Rolls-Royce Annual Report 2011

Plain-text annual report

Rolls-Royce Holdings plc Annual report 2011 Trusted to deliver excellence R o l l s - R o y c e H o d n g s p c l l i A n n u a l r e p o r t 2 0 1 1 ® ® © Rolls-Royce plc 2012 Rolls-Royce Holdings plc Registered office: 65 Buckingham Gate London SW1E 6AT T +44 (0)20 7222 9020 www.rolls-royce.com Company number 7524813 T r u s t e d t o d e l i v e r e x c e l l e n c e Contents Civil aerospace Defence aerospace p18 p20 Marine Energy p22 p24 Technology Operations p26 p28 Visit Rolls-Royce online Below are some examples of the type of information and services available:  The Group’s business  Governance  Sustainability  News/updates  People  Investors  Heritage www.rolls-royce.com/investors Business review Introduction 1 2 Chairman’s statement 4 Chief Executive’s review 6 Our business model and strategy 8 Our business segments 9 Market opportunities 10 Key performance indicators 14 Finance Director’s review 18 Civil aerospace 20 Defence aerospace 22 Marine 24 Energy 26 Excellence in technology 28 Excellence in operations 30 Sustainability 34 Principal risks and uncertainties 36 Additional financial information Governance 38 Board of directors 40 International Advisory Board 40 The Group Leadership Team 41 Chairman’s introduction 42 UK Corporate Governance Code 46 Audit committee report 48 Nominations committee report 50 Ethics committee report 51 Risk committee report 52 55 Directors’ remuneration report 66 Shareholders and share capital 68 Other statutory information Remuneration committee report Financial statements Contents listed on page 71 Other matters 122 Subsidiaries, jointly controlled entities and associates 125 Independent Auditor’s report 126 Group five-year review 127 Shareholder information 129 Glossary Directors’ report The Directors’ report which includes the Business review is set out on pages 1 to 70. Forward-looking statements This Annual report contains forward- looking statements. Any statements that express forecasts, expectations and projections are not guarantees of future performance and will not be updated. By their nature, these statements involve risk and uncertainty, and a number of factors could cause material differences to the actual results or developments. This report is intended to provide information to shareholders, is not designed to be relied upon by any other party, or for any other purpose and the Company and its directors accept no liability to any other person other than under English law. 129 Glossary Glossary ABC ABI ACARE ADR ADVENT AEBS AFRL AGM ANA APB APRA ASD BDI BIS BitC CAD CDP CEO CGU CO2 CPI CPS CRIP DJSI EASA EFE EPS ESOP EU FSA GBP GDP GHG GLT HR HS&E I&C IAB IAE IAS IASB IFBEC IFRIC Anti-bribery and corruption Association of British Insurers Advisory Council for Aviation Research and Innovation in Europe American Depositary Receipts Programme Adaptive Versatile Engine Technology All-Employee Bonus Scheme US Air Force Research Lab Annual General Meeting All Nippon Airways Auditing Practices Board Annual Performance Related Award plan Aerospace and Defence Industries Association of Europe Federation of German Industries Department for Business, Innovation and Skills Business in the Community Corporate Responsibility Index Canadian dollar Carbon Disclosure Project Chief Executive Officer Cash-generating unit Carbon dioxide Consumer Price Index Cash flow per share C Share Reinvestment Plan Dow Jones Sustainability World and European Indexes European Aviation Safety Agency Environmentally Friendly Engine Earnings per ordinary share Executive Share Option Plan European Union Financial Services Authority Great British pound or pound sterling Gross domestic product Greenhouse gas Group Leadership Team Human Resources Health, Safety and Environment Instrumentation and control International Advisory Board IAE International Aero Engines AG International Accounting Standards International Accounting Standards Board International Forum on Business Ethical Conduct International Financial Reporting Interpretations Committee International Financial Reporting Standards IFRS Integrated Vehicle Energy Technology INVENT Integrated Power and Thermal Management System Development IPTMSD International Standards Organisation ISO Liability-driven investment LDI London Inter-bank Offered Rate LIBOR Limited Liability Partnership LLP Long-Term Service Agreement LTSA UK Ministry of Defence MoD Memorandum of Understanding MoU Megawatt hours MWh North Atlantic Treaty Organisation NATO Nitrogen oxides NOx Other comprehensive income OCI Original Equipment OE Organisation for Economic Cooperation and Development OECD Over-the-counter OTC Political Action Committee PAC Product Introduction and Lifecycle Management PILM Public Limited Company PLC Performance Share Plan PSP Pressurised Water Reactor PWR Research and Development R&D Research and Technology R&T RCF Revolving credit facility Registrar Computershare Investor Services PLC Rolls-Royce North America RRNA Risk and Revenue Sharing Partnerships RRSPs Restricted stock units RSUs Systems, applications and products SAP Supply Chain Relationships in Aerospace SCRIA Strategic Defence and Security Review SDSR Share Incentive Plan SIP Sulphur oxides SOx Shareholder Reference Number SRN Science, technology, engineering and maths STEM Short Take-Off and Vertical Landing STOVL Total reportable injuries TRI TSR Total Shareholder Return UK GAAP UK Generally Accepted Accounting Practices USD VDA United States dollar Verband der Automobilindustrie (German Association of the Automotive Industry) Vice President VP Designed and produced by conran design group The paper used in the report contains 75% recycled content, of which 75% is de-inked post-consumer. All of the pulp is bleached using an elemental chlorine free process (ECF). environmental printing technology, Printed in the UK by PurePrint using their and and vegetable inks were used throughout. PurePrint is a CarbonNeutral® company. Both manufacturing mill and the printer are registered to the Environmental Management System ISO 14001 and are Forest Stewardship Council® (FSC) chain-of-custody certified. s t n e m e t a t s l i a c n a n F i 1 Introduction Rolls-Royce is a global company providing power solutions for customers in civil and defence aerospace, marine and energy markets. We support our customers through a worldwide network of offices, manufacturing and service facilities in over 50 countries. Our ability to design and develop high-technology products and then integrate these into sophisticated systems for use on land, sea and air, provides us with access to global markets. 2010 2011 % change Order book – firm and announced £59.2bn £62.2bn Underlying revenue* Profit before financing Underlying profit before tax* Underlying earnings per ordinary share* Payments to shareholders * See explanation in note 2 on page 84 £10,866m £11,277m £1,134m £1,189m £955m 38.73p 16.00p £1,157m 48.54p 17.50p +5% +4% +5% +21% +25% +9% Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review3 Chairman’s statement Rolls-Royce has a highly-skilled and motivated team – proud of its heritage and ambitious for its future. Sir Simon Robertson Chairman February 8, 2012 is being made. One good example is the Boeing 787 Dreamliner that entered service in September 2011. This extraordinary aeroplane is designed to be 20 per cent more fuel efficient than the earlier generation of aircraft it replaces, thanks largely to advances in aero-engine technology. Our marine business has advanced hull designs, engines, and integrated propulsion systems that are reducing emissions dramatically. In our energy business we have continued to make good progress developing the scope of our civil nuclear capabilities. I would like to thank my fellow directors for their great support and hard work in the past year. I would also like particularly to express my gratitude to Andrew Shilston, who retired from the Board at the year end. Andrew served Rolls-Royce as Finance Director for nine years and has done an outstanding job. I wish him well in his future endeavours. My congratulations go to Mark Morris, who succeeds Andrew and was appointed to the Board in January 2012. Mark joined Rolls-Royce as a graduate 25 years ago. Sir John Rose, who had been with the Group for 27 years and was Chief Executive for 15 years, retired at the end of March and was succeeded by John Rishton. I have paid tribute to John Rose on a number of occasions including in last year’s Annual report. Suffice it for me to say, we owe John a huge amount for what he achieved. I am very pleased to report that John Rishton has made a tremendous start as our new Chief Executive. Sir Peter Gregson has expressed his wish to retire as a non-executive director of Rolls-Royce at this year’s Annual General Meeting (AGM) and therefore will not be seeking re-election. Peter has made a valuable contribution during the past five years and I would like to thank him for his commitment. I am delighted to welcome both Lewis Booth and Sir Frank Chapman onto the Board as non-executive directors. Lewis Booth, who chairs the audit committee, is Executive Vice President and Chief Financial Officer of Ford Motor Company and one of the most senior leaders within the auto industry. Sir Frank has been Chief Executive at BG Group for the past 11 years. He brings an additional deep technical understanding and knowledge of advanced engineering to the Board. He has agreed to chair a new safety committee that will be formed in 2012. We are fortunate to benefit from the advice of an International Advisory Board (IAB), comprised of some of the world’s most distinguished business and political leaders. The IAB, whose membership is detailed later, provides invaluable strategic advice about the global markets in which we operate under the able guidance of Lord Powell of Bayswater. I would like to thank its members for their time and wisdom. Through the disciplined application of a long-term strategy, Rolls-Royce has doubled its revenues in the past decade and we are confident of doubling them again in the coming ten years. Rolls-Royce has a strong balance sheet and we intend to run our business so that we maintain a single ‘A’ credit rating. In all parts of our business we see opportunities for profitable growth, building on the firm foundations I have described above. At the heart of our business lie our people. Our past, current and future success rests entirely with them. I believe Rolls-Royce has a highly-skilled and motivated team which is proud of its heritage and ambitious for its future. The strength of our order book demonstrates the confidence our customers have placed in us. We are focused on delivering these commitments for the long-term good of the families and communities who depend upon us and for the benefit of our customers and of our shareholders. Business reviewBusiness review 4 Chief Executive’s review Delivering for customers and investing in the business Demand for our products and services in 2011 remained strong. Despite the global economic turbulence of recent years, Rolls-Royce has continued to grow. In my first year as Chief Executive, I have spent much of my time visiting Rolls-Royce sites around the world to meet employees, customers, suppliers and investors to hear what they have to say about your company. Without exception, the employees I have met are dedicated, professional and committed to delivering our brand promise – ‘trusted to deliver excellence’. Our customers are supportive and enthusiastic about our technology and, of course, they want even better performance both from our products and our team. Our suppliers are excited by the opportunity for growth and understand our requirement for better quality, on time delivery and lower cost. Investors express support for our strategy and naturally share our desire for still better financial performance in the future. At the 2011 AGM, I confirmed that we will continue to follow the strategy that has been in place for many years, and can be summarised as: 1. addressing four global markets: civil aerospace, defence aerospace, marine and energy; 2. investing in technology, capability and infrastructure; 3. developing a competitive portfolio of products and services; 4. focusing on growing market share and our installed product base; and 5. adding value for our customers through product-related services. This strategy has stood the test of time and has proved itself in battle. Since 2007, and despite the turbulence of recent years, Rolls-Royce has grown underlying revenue by 44 per cent, underlying profits by 45 per cent and payments to shareholders by 35 per cent. We have doubled our revenues in the past decade and, through organic growth alone, we are confident that we will do the same in the decade ahead. While we continue to follow this strategy, in the coming years, I see three main priorities: 1. Delivering the promises we have made With a record order book of £62.2 billion, our customers have placed a huge amount of trust in us and it is essential we meet our commitments. This will require a very significant increase in capacity. To put this growth into perspective, since we started building Trent engines 18 years ago we have delivered just over 2,000 units. We will deliver the next 2,000 in just five years which means more than doubling our current rate of production. To achieve this we continue to invest in new facilities around the world. These investments include our new plants at Crosspointe in Virginia, USA where we are making discs for civil jet engines and Seletar, in Singapore, where we will make wide-chord fan blades and assemble and test Trent engines. We are also expanding and renewing our facilities in the UK where we still invest half of our capital expenditure and more than half of our research and development budget. As well as investing in our own facilities, we are working hard with our suppliers and partners to make sure our global supply chain can support our growth and keep pace with demand. 2. Deciding where we invest for future growth We can see opportunity in all areas of our business but we need to concentrate our resources and decide which opportunities we are going to pursue and which we are not. 3. Continuing to improve the financial performance of the business Although we are subject to inflationary pressures and tough competition we will benefit from the growth of the business, from investments that will improve efficiency and from an increasing focus on cost performance and cash conversion. In support of our strategy, during 2011 we made three very important decisions for the future. The first was our acquisition of the German industrial engines group Tognum, our biggest acquisition, that we made in a joint offer with Daimler. It will bring together highly complementary product and technology portfolios and creates significant new opportunities for our marine and energy businesses. Second, we signed an exclusive deal with Airbus to power the long-range Airbus A350-1000 aircraft, for which we will develop an enhanced Trent XWB engine. Rolls-Royce Holdings plc Annual report 2011Business review5 Chief Executive’s review Our strategy has stood the test of time and has proved itself in battle. John Rishton Chief Executive February 8, 2012 Third, we agreed to sell our equity stake in International Aero Engines (IAE) to Pratt & Whitney, at the same time announcing our intention to form a new joint venture to develop engines for the next generation of mid-size aircraft. This agreement builds on a long and successful partnership with Pratt & Whitney, and charts a clear course for our future in this important market segment. In addition, we have continued to extend our portfolio and have advanced a number of important programmes. These are described in greater detail later in this Annual report, but it is encouraging to note progress in each of our customer facing businesses. In civil aerospace, we celebrated the first commercial flight of the Boeing 787 Dreamliner, operated by All Nippon Airways (ANA) and powered by Trent 1000 engines. The Trent XWB engine programme for the Airbus A350 XWB is progressing well with over 1,500 test hours completed. Our BR725 engine, developed for Gulfstream’s new flagship executive jet, the G650, is due to enter service later this year. In defence, our LiftFan™ system for the Joint Strike Fighter has performed well during intensive flight tests that included more than 70 short take-offs and vertical landings on board the aircraft carrier USS Wasp. The TP400 engine for the Airbus A400M is on course to enter service in 2013, further strengthening our position in the military transport market. In our marine business, we have secured the first orders for our award- winning Environship, a cargo vessel powered by liquid natural gas that substantially increases fuel efficiency through a combination of innovative hull design and power systems. In May 2011, the UK Government awarded Rolls-Royce the contract to develop a new propulsion system for the next generation of nuclear-powered submarines. Our energy business signed its biggest ever single contract to supply Petrobras, Brazil’s leading oil company, with 32 gas turbine generation packages to support its offshore operations. Within our civil nuclear business we have continued to expand our instrumentation and controls business while strategic relationships with reactor vendors and utility operators were further strengthened during 2011 through a number of cooperation agreements. In 2011, Rolls-Royce performed well in difficult market conditions. We have a £62.2 billion order book, underlying revenue has grown to £11.3 billion and underlying profit has increased 21 per cent to £1.2 billion. This success is due to the extraordinary team of over 40,000 people that work for Rolls-Royce. I thank all of them for their support and effort in 2011. Their skills, the breadth of our portfolio, the strength of our order book and the access we have to parts of the world where demand for our products and services remain strong, make your company increasingly resilient. Business reviewBusiness review 6 Our business model and strategy Invest in leading technologies and skilled people Provide services that add value Trusted to deliver excellence Develop world-class products Develop close customer relationships globally Manufacture efficiently Rolls-Royce is a global company providing power solutions for customers in civil and defence aerospace, marine and energy markets. The Group has an ongoing commitment to investing in research and development (R&D) which provides the technologies and intellectual property that allow us to compete on a global basis and creates high barriers for entry to our markets. Two-thirds of our annual R&D funding is aimed at improving the environmental performance of our products. We maximise our research and development investment through our approach of ‘invest once use many times’ in products across the four major segments. Our manufacturing operations and supply bases are integrated and global. Rolls-Royce Holdings plc Annual report 2011Business review7 Our business model and strategy A leading producer of mission-critical, integrated power systems and services for use in civil and defence aerospace, marine and energy segments. Address four global markets Revenue 2011 (£m) 1. £5,572m civil aerospace 2. £2,235m defence aerospace 3. £2,271m marine 4. £1,199m energy 1 4 3 2 We invest close to £1 billion annually in R&D and during 2011 we invested £467 million in capital projects to grow our global capability and productivity. Invest in technology infrastructure and capability Develop a competitive portfolio of products and services We have 40 major engineering programmes under management. We continue to introduce major new products, including the Trent 1000 in 2011. Our key projects will help define the power systems markets for many years ahead. Across the Group the growing installed product base and integrated systems will generate attractive returns for many decades. Over half our revenues come from services. We seek to develop our customer relationships, through long-term service contracts where we can grow strong business collaboration. Grow market share and our installed product base Add value for customers through the provision of product-related services Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review8 Our business segments (charts show business segment revenue as a percentage of total revenue) Civil aerospace Defence aerospace Marine Energy OVERVIEW OF BUSINESS Our civil aerospace business provides the power for more than 30 types of commercial aircraft and supports customers around the world. We have a good presence in narrowbody and a strong position in widebody, corporate and regional aircraft. MAIN OPERATIONAL LOCATIONS – Derby, UK – Indianapolis, US – Virginia, US – Singapore – Dahlewitz, Germany 49% OVERVIEW OF BUSINESS We are the world’s second largest provider of defence aero-engine products and services with 160 customers in over 100 countries. MAIN OPERATIONAL LOCATIONS – Bristol, UK – Indianapolis, US – Virginia, US – Dahlewitz, Germany OVERVIEW OF BUSINESS Our marine business serves more than 4,000 customers and has equipment installed on over 30,000 vessels, including those of 70 navies. OVERVIEW OF BUSINESS We are a world leader in power for the offshore and onshore oil and gas industry. We supply gas turbines and diesel engines for power generation and are developing a strong capability in the civil nuclear power market. MAIN OPERATIONAL LOCATIONS – Singapore – Bristol, Derby, UK – Ulsteinvik, Ålesund, Bergen, Norway – Kristinehamn, Sweden – Rauma, Finland – Hamburg, Germany – Shanghai, China – Pusan, Korea – Vung Tau City, Vietnam – Walpole, US MAIN OPERATIONAL LOCATIONS – Mount Vernon, US – Montreal, Canada – Bergen, Norway 20% 20% 11% Rolls-Royce Holdings plc Annual report 2011Business review9 Market opportunities over the next 20 years The Group’s forecast predicts faster growth rates for long-haul markets and those markets to, from and within Asia. Factors affecting demand include GDP growth, aircraft productivity, operating costs, environmental issues and the number of aircraft retirements. We forecast a demand for civil aero engines of US$800 billion over the next 20 years and for services of US$600 billion over the same period. US$800bn Civil engine market US$600bn Civil services market With traditional defence markets under budget pressures there may be delays in new programmes but these will be offset by longer term services on current programmes where we are well placed. Demand for military engines over the next 20 years is estimated at US$155 billion and for services and support equipment we estimate a market of US$260 billion over the same period. US$155bn Defence engine market US$260bn Defence services market The Group forecasts a demand for marine power and propulsion systems valued at US$215 billion over the next 20 years. Marine aftermarket services are expected to generate significant opportunities with demand forecast at US$125 billion over the same period. US$215bn Marine equipment market US$125bn Marine services market The Group’s 20-year forecast values the total aero-derivative gas turbines sales in the oil and gas and power generation sectors at more than US$70 billion. Over this period, demand for associated services is expected to be around US$50 billion. US$120bn Energy engine and services market Based on the International Energy Agency forecasts, the Group has conservatively estimated that demand for mission-critical equipment, systems and engineering services for the nuclear island could reach US$390 billion over the next 20 years while demand for associated reactor support services could amount to US$250 billion over the same period. US$640bn Civil nuclear equipment and services market Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review10 Key performance indicators The Board uses a range of financial and non-financial indicators to monitor Group and segmental performance in line with the strategy. +4% UNDERLYING REVENUE Monitoring of revenues provides a measure of business growth. Underlying revenue is used in order to eliminate the effect of the decision not to adopt hedge accounting and to provide a clearer year-on-year measure. The Group measures foreign currency sales at the actual exchange rate achieved as a result of settling foreign exchange contracts from forward cover. +19% UNDERLYING PROFIT BEFORE FINANCING Underlying profit before financing is presented on a basis that shows the economic substance of the Group’s hedging strategies in respect of the transactional exchange rate and commodity price movements. In particular: (a) revenues and costs denominated in US dollars and euros are presented on the basis of the exchange rates achieved during the year; (b) similar adjustments are made in respect of commodity derivatives; and (c) consequential adjustments are made to reflect the impact of exchange rates on trading assets and liabilities and long-term contracts on a consistent basis. The derivation of underlying profit before financing is shown in note 2 on page 84 of the consolidated financial statements. CASH FLOW -608% The figure for 2011 includes investment of £1,496 million in Tognum. In a business requiring significant investment, the Board monitors cash flow to ensure that profitability is converted into cash generation, both for future investment and as a reward for shareholders. The Group measures cash flow as the movement in net funds/debt during the year, after taking into account the value of derivatives held to hedge the value of balances denominated in foreign currencies. The figure in 2007 includes a £500 million special contribution to the Group’s UK pension schemes, as part of the restructuring of these pension schemes. RETURN ON CAPITAL EMPLOYED +0.5% Return on capital employed is calculated as the after-tax underlying profit, divided by the average net assets during the year, adjusted for net cash, net post-retirement deficit and goodwill previously written off. It represents a measure of the return the Group is making on its investments. £m 12,000 8,000 4,000 0 £m 1,200 800 400 0 £m 700 350 0 -350 -700 -1050 -1400 % 18 12 6 0 9,147 10,108 7,817 10,866 11,277 07 08 09 10 11 832 919 983 1,010 1,206 07 08 09 10 11 570 258 62 (183) (1,310) 07 08 09 10 11 17.2 17.1 17.2 17.3 17.8 07 08 09 10 11 Rolls-Royce Holdings plc Annual report 2011Business review11 Key performance indicators Underlying revenue Underlying profit before financing Cash flow Return on capital employed Net research and development charge Gross research and development expenditure Net research and development expenditure as a proportion of underlying revenue Capital expenditure Order book Training and development Underlying revenue per employee Engine deliveries Installed thrust – civil aerospace Percentage of civil fleet under management Underlying services revenue Emissions NET RESEARCH AND DEVELOPMENT CHARGE +10% Investment in research and development underpins all the elements of the Group’s strategy. Programme expenditure is monitored in conjunction with a gated review process on each programme and progress is reviewed at key milestones. GROSS RESEARCH AND DEVELOPMENT EXPENDITURE -2% The Group’s R&D activities comprise both self-funded and customer funded programmes. Gross expenditure measures total research and development activity and is an indicator of the actions taken to enhance the Group’s intellectual property. -2% +29% NET RESEARCH AND DEVELOPMENT EXPENDITURE AS A PROPORTION OF UNDERLYING REVENUE R&D is measured as the self-funded expenditure both before amounts capitalised in the year and amortisation of previously capitalised balances. The Group expects to spend approximately five per cent of revenues on research and development although this proportion will fluctuate depending CAPITAL EXPENDITURE To deliver on its commitments to customers, the Group invests significant amounts in its infrastructure. All proposed investments are subject to rigorous review to ensure that they are consistent with forecast activity and will provide value for money. on the stage of development of current programmes. This measure reflects the need to generate current returns as well as to invest for the future. Annual capital expenditure is measured as the cost of property, plant and equipment acquired during the period. £m 500 375 250 125 0 £m 1,000 750 500 250 0 % 6 4 2 0 £m 500 375 250 125 0 381 403 379 422 463 07 08 09 10 11 824 885 864 923 908 07 08 09 10 11 5.8 5.4 4.7 4.7 4.6 07 08 09 10 11 304 283 291 467 361 07 08 09 10 11 Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review12 Key performance indicators +5% ORDER BOOK The order book provides an indicator of future business. It is measured at constant exchange rates and list prices and includes both firm and announced orders. In civil aerospace, it is common for a customer to take options for future orders in addition to firm orders placed. Such options are excluded from the order book. In defence aerospace, long-term programmes are often ordered for only one year at a time. In such circumstances, even though there may be no alternative engine choice available to the customer, only the contracted business is included in the order book. Only the first seven years’ revenue of long-term aftermarket contracts is included. TRAINING AND DEVELOPMENT +15% Training and development is a core element of the Group’s investment in its capability and is measured as the expenditure on the training and development of employees, customers and suppliers. Effectiveness is monitored by using a range of external and internal sources and by gathering user feedback. UNDERLYING REVENUE PER EMPLOYEE +6% A measure of personnel productivity, this indicator measures underlying revenue generated per employee on a three-year rolling basis. +12% ENGINE DELIVERIES The Group’s installed engine base represents an opportunity to generate future aftermarket business. This is measured as the number of Group products delivered during the year within each business except for marine, as its products do not lend themselves to this measure due to their diversity. 2,000 1,500 1,000 0 1,621 1,600 1,657 1,439 1,853 07 08 09 10 11 Rolls-Royce Holdings plc Annual report 2011Business review13 Key performance indicators INSTALLED THRUST – CIVIL AEROSPACE +5% Installed thrust is the indicator of the amount of product in use by our customers and therefore the scale of opportunity this presents for our services business. PERCENTAGE OF CIVIL FLEET UNDER MANAGEMENT -3% Long-term contracts are an important way of generating value for customers. The percentage of fleet under management gives a measure of the proportion of the installed engine base where the future aftermarket arrangements are agreed under long-term contracts. +9% UNDERLYING SERVICES REVENUE Underlying services revenue shows the amount of business during the year that has been generated from the installed engine base. This is measured as the revenue derived from spare parts, overhaul services and long-term service agreements. m lbs 400 300 200 100 0 % 80 60 40 20 0 £m 6,000 4,000 2,000 0 334 348 367 382 400 07 08 09 10 11 55 57 59 70 68 07 08 09 10 11 4,755 4,927 4,265 6,019 5,544 07 08 09 10 11 EMISSIONS Around two-thirds of our research and development expenditure is focused on reducing emissions of the Group’s products. The Group measures both the emissions of its products and the emissions of its manufacturing operations. These measures are described in detail in the environment report, ‘Powering a better world’, which is available on the Group’s website at www.rolls-royce.com. