10) Net foreign exchange loss Operating lease rentals Other operating income 2014 £’m 0.7 – 0.7 – 1.4 2014 £’m 423.2 (13.4) 541.8 70.6 8.8 24.9 10.8 68.1 8.0 31.2 0.4 12.5 29.2 0.6 15.3 (3.1) 2013 £’m 0.8 0.1 0.6 0.1 1.6 2013 £’m 450.6 (5.9) 566.1 64.7 13.7 25.4 9.8 74.3 3.2 32.2 (1.1) 28.4 (6.1) 2.1 14.3 (4.6) * Total research and development expenditure in the year was £148.3 million (2013: £134.9 million) of which £28.9 million (2013: £24.5 million) was charged to cost of sales, £41.7 million (2013: £40.2 million) was charged to net operating costs and £77.7 million (2013: £70.2 million) was capitalised as development costs (see note 19). 9. Employee information Employee costs including executive directors: Wages and salaries Social security costs Retirement benefit costs (see note 33) Share-based payment expense (see note 35) Total 2014 £’m 434.7 78.8 26.6 1.7 541.8 2013 £’m 441.0 79.1 34.1 11.9 566.1 Details of directors’ remuneration is provided in the Directors’ remuneration report on pages 55 to 75, which forms part of these financial statements. Average monthly number of persons employed including executive directors: Meggitt Aircraft Braking Systems Meggitt Control Systems Meggitt Polymers & Composites Meggitt Sensing Systems Meggitt Equipment Group Corporate including shared services and centres of excellence Total Prior year comparatives have been restated to reflect the new divisional structure (see note 6). 2014 Number 2013 Restated Number 1,228 1,811 1,876 3,138 1,975 657 1,191 1,804 1,979 3,078 2,402 581 10,685 11,035 93987_p90-132.indd 102 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 103 10. Reconciliations between profit and underlying profit Underlying profit is used by the Board to monitor and measure the underlying trading performance of the Group. It excludes certain items as described below: Operating profit Exceptional operating items (see note 11) Amortisation of intangible assets acquired in business combinations Disposal of inventory revalued in business combinations Financial instruments Adjustments to operating profit* Underlying operating profit Profit before tax Adjustments to operating profit per above Net interest expense on retirement benefit obligations (see note 33) Adjustments to profit before tax Underlying profit before tax Profit for the year Adjustments to profit before tax per above Tax effect of adjustments to profit before tax Adjustments to profit for the year Underlying profit for the year Note a b 2014 £’m 2013 £’m 236.2 300.3 12.5 68.1 – 29.2 109.8 346.0 28.4 74.3 0.3 (6.1) 96.9 397.2 208.9 269.4 109.8 10.0 119.8 328.7 96.9 11.5 108.4 377.8 177.0 232.3 119.8 (36.6) 83.2 260.2 108.4 (43.8) 64.6 296.9 * Of the adjustments to operating profit, £5.5 million (2013: £28.8 million) relating to exceptional operating items and £Nil (2013: £0.3 million) relating to the disposal of inventory revalued in business combinations has been charged to cost of sales, with the balance of £104.3 million (2013: £67.8 million) included within net operating costs. a. The Group excludes from its underlying profit figures the amortisation of intangible assets acquired in business combinations. Amortisation of other intangible assets (see note 20) Less amortisation of other purchased intangible assets (see note 20) Amortisation of intangible assets acquired in business combinations 2014 £’m 78.9 (10.8) 68.1 2013 £’m 84.1 (9.8) 74.3 b. Although the Group uses foreign currency forward contracts to hedge against foreign currency exposures, it has decided that the costs of meeting the extensive documentation requirements to be able to apply hedge accounting under IAS 39 ‘Financial Instruments: Recognition and Measurement’ are not merited. The Group’s underlying profit figures exclude amounts which would not have been recorded if hedge accounting had been applied. Where interest rate derivatives do not qualify to be hedge accounted, movements in the fair value of the derivatives are excluded from underlying profit. Where interest rate derivatives do qualify to be hedge accounted, any difference between the movement in the fair value of derivatives and in the fair value of fixed rate borrowings is excluded from underlying profit. Movement in the fair value of foreign currency forward contracts Impact of retranslating net foreign currency assets and liabilities at spot rate Movement in the fair value of interest rate derivatives Movement in the fair value of fixed rate borrowings Financial instruments – loss/(gain) 2014 £’m 31.1 (1.9) (4.2) 4.2 29.2 2013 £’m (12.0) 0.8 18.6 (13.5) (6.1) 93987_p90-132.indd 103 04/03/2015 17:11 104 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 11. Exceptional operating items Site consolidations Loss/(gain) on disposal or closure of businesses Raw material supply issue Costs related to acquisition and integration of businesses Other Exceptional operating items Note a b c Income statement Cash expenditure 2014 £’m 7.5 2.9 – 2.1 – 12.5 2013 £’m 8.2 (9.0) 20.0 7.9 1.3 28.4 2014 £’m 7.5 0.5 4.7 4.4 – 2013 £’m 6.4 0.5 3.1 5.0 1.2 17.1 16.2 a. This principally relates to the consolidation of the Group’s two North American sensor businesses onto a single new site in California, USA and the movement of production to the Group’s low cost manufacturing locations. b. The charge in 2014 relates to the closure of a business in the US. In the prior year, the Group disposed of the shares of Meggitt (Addison), Inc, realising a profit of £14.9 million and the shares of the Sunbank Family of Companies LLC, realising a loss of £5.9 million. Cash expenditure relates to business disposal expenses. Proceeds from the disposal of businesses are reported separately as part of cash outflow from investing activities. c. In 2013, the Group announced it had identified an issue relating to the supply from a vendor of non-conforming raw material in one of our businesses. A provision of £20.0 million was made for the estimated cost of this issue, including where necessary the replacement of the relevant parts over the next few years. No amounts were recorded in the income statement in respect of this issue in 2014. The tax credit in respect of exceptional operating items was £4.1 million (2013: £10.7 million). 12. Finance income Interest on bank deposits Unwinding of interest on other receivables Other finance income Finance income 13. Finance costs Interest on bank borrowings Interest on senior notes Interest on obligations under finance leases Unwinding of discount on provisions (see note 31) Net interest expense on retirement benefit obligations (see note 33) Amortisation of debt issue costs* Less: amounts capitalised in the cost of qualifying assets (see note 19) Finance costs 2014 £’m 0.1 0.9 0.2 1.2 2014 £’m 2.7 12.7 0.9 1.1 10.0 3.1 (2.0) 28.5 2013 £’m 0.1 – 0.2 0.3 2013 £’m 3.5 15.4 1.1 – 11.5 1.2 (1.5) 31.2 * An additional charge of £1.8 million was recorded in 2014, following the early refinancing of the Group’s committed syndicated bank facilities. 93987_p90-132.indd 104 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 105 14. Tax Current tax – current year Current tax – adjustment in respect of prior years Deferred tax – origination and reversal of temporary differences Deferred tax – effects of changes in tax rates Deferred tax – adjustment in respect of prior years Total taxation 2014 £’m 20.4 0.2 17.2 – (5.9) 31.9 2013 £’m 38.0 (6.5) 12.7 (5.4) (1.7) 37.1 The Finance Act 2013, included legislation to reduce the main rate of corporation tax in the UK from 23% to 21% with effect from 1 April 2014 and to 20% with effect from 1 April 2015. As these changes were substantively enacted during 2013, they were reflected in the tax charge for that year. Reconciliation of total tax charge A reconciliation of the notional tax charge based on average standard rates of tax (weighted in proportion to accounting profits) to the actual tax charge is as follows: Profit on ordinary activities before tax at UK corporation tax rate of 21.5%* (2013: 23.25%) Effects of: Different tax rates of subsidiaries operating in other jurisdictions Permanent differences Temporary differences Changes in statutory tax rates Tax credits and incentives Current tax – adjustment in respect of prior years Deferred tax – adjustment in respect of prior years Total taxation 2014 £’m 44.9 12.5 (16.0) (0.6) – (3.2) 0.2 (5.9) 31.9 2013 £’m 62.6 14.1 (20.1) (1.5) (5.4) (4.4) (6.5) (1.7) 37.1 * The sensitivity of the tax charge to changes in the tax rate is such that a one percentage point increase, or reduction, in the tax rate would cause the total taxation charge for 2014 to increase, or reduce respectively, by approximately £2.1 million. Tax relating to components of other comprehensive income Current tax – currency translation movements Deferred tax – currency translation movements Deferred tax – remeasurement of retirement benefit obligations Deferred tax – cash flow hedge movements Other comprehensive income Current tax Deferred tax Total Tax relating to items recognised directly in equity Current tax credit relating to share-based payment expense Deferred tax (charge)/credit relating to share-based payment expense Total After tax £’m 76.7 0.4 (73.5) (0.7) 2.9 Before tax £’m (31.9) (5.3) 46.8 1.9 11.5 Before tax £’m 77.0 0.4 (97.7) (0.8) (21.1) 2014 Tax credit/ (charge) £’m (0.3) – 24.2 0.1 24.0 (0.3) 24.3 24.0 2013 Tax credit/ (charge) £’m 0.2 0.2 (21.6) (0.3) (21.5) 0.2 (21.7) (21.5) 2014 £’m 1.2 (1.8) (0.6) After tax £’m (31.7) (5.1) 25.2 1.6 (10.0) 2014 £’m 5.3 3.3 8.6 93987_p90-132.indd 105 04/03/2015 17:11 106 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 15. Earnings per ordinary share Earnings per ordinary share (‘EPS’) is calculated by dividing the profit attributable to owners of the Company by the weighted average number of shares in issue during the year. The weighted average number of shares used excludes any shares bought by the Group and held during the year by an independently managed Employee Share Ownership Plan Trust (see note 36). The weighted average number of own shares excluded was 0.1 million shares (2013: Nil). The calculation of diluted EPS adjusts the weighted average number of shares to reflect the assumption that all potentially dilutive ordinary shares convert. For the Group this means assuming all share awards in issue are exercised. Basic EPS Potential effect of dilutive ordinary shares Diluted EPS * Profit for the year attributable to equity owners of the Company. 2014 Profit* £’m 177.0 – 177.0 2014 Shares Number ‘m 804.1 11.0 815.1 2014 EPS Pence 22.0 (0.3) 21.7 2013 Profit* £’m 2013 Shares Number ‘m 232.3 – 232.3 791.1 13.1 804.2 2013 EPS Pence 29.4 (0.5) 28.9 Underlying EPS is based on underlying profit for the year (see note 10) and the same number of shares as is used in the calculation of basic EPS. It is reconciled to basic EPS below: Basic EPS Adjust for effects of: Exceptional operating items Amortisation of intangible assets acquired in business combinations Financial instruments Net interest expense on retirement benefit obligations Underlying basic EPS 2014 Pence 22.0 1.1 5.5 2.9 0.9 32.4 2013 Pence 29.4 2.2 5.6 (0.7) 1.0 37.5 Diluted underlying EPS is based on underlying profit for the year (see note 10) and the same number of shares used in the calculation of diluted EPS. Diluted underlying EPS for the year was 31.9 pence (2013: 36.9 pence). 16. Dividends In respect of earlier years In respect of 2013: Interim of 3.95p per share Final of 8.80p per share In respect of 2014: Interim of 4.25p per share Dividends paid Less paid as scrip dividend (see note 41) Dividends paid in cash 2014 £’m – – 70.2 34.2 104.4 (53.0) 51.4 2013 £’m 64.4 31.2 – – 95.6 (20.0) 75.6 A final dividend in respect of 2014 of 9.50p per share (2013: 8.80p), amounting to an estimated total final dividend of £76.2 million (2013: £70.2 million) is to be proposed at the Annual General Meeting on 23 April 2015. This dividend is not reflected in these financial statements as it is has not been approved by the shareholders at the balance sheet date. 93987_p90-132.indd 106 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 107 17. Related party transactions Transactions between the Company and its subsidiaries have been eliminated on consolidation. The remuneration of key management personnel of the Group, which is defined for 2014 as members of the Board, the Executive Board and the Operations Board, is set out below. Prior year comparatives have not been restated to reflect changes to the definition of key management personnel during the current year: Salaries and other short-term employee benefits Retirement benefit expense Share-based payment expense Total 2014 £’m 7.3 0.3 0.6 8.2 2013 £’m 6.8 0.4 3.2 10.4 Interests of key management personnel, including executive directors, in share schemes operated by the Group at the balance sheet date are set out below: Share options Share appreciation rights – equity-settled Equity participation plan shares Meggitt Long Term Incentive Plan 2014 2014 Average exercise price Pence 393.00 359.71 – – 2014 Number outstanding ‘m 0.1 5.1 2.5 1.5 2013 Average exercise price Pence 348.66 353.23 – – 2013 Number outstanding ‘m 0.1 5.7 2.8 – Full details of all elements in the remuneration package of each director, together with directors’ share interests and share awards, are given in the Directors’ remuneration report on pages 55 to 75 which forms part of these financial statements. 18. Goodwill Cost at 1 January Exchange rate adjustments Businesses acquired (see note 42) Businesses disposed Cost at 31 December 2014 £’m 1,457.1 64.1 19.9 – 2013 £’m 1,494.2 (19.6) 9.0 (26.5) 1,541.1 1,457.1 Goodwill is tested for impairment annually or more frequently if there is any indication of impairment. No impairment charge was required in the year (2013: £Nil) and the cumulative impairment charge recognised to date is £Nil (2013: £Nil). The total amount of goodwill and other intangible assets acquired as part of the acquisition of Precision Engine Controls Corporation (see note 42) that are expected to be deductible for tax purposes will be assessed during 2015. For the purpose of impairment testing, goodwill is allocated to the Group’s cash generating units (‘CGUs’) which principally comprise its individual business operations. Goodwill is initially allocated, in the year a business is acquired, to CGUs expected to benefit from the acquisition. Subsequent adjustments are made to this allocation to the extent operations to which goodwill relates are transferred between CGUs. An analysis of goodwill by principal CGU is shown below: Meggitt Aircraft Braking Systems (‘MABS’) Meggitt (North Hollywood), Inc. Meggitt Safety Systems, Inc./Pacific Scientific HTL Meggitt Sensing Systems (‘MSS’)* Meggitt (Rockmart), Inc. Meggitt Training Systems, Inc. Other Total 2014 £’m 699.9 188.0 137.7 81.9 72.8 66.8 294.0 2013 £’m 665.3 177.2 129.6 82.9 68.6 62.9 270.6 1,541.1 1,457.1 * During 2014, the Group announced the divisional structure had been realigned and the power businesses have moved from Meggitt Equipment Group to Meggitt Sensing Systems (see note 6). For the purpose of impairment testing, the power businesses currently continue to be considered as individual CGUs, and are excluded from the MSS CGU shown above. 