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review14 Finance Director’s review A strong performance Demand for our products and services remains robust. Mark Morris Finance Director Summary Summary data – £ million Order book Underlying revenue* Underlying profit before tax* Underlying earnings per ordinary share* Full year payment to shareholders Reported revenue Reported profit before financing Net funds Average net funds * See explanation in note 2 on page 84 2011 62,201 11,277 1,157 48.54p 17.5p 11,124 1,189 223 320 2010 59,153 10,866 955 38.73p 16.0p 11,085 1,134 1,533 960 Change +5% +4% +21% +25% +9% 0% +5% The difficulties faced by the global economy, by the Eurozone and by those governments with budgetary imbalances are well publicised. However, demand for our products and services remains robust, particularly in developing markets. This demand results from the breadth and diversity of our businesses, customers and programmes, the competitive strength of our products and the relative youth of our installed base. The visibility of significant growth in the next decade provided by the record order book underpins our continued investment in technology, operations and services. These investments safeguard our competitive advantage, support delivery on our commitments to customers and improve our operational effectiveness. The Group’s 2011 performance was achieved after absorbing a ten per cent increase in net R&D expense to £463 million and a 29 per cent increase in capital expenditure to £467 million. The Group’s joint venture with Daimler now owns over 99 per cent of Tognum for which Rolls-Royce paid cash consideration of £1.5 billion in 2011. This joint venture investment made a £30 million net contribution (after costs and financing) to underlying profit before tax but did not impact the Group’s 2011 revenues. On January 2, 2012, the Group contributed its Bergen Diesels business to the joint venture, resulting in a cash benefit to the Group of €200 million. The Group’s proposed sale of its 32.5 per cent shareholding in IAE is subject to regulatory approval and did not impact 2011 financial performance. Rolls-Royce will continue to play an active role as a first tier supplier to IAE of high-pressure compressors and fan blades and remains responsible for the final assembly of 50 per cent of the production engines. The announced new joint venture with Pratt & Whitney to develop an engine to power the next generation of mid-size aircraft is also subject to regulatory approval and had no effect on 2011 financial performance. Business review15 Finance Director’s review For more financial information go online: www.rolls-royce.com/investors Underlying figures are considered more representative of the trading performance by excluding the impact of year end mark-to-market adjustments of outstanding financial instruments on the reported performance, principally relating to the GBP/USD hedge book. In addition the net post-retirement financing is excluded and, in 2011, adjustments have been made to exclude one-off past-service credits on post-retirement schemes and the effect of acquisition accounting. The adjustments between the underlying income statement and the reported income statement are set out in more detail in note 2 of the financial statements. This basis of presentation has been applied consistently since the transition to IFRS in 2005. Underlying income statement Underlying income statement extracts – £ million Revenue civil aerospace defence aerospace marine energy Profit before financing costs and taxation civil aerospace defence aerospace marine energy engine holding (Tognum JV) central costs Net financing costs Profit before taxation Taxation Profit for the year EPS Payment to shareholders Other items Other operating income Gross R&D investment Net R&D charged to the income statement 2011 11,277 5,572 2,235 2,271 1,199 1,206 499 376 323 24 36 (52) (49) 1,157 (261) 896 48.54p 17.5p 70 908 463 2010 10,866 4,919 2,123 2,591 1,233 1,010 392 309 332 27 – (50) (55) 955 (236) 719 38.73p 16.0p 87 923 422 Change +4% +13% +5% -12% -3% +19% +27% +22% -3% -11% – -4% +11% +21% +11% +25% +25% +9% -20% -2% +10% Underlying revenue increased four per cent to £11.3 billion. This includes a nine per cent growth in services revenue to £6.0 billion that more than offset a one per cent reduction in OE revenue to £5.3 billion. OE performance included strong 18 per cent growth in civil aerospace offset by a greater than anticipated reduction of 23 per cent in marine OE revenue. Underlying services revenue continues to represent more than half (53 per cent) of the Group’s underlying revenues. In 2011, growth in underlying services revenue was due to a number of factors: the installed base of products grew and the services network expanded; defence aerospace benefited from one-off contract termination settlements resulting from the Strategic Defence and Security Review (SDSR) of the UK Ministry of Defence (MoD); and marine services saw further growth of nine per cent. Underlying profit before financing costs and taxation increased 21 per cent to £1.16 billion. This was due to a number of factors, a better mix between OE and services, a significant improvement in productivity resulting from the focus on cost, net foreign exchange (FX) benefits of £54 million including an eight cent improvement in the achieved rate on selling USD income, £30 million from Tognum net of the costs of the acquisition and a number of one-off items, the most significant which relates to a £60 million benefit from the SDSR settlements referred to earlier. Further discussion of trading is included in the business segment reports on page 18 to 25. Underlying financing costs reduced 11 per cent to £49 million, including a small reduction in financial Risk & Revenue Sharing Partnerships (RRSPs) costs and lower funding costs due to the settlement of the Group’s €750 million Eurobond during the year. Underlying taxation was £261 million, an underlying tax rate of 22.6 per cent compared with 24.7 per cent in 2010. This reduction reflects increased profits from joint ventures (which are accounted for on a post-tax basis) and some adjustments to prior year estimates. Underlying EPS increased 25 per cent to 48.54 pence, in line with the increase in the underlying profit after tax. Payments to shareholders At the AGM on May 4, 2012, the directors will recommend an issue of 106 C Shares with a total nominal value of 10.6 pence for each ordinary share. The final issue of C shares will be made on July 2, 2012 to shareholders on the register on April 27, 2012 and the final day of trading with entitlement to C Shares is April 24, 2012. Together with the interim issue on January 3, 2012 of 69 C Shares for each ordinary share with a total nominal value of 6.9 pence, this is the equivalent of a total annual payment to ordinary shareholders of 17.5 pence for each ordinary share. The payment to shareholders will, as before, be made in the form of redeemable C Shares which shareholders may either choose to retain or redeem for a cash equivalent. The Registrar, on behalf of the Company, operates a C Share Reinvestment Plan (CRIP) and can, on behalf of shareholders, purchase ordinary shares from the market rather than delivering a cash payment. Shareholders wishing to redeem their C Shares or else redeem and participate in the CRIP must ensure that their instructions are lodged with the Registrar, Computershare Investor Services Plc, no later than 5pm on Friday June 1, 2012. Other operating income relates to programme receipts from RRSPs, which reimburse past R&D costs. These receipts decreased by 20 per cent in 2011 due to the phasing of major programmes such as the Trent XWB. Net R&D charged to the income statement increased by ten per cent to £463 million. The Group recruited an additional 1,000 engineers to develop the products of the future and to help improve the in-service performance of the existing installed base of products. This investment and the 29 per cent increase in capital expenditure to £467 million will prepare our infrastructure and global supply chain for significant growth in the next decade. The Group continues to expect net R&D investment to remain within four to five per cent of Group underlying revenue. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review16 Finance Director’s review Balance sheet Summary balance sheet – £ million Intangible assets Property, plant and equipment Net post-retirement scheme deficits Net working capital Net funds Provisions Net financial assets and liabilities Share of results of joint ventures and associates Assets held for sale Other net assets and liabilities Net assets Other items USD hedge book (US$ million) Net TotalCare assets Gross customer finance contingent liabilities Net customer finance contingent liabilities 2011 2,882 2,338 (397) (1,098) 223 (502) (718) 1,680 178 (67) 4,519 2010 2,884 2,136 (856) (973) 1,533 (544) (627) 393 9 24 3,979 22,000 956 612 124 20,900 920 633 121 Intangible assets relate to goodwill, certification costs, participation fees, development expenditure, recoverable engine costs, software and other costs that represent long-term assets of the Group. In aggregate, these assets remained broadly unchanged at £2.9 billion: this was largely due to increased development, certification and software costs being offset by the reclassification of V2500 assets on the balance sheet as assets held for sale. The carrying values of the intangible assets are assessed for impairment against the present value of forecast cash flows generated by the intangible asset. The principal risks remain: reductions in assumed market share; programme timings; increases in unit cost assumptions; and adverse movements in discount rates. There have been no impairments in 2011. Further details are given in note 8 of the financial statements. Property, plant and equipment increased by nine per cent to £2.3 billion due to the ongoing development and refreshment of facilities and tooling as the Group prepares for increased production volumes. Net post-retirement scheme deficits decreased 54 per cent to £397 million, including: (i) the impact of the change in pensions’ indexing to CPI in the UK (£130 million); (ii) revised healthcare benefits in certain overseas schemes (£74 million); and (iii) the reduction in discount rates having a larger impact on the value of the assets than the obligations (calculated on an IAS 19 basis). Overall funding across the schemes has improved in recent years as the Group has adopted a lower risk investment strategy that reduces volatility going forward and enables the funding position to remain stable: interest rate and inflation risks are largely hedged; exposure to equities has reduced to around 20 per cent of scheme assets, this has been achieved against the headwind of increasing life expectancy assumptions. In 2011, the Group made further arrangements to reduce volatility and enable future funding to be predicted with more certainty. A longevity swap was transacted with a third party to eliminate the risk of increasing life expectancy of pensioners in the largest UK defined benefit scheme. No significant change is expected to the ongoing funding levels of the UK pension schemes in 2012. Net funds decreased by 85 per cent to £223 million largely due to the £1.5 billion consideration paid during the year for the Group’s shared investment in Tognum. As a result, average net funds fell by £640 million to £320 million (£805 million excluding acquisitions). Investment – joint ventures and associates increased in the year as a result of the investment in Tognum. Assets held for sale represent the assets and liabilities expected to be derecognised of as a result of the anticipated restructuring of IAE. Provisions largely relate to warranties and guarantees provided to secure the sale of OE and services. These provisions reduced modestly during the year. Net financial assets and liabilities relate to financial RRSPs and the fair value of foreign exchange, commodity and interest rate contracts, set out in detail in note 17 to the financial statements. The change largely reflects the impact of the change in the GBP/USD exchange rate on the valuation of foreign exchange contracts. The USD hedge book increased five per cent to US$22.0 billion. This represents around four and a half years of net exposure and has an average book rate of £1 to US$1.60. Current forward market exchange rates are similar to current average book rates. Net TotalCare® assets relate to long-term service agreement (LTSA) contracts in the civil aerospace business, including the flagship services product TotalCare. These assets represent the timing difference between the recognition of income and costs in the income statement and cash receipts and payments. Customer financing facilitates the sale of original equipment (OE) and services by providing financing support to certain customers. Where such support is provided by the Group, it is generally to customers of the civil aerospace business and takes the form of various types of credit and asset value guarantees. These exposures produce contingent liabilities that are outlined in note 23 to the financial statements. The contingent liabilities represent the maximum aggregate discounted gross and net exposure in respect of delivered aircraft, regardless of the point in time at which such exposures may arise. During 2011, the Group’s exposure remained stable with gross and net exposures of £612 million and £124 million respectively. As has been well-publicised, some banks that have been active in recent years in providing funds for aircraft financing have chosen during 2011 to substantially reduce their exposure in this market segment. Although this may have some effect on the terms and pricing of new aircraft finance transactions in the near future, the Group expects that other providers of USD funding and ongoing support from the export credit agencies will largely fill the gap left by these banks. Rolls-Royce Holdings plc Annual report 2011Business review17 Finance Director’s review For more financial information go online: www.rolls-royce.com/investors Group 2012 guidance Excluding the impact of the Tognum acquisition and the proposed IAE transaction, in 2012 the Group expects to see good growth in underlying revenue and underlying profit with a cash flow around breakeven as we continue to invest for future growth. In civil aerospace, we anticipate good growth in underlying revenue and strong growth in underlying profit. In defence aerospace, we expect modest growth in underlying revenue and profit. In marine, we expect a modest increase in underlying revenue, with underlying profit broadly flat. And in energy, we see growth in revenue and some improvement in profit. Other relevant data Foreign exchange: neutral. Taxation: the underlying tax rate is expected to be around 24 per cent. R&D: a modest increase in expenditure combined with lower net capitalisation and higher amortisation due to the phasing of new programmes. Capital expenditure: a modest increase, including increased investment in IT. Pensions: no material changes expected to funding levels. Intangible assets: modest increase compared with 2011 due to a modest increase in recoverable engine costs partially offset by a decrease in development costs due to the phasing of new programmes. Property, plant and equipment: modest increase compared with 2011 as we continue to invest in capability and infrastructure. Tognum Tognum is expected to contribute in the first half to the Group’s share of results of joint ventures and associates. Tognum’s results are expected to be fully consolidated around the half year with Daimler’s 50 per cent share of the result recorded as a non-controlling interest. For 2012, Tognum will be reported separately. As Tognum remains a listed company and will issue its preliminary results on March 8, 2012, the Group is not providing guidance at this time. IAE The sale of the Group’s 32.5 per cent shareholding in IAE is expected to receive regulatory approval during 2012, at which time the initial cash consideration of US$1.5 billion will be received. For the first full year following settlement, the impact of the sale on subsequent trading will have a small negative effect on underlying revenue and a positive effect of around £140 million on underlying profit. The impact on the order book will be a reduction of around £4 billion. Additional financial information can be found on pages 36 and 37. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review18 Civil aerospace Strong programme positions supported further robust order flow in 2011. A 47 per cent increase in the order intake to £11.0 billion contributed to a record order book of £52 billion, up seven per cent on 2010. The order book contains over 5,000 engines that will add, over time, around 250 million pounds of installed thrust, or 65 per cent, to our current installed base of 400 million pounds of thrust. M P a C i v r e r k K i n si d il A e r e n o s t – g p a c e 2011 saw a strong performance as revenue increased by 13 per cent. (OE) revenue grew 18 per cent, largely as a result of significantly higher deliveries of widebody and corporate and regional engines. Services revenue grew by ten per cent, reflecting the growth in TotalCare revenue during the year, some recovery in time and materials revenue and some benefit from a better achieved USD exchange rate in the period. Highlights  Trent 1000 enters service on Boeing 787  Trent XWB exclusive contract on longer range Airbus A350 XWB  I,000th Trent 700 delivered for Airbus A330  New joint venture announced to address engines for future mid-size aircraft  BR725 certification programme for the Gulfstream G650 on course £5,572m Underlying revenue 2011 £499m Underlying profit 2011 Key financial data Order book £bn Engine deliveries Underlying revenue £m Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m 2007 35.9 +80% 851 4,038 +3% 1,484 2,554 564 +9% 2008 43.5 +21% 987 4,502 +11% 1,776 2,726 566 0% 2009 47.0 +8% 844 4,481 0% 1,855 2,626 493 -13% 2010 48.5 +3% 846 4,919 +10% 1,892 3,027 392 -20% 2011 51.9 +7% 962 5,572 +13% 2,232 3,340 499 +27% Rolls-Royce Holdings plc Annual report 2011Business review19 Civil aerospace For more information on civil aerospace go online: www.rolls-royce.com/civil The civil aerospace business is a major manufacturer of aero engines for all sectors of the airliner and corporate jet market. Rolls-Royce powers more than 30 types of commercial aircraft and over 13,000 engines are in service with customers around the world. Narrowbody A new joint venture with Pratt & Whitney was announced in October 2011 to develop engines for future generation mid-size aircraft. This move enhances the strong position of Rolls-Royce in the mid-size airliner market. Rolls-Royce is also to sell its shareholding in IAE, manufacturer of the V2500 engine, to Pratt & Whitney. The relevant agreements remain subject to various closing conditions including regulatory approvals. Rolls-Royce will remain a key supplier, responsible for the engineering support and manufacture of high-pressure compressors and the final assembly of 50 per cent of the V2500 engine. Orders for over 150 V2500-powered aircraft were taken in 2011. Corporate and regional In March 2011, Rolls-Royce delivered the 2,000th BR710 engine from the Dahlewitz plant in Germany where the engine was developed. The BR710 powers a number of Bombardier and Gulfstream business jets. The certification programme for the Gulfstream G650 powered by Rolls-Royce BR725 engines remains on course despite the tragic accident suffered by one of the test aircraft in April 2011. Service entry is expected in mid-2012. The development programme for the AE 3007C engine for the Cessna Citation TEN is on plan and the first flight took place in December 2011. Entry into service is planned by the end of 2013. Services Revenue and engine flying hours from TotalCare improved during 2011, driven by the growth of aircraft in service and increased utilisation of existing fleets. In 2011, the airline industry continued a slow but steady recovery despite continued economic uncertainty. Passenger traffic continued to show above average growth but the cargo market slackened. Whilst the small and mid-size business jet market remained flat, Rolls-Royce continued to benefit from the resilience of the market for large-cabin business aircraft. Widebody 2011 was an important year for the Trent family of engines. In September 2011, Rolls-Royce was proud to power the entry into service of the Boeing 787 Dreamliner with launch customer ANA. During the year two new customers placed orders for Trent 1000s to power their Dreamliners. Development of the Trent XWB continued apace, with the test programme yielding exceptional results in terms of fuel efficiency and reliability. The Trent XWB for the Airbus A350 XWB, is the fastest ever selling member of the Trent family of engines. Over 1,100 Trent XWBs have been ordered so far, more than the total number of Trent 700s currently in service. Market successes in 2011 included significant orders from Thai Airways International and Air France. Entry into service is now expected in the first half of 2014. In June 2011, Rolls-Royce announced an exclusive engine provider agreement with Airbus for Rolls-Royce to produce a higher-thrust version of the Trent XWB, enabling Airbus to offer increased range and capacity for the A350-1000. In October 2011, the 1,000th Trent 700 engine was delivered for the A330 programme. During the year, further orders were received for approximately 150 Trent 700 engines from customers around the world including major orders from Cathay Pacific, Saudi Arabian Airlines and Singapore Airlines. There are three engine options for the A330 and the Trent 700 won 75 per cent of the orders contested in 2011. The Trent 900 continues to be the leading engine for the Airbus A380 in terms of through-life fuel burn and emissions. The Trent 900 has been selected by 11 of the 16 airlines that have so far made an engine choice. China Southern is the latest customer to place Rolls-Royce powered A380s into service. New order announcements in 2011 came from Asiana of Korea and Skymark of Japan. In November 2011, American Airlines entered Chapter 11 bankruptcy protection. The Group has equipment in service and a joint venture repair and overhaul business with the airline and remains in close contact with the customer as the airline manages this process. There was no significant impact on the financial results. The Trent 1000 entered service last year with Japanese airline ANA, as the launch engine for the new Boeing 787 Dreamliner. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review20 Defence aerospace A broad and diverse base of customers and products underpinned a resilient performance in 2011. Demand for our products and services, particularly in the military transport sector, held up well. Revenue increased five per cent as a result of an eight per cent increase in OE revenue and a three per cent increase in services revenue. D D a P e f e r e n K si d n c e e A n e r o s o r t t – e p a c e A seven per cent decline in the order book reflects the cautious budgetary environment in many nations. However, new orders of £1.8 billion provides continued confidence that opportunities remain, both in traditional and in developing markets. Profit grew 22 per cent as a result of increased revenue, cost reduction and the £60 million benefit of termination settlements as a result of the UK MoD’s SDSR. Highlights  TP400 engine for A400M transporter is certified  F-35B LiftSystem™ achieves programme and test milestones  US Navy renews Adour F405 support contract  750th EJ200 engine delivered for the Eurofighter programme £2,235m Underlying revenue 2011 £376m Underlying profit 2011 Key financial data Order book £bn Engine deliveries Underlying revenue £m Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m 2007 4.4 +38% 495 1,673 +4% 796 877 199 +3% 2008 5.5 +25% 517 1,686 +1% 739 947 223 +12% 2009 6.5 +18% 662 2,010 +19% 964 1,046 253 +13% 2010 6.5 0% 710 2,123 +6% 1,020 1,103 309 +22% 2011 6.0 -7% 814 2,235 +5% 1,102 1,133 376 +22% Rolls-Royce Holdings plc Annual report 2011Business review21 Defence aerospace For more information on defence aerospace go online: www.rolls-royce.com/defence Rolls-Royce is the world’s second largest provider of defence aero-engine products and services, with 18,000 engines in service for 160 customers in 103 countries. Our engines power aircraft in all sectors: transport, combat, reconnaissance, training, helicopters, and unmanned aerial vehicles. Unmanned vehicles In the unmanned air systems sector we successfully completed a US Air Force funded flight-test programme for the growth variant of the AE 3007H engine for Global Hawk. Transport We are a world leader in the military transport market with over 6,700 engines in service. Small engines GippsAero of Australia selected the M250 turboprop engine to power its new ten seat passenger aircraft, the GA10. In the helicopter market, the Apache fleet of the UK Army Air Corps, powered by the RTM322 engine, reached 200,000 flying hours. Services The success of our services business continued in 2011, with MissionCare™ contracts secured to provide availability-based engine support for the C-130 fleets of the UK and US air forces. The US Navy again renewed its US$100 million support agreement for Adour F405 engines in the T-45 Goshawk trainer. Rolls-Royce also earned praise for its support of the frontline operations of the UK armed forces air campaign over Libya which involved eight different types of Rolls-Royce powered aircraft. The global fleet of AE 2100 engines, which powers both the Lockheed Martin C-130J and the Alenia C-27J transport aircraft, continues to expand. The Emirate of Qatar and the Indian Air Force both received their first C-130Js in 2011. The global AE 2100 fleet also passed the three million flight hour milestone during the year. The TP400 engine for the Airbus A400M military transport aircraft received civil certification from EASA in May 2011 and has amassed over 8,000 flying hours as part of the flight-test programme. Delivery of the engines for the first production aircraft are due to begin in early 2012, part of the initial order of 180 aircraft. Important milestones were achieved in the T56 upgrade programme for legacy variants of the C-130 and P-3 Orion aircraft. This engine variant provides significant fuel and operating cost savings. Combat In the combat sector the Rolls-Royce LiftSystem® for the short take-off and vertical landing (STOVL) variant of Lockheed Martin’s F-35 Lightning II Joint Strike Fighter achieved its ‘Initial Service Release’. In October 2011, two F-35B aircraft accomplished 72 STOVLs on the USS Wasp during a successful three-week testing period of sea trials. In the same month, the first LiftFan™ to be assembled at our new dedicated state-of-the-art factory in Indianapolis, USA, rolled off the production line. In January 2012 , probationary status was lifted for the F-35B and the first STOVL aircraft were delivered to the customer. Funding for the development programme of the F136 engine, in which Rolls-Royce is a 40 per cent partner, for the F-35 Joint Strike Fighter was terminated by the US Department of Defense in February 2011, despite strong continuing Congressional support. During 2011, we delivered the 750th EJ200 engine on behalf of Eurojet for the Eurofighter programme. The Eurofighter Typhoon was deployed on combat operations for the first time as part of the NATO operation in Libya, displaying outstanding levels of performance and reliability. The Typhoon is a contender for the KF-X programme in South Korea. We continue to make good progress on the US Air Force Adaptive Versatile Engine Technology (ADVENT) demonstrator programme. It is designed to significantly reduce fuel consumption, enabling extended mission ranges and loiter times for future generations of military aircraft. We are a major partner in the TP400 engine for the new Airbus A400M large military transport aircraft. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review22 Marine Despite the uncertain market and macro-economic conditions, a resilient performance was achieved in 2011, as demand for our products and services gradually returns. New order intake during the year was strong, up 15 per cent to £2.1 billion, although the order book decreased largely due to the slower than expected conversion of OE bid activity to new orders. P r e si d T o n e n y t – W o o d M a ri n e Revenue decreased 12 per cent, impacted mainly by slow second half OE revenue that resulted in OE revenue for the full year down 23 per cent. This slower than expected recovery of OE revenue was partially offset by a nine per cent increase in underlying service revenue. Our expanding network of service centres continues to take advantage of the growth in recent years of the global fleet of vessels equipped with our products, engines and propulsion systems. £2,271m Underlying revenue 2011 Profit declined by three per cent relative to a fall in revenue of 12 per cent, reflecting an improved revenue mix and an increased focus on costs and operational performance. Highlights  Significant increase in new orders and continued growth in offshore oil and gas sector  First contract secured for award-winning NVC 405 Environship liquid natural gas-powered cargo vessels £323m Underlying profit 2011  Service centres in Europe, Africa and Asia opened or expanded  Customer training and simulator centres opened in Norway and Singapore  Tognum acquisition largely completed Key financial data Order book £bn Underlying revenue £m Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m 2007 4.7 +96% 1,548 +19% 1,003 545 113 +12% 2008 5.2 +11% 2,204 +42% 1,492 712 183 +62% 2009 3.5 -33% 2,589 +17% 1,804 785 263 +44% 2010 3.0 -16% 2,591 +0% 1,719 872 332 +26% 2011 2.7 -8% 2,271 -12% 1,322 949 323 -3% Rolls-Royce Holdings plc Annual report 2011Business review 23 For more information on marine go online: www.rolls-royce.com/marine Rolls-Royce has a world-leading range of capabilities in the marine market, encompassing vessel design, the integration of complex systems and the supply and support of power and propulsion equipment. We are leaders in mission-critical systems for offshore oil and gas, merchant and naval vessels. Offshore Marine performed strongly in the offshore oil and gas sector. This was largely based on the proven success of our specialist UT vessel design capabilities and our proficiency at integrating sophisticated systems into complex ships. As the industry continues to explore ever deeper waters, like those in the South Atlantic off the coast of Brazil, we will continue to be a strong partner for our customers for offshore oil and gas exploration, production, service and support. Merchant We continue to invest in technology that addresses the need for more efficient and environmentally sustainable power and propulsion systems. Our successful design and systems integration approach was validated in 2011 through an order by NorLines for two award-winning NVC 405 Environship short sea cargo vessels. These vessels incorporate a wave- piercing hull, a liquid natural gas engine and an integrated rudder and propeller system, which, in combination, reduces fuel consumption and cuts CO2 emissions by up to 40 per cent compared to conventional vessels. Naval Power and propulsion equipment was delivered for the UK’s Queen Elizabeth class aircraft carriers. In early 2011, we received an order from Lockheed Martin for the provision of MT30s, the world’s most powerful Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review24 Energy Significant demand for our products and services in offshore oil and gas applications drove a 57 per cent increase in the order intake to £1.5 billion, as the order book increased 28 per cent. Revenue declined by three per cent, largely due to the phasing of OE delivery in the power generation business. Demand for aftermarket products and services continued to grow strongly, with an increase of ten per cent over 2010. Profit fell by 11 per cent to £24 million as a result of a change in revenue mix and the additional charges incurred to develop the civil nuclear business and our options in tidal and fuel cells. This was despite the benefit of the non-recurring industrial Trent retrofit charges incurred in 2010. Highlights  50 RB211 gas turbine packages ordered for oil and gas applications  50 Bergen diesel engines ordered for land-based power applications  Service revenue up ten per cent, with 701 engines under long-term agreements  Achieved the prestigious ASME-N accreditation for UK nuclear manufacturing facilities  Completed acquisition of leading US Remote inspection services business, R. Brooks Associates  Signed a 14-year contract with EDF to supply I&C technologies for the world’s largest reactor modernisation project Key financial data Order book £bn Engine deliveries Underlying revenue £m Underlying OE revenue (£m) Underlying service revenue £m Underlying profit before financing £m 2007 0.9 +80% 78 558 +2% 269 289 5 +128% 2008 1.3 +44% 106 755 +35% 385 370 (2) -140% 2009 1.3 0% 87 1,028 +36% 558 470 24 +1300% 2010 1.2 -8% 95 1,233 +20% 691 542 27 +13% 2011 1.5 +28% 75 1,199 -3% 602 597 24 -11% P r e A n d si d r e e w n H e t – E a t n h e r g y £1,199m Underlying revenue 2011 £24m Underlying profit 2011 Rolls-Royce Holdings plc Annual report 2011Business review 25 Energy For more information on energy go online: www.rolls-royce.com/energy www.rolls-royce.com/nuclear Our energy business supplies customers with gas turbines, compressors, reciprocating engines, and related services to support the efficient production of oil and gas, and power generation around the world. We are establishing a strong position in the civil nuclear sector for the provision of mission-critical equipment, systems and engineering services. The balanced nature of our portfolio has enabled us to deliver solid revenues of £1.2 billion, broadly in line with 2010. While the power generation sector in mature economies remains suppressed, due to excess generating capacity and low industrial demand, we continue to see growth in developing countries. The demand for oil and gas remains high, driven by a resilient oil price and global demand growth. In the second half of the year we secured significant oil and gas orders, increasing market share in the key Brazilian offshore market. Oil and gas In total, 50 RB211 packages were ordered during the year for oil and gas applications, 38 of which were for offshore. The high price of oil continues to drive capital investment in the sector, particularly in deepwater exploration and production environments where the Group has technologies and expertise that are applicable. The business was awarded a new contract, valued at up to US$650 million to supply 32 RB211 gas turbine power generation packages and related services to Petrobras to support its long-term production activities offshore Brazil. This order increases the number of Rolls-Royce RB211-powered industrial gas turbine units installed in Brazil over the past ten years to 62. In February 2011, we announced plans for the construction of a new purpose-built packaging, assembly and test facility in Rio de Janeiro, Brazil. The facility, expected to become operational in the first quarter of 2013, will strengthen our support of Petrobras’ exploration and production activities in the rapid growth pre-salt deepwater oil fields offshore Brazil. Tognum As with the marine business, our energy business will benefit from the acquisition of Tognum through our joint venture with Daimler. By combining our medium-speed diesel and gas Bergen engines business with Tognum’s high-speed reciprocating engines, we will create a world leading reciprocating engines offering in the energy industry, significantly enhancing our core product and systems portfolio and global network of sales and service facilities. This will benefit customers across high-growth applications, including offshore and shale gas fracturing, as well as primary, standby and rental land-based power generation. In January 2012, the ownership of Bergen Engines transferred from Rolls-Royce to Engine Holding GmbH, the 50/50 joint venture company formed with Daimler. Civil nuclear Rolls-Royce made significant progress in developing its nuclear business in 2011, securing the prestigious ASME-N stamp accreditation at our UK nuclear manufacturing facilities. Plans for a new UK civil manufacturing facility progressed throughout 2011 and the business received outline planning permission for a potential site in South Yorkshire. Strategic relationships with reactor vendors and utility operators were further strengthened. An important cooperation agreement was signed with Areva in March 2011, to cover the manufacture of complex components for the first European Pressurised Water Reactors (PWR) to be built in the UK. Enhanced MoUs were also signed with Nuclear Power Delivery UK and EDF, the world’s largest utility operator. Additionally, the business entered into a landmark agreement with Rosatom, the Russian state-owned nuclear company, for the development of global civil nuclear programmes. As a key step in growing its reactor services business, Rolls-Royce completed the acquisition of US-based R. Brooks Associates, a world leader in remote visual inspection. In addition, we expanded our role in China’s gas pipeline industry with contracts to supply PetroChina, the largest oil and gas producer in China, with six RB211 gas turbine compressor packages for Line 2 of the West-East China Pipeline Project. We signed a €250 million contract with EDF to supply instrumentation and control (I&C) technologies to the world’s largest reactor upgrade programme, being carried out in France. We also opened a dedicated I&C service centre to enhance our operations for customers in China. Power generation The power generation sector remains suppressed in the developed world, the traditional market for the Trent gas turbine, which resulted in three new Trent unit orders. Demand for Bergen reciprocating engines remains strong, reflected by an order intake of 50 units, of which 30 are for Bangladesh to help address the country’s power shortfalls, bringing total Bergen engines orders in Bangladesh to 82. Services Demand for aftermarket products and services again grew strongly, delivering revenue of £597 million, an increase of ten per cent over 2010. Including the land-based reciprocating engines, there are now a total of 701 units, or 35 per cent of the engine fleet, under long-term service agreements. In 2012, we will launch the RB211 Gzero, an aftermarket upgrade product for the RB211-G gas generator that increases power by a nominal ten per cent. Six RB211 gas turbine sets provide 100MW for this floating production, storage and offloading unit. (image © Total S.A.) Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review26 Excellence in technology D ir a n e C c t o o li n S r – E d T m e c n h n g i n it h o l o e e ri n g y g Our research and development investment represents both a commitment to continuous improvement of our existing portfolio and a long-term investment in future technology. In 2011, Rolls-Royce invested £908 million in gross research and development, of which £520 million was funded from Group resources. Globally, 475 new patent applications were approved for filing – a record number for the Group. Research and technology The Group’s 12,400 engineers are an increasingly integrated global resource, whose activities include research and technology, product development and in-service support. Our successful model of collaboration, through a network of 28 University Technology Centres and seven advanced manufacturing research centres, provides access to world-class research. With the opening of three advanced manufacturing research centres in the UK during 2011, a total of five are now operational. The next two are due to be opened in the US in 2012 and Singapore in 2013. These centres bring companies, industrial sectors and universities around the world together, in a common endeavour to develop step-change improvements across a portfolio of manufacturing technologies. In addition, the Advanced Simulation Research Centre was opened in Bristol, UK, in March 2011 and is now enabling Rolls-Royce and member organisations to access the latest simulation technologies for product development, reducing the need for costly physical testing and improving product design efficiency. Civil aerospace The year was notable for the successful entry into service of our latest large engine, the Trent 1000, as launch engine for the Boeing 787 Dreamliner. The Trent 1000 completed 670 flights in service with launch customer ANA by the year end. Flight testing of the BR725-powered Gulfstream G650 recovered from the tragic loss of a test aircraft in April to achieve Provisional Type Certification from the Federal Aviation Authority in November 2011. The Trent XWB development programme continued successfully, with several key functional, maturity and certification tests completed at sites in Rolls-Royce Holdings plc Annual report 2011Business review27 Excellence in technology 475 Patent applications were approved for filing – a record number for the Group. Gross research and development £m 1,000 750 500 250 0 824 885 864 923 908 07 08 09 10 11 Major technology programmes The Trent XWB is the latest member of the Trent family in development and is designed to be the most efficient, large aero gas turbine ever produced. For more information on excellence in technology go online: www.rolls-royce.com/technology-innovation four countries. The engine is the only option for the Airbus A350 airliner family. The Trent XWB promises to be the most efficient, large aero gas turbine ever produced. Our ongoing work to improve the environmental performance of our products continued with key technology demonstrators. The Environmentally Friendly Engine (EFE) completed successful testing of an advanced ‘lean burn’ combustor. Meanwhile, the latest E3E medium-size, two-shaft demonstrator core completed testing at the University of Stuttgart’s altitude facility during the year. Defence aerospace Our engineers in Indianapolis are working on key enabling technologies for the US Air Force ADVENT contract. This work focuses on developing and demonstrating variable cycle engine technologies aimed at incorporation in future generation US military aircraft. The team completed designs and procured test hardware in preparation for a core engine test which will take place in 2012 and a full demonstrator engine test in 2013. In addition, during the year we won contracts for the US Air Force Research Lab (AFRL) Integrated Vehicle Energy Technology (INVENT) and Integrated Power and Thermal Management System Development (IPTMSD) programmes. These both focus on development of electrical and thermal management architectures to support the next generation of military aircraft. Marine Engineers in our submarines business are engaged in detailed design of the PWR3 reactor plant, which, in May 2011, was selected for the next generation of Royal Navy submarines. This project now represents the second largest technology programme in Rolls-Royce after the Trent XWB. Rolls-Royce has been designing and supplying nuclear reactors for the Royal Navy for over 50 years, with the PWR2 model currently the latest version in service. At the Nor-Shipping Exhibition in Oslo, our Environship concept, the NVC 405 Environship, won the ‘Next Generation Ship’ award, and we launched a new ‘concept bridge’ for marine vessels. In other marine programmes, we completed our first production Permanent Magnet Tunnel Thruster, and the Rolls-Royce operated NATO Submarine Rescue Service achieved full operational capability. A prototype carbon fibre azimuthing thruster exceeded performance and noise expectations during sea trials. Azimuthing thrusters rotate 360 degrees allowing them to perform both the propulsion and steering duties for a vessel. Energy In civil nuclear, EDF selected Rolls-Royce to modernise the safety-critical I&C systems of 20 French nuclear power plants. This contract, combined with a 25-year services agreement, means we are committed to support our SPINLINE™ technology with EDF until 2048. Summary Rolls-Royce has developed a reputation for engineering excellence and has been at the forefront of innovation for over 100 years. We continue to push technological barriers, create intellectual property on behalf of our stakeholders and develop advanced power products across each of our chosen markets. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review28 Excellence in operations C h i e M f O i k p e T e r a e r r e ti n t t g O ffi c e r £274k Underlying revenue per employee £467m Capital expenditure on new and improved facilities We continue to invest in operational capacity to fulfil the commitments we have made to our customers and to enable the long-term growth and productivity of our business. Focused on efficiency and delivery We are focused on improving the efficiency of all our operational activities while, at the same time, expanding capacity in order to deliver our record order book. In 2011, our capital investment on new and improved facilities was £467 million. Over the last decade underlying revenue per employee has more than doubled from £128k in 2001 to £274k in 2011. Our Group is headquartered in the UK which remains our main employment centre and a key operations and manufacturing base. However, we are an increasingly global company. Early in 2012 we celebrated the opening of our major new facilities at Seletar, in Singapore, where we will manufacture wide-chord fan blades, and assemble and test Trent aero engines – the first time we have undertaken these activities outside the UK. This represents an important commitment to our growing customer base in Asia, and is one of 14 new facilities that we have opened over the past three years in locations including the UK, Germany, the US, Norway, China and Brazil. As well as extending our global footprint, we continue to expand our product portfolio. 2011 saw the Trent 1000 engine enter service with ANA and the production programme for this latest member of the Trent family come on stream. In other major programmes we started production deliveries of the LiftSystem for the Joint Strike Fighter and the marine gas turbine, MT30 for the US Navy. The BR725 which powers the new Gulfstream G650 is scheduled to enter service later this year. In October 2011, we announced a new joint venture with Pratt & Whitney to develop engines for the next generation of mid-sized aircraft. We also decided to restructure our participation in IAE, the joint venture which produces the V2500 engine for the A320 family of aircraft. We agreed to sell our equity stake in IAE to Pratt & Whitney, while remaining an important supplier of parts and engineering support for the engine programme. We continue to assemble 50 per cent of V2500 engines. At the same time we continue to aim to offset all inflationary pressures through improved productivity and waste reduction programmes. Rolls-Royce Holdings plc Annual report 2011Business review 29 Excellence in operations For more information on excellence in operations go online: www.rolls-royce.com/suppliers New manufacturing and assembly facilities Singapore We have developed two new plants, one for the assembly and test of Trent engines and the other to manufacture our high-technology wide-chord fan blades for aero engines. Integrated global approach As we expand around the world, our operations strategy demands an integrated approach across activities, time zones and locations. We continue to develop local capabilities to meet our customer requirements where appropriate. Brazil is a good example of this. We have had an aero repair and overhaul business there for over 50 years. In 2009 we opened a service centre to support our growing marine business and, in 2011, we announced plans for the construction of a new US$100 million-plus gas turbine package, assembly and test facility for our energy business. This is expected to become operational in the first quarter of 2013. These investments not only grow our global footprint but bring us closer to our customers in Brazil, adding significantly to our capabilities in a key growth market and enabling us to pursue further opportunities. Supply partnerships and new programmes Close collaboration with our suppliers is critical to our continued success. Around 70 per cent of our manufacturing is conducted within our supply chain. As we continually develop intellectual property in technology, manufacturing, materials and processes we decide which elements of our programmes we produce ourselves and those which will be subcontracted to our suppliers. Our relationship is open, analytical and collaborative. We estimate that our supply base is currently investing at around twice the level of Rolls-Royce in order to accommodate growth and deliver greater efficiency. As well as working with suppliers, we partner with universities and manufacturing research centres around the world to develop new technologies and processes which are more effective, efficient and robust. Rolls-Royce is a long-term business in which consistent investment sustained over many years has delivered expanding global capability, accompanied by steadily improving productivity and performance. These factors coupled with a high focus on product integrity, enable us to effectively address both our customers’ current needs and their future requirements. Rolls-Royce continues to manufacture parts and assemble engines for the IAE V2500 programme. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review30 Sustainability We remain committed to working with all our stakeholders to develop new approaches and technologies that will help provide solutions to sustainable economic growth. We are striving to power a better world and recognise that we have a key part to play. We will continue to invest for the long term; we have a strong track record of innovation, and a long-standing commitment to research and development. Our sustainability programmes address: the environment; our people; and, the communities in which we operate. 2011 Business in the Community Corporate Responsibility Index (BitC) The BitC Index assesses the extent to which corporate strategy is integrated into business practice throughout an organisation. In 2011, Rolls-Royce retained its Gold status with an overall score of 91 per cent. We also scored 94 per cent in the Environmental Index component of the overall survey. Dow Jones Sustainability World and European Indexes (DJSI) Rolls-Royce has retained its position in the DJSI for the tenth consecutive year, with an overall score of 78 per cent (aviation and defence sector average 49 per cent). Carbon Disclosure Project (CDP) Rolls-Royce continues to be one of the leading companies in the CDP Index. Although our disclosure score in 2011 was lower than the previous year (75 vs 79 per cent in 2010) we remain committed to improving and reporting the carbon footprint of our operations. Environment Our environment strategy focuses on three key areas: 1. maintain our drive to reduce the environmental impact of all our business activities; 2. further reduce the environmental impact of our products; and 3. develop entirely new low emission and renewable energy products. 1. Maintain our drive to reduce the environmental impact of all our business activities Greenhouse gas emissions We recognise the need to reduce the global greenhouse gas emissions (GHG) within our operations. For the past two years individual reduction targets and budgets have been agreed for our top 25 energy consuming sites. This has resulted in a further five per cent reduction (normalised on turnover) during 2011 in total GHG emissions (1) (including product test and development). Emissions from our facilities (excluding product test and development) have reduced by six per cent since 2009 compared with our five per cent reduction target by 2012 (2). In absolute terms, total GHG emissions have increased to 586.5 kt CO2e (scope 1 and 2). (1) Following further validation in 2012, the Group GHG emissions for 2009 have been re-stated. (2) Energy/GHG data for 2011 has been forecast based on data collected during January to October 2011. For details of the methodology see our ‘Basis of Reporting’ available at www.rolls-royce.com. In 2011, we invested over £3.5 million in energy improvement projects including the upgrade of lighting, boiler controls and metering. Our new facility at Seletar received the Singapore government’s Building Construction Authority (BCA) Green Mark (Platinum) award in construction, for having a reduced environmental footprint. Progress on certification Rolls-Royce continues to maintain accredited third-party certification to ISO 14001 for its environmental management systems, achieving full global re-certification in 2011. The ‘green roof’ of our manufacturing facility in Singapore gained a BCA award for environmental construction. Rolls-Royce Holdings plc Annual report 2011Business review 31 Sustainability For more information on sustainability go online: www.rolls-royce.com/sustainability Global supply chain In 2011, we led Global and Regional Supplier Forums, which focused on near-term and long-term improvements. We also hosted regional supplier groups, culminating in a global best practice sharing event aimed at promoting the application of lean techniques across the supply chain. 2. Further reduce the environmental impact of our products We believe that we can make a significant contribution to mitigating emissions by providing increasingly efficient products worldwide. We benefit from independent expert advice from an Environmental Advisory Board made up of distinguished academics who are leading authorities in their respective fields to inform business strategy and design process. In 2011, the Group renewed its commitment, now extended to 2050, in taking a leading role in the goals set by the Advisory Council for Aviation Research and Innovation in Europe (ACARE). These challenging goals include: • reducing aircraft CO2 emissions by 75 per cent per passenger kilometre • reducing noise by 65 per cent; and • 90 per cent reduction in oxides of nitrogen (NOx) relative to the year 2000. The environmental improvements already achieved by the Trent 900 and 1000 engines for the Airbus A380 and Boeing 787 respectively, and in future the Trent XWB for the Airbus A350 XWB, will help us make progress meeting our contribution towards the ACARE goals. Chart shows target of 20% lower CO2 Trent 895 Trent family ACARE target 0 -5 -10 -15 -20 Trent 500 Trent 900 Trent 1000 Trent XWB 2000 2005 2010 2015 2020 (Advisory Council for Aviation Research and Innovation in Europe) In the marine segment, the Rolls-Royce Environship concept, received the prestigious ‘Next Generation Ship’ award at the Nor-Shipping event held in, Norway. The Rolls-Royce Bergen B-Series lean-burn gas engines, as used in the Environship, emit around 20 per cent less CO2 than comparative diesel engines. The use of gas fuelled engines means that NOx emissions are reduced by about 90 per cent and SOx emissions are negligible. These emissions already meet the International Maritime Organisation legislation due to come into force in 2016. 3. Develop entirely new low emission and renewable energy products The Group is investing in other renewable energy sources such as tidal power, working in partnership with the UK Energy Technologies Institute. In addition, we are working with customers and fuel companies to ensure that future biofuels, which will be part of the solution for aviation towards 2050, meet our requirements, with the important caveats that they are sustainable, do not compete with the growth of food crops and are used in the most effective way to maximise the reduction in GHG emissions. Nuclear generation delivers low carbon power. Rolls-Royce has extensive knowledge of nuclear safety and I&C technology. Nuclear power will represent an important component of future low- carbon electricity generation. We have substantial experience in this area gained through supplying power systems for the Royal Navy nuclear submarine fleet for many decades. Our core capabilities in safety and I&C will enable the Group to provide solutions in this area that will help address the requirements for low or zero carbon power generation. Our people Our working environment We seek to create an inclusive working environment that attracts and retains the best people, enhances their flexibility, capability and motivation, and encourages them to be involved in the ongoing success of the Group. The organisation is experiencing a period of significant change as we grow and invest globally. We continue to place great value on giving a voice to our workforce and engage with our employees in many ways throughout the world to ensure they are kept informed of changes that may impact them. For example, employee opinions are obtained via a two-year rolling engagement programme and improvement activities are then embedded into local and corporate business planning activities. In addition we have established communication channels which provide updates on key business changes and activities. Rolls-Royce employs 40,400 people in more than 50 countries. Our workforce is dispersed globally across our business segments as follows: Business segments average number of employees 2011 Civil aerospace Defence aerospace Marine Energy Total Employees 20,600 6,800 9,400 3,600 40,400 Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review32 Sustainability Ethics The Global Code of Business Ethics (Global Code) supports the Group’s approach to business conduct and defines its ethical principles and behaviours. Internal and external assessments of the Global Code during 2011 confirmed that it represents best-in-class standards. During the year, the Group completed a review of its anti-bribery and corruption related policies and procedures. This review considered applicable law, including the UK Bribery Act, which came into force on July 1, 2011. We also put in place a compliance organisation, led by a Chief Compliance Officer. We issued a number of new and updated global polices in multiple languages including: raising concerns, conflicts of interest, competitive intelligence and, sponsorships and charitable donations. Training was developed to support these as required. Rolls-Royce actively supports aerospace and defence industry initiatives to drive responsible business behaviour in the sector. We are represented on the Business Ethics Committee of the Aerospace and Defence Industries Association of Europe (ASD) and we are one of the international companies on the task force managing the International Forum for Business Ethics (IFBEC), a body which brings together US and European aerospace and defence companies to share best practice and develop common standards. Encouraging diversity Our global governance framework for diversity includes a senior executive Global Diversity Steering Group that provides leadership and shapes strategic direction. During 2011, our most senior executives have been reverse mentored by a colleague who is junior to them in the organisation. The reverse mentors are a diverse group in terms of gender, nationality, business, function and their working location. The aim is to give senior executives a different perspective from a colleague who can share diverse experiences and ideas. Lord Davies of Abersoch, on behalf of the UK Government, outlined a number of recommendations in 2011 to improve gender diversity in UK boardrooms. We will take opportunities to increase diversity at Board level, and have committed to make demonstrable progress on this by 2015. Overall female representation across our global workforce is 15 per cent, seven per cent at the senior executive level and six per cent in our Group Leadership Team (GLT). Approximately two thirds of our workforce is in engineering or manufacturing roles where female representation has been historically low. We continue to counter this through active involvement in education outreach along with recruitment and development planning in order to maximise the potential of diverse talent across our global business. We are encouraged by some of the progress we are making in graduate recruitment where female representation has steadily increased over recent years. 