93987_p90-132.indd 107 04/03/2015 17:11 108 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 18. Goodwill continued For each CGU, the Group has determined its recoverable amount from value in use calculations. The value in use calculations are based on cash flow forecasts derived from the most recent budgets and plans for the next five years, as approved by management in December 2014. Cash flows for periods beyond five years are extrapolated using estimated growth rates. The resultant cash flows are discounted using a pre-tax discount rate appropriate for the relevant CGU. The key assumptions for the value in use calculations are shown below: • Sales volumes, selling prices and cost increases over the five years covered by management’s detailed plans. Sales volumes are based on industry forecasts and management estimates for the businesses in which each CGU operates including forecasts for OEM deliveries of large jets, regional aircraft and business jets, air traffic growth and military spending by the US DoD and other major governments. Selling prices and cost increases are based on past experience and management expectations of future changes in the market. Overall a cautious approach to volume levels, selling prices and cost increases has been taken given the continued global economic uncertainty. The extent to which these assumptions affect each principal CGU with a significant level of goodwill are described below. MABS, Meggitt (North Hollywood), Inc., Meggitt Safety Systems, Inc./Pacific Scientific HTL and MSS are broadly spread across both civil aerospace and military platforms with Meggitt (North Hollywood), Inc. and MSS also operating in the energy sector. MABS is a leading supplier of wheels, brakes and brake control systems, particularly for regional aircraft, business jets and military aircraft. Meggitt (North Hollywood), Inc. designs and manufactures fluid control devices and systems for most aircraft types and has a higher content on large jets. Meggitt Safety Systems, Inc./ Pacific Scientific HTL designs and manufactures fire protection and control systems for large, regional, business and military aircraft. MSS is a leading provider of high-performance sensing and condition-monitoring solutions for high-value rotating machinery and other assets and, within the aerospace sector, has a higher content on large jets. All four CGUs have significant OEM and aftermarket revenue derived from sole-source positions with the aftermarket, where platform lives can be up to thirty years for civil aircraft and longer for military, representing the greater proportion of revenue except for MSS which has a higher OEM content. Meggitt (Rockmart), Inc. and Meggitt Training Systems, Inc. both operate mainly in military markets. The principal customer of Meggitt (Rockmart), Inc. is the US DoD to whom Meggitt (Rockmart), Inc. are a leading supplier of flexible fuel tanks. Meggitt Training Systems, Inc. supplies integrated live and virtual training packages for armed forces and law enforcement agencies across the world. In civil aerospace, capacity measured in available seat kilometres (ASKs) is forecast to grow in line with the long-term trend rate of 5% which, together with the Group’s growing fleet and price increases, should drive an increase in aftermarket revenue of 8 to 9% per annum over the medium term. The Group’s continuing confidence in air passenger traffic growth is supported by the sustained high levels of order intake at Boeing and Airbus. Large jet deliveries increased by 8% in 2014, and the Group expects good delivery growth over the next five years underpinned by continued strong order intake and a backlog at Boeing and Airbus which equates to over seven years of deliveries at the current production rate. Deliveries of regional aircraft increased by 2% in 2014, with modest growth anticipated over the next five years, driven principally by demand for 70-90 seat aircraft, on which the Group has a strong shipset content. Total business jet deliveries increased by 6% in 2014 but deliveries of super-midsize and long-range aircraft, where the Group benefits from particularly strong market positions, grew more strongly. Further growth is anticipated in this market over the next five years, driven by increasing internationalisation of the customer base and the ongoing improvement in the US economy. Military markets look to be entering a more benign phase, with lower rates of decline than have been seen in recent years and even some suggestion of growth in the all important US budget from 2016. The threat of sequestration remains, although the likelihood, timing and impact are unknown at this stage. However, the Group has key positions on future growth platforms and, in the absence of any clarity on if or where sequestration cuts will ultimately fall, continues to anticipate average compound organic military growth of around 2% per annum in the medium term. • Growth rates used for periods beyond those covered by management’s detailed budgets and plans. Growth rates are derived from management’s estimates which take into account the long-term nature of the industry in which each CGU operates, external industry forecasts of long-term growth in the aerospace and defence sectors, the extent to which a CGU has sole-source position on platforms where it is able to share in a continuing stream of highly profitable aftermarket revenues, the maturity of the platforms supplied by the CGU and the technological content of the CGU’s products. For the purpose of impairment testing, a conservative approach has been used and where the derived rate is higher than the long-term GDP growth rates for the countries in which the CGU operates (UK: 2.3% (2013: 2.4%), US: 2.4% (2013: 2.4%)), the latter has been used. • Discount rates applied to future cash flows. The Group’s pre-tax weighted average cost of capital (WACC) was used as the foundation for determining the discount rates to be applied. The WACC was then adjusted to reflect risks specific to the CGU not already reflected in the future cash flows for that CGU. The discount rates used were as follows: MABS 10.2% (2013: 10.3%), Meggitt (North Hollywood), Inc., 10.9% (2013: 11.0%), Meggitt Safety Systems, Inc./Pacific Scientific HTL 10.9% (2013: 10.8%), MSS 10.1% (2013: 9.7%), Meggitt (Rockmart), Inc. 10.4% (2013: 10.7%), and Meggitt Training Systems, Inc. 9.8% (2013: 10.9%). The discount rates used for ‘Other’ CGUs ranged between 8.3% to 11.0% (2013: 9.3% to 10.9%). A sensitivity analysis was carried out for each CGU to determine the extent to which its assumptions would need to change for the calculated recoverable amounts from value in use, to fall below the carrying value of goodwill of the CGU. Management has concluded that no reasonably foreseeable change in the key assumptions used in the impairment model would result in a significant impairment charge being recorded in the financial statements. The CGU with the least headroom in percentage terms is MSS followed by MABS. ‘Other’ goodwill of £294.0 million (2013: £270.6 million) relates to approximately 10 individual CGUs, all of which have headroom in percentage terms greater than that of MABS and MSS. To require an impairment in the Group financial statements, one of the following would be required: Reduction in estimates of cash flows (more than) Reduction of long-term growth rates (more than) Increase in the discount rate applied to future cash flows (more than) Headroom MABS MSS 18% 62% 14% £313.6m 14% 100% 14% £53.4m 93987_p90-132.indd 108 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 109 19. Development costs and programme participation costs At 1 January 2013 Cost Accumulated amortisation Net book amount Year ended 31 December 2013 Opening net book amount Exchange rate adjustments Additions – Internal development costs – Free of charge/deeply discounted manufactured parts – Cash payments Disposals Interest capitalised Impairment loss Amortisation* Net book amount At 31 December 2013 Cost Accumulated amortisation Net book amount Year ended 31 December 2014 Opening net book amount Exchange rate adjustments Additions – Internal development costs – Free of charge/deeply discounted manufactured parts – Cash payments Interest capitalised Impairment loss Amortisation* Net book amount At 31 December 2014 Cost Accumulated amortisation Net book amount Development costs £’m 276.0 (54.5) 221.5 221.5 (3.8) 70.2 – – (2.0) 1.5 (3.2) (13.7) 270.5 340.7 (70.2) 270.5 270.5 9.5 77.7 – – 2.0 (8.0) (8.8) Programme participation costs £’m 326.9 (123.3) 203.6 203.6 (3.3) – 30.4 5.3 – – – (25.4) 210.6 356.0 (145.4) 210.6 210.6 10.7 – 43.3 2.7 – – (24.9) 342.9 242.4 431.2 (88.3) 419.2 (176.8) 342.9 242.4 * Charged to net operating costs in respect of development costs and to cost of sales in respect of programme participation costs. Interest has been capitalised using the average rate payable on the Group’s floating rate borrowings of 1.5% (2013: 1.6%). The net book amount of development costs includes £125.5 million (2013: £91.1 million) in respect of Meggitt Aircraft Braking Systems which have an estimated weighted average remaining life of 14.2 years (2013: 9.1 years). The net book amount of programme participation costs includes £228.6 million (2013: £202.7 million) in respect of Meggitt Aircraft Braking Systems which have an estimated weighted average remaining life of 9.0 years (2013: 8.4 years). 93987_p90-132.indd 109 04/03/2015 17:11 110 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 20. Other intangible assets At 1 January 2013 Cost Accumulated amortisation Net book amount Year ended 31 December 2013 Opening net book amount Exchange rate adjustments Business acquired Businesses disposed Additions Amortisation – net operating costs (see note 10) Net book amount At 31 December 2013 Cost Accumulated amortisation Net book amount Year ended 31 December 2014 Opening net book amount Exchange rate adjustments Businesses acquired (see note 42) Additions Amortisation – net operating costs (see note 10) Net book amount At 31 December 2014 Cost Accumulated amortisation Net book amount Customer relationships Technology Order backlogs (*) £’m (*) £’m (*) £’m Trade names and trademarks (*) £’m Other purchased (**) £’m Total £’m 832.1 (279.8) 552.3 552.3 (5.8) 10.0 (9.5) – (54.7) 492.3 807.9 (315.6) 492.3 492.3 22.0 1.7 – (50.7) 240.5 (93.9) 146.6 146.6 (1.4) 5.6 (1.1) – (17.0) 132.7 238.8 (106.1) 132.7 132.7 5.3 – – (15.3) 465.3 122.7 848.5 (383.2) 249.6 (126.9) 465.3 122.7 11.2 (10.9) 0.3 0.3 – 0.1 – – (0.3) 0.1 10.9 (10.8) 0.1 0.1 – – – (0.1) – – – – 29.9 (18.2) 11.7 11.7 – – (0.6) – (2.3) 8.8 27.9 (19.1) 8.8 8.8 0.4 – – (2.0) 7.2 98.4 (30.4) 68.0 1,212.1 (433.2) 778.9 68.0 (0.4) 0.1 – 15.5 (9.8) 73.4 778.9 (7.6) 15.8 (11.2) 15.5 (84.1) 707.3 110.8 (37.4) 73.4 1,196.3 (489.0) 707.3 73.4 0.9 2.3 12.0 (10.8) 77.8 707.3 28.6 4.0 12.0 (78.9) 673.0 29.0 (21.8) 7.2 126.4 (48.6) 77.8 1,253.5 (580.5) 673.0 * Acquired in business combinations. Amortisation of these items is excluded from the Group’s underlying profit figures (see note 10). ** Principally relates to software costs. Amortisation of £Nil (2013: £1.4 million) has been charged to exceptional operating items and is excluded from the Group’s underlying profit figures (see note 10). During 2014, cost and accumulated amortisation relating to completed order backlogs were eliminated. The net book amount of customer relationships includes £332.1 million (2013: £350.2 million) in respect of Meggitt Aircraft Braking Systems and £55.7 million (2013: £59.8 million) in respect of Meggitt Sensing Systems which have an estimated weighted average remaining life of 9.0 years (2013: 10.0 years) and 10.2 years (2013: 11.2 years) respectively. The net book amount of technology includes £66.4 million (2013: £70.2 million) in respect of Meggitt Aircraft Braking Systems and £19.4 million (2013: £22.0 million) in respect of Meggitt Sensing Systems which have an estimated weighted average remaining life of 9.0 years (2013: 10.0 years) and 6.9 years (2013: 7.9 years) respectively. Meggitt Sensing Systems comparatives for 2013 have been restated to reflect the impact of the change in divisional structure described in note 6. 93987_p90-132.indd 110 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 111 21. Property, plant and equipment At 1 January 2013 Cost Accumulated depreciation Net book amount Year ended 31 December 2013 Opening net book amount Exchange rate adjustments Business acquired Businesses disposed Additions Disposals Depreciation* Net book amount At 31 December 2013 Cost Accumulated depreciation Net book amount Year ended 31 December 2014 Opening net book amount Exchange rate adjustments Businesses acquired (see note 42) Additions Disposals Reclassification Depreciation* Net book amount At 31 December 2014 Cost Accumulated depreciation Net book amount Land and buildings £’m 169.2 (55.0) 114.2 114.2 (0.8) – (0.1) 21.9 (0.1) (6.5) 128.6 185.9 (57.3) 128.6 128.6 1.3 0.1 3.6 (1.8) (2.4) (6.3) Plant, equipment and vehicles £’m 380.7 (262.7) 118.0 118.0 (1.1) 0.7 (4.0) 29.6 (0.6) (25.7) 116.9 Total £’m 549.9 (317.7) 232.2 232.2 (1.9) 0.7 (4.1) 51.5 (0.7) (32.2) 245.5 385.0 (268.1) 116.9 570.9 (325.4) 245.5 116.9 2.7 0.5 31.6 (1.2) 2.4 (24.9) 245.5 4.0 0.6 35.2 (3.0) – (31.2) 123.1 128.0 251.1 179.6 (56.5) 123.1 413.8 (285.8) 128.0 593.4 (342.3) 251.1 * Depreciation of £0.1 million (2013: £0.8 million) has been charged to exceptional operating items and is excluded from the Group’s underlying profit figures (see note 10). The Group’s obligations under finance leases (see note 27) are secured by the lessors’ title to the leased assets, which have a carrying amount of £4.4 million included within land and buildings (2013: £4.4 million) and £0.1 million (2013: £0.2 million) included within plant, equipment and vehicles. 22. Inventories Contract costs incurred Less progress billings Net contract costs Raw materials and bought-in components Manufacturing work in progress Finished goods and goods for resale Total 2014 £’m 9.3 – 9.3 121.1 141.0 55.8 327.2 2013 £’m 10.8 (3.0) 7.8 115.1 127.9 48.4 299.2 The cost of inventories recognised as an expense and included in cost of sales was £897.6 million (2013: £923.7 million). The cost of inventories recognised as an expense includes £6.4 million (2013: £2.3 million) in respect of write-downs of inventory to net realisable value, and has been reduced by £3.0 million (2013: £7.4 million) in respect of the reversal of write-downs made in previous years. 93987_p90-132.indd 111 04/03/2015 17:11 112 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 23. Trade and other receivables Trade receivables Amounts recoverable on contracts Prepayments and accrued income Other receivables Total Less non-current portion: Other receivables Non-current portion Current portion 2014 £’m 232.3 55.1 14.5 123.4 425.3 93.4 93.4 2013 £’m 244.6 35.9 12.2 126.1 418.8 89.9 89.9 331.9 328.9 Other receivables includes £95.5 million (2013: £95.9 million) in respect of insurance receivables arising on environmental issues relating to businesses sold by Whittaker Corporation prior to its acquisition by the Group (see note 31) of which £11.1 million (2013: £10.5 million) is shown as current. Trade receivables are stated after a provision for impairment of £3.7 million (2013: £4.1 million). Other balances within trade and other receivables do not contain impaired assets. The provision for impairment against trade receivables is based on a specific risk assessment taking into account past default experience and is analysed as follows: At 1 January Exchange rate adjustments Businesses disposed Credit to income statement – net operating costs At 31 December 2014 £’m 4.1 0.1 – (0.5) 3.7 2013 £’m 6.6 0.1 (0.5) (2.1) 4.1 At 31 December 2014, trade receivables and amounts recoverable on contracts of £67.5 million (2013: £61.8 million) were past due but not impaired. These relate to a number of independent customers for whom there is no recent history of default. The ageing analysis of these trade and other receivables is as follows: Up to 3 months overdue Over 3 months overdue Total 2014 £’m 41.5 26.0 67.5 2013 £’m 53.2 8.6 61.8 The maximum exposure to credit risk at the balance sheet date is the fair value of each class of receivable reported above. The Group does not hold any collateral as security. Trade and other receivables are denominated in the following currencies: Sterling US dollar Euro Other Total 2014 £’m 87.9 295.9 28.6 12.9 425.3 2013 £’m 79.2 289.3 41.7 8.6 418.8 93987_p90-132.indd 112 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 113 24. Cash and cash equivalents Cash at bank and on hand Short-term bank deposits Total Cash and cash equivalents are subject to interest at floating rates. The credit quality of cash and cash equivalents is as follows: S&P/Moody’s rating: AAA AA A BBB Total 25. Trade and other payables – current Payments received on account Trade payables Social security and other taxes Accrued expenses Share buyback - close period commitment Other payables Total 26. Trade and other payables – non-current Deferred consideration relating to acquired businesses Other payables Total 27. Obligations under finance leases Amounts payable under finance leases: In one year or less In more than one year but not more than five years In more than five years Total Less: future finance charges Present value of lease obligations Less non-current portion Current portion 2014 £’m 95.4 10.1 105.5 2014 £’m 0.3 25.5 77.4 2.3 2013 £’m 101.0 15.1 116.1 2013 £’m 0.7 29.0 81.7 4.7 105.5 116.1 2014 £’m 31.5 127.3 8.4 52.6 20.0 118.7 358.5 2014 £’m 3.0 2.9 5.9 2013 £’m 42.2 128.2 12.5 47.8 – 98.4 329.1 2013 £’m 2.9 2.3 5.2 2013 £’m 2.4 1.3 3.8 7.5 Minimum lease payments Present value of minimum lease payments 2014 £’m 0.1 0.2 5.1 5.4 2014 £’m 1.1 4.0 12.4 2013 £’m 3.4 3.8 12.7 17.5 (12.1) 19.9 (12.4) 5.4 5.3 0.1 7.5 5.1 2.4 Obligations under finance leases are principally US dollar denominated. The weighted average period to maturity is 15.4 years (2013: 11.0 years) and the weighted average interest rate is 18.0% (2013: 13.9%). 93987_p90-132.indd 113 04/03/2015 17:11 114 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 28. Bank and other borrowings Current Bank loans Other loans Total current Non-current Bank loans Other loans Total non-current Total Analysis of bank and other borrowings repayable: In one year or less In more than one year but not more than five years In more than five years Total Analysis of bank and other borrowings: Drawn under committed facilities Less unamortised debt issue costs Fair value adjustment to fixed rate borrowings Drawn under uncommitted facilities Interest accruals Total 2014 £’m 10.8 48.1 58.9 212.6 404.1 616.7 2013 £’m 3.9 3.3 7.2 245.8 420.2 666.0 675.6 673.2 58.9 344.4 272.3 675.6 644.9 (3.6) 19.5 11.6 3.2 675.6 7.2 413.7 252.3 673.2 653.2 (3.9) 15.3 5.6 3.0 673.2 Debt issue costs are amortised over the period of the facility to which they relate. The Group has no secured borrowings (2013: £Nil). The Group has the following committed facilities: Senior notes (USD 70.0 million) Senior notes (USD 600.0 million) Syndicated credit facility (USD 700.0 million) Syndicated credit facility (USD 400.0 million) Syndicated credit facility (USD 900.0 million) 2014 Drawn £’m Undrawn £’m 44.9 384.8 – – 215.2 – – – – 362.0 Total £’m 44.9 384.8 – – 577.2 Total 644.9 362.0 1,006.9 Drawn £’m 42.3 362.3 186.4 62.2 – 653.2 2013 Undrawn £’m – – 236.1 179.3 – 415.4 Total £’m 42.3 362.3 422.5 241.5 – 1,068.6 The Group issued USD 70.0 million of loan notes to private placement investors in 2003. The notes carry an interest rate of 5.46% and are due for repayment in 2015. The Group issued USD 600.0 million of loan notes to private placement investors in 2010. The notes are in four tranches as follows: USD 200.0 million carry an interest rate of 4.62% and are due for repayment in 2017, USD 125.0 million carry an interest rate of 5.02% and are due for repayment in 2020, USD 150.0 million carry an interest rate of 5.17% and are also due for repayment in 2020 and USD 125.0 million carry an interest rate of 5.12% and are due for repayment in 2022. During 2014, the Group secured a new five year USD 900.0 million syndicated revolving credit facility which matures in 2019 to replace the existing USD 700.0 million and USD 400.0 million syndicated revolving credit facilities which were due to mature in 2016 and 2017 respectively. The new facility includes one-year extension options at the end of the first and second years. At 31 December 2014, the amounts drawn under revolving credit facilities were £215.2 million (2013: £248.6 million) represented by borrowings denominated in US dollars of £142.5 million (2013: £97.0 million), in Euros of £50.4 million (2013: £62.3 million), in Swiss francs of £10.3 million (2013: £78.3 million) and in Sterling of £12.0 million (2013: £11.0 million). Borrowings under the facilities are subject to interest at floating rates. 93987_p90-132.indd 114 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 115 28. Bank and other borrowings continued The committed facilities available at each balance sheet date expire as follows: 2014 Drawn £’m Undrawn £’m In one year or less In more than one year but not more than five years In more than five years Total 44.9 343.5 256.5 644.9 The Group also has various uncommitted facilities with its relationship banks. The fair value of bank and other borrowings is as follows: Current Non-current Total Total £’m 44.9 705.5 256.5 – 362.0 – 362.0 1,006.9 Drawn £’m – 411.7 241.5 653.2 2013 Undrawn £’m – 415.4 – 415.4 Total £’m – 827.1 241.5 1,068.6 2014 2013 Book value £’m 58.9 616.7 675.6 Fair value £’m 61.6 625.7 687.3 Book value £’m 7.2 666.0 673.2 Fair value £’m 7.2 676.3 683.5 After taking account of financial derivatives that alter the interest basis of the financial liabilities entered into by the Group, the interest rate exposure on gross bank and other borrowings is: As at 31 December 2014: US dollar Swiss franc Euro Sterling Gross bank and other borrowings Less unamortised debt issue costs Bank and other borrowings As at 31 December 2013: US dollar Swiss franc Euro Sterling Gross bank and other borrowings Less unamortised debt issue costs Bank and other borrowings Fixed rate borrowings Weighted average interest rate % 3.7 Weighted average period for which rate is fixed Years 3.3 Fixed rate borrowings Weighted average interest rate % 4.2 0.7 Weighted average period for which rate is fixed Years 4.3 3.1 Floating Fixed £’m 317.6 14.8 50.4 18.1 400.9 (2.8) £’m 277.4 – – – 277.4 (0.8) 398.1 276.6 Non-interest bearing £’m – – 0.9 – 0.9 – 0.9 Floating Fixed £’m 262.7 79.6 62.3 11.0 415.6 (3.2) 412.4 £’m 259.6 – 0.3 – 259.9 (0.7) 259.2 Non-interest bearing £’m – – 1.6 – 1.6 – 1.6 Total £’m 595.0 14.8 51.3 18.1 679.2 (3.6) 675.6 Total £’m 522.3 79.6 64.2 11.0 677.1 (3.9) 673.2 The weighted average interest rate reflects the relative impact of interest rates based on both principal amounts and duration of borrowings. The weighted average period to maturity for non-interest bearing borrowings is 4.4 years (2013: 3.5 years). 93987_p90-132.indd 115 04/03/2015 17:11 116 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 29. Financial instruments As at 31 December 2014: Non-current: Trade and other receivables (see note 23) Derivative financial instruments (see note 30) Current: Trade and other receivables* Derivative financial instruments (see note 30) Cash and cash equivalents (see note 24) Financial assets Current: Trade and other payables** Derivative financial instruments (see note 30) Obligations under finance leases (see note 27) Bank and other borrowings (see note 28) Non-current: Trade and other payables (see note 26) Derivative financial instruments (see note 30) Obligations under finance leases (see note 27) Bank and other borrowings (see note 28) Financial liabilities Total As at 31 December 2013: Non-current: Trade and other receivables (see note 23) Derivative financial instruments (see note 30) Current: Trade and other receivables* Derivative financial instruments (see note 30) Cash and cash equivalents (see note 24) Financial assets Current: Trade and other payables** Derivative financial instruments (see note 30) Obligations under finance leases (see note 27) Bank and other borrowings (see note 28) Non-current: Trade and other payables (see note 26) Derivative financial instruments (see note 30) Obligations under finance leases (see note 27) Bank and other borrowings (see note 28) Financial liabilities Total Held at fair value Held at amortised cost Through profit & loss £’m Derivatives used for hedging £’m Loans & receivables Liabilities £’m £’m – 28.3 – 1.1 – 29.4 – (9.6) – – – (2.9) – (276.9) (289.4) – 1.3 – – – 1.3 – – – – – – – – – 93.4 – 317.4 – 105.5 516.3 – – – – – – – – – – – – – – – (350.1) – (0.1) (58.9) (5.9) – (5.3) (339.8) Total book value £’m 93.4 29.6 317.4 1.1 105.5 547.0 (350.1) (9.6) (0.1) (58.9) (5.9) (2.9) (5.3) (616.7) Total fair value £’m 93.4 29.6 317.4 1.1 105.5 547.0 (350.1) (9.6) (0.1) (61.6) (5.9) (2.9) (5.3) (625.7) (760.1) (1,049.5) (1,061.2) (260.0) 1.3 516.3 (760.1) (502.5) (514.2) Held at fair value Held at amortised cost Through profit & loss £’m Derivatives used for hedging £’m Loans & receivables Liabilities £’m £’m – 33.4 – 11.2 – 44.6 – (0.7) – – – (0.1) – (256.8) (257.6) (213.0) – 2.1 – – – 2.1 – – – – – – – – – 89.9 – 316.7 – 116.1 522.7 – – – – – – – – – 2.1 522.7 – – – – – – (316.6) – (2.4) (7.2) (5.2) – (5.1) (409.2) (745.7) (745.7) Total book value £’m 89.9 35.5 316.7 11.2 116.1 569.4 (316.6) (0.7) (2.4) (7.2) (5.2) (0.1) (5.1) (666.0) Total fair value £’m 89.9 35.5 316.7 11.2 116.1 569.4 (316.6) (0.7) (2.4) (7.2) (5.2) (0.1) (5.1) (676.3) (1,003.3) (1,013.6) (433.9) (444.2) * Excludes prepayments and accrued income of £14.5 million (2013: £12.2 million) (see note 23). ** Excludes social security and other taxes of £8.4 million (2013: £12.5 million) (see note 25). 93987_p90-132.indd 116 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 117 29. Financial instruments continued Fair value measurement and hierarchy For trade and other receivables, cash and cash equivalents, trade and other payables, obligations under finance leases and the current element of floating rate bank and other borrowings, fair values approximate to book values due to the short maturity periods of these financial instruments. For trade and other receivables, allowances are made within book value for credit risk. Derivative financial instruments measured at fair value, are classified as level 2 in the fair value measurement hierarchy, as they have been determined using significant inputs based on observable market data. The fair values of foreign currency forward contracts have been derived from forward exchange rates observable at the balance sheet date together with the contractual forward rates. The fair values of interest rate derivatives have been derived from forward interest rates based on yield curves observable at the balance sheet date together with the contractual interest rates. The non-current portion of bank and other borrowings measured at fair value, is classified as level 3 in the fair value measurement hierarchy, as it has been determined using significant inputs which are a mixture of those based on observable market data (interest rate risk) and those not based on observable market data (credit risk). The fair value attributable to interest rate risk has been derived from forward interest rates based on yield curves observable at the balance sheet date together with the contractual interest rates and with the credit risk margin kept constant. The fair value attributable to credit risk has been derived from quotes from lenders for borrowings of similar amounts and maturity periods. The same methods of valuation have been used to derive the fair value of the current element of fixed rate bank and other borrowings and the non-current element of bank and other borrowings which are held at amortised cost, but for which fair values are provided in the table above. There were no transfers of assets or liabilities between levels of the fair value hierarchy during the year. Financial liabilities designated as fair value through profit or loss Cumulative unrealised changes in the fair value of the non-current portion of bank and other borrowings arising from changes in credit risk are as follows: Fair value at 1 January Credited/(charged) to net operating costs Fair value at 31 December 2014 £’m 7.0 0.7 7.7 2013 £’m 10.0 (3.0) 7.0 The difference between the fair value and contractual amount at maturity of the non-current portion of bank and other borrowings is as follows: Fair value Difference between fair value and contractual amount at maturity Contractual amount payable at maturity Financial liabilities classified as level 3 in the hierarchy Changes in fair value are as follows: Bank and other borrowings at fair value through profit or loss: At 1 January Exchange rate adjustments Loss/(gain) recognised in net operating costs At 31 December 2014 £’m 276.9 (19.5) 257.4 2013 £’m 256.8 (15.3) 241.5 2014 £’m 256.8 16.1 4.0 276.9 2013 £’m 274.9 (4.4) (13.7) 256.8 The largest movement in credit spread seen in a six month period since inception of the borrowings is 70 basis points. A 70 basis point movement in the credit spread used as an input in determining the fair value at 31 December 2014, would impact profit before tax by approximately £9.0 million. 93987_p90-132.indd 117 04/03/2015 17:11 118 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 30. Derivative financial instruments As at 31 December 2014: Interest rate swaps – cash flow hedges Interest rate swaps – fair value hedges Foreign currency forward contracts – not hedge accounted Total Less non-current portion: Interest rate swaps – cash flow hedges Interest rate swaps – fair value hedges Foreign currency forward contracts – not hedge accounted Non-current portion Current portion As at 31 December 2013: Interest rate swaps – cash flow hedges Interest rate swaps – fair value hedges Foreign currency forward contracts – not hedge accounted Total Less non-current portion: Interest rate swaps – cash flow hedges Interest rate swaps – fair value hedges Foreign currency forward contracts – not hedge accounted Non-current portion Current portion Interest rate swaps Contract or underlying principal amount Fair value Assets £’m Liabilities £’m Assets £’m Liabilities £’m 102.6 256.5 134.3 493.4 102.6 256.5 72.0 431.1 – – (284.3) (284.3) – – (131.2) (131.2) 62.3 (153.1) 1.3 27.0 2.4 30.7 1.3 27.0 1.3 29.6 1.1 – – (12.5) (12.5) – – (2.9) (2.9) (9.6) Contract or underlying principal amount Fair value Assets £’m 96.6 241.5 344.5 682.6 96.6 241.5 170.6 508.7 173.9 Liabilities £’m Assets £’m Liabilities £’m – – (12.4) (12.4) – – (1.6) (1.6) (10.8) 2.1 22.8 21.8 46.7 2.1 22.8 10.6 35.5 11.2 – – (0.8) (0.8) – – (0.1) (0.1) (0.7) The total notional principal amount of outstanding interest rate swap contracts at 31 December 2014 is £359.1 million (2013: £338.1 million), of which £64.1 million will expire in 2017, £102.6 million will expire in 2018, £112.2 million will expire in 2020 and £80.2 million will expire in 2022. The contracts are all denominated in USD. Of the notional principal amount outstanding, £102.6 million (2013: £96.6 million) has the economic effect of converting floating rate US dollar borrowings into fixed rate US dollar borrowings and £256.5 million (2013: £241.5 million) has the economic effect of converting fixed rate US dollar borrowings into floating rate US dollar borrowings. To the extent they meet the criteria for hedge accounting, the floating rate to fixed rate swap contracts are accounted for as cash flow hedges and the fixed rate to floating rate swap contracts as fair value hedges. Foreign currency forward contracts Although the Group uses foreign currency forward contracts to hedge against foreign currency exposures, it has decided that the costs of meeting the extensive documentation requirements to be able to apply hedge accounting under IAS 39 ‘Financial Instruments: Recognition and Measurement’ are not merited. Fair value: US dollar forward sales (USD/£) Forward sales denominated in other currencies Total 2014 Assets £’m 2014 Liabilities £’m 2013 Assets £’m 2013 Liabilities £’m 2.3 0.1 2.4 (3.8) (8.7) (12.5) 17.4 4.4 21.8 – (0.8) (0.8) 93987_p90-132.indd 118 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 119 30. Derivative financial instruments continued Credit quality of derivative financial assets The credit quality of derivative financial assets is as follows: S&P/Moody’s rating: AA A BBB Total 31. Provisions At 1 January 2014 Exchange rate adjustments Business acquired (see note 42) Additional provision in year – cost of sales Additional provision in year – net operating costs Unused amounts reversed – cost of sales Unused amounts reversed – net operating costs Charge to income statement – net finance costs (see note 13) Utilised At 31 December 2014 Current Non-current At 31 December 2014 Environmental (a) £’m 120.4 7.6 – – 25.2 – (8.6) 1.1 (12.7) 133.0 Onerous contracts (b) £’m Warranty costs (c) £’m 40.2 0.8 – 2.5 – (7.5) (4.0) – (9.7) 22.3 12.6 0.3 0.1 8.1 – (0.2) – – (7.9) 13.0 2014 £’m 4.0 26.7 – 30.7 Other (d) £’m 20.3 0.4 – – 3.6 (2.4) (9.9) – (4.7) 7.3 2014 £’m 45.1 130.5 175.6 2013 £’m 7.2 33.8 5.7 46.7 Total £’m 193.5 9.1 0.1 10.6 28.8 (10.1) (22.5) 1.1 (35.0) 175.6 2013 £’m 44.3 149.2 193.5 a. Provision has been made for known exposures arising from environmental remediation in a number of businesses. The Group’s operations and facilities are subject to laws and regulations that govern the discharge of pollutants and hazardous substances into the ground, air and water as well as the handling, storage and disposal of such materials and other environmental matters. Failure to comply with its obligations potentially exposes the Group to serious consequences, including fines, other sanctions and limitations on operations. The Group is involved in the investigation and remediation of current and former sites for which it has been identified as a potentially responsible party under US law. Provision has been made for the expected costs arising from these sites based on information currently available. The provisions are expected to be substantially utilised over the next fifteen years and are discounted, where appropriate, using an appropriate discount rate. A receivable has been established to the extent these costs are recoverable under the Group’s environmental insurance policies or from other parties (see note 23). The net charge to net operating costs of £16.6 million was partly offset by a credit to net operating costs of £9.7 million, recognised in respect of an increase in the year in amounts recoverable under these insurance policies and from other parties. b. Onerous contracts include lease obligations and trading contracts. Provision has been made for the estimated rental shortfall in respect of properties with onerous lease obligations. These will be utilised over the lease terms typically up to five years and are discounted, where appropriate, using a discount rate appropriate to each provision. Provision has also been made for estimated losses under certain trading contracts. As described in note 11, during 2013 the Group was made aware of an issue relating to the supply from a vendor of non-conforming raw material in one of our businesses. Provision has been made for the estimated future costs associated with this matter, which include the provision of a number of free of charge replacement parts to customers over a period of several years. There are a number of uncertainties regarding the ultimate amounts that will be payable, including the extent to which replacement parts will be required. However, the directors believe, based on the information currently available, that the ultimate outcome will not be significantly different from that recognised. Onerous trading contract provisions are expected to be substantially utilised over the next ten years and are discounted, where appropriate, using a discount rate appropriate to each provision. c. Provision has been made for product warranty claims. These provisions are expected to be utilised over the next three years. d. A number of asbestos-related claims have been made against subsidiary companies of the Group. To date, the amount connected with such claims in any year has not been material and many claims are covered fully or partly by existing insurance and indemnities. There is a provision for claims which cannot be recovered from insurers. During 2013, an administrative settlement was reached with the US Government following its investigation of alleged violations of US export control laws by certain subsidiaries of the Group. Under the terms of the 30-month consent agreement, Meggitt-USA, Inc. was assessed a civil penalty of USD 25 million, of which USD 22 million was suspended on condition the Government approves certain past or future remedial costs incurred or to be incurred by the Group’s US subsidiaries. In addition, the Group is required to implement additional future compliance measures. No provision is held for the suspended penalty as it is not considered probable that such amounts will be payable. The provisions are expected to be substantially utilised over the next ten years and are discounted, where appropriate, using a discount rate appropriate to each provision. 93987_p90-132.indd 119 04/03/2015 17:11 120 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 32. Deferred tax Movements in deferred tax assets and liabilities during the year, without taking into consideration the offsetting of balances, are as follows: Deferred tax assets At 1 January 2013 Exchange rate adjustments Business acquired Businesses disposed Reclassifications Charge to income statement (see note 14) Charge to other comprehensive income (see note 14) Credit to equity (see note 14) At 31 December 2013 Exchange rate adjustments Reclassifications (Charge)/credit to income statement (see note 14) Credit to other comprehensive income (see note 14) Charge to equity (see note 14) At 31 December 2014 Deferred tax liabilities At 1 January 2013 Exchange rate adjustments Businesses disposed Reclassifications (Charge)/credit to income statement (see note 14) At 31 December 2013 Exchange rate adjustments Reclassifications Charge to income statement (see note 14) Charge to other comprehensive income (see note 14) At 31 December 2014 * Acquired in business combinations. Retirement benefit obligations £’m 94.3 (0.1) – – – (4.5) (21.6) – 68.1 2.7 – (7.3) 24.2 – Other Total £’m 21.0 0.1 (0.1) 4.6 0.6 (13.4) (0.1) 3.3 16.0 0.3 (3.7) 2.1 0.2 (1.8) £’m 115.3 – (0.1) 4.6 0.6 (17.9) (21.7) 3.3 84.1 3.0 (3.7) (5.2) 24.4 (1.8) 87.7 13.1 100.8 Accelerated tax depreciation £’m Intangible assets (*) £’m (16.5) 0.3 – (0.3) (2.8) (19.3) (0.9) (0.1) (1.8) – (288.1) 4.0 (6.0) – 15.1 (275.0) (14.1) 0.9 (4.3) (0.1) Total £’m (304.6) 4.3 (6.0) (0.3) 12.3 (294.3) (15.0) 0.8 (6.1) (0.1) (22.1) (292.6) (314.7) Deferred tax assets and liabilities are offset where there is a legally enforceable right to offset current tax assets against current tax liabilities and when the deferred income taxes relate to the same tax authority. The balances after allowing for such offsets are as follows: Deferred tax assets Deferred tax liabilities Net balance at 31 December Deferred tax assets are analysed as follows: To be recovered within one year To be recovered after more than one year Total Deferred tax liabilities are analysed as follows: Due within one year Due after more than one year Total 2014 £’m 0.9 (214.8) (213.9) 2014 £’m 0.2 0.7 0.9 2014 £’m – (214.8) 2013 £’m 9.1 (219.3) (210.2) 2013 £’m 0.2 8.9 9.1 2013 £’m (0.3) (219.0) (214.8) (219.3) The Group has unrecognised tax losses of £23.5 million (2013: £25.2 million) for which no deferred tax asset has been recognised. Deferred tax assets have not been recognised in respect of these losses, as it is not regarded as more likely than not that they will be recovered. Deferred tax assets not recognised, would be recoverable in the event they reverse and suitable taxable profits are available. There are no unremitted earnings in foreign subsidiaries that would give rise to a tax liability in the event of those subsidiaries remitting their earnings. 93987_p90-132.indd 120 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 121 33. Retirement benefit obligations Pension schemes The Group operates a number of pension schemes for the benefit of its employees. The nature of each scheme which has a significant impact on the financial statements is as follows: • In the UK, the Group operates a funded defined benefit scheme which is closed to new members but open to future accrual for existing members; • In the US, the Group operates five defined benefit schemes, all of which are closed to new members. With two exceptions, these schemes are open to future accrual for existing members. The schemes are a mixture of funded and unfunded schemes; and • In Switzerland, the Group operates a funded defined benefit scheme which is open to new members and to future accrual. The UK and US schemes provide benefits to members in the form of a guaranteed level of pension payable for life. The benefits provided depend on a member’s length of service. For the majority of schemes, the benefits are also dependent on salary at retirement or average salary over employment in the final years leading up to retirement. In the US, one scheme provides a fixed benefit for each year of service. The Swiss scheme has many of the characteristics of a defined contribution scheme but provides for certain minimum benefits to be guaranteed to members. For all funded schemes, benefit payments are made from funds administered by third parties unrelated to the Group. The assets of such schemes are held in trust funds, or their equivalent, separate from the Group’s finances. The UK scheme is a registered scheme and subject to the statutory scheme-specific funding requirements outlined in UK legislation, including the payment of levies to the Pension Protection Fund. It is established under trust and the responsibility for its governance lies with the trustees who also agree funding arrangements with the Group. The funded US schemes are tax-qualified pension schemes regulated by the Pension Protection Act 2006 and are insured by the Pension Benefit Guarantee Corporation up to certain limits. They are established under, and governed by, the US Employee Retirement Income Security Act 1974. Meggitt is a named fiduciary with the authority to manage the operation of the US schemes. For all unfunded schemes, benefit payments are made by the Group as obligations fall due. The Group also operates a number of defined contribution schemes under which the Group has no further obligations once the contributions have been paid. Healthcare schemes The Group has two principal other post-retirement benefit schemes providing medical and life assurance benefits to certain employees, and former employees, of Meggitt Aircraft Braking Systems Corporation and Meggitt (Rockmart), Inc. These schemes are unfunded. Amounts recognised in the income statement Total charge in respect of defined contribution pension schemes Defined benefit pension schemes: Service cost Past service cost Net interest expense on retirement benefit obligations Total charge in respect of defined benefit pension schemes Healthcare schemes: Service cost Past service credit* Net interest expense on retirement benefit obligations Total (credit)/charge in respect of healthcare schemes Total charge 2014 £’m 21.7 11.9 1.1 7.8 20.8 0.8 (8.9) 2.2 (5.9) 36.6 2013 £’m 19.2 12.7 0.7 9.5 22.9 1.5 – 2.0 3.5 45.6 * During the year, the Group made changes to the way in which medical benefits are provided. These changes, following which the Group continues to provide comparable benefits, resulted in a past service credit being recognised of £8.4 million (2013: Nil) which is included within the amounts shown in the table. Of the total charge, £26.6 million (2013: £34.1 million) has been charged to operating profit (see note 9), of which £19.5 million (2013: £18.9 million) has been included in cost of sales and £7.1 million (2013: £15.2 million) in net operating costs. The remaining £10.0 million (2013: £11.5 million) is included in finance costs (see note 13). 93987_p90-132.indd 121 04/03/2015 17:11 122 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 33. Retirement benefit obligations continued Amounts recognised in the balance sheet Present value of scheme liabilities Fair value of scheme assets Retirement benefit obligations Present value of scheme liabilities Fair value of scheme assets Retirement benefit obligations 2014 Overseas pension schemes £’m Overseas healthcare schemes £’m 350.7 (259.7) 91.0 46.8 – 46.8 2013 Overseas pension schemes £’m Overseas healthcare schemes £’m 304.8 (238.5) 66.3 48.3 – 48.3 UK pension scheme £’m 681.4 (501.4) 180.0 UK pension scheme £’m 573.4 (449.9) 123.5 Of the total deficit of £317.8 million (2013: £238.1 million), £63.8 million (2013: £61.0 million) is in respect of unfunded schemes. Changes in the present value of retirement benefit obligations At 1 January Exchange rate adjustments Service cost Past service (credit)/cost Interest expense/(income) (see note 13) Contributions – Group Contributions – members Benefits paid Remeasurement of retirement benefit obligations: Loss/(gain) from change in demographic assumptions Loss/(gain) from change in financial assumptions Return on schemes’ assets excluding amounts included in interest income Total remeasurement loss/(gain) Administrative expenses borne directly by schemes 2014 2013 Liabilities (*) £’m Assets (**) £’m Total £’m Liabilities (*) £’m Assets (**) £’m 926.5 15.6 12.7 (7.8) 38.9 – 3.2 (38.8) 10.8 117.8 (688.4) (7.9) – – (28.9) (42.0) (3.2) 38.8 – – 238.1 7.7 12.7 (7.8) 10.0 (42.0) – – 10.8 117.8 – (30.9) (30.9) 128.6 – (30.9) 1.4 97.7 1.4 934.4 (4.0) 14.2 0.7 36.4 – 3.6 (37.5) (6.9) (14.4) – (21.3) – (634.7) 3.1 – – (24.9) (41.6) (3.6) 37.5 – – (25.5) (25.5) 1.3 Total £’m 1,078.9 (761.1) 317.8 Total £’m 926.5 (688.4) 238.1 Total £’m 299.7 (0.9) 14.2 0.7 11.5 (41.6) – – (6.9) (14.4) (25.5) (46.8) 1.3 At 31 December 1,078.9 (761.1) 317.8 926.5 (688.4) 238.1 * Present value of schemes’ liabilities. ** Fair value of schemes’ assets. 93987_p90-132.indd 122 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 123 33. Retirement benefit obligations continued Analysis of pension scheme assets Quoted Unquoted 2014 Equities Government bonds Corporate bonds Cash Other assets UK pension scheme Equities Government bonds Corporate bonds Property Cash Other assets Overseas pension schemes Equities Government bonds Corporate bonds Property Cash Other assets £’m 146.0 196.6 80.1 35.7 8.2 466.6 58.0 67.5 85.2 8.9 2.2 24.4 246.2 204.0 264.1 165.3 8.9 37.9 32.6 £’m – 1.9 18.9 – 14.0 34.8 – – – 13.5 – – 13.5 – 1.9 18.9 13.5 – 14.0 Total £’m 146.0 198.5 99.0 35.7 22.2 501.4 58.0 67.5 85.2 22.4 2.2 24.4 % 29.1 39.6 19.8 7.1 4.4 100.0 22.3 26.0 32.8 8.7 0.8 9.4 259.7 100.0 204.0 266.0 184.2 22.4 37.9 46.6 26.8 34.9 24.2 3.0 5.0 6.1 Total pension schemes’ assets 712.8 48.3 761.1 100.0 Quoted Unquoted 2013 £’m 199.4 132.7 42.7 22.3 14.6 411.7 112.6 22.8 65.9 9.9 10.6 5.2 227.0 312.0 155.5 108.6 9.9 32.9 19.8 638.7 £’m 0.4 1.9 26.4 – 9.5 38.2 – – – 11.5 – – 11.5 0.4 1.9 26.4 11.5 – 9.5 49.7 Total £’m 199.8 134.6 69.1 22.3 24.1 449.9 112.6 22.8 65.9 21.4 10.6 5.2 238.5 312.4 157.4 135.0 21.4 32.9 29.3 688.4 % 44.4 29.9 15.4 5.0 5.3 100.0 47.2 9.6 27.6 9.0 4.4 2.2 100.0 45.4 22.8 19.6 3.1 4.8 4.3 100.0 Other assets include hedge funds, commodities and derivatives. The schemes have no investments in any assets of the Group. Financial assumptions used to calculate scheme liabilities Discount rate Inflation rate Increases to deferred benefits during deferment* Increases to pensions in payment* Salary increases * To the extent not overridden by specific scheme rules. 2014 UK pension scheme Overseas pension schemes Overseas healthcare schemes 3.60% 3.10% 2.10% 3.00% 4.10% 3.85% N/A N/A N/A 4.74% 3.85% N/A N/A N/A N/A UK pension scheme 4.60% 3.40% 2.60% 3.30% 4.40% 2013 Overseas pension schemes Overseas healthcare schemes 4.55% N/A N/A N/A 4.76% 4.55% N/A N/A N/A N/A In determining the fair value of scheme liabilities, the Group uses mortality assumptions which are based on published mortality tables adjusted to reflect the characteristics of the scheme populations. The Group’s mortality assumptions in the UK are based on recent mortality investigations of Self Administered Pension Schemes adjusted to reflect the profile of the membership of the scheme, which include the results of a postcode analysis of members used to support the 2012 triennial UK actuarial valuation. Allowance has been made for rates of mortality to continue to fall at the rate of 1.25% per annum. In the US, mortality assumptions were previously based on the RP2000 IRS RPA tables. During 2014, new mortality tables have been adopted and the assumptions are now based on the RPH-2014 headcount weighted table, for schemes where benefits are not salary-linked, and the RP-2014 table for other schemes, with both tables projecting rates of mortality to fall using the Social Security Administration’s projection scale (‘Scale SSA’). 93987_p90-132.indd 123 04/03/2015 17:11 124 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 33. Retirement benefit obligations continued Member age 45 (life expectancy at age 65) – male Member age 45 (life expectancy at age 65) – female Member age 65 (current life expectancy) – male Member age 65 (current life expectancy) – female 2014 2013 UK scheme Years Overseas schemes Years UK scheme Years Overseas schemes Years 23.6-25.3 26.4-28.0 21.9-23.6 24.5-26.1 21.6-22.2 23.4-23.7 20.3-20.9 22.3-22.5 23.5-25.2 26.3-27.9 21.8-23.6 24.3-26.0 19.3 21.1 19.3 21.1 Details on the sensitivity of scheme liabilities to changes in assumptions are provided below: • The impact of a 10 basis point reduction in discount rate would cause scheme liabilities at 31 December 2014 to increase by approximately £18.3 million; • The impact of a 10 basis point increase in inflation and salary inflation rates would cause scheme liabilities at 31 December 2014 to increase by approximately £13.5 million; • The impact of assuming every scheme member were to live for an additional year would cause scheme liabilities at 31 December 2014 to increase by approximately £27.5 million. The above sensitivity analyses are based on a change in a single assumption while keeping all other assumptions constant. In practice, this is unlikely to occur, and changes in some assumptions may be correlated. When calculating the sensitivity of the defined benefit obligation to significant actuarial assumptions, the same method of calculating the defined benefit obligation has been used as when calculating the retirement benefit obligations recognised in the balance sheet. The methods and types of assumptions used in preparing the sensitivity analysis are consistent with the previous year. Risks The Group is exposed to a number of risks arising from operating its defined benefit pension and healthcare schemes, the most significant of which are detailed below. Except as discussed below, the Group has not changed the processes used to manage defined benefit scheme risks during the year. Asset volatility In determining the present value of schemes’ defined benefit obligations, liabilities are discounted using interest rates of high quality corporate bonds. To the extent the actual return on schemes’ assets is below this yield, the retirement benefit obligations recognised in the consolidated financial statements would increase. This risk is partly mitigated by funded schemes investing in matching corporate bonds, such that changes in asset values are offset by similar changes in the value of scheme liabilities. However, the Group also invests in other asset types such as equities, property, hedge funds, commodities and derivatives where movements in asset values may be uncorrelated to movements in the yields on high quality corporate bonds. The Group believes that, due to the long-term nature of its scheme liabilities, it is appropriate to invest in assets which are expected to out-perform corporate bonds over this timeframe. Scheme assets are well diversified, such that the failure of any single investment would not have a material impact on the overall level of assets. During the year, part of the equity portfolio held by the UK and US schemes was disinvested. The amounts disinvested totalled approximately £100 million. The proceeds were used to purchase structured investments consisting of high quality government bonds together with equity derivatives. The structured investments enable the schemes to benefit from equity-like returns, subject to certain caps, on the amounts invested, whilst providing an element of protection against falls in equity markets. The Group actively monitors how the duration and expected yield of scheme assets are matching the expected cash outflows arising from the pension obligations. For each funded scheme, there is a ‘glide-path’ in place which provides, to the extent the funding position improves, for asset volatility to be reduced by increased investment in long-term index linked securities with maturities that match the benefit payments as they fall due. Interest risk In determining the present value of schemes’ defined benefit obligations, liabilities are discounted using interest rates of high quality corporate bonds. If these yields fall, the retirement benefit obligations recognised in the consolidated financial statements would increase. This risk is partly mitigated through the funded schemes investing in matching assets as described above. Inflation risk In determining the present value of schemes’ defined benefit obligations, estimates are made as to levels of salary inflation, inflation increases that will apply to deferred benefits during deferment and pensions in payment, and healthcare cost inflation. To the extent actual inflation exceeds these estimates, the retirement benefit obligations recognised in the consolidated financial statements would increase. Salary inflation risk is partly mitigated in both the UK and US schemes by linking benefits in respect of future service to average salaries over a period of employment rather than final salary at retirement. Benefits in respect of certain periods of past service are still linked to final salary at retirement. In the UK, inflation risk in respect of deferred benefits and pensions in payment is mitigated by caps on the levels of inflation under the scheme rules. In the US and Switzerland, the schemes provide for no inflation to be applied to benefits in deferment or retirement. Exposure to inflation on US healthcare costs has been mitigated by freezing Group contributions to medical costs at 2011 cost levels. 93987_p90-132.indd 124 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 125 33. Retirement benefit obligations continued Longevity risk In determining the present value of schemes’ defined benefit obligations, assumptions are made as to the life expectancy of members during employment and in retirement. To the extent life expectancy exceeds this estimate, the retirement benefit obligations recognised in the consolidated financial statements would increase. This risk is more significant in the UK plan, where inflationary increases result in higher sensitivity to changes in life expectancy. The Group currently does not use derivatives, such as longevity swaps, to mitigate this risk. Other information In the UK, the last triennial valuation was in 2012 following which the Group agreed with the trustees to increase deficit reduction payments, with the aim being to eliminate the deficit by 2024. Under the agreement with the trustees, deficit payments in 2015 will be £21.4 million and will increase by approximately 5% per annum until 2024. Although the present value of future deficit payments agreed as part of the 2012 actuarial valuation exceed the scheme deficit at 31 December 2014, such amounts would be recoverable by the Group under the scheme rules once the last member has died and accordingly no additional minimum funding liability arises. In the US, deficit reduction payments are driven by regulations and provide for deficits to be eliminated over periods up to 15 years. Deficit payments in 2015 are expected to be £4.4 million and, absent any changes in legislation, will reduce over the following two years before increasing to £6.7 million by 2019. Thereafter, annual payments are expected to remain relatively stable for the remainder of the recovery period. The present value of deficit payments due under legislation do not exceed the schemes’ deficits at 31 December 2014 and accordingly no additional minimum funding liability arises. There is no significant deficit in the Swiss scheme. The estimated total Group contributions expected to be paid to the schemes during 2015 are £43.1 million. The weighted average duration of the UK schemes’ defined benefit obligation is 19.6 years. The weighted average duration of the overseas schemes’ defined benefit obligation is 11.5 years. The expected maturity of undiscounted pension and healthcare benefits at 31 December 2014 is as follows: Less than a year Between 1-2 years Between 2-5 years Between 5-10 years Between 10-15 years Between 15-20 years Between 20-25 years Over 25 years Total 34. Share capital and share schemes Issued share capital Allotted and fully paid: At 1 January 2013 Issued on exercise of executive share awards Issued on exercise of sharesave awards Scrip dividends At 31 December 2013 Issued on exercise of executive share awards Share buyback – purchased in year Scrip dividends At 31 December 2014 Pension schemes £’m Healthcare schemes £’m 35.8 36.6 112.1 199.7 246.3 257.6 252.8 696.5 3.4 3.2 9.7 15.4 12.5 9.8 7.6 14.5 Total £’m 39.2 39.8 121.8 215.1 258.8 267.4 260.4 711.0 1,837.4 76.1 1,913.5 Ordinary shares of 5p each Number ‘m Nominal value Net consideration £’m £’m 785.0 7.2 1.1 3.8 797.1 0.4 (6.8) 11.6 802.3 39.3 0.3 0.1 0.2 39.9 – (0.3) 0.5 40.1 0.5 2.0 20.0 0.1 (33.7) 53.0 93987_p90-132.indd 125 04/03/2015 17:11 126 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 34. Share capital and share schemes continued Share Options Year of grant Meggitt 2008 Sharesave Scheme 2008 2010 2010 2012 2012 2013 2013 2014 2014 Meggitt Executive Share Option Scheme 2005 Part A 2005 2006 2007 2008 2009 2010 2011 2012 2013 2013 Number of ordinary shares under award Exercise price per share Exercise period From To 65,963 430,711 50,781 682,810 369,802 398,515 136,635 578,493 382,956 51,759 9,384 7,459 990 30,531 8,686 48,031 211,862 217,649 5,504 171.40p 222.35p 222.35p 326.94p 326.94p 426.40p 426.40p 374.19p 374.19p 278.65p 263.67p 299.00p 252.50p 169.50p 286.10p 351.70p 397.20p 526.50p 545.00p 01.11.15 01.11.15 01.11.17 01.11.15 01.11.17 01.11.16 01.11.18 01.11.17 01.11.19 10.10.08 27.09.09 29.03.10 25.03.11 30.04.12 12.03.13 02.03.14 10.04.15 05.09.16 09.09.16 30.04.16 30.04.16 30.04.18 30.04.16 30.04.18 30.04.17 30.04.19 30.04.18 30.04.20 09.10.15 26.09.16 28.03.17 24.03.18 29.04.19 11.03.20 01.03.21 09.04.22 04.09.23 08.09.23 All the above awards, which were granted for nil consideration, may in certain circumstances, be exercised earlier than the dates given. The weighted average remaining contractual life of outstanding awards is 3.4 years (2013: 4.2 years). Share Appreciation Rights – Equity-settled Year of grant Meggitt Executive Share Option Scheme 2005 Part B 2005 2006 2007 2007 2008 2008 2009 2010 2011 2011 2012 2013 2013 Indicative number of shares to be released* Number of ordinary shares under award Exercise price per share Exercise period From To 146,630 202,199 175,934 32,533 459,613 156,656 811,243 719,939 511,432 70,519 1,038,807 – – 316,625 411,002 415,045 73,332 895,082 258,109 1,204,679 1,604,329 1,586,569 210,948 4,426,443 3,688,877 11,679 278.65p 263.67p 299.00p 288.75p 252.50p 204.00p 169.50p 286.10p 351.70p 345.50p 397.20p 526.50p 545.00p 10.10.08 27.09.09 29.03.10 17.08.10 25.03.11 07.08.11 30.04.12 12.03.13 02.03.14 17.08.14 10.04.15 05.09.16 09.09.16 09.10.15 26.09.16 28.03.17 16.08.17 24.03.18 06.08.18 29.04.19 11.03.20 01.03.21 16.08.21 09.04.22 04.09.23 08.09.23 * Based on an indicative share price of 519.00p, the share price at 31 December 2014. All the above share appreciation rights, which were granted for nil consideration, may in certain circumstances, be exercised earlier than the dates given. The weighted average remaining contractual life of outstanding awards is 6.3 years (2013: 7.1 years). 35. Share-based payment The Group operates a number of share schemes for the benefit of its employees. The total expense recorded in the income statement in respect of such schemes was £1.7 million (2013: £11.9 million) (see note 9). The nature of each scheme which has a significant impact on the expense recorded in the income statement is set out below. Meggitt Long Term Incentive Plan 2014 Equity-settled Under the Meggitt Long Term Incentive Plan 2014, an annual award of shares may be made to certain senior executives. For awards made in 2014 the number of shares, if any that an executive ultimately receives, depends on three performance conditions: • An earnings per share (EPS) measure (33% of the award); • A return on trading assets (ROTA) measure (33% of the award); and • A strategic goals measure (33% of the award). 93987_p90-132.indd 126 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 127 35. Share-based payment continued Each of the conditions is measured over a three year performance period. An expense of £1.7 million (2013: £Nil) was recorded in the year. Awards are made as nil cost options. An employee is generally entitled to a payment at the end of the vesting period, equivalent to dividends that would have been paid during the vesting period, on any shares that vest. The fair value of the award made in 2014 has been estimated at the market price of the share on the date of grant, which was 467.54 pence. Movements in the number of outstanding shares that may potentially be released to employees are as follows: At 1 January Awarded At 31 December At 31 December 2014, none of the shares under award are eligible for release. Meggitt Executive Share Option Scheme 2005 2014 Number of shares under award outstanding ‘m – 4.2 4.2 Equity-settled Awards are no longer made under this scheme. Share awards under the scheme were granted to certain senior executives at an exercise price equal to the market price of the shares on the day before the grant was made. The awards are generally exercisable at the earliest three years after the grant date. Awards can only be exercised if the Group meets an earnings per share performance condition. The Group has no obligation, legal or constructive, to settle the awards in cash. Awards under Part A of the scheme provide for the executive on exercise to be entitled, on payment of the exercise price, to the number of shares under award. Awards under Part B of the scheme are in the form of equity-settled share appreciation rights (SAR’s) and provide for the executive on exercise to be entitled to receive equity equivalent to the gain in value between the exercise price and the market price on the date of exercise. Awards may be exercised at any point between the vesting date and ten years after the date the award was made. A credit of £0.9 million (2013: £2.5 million expense) was recorded in the year. Movements in the number of outstanding awards and their related weighted average exercise prices are as follows: At 1 January Granted Lapsed Modified from cash-settled Exercised At 31 December 2014 Average exercise price Pence 360.49 – 371.43 – 292.76 2014 Number of awards outstanding ‘m 21.1 – (2.0) – (3.4) 373.89 15.7 2013 Average exercise price Pence 304.35 526.58 365.26 262.04 262.42 360.49 2013 Number of awards outstanding ‘m 24.5 4.1 (0.5) 3.4 (10.4) 21.1 At 31 December 2014, of the total number of awards outstanding, 7.1 million are exercisable at an average exercise price of 274.59 pence (2013: 7.2 million at an average exercise price of 245.50 pence). The fair values of the awards made in 2013 were determined using the Black-Scholes option pricing model. The significant assumptions used in the model and the fair values determined were: Share price at date of grant/modification (pence) Exercise price (pence) Vesting period (years) Expected volatility Expected life of award (years) Risk free rate Expected dividend yield Fair value at date of award (pence) 2013 Award in September 2013 Modification in April 526.50 526.50 3.0 35% 5.0 1.56% 3.24% 121.37 468.60 351.70 1.0 27% 3.0 0.73% 2.65% 120.54 Expected volatility figures were based on volatility over the last five years measured using a statistical analysis of daily share prices. 93987_p90-132.indd 127 04/03/2015 17:11 128 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 35. Share-based payment continued Cash-settled Awards are no longer made under this scheme. Under the scheme the Group was able to grant cash-settled SARs to certain overseas employees. The Group is required to pay the intrinsic value of the SARs to the employee at the date of exercise. Awards can only be exercised if the Group meets an earnings per share performance condition. Awards may be exercised at any point between the vesting date and ten years after the date the award was made. An expense of £Nil (2013: £3.1 million) was recorded in the year. The Group has recorded a liability at the balance sheet date of £0.1 million (2013: £0.7 million). The total intrinsic value at the balance sheet date was £0.1 million (2013: £0.9 million). Movements in the number of outstanding awards and their related weighted average exercise prices are as follows: At 1 January Granted Lapsed Modified to equity-settled Exercised At 31 December 2014 Average exercise price Pence 354.05 – 326.04 – 264.18 436.22 2014 Number of awards outstanding ‘m 0.6 – (0.1) – (0.2) 0.3 2013 Average exercise price Pence 267.74 526.50 385.07 262.04 242.59 354.05 2013 Number of awards outstanding ‘m 4.8 0.1 (0.1) (3.4) (0.8) 0.6 At 31 December 2014, of the total number of awards outstanding, Nil million are exercisable (2013: 0.2 million at an average exercise price of 205.24 pence). As a cash-settled award, the fair value of outstanding awards is remeasured at each balance sheet date. Meggitt Equity Participation Plan 2005 Awards are no longer made under this scheme. Under the Meggitt Equity Participation Plan 2005, an annual award of shares could be made to certain senior executives. For awards made under the plan, the number of shares an executive ultimately receives, depends on three performance conditions: • An earnings per share (EPS) measure (50% of the award); • A cash flow measure (25% of the award); and • Total Shareholder Return (TSR) achieved by the Group as measured against a comparator group selected by the Remuneration Committee (25% of the award). Each of the conditions is measured over a three year performance period. An expense of £0.3 million (2013: £5.4 million) was recorded in the year. Movements in the number of outstanding shares that may potentially be released to employees are as follows: At 1 January Awarded Lapsed Released to employees At 31 December 2014 Number of shares under award outstanding ‘m 2013 Number of shares under award outstanding ‘m 7.7 – (1.5) (1.1) 5.1 7.8 2.1 (0.6) (1.6) 7.7 At 31 December 2014, of the total number of shares under award outstanding, 1.1 million are eligible for release (2013: 1.5 million). The fair value of the award made in 2013, subject to the EPS and cash flow performance conditions, was 478.00 pence. The fair value of the award made in 2013, subject to the TSR performance condition, was determined using a Monte Carlo model. The significant assumptions used in the model and the fair value determined were: Share price at date of grant (pence) Vesting period (years) Expected volatility Expected life of award (years) Risk free rate Fair value at date of award (pence) 2013 Award in March 478.00 3.0 26% 3.0 0.26% 248.00 93987_p90-132.indd 128 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 129 36. Own shares Own shares represent shares in the Company that are held by an independently managed Employee Share Ownership Plan Trust (‘the trust’) formed to acquire shares to be used to satisfy share options and awards under the employee share schemes as described in the Directors’ remuneration report on pages 55 to 75. At 31 December 2014, the trust held 337,664 ordinary shares (2013: Nil) of which 281,638 were unallocated, being retained by the trust for future use. The balance of 56,026 shares were held in vested share accounts to satisfy particular awards which have fully vested in employees. All shares, whether or not allocated, are held for the benefit of employees. The shares were purchased during the year and have a cost of £1.7 million at 31 December 2014. The market value of the shares at 31 December 2014 was £1.8 million representing 0.04% of the issued share capital of the Company. 37. Contingent liabilities The Company has given guarantees in respect of credit facilities for certain of its subsidiaries, some property leases, other leasing arrangements and the performance by some current and former subsidiaries of certain contracts. Also, there are similar guarantees given by certain other Group companies. The directors do not believe that the effect of giving these guarantees will have a material adverse effect upon the Group’s financial position. The Company and various of its subsidiaries are, from time to time, parties to legal proceedings and claims which arise in the ordinary course of business. The directors do not anticipate that the outcome of these proceedings, actions and claims, either individually or in aggregate, will have a material adverse effect upon the Group’s financial position. 38. Contractual commitments Capital commitments Contracted for but not incurred: Intangible assets Property, plant and equipment Total Operating lease commitments 2014 £’m 0.9 11.0 11.9 2013 £’m 1.4 7.5 8.9 The Group leases various factories, warehouses and offices under non-cancellable operating leases. These leases have various lease periods, escalation clauses and renewal rights. None of these terms represent unusual arrangements or create material onerous or beneficial rights or obligations. Additionally the Group leases various items of plant and machinery under both cancellable and non-cancellable operating leases. Expenditure on operating leases is charged to the income statement as incurred and is disclosed in note 8. The future aggregate minimum lease payments under non–cancellable operating leases are as follows: In one year or less In more than one year but not more than five years In more than five years Total Other financial commitments 2014 £’m 12.7 37.2 24.1 74.0 2013 £’m 13.0 38.2 25.7 76.9 The Group enters into long-term arrangements with Aircraft and original equipment manufacturers to design, develop and supply products to them for the life of the aircraft. This represents a significant long-term financial commitment for the Group and requires the consideration of a number of uncertainties including the feasibility of the product and the ultimate commercial viability over a period which can extend over 40 years. The directors are satisfied that, at this time, there are no significant contingent liabilities arising from these commitments. Based on latest OE delivery forecasts from external agencies, the future estimated expenditure under contractual commitments to incur development costs and programme participation costs at 31 December, 2014, which are expected to be recognised as intangible assets when incurred are as follows: In one year or less In more than one year but not more than five years In more than five years Total Development costs £’m Programme participation costs £’m 62.0 19.2 2.7 83.9 40.1 220.5 732.4 993.0 93987_p90-132.indd 129 04/03/2015 17:11 130 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 39. Cash inflow from operations Profit for the year Adjustments for: Finance income (see note 12) Finance costs (see note 13) Tax (see note 14) Depreciation (see note 21) Amortisation (see notes 19 and 20) Impairment loss (see note 19) Loss/(gain) on disposal of property, plant and equipment Loss/(gain) on disposal or closure of businesses (see note 11) Financial instruments (see note 10) Retirement benefit obligation deficit payments Share-based payment expense (see note 35) Changes in working capital: Inventories Trade and other receivables Trade and other payables Provisions Cash inflow from operations 40. Movements in net debt At 1 January Free cash inflow Businesses acquired (see note 42) Business acquisition expenses Businesses disposed Business disposal expenses (see note 11) Dividends paid to Company’s shareholders (see note 16) Purchase of own shares Issue of equity share capital Share buyback - purchased in year Net cash generated – inflow Debt acquired with businesses Exchange rate adjustments Other non-cash movements At 31 December Analysed as: Bank and other borrowings – current (see note 28) Bank and other borrowings – non-current (see note 28) Obligations under finance leases – current (see note 27) Obligations under finance leases – non-current (see note 27) Cash and cash equivalents (see note 24) Total 2014 £’m 2013 £’m 177.0 232.3 (1.2) 28.5 31.9 31.2 112.6 8.0 0.4 2.9 29.2 (29.3) 1.7 (17.7) 9.8 (10.1) (28.0) (0.3) 31.2 37.1 32.2 123.2 3.2 (1.1) (9.0) (6.1) (27.4) 11.9 (16.4) (24.6) (13.1) (27.4) 346.9 345.7 2014 £’m 2013 £’m 564.6 642.5 (146.8) 28.6 – – 0.5 51.4 11.6 (0.1) 33.7 (21.1) – 24.7 7.3 (110.4) 26.5 0.4 (53.3) 0.5 75.6 – (2.5) – (63.2) 0.3 (2.7) (12.3) 575.5 564.6 2014 £’m 58.9 616.7 0.1 5.3 (105.5) 575.5 2013 £’m 7.2 666.0 2.4 5.1 (116.1) 564.6 93987_p90-132.indd 130 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 131 41. Major non-cash transactions During the year, the Company issued 11.6 million shares worth £53.0 million in respect of scrip dividends (2013: 3.8 million shares worth £20.0 million) (see notes 16 and 34). 42. Business combinations On 31 December 2014, the Group acquired 100% of the voting rights of Precision Engine Controls Corporation (‘PECC’). PECC is a leading supplier of actuation systems and fuel metering valves to manufacturers of small-frame gas turbines used predominantly in the oil and gas and power generation industries. PECC’s products are complementary to Meggitt’s existing valve technology in the aero-derivative gas turbine market and expand our range of actuation capabilities. The assets and liabilities of PECC at the date of acquisition, including the goodwill arising on consolidation, were as follows: Goodwill (see note 18) Other intangible assets Property, plant and equipment Inventories Trade and other receivables - current Trade and other payables - current Provisions - non-current (see note 31) Net assets Consideration satisfied in cash Less amounts recoverable under working capital mechanism Total consideration payable Net assets £’m 19.9 3.9 0.4 3.0 1.4 (0.6) (0.1) 27.9 28.3 (0.4) 27.9 Due to the proximity of the acquisition to the balance sheet date, the difference between the book value of acquired net assets and consideration payable has been provisionally recognised as goodwill. During 2015, the Group will determine the fair value of the identifiable assets acquired and liabilities and contingent liabilities assumed, with any corresponding adjustment necessary being made to the value of goodwill recognised. Costs related to the acquisition were £0.5 million. The impact of the acquired business on the results of the Group for the period since acquisition is not significant and would not have been significant had it been acquired on 1 January 2014. Total consideration paid in respect of acquisitions during the year is as follows: Cash paid in respect of PECC Cash paid in respect of Piezotech Cash paid in respect of other acquisitions* Total 2014 £’m 28.3 – 0.3 28.6 2013 £’m – 26.5 – 26.5 * On 10 September 2014, the Group acquired a small business which included the acquisition of other intangible assets of £0.1 million and property, plant and equipment of £0.2 million. 93987_p90-132.indd 131 04/03/2015 17:11 132 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the consolidated financial statements continued 43. Group companies The following information is not a complete listing of all subsidiary companies at 31 December 2014 and relates only to those subsidiaries principally affecting the revenues, profits or assets of the Group. United Kingdom Meggitt Aerospace Limited Meggitt Finance Limited ‡ Continental Europe Artus SAS – France North America Linear Motion LLC Meggitt Aircraft Braking Systems Corporation Meggitt Defense Systems, Inc. Meggitt GP, Inc. ‡ Meggitt Oregon, Inc. Meggitt Safety Systems, Inc. Meggitt Training Systems, Inc. Meggitt USA, Inc. ‡ Meggitt (UK) Limited Meggitt SA – Switzerland Meggitt (North Hollywood), Inc. Meggitt (Orange County), Inc. Meggitt (Rockmart), Inc. OECO, LLC Pacific Scientific Company Securaplane Technologies, Inc. Whittaker Corporation ‡ Rest of World Meggitt Aerospace Asia Pacific Pte Limited – Singapore Meggitt Brasil (Soluçeos de Engenharia) Limited – Brazil a. United Kingdom companies listed above are incorporated and registered in England and Wales. North American companies listed above are incorporated and registered in the United States of America. Other companies listed above are incorporated in the country named. b. The ordinary shares of all subsidiaries were 100% owned by the Company, either directly or indirectly, at 31 December 2014. c. All companies listed above are included in the consolidation. d. Companies marked ‡ are management companies. Otherwise all companies are operating companies engaged in the Group’s principal activities as described in note 1. A full list of subsidiary companies will be annexed to the next annual return to the Registrar of Companies. 93987_p90-132.indd 132 04/03/2015 17:11  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 133 Independent auditors’ report to the members of Meggitt PLC Report on the company financial statements Our opinion In our opinion, Meggitt PLC’s company financial statements (the ‘financial statements’): • give a true and fair view of the state of the company’s affairs as at 31 December 2014; have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and have been prepared in accordance with the requirements of the Companies Act 2006. • • What we have audited Meggitt PLC’s financial statements comprise: • the Company balance sheet as at 31 December 2014; and • the notes to the financial statements, which include a summary of significant accounting policies and other explanatory information. Certain required disclosures have been presented elsewhere in the Annual Report and Accounts (the ‘Annual Report’), rather than in the notes to the financial statements. These are cross-referenced from the financial statements and are identified as audited. The financial reporting framework that has been applied in the preparation of the financial statements is applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice). Other required reporting Consistency of other information Companies Act 2006 opinion In our opinion, the information given in the Strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. ISAs (UK & Ireland) reporting Under International Standards on Auditing (UK and Ireland) (‘ISAs (UK & Ireland)’) we are required to report to you if, in our opinion, information in the Annual Report is: • materially inconsistent with the information in the audited financial statements; or apparently materially incorrect based on, or materially inconsistent with, our knowledge of the company acquired in the course of performing our audit; or is otherwise misleading. • • We have no exceptions to report arising from this responsibility. Adequacy of accounting records and information and explanations received Under the Companies Act 2006 we are required to report to you if, in our opinion: • we have not received all the information and explanations we require for our audit; or adequate accounting records have not been kept by the company, or returns adequate for our audit have not been received from branches not visited by us; or the financial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns. • • Other Companies Act 2006 reporting Under the Companies Act 2006 we are required to report to you if, in our opinion, certain disclosures of directors’ remuneration specified by law are not made. We have no exceptions to report arising from this responsibility. Responsibilities for the financial statements and the audit Our responsibilities and those of the directors As explained more fully in the Statement of directors’ responsibilities set out on pages 78 to 79, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and ISAs (UK & Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors. This report, including the opinions, has been prepared for and only for the company’s members as a body in accordance with Chapter 3 of Part 16 of the Companies Act 2006 and for no other purpose. We do not, in giving these opinions, accept or assume responsibility for any other purpose or to any other person to whom this report is shown or into whose hands it may come save where expressly agreed by our prior consent in writing. What an audit of financial statements involves We conducted our audit in accordance with ISAs (UK & Ireland). An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: • whether the accounting policies are appropriate to the company’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the directors; and the overall presentation of the financial statements. • • We primarily focus our work in these areas by assessing the directors’ judgements against available evidence, forming our own judgements, and evaluating the disclosures in the financial statements. We test and examine information, using sampling and other auditing techniques, to the extent we consider necessary to provide a reasonable basis for us to draw conclusions. We obtain audit evidence through testing the effectiveness of controls, substantive procedures or a combination of both. In addition, we read all the financial and non-financial information in the Annual Report to identify material inconsistencies with the audited financial statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with, the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report. Other matter We have reported separately on the group financial statements of Meggitt PLC for the year ended 31 December 2014. We have no exceptions to report arising from this responsibility. Directors’ remuneration Directors’ remuneration report - Companies Act 2006 opinion In our opinion, the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006. Andrew Paynter (Senior Statutory Auditor) for and on behalf of PricewaterhouseCoopers LLP Chartered Accountants and Statutory Auditors London 23 February 2015 93987_p133.indd 133 04/03/2015 17:37 134 MEGGITT PLC REPORT AND ACCOUNTS 2014 Company balance sheet As at 31 December 2014 Fixed assets Tangible fixed assets Derivative financial instruments Investments Current assets Debtors Derivative financial instruments Cash at bank and in hand Creditors – amounts falling due within one year Derivative financial instruments Net current assets Total assets less current liabilities Creditors – amounts falling due after more than one year Provision for liabilities and charges Derivative financial instruments Net assets Capital and reserves Called-up share capital Share premium account Capital redemption reserve Other reserves Profit and loss reserve Total shareholders’ funds Notes 2014 £’m 2013 £’m 3 9 4 5 9 6 9 7 8 9 12 13 13 13 13 13 34.5 30.6 2,070.1 2,135.2 997.0 6.6 3.8 1,007.4 (212.2) (10.4) 784.8 31.1 35.5 2,069.9 2,136.5 940.0 11.4 17.0 968.4 (79.5) (9.3) 879.6 2,920.0 3,016.1 (403.3) (2.8) (3.1) (664.5) (1.7) (10.2) 2,510.8 2,339.7 40.1 1,218.9 0.3 17.5 1,234.0 39.9 1,166.3 - 17.5 1,116.0 2,510.8 2,339.7 The financial statements on pages 134 to 140 were approved by the Board of Directors on 23 February 2015 and signed on its behalf by: S G Young Director D R Webb Director 93987_p134.indd 134 04/03/2015 17:14  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 135 Notes to the financial statements of the Company 1. Basis of preparation Foreign currencies These financial statements have been prepared on a going concern basis and under the historical cost accounting convention, as modified by the revaluation of certain financial assets and financial liabilities (including derivative financial instruments) at fair value, in accordance with the Companies Act 2006. The Company continues to prepare its financial statements in accordance with UK Generally Accepted Accounting Practice (UK GAAP). 