25 per cent of participants in our graduate development programmes are female and this increases significantly in functions outside of engineering and manufacturing. We participate in the FTSE 100 Cross Company Mentoring Programme, the objective of which is for the chairmen and chief executives to provide advice and guidance to senior females with the aim of attaining a non-executive and/or an executive director role. Our Chairman is a mentor and three of our female executives have participated to date. Our graduate recruitment team won the award for best graduate recruiter in the Engineering Sector at the TARGETjobs awards. These UK national awards are voted entirely by students via an online poll. The Group is committed to developing a diverse workforce and equal opportunities for all. Our policy is to provide, wherever possible, employment training and development opportunities for disabled people. We are committed to supporting employees who become disabled during employment and helping disabled employees make the best use of their skills and potential. Learning During 2011, we provided over 3,500 learning solutions to our employees from all of our 57 countries, resulting in 35,500 employees undertaking more than 105,000 days of learning. We also built new Learning and Development Centres in Singapore and Ålesund, Norway. The centres will deliver training to both customers and employees in the regions. Learning investment for 2011 was £38 million. Recruitment In 2011, over 2,500 experienced professionals were recruited to support the growth of our business, more than double the previous year. More than 50 per cent were recruited from outside of the UK and 34 per cent came from countries outside the UK/US. We ran major recruitment campaigns across engineering, manufacturing and purchasing and these constituted the majority (61 per cent) of our hiring in 2011. During 2011, more than 400 young graduates joined Rolls-Royce. Our campus teams actively engaged with more than 60 universities in the UK, Europe, Asia, and Americas and we recruited 242 graduates (up nine per cent) on to our graduate programme from 43 universities and 25 nations globally. We have plans to significantly increase our graduate programme size to 389 (60 per cent increase) in 2012 to accommodate our long-term growth objectives. In addition, we recruited 295 apprentices in Europe and were awarded top 100 apprenticeship employer status in the UK. Health and safety at work Over the past five years our focus on improving our health, safety and environment (HS&E) performance has resulted in the number of significant injuries that occur each year being almost halved from 1.31 total reportable injuries (TRI) per 100 employees in 2006, to 0.66 TRI per 100 employees in 2011. Rolls-Royce Holdings plc Annual report 2011Business review33 Sustainability For more information on sustainability go online: www.rolls-royce.com/sustainability Performance improvement is delivered through the implementation of a focused global HS&E strategy covering: leadership; capability; management systems; risk; assurance; learning from incidents and informed decision making. policies; and renewable energy. We contributed to the development of the Commission’s proposal for ‘Horizon 2020’ – a new Research and Innovation funding framework for 2014-2021, and also ‘Flightpath 2050 – Europe’s vision for Aviation’. As part of a global safety programme, we have invested more than £20 million to further enhance the safety standards of our machinery. More than 11,000 machines have been reviewed worldwide and for around 2,500 machines, opportunities to enhance safety still further were identified such as improving guarding and the fitting of additional safety features. Community investment Rolls-Royce has a firm, long-standing commitment to the communities in which we operate around the world. During 2011, the Group’s total contributions (including money, employee time and gifts in kind) were £7.1 million. A global programme of review and corrective action is also underway to improve our control of lifting operations. Similarly, a global programme to improve process safety management is focusing on our management of operational processes with hazards. Our community investment activities support the Group’s strategy and future success, particularly in the areas of: recruitment and employee retention, employee engagement, professional development and the Group’s reputation in the community. ‘Leading excellence in HS&E’ workshops have been held with leadership teams from all of our sectors and businesses. ‘Leadership in Action’ days were also held for some 700 senior leaders with HS&E being one of the topics covered. Engaging with our communities Working with governments Rolls-Royce seeks to build strategic relationships with host governments in our key market countries. Governments are often our direct customers. They set the legislative and policy framework within which our business must be conducted. They are a potential source of funding and support for R&T, R&D, manufacturing, education and training initiatives, as well as for certain capital projects. And finally, on occasion, they support or sponsor our partners, suppliers and competitors. We engage in dialogue and negotiation to try to align the business needs of Rolls-Royce with the political, social, economic, industrial and commercial requirements of the national government. Where we can achieve such alignment, for example in Singapore, the benefits for both the Group and the country can be considerable. On March 6, 2011, we hosted a meeting of the UK Cabinet in Derby. Sir John Rose addressed the Cabinet before their meeting and later that day, Prime Minister David Cameron performed the official opening of the new technology centre on site. On October 25 and 26, 2011, Rolls-Royce along with the University of Sheffield and Boeing led a series of high profile events in Westminster to highlight the importance of high-value manufacturing. These events generated considerable interest from Government Ministers, Parliamentarians and officials. With a majority of legislation affecting our European operations emanating from the European Union, we are now building extra capacity in our EU Affairs team. Throughout 2011, our key challenge in the EU has been to monitor the EU legislation on financial regulatory reform and its impact on the real economy and potential unintended consequences for non- financial companies like Rolls-Royce. Other policy areas have also required our attention, such as the inclusion of marine emissions in EU’s GHG commitment; new noise regulation in the field of aviation; alternative fuel During the year, the Group approved a new global charitable contributions and social sponsorships policy and procedure, confirming our major areas of support as: • education and skills, particularly in the areas of STEM which are key to our future success; • environment, adding value to the Group’s environment strategy; • social investment, making a positive difference to the communities in which we operate; • arts and culture, contributing to the cultural vibrancy in geographic areas in which we operate; and • requests relating to the Group’s business such as armed services related, engineering and aviation. The new policy and procedure also sets out a clear structure for global governance, ensuring consistency of approach and global visibility of contributions. 2011 charitable contributions and sponsorships, and payroll giving Charitable contributions and social sponsorships – UK – Asia and Middle East £0.3m, Americas £0.7m, Europe £0.6m Commercial sponsorship Employee time Gifts in kind Total Payroll giving UK £0.5m and North America £0.3m £m 2.1 1.6 0.7 2.6 0.1 7.1 0.8 £7.1m The Group’s total contributions and sponsorships Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review 34 Principal risks and uncertainties It is recognised that the Group’s business objectives can only be achieved if risks are taken and managed effectively. By understanding the nature of our risks we can be in a position to make better decisions and maximise the returns of the Group while managing our reputation. Regular review of risks and actions to address risks takes place at all levels of the Group. Risks are defined as threats to the achievement of business objectives or to the continuing reputation of the Group. The top level corporate risk register reflects the outcomes of lower level programme, function or business unit risk reviews and is reviewed in detail by the risk committee. Nevertheless, the Board retains its strategic responsibility for risk decision making regularly reviewing the corporate risk register and considering these risks in the context of the business strategy, as reported to it by the risk committee. The risks and uncertainties on these pages are considered to be principal to delivering our strategy and business results, and specific to the nature of our business, notwithstanding that there are other risks that may occur and may impact on the achievement of the Group’s objectives. Risk or uncertainty and potential impact How we manage it Significant external events affecting demand for transportation such as terrorism, political change, global pandemic, natural disaster or continued and deeper economic retrenchment Failure to minimise the environmental impact of the Group’s products and operations leading to reputational damage and ultimately loss of market share  Established a balanced business portfolio  Strong access to parts of the world where demand remains robust  Diversity of global operations  Regularly exercised senior response team  R&D in low carbon technologies such as nuclear power, tidal energy and fuel cells  Significant investment in innovative solutions for aviation, marine and energy markets  Governance structure headed by the environment council to oversee improvements Reduction in government spending due to global financial uncertainty and budgetary constraint in Europe and the US in particular causing reduced revenues on existing platforms and inhibiting investment in new technologies  Development of a diversified portfolio of products and services for various markets and regions  Proactive lobbying for research and technology funding  Achieve commitments under current contracts Failure of counterparties, including financial institutions, customers, joint venture partners and insurers, driven mainly by the economic uncertainties and pressures in the current environment, potentially affecting short-term cash flows  Established policy for managing counterparty credit risk  Common framework to measure, report and control exposures to counterparties across the Group using value-at-risk and fair-value techniques  Internal credit rating assigned to each counterparty, assessed with reference to publicly available credit information and subject to regular review Fluctuations in foreign currency exchange rates affecting operational results or the outcomes of financial transactions  Long-term hedging policy, using a variety of financial instruments (see note 17, page 101 for more information) Regulatory changes relating to financial derivatives may require the Group to post cash collateral, increasing cash flow volatility and the risk of default  Where applicable, currency matching of assets and liabilities to manage translational exposures  Regular review of risks and appropriate risk mitigation performed where material mismatches arise  Close monitoring of proposed changes  Evaluation of potential financial impact in terms of cash collateral required and use of public trading exchanges  Lobbying politicians and regulators in conjunction with other large European corporates If the Group’s products, services and pricing do not remain competitive, this could result in the loss of market share, with attendant impact on long-term financial performance  Establishment of long-term customer relationships to differentiate products and services and protect margins  Steady focus on improvement in operational performance, for example through the modernisation of facilities  Increased focus on managing the costs of operations and products  Sustained investment in technology acquisition Rolls-Royce Holdings plc Annual report 2011Business review35 Principal risks and uncertainties Risk or uncertainty and potential impact How we manage it Non-compliance with applicable legislation and regulations, for example export controls, anti-bribery and authorisation of chemicals and substances compromising the ability to conduct business in certain jurisdictions and exposing the Group to reputational damage and potential financial penalties  A business-wide compliance structure focusing on anti-bribery and corruption legislation  Exports committee, chaired by the Chief Operating Officer directs strategy and policy on exports  Resources to comply with requirements are embedded throughout Failure to grow capable resource globally due to demographic trends and limited supply of appropriately skilled personnel affecting programme delivery, damaging reputation and stifling opportunities for future innovation Product performance not meeting expectations affecting safety and reliability with adverse long-term financial consequences the business  Employee awareness training  Continued significant investment in resourcing and capability infrastructure  Objective assessment of performance using improved system for developing and monitoring the competency of individuals  Regularly refreshed framework to develop managers and leaders  Operating a ‘safety first’ culture, including delivery of regularly refreshed mandated product integrity training to employees and suppliers  Future safety requirements are defined by the product safety assurance team  Activities to improve maturity of products at entry into service  Engineering focus on improvements to product reliability and service lives Disruption of supply chain due to external factors or failure to deliver parts to committed costs and quality reducing the ability to meet customer commitments, win future business or achieve operational results  Continuous improvement of all processes and project management controls to ensure both technical and business objectives are achieved  Customer excellence centre provides improved response to and analysis of supply chain disruption  Focus on production quality through plant and supplier improvement plans  Providing duality of capability through establishment of world-class manufacturing centres  Pursuit of low cost sourcing strategies Downgrade in credit rating restricting the Group’s ability to secure funding, hedge forward or provide vendor financing  The Group has developed a strong financial risk profile and continues to improve the business risk profile Failure to conduct business in an ethical and socially responsible manner causing disruption and reputational damage  Ethics committee established to oversee and maintain the highest ethical standards (see page 50 for its report) Failure to manage multiple complex product programmes effectively with potentially significant adverse financial and reputational consequences, including the risk of impairment of the carrying value of the Group’s intangible assets and the impact of potential litigation Breach of IT security through increasing volumes of data being transmitted electronically across international borders may cause controlled data to be lost, corrupted or accessed by unauthorised users, impacting the Group’s reputation Failure to execute the programme to modernise the IT infrastructure impacting efficiency and effectiveness of business operations  Global Code, in 18 languages, issued to all employees supported by a training and engagement programme to improve awareness of the Group’s values  Global telephone and intranet channels are available for employees to report in confidence any concerns regarding potentially unethical behaviours  Continuous improvement of all processes and project management controls to ensure both technical and business objectives are achieved  All major programmes subject to approval and regular review by the Board, with particular focus on the nature and potential impact of emerging risks and the effective mitigation of previously identified threats  Continual upgrading of security equipment and software  Deployment of a multi-layered protection system that includes web gateway filtering, firewalls and intrusion detection  Specialist resources employed to increase capability  Active sharing of information through industry and government forums  Governance structure established to oversee the programme  Project and risk management methodologies are being followed  Specialist resources have been secured to increase capability  Involvement of multiple service providers to provide competition and remove dependency on any single supplier Loss or unintended disclosure of Intellectual Property damaging the Group’s competitive position and causing potential breach of contractual requirements  Strengthening of resources to manage patents  Creation of a global framework of Intellectual Property officers  Procurement of a global IT system to make patent information more widely available to engineers Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review36 Additional financial information Foreign exchange Foreign exchange rate movements influence the reported income statement, the cash flow and closing net cash balance. The average and spot rates for the principal trading currencies of the Group are shown in the table below: USD per GBP EUR per GBP Year end spot rate Average spot rate Year end spot rate Average spot rate 2011 1.55 1.60 1.20 1.15 2010 1.57 1.54 1.17 1.17 Change -1% +4% +3% -2% Taxation The Group believes that it has a duty to shareholders to seek to minimise its tax burden but to do so in a manner which is consistent with its commercial objectives and meets its legal obligations and ethical standards. Every effort is made to maximise the tax efficiency of business transactions and this includes taking advantage of available tax incentives and exemptions. However, the Group has regard for the intention of the legislation concerned rather than just the wording itself. The Group is committed to building open relationships with tax authorities and to following a policy of full disclosure in order to effect the timely settlement of its tax affairs and to remove uncertainty in its business transactions. Where appropriate, the Group enters into consultation with tax authorities to help shape proposed legislation and future tax policy. Transactions between Rolls-Royce subsidiaries and associates in different jurisdictions are conducted on an arms-length basis and priced as if the transactions were between unrelated entities, in compliance with the OECD Model Tax Convention and the laws of the relevant jurisdictions. Investments and capital expenditure The Group subjects all major investments and capital expenditure to a rigorous examination of risks and future cash flows to ensure that they create shareholder value. All major investments require Board approval. Capital structure Capital summary – £ million Total equity Cash flow hedges Group capital Net funds 2011 4,519 52 4,571 223 2010 3,979 37 4,016 1,533 Operations are funded through various shareholders’ funds, bank debt, bonds, notes and finance leases. The capital structure of the Group reflects the judgement of the Board as to the appropriate balance of funding required. Funding is secured by the Group’s continued access to the global debt markets. Borrowings are funded in various currencies using derivatives where appropriate to achieve a required currency and interest rate profile. The Board’s objective is to retain sufficient financial investments and undrawn facilities to ensure that the Group can both meet its medium- term operational commitments and cope with unforeseen obligations and opportunities. The Group holds cash and short-term investments which, together with the undrawn committed facilities, enable it to manage its liquidity risk. After repayment from cash resources of the €750 million Eurobond, the Group retained at year end aggregate liquidity of £2.5 billion. This liquidity comprised net funds of £223 million and aggregate borrowing facilities of £2.3 billion, of which £1.2 billion remained undrawn. This represents a 34 per cent decrease in net drawn borrowing facilities during the year. The maturity profile of the borrowing facilities is regularly reviewed to ensure that refinancing levels are manageable in the context of the business and market conditions. No facilities mature in 2012. There are no rating triggers in any borrowing facility that would require the facility to be accelerated or repaid due to an adverse movement in the Group’s credit rating. The Group has a portfolio of projects at different stages of their life cycles. Discounted cash flow analysis of the remaining life of projects is performed on a regular basis. Sales of engines in production are assessed against criteria in the original development programme to ensure that overall value is enhanced. During 2011, the £250 million bank revolving credit facility (RCF) due in 2012 and £750 million RCF due in 2013 were both refinanced with a new £1 billion RCF due in 2016 provided by a syndicate of relationship banks. The borrowing margin for this new RCF varies for a given credit rating. Depending on the extent drawn, the current margin would be 0.40 per cent to 0.70 per cent over sterling LIBOR. Financial risk management The Board has an established and structured approach to financial risk management. The Financial Risk Committee (Frc) is accountable for managing, reporting and mitigating the Group’s financial risks and exposures. These risks include the Group’s principal counterparty, currency, interest rate, commodity price, liquidity and credit rating risks outlined in more depth in note 17 to the financial statements. The Frc is chaired by the Finance Director. The Group has a comprehensive financial risk policy that advocates the use of financial instruments to manage and hedge business operations risks that arise from movements in financial, commodities, credit or money markets. The Group’s policy is not to engage in speculative financial transactions. The Frc sits quarterly to review and assess the key risks and agree any mitigating actions required. The Group conducts some of its business through a number of joint ventures. A major proportion of the debt of these joint ventures is secured on the assets of the respective companies and is non-recourse to the Group. This non-recourse debt is further outlined in note 10 to the financial statements. Rolls-Royce Holdings plc Annual report 2011Business review37 Additional financial information For more financial information go online: www.rolls-royce.com/investors Credit rating Rating agency Moody’s Investors Service Standard & Poor’s Rating A3 A- Outlook Stable Positive Grade Investment Investment The Group subscribes to both Moody’s Investors Service and Standard & Poor’s for independent long-term credit ratings. At December 31, 2011, the Group maintained investment grade ratings from both agencies. As a capital-intensive business making long-term commitments to our customers, the Group attaches significant importance to maintaining or improving the current investment grade credit ratings. Accounting and regulatory The consolidated financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), as adopted by the EU. In 2011, there were no changes that have had a significant effect on the Group’s financial statements. A summary of changes which have not been adopted in 2011 is included within the accounting policies in note 1 to the financial statements. Governments and regulators around the world continue to consider reforms to the financial markets with the aim of improving transparency and reducing systemic risk. Although the proposed reforms are predominantly directed at financial institutions, they will also affect non-financial institutions such as the Group. In particular, proposals by both US and European regulators to reform the Over-the-counter (OTC) derivatives market may have adverse implications for the Group. If, as is being contemplated, parties to future OTC derivative transactions are required to use an exchange to clear the transactions and post cash collateral to reduce counterparty risk, the Group’s future funding requirements could be adversely affected and cash flow more volatile. Share price During the year the share price increased by 20 per cent from 623p to 746.5p, compared to a 0.7 per cent increase in the FTSE aerospace and defence sector and a 5.6 per cent decrease in the FTSE 100. The Company’s share price ranged from 557.5p in March to 746.5p at the year end. Rolls-Royce Holdings plc Annual report 2011Business reviewBusiness review38 Governance Board of directors Sir Simon Robertson Non-executive Chairman John Rishton Chief Executive Iain Conn Senior Independent Director Dame Helen Alexander Non-executive director Lewis Booth Non-executive director Peter Byrom Non-executive director Sir Frank Chapman Non-executive director Sir Peter Gregson Non-executive director Sir Simon Robertson (70) 2* Non-executive Chairman, appointed January 2005 Skills and experience: Sir Simon brings to the Board a background in international corporate advisory with a wealth of experience in mergers and acquisitions, merchant banking, investment banking and financial markets. During his career he has worked in France, Germany, the UK and the US. In June 2010, he was honoured with a knighthood in recognition of his services to business. External appointments: Sir Simon is the founder member of Simon Robertson Associates LLP and Deputy Chairman of HSBC Holdings plc. He is a non-executive director of Berry Bros & Rudd Limited and The Economist Newspaper Limited. Sir Simon is a director of The Royal Opera House Covent Garden Limited and a Trustee of The Eden Project and of the Royal Opera House Endowment Fund. John Rishton (53) 2, 5* Chief Executive, appointed March 2011 Skills and experience: John is the former Chief Executive Officer of Royal Ahold. He began his career in 1979 at Ford Motor Company and held a variety of positions both in the UK and in Europe. In 1994 he joined British Airways Plc, where he was Chief Financial Officer from 2001 to 2005. Prior to his appointment as Chief Executive, John had been appointed as a non-executive director of the Company in 2007 and served as Chairman of the audit committee and a member of the ethics and nominations committees. He is a former non-executive director of Allied Domecq. Media and Deputy Chairman of esure Group Holdings, and senior adviser to Bain Capital. Dame Helen is Chancellor of the University of Southampton. Iain Conn (49) 1, 2 Senior Independent Director, appointed January 2005 Skills and experience: Iain joined the BP group in 1986 and has held a number of executive positions within the BP group worldwide. External appointments: Iain is a Group Managing Director and Chief Executive of Refining and Marketing, BP p.l.c. He is also Chairman of the Advisory Board of The Imperial College Business School and a member of Imperial College Council. Dame Helen Alexander (54) 2, 3*, 4 Non-executive director, appointed September 2007 Skills and experience: Dame Helen is currently involved with a number of not-for-profit organisations in media, the internet, the arts and education. She has also been a non-executive director of Northern Foods Limited, Centrica PLC and BT Group PLC. She was Chief Executive of the Economist Group till 2008, having joined the company in 1985. External appointments: Dame Helen is Deputy President of the CBI, where she was President until June 2011. She is Chairman of the Port of London Authority (PLA), Incisive Lewis Booth (63) 1*, 2, 4 Non-executive director, appointed May 2011 Skills and experience: Lewis has held a series of senior positions within the Ford Motor Company in Europe, Asia, Africa and the United States. Lewis began his career with British Leyland, before joining Ford in 1978. External appointments: Lewis is executive Vice President and Chief Financial Officer of Ford Motor Company, a position he has held since November 2008. Peter Byrom (67) 2, 4 Non-executive director, appointed January 1997 Skills and experience: Peter was a director of AMEC plc from 2005 to 2011 and of NM Rothschild & Sons Limited from 1977 to 1996. He is a Fellow of the Royal Aeronautical Society. External appointments: Peter is Chairman of Domino Printing Sciences plc. Sir Frank Chapman (58) 2, 3 Non-executive director, appointed November 2011 Skills and experience: Sir Frank has worked in the oil and gas industry for 37 years, including operational and business development roles within Royal Dutch Shell plc and BP p.l.c. Sir Frank graduated with first class honours in Mechanical Engineering from Queen Mary College, London University, and is a Fellow of the Institution of Mechanical Engineers. He was knighted in 2011 for services to the oil and gas industries. External appointments: Sir Frank has been Chief Executive of BG Group plc for the past 11 years, managing the Group through a period of transformational growth and international diversification. Sir Peter Gregson (54) 2, 3 Non-executive director, appointed March 2007 Skills and experience: Appointed to the academic staff at the University of Southampton in 1983, Sir Peter became Professor of Aerospace Materials in 1995 and Deputy Vice-Chancellor in 2000. He is a Fellow of the Royal Academy of Engineering and a Member of the Royal Irish Academy and has served on the Councils of the Royal Academy of Engineering and the Central Laboratory of the Research Councils. He was knighted in 2011 for services to higher education. External appointments: Sir Peter is President and Vice-Chancellor of Queen’s University Belfast; he serves on the Council of CBI Northern Ireland and is a member of the Board of the UK Universities and Colleges Employers Association. He is Deputy Lieutenant of Belfast. Rolls-Royce Holdings plc Annual report 2011Governance39 Board of directors John McAdam Non-executive director John Neill CBE Non-executive director Ian Strachan Non-executive director James Guyette President and Chief Executive Officer of Rolls-Royce North America Inc Mark Morris Finance Director Colin Smith Director – Engineering and Technology Mike Terrett Chief Operating Officer Paul Davies Acting Company Secretary John McAdam (63) 2, 3 Non-executive director, appointed February 2008 non-executive director of Johnson Matthey plc, Commercial Union and Reuters Group plc. Colin Smith (56) 5 Director – Engineering and Technology, appointed July 2005 External appointments: Ian is a non-executive director of Xstrata plc, Transocean Inc and Caithness Petroleum Limited. James Guyette (66) 5 President and Chief Executive Officer of Rolls-Royce North America Inc., appointed January 1998 Skills and experience: Before joining the Company, Jim was Executive Vice President, Marketing and Planning of United Airlines. External appointments: Jim is Chairman of PrivateBancorp, Inc., of Chicago, Illinois and he is a director of priceline.com Inc., of Norwalk, Connecticut. Jim is Chairman of the Smithsonian National Air and Space Museum, Washington DC. Mark Morris (48) 5 Finance Director, appointed January 2012 Skills and experience: Mark joined Rolls-Royce in 1986. He has held a number of senior positions throughout the Group and, prior to his appointment as Finance Director, was Group Treasurer from 2001. Skills and experience: Colin joined Rolls-Royce in 1974. He has held a variety of key positions within the Company, including Director – Research and Technology and Director of Engineering and Technology – Civil Aerospace. Colin is a Fellow of the Royal Academy of Engineering, the Royal Aeronautical Society and the Institution of Mechanical Engineers. Mike Terrett (55) 5 Chief Operating Officer, appointed September 2007 Skills and experience: Mike joined Rolls-Royce in 1978. He has held a variety of senior positions in the development of new aero-engine programmes including Managing Director of Airlines and President and Chief Executive Officer of IAE based in the United States. Prior to his appointment as Chief Operating Officer he was President – Civil Aerospace. Mike is a Member of the Institute of Mechanical Engineers and a Fellow of the Royal Aeronautical Society. Skills and experience: John was the Chief Executive of ICI plc until ICI’s acquisition by Akzo Nobel. He has held a number of positions at Unilever, within its Birds Eye, Walls, Quest International and Unichema International businesses. External appointments: John is Chairman of United Utilities Group PLC and of Rentokil Initial plc, the Senior Independent Director of J Sainsbury plc and a non-executive director of Sara Lee Corporation. John Neill CBE (64) 1, 2 Non-executive director, appointed November 2008 Skills and experience: John is a member of the Council and Board of Business in the Community, is Vice President of the Society of Motor Manufacturers and Traders, BEN, the automotive industry charity and The Institute of the Motor Industry. He was awarded a CBE in June 1994 for his services to industry. Ian Strachan (68) 1, 2, 4* Non-executive director, appointed September 2003 Skills and experience: Ian is the former Chief Executive of BTR plc, former Deputy Chief Executive and Chief Financial Officer of Rio Tinto plc, former non-executive Chairman of Instinet Group Inc and a former Paul Davies (56) Acting Company Secretary Skills and experience: Paul joined Rolls-Royce in 2008. He began his career in the secretariat of Ford Motor Company in 1980 and progressed via roles with Burberrys and Hunter Saphir plc. He was appointed Company Secretary of Norwest Holst plc in 1991, of Kingsbury Group plc in 1997 and, after the takeover of Kingsbury, of Galliford plc. He then worked for United Utilities plc (for seven years) as both Deputy Company Secretary, and acting Company Secretary, before joining Rolls-Royce as Deputy Company Secretary. Committee membership 1 Audit committee 2 Nominations committee 3 Remuneration committee 4 Ethics committee 5 Risk committee * Denotes chairman of committee Non-executive directors Executive directors Acting Company Secretary Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance40 International Advisory Board (IAB) The IAB, formed in 2006, advises the Board on emerging worldwide trends and, in 2011, considered implications of the World Outlook, the US/China relationship, cyber security and cyber warfare. Membership of the IAB is as follows: Lord Powell of Bayswater Chairman of IAB, former Foreign Affairs and Defence Adviser to Prime Ministers Margaret Thatcher and John Major Fernando Cardoso Former President of Brazil and professor emeritus, University of São Paulo Bernard Duc, CBE Senior Partner HMI Ltd (Hong Kong), Chairman of the Rolls-Royce South East Asia Advisory Board Sir Rod Eddington Chairman – Australia & New Zealand, J.P. Morgan, and former Chief Executive, British Airways Plc Dr Fan Gang Professor at China’s Academy of Social Sciences and Director of National Economic Research Institute Ambassador Hills Chair and CEO, Hills & Company, International Consultants, former US Trade Representative, former Secretary of Housing and Urban Development, former Assistant Attorney General General Sir Mike Jackson Former Chief of the General Staff, UK Ministry of Defence Mustafa Koç Chairman of Koç Holding, A.