2. Summary of significant accounting policies The principal accounting policies adopted by the Company in the preparation of the financial statements are set out below. These policies have been applied consistently to all periods presented unless stated otherwise. Investments Investments in subsidiaries are stated at cost less provision for impairment in value, except for investments acquired before 1 January 1988 where Section 612 merger relief has been taken and investments are stated at the nominal value of the shares issued in consideration. Tangible fixed assets Tangible fixed assets are stated at cost, net of depreciation and any impairment losses. Cost includes the original purchase price of the asset and costs attributable to bringing the asset into use. Depreciation is not provided on freehold land. On other assets it is provided in equal annual instalments over their estimated useful lives as follows: Land and buildings ...................................... Over period of lease Plant and equipment ................................... 3 to 10 years Motor vehicles.............................................. 5 years Operating leases Rental costs under operating leases are charged to the profit and loss account on a straight-line basis over the lease term, even if the payments are not made on this basis. Taxation The charge for taxation is based on the profit for the period and takes into account taxation deferred because of timing differences between the treatment of certain items for taxation and accounting purposes. Deferred taxation is provided in full, without discounting, 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 they crystallise based on current tax rates and law. Deferred taxation assets are recognised to the extent it is regarded as more likely than not that they will be recovered. Deferred taxation is not provided on timing differences arising from the sale or revaluation of fixed assets unless, at the balance sheet date, a binding commitment to sell the asset has been entered into and it is unlikely that any gain will qualify for rollover relief. Transactions in foreign currencies are recorded at exchange rates prevailing at the dates of the transactions. Monetary assets and liabilities, denominated in foreign currencies at the balance sheet date, are reported at exchange rates prevailing at that date. Exchange differences on retranslating monetary assets and liabilities are recognised in the profit and loss account, except where they relate to qualifying cash flow hedges in which case the exchange differences are recognised in equity. Pension scheme arrangements As the Company is unable to identify its share of the underlying assets and liabilities of the Meggitt Pension Plan on a consistent and reasonable basis, the Company accounts for the scheme as though it were a defined contribution scheme. Accordingly the amount charged to the profit and loss account is the contribution payable in the period. Differences between contributions payable in the period and contributions paid are shown as accruals or prepayments in the balance sheet. Share-based compensation The fair value of services received from employees is recognised as an expense in the profit and loss account over the period for which services are received (‘the vesting period’). Awards made to employees of the Company are equity-settled. The fair value of an award is measured at the date of grant and reflects any market-based vesting conditions. Non market-based vesting conditions are excluded from the fair value of the award. At the date of grant, the Company estimates the number of awards expected to vest as a result of non market-based vesting conditions and the fair value of this estimated number of awards is recognised as an expense in the profit and loss account on a straight-line basis over the vesting period. At each balance sheet date, the Company revises its estimate of the number of awards expected to vest as a result of non market-based vesting conditions and adjusts the amount recognised cumulatively in the profit and loss account to reflect the revised estimate. Proceeds received, net of directly attributable transaction costs, are credited to share capital (nominal value) and share premium. The grant by the Company of options over its equity instruments to employees of subsidiary undertakings, is treated as a capital contribution. The fair value of the awards made is recognised, over the vesting period, as an increase in investment in subsidiary undertakings, with a corresponding credit to the profit and loss reserve. Shares in the Company are held by an independently managed Employee Share Ownership Trust (‘ESOP Trust’), to meet future obligations in respect of the Company’s employee share schemes. The cost of own shares held by the ESOP Trust is deducted from shareholders’ funds. 93987_p135-140.indd 135 04/03/2015 17:15 136 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the financial statements of the Company continued 2. Summary of significant accounting policies continued Loans Derivative financial instruments and hedging Derivative financial instruments are recognised at fair value on the date the derivative contract is entered into and are subsequently remeasured at fair value at each balance sheet date. To the extent the maturity of the financial instrument is more than 12 months from the balance sheet date, the fair value is reported as a non-current asset or liability. Derivative financial instruments with maturities of less than 12 months from the balance sheet are shown as current assets or liabilities. The method by which any gain or loss is recognised depends on the designation of the derivative financial instrument: Fair value hedges Fair value hedges are hedges of the fair value of recognised assets or liabilities or a firm commitment. Interest rate swaps that change fixed rate interest to variable rate interest are treated as fair value hedges provided they meet the hedge criteria. Changes in the fair value of derivative financial instruments, designated as fair value hedges, are recognised in the profit and loss account together with changes in the fair value of the hedged item. Cash flow hedges Cash flow hedges are hedges of highly probable forecast transactions. Interest rate swaps that change variable rate interest to fixed rate interest are treated by the Company as cash flow hedges provided they meet the hedge criteria. Changes in fair value of the effective portion of derivative financial instruments, designated as cash flow hedges, are initially recorded within equity. To the extent changes in fair value are recorded in equity, they are recycled to the profit and loss account in the periods in which the hedged item affects the profit and loss account. However, when the transaction to which the hedge relates results in the recognition of a non-monetary asset or a liability then gains and losses previously recognised in equity are included in the initial measurement of the cost of the non-monetary asset or liability. If the forecast transaction to which the cash flow hedge relates is no longer expected to occur, the cumulative gain or loss previously recognised in equity is transferred to the profit and loss account immediately. If the hedging instrument is sold, expires or no longer meets the criteria for hedge accounting the cumulative gain or loss previously recognised in equity is transferred to the profit and loss account when the forecast transaction is recognised in the profit and loss account. Derivatives that do not meet the criteria for hedge accounting Where derivatives do not meet the criteria for hedge accounting, changes in fair value are recognised immediately in the profit and loss account. The Company utilises a number of foreign currency forward contracts to mitigate against currency fluctuations. The Company has determined that the additional costs of meeting the extensive documentation requirements for the Company’s large number of foreign currency contracts are not merited. Accordingly gains and losses arising from measuring the contracts at fair value are recorded immediately in the profit and loss account. Loans are initially stated at proceeds received less directly attributable transaction costs incurred. Transaction costs are amortised to the profit and loss account over the period of the loans. Fixed interest rate borrowings are held at fair value where a hedge relationship is in place. Any related interest accruals are included within the value at which loans are recorded. Loans are classified as current liabilities unless the Company has an unconditional right to defer settlement of the liability for at least 12 months after the balance sheet date. Capital instruments Ordinary shares are classified as equity. Incremental costs directly attributable to the issue of new shares are deducted from the proceeds recorded in equity. Other instruments are classified as liabilities if they contain an obligation to transfer economic benefits, otherwise they are included in shareholders’ funds. Dividends Interim dividends are recognised when they are approved by the Board. Final dividends are recognised when they are approved by the Company’s shareholders. Profit and recognised gains and losses of the Company The Company has taken advantage of the legal dispensation contained in Section 408 of the Companies Act 2006 allowing it not to publish a separate profit and loss account and related notes. The Company has also taken advantage of the legal dispensation contained in Section 408 of the Companies Act 2006 allowing it not to publish a separate statement of recognised gains and losses. Related party transactions The Company has taken advantage of the exemption contained in FRS 8 from the requirement to disclose related party transactions within the Group. Share buyback On 5 November 2014, the Company announced the intention to commence a share buyback programme. The total consideration payable for shares purchased is deducted from the profit and loss reserve. The shares when purchased are cancelled and the nominal value of the cancelled shares is transferred from share capital to a separate capital redemption reserve. Where the Company has entered into an irrevocable non-discretionary contract to purchase for cancellation, shares on its behalf during a close period, the obligation to purchase shares is recognised in full at the inception of the contract, even when that obligation is conditional on the share price. The obligation is remeasured at each balance sheet date with changes recognised in the profit and loss account. 93987_p135-140.indd 136 04/03/2015 17:15  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 137 3. Tangible fixed assets Cost at 1 January 2014 Additions Disposals Cost at 31 December 2014 Accumulated depreciation at 1 January 2014 Charge for year Disposals Accumulated depreciation at 31 December 2014 Net book amount at 31 December 2014 Net book amount at 31 December 2013 Net book amount of land and buildings: Short leasehold Total 4. Investments Shares in subsidiaries: At 1 January Capital contributions (see note 13) Less contributions from subsidiary companies At 31 December Land and buildings £’m 0.7 – (0.1) 0.6 0.4 – (0.1) 0.3 0.3 0.3 Plant, equipment and vehicles £’m 39.0 7.5 (0.2) 46.3 8.2 4.0 (0.1) 12.1 34.2 30.8 2014 £’m 0.3 0.3 Total £’m 39.7 7.5 (0.3) 46.9 8.6 4.0 (0.2) 12.4 34.5 31.1 2013 £’m 0.3 0.3 2014 £’m 2013 £’m 2,069.9 1.2 (1.0) 2,060.7 9.2 – 2,070.1 2,069.9 The directors believe the carrying value of investments is supported by their underlying assets. A list of principal subsidiaries is included in note 43 of the Group accounts. 5. Debtors Amounts falling due within one year: Amounts owed by subsidiary undertakings Other debtors Prepayments and accrued income Total 6. Creditors – amounts falling due within one year Bank loans and overdrafts Other loans Trade creditors Amounts owed to subsidiary undertakings UK corporation tax payable Taxation and social security Other creditors Share buyback – close period commitment Accruals Total Bank loans and overdrafts, other loans and amounts owed to subsidiary undertakings are unsecured. 2014 £’m 2013 £’m 993.4 0.3 3.3 997.0 2014 £’m 6.1 48.0 1.4 115.6 13.1 2.7 1.7 20.0 3.6 212.2 936.3 1.2 2.5 940.0 2013 £’m 0.1 2.9 2.8 45.5 16.2 5.6 1.9 – 4.5 79.5 93987_p135-140.indd 137 04/03/2015 17:15 138 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the financial statements of the Company continued 7. Creditors – amounts falling due after more than one year Bank loans Other loans Total Bank loans and other loans are unsecured. Analysis of bank loans and overdrafts repayable: In one year or less In more than one year but not more than five years Total Analysis of other loans repayable: In one year or less In more than one year but not more than five years In more than five years Total Amounts repayable in more than five years mature in 2020 and 2022. 8. Provision for liabilities and charges Movements in the deferred tax provision are analysed as follows: At 1 January Charge/(credit) to profit and loss account (Credit)/charge to profit and loss reserve At 31 December The deferred tax provision is analysed as follows: Accelerated capital allowances Other short-term timing differences Total 2014 £’m – 403.3 403.3 2014 £’m 6.1 – 6.1 2014 £’m 48.0 131.3 272.0 451.3 2014 £’m 1.7 1.3 (0.2) 2.8 2014 £’m 2.9 (0.1) 2.8 2013 £’m 245.8 418.7 664.5 2013 £’m 0.1 245.8 245.9 2013 £’m 2.9 166.8 251.9 421.6 2013 £’m 1.8 (0.2) 0.1 1.7 2013 £’m 1.7 – 1.7 93987_p135-140.indd 138 04/03/2015 17:15  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 139 9. Derivative financial instruments Interest rate swaps Foreign currency forward contracts Total Less non-current portion: Interest rate swaps Foreign currency forward contracts Non-current portion Current portion 2014 Assets £’m 2014 Liabilities £’m 28.3 8.9 37.2 28.3 2.3 30.6 6.6 – (13.5) (13.5) – (3.1) (3.1) (10.4) 2013 Assets £’m 24.9 22.0 46.9 24.9 10.6 35.5 11.4 2013 Liabilities £’m – (19.5) (19.5) – (10.2) (10.2) (9.3) The Company is exempt from the FRS 29 disclosures as the consolidated financial statements of the Group give the disclosures required by IFRS 7 (see Group accounts notes 29 and 30). 10. Commitments Capital commitments Contracted for but not incurred: Plant, equipment and vehicles Total Operating lease commitments Annual commitments under non-cancellable operating leases, all of which relate to land and buildings, expire as follows: Later than five years Total 11. Pensions 2014 £’m 0.2 0.2 2014 £’m 0.1 0.1 2013 £’m 0.1 0.1 2013 £’m 0.1 0.1 The directors believe the FRS 17 deficit for the scheme in which the Company participates would be consistent with the IAS 19 deficit reported in note 33 to the Group accounts in respect of the UK scheme. At 31 December 2014, an amount of £0.1 million (2013: £0.1 million) relating to contributions payable in respect of the defined contribution scheme were outstanding. 12. Called-up share capital Allotted and fully paid: At 1 January 2014 Issued on exercise of executive share awards Share buyback – purchased in year Scrip dividends At 31 December 2014 Ordinary shares of 5p each Number ‘m Nominal value Net consideration £’m £’m 797.1 0.4 (6.8) 11.6 802.3 39.9 – (0.3) 0.5 40.1 0.1 (33.7) 53.0 93987_p135-140.indd 139 04/03/2015 17:15 140 MEGGITT PLC REPORT AND ACCOUNTS 2014 Notes to the financial statements of the Company continued 13. Reconciliation of movements in shareholders’ funds Called-up share capital £’m Share premium account £’m Capital redemption reserve £’m At 1 January 2014 Profit for the financial year Dividends Cash flow hedge movements Currency translation differences Employee share option schemes: Value of subsidiary employee services (see note 4) Value of services provided Purchase of own shares Shares issued Share buyback - purchased in year Share buyback - close period commitment Scrip dividends 39.9 – – – – – – – – (0.3) – 0.5 1,166.3 – – – – – – – 0.1 – – 52.5 At 31 December 2014 40.1 1,218.9 – – – – – – – – – 0.3 – – 0.3 Details of the Group’s employee share schemes are included in note 35 of the Group accounts. Other reserves £’m 17.5 – – – – – – – – – – – Profit and loss reserve £’m 1,116.0 286.5 (104.4) (0.6) 0.1 1.2 0.5 (11.6) – (33.7) (20.0) – Total 2014 £’m 2,339.7 286.5 (104.4) (0.6) 0.1 1.2 0.5 (11.6) 0.1 (33.7) (20.0) 53.0 Total 2013 £’m 2,309.3 90.3 (95.6) 1.6 0.2 9.2 2.2 – 2.5 – – 20.0 17.5 1,234.0 2,510.8 2,339.7 93987_p135-140.indd 140 04/03/2015 17:15  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 141 Five-year record Revenue and profit Revenue Underlying profit before tax Exceptional operating items Amortisation of intangible assets acquired in business combinations Disposal of inventory revalued in business combinations Financial instruments Net interest expense on retirement benefit obligations Profit before tax Earnings and dividends Earnings per share – basic Earnings per share – underlying Dividends per ordinary share (paid or proposed in respect of the year) Gearing ratio Year end net debt as a percentage of capital employed 2014 £’m 2013 £’m 2012 £’m 2011 £’m 2010 £’m 1,553.7 1,637.3 1,605.8 1,455.3 1,162.0 328.7 (12.5) (68.1) – (29.2) (10.0) 208.9 377.8 (28.4) (74.3) (0.3) 6.1 (11.5) 269.4 366.0 (13.3) (80.6) (0.2) 23.4 (14.0) 281.3 325.3 (20.3) (75.1) (11.3) 9.7 (12.1) 216.2 22.0p 32.4p 13.75p 29.4p 37.5p 12.75p 30.1p 36.5p 11.80p 23.1p 32.1p 10.50p 263.7 (15.7) (64.7) – (3.2) (15.3) 164.8 19.3p 28.6p 9.20p 26.9% 27.2% 33.7% 44.0% 50.2% 93987_p141.indd 141 04/03/2015 17:17 142 MEGGITT PLC REPORT AND ACCOUNTS 2014 Investor information Contacts Investor relations Information on Meggitt PLC, including the latest share price: www.meggitt.com T: 01202 597597 E: investors@meggitt.com Shareholder enquiries Enquiries about the following administrative matters should be addressed to Meggitt PLC’s registrar: Registrar: Computershare Investor Services PLC The Pavilions Bridgwater Road Bristol BS99 6ZZ T: 0870 703 6210 E: www.investorcentre.co.uk/contactus • Change of address notification. • Lost share certificates. • Dividend payment enquiries. • Dividend mandate instructions. Shareholders may have their dividends paid directly into their bank or building society accounts by completing a dividend mandate form. Tax vouchers are sent directly to shareholders’ registered addresses. • Amalgamation of shareholdings. Shareholders who receive more than one copy of the annual report are invited to amalgamate their accounts on the share register. Shareholders can view and manage their shareholdings online at www.investorcentre.co.uk, including updating address records, making dividend payment enquiries, updating dividend mandates and viewing the latest share price. Shareholders will need their Shareholder Reference Number (SRN), which can be found on their share certificate or a recent dividend tax voucher, to access this site. Once signed up to Investor Centre, an activation code will be sent to the shareholder’s registered address to enable the shareholder to manage their holding. Other useful contacts Share dealing services are provided for shareholders by Computershare Investor Services PLC. These services are provided by telephone (0870 703 0084) and online (to access the service, shareholders should have their SRN and log onto www.computershare.com/dealing/uk). ShareGift (www.sharegift.org, registered charity number 1052686): 17 Carlton House Terrace, London, SW1Y 5AH (0207 930 3737). ShareGift, the independent share donation charity, is especially useful for those who may want to dispose of a small number of shares which are uneconomic to sell on their own. Shares which have been donated to ShareGift are aggregated and sold when practicable, with the proceeds passed on to a wide range of UK registered charities. Other Information Dividends The proposed 2014 final dividend of 9.50p per ordinary share, if approved, will be paid on 8 May 2015 to shareholders on the register on 20 March 2015. The expected payment date for the 2015 interim dividend is 2 October 2015. 2015 provisional financial calendar Key dates 2015 Full-year results for year ended 31 December 2014 Final dividend ex-dividend date Final dividend record date Report and accounts for year ended 31 December 2014 despatched Deadline for receipt of dividend reinvestment plan elections AGM and trading statement 2014 Final dividend payment date Interim results for period ended 30 June 201 5 Interim dividend ex-dividend date Interim dividend record date Deadline for receipt of dividend reinvestment plan elections 2015 Interim dividend payment date 24 February 19 March 20 March 20 March 16 April 23 April 8 May 4 August 3 September 4 September 11 September 2 October FEBRUARY APRIL AUGUST 24 Full-year results 23 AGM & interim management statement 4 Interim results 93987_p142.indd 142 04/03/2015 17:19  STRATEGIC REPORT GOVERNANCE REPORTS FINANCIAL STATEMENTS SUPPLEMENTARY INFORMATION 143 Glossary Aftermarket Spares and repairs AGM ALM ASK ATA Annual general meeting Additive layer manufacturing Available seat kilometres Air Transport Association Chapter numbers represent an industry-wide approach to commercial aircraft system numbering and documentation. Meggitt offers full ATA Chapter 26 fire protection and is expanding its ATA 32 landing gear system offering Board Board of directors Book to bill The ratio of orders received to revenue recognised in a specific period CAGR Compound annual growth rate Capability Expertise in technology and manufacturing CGU CO2 Code CODM Cash generating unit Carbon dioxide UK Corporate Governance Code Chief operating decision-maker FRC FRS FTSE GAAP GBP GC 100 GDP GHG Group HMRC HSE IAS IDIQ IED IFRIC Financial Reporting Council Financial Reporting Standard Share index of companies listed on the London Stock Exchange Generally Accepted Accounting Practice British pound or pound sterling Association of General Counsel & Company Secretaries of FTSE-100 companies Gross domestic product Greenhouse gas Meggitt PLC and its subsidiaries HM Revenue & Customs Health, safety and environment International Accounting Standards Indefinite delivery, indefinite quantity Improvised explosive device International Financial Reporting Interpretations Committee Company Meggitt PLC IFRS International Financial Reporting Standards Condition-monitoring Monitoring the condition of aerospace and land- Installed base The sum total of the Meggitt products and sub- systems installed on customers’ equipment based turbines and supporting equipment to predict wear and tear, promoting safety, up-time and planned maintenance Continuing Resolution Appropriations legislation restricting modification from prior-year funding patterns IRS ISA KPI Internal Revenue Services International Standards on Auditing Key performance indicator Department of Energy & Climate Change Large jets Commercial aircraft with greater than 100 seats DECC DEFRA DoD DPPM DRIP DTR EBITDA ESOP EU Executive Board Department for Environment, Food & Rural Affairs (United States) Department of Defense Defective Parts Per Million Dividend reinvestment plan Disclosure and Transparency Rules Earnings Before Interest, Tax, Depreciation and Amortisation Employee Share Ownership Plan European Union Board which assists the Chief Executive with the development and implementation of the Group’s strategy, the management of the business and the discharge of responsibilities delegated by the Board Facility Factory FAA FCA FIFO FLNG FOC FPSO Federal Aviation Administration Financial Conduct Authority First-in first-out Floating liquefied natural gas Free of charge Floating production, storage and offload LIBOR LTIP LNG MAAP London Inter-Bank Offered Rate Long-Term Incentive Plan Liquefied natural gas Meggitt Aerospace Asia Pacific, the Group’s maintenance, repair and overhaul hub in Singapore MABS Meggitt Aircraft Braking Systems M&A MCS MEG Meggitt Production System (MPS) Mix MoD MPC MPP MRO Mergers and acquisitions Meggitt Control Systems Meggitt Equipment Group Our single global approach to continuous improvement using tools and processes tailored for the Group, and extending from the factory floor into every function The impact on performance of revenue streams with higher or lower profitability growing at differing rates UK Ministry of Defence Meggitt Polymers & Composites Meggitt Pension Plan Maintenance, repair and overhaul 93987_p143-144.indd 143 11/03/2015 13:01 144 MEGGITT PLC REPORT AND ACCOUNTS 2014 Glossary continued MSS M4 Meggitt Sensing Systems Meggitt Modular Modifiable Manufacturing, an advanced manufacturing engineering concept that will underpin the more efficient aerospace factories of the future. They will continue to accommodate low volumes of largely handmade products but those products will become increasingly complex and often involve new manufacturing technologies requiring new kinds of factory operators and managers and new standards of traceability SCRIP SIP Shipset Smart engineering for extreme environments Share dividend plan Share Incentive Plan Total value of the components and subsystems installed on a single aircraft or ground vehicle type What Meggitt specialises in: long-life, highly reliable, often mission-critical products that must operate effectively in the harsh conditions of aero-engines, oil and gas and power generation environments and combat Sequestration US government defence budget cuts SRN STEM STIP TRI TSR UAV USD Shareholder Reference Number Science, technology, engineering and mathematics Short Term Incentive Plan Total reportable injuries Total shareholder return Unmanned aerial vehicle United States dollar WACC Weighted average cost of capital Organic growth Growth excluding the impact of currency and acquisitions and disposal of businesses OE OECD Original equipment Organisation for Economic Cooperation and Development OEM Original equipment manufacturer Operations Board Operations excellence ORB OTD PBT PCHE PECC Platform Assists the Chief Operating Officer to manage the Group’s operations and discharge the responsibilities delegated by the Executive Board A system of tools and processes that embraces the way in which every aspect of Meggitt is managed from the factory floor to all functions and every level of leadership from supervisors to the Executive Board The Group’s obsolescence review board On-time Delivery Profit before tax Printed circuit heat exchanger – a block of flat, diffusion-bonded plates on to which fluid flow channels have been chemically milled Precision Engine Controls Corporation Aircraft or ground vehicle model incorporating Meggitt products PPC Programme Participation Cost Programme The production and utilisation lifecycle of an aircraft model or ground vehicle PwC R&D REACH PricewaterhouseCoopers LLP Research and development Registration, Evaluation and Authorisation of Chemicals Regional aircraft Commercial aircraft with fewer than 100 seats Registrar Computershare Investor Services PLC RIDDOR ROTA RPA SAP SARs SAYE The Reporting of Injuries, Diseases and Dangerous Occurrences Regulations Return on trading assets Retirement Protection Act The Group’s selected enterprise management system Share appreciation rights Sharesave Scheme 93987_p143-144.indd 144 04/03/2015 17:19 Quick reference Contents What is Meggitt? How did we perform in 2014? 02 04 31 What is our strategy and business model? 06 08 What are our markets and what drives them? 10 How do we manage risk? What are our key performance indicators? 24 27 How do we perform as corporate citizens? 38 Who runs Meggitt and how do we reward them? 01-41 Strategic report 01 02 03 04 05 06-07 08-09 10-12 13-17 18-19 20-21 22-23 24-26 27-30 31-37 38-41 Introduction Group overview Capabilities Financial highlights Chairman’s statement Chief Executive’s review Group strategy Market review Meggitt divisions The Meggitt Production System Talent Technology Principal risks and uncertainties Key performance indicators Chief Financial Officer’s review Corporate responsibility 42-79 Governance reports Chairman’s introduction 43 Board of directors 44-45 Corporate governance report 46-50 Audit Committee report 51-53 Nominations Committee report 54 Directors’ remuneration report 55-75 Directors’ report 76-79 80-140 Financial statements 80-84 Group financial statements Independent auditors’ report to the members of Meggitt PLC Consolidated income statement 85 Consolidated statement of comprehensive income 86 Consolidated balance sheet 87 Consolidated statement of changes in equity 88 89 Consolidated cash flow statement 90-132 Notes to the consolidated financial statements 44 55 133 Company financial statements Independent auditors’ report to the members of Meggitt PLC Company balance sheet 134 135-140 Notes to the financial statements of the Company Smart engineering is second nature to us High pressure air travelling through the geometry of bleed air valves cast or machined in the traditional way is extremely noisy, something that will be familiar to those who live near airports. In future, air could flow more quietly through a radical new concept from Meggitt based on a fir-cone design, an organic structure made possible through additive layer manufacturing. The bold use of innovative processes forms part of Meggitt’s centrally coordinated and highly focused technology strategy. 141-144 Supplementary information 141 142 143-144 Glossary Five-year record Investor information Download the 2014 Meggitt PLC annual report and accounts from www.meggitt.com Designed by Hybrid Creative Typeset by Whitehouse Associates Printed by Pureprint The papers used for the production of this report are certified by the Forestry Stewardship Council® and are elemental chlorine free. They are produced at paper mills certified to ISO 14001 and registered to EMAS. 93987_Cover.indd 2 04/03/2015 16:10 Company information Meggitt PLC Atlantic House Aviation Park West Bournemouth International Airport Christchurch Dorset BH23 6EW United Kingdom T +44 (0) 1202 597 597 F +44 (0) 1202 597 555 www.meggitt.com Registered in England and Wales Company number 432989 M E G G I T T P L C A N N U A L R E P O R T A N D A C C O U N T S | 2 0 1 4 Smart engineering is second nature to us. ANNUAL REPORT AND ACCOUNTS 2014 93987_Cover.indd 1 04/03/2015 16:10 

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