Ş. Taizo Nishimuro Former Chairman of Tokyo Stock Exchange Group, Inc. and former Chairman of Toshiba Corporation Lubna Olayan CEO and Deputy Chairperson of the Olayan Financing Company Eduardo Serra President and founder of Eduardo Serra y Asociados (ESYA), President of Everis Foundation, former Spanish Defence Minister, former President of the Royal Board of Trustees of the Prado Museum Rair Simonyan Chairman, Morgan Stanley, Russia, former first VP of Russian State oil company, Rosneft Ratan Tata Chairman of Tata Sons Limited Matthias Wissmann President of the German Association of the Automotive Industry (VDA), Vice-Chairman of the Federation of German Industries (BDI) and Senior International Counsel at WilmerHale, former Federal Minister of Research and Technology and of Transport of Germany Lee Hsien Yang Chairman, Fraser and Neave Limited Ernesto Zedillo Former President of Mexico, Director, Yale Center for the Study of Globalization The Group Leadership Team (GLT) John Rishton, Chief Executive, chairs meetings of the GLT. The GLT acts as an important communications channel between the executive directors and the Group’s senior managers. In addition to John Rishton, its other members are: Miles Cowdry Director – Global Corporate Development Kath Durrant Director – Human Resources James Guyette President and Chief Executive Officer of Rolls-Royce North America Inc. Michael Haidinger President – Rolls-Royce Deutschland Ltd & Co KG Lawrie Haynes President – Nuclear Andrew Heath President – Energy Peter Morgan Director – Corporate Affairs Harry Holt Director – Global Government Relations John Paterson President – Marine and Industrial Power Systems Mark King President – Civil Aerospace Dan Korte President – Defence Aerospace Alain Michaelis President – Gas Turbine Supply Chain & Deputy Chief Operating Officer Mark Morris Finance Director Colin Smith Director – Engineering and Technology Mike Terrett Chief Operating Officer Robert Webb General Counsel Tony Wood President – Marine Rolls-Royce Holdings plc Annual report 2011Governance41 Chairman’s introduction In 2011, the nominations committee commissioned an external review of the Board’s effectiveness by JCA Partners LLP. I am very pleased to report that the review found that all members of the Board were united in believing the Board worked very well and that it is seen as an effective Board with a unity of purpose. The review is described in more detail in the nominations committee report on page 48. In September 2011, we issued our response to the Davies Report on women on boards confirming our support for the development of a diverse workforce. We govern this through our Global Diversity and Inclusion Steering Group, the membership of which includes main board directors and senior executives. The nominations committee discusses this topic regularly and expects to make demonstrable progress in this area by 2015. In this report, the Board has taken account of the concerns expressed by the Financial Reporting Review panel (February 2011) about how companies are reporting risks and the discussions of the Financial Reporting Council (FRC) summarised in ‘Boards and Risk’ (September 2011). In December 2011, the Board received a detailed report from the risk committee (including a review of all internally significant risks), which, following discussion, confirmed and defined the Board’s tolerance for risk, ensured all directors understood the Group’s risk exposure and provided an impact review of potential changes in risk. We have therefore endeavoured to make sure that the risks we identify on pages 34 and 35 are indeed the key risks facing the Group, to ensure that we eliminate risks expressed in generic terms and to show how risks are managed. A description of our risk management process is set out in the risk committee report, detailed on page 51. In December 2011, the FRC published a paper entitled ‘Developments in Corporate Governance 2011’ in which it expressed concern about the level of reporting of the activities of a company’s committees in the annual report, particularly the work of the audit committee. As a result, I have asked the committee chairmen to make personal reports in this year’s Annual report in order to provide greater insight into committee work. In January 2012, the UK Government announced its intention to introduce reforms to the way directors’ remuneration is set, approved and reported. At Rolls-Royce, we believe strongly in the alignment of executive rewards to the creation of long-term shareholder value. In the report by the chairman of the remuneration committee on pages 52 to 54 we have endeavoured to provide a clearer view of how we believe we achieve that and we will engage in a positive way with the proposals outlined by the UK Government. I believe that the strength of the Company’s corporate values, its reputation and its ability to achieve its objectives are influenced by the effectiveness of the Company’s approach towards corporate governance, which is why the Board will continue to attach the highest priority to its compliance with the Code’s principles. Following the introduction of the UK Corporate Governance Code, I am pleased to be able to provide a fuller view of the operation of the Board and to confirm how the Company has met its obligations. The working of a Board cannot be captured and tabled by a ‘standard’ approach and this introduction, and the following pages, allied to the usual committees’ reports, will I hope provide a clear insight into the corporate governance structure and practices of Rolls-Royce. The Board’s committee structure has been reviewed during the year and due to the importance of safety in our business, both in terms of the safety of our products and the health and safety of our employees, the Board has agreed to the introduction in 2012 of a safety committee, which will be chaired by Sir Frank Chapman. The safety committee’s terms of reference, once reviewed and approved by the Board, will be added to those of the other committees on the Group’s website. In accordance with the provisions of the UK Corporate Governance Code (the Code), all Board directors are required to seek re-election at the AGM in 2012. Following the performance evaluation process, I am pleased to confirm that each of the non-executive director’s performance and contribution continues to be timely, thoughtful, challenging and relevant. In addition, each has provided, and continues to provide, excellent commitment to the role, ensuring sufficient time is available for meeting preparation and non-scheduled meetings. However, I would advise that Sir Peter Gregson has decided to retire at the 2012 AGM and will not seek re-election. The Board continues to support our longest serving non-executive director, Peter Byrom, who has been a Rolls-Royce Board member since 1997. We are a complex and technologically advanced company with a long business cycle from the development of an engine to its eventual retirement, and the Board greatly values Peter’s independent experience and his continuing contribution to debate. In supporting Peter, the Board has taken full account of the Code’s requirement to consider carefully a non-executive director’s independence where that director has served on the Board for more than nine years from the date of their first election. The Group values its communications with existing and potential shareholders who offer a rich and diverse source of capital to fund the future growth of the Group. Our engagement with shareholders is described in more detail on page 42. Sir Simon Robertson Chairman Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance42 UK Corporate Governance Code The Code In the year to December 31, 2011, the revised principles and provisions of the Code (published in May 2010 by the FRC) applied to the Company. A printed copy of the Code can be obtained free of charge from FRC Publications, 145 London Road, Kingston upon Thames, Surrey KT2 6SR – telephone: +44 (0)20 8247 1264 and online at: www.frcpublications.com. This report, which includes the Directors’ remuneration report on pages 55 to 65, explains how the Company discharges its corporate governance responsibilities. The Board confirms that throughout 2011, the Company complied with the provisions of the Code, with the following exception: Code provision C.3.4 – The audit committee should review arrangements by which staff of the company may, in confidence, raise concerns about possible improprieties in matters of financial reporting or other matters. Explanation The Board considered it appropriate that this provision of the Code be the responsibility of the ethics committee which refers matters of improprieties in matters of financial reporting to the audit committee. Board membership The nominations committee monitors the composition and performance of the Board and the composition of its committees. During 2011, the Board’s composition changed with the appointment of a new Chief Executive and two new independent non-executive directors. Following Andrew Shilston’s retirement, the committee also agreed the proposed appointment of a new Finance Director. These appointments are discussed in more depth in the nominations committee report on page 48. Roles and responsibilities Sir Simon Robertson, as Chairman of the Board of directors, is responsible for leadership of the Board and ensuring its effectiveness on all aspects of its role. John Rishton is the Chief Executive responsible for the leadership, operational and performance management of the Group, defined by the strategy and business plan agreed by the Board. The division of responsibilities between them is set down in writing and agreed by the Board and a copy of this document can be found on our website at www. rolls-royce.com. Iain Conn is the Company’s Senior Independent Director. Role of the Board The principal role of the Board is to ensure that the Group’s strategy creates long-term success for the Group, within an acceptable risk profile, and providing value for the long-term investor. The Board retains responsibility for the approval of certain matters which affect the shape and risk profile of the Group, as well as items such as the annual budget and performance targets, the financial statements, payments to shareholders, major capital investments, substantial changes to balance sheet management policy and the strategic plan. The division of responsibilities between the Board and the executive team is set out in detail in a schedule approved annually by the Board, which also defines those decisions which can only be taken by the Board. The day-to-day running of the Group is delegated by the Board to the executive team under the leadership of John Rishton, the Chief Executive. To achieve its long-term success, the Board has set itself the following tasks to: • ensure the development of the Group’s strategy, together with monitoring of both its achievement and the Group’s risk appetite; • ensure the safety of its products and its people; • uphold the values of the Group, including its brand and corporate reputation; • oversee the quality and performance of management and ensure it is maintained at world-class standards, through effective succession planning and remuneration policies; and • maintain an effective corporate governance framework, with transparent reporting. Directors’ induction and training Newly appointed directors participate in a structured induction programme and receive a comprehensive data pack providing detailed information on the Group. An existing executive director acts as a mentor to each newly appointed non-executive director, giving guidance and advice as required. Ongoing training is available for all the directors, including presentations by the executive team on particular aspects of the business. There is a procedure for directors to take independent professional advice at the Company’s expense. This is in addition to the access every director has to the General Counsel and the Company Secretary. Issues Operation of the Board and governance Group strategy development and current issues Financial structure Risk strategy Facilitated by Chairman and Company Secretary Chief Executive Finance Director General Counsel Operational strategy Chief Operating Officer Technology and engineering issues Director – Engineering and Technology Key site visits Director – Engineering and Technology Committee technical requirements Committee chairman, internal or external experts Shareholder relations Communications with shareholders regarding business strategy and financial performance are coordinated by a dedicated Investor Relations department that reports to the Finance Director. Communications regarding the general administration of shareholdings are coordinated by the Company Secretariat, reporting to the Company Secretary. The two primary written sources of information about the Group for shareholders are the website (www.rolls-royce.com) and the published Annual report, an online version of which is also available on the website. The website also carries a wealth of financial and other information about the Group that includes current business strategy, historical financial data, recent presentation materials as well as factual data about the Group’s businesses, products and services. The Group conducts a dedicated investor relations programme with institutional investors which includes various formal events during the year, as well as a regular series of one-to-one and group meetings. The purpose of the events is to highlight a particular issue, theme or announcement that the Group believes warrants further explanation or clarification. The events also provide opportunities for shareholders to Rolls-Royce Holdings plc Annual report 2011Governance43 UK Corporate Governance Code meet members of the senior management team to discuss topics of interest. Examples of these events in 2011 were: the preliminary and half-yearly results announcements; the AGM; the announcement of the intention with Daimler AG to acquire Tognum AG; the update given at the Paris Air Show on trends in the civil and defence aerospace businesses; the announcement with Pratt & Whitney to restructure the Group’s participation in IAE and form a new joint venture; the annual investor briefing; visits to the Group’s sites; and industry conferences. The one-to-one and group meetings provide additional context around the Group’s business strategy and financial performance such that shareholders are able to consistently and fairly value the Group’s businesses. In 2011, around 350 meetings took place with 1,350 existing and potential institutional shareholders. Of those meetings, the Chief Executive attended over 50 meetings and the Finance Director 30 meetings. From a regional perspective, the majority of meetings took place in the UK (approximately 250) with over 500 investors. Forty meetings occurred in the USA involving 90 investors and a further 25 European meetings included around 55 investors. As well as providing context and answering questions about the announcements during the year, the principal areas discussed with shareholders and potential investors were: the Group’s continued investment over decades in complex technology, people and infrastructure that creates high-cost barriers to entry; the breadth, balance and diversity of the product portfolio that underpins the resilient financial performance of the Group during this time of relative economic uncertainty; the scale of the record order book that provides opportunities for operational leverage; the importance of the Group’s strong balance sheet; the potential impact of budgetary pressures, particularly in the defence aerospace business; development of the services model in the marine business; the options for future growth in the energy business and the initial views of the Chief Executive. Board and committee attendance 2011 Holders of ordinary shares may attend the Company’s AGM at which the Company highlights key business developments during the year and at which shareholders have an opportunity to ask questions. The chairmen of the audit, nominations, remuneration, ethics and risk committees are available to answer any questions from shareholders on the work of their committees. The Annual General Meeting (AGM) This year’s AGM will be held at 11.00am on Friday May 4, 2012 at the QEII Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE. The Notice of AGM and the Annual report will be available to view on the Group’s website. Shareholders unable to attend the AGM are invited to vote on the business of the meeting by completing a proxy form and returning it to the Computershare Investor Services PLC (the Registrar). Following agreement to receive electronic communications, shareholders are able to vote online. The Company confirms that it sends the AGM notice and relevant documentation to all shareholders at least 20 working days before the date of the AGM. For those shareholders who have consented to receive communications electronically, notice is given by email or by written notice of the availability of documents on the Group’s website. The Board The Board met 12 times during the year, seven of which were scheduled. Five meetings were called at short notice to discuss such issues as the acquisition of Tognum AG, the provision of a new higher thrust version of the Trent XWB to Airbus for the A350-1000 and the agreement of a new joint venture with Pratt & Whitney to develop new engines for future generation mid-size aircraft. The attendance by individual directors at meetings of the Board and its committees in 2011 is shown in the table below. Sir Simon Robertson (Chairman) Dame Helen Alexander Lewis Booth1 Peter Byrom Sir Frank Chapman2 Iain Conn3 Sir Peter Gregson James Guyette John McAdam John Neill CBE John Rishton Sir John Rose4 Andrew Shilston5 Colin Smith Ian Strachan Mike Terrett Board 12(12) 11(12) 6(6) 11(12) 1(1) 9(12) 12(12) 12(12) 11(12) 11(12) 11(12) 4(4) 12(12) 12(12) 10(12) 12(12) Audit Remuneration 5(5) 0(1) 4(5) 5(5) 2(2) 4(4) 4(4) 4(4) Nominations 3(3) 3(3) 1(2) 3(3) 0(1) 3(3) 2(3) 3(3) 3(3) 3(3) 0(0) 3(3) Ethics Risk 3(3) 2(2) 3(3) 3(3) 2(2) 2(2) 0(0) 2(2) 2(2) 2(2) Figures in brackets denote the maximum number of meetings that could have been attended (seven Board meetings were scheduled and five called at short notice). The figures include meetings of the former holding company, Rolls-Royce Group plc to May 23, 2011. 1 Lewis Booth was appointed as a non-executive director on May 25, 2011. 2 Sir Frank Chapman was appointed as a non-executive director on November 10, 2011. 3 Iain Conn attended six out of seven scheduled Board meetings. 4 Sir John Rose retired as Chief Executive on March 31, 2011. 5 Andrew Shilston retired as Finance Director on December 31, 2011 and was replaced by Mark Morris who joined the Board with effect from January 1, 2012. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance44 UK Corporate Governance Code There are currently 15 directors on the Board comprising the non-executive Chairman, the Chief Executive, four other executive directors and nine non-executive directors. Executive directors are employees who have day-to-day responsibilities as executives of the Group in addition to their duties as directors. Non-executive directors are not employees and do not participate in the daily business management of the Group. Each executive director receives a service contract on appointment and each non-executive director receives a letter setting out the conditions of his or her appointment (see pages 58 and 65, respectively, for further information). The quality and broad experience of the directors, the balance of the Board’s composition and the dynamics of the Board as a group, ensure the Board’s effectiveness and also prevent any individual or small group dominating the Board’s decision making. Non-executive directors are appointed for an initial term of three years, which may be extended with the agreement of the Board, although reappointment is not automatic and their term of office is subject to annual re-election by shareholders at the AGM. Under Article 112 of the Company’s Articles of Association, all directors (with the exception of Sir Peter Gregson) will offer themselves for re-election at the 2012 AGM. The work of the Board in 2011 During the year, in addition to its routine business, matters considered by the Board included: • an investment to create a replacement new disc facility at a site close to Sunderland; • the resolution of the issues arising from the Qantas QF32 incident and lessons learned; • the offer by Engine Holding GmbH, a joint venture with Daimler AG, to acquire the whole of the issued share capital of Tognum AG; • the introduction and listing of a new holding company for the Group, Rolls-Royce Holdings plc; • the impact on the Group’s people, its operations and its suppliers of the earthquake in Japan; • the withdrawal of support by the US Secretary of Defense of the F136 programme; • plans to modernise the Group’s IT infrastructure; • development of a new higher thrust version of the Trent XWB for the Airbus A350-1000; • the restructuring of the Group’s participation in IAE with Pratt & Whitney, together with a new partnership for a joint venture to develop engines for future generation mid-size aircraft; and • the effects of consolidation in the industry and the European sovereign debt crisis. In addition, executive directors (and senior executives, as appropriate) supplied reports on business and financial performance together with regular updates on health, safety and the environment, IT infrastructure and disaster recovery arrangements, corporate governance, corporate affairs and quality and process excellence. All Board committee chairmen provided verbal reports on the activities of their committee at the next Board meeting. In September 2011, the Board held its annual day-long strategy meeting, which included discussions with the presidents of each of its business sectors and presentations on the ten-year financial plan, customer relations, delivery of the order book, technology acquisition and low-carbon technologies. Independence of the non-executive directors The Board applies a rigorous process in order to satisfy itself that its non-executive directors remain independent by reviewing the independence of the non-executive directors every year, based on the criteria in the Code. This review was undertaken in November 2011 and the Board concluded that all the non-executive directors were independent in character and judgement. The Code does not consider the test of independence to be appropriate to the chairman of a company. However, Sir Simon Robertson did meet the Code’s independence criteria upon his appointment as Chairman in January 2005. His other external commitments are described on page 38. As referenced in the Chairman’s introduction on page 41, the Board will again be asking shareholders to re-appoint Peter Byrom as a director, even though he has served as a director of the Group since January 1, 1997. Conflicts of interest Directors have a duty to avoid a situation in which they have, or can have, a direct or indirect interest which conflicts, or possibly may conflict, with the interests of the Company unless that situational conflict has been authorised by the Board. The nominations committee has reviewed and authorised all directors’ situational conflicts and has agreed that while directors are required to keep confidential all Company information, they shall not be required to share with the Company confidential information received by them from a third party which is the subject of the situational conflict. Indemnity The Company has entered into separate Deeds of Indemnity in favour of its directors. The deeds provide substantially the same protection as that already provided to directors under the indemnity in Article 216 of the Company’s Articles of Association. The Company has also reviewed, arranged and maintains appropriate insurance cover for any legal action taken against its directors and officers. Board committees The Board has established a number of committees, the principal ones being audit, remuneration, nominations, ethics and risk. A safety committee will also be established during 2012. Terms of reference for each committee are, or will be available, on the Group’s website at www.rolls-royce.com. The membership, responsibilities and activities of these committees are described in this governance report on pages 46 to 65. Executive committees During the year, the governance structure of the group below Board level developed further with the establishment of the Executive Board as the primary channel for executive approval. The Executive Board, comprised of all executive directors, carries out a pre-approval review of those items requiring the approval of the Board and acts as the primary approval channel for matters below Board level, in accordance with the Group’s delegated authorities manual. It establishes corporate priorities, assists the Board in the development of Group policy and strategy, decides on senior succession and makes recommendations to the nominations committee in relation to succession to the Executive Board itself and to the GLT. At each meeting the Executive Board reviews the HS&E performance of the Group, considers customer relations, reviews financial and operational performance and receives an update on potential acquisitions and disposals. Rolls-Royce Holdings plc Annual report 2011Governance 45 UK Corporate Governance Code The GLT, which generally meets immediately after the Executive Board meeting, receives an update from the Chief Executive on the work transacted at that meeting. The GLT’s responsibilities are: a) to provide input and advice to the Executive Board on policy and strategy; b) to discuss Group performance; and c) to act as an important communications forum between the executive directors and the Group’s senior management. During the year, the GLT met on a face-to-face basis ten times and held regular catch up meetings by teleconference between each of its meetings. Like the Executive Board, it routinely considers the HS&E performance of the Group, customer relations and financial and operational performance at each of its formal meetings. In addition to its routine business, the committee received presentations on such subjects as the Group’s anti-bribery and corruption programme, the introduction of worldwide all-employee global grading (together with the existing system of performance appraisal/management), government relations and product safety. In addition to the Executive Board and the GLT, the Operations Executive, chaired by the Chief Operating Officer, considers detailed operational issues in its pursuit of world-class performance in terms of cost, quality and delivery. The Group’s functions are placed under similar scrutiny by the Functional Executive chaired by the Finance Director. Each of the Group’s business segments have their own governance structures which broadly mirror that of the holding company. Meetings at sector level generally take place a week ahead of the Executive Board and GLT meetings. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance46 Report from Lewis Booth Chairman of the audit committee I am pleased to present my first report describing the work of the audit committee, having taken on the role of chairman of the committee from July 31, 2011. I would like to acknowledge the work of my predecessor, Ian Strachan, who took the chair at short notice in October 2010, ensuring the committee maintained its critical appraisal. The results of the recent board evaluation confirmed that the audit committee works well and has a good relationship with the finance function, which I intend to continue under my chairmanship. Membership The committee (consisting of non-executive directors) met four times in 2011 and attendance by the members is shown in the table on page 43. During the year, KPMG (KPMG Audit Plc – the external auditors), the Head of Business Assurance and the General Counsel and Company Secretary attended the meetings, together with the Chairman of the Board, Chief Executive and Finance Director. Other Board members and/or senior executives attend meetings at my invitation. The General Counsel, and the Head of Business Assurance, have direct access to the committee. Responsibilities The committee recommends the financial statements to the Board and reviews the Group’s financial reporting and accounting policies, including formal announcements and trading statements relating to the Company’s financial performance. It oversees the relationship with KPMG and the role and effectiveness of the internal audit function (business assurance). The committee reviews the Group’s procedures for detecting, monitoring and managing the risk of fraud and the Group’s internal controls and systems for assessing and mitigating risk. The committee’s terms of reference are available on the Group’s website at www.rolls-royce.com. The Board’s review of the risk management process and its statement on internal control as required by the ‘Turnbull guidance’ is contained on page 69. Work of the committee in 2011 Financial reporting The committee reviewed the form and content of the Group’s Annual report and financial statements, half-yearly results announcement and interim management statements. In conducting its reviews of these publications, the committee considered reports prepared by management, business assurance and the external auditor. Amongst other things, these reports covered the key areas of judgement and sources of estimation uncertainty described in note 1 of the financial statements, such as: long-term aftermarket contracts; the carrying value of intangible assets, including the forecasts on which these are based; post-retirement benefits; provisions; and contingent liabilities. The focus at the meetings in February and July was on the Annual report and financial statements and half-yearly results announcement respectively, including the going concern statement therein. The May and November meetings reviewed the interim management statements and considered those matters which it was expected would require consideration at the following half year and full year. Business assurance In May and November, the Head of Business Assurance presented a summary of the reviews performed in the previous six months and the results of control self assessment returns from the businesses. The committee reviewed the effectiveness of the internal control environment and the progress on the phased increase in business assurance resources. It noted the introduction of audit committees at business sector level, attended by KPMG, to improve the governance structure and, at the November meeting, reviewed and agreed the work plan for 2012. In February, the Head of Business Assurance tabled a report on the compliance with the Group’s policies in respect of expenses incurred by the director’s and other senior executives. Auditors KPMG presented its group audit strategy and plan and the proposed audit fee and in February, the committee reviewed the directors’ representation letter to be given to KPMG in respect of the Annual report and considered the independence and objectivity of the auditors. Non-audit fees The committee reviewed non-audit fees charged by KPMG at each meeting and performed its annual review of the limits for pre-approval of non-audit fees. Expenditure on audit and non-audit services is set out in note 7 to the financial statements. Other matters During the year, the committee received presentations on risk management from the Chief Information Officer and the President of the Gas Turbine Supply Chain. The committee reviewed and amended its own terms of reference including the removal of its oversight of the whistle- blowing policy. This will now be the responsibility of the ethics committee, subject to any financial irregularity being reported to the audit committee. Private meetings As part of the governance structure, during the year, the committee met with the Finance Director, KPMG and the Head of Business Assurance. In advance of each meeting, I also meet the lead audit partner in private. Rolls-Royce Holdings plc Annual report 2011Governance47 Report of the audit committee Non-audit services provided by KPMG In order to safeguard auditors’ independence and objectivity, the following policy is applied in relation to services provided by the auditors: Audit related services – the auditors undertake these services as it is work that they must, or are best suited to, perform. It includes formalities relating to borrowings, grants, shareholder and other circulars, risk management services, various regulatory reports and work in respect of acquisitions and disposals; Tax, accounting and mergers and acquisitions – the auditors are used for this work where they are best suited to undertake it. All other significant consulting work in these areas is put out to tender; All other advisory services/consulting – the auditors are generally prohibited from providing these services; and Audit committee pre-approval – this is required for non-audit fees exceeding pre-determined thresholds which vary according to the nature of the service being proposed. As noted above, the audit committee reviews the level of non-audit fees at every meeting. External auditors’ appointment Annually, the committee reviews the effectiveness and performance of the external auditors with feedback from committee members, business assurance and group finance. The lead audit partner is required to rotate every five years and other key audit partners are required to rotate every seven years. The current lead audit partner has served four years of his term. No contractual obligations restrict the committee’s choice of external auditors. The committee and the Board has recommended the reappointment of the existing auditors. Accordingly, resolutions to reappoint the external auditors, KPMG Audit Plc, and to authorise the directors to determine the auditors’ remuneration, will be proposed at the AGM on May 4, 2012. I hope that you will vote in favour of the resolutions as the directors intend to do in respect of their own shareholdings. Lewis Booth Chairman of the audit committee Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance48 Report from Sir Simon Robertson Chairman of the nominations committee During the year, the committee considered the tenure of office of the existing non-executive directors and discussed, at length, plans for an orderly succession to ensure the necessary skill sets continued to be represented on the Board, reflecting the increasing range and geographical spread of activities carried out by the Group. The committee also invited the executive directors to attend one of its meetings in 2011 to discuss detailed succession plans for the executive directors and the GLT. The committee considered carefully arrangements to ensure that those executives identified as potential successors would receive suitable development opportunities to broaden their experience. Following the publication of the Davies Report, the committee spent some considerable time looking at the composition of the Board and opportunities to increase diversity on the Board in its widest sense by considering a number of potential non-executives of high calibre who could clearly bring an additional dimension to Board debate. Rolls-Royce continues to be committed to developing a diverse workforce and equal opportunities for all, improving diversity at all levels of leadership and to making appointments based on merit at the most senior levels of our organisation. As already noted, the development of a diverse workforce and equal opportunities is governed through our Global Diversity and Inclusion Steering Group, membership of which includes Board directors and senior executives. We expect to make demonstrable progress in this area by 2015. In support of our executive succession planning process, we continue to participate in the FTSE 100 Cross Company Mentoring Programme, the objective of which is to increase the pool of eligible senior female candidates for UK Board positions. We have also issued guidance to executive search companies outlining the importance of diverse candidate short lists. In the autumn of 2011, JCA Partners LLP conducted a Board review which took the form of a facilitated self-evaluation by the Board. The review included confidential, unattributable, one-on-one interviews with each Board member, the incoming Finance Director and the HR Director which covered corporate governance, Board effectiveness, strategy development, risk management and Board and committee organisation, composition, operation and dynamics. All Board members unanimously agreed that the Board was working as an effective whole. The Board reviewed the way it had operated during the Qantas incident and conducted a thorough ‘lessons learnt’ exercise. Following the arrival of a new Chief Executive, and Finance Director, the Board is reviewing future key performance indicators and areas for discussion, which will enable it to assess how the agreed Group strategy is being executed. The Board is reviewing the committee structure to optimise its focus on safety. Also, the nominations committee will give increased focus to long-term succession planning for both executives and Board members. My first priority is to ensure that Rolls-Royce has a strong leadership team. During 2010, the nominations committee was required to find a suitable successor to Sir John Rose as Chief Executive. Following a search process with the assistance of independent consultants, the committee unanimously agreed that John Rishton, who had already served as a non-executive director for the previous four years, had all of the necessary qualities to make a success of that role. John Rishton became Chief Executive at the beginning of April 2011 on John Rose’s retirement. During 2011, Andrew Shilston expressed his wish to retire as Finance Director at the end of the year. The committee believed strongly that the new Finance Director should know the business well and therefore ideally would be an existing employee. Mark Morris is an outstanding individual, having served the Group ably for many years across many disciplines, latterly as the Group Treasurer. Following leadership evaluations conducted independently by Korn Ferry and Egon Zehnder, the nominations committee recommended Mark’s appointment, which was announced in September 2011. Mark was invited to attend Board meetings from the date of the announcement as part of his induction before formally taking up the post on January 1, 2012. In addition, the committee recommended the recruitment of two new independent non-executive directors. An independent consultant, MWM Boardroom Consulting LLP, was appointed to conduct the search. The committee recommended a person of the highest calibre in Lewis Booth, the Chief Financial Officer of Ford Motor Company. Lewis was appointed to the Board on May 25, 2011 and, after the publication of the interim results in 2011, took over the chairmanship of the audit committee from Ian Strachan, who had taken over the role on a acting basis from John Rishton. The second non-executive search conducted by MWM in the year was to find a non-executive who could fulfil a role as chairman of a new safety committee which the Board intends to form in 2012. We selected Sir Frank Chapman who has spent over 37 years in the oil and gas industry, the last 11 years as Chief Executive of BG Group (formerly British Gas plc). Frank joined the Board on November 10, 2011 and has an extensive engineering and technological background, and experience in a safety conscious industry. Rolls-Royce Holdings plc Annual report 2011Governance49 Report of the nominations committee The principal role of the committee is to consider, and recommend for approval to the Board, the appointment of suitable persons as directors of the Company and to lead the process for such appointments. The committee is also responsible for reviewing and overseeing senior management development to ensure orderly succession planning at, and immediately below, Board level. The full terms of reference for the committee are available on the Group’s website at www.rolls-royce.com. During 2011, the committee met three times and details of the members who attended can be found in the table on page 43. In addition to the work described above, the committee also carried out the following tasks during the year: • reviewed its terms of reference; • considered the independence of the non-executive directors; • agreed to extend the terms of office of Peter Byrom and John Neill; • dealt with the authorisation of potential conflicts of interest, reviewed such authorisations previously agreed by the Board and recommended their renewal; • upon the resignation of the Company Secretary, recommended the appointment of an Acting Company Secretary; • considered time commitments of non-executive directors who had declared additional directorships; and • considered the content of this report. In conclusion, I would like to confirm that my first priority as chairman of the nominations committee and of the Board is to ensure that Rolls-Royce has a strong leadership team and it follows that the committee will continue to review, recommend and appoint the most able and appropriate candidates. Sir Simon Robertson Chairman of the nominations committee Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance50 Report from Ian Strachan Chairman of the ethics committee Conducting our business in accordance with the highest ethical standards is critical to the long-term success, profitability and prosperity of Rolls-Royce. The ethics committee was formed in 2008 and consists exclusively of independent non-executive directors. During 2011, the committee met three times and details of its membership and attendance can be found in the table on page 43. The Director of Risk, who had executive responsibility for ethics during the year, attended the meetings as did the General Counsel and Company Secretary. The Chairman of the Board, the Chief Executive, the Head of Business Ethics and the Chief Compliance Officer were also invited to attend meetings of the committee on a regular basis. Responsibilities The Board believes strongly that the Group’s business should be conducted in a way that reflects the highest ethical standards and established the ethics committee to: • review compliance with the Group’s Global Code, which sets out the principles and rules to be followed by employees when conducting business; • review recommendations on ethical matters made by external regulatory authorities, or other bodies, and make recommendations to the Board about whether these should be applied to the Group; and • monitor reports on issues raised through the Group’s confidential reporting line and review the results of any subsequent investigations. The full terms of reference for the committee are available on the Group’s website at www.rolls-royce.com. The work of the committee during 2011 During the year, the committee received reports on the ethics and compliance programmes which continued the extensive activity undertaken in 2010. Reports were received on the following key topics: Anti-bribery and corruption (ABC) compliance programme In 2011, the Group reviewed its policies and procedures ahead of the introduction of the UK Bribery Act (the Act). This work included updating the Group’s policies covering gifts and hospitality, as well as third party intermediaries and other related areas. The Company also created a compliance organisation, led by a Chief Compliance Officer, to oversee the introduction of the new procedures and to ensure staff received appropriate training. The Group was fully compliant with the new Act upon its introduction on July 1, 2011. Use of third party intermediaries At each meeting, the committee received reports upon the Group’s use of third party intermediaries. The committee ensures that agreements with intermediaries are subject to strict and continual review. These reviews cover matters such as payments to intermediaries, their qualifications and the business case behind the necessity for their use. Global Code and supporting policies At the July and November 2011 meetings, the committee reviewed the Global Code, issued in 2009. Following internal and external scrutiny of its quality, which demonstrated that it continued to represent best-in-class standards, it was decided that the Global Code would not require a major update in 2012. Nevertheless, the committee agreed that continued training and communications should take place to ensure the Global Code maintained a high profile across the organisation. New and updated policies in support of the Global Code were reviewed and endorsed. These included policies covering ‘whistle-blowing’, conflicts of interest and competitive intelligence. These policies, supported by appropriate training and communications activity, became effective during the year. Confidential helpline reports At each meeting the committee received reports on calls made to the confidential reporting line (‘Tell Us’) and the helpline (‘Ask Us’). These reports summarised the trends in the numbers of contacts, including analysis by category of geographical spread and the outcomes of the investigations undertaken. Information on the nature of the higher risk cases was also reviewed. Global Principles of Business Ethics for the Aerospace and Defence Industry At its February 2011 meeting, the committee agreed that Rolls-Royce should sign a statement of the Global Principles of Business Ethics for the Aerospace and Defence Industry. As a signatory, the Group has committed to follow programmes and policies that foster ethical business conduct. More information about the Global Principles can be found at www.ifbec.info. The committee believes that Rolls-Royce maintains an environment in which all employees understand the standards of behaviour expected of them and feel able to report any suspected breaches of the Global Code and that conducting business in accordance with the highest ethical standards is critical to the long-term success, profitability and prosperity of Rolls-Royce. Ian Strachan Chairman of the ethics committee Rolls-Royce Holdings plc Annual report 2011Governance51 Report from John Rishton Chairman of the risk committee We have a well established approach to risk management. The risk committee is responsible for developing and, following Board review and approval, implementing the Group’s risk management strategy and mitigation policy. Its full terms of reference can be found on our website at www.rolls-royce.com. All of the executive directors are members of the committee and, during the year, the Director of Risk, the General Counsel and Company Secretary and all of the members of the GLT attended the meeting. In 2011, the committee met twice and details of the members who attended can be found in the table on page 43. The committee has noted the challenges made by the Financial Reporting Review Panel (February 2011) as well as the recent summary on ‘Boards and Risk’ issued by the FRC (September 2011). We have made a number of improvements in this area over the year, including expanding our employee training and enhancing our focus in the Asia-Pacific region. Work of the committee during the year In 2011, the committee continued to discuss and agree proposed additions, deletions and amendments to the top level corporate risk register and considered the mitigation of those risks. This is the committee’s principal item of business at each meeting. At its meeting in June 2011, the Director of the Product Introduction and Lifecycle Management (PILM) programme gave a presentation on the PILM process, which applies across all product programmes covering all of our business sectors and geographical locations. The committee also reviewed an initiative to improve the Group’s intelligence on political and country risks as it enters new territories. In addition, it discussed the Group’s preparedness in respect of business continuity and crisis management. In November 2011, the committee considered a report from the Director of Security on data privacy. In addition, it reviewed the Group’s insurance programme. It also reviewed and recommended certain minor changes to its terms of reference. The committee also considered the format of its annual report on risk to the Board which: • set out the significant risks that it considered might have a financial or reputational impact to the Group and described the associated plans to manage/mitigate the risks; • described changes that had been made to the nature and extent of risks since 2010; • illustrated the movements in the Group’s risk profile over the past five years; • described improvements that had been made to the risk process, tools and reports; • reported on the status of the business continuity programme; and • provided an overview of the Group’s insurance programmes. As noted in the Chairman’s introduction, the Board, with the assistance of the risk and audit committees, has determined the Group’s approach to the management of risk. The committee ensures all of the risks on the register are discussed at Board meetings, either in the normal course of business or through specific reports. The Group’s key risks and uncertainties are described in the table on pages 34 and 35, together with highlights of how the risk will be managed. Risk management We recognise that managing risks is a vital part of delivering our business results. Risks are defined as threats to the achievement of business objectives or to the continuing reputation of the Group and may arise from a variety of internal or external sources. Our managers are responsible for applying the global risk policy in their day-to-day management activities and promoting a culture of learning from and sharing prior experience within their teams. The quality of decisions is improved by employees taking responsibility for communicating key risks to appropriate levels of management. The risk policy and risk management process form a key element of the Group’s internal control system. The structured process is used to identify, assess, communicate and manage risks at all levels of the organisation, aided by an enterprise-wide software solution. A dedicated enterprise risk management team, now reporting to the General Counsel, is responsible for disseminating the risk management process and tools throughout the organisation. A global network of risk champions, mentors and facilitators helps share and embed best practice. The top level corporate risk register reflects the outcomes of business unit, programme and function risk reviews. Risks and associated actions are owned by a senior executive, reviewed and discussed by the risk committee and communicated to the Board. The risk management process is continually improving and has been in place throughout 2011 and up to, and including, the date of approval of this Annual report. The Board’s review of the risk management process and its statement on internal control as required by the ‘Turnbull guidance’ is contained on page 69 . John Rishton Chairman of the risk committee Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance52 Report from Dame Helen Alexander Chairman of the remuneration committee Our commitment remains to align pay with performance. Rolls-Royce has followed a consistent strategy towards executive remuneration over many years. We believe that a significant proportion of senior executives’ remuneration should be made up of performance- related incentives so that overall reward is closely aligned to the creation of long-term stakeholder value. These principles are well-established in Rolls-Royce. In our report this year, we are showing the link between performance and remuneration in Rolls-Royce even more clearly. Base salaries Base salaries are set by the committee at levels required to recruit and retain high quality senior executives with reference to the marketplace for companies of similar size, global reach and complexity, taking account of pay elsewhere in the Group. Salaries are set annually on March 1 with performance taken into account. Annual bonus outcome 2011 It is an important principle of the Rolls-Royce executive bonus arrangements that no bonus can be paid to anyone unless the entire Group has achieved the financial targets set by the committee. During 2011, the Group delivered 21 per cent growth in underlying profit before tax and, before the cost of acquisition and foreign exchange translation effects, a net cash inflow of £210 million. This strong performance was achieved in challenging economic circumstances whilst maintaining the long-term investment programmes needed to deliver our record order book and future growth. The committee is satisfied that the annual bonus outcome for the executive directors for 2011 appropriately reflects these results and the significant value delivered to all stakeholders. 1,200 1,100 1,000 1,157 900 955 800 10 11 65 60 55 50 62.2 59.2 10 11 2011 PERFORMANCE Underlying profit before tax (£m) +21% Order book (£bn) +5% 2011 REMUNERATION (£000) 4,000 3,000 2,000 1,785 1,000 1,124 1,255 1,021 1,277 For executive directors, 40 per cent of the bonus is delivered in deferred shares which must be held for a period of two years. 0 226 James Guyette John Rishton Sir John Rose Andrew Shilston Colin Smith Mike Terrett Bonus Benefits (excluding pension) Salary Bonus (cash and shares). This is the total bonus award for performance in 2011. Forty per cent of the bonus is deferred into shares which are released after two years (ie in early 2014) subject to continuing employment. Sixty per cent of the bonus is delivered in cash in early 2012. Benefits (excluding pension). This is the value of total benefits (excluding pension) received during 2011. Salary. This is salary paid during 2011. Pension. In addition to the annual pay and benefits in the table above, the directors received pension benefits, as described on page 60 of the Directors’ remuneration report. Rolls-Royce Holdings plc Annual report 2011Governance53 Report from Dame Helen Alexander Chairman of the remuneration committee Performance Share Plan (PSP) outcome 2009-2011 The long-term incentive plans at Rolls-Royce are designed to reward long-term value creation, are calculated over three years and measured against Total Shareholder Return (TSR), earnings per share and cash generation. Against all these measures Rolls-Royce has performed well. The Rolls-Royce share price, for example, has increased by 187 per cent between March 10, 2009 (date of grant for the 2009 PSP award) and December 31, 2011, compared to an increase in the FTSE 100 index over the same period of 58 per cent. This has benefited all Rolls-Royce shareholders including many employees. We have arrangements such as ShareSave which we put in place specifically to encourage employees to have a long-term interest in our success. The March 2009 PSP award was made on the basis of a share price of 260.42 pence. By the close of the three-year performance period in December 2011 the share price had increased to 746.50 pence. The following chart tracks the value of £100 invested in Rolls-Royce shares (to be clear, without taking account of dividends) versus the FTSE 100 index from January 1, 2009 to December 31, 2011, in line with the performance period for the March 2009 PSP award. Rolls-Royce versus FTSE 100 Rolls-Royce (rebased to 100) FTSE 100 (rebased to 100) 250 225 200 175 150 125 100 75 50 LONG-TERM PERFORMANCE Rolls-Royce versus FTSE 100 TSR growth in each performance year 2009 2010 2011 FTSE 100 Rolls-Royce +14% +41% +19% +37% +1% +13% LONG-TERM REMUNERATION IN 20111 (£000) 4,000 3,000 2,000 3,289 2,327 2,365 FTSE100 (rebased to 100) Rolls Royce (rebased to 100) 0 1,000 250 225 200 175 150 James Guyette 125 100 PSP (appreciation in share price) PSP (value at grant in 2009) 75 50 50% of these shares to be retained until retirement Sir John Rose Andrew Shilston Colin Smith Mike Terrett 2,150 1,661 FTSE100 (rebased to 100) Rolls Royce (rebased to 100) 2009 2010 2011 2012 Rolls-Royce TSR over the ten-year period to December 31, 2011 was 372 per cent. Only 69 of the companies which made up the FTSE 100 at the beginning of that period are still trading independently and the median TSR amongst these 69 companies over the same ten-year period is 30 per cent. Total returns over the period to December 31, 2011 Last year Last 3 years Last 5 years Last 7 years Last 10 years FTSE 100 1% 30% 4% 48% 30% Rolls-Royce 13% 116% 71% 217% 372% PSP (appreciation in share price). This is the increase in value of the PSP awards due to share price appreciation over the period, from 260.42 pence at March 10, 2009 to 746.50 pence at December 31, 2011. PSP (value at grant in 2009). This is the value of performance share awards vesting during March 2012, using a share price at grant of 260.42 pence as at March 10, 2009. These shares relate to performance over the 3-year period 2009-2011. The cash flow per share target was achieved in full and a 1.5 multiplier was achieved because the Group’s TSR exceeded the upper quartile of the FTSE 100. Fifty per cent of the after-tax shares must be held until retirement or until minimum shareholding requirements are achieved. 1 John Rishton was not an employee and did not receive a grant of PSP shares in 2009. Note: All TSR numbers on this page are calculated based on start and end values for Rolls-Royce and the FTSE 100 averaged over the previous six months. This is consistent with the rules of the PSP. The TSR chart on page 58 is based on spot values and does not therefore align to the numbers on this page, but both spot and average methodologies confirm Rolls-Royce TSR has consistently out-performed the FTSE 100. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance 54 Report from Dame Helen Alexander Chairman of the remuneration committee In September, the committee considered the principles to be applied when setting bonus targets and discussed, in particular, whether the cash hurdle could be refined. It also considered the terms of appointment for the new Finance Director. Shareholders are asked to note that in line with the policy applied elsewhere in the Group, the Finance Director’s salary has been set at a level which is at the lower end of a market competitive range, allowing headroom for future performance-related growth. In November, the committee discussed the Department of Business Innovation and Skills (BIS) consultation paper referred to above and agreed its response. It also reviewed the ‘Principles of Remuneration’ issued by the Association of British Insurers (ABI) in September 2011 and resolved to make every effort to ensure it complied with its overarching principles. In December, the committee considered the nature of the bonus and PSP targets to be set for 2012. The committee discussed the methodology applied by Deloitte LLP when benchmarking senior executive salaries against current market practice. Directors’ remuneration report This year’s remuneration reflects a strong performance against all measures of success. Rolls-Royce has achieved record underlying revenues, underlying profits, and has a record order book which should ensure that the business will remain strong for many years to come. We support the clear message on executive remuneration sent by BIS in the UK that: ‘generous rewards for leading executives are not an issue where executive remuneration is well-structured, clearly linked to the strategic objectives of a company, and which rewards executives that contribute to the long- term success of that company’. The committee’s view is that the performance of the Group, backed by the growth in the Rolls-Royce share price in recent years, warrants the rewards which our executives will receive in 2012. Dame Helen Alexander Chairman of the remuneration committee Over the three-year performance period for the 2009 PSP grant, our performance in terms of cash flow and earnings per share was sufficient to release 100 per cent of the conditional shares originally granted. The Company’s TSR was eighth in the FTSE 100 over the three-year performance period. This TSR performance triggers an increase of 50 per cent in the shares released to executive directors and other members of the GLT and an increase of 25 per cent for other executives. The value of the shares vesting under the PSP scheme for the three-year performance period to the end of December 2011 has been estimated using the share price as at December 31, 2011 (the actual value will depend on the share price at the vesting date in March 2012). Executives must retain 50 per cent of the shares they receive under the scheme until they retire from the Company or achieve a minimum shareholding requirement which is 200 per cent of salary for the Chief Executive or 150 per cent for other executive directors. This ensures the directors have a personal financial interest in the long-term success of the business. Remuneration and opportunities for other employees All employees worldwide have the opportunity to benefit from our success through participation in our global bonus and share plans. All employees who were with us throughout 2011 will be receiving a bonus of at least two weeks’ pay as a result of our 2011 performance. More than a third of our employees currently participate in our global ShareSave plan. More than 6,000 participate in our SharePurchase and ShareBonus plans which allow employees to purchase shares on a regular basis and to convert bonus payments into shares. It is worth noting that Rolls-Royce employees also enjoy competitive salaries, benefits and career opportunities which are made possible through the Group’s robust performance in recent years. The work of the committee during 2011 In February 2011, the committee endorsed the outturn for bonus and long-term incentive plans. It also considered a benchmarking report by Deloitte LLP and assessments of performance before approving salary increases for senior executives. The committee approved the terms for the appointment of the Group HR Director and considered a draft of the Directors’ remuneration report which it agreed to recommend to the Board for approval. In May, the committee selected the Organisation for Economic Cooperation and Development (OECD) index of consumer prices as a measure of the earnings per share (EPS) growth hurdle for the PSP 2011 grant. In 2011, it was confirmed that the personal element of management bonuses would be based on overall performance development ratings rather than on the achievement of specific performance objectives, thereby strengthening the link between overall performance and reward. The committee also agreed the basis for the launch of the 2011 ShareSave offer. Rolls-Royce Holdings plc Annual report 2011Governance55 Directors’ remuneration report Membership of the remuneration committee The remuneration committee, which consists entirely of non-executive directors, met five times in 2011 and details of those members attending can be found in the table on page 43. Peter Byrom retired as a member of the remuneration committee on February 8, 2011. He continued to attend meetings by invitation. Sir Frank Chapman was appointed as a member of the committee on November 10, 2011. Sir Simon Robertson, Chairman, John Rishton, Chief Executive, the Director – Human Resources, the HR Director – Performance, Reward and Recognition and the General Counsel and Company Secretary routinely attended the meetings and the committee invited the Finance Director to attend for certain items of business. None of these executives were present during any discussion of their own emoluments. Responsibilities The committee is responsible for making recommendations to the Board on the Group’s policy regarding executive remuneration and determines, on the Board’s behalf, the specific remuneration packages of the Chairman, the executive directors and a number of senior executives. A copy of the committee’s terms of reference is available on the Group’s website at www.rolls-royce.com. Advice to the committee During 2011, the committee had access to advice from: • Deloitte LLP 1; • Kepler Associates; and • Freshfields Bruckhaus Deringer LLP, the Company’s lawyers. 1 Deloitte LLP advised the Group on tax, assurance, pensions and corporate finance and Deloitte MCS Limited provided consulting services. The remuneration policy framework The Group operates in a highly competitive, international market. Its business is complex, technologically advanced and has long time- horizons. The Group is committed to achieving sustained improvements in performance and this depends crucially on the individual contributions made by the executive team and by employees at all levels. The Board therefore believes that an effective remuneration strategy plays an essential part in the future success of the Group. The main components of remuneration The main components of remuneration for all executives worldwide comprise base salary, annual incentive arrangements, share-based long-term incentives and benefits. Executives are also entitled to participate in all-employee share plans. Component Base salary Annual Performance Related Award plan (APRA) Summary • Set by the committee at levels required to recruit and retain high quality senior executives with reference to the marketplace for companies of similar size, internationality and complexity and taking account of pay elsewhere in the Group. • Set with reference to the median of market practice. • Annual incentive. • Measures set by the committee based on underlying profit, cash flow and individual objectives and performance. • Strong link between performance and remuneration. • Promotes share ownership and encourages decisions in the long-term interest of shareholders. Time frame Not applicable Main features • Normally set annually on March 1. Performance is taken into account. One year plus two year deferred element • Compulsory deferral of 40 per cent of bonus into shares. • Bonus potential: – for on target performance – 75 per cent of salary for executive directors, and 81 per cent for Chief Executive. – for maximum performance – 125 per cent of salary for executive directors, and 135 per cent for Chief Executive. • • • Bonus can be increased by up to 20 per cent to reflect exceptional personal performance. Shares vest after two years subject to continued employment. 50 per cent must be held until retirement or the minimum shareholding requirement is met. • Potential: – for maximum CPS performance – 100 per cent of salary for executive directors and 120 per cent for Chief Executive. – for maximum CPS and TSR performance – 150 per cent of salary for executive directors and 180 per cent for Chief Executive. • • • Shares vest after three years provided performance criteria are met. ShareSave options may be exercised in three or five years from the date of grant. Shares under the SIP vest after five years free from income tax and national insurance. Performance Share Plan (PSP) • Share-based long-term incentive. • Conditional on corporate performance. • Measures based on Cash Flow Per Share (CPS), TSR and an underlying earnings per ordinary share hurdle (EPS). Three years All-employee share plans • • • ShareSave Plan – a savings-related share option plan available to all employees allowing purchase of shares at a discount to the share price at date of grant. ‘Free Share’ element of the Share Incentive Plan (SIP) where UK employees receive shares as part of any bonus paid. ‘Partnership Share’ element of the SIP under which UK employees may make regular purchases of shares from pre-tax income. Not applicable In addition to the above, pension and other benefits, which are competitive in local markets, are provided. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance56 Directors’ remuneration report Accordingly, we remain committed to a remuneration policy which, whilst sufficiently flexible to take account of future changes in the Group’s business environment and in remuneration practice, will continue to reflect the following broad principles: • the remuneration of executive directors and other senior executives should reflect their responsibilities and contain incentives to deliver the Group’s performance objectives without encouraging excessive risk taking; • remuneration must be capable of attracting and retaining the individuals necessary for business success; • total remuneration should be based on Group and individual performance, both in the short and long term; • the system of remuneration should establish a close identity of interest between senior executives and shareholders through measures such as encouraging the senior executives to acquire shares in the Company. Therefore, a significant proportion of senior executive remuneration will comprise share-based long-term incentives; and • when determining remuneration, the remuneration committee will take into account pay and employment conditions elsewhere in the Group. The committee reviews regularly both the competitiveness of the Group’s remuneration structure and its effectiveness in incentivising executives to enhance value for all stakeholders over the longer term. Base salaries The committee has commissioned a range of salary benchmarks from Deloitte LLP. The benchmarks have been prepared using their company size and complexity methodology. All salary increases must be justified on the basis of performance and are not automatic. The committee is informed of pay and conditions elsewhere in the Group and these are taken into account in determining remuneration for the executive directors. Annual incentives Executive directors and selected senior executives participate in APRA. For UK participants, APRA awards do not form part of pensionable earnings. Target and maximum APRA bonus opportunity The committee considers that there should be a continuing emphasis on those at-risk elements of remuneration, such as annual and long-term incentives, which directly influence the performance of senior executives. For the Chief Executive, a 162 per cent maximum bonus opportunity means that 62 per cent of combined basic pay and bonus opportunity is directly related to annual financial and personal performance. Under APRA as operated in 2011, executive directors were eligible for awards in accordance with the table below: The committee has determined that the bonus in respect of 2012 will be operated on substantially similar terms to 2011 except that access to bonus earned through profit performance will now be determined by cash flow based on a linear scale rather than by an all-or-nothing hurdle. The committee is mindful of corporate, environmental, social and governance risks when setting personal objectives. There will be no change to the maximum bonus opportunities for executive directors. APRA performance measures For 2011, the performance targets operated so that three Group underlying profit targets were set in respect of bonus levels as follows: Base Stretch (1) Stretch (2) (% of maximum) 30 60 100 The bonus payable was also subject to a cash flow hurdle. For 2011, the performance outturns which resulted in the APRA bonus outturns were as follows: Cash flow hurdle Group underlying profit Cash flow* for the year was £216 million which exceeded the cash flow hurdle. Group underlying profit* was £1,119 million which exceeded the Base and the Stretch (1) target but was less than the Stretch (2) target. The performance resulted in achievement of 90 per cent of the maximum. * Cash flow and Group underlying profit are prior to the impact of unbudgeted acquisition adjustments and exclude the effect of unbudgeted foreign exchange translation where material. Deferred APRA For executive directors and other senior executives, 40 per cent of APRA is delivered in the form of a deferred share award in the Company’s shares. For other participants in APRA, 33 per cent is delivered in the form of deferred shares. Details of deferred shares held under the plan are shown in the table on page 63. A participant who is granted a deferred share award under APRA must normally continue to remain an employee of the Group for two years from the date of the award in order for the shares to vest, although shares will be released early in certain circumstances including retirement or redundancy. The value of any deferred share awards is derived from the annual bonus criteria and is therefore dependent on personal and business financial performance. This arrangement provides a strong link between performance and remuneration, promotes a culture of share ownership amongst the Group’s senior management and encourages decisions in the long-term interest of shareholders. James Guyette John Rishton Andrew Shilston Colin Smith Mike Terrett Target bonus (as a % of salary)1 75 81 75 75 75 Maximum bonus (as a % of salary)1 125 135 125 125 125 1 It is possible for a bonus award to be increased by a further 20 per cent to reflect exceptional personal performance. Therefore the overall maximum was 162 per cent for the Chief Executive and 150 per cent for the other executive directors. APRA timeline Start of performance period End of performance period Deferred share awards allocated and cash awards paid End of two year retention period Deferred shares released 1 Jan 12 31 Dec 12 31 Dec 13 31 Dec 14 Rolls-Royce Holdings plc Annual report 2011Governance 57 Directors’ remuneration report Other annual incentives The same financial targets as set for APRA are used for the Managers’ Bonus and All-Employee Bonus Scheme (AEBS). The Managers’ Bonus typically enables managers worldwide to receive a bonus of up to ten per cent of pay and the AEBS up to two weeks’ pay, based on corporate and business performance. Participants in APRA or the Managers’ Bonus do not participate in the AEBS. Performance measures Vesting criteria EPS growth Purpose of the measure Hurdle to ensure any payouts are supported by sound profitability Performance condition over three-year period • If EPS growth exceeds the hurdle, the number of shares vesting will be determined in accordance with the CPS targets. If EPS growth does not exceed the hurdle – zero vesting. • PSP The PSP is designed to reward and incentivise selected senior executives who can influence the long-term performance of the Group. The size of awards under the PSP take into account competitive levels within the marketplace for UK companies of a similar size and complexity to the Group. In 2011, John Rishton received a conditional award of shares with a market value at the time of grant of 120 per cent of his annual salary prorated to his date of appointment as an executive director on March 1, 2011. He also received a special award detailed on page 65. The 2011 grant for other executive directors was 100 per cent of their annual salary, for business heads 80 per cent, and 65 per cent for other members of the Group Leadership Team. Under the rules of the PSP selected senior executives are granted conditional share awards entitling them to a number of shares determined by reference to corporate performance over a three-year performance period. The measures of corporate performance are CPS, EPS and TSR. These measures are considered particularly important in generating shareholder value and are explained in more detail in the following table. There is no retesting of the performance criteria and no automatic vesting in the event of a takeover. In the three-year period to December 31, 2011 the Company’s financial and TSR performance generated 100 per cent of the number of shares conditionally granted in 2009. PSP timeline Start of performance period End of performance period After tax shares released subject to performance criteria 50% of after tax shares continue to be held under retention policy 1 Jan 12 31 Dec 12 31 Dec 13 31 Dec 14 Aggregate CPS Incentivise generation of cash flow in line with the Group’s strategy TSR performance against FTSE 100 index Align interests with shareholders by rewarding out- performance of FTSE 100 returns • Below threshold cash flow target – zero vesting. • Threshold cash flow target – 30 per cent vesting. • Vesting will increase on a straight-line basis between 30 per cent and 100 per cent. • 50th percentile (median) and below – no additional vesting. • Above 50th percentile (median) – vesting will be enhanced by 25 per cent. For executive directors and selected senior executives, a straight-line basis will operate from 25 per cent to 50 per cent enhancement for upper quartile TSR performance. The profit hurdle for the 2012 grant will require EPS to show real growth by exceeding the OECD index of consumer prices. The following CPS targets will apply to the grants to be made in 2012: Aggregate CPS over three-year performance period 56p 83p Percentage of maximum award released 30 100 The committee believes that these CPS targets are challenging and that the performance necessary to achieve awards towards the upper end of the range is stretching. They should not, therefore, be interpreted as providing guidance on the Group’s performance over the relevant period. PSP awards granted in 2012 For 2012, the size of awards under the PSP will be unchanged from 2011 (except for the additional special award made to John Rishton on his appointment) and will be as follows: James Guyette Mark Morris John Rishton Colin Smith Mike Terrett PSP award (as a % of salary) 100 100 120 100 100 PSP award maximum (as a % of salary) 150 150 180 150 150 Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance58 Directors’ remuneration report Share retention policy The committee believes it is important that the interests of the executive directors should be closely aligned with those of shareholders. The deferred APRA award and the PSP provide considerable alignment. However, participants in the PSP are also required to retain at least one half of the number of after tax shares released from the PSP, until the value of their shareholding reaches 200 per cent of salary for the Chief Executive and 150 per cent for other executive directors. When this level is reached, it must be retained until retirement or departure from the Group. Details of the executive directors’ share interests are set out on pages 61 to 65. The current executive directors have each complied with the minimum shareholding requirement. The following table summarises the terms of the executive directors’ service contracts: James Guyette Mark Morris John Rishton Colin Smith Mike Terrett Date of contract 29 September 1997 1 January 2012 10 March 2011 1 July 2005 1 September 2007 Unexpired term Indefinite 12 months 12 months 12 months 12 months Notice period Group 30 days1 12 months 12 months 12 months 12 months Notice period individual 30 days 6 months 6 months 6 months 6 months 1 James Guyette has a contract with Rolls-Royce North America Inc., drawn up under the laws of the State of Virginia, US. It provides that, on termination without cause, he is entitled to 12 months’ severance pay without mitigation and, in addition, appropriate relocation costs. All-employee share plans The committee believes that share-based plans make a significant contribution to the close involvement and interest of all employees in the Group’s performance. Executive directors are eligible to participate in the Group’s all-employee share plans on the same terms as other employees: i) the ShareSave Plan – a savings-related share option plan available to all employees. In the UK, this plan operates within UK tax legislation (including a requirement to finance the exercise of the option using the proceeds of a monthly savings contract) but the key principles are applied globally. The exercise of the option is not subject to the achievement of a performance target; ii) the ‘Free Share’ element of the SIP under which UK employees may receive shares as part of the Company component of any bonus paid. The SIP attracts tax benefits for UK employees; and iii) the ‘Partnership Share’ element of the SIP under which UK employees may make regular purchases of shares from pre-tax income. Benefits Executive directors and senior executives are entitled to a company car or car allowance, private medical insurance and financial counselling. James Guyette is entitled to a housing allowance and the costs of additional housing are met for John Rishton and Mike Terrett. Service contracts The committee’s policy is that executive directors appointed to the Board are offered notice periods of 12 months. The committee recognises that in the case of appointments to the Board from outside the Group, it may be necessary to offer a longer initial notice period, which would subsequently reduce to 12 months after that initial period. The committee has a defined policy on compensation and mitigation to be applied in the event of a UK director’s contract being terminated prematurely. In these circumstances, steps are taken to ensure that poor performance is not rewarded. When calculating termination payments, the committee takes into account a range of factors including the director’s obligation to mitigate his or her own loss. External directorships of executive directors During 2011, James Guyette was chairman of PrivateBancorp Inc. and a director of priceline.com Inc. Andrew Shilston was appointed as a non-executive director of Circle Holdings plc on August 5, 2011. In each case the director retained the relevant fees from serving on the boards of these companies, as shown in the table below: External directorship fees James Guyette 1, 2 Andrew Shilston Payment received £000 102 16 1 James Guyette was paid in US dollars translated at £1=US$1.6037 2 I n addition to an annual fee, James Guyette received 3,621 Restricted Stock Units (RSUs) at US$13.81 per share in PrivateBank. During 2011, 3,651 RSUs vested. He was granted 366 shares of restricted stock at US$464.79 per share in priceline.com. During 2011, 832 shares of restricted stock vested at US$469.13 per share and 333 shares of restricted stock vested at US$464.79 per share. TSR over five years The Company’s TSR performance over the previous five years compared to a broad equity market index is shown in the graph below. The FTSE 100 has been chosen as the comparator index because it contains a broad range of other leading UK listed companies. The graph shows the plc growth in value of a hypothetical £100 holding in Rolls-Royce Holdings plc (previously Rolls-Royce Group plc) ordinary shares over five years, relative to the FTSE 100 index. The values of the hypothetical £100 holdings at the end of the five year period were £194.00 and £107.90 respectively. Rolls-Royce (rebased to 100) FTSE 100 (rebased to 100) Rolls-Royce – five year TSR data 220 200 180 160 140 120 100 80 60 2006 2007 2008 2009 2010 2011 Rolls-Royce Holdings plc Annual report 2011Governance59 Directors’ remuneration report Directors’ aggregate emoluments (audited) The individual directors’ emoluments are analysed as follows: Executive directors James Guyette 5 John Rishton 6 Sir John Rose 7 Andrew Shilston 8 Colin Smith Mike Terrett Non-executive directors Dame Helen Alexander Lewis Booth 9 Peter Byrom Sir Frank Chapman 10 Iain Conn Professor Sir Peter Gregson John McAdam John Neill CBE Sir Simon Robertson Ian Strachan Basic salary/fees £000 Annual Bonus (APRA) 1 £000 Cash allowance 2 £000 Taxable benefits 3 £000 Aggregate emoluments 4 Aggregate emoluments 4 £000 £000 2011 2010 499 739 217 580 455 543 3,033 74 44 60 11 72 60 60 60 370 86 3,930 561 898 – 657 546 619 3,281 – – – – – – – – – – 3,281 – 125 – – 114 – 239 – – – – – – – – – – 239 64 148 9 18 20 115 374 – – – – – – – – 15 – 389 1,124 1,910 226 1,255 1,135 1,277 6,927 74 44 60 11 72 60 60 60 385 86 7,839 1,120 69 2,299 1,308 1,027 1,270 7,093 67 – 55 – 65 55 55 55 386 71 7,902 1 For executive directors, 60 per cent of APRA is delivered in cash and 40 per cent is delivered in the form of a deferred share award. Shares forming part of the bonus under APRA have been valued at the date of award. The Trustee will acquire the required number of shares at the prevailing market price by March 31, 2012. 2 Colin Smith received a cash allowance in lieu of future pension accrual. John Rishton received employer contributions into the executive defined contribution pension arrangement restricted to the annual allowance limits with any excess paid as a cash allowance. 3 Taxable benefits may include the following: a car or car allowance; the use of a driver; private medical insurance and financial counselling; in the case of James Guyette, a housing allowance and club membership fees; in the case of John Rishton, the figure above includes school fees (for one school term following his appointment) paid on his behalf and the tax charge on that benefit paid by the Group; in the case of John Rishton and Mike Terrett, the figure in the above table includes additional housing costs paid on their behalf and the tax charge on that benefit paid by the Group. 4 Aggregate emoluments exclude pensions contributions. Details of the directors’ pensions are set out on pages 60 and 61. 5 James Guyette was paid in US dollars translated at £1 = US$1.6037. 6 John Rishton was appointed as an executive director on March 1, 2011. 7 Sir John Rose retired as an executive director on March 31, 2011. 8 Andrew Shilston retired as an executive director on December 31, 2011. 9 Lewis Booth was appointed as a non-executive director on May 25, 2011. 10 Sir Frank Chapman was appointed as a non-executive director on November 10, 2011. Payments made to former directors of the Company (audited) John Cheffins retired from the Board on September 30, 2007. He has continued in his role as Chairman of Rolls-Royce Fuel Cell Systems Limited and provided non-executive advice to the energy business. He was paid £47,617 and benefits totalling £4,770 in 2011 (paid in Canadian dollars translated at £1= CAD$1.5862). Dr Mike Howse retired from the Board on June 30, 2005. He has continued to be retained by the Group for his expertise in engineering and was paid £34,650 in 2011. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance60 Directors’ remuneration report Pensions (audited) The Group’s UK pension schemes are funded, registered schemes and were approved under the regime applying until April 6, 2006. They include defined benefit pension schemes, providing at retirement, a pension of up to two thirds of final remuneration, subject to HM Revenue & Customs limits. Mike Terrett opted out of future pension accrual with effect from April 1, 2006 and started to receive his pension from November 1, 2009. Since starting to receive his pension, he does not accrue any further pension benefit or allowance in lieu of pension benefit from his ongoing employment with the Group. Sir John Rose retired on March 31, 2011 and was already in receipt of his pension. John Rishton was appointed to the Board on March 1, 2011 and received employer contributions into the executive defined contribution pension arrangement restricted to the annual allowance limits with any excess paid as a cash allowance. The cash allowance is calculated as equivalent to the cost of the pension contributions allowing for national insurance costs. Andrew Shilston was a member of one of the Group’s UK pension schemes until his retirement on December 31, 2011. He was also a member of the Rolls-Royce Supplementary Retirement Scheme (the Scheme). The purpose of the Scheme is to fund pension provision above the pensionable earnings cap which was imposed on approved pension schemes by the 1989 Finance Act. Membership of the Scheme is restricted to executive directors and to a limited number of senior executives. Employer contributions to the Scheme during 2011 have been added to the increase in transfer value over 2011 for the registered defined benefit plans, and are therefore included in the figures shown in the final two columns of the first table below. Andrew Shilston was replaced on the Board by Mark Morris with effect from January 1, 2012. His pension disclosures will be reported in the 2012 Annual report. Colin Smith opted out of future pension accrual with effect from April 1, 2006. He receives a cash allowance in lieu of future pension accrual. Had he elected to continue to accrue pension the estimated cost of that accrual would be higher than the cash allowance being paid in lieu. James Guyette participates in pension plans sponsored by Rolls-Royce North America Inc. He is a member of two defined benefit plans in the US, one qualified and one non-qualified. He accrues a retirement lump sum benefit in both of these plans. The aggregate value of the retirement lump sums accrued in these two plans, and the transfer values of these benefits, are shown in the second table below. In addition, James Guyette is a member of two 401(k) Savings Plans in the US, one qualified and one non-qualified, to which both he and his employer, Rolls-Royce North America Inc., contribute. He is also a member of an unfunded non- qualified deferred compensation plan in the US, to which his employer makes notional contributions. Employer contributions to these three plans during 2011 have been added to the increase in transfer value over 2011 for the defined benefit plans, and are therefore included in the figures shown in the final two columns of the second table below. The transfer values in the tables below have been calculated on the basis of actuarial advice. Details of the pension benefits, which accrued over the year in the Group’s registered UK defined benefit pension scheme1, are given below: Increase in accrued pension during the year ended Dec 31, 2011 £000pa 4 Increase/decrease in accrued pension during the year ended Dec 31, 2011 2 £000pa (10) 3 42 1 2 34 (6) Total accrued pension entitlement at the year ended Transfer value of accrued pension as Transfer value as at Dec 31, 2010 of accrued pension at Dec 31, 2011 3 at Dec 31, 2011 4 £000pa 457 20 302 241 £000 10,457 575 6,002 5,666 that date 4 £000 8,828 412 4,467 4,739 Increase in transfer value over 2011 net of the member’s own contributions £000 1,629 327 1,535 927 Transfer value of increase/decrease in accrued pension over 2011 net of the member’s own contributions 5 £000 (199) 233 613 (119) Increase in accrued retirement lump sum during the year ended Dec 31, 2011 £000pa 125 Increase in accrued retirement lump sum during the year ended Dec 31, 2011 2 £000pa 92 Total accrued retirement lump sum entitlement at the year ended Dec 31, 2011 8 £000pa 965 Transfer value of accrued retirement lump sum as at Dec 31, 2011 £000 965 Transfer value as at Dec 31, 2010 of accrued retirement lump sum at that date £000 839 Increase in transfer value over 2011 net of the member’s own contributions £000 520 Transfer value of increase in accrued retirement lump sum over 2011 net of the member’s own contributions 5 £000 486 Sir John Rose 6 Andrew Shilston 7 Colin Smith Mike Terrett James Guyette 9 1 Members of the schemes have the option to pay Additional Voluntary Contributions. Neither the contributions nor the resulting benefits are included in the above table. 2 This column shows the increase/decrease in pension/retirement lump sum during the year ended December 31, 2011 but in this case excluding the effect of inflation. 3 The pension entitlement shown is that which would be paid annually on retirement, based on service to the end of the year, or to April 1, 2006 for members with enhanced protection from ‘A’ day. For Sir John Rose and Mike Terrett, the pension shown is the annual pension in payment at December 31, 2011. 4 The transfer values stated represent liabilities of the Rolls-Royce sponsored pension schemes and are not sums paid to the individuals. The transfer values of the accrued pensions as at December 31, 2010 and December 31, 2011 have been calculated on a basis adopted by the trustees on October 6, 2008 following receipt of actuarial advice. 5 This column shows the transfer value of the increase/decrease in pension/retirement lump sum during the year ended December 31, 2011 excluding the effect of inflation, and net of the member’s own contributions. 6 Sir John Rose retired as an executive director on March 31, 2011. 7 Andrew Shilston retired as an executive director on December 31, 2011. 8 The lump sum entitlement shown is that which would be paid on immediate retirement based on service to the end of the year. 9 Benefits are translated at £1 = US$1.5541. Rolls-Royce Holdings plc Annual report 2011Governance 61 Directors’ remuneration report Details of the money purchase pension contributions paid by the Group on behalf of the following executive directors are given below: James Guyette 1 John Rishton Andrew Shilston 1 2011 £000 381 115 171 2010 £000 373 – 166 1 Employer contributions for the defined contribution plans during 2011, have been included in the increase in transfer value over 2011 for the defined benefit plans and shown in the final two columns of the tables on page 60 for James Guyette and Andrew Shilston. Directors’ share interests (audited) The directors who held office at December 31, 2011 and their connected persons had the following interests in the ordinary shares and C Shares 1 of the Company in respect of which transactions are notifiable to the Company under DTR 3.1.2R of the Disclosure Rules and Transparency Rules: James Guyette John Rishton Sir John Rose 2 Andrew Shilston 3 Colin Smith Mike Terrett Dame Helen Alexander Peter Byrom Lewis Booth 4 Sir Frank Chapman 5 Iain Conn Sir Peter Gregson John McAdam John Neill CBE Sir Simon Robertson Ian Strachan January 1, 2011# 324,231 8,996 914,478 525,427 175,179 428,295 1,071 218,017 – – 17,918 3,407 1,124 24,614 40,846 11,500 Changes in 2011 (49,434) 690 153,320 87,830 43,375 78,871 – 5,304 5,000 – 2,292 811 447 11,850 993 – Ordinary shares December 31, 2011§ 274,797 9,686 1,067,798 613,257 218,554 507,166 1,071 223,321 5,000 – 20,210 4,218 1,571 36,464 41,839 11,500 January 1, 2011# – – – – – – – – – – – – 116,769 350,100 – – Changes in 2011 – – – – – – 102,816 – – – – – 109,311 1,508,652 – – C Shares December 31, 2011§ – – – – – – 102,816 – – – – – 226,080 1,858,752 – – # Or date of appointment if later. § Or date of retirement if earlier. 1 Non-cumulative redeemable preference shares of 0.1p each. 2 Sir John Rose retired as an executive director on March 31, 2011. 3 Andrew Shilston retired as an executive director on December 31, 2011. 4 Lewis Booth was appointed as a non-executive director on May 25, 2011. 5 Sir Frank Chapman was appointed as a non-executive director on November 10, 2011. Directors’ interests in the Company’s share plans are shown separately on pages: 62 (SIP); 63 (share options); 63 (APRA); and 64 (PSP). No director had any other interests, beneficial or otherwise, in the share capital of the Company or any of its subsidiaries as at December 31, 2011. Changes in the interests of the executive directors and non-executive directors between December 31, 2011 and February 8, 2012 are listed below. Dame Helen Alexander Peter Byrom Iain Conn Sir Peter Gregson James Guyette John McAdam John Neill John Rishton Sir Simon Robertson Colin Smith Mike Terrett Ordinary shares – 2,020 819 137 2,488 61 254 87 378 2,115 4,593 C Shares 73,899 – 11,178 – – 103,776 2,025,978 – – 332,166 112,815 Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance 62 Directors’ remuneration report Partnership shares held in trust under the SIP 1 Sir John Rose 2 Andrew Shilston 3 Colin Smith 4 Mike Terrett 4 § Or date of retirement if earlier. Free shares held in trust under the SIP 1 Andrew Shilston 3 Colin Smith § Or date of retirement if earlier. Unrestricted shares held under the SIP 1 Sir John Rose 2 Andrew Shilston 3 Colin Smith Mike Terrett January 1, 2011 1,734 1,734 1,734 1,733 January 1, 2011 3,381 3,381 January 1, 2011 9,638 6,198 3,977 4,186 Changes in 2011 (30) (123) (124) (124) Ordinary shares December 31, 2011§ 1,704 1,611 1,610 1,609 January 1, 2011 – 382,710 382,533 382,241 Changes in 2011 – (382,710) (382,533) (382,241) Changes in 2011 (201) (202) Ordinary shares December 31, 2011§ 3,180 3,179 January 1, 2011 839,168 839,168 Changes in 2011 (839,168) (839,168) Changes in 2011 89 1,039 1,041 359 Ordinary shares December 31, 2011§ 9,727 7,237 5,018 4,545 January 1, 2011 – 90,591 90,298 90,500 Changes in 2011 – (90,591) (90,298) (90,500) C Shares December 31, 2011§ – – – – C Shares December 31, 2011§ – – C Shares December 31, 2011§ – – – – § Or date of retirement if earlier. 1 Under the SIP, free shares and partnership shares held in trust for more than five years are classified as unrestricted and are no longer subject to income tax or national insurance contributions on withdrawal. Unrestricted shares can be held in Trust under the SIP for as long as the participant remains an employee of the Group. 2 Sir John Rose retired as an executive director on March 31, 2011. 3 Andrew Shilston retired as an executive director on December 31, 2011. 4 On January 9, 2012 and February 7, 2012 the ordinary shares held as partnership shares by Colin Smith 28 and 28, and Mike Terrett 27 and 28 respectively were classified as unrestricted shares. Rolls-Royce Holdings plc Annual report 2011Governance63 Directors’ remuneration report Share options (audited) The directors held options under the Rolls-Royce Sharesave plans. James Guyette John Rishton Colin Smith January 1, 2011 683 – 1,233 Granted in 2011 – 1,450 – Lapsed in 2011 – – – Exercised in 2011 (683) – (1,233) December 31, 2011 – 1,450 – Exercise price 416p 525p 298p Market price at date exercised 613.00p – 651.50p Aggregate gains 2011 £000 1 – 4 Aggregate gains 2010 £000 – – – Exercisable dates – 2017 – The market price of the Company’s ordinary shares ranged between 557.50p and 746.50p during 2011. The closing price on December 31, 2011 was 746.50p. Long-term incentive awards (audited) The directors as at December 31, 2011 had the following share awards arising out of the operation of APRA 1: James Guyette Sir John Rose 2 Andrew Shilston 3 Colin Smith Mike Terrett Total value of shares vested January 1, 2011 42,397 73,804 41,009 29,816 37,996 Dividend enhancement during 2011 1,645 2,772 1,524 1.090 1,412 Vested during 2011 (27,770) (46,791) (25,735) (18,426) (23,853) Granted during 2011 35,595 93,481 48,540 32,197 44,127 December 31, 2011§ 51,867 123,266 65,338 44,677 59,682 Value of shares vested in 2011 £000 158 283 156 112 144 853 § Or date of retirement if earlier. 1 Under APRA, shares vest after two years. Shares went into trust in 2009, 2010 and 2011 at prices of 289.65p, 537.20p and 601.00p respectively. At December 31, 2011, the amounts stated in the emoluments table representing the 2011 APRA deferred shares had not yet been applied by the Trustee to purchase shares. The market value per share which vested under APRA during 2011 was 605.47p. The effective market value per share which vested under APRA for James Guyette was 569.86p. 2 Sir John Rose retired as an executive director on March 31, 2011. 3 Andrew Shilston retired as an executive director on December 31, 2011. Conditional awards, granted under the PSP to executive directors are shown on page 64. The number of shares released will be dependent upon the achievement of the EPS and CPS targets over the three-year performance period. In respect of awards made up to and including 2008, the number of shares released will be increased by 25 per cent if the TSR exceeds the median for the FTSE 100 index over the three-year performance period. For the 2009, 2010 and 2011 grants, if the Company’s TSR is above the median of the FTSE 100 index, the number of shares due to be released to an executive will be increased by between 25 per cent and 50 per cent. This increase is on a straight-line basis between the median and upper-quartile TSR performance in the performance period. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance64 Directors’ remuneration report Sir John Rose 3 212,888 391,675 191,005 795,568 Andrew Shilston 4 100,183 211.198 102,993 – 414,374 70,356 148,319 78,025 – 296,700 91,075 191,998 93,630 – 376,703 Colin Smith Mike Terrett Total value of shares vested PSP James Guyette January 1, 2011 Granted during 2011 TSR uplift at vesting 1 Total vested during 2011 December 31, 2011§ Value of shares vested in 2011 £000 17,668 (88,340) – 504 70,672 207,845 91,383 – 369,900 – – – 82,404 82,404 John Rishton 2 – 164,866 – – – 17,668 – – – – (88,340) 207,845 91,383 82,404 381,632 – 164,866 53,222 (266,110) – – – 391,675 – 53,222 – (266,110) 191, 005 582,680 25,046 (125,229) – – – – – 97,091 97,091 – 25,046 – (125,229) 74,813 74,813 – 17,589 – (87,945) 17,589 (87,945) – – – – – 22,769 (113,844) – – – – – 91,438 91,438 – 22,769 – (113,844) 211,198 102,993 97,091 411,282 148,319 78,025 74,813 301,157 191,998 93,630 91,438 377,066 – – – – – – – – – – – – – Performance period Jan 1, 2008 to Dec 31, 2010 Jan 1, 2009 to Dec 31, 2011 Jan 1, 2010 to Dec 31, 2012 Jan 1, 2011 to Dec 31, 2013 Jan 1, 2011 to Dec 31, 2013 Jan 1, 2008 to Dec 31, 2010 Jan 1, 2009 to Dec 31, 2011 Jan 1, 2010 to Dec 31, 2012 Jan 1, 2008 to Dec 31, 2010 Jan 1, 2009 to Dec 31, 2011 Jan 1, 2010 to Dec 31, 2012 Jan 1, 2011 to Dec 31, 2013 Jan 1, 2008 to Dec 31, 2010 Jan 1, 2009 to Dec 31, 2011 Jan 1, 2010 to Dec 31, 2012 Jan 1, 2011 to Dec 31, 2013 Jan 1, 2008 to Dec 31, 2010 Jan 1, 2009 to Dec 31, 2011 Jan 1, 2010 to Dec 31, 2012 Jan 1, 2011 to Dec 31, 2013 Date of grant March 3, 2008 March 10, 2009 March 1, 2010 March 9, 2011 March 9, 2011 March 3, 2008 March 10, 2009 March 1, 2010 March 3, 2008 March 10, 2009 March 1, 2010 March 9, 2011 March 3, 2008 March 10, 2009 March 1, 2010 March 9, 2011 March 3, 2008 March 10, 2009 March 1, 2010 March 9, 2011 Market price at date of grant 439.20p 260.42p 544.70p 601.50p 601.50p 439.20p 260.42p 544.70p 439.20p 260.42p 544.70p 601.50p 439.20p 260.42p 544.70p 601.50p 439.20p 260.42p 544.70p 601.50p – – – 504 – 1,615 – – 1,615 760 – – 760 534 – – 534 691 – – 691 4,104 § Or date of retirement if earlier. 1 Under the rules of the PSP, the number of shares vesting in 2011 was increased by 25 per cent as the TSR exceeded the median of the FTSE 100 index during the three-year performance period to December 31, 2011. The market value per share, which vested under the PSP during 2011, was 607.03p. For James Guyette, the market value per share, which vested under the PSP was 570.76p. 2 John Rishton was appointed as an executive director on March 1, 2011. 3 Sir John Rose retired as an executive director on March 31, 2011. 4 Andrew Shilston retired as an executive director on December 31, 2011. Rolls-Royce Holdings plc Annual report 2011Governance65 Directors’ remuneration report Grant of shares John Rishton received a special grant of shares on joining the Company intended to mirror the fair value and vesting profile of the incentives he forfeited on resigning from his previous employer. This award was reported in the 2010 Annual report and is detailed below: Performance related Restricted shares Performance related Restricted shares Performance related Performance related Total Number of shares 49,099 126,019 76,365 76,143 63,397 40,565 431,588 Performance period Jan 1, 2009 to Dec 31, 2011 n/a Jan 1, 2010 to Dec 31, 2012 n/a Jan 1, 2011 to Dec 31, 2013 Jan 1, 2012 to Dec 31, 2014 Vesting date March 1, 2012 March 1, 2012 March 1, 2013 March 1, 2013 March 1, 2014 March 1, 2015 Market price at date of grant 601.50p 601.50p 601.50p 601.50p 601.50p 601.50p The Chairman and the non-executive directors are not eligible to participate in any of the Group’s share schemes, incentive arrangements or pension schemes. A facility is in place which enables non-executive directors to use some or all of their fees, after the appropriate statutory deductions, to make market purchases of shares in the Company on a monthly basis. Statutory requirements The remuneration report has been prepared on behalf of the Board by the remuneration committee. The committee adopts the principles of good governance as set out in the Code and complies with the Listing Rules of the Financial Services Authority and the relevant schedules of the Companies Act 2006 and the Directors’ Report Regulations in Schedule 8 of the Large and Medium- sized Companies and Groups (Accounts and Reports) Regulations 2008. The report is divided into audited and unaudited information. The above regulations require the Company’s auditors to report on the audited information in their report on page 125 and to state that this section has been properly prepared in accordance with these regulations. The report is subject to shareholder approval at the AGM on May 4, 2012. The Directors’ remuneration report was approved by the Board on February 8, 2012 and signed on its behalf. Dame Helen Alexander Chairman of the remuneration committee Non-executive directors’ remuneration Policy The committee determines, on the Board’s behalf, the remuneration package of the Chairman. The Board determines the remuneration of the other non-executive directors. The Chairman and the non-executive directors have letters of appointment rather than service contracts. No compensation is payable to the Chairman or to any non-executive director if the appointment is terminated early. Dame Helen Alexander Lewis Booth Peter Byrom Sir Frank Chapman Iain Conn Sir Peter Gregson John McAdam John Neill CBE Sir Simon Robertson Ian Strachan Appointment date 01/09/2007 25/05/2011 01/01/1997 10/11/2011 20/01/2005 01/03/2007 19/02/2008 13/11/2008 01/01/2005 19/09/2003 Current letter of appointment start date 23/05/2011 25/05/2011 01/01/2012 10/11/2011 23/05/2011 23/05/2011 23/05/2011 13/11/2011 23/05/2011 23/05/2011 Current letter of appointment end date 31/08/2013 24/05/2014 31/12/2012 09/11/2014 19/01/2014 28/02/2013 18/02/2014 12/11/2014 31/12/2013 18/09/2012 Non-executive directors’ fees The Board takes account of independent market surveys in determining the fees payable to the Chairman and the non-executive directors. The fees payable to the non-executive directors are reviewed annually by the Board. The table below shows the current fee structure with effect from February 1, 2011. Chairman Other non-executive directors Chairman of audit committee Chairman of remuneration committee Chairman of ethics committee Senior Independent Director Fee £000 370 60 20 15 15 12 Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance 66 Shareholders and share capital Share capital and voting rights On December 31, 2011 there were 1,872,240,012 ordinary shares, 6,371,021,124 C Shares and one Special Share in issue. The ordinary shares are listed on the London Stock Exchange. The Annual General Meeting This year’s AGM will be held at 11.00am on Friday May 4, 2012 at the QEII Conference Centre, Broad Sanctuary, Westminster, London, SW1P 3EE. The Notice of AGM and the Annual report will be available to view on the Group’s website. C Shares The Company issues non-cumulative redeemable preference shares (C Shares) as an alternative to paying a cash dividend. Shareholders can choose to: • redeem all C Shares for cash; • redeem all C Shares for cash and reinvest the proceeds in additional ordinary shares using the CRIP operated by the Registrar; or • keep the C Shares. Shareholders unable to attend the AGM are invited to vote on the business of the meeting by completing a proxy form and returning it to the Registrar. If you have elected to receive electronic communications, you will be able to vote online. Payments to shareholders At the AGM on May 4, 2012, the directors will recommend an issue of 106 C Shares with a total nominal value of 10.6 pence for each ordinary share. The final issue of C Shares will be made on July 2, 2012. Together with the interim issue on January 3, 2012 of 69 C Shares for each ordinary share with a total nominal value of 6.9 pence, this is the equivalent of a total annual payment to ordinary shareholders of 17.5 pence for each ordinary share. The payment to shareholders will, as before, be made in the form of redeemable C Shares which shareholders may either choose to retain or redeem for a cash equivalent. The Registrar, on behalf of the Company, operates a C Share Reinvestment Plan (CRIP) and can, on behalf of shareholders, purchase ordinary shares from the market rather than delivering a cash payment. Shareholders wishing to redeem their C Shares or else redeem and participate in the CRIP must ensure that their instructions are lodged with the Registrar no later than 5pm on Friday June 1, 2012. Share class rights The rights and obligations attaching to the different classes of shares are set out in the Company’s Articles of Association. Ordinary shares Holders of ordinary shares are entitled to receive the Company’s Annual report. They are also entitled to attend and speak at general meetings of the Company, to appoint one or more proxies or, if they are corporations, corporate representatives, and to exercise voting rights. They have the right to ask questions at the AGM relating to the business of the meeting and for these to be answered, unless such answer would interfere unduly with the business of the meeting, involve the disclosure of confidential information, if the answer has already been published on the Group’s website or if it is not in the interests of the Group or the good order of the meeting that the question be answered. Holders of ordinary shares may receive a bonus issue of C Shares or a dividend and on liquidation may share in the assets of the Company. Any C Shares retained attract a dividend of 75 per cent of LIBOR on the 0.1p nominal value of each share, paid on a twice-yearly basis, and have limited voting rights. The Company has the option to compulsorily redeem the C Shares, at any time, if the aggregate number of C Shares in issue is less than ten per cent of the aggregate number of all C Shares issued, or on the acquisition or capital restructuring of the Company. On a return of capital on a winding-up, the holders of C Shares shall be entitled, in priority to any payment to the holders of ordinary shares, to the repayment of the nominal capital paid-up or credited as paid-up on the C Shares held by them, together with a sum equal to the outstanding preferential dividend which will have been accrued but not been paid until the date of return of capital. The holders of C Shares are entitled to attend, speak and vote at a General meeting only if a resolution to wind up the Company is to be considered, in which case they may vote only on such resolution. Special Share Certain rights attach to the special rights non-voting share (Special Share) issued to HM Government (Special Shareholder). Subject to the provisions of the Companies Act 2006, the Treasury Solicitor may redeem the Special Share at par at any time. The Special Share confers no rights to dividends but in the event of a winding-up it shall be repaid at its nominal value in priority to any other shares. Certain Articles (in particular those relating to the foreign shareholding limit, disposals and the nationality of directors) that relate to the rights attached to the Special Share may only be altered with the consent of the Special Shareholder. The Special Shareholder is not entitled to vote at any general meeting or any other meeting of any class of shareholders. The latest copy of the Articles of the Company can be found on the Group’s website: www.rolls-royce.com. Restrictions on transfer of shares and limitations on holdings There are no restrictions on transfer or limitations on the holding of the ordinary shares or C Shares other than under the Articles of Association (as described here), under restrictions imposed by law or regulation (for example, insider trading laws) or pursuant to the Company’s share dealing code. The Articles of Association provide that the Company should be and remain under United Kingdom control. As such, an individual foreign shareholding limit is set at 15 per cent of the aggregate votes attaching to the share capital of all classes (taken as a whole) and capable of being cast on a poll and to all other shares that the directors determine are to be included in the calculation of such holding. Rolls-Royce Holdings plc Annual report 2011Governance67 Shareholders and share capital Shareholder agreements and consent requirements There are no known arrangements under which financial rights carried by any of the shares in the Company are held by a person other than the holder of the shares and no known agreements between the holders of shares with restrictions on the transfer of shares or exercise of voting rights. No disposal may be made to a non-Group member which, alone or when aggregated with the same or a connected transaction, constitutes a disposal of the whole or a material part of either the nuclear business or the assets of the Group as a whole, without consent of the Special Shareholder. Authority to issue shares At a general meeting in 2011, authority was given to the directors to allot new ordinary shares up to a nominal value of £124,811,895, equivalent to one-third of the issued share capital of the Company. This is called the first section 551 amount. In addition, a special resolution was passed to effect a disapplication of pre-emption rights for a maximum of five per cent of the issued share capital of the Company. These authorities are valid until the AGM in 2012 and the directors propose to renew these authorities at that AGM. In line with revised guidance issued by the Association of British Insurers in November 2009, it is proposed to seek a further authority, as last year, at the AGM in 2012 to allot up to two thirds of the total issued share capital, but only in the case of a rights issue. This is called the second section 551 amount. The Board believes that this additional authority will allow the Company to retain the maximum possible flexibility (consistent with evolving market practice) to respond to circumstances and opportunities as they arise. Also at a general meeting in 2011, authority was given to the directors to allot new C Shares up to a nominal value of £350 million as an alternative to a cash dividend. Such authority expires at the conclusion of the AGM in 2012. The directors propose to renew an authority to allot new C Shares at the AGM in 2012 at an increased level of £400 million to provide headroom for potential future payments to shareholders. Authority to purchase own shares At a general meeting in 2011, the Company was authorised by shareholders to purchase up to 187,217,843 of its own ordinary shares representing ten per cent of its issued ordinary share capital. The Company did not make use of this authority during 2011. The authority for the Company to purchase its own shares expires at the conclusion of the AGM in 2012 or 18 months from May 16, 2011, whichever is the earlier. A resolution to renew it will be proposed at that meeting. Voting rights Deadlines for exercising voting rights Electronic and paper proxy appointments, and voting instructions, must be received by the Company’s Registrar not less than 48 hours before a general meeting. Voting rights for employee share plan shares Shares are held in various employee benefit trusts for the purpose of satisfying awards made under the various employee share plans. For shares held in a nominee capacity or if plan/trust rules provide the participant with the right to vote in respect of specifically allocated shares, the trustee votes in line with the participants’ instructions. For shares that are not held absolutely on behalf of specific individuals, the general policy of the trustees, in accordance with investor protection guidelines, is to abstain from voting in respect of those shares. Major shareholdings At February 8, 2012, the following companies had notified an interest in the issued ordinary share capital of the Company in accordance with the Financial Services Authority’s Disclosure and Transparency Rules: Company AXA S.A. BlackRock Inc. Invesco Limited Legal & General Group plc Date notified January 11, 2010 September 3, 2010 February 4, 2008 October 14, 2009 % of issued ordinary share capital 4.90 5.02 6.91 3.96 Rolls-Royce Holdings plc Annual report 2011GovernanceGovernance68 Other statutory information Political donations In line with its established policy, the Group made no political donations pursuant to the authority granted at the 2011 AGM. Although the Company does not make, and does not intend to make, donations to political parties, within the normal meaning of that expression, the definition of political donations under the Companies Act 2006 is very broad and includes expenses legitimately incurred as part of the process of talking to members of parliament and opinion formers to ensure that the issues and concerns of the Group are considered and addressed. These activities are not intended to support any political party and the Group’s policy is not to make any donations for political purposes in the normally accepted sense. A resolution will therefore be proposed at the 2012 AGM seeking shareholder approval for the directors to be given authority to make donations and incur expenditure which might otherwise be caught by the terms of the Companies Act 2006. The authority sought will be limited to a maximum amount of £25,000 per Group company but so as not to exceed £50,000 for the entire Group in aggregate. During the year, the business expenses incurred by Rolls-Royce North America Inc. towards the operation of the Rolls-Royce North America Political Action Committee (RRNAPAC) in the USA was US$44,436 (2010: nil). PACs are a common feature of the US political system and are governed by the Federal Election Campaign Act. The PAC is independent of the Company and independent of any political party. The PAC funds are contributed voluntarily by employees and the Company cannot affect how they are applied, although under US Law, the business expenses are paid by the Company. Such contributions do not require authorisation by shareholders under the Companies Act 2006 and therefore do not count towards the £25,000 and £50,000 limits for political donations and expenditure for which shareholder approval will be sought at the AGM. Change of control Contracts and joint venture agreements There are a number of contracts and joint venture agreements which would allow the counterparties to terminate or alter those arrangements in the event of a change of control of the Company. These arrangements are commercially confidential and their disclosure could be seriously prejudicial to the Company. Borrowings and other financial instruments The Group has a number of borrowing facilities provided by various banks. These facilities generally include provisions which may require any outstanding borrowings to be repaid or the alteration or termination of the facility upon the occurrence of a change of control of the Company. At December 31, 2011 these facilities were less than 20 per cent drawn. The Group has entered into a series of financial instruments to hedge its currency, interest rate and commodity exposures. These contracts provide for termination or alteration in the event that a change of control of the Company materially weakens the creditworthiness of the Group. Employee share plans In the event of a change of control of the Company, the effect on the employee share plans would be as follows: • PSP – awards would vest pro rata to service in the performance period, subject to remuneration committee judgement of Company performance; • APRA deferred shares – the shares would be released from trust immediately; • ShareSave – options would become exercisable immediately. The new company might offer an equivalent option in exchange for cancellation of the existing option; and • SIP – consideration received as shares would be held within the SIP, if possible, otherwise the consideration would be treated as a disposal from the SIP. Essential commercial relationships Supply chain Certain suppliers to the Group contribute key components or services, the loss of which could cause disruption to the Group’s deliveries. However, none are so vital that their loss would affect the viability of the business as a whole. When dealing with suppliers, the Group is guided by the Supply Chain Relationships in Aerospace (SCRIA) initiative. It seeks the best possible terms from suppliers and when entering into binding purchasing contracts, gives consideration to quality, delivery, price and the terms of payment. In the event of disputes, efforts are made to resolve them quickly. Customers The increasingly global nature of the business, balanced across the civil aerospace, defence aerospace, marine and energy segments, ensures that the Group is not overly dependent on any individual customer. Material litigation During the year, the litigation with United Technologies Corporation in connection with an alleged patent infringement was withdrawn, without financial impact. Creditor days As the Company is a holding company and does not itself trade, it owed no amounts to trade creditors at December 31, 2011 and therefore the number of creditor days required to be shown in this report to comply with the provisions of the Companies Act 2006 is nil. Rolls-Royce Holdings plc Annual report 2011Governance 69 Other statutory information Internal control and risk management The Board’s responsibility for internal control and risk management The directors are responsible for the Group’s system of internal control and for maintaining and reviewing its effectiveness from both a financial and an operational perspective. The system of internal control is designed to manage, rather than 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 approach to internal control is based on the underlying principle of line management’s accountability for control and risk management. In reviewing the effectiveness of the system of internal control, the Board has taken account of the results of the work carried out to audit and review the activities of the Group. Annual report and financial statements Statement of directors’ responsibilities in respect of the Annual report and the financial statements The directors are responsible for preparing the Annual report and the Group and parent company financial statements in accordance with applicable law and regulations. Company law requires the directors to prepare Group and parent company financial statements for each financial year. Under that law they are required to prepare the Group financial statements in accordance with IFRS as adopted by the EU and applicable law and have elected to prepare the parent company financial statements in accordance with UK Accounting Standards and applicable law (UK Generally Accepted Accounting Practice). There is an ongoing process to identify, assess and manage risk, including those risks affecting the Group’s reputation. This process is subject to continuous improvement and has been in place throughout the financial year to which these statements apply and up to the date of their approval. Under company law the directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent company and of their profit or loss for that period. In 2011, the effectiveness and consistency of risk management at all levels of the organisation has been measured, improved and reported via the sector and function assurance framework. The Board has reviewed the risk management process and confirms that ongoing processes and systems ensure that the Group continues to be compliant with the ‘Turnbull guidance’ as contained in ‘Internal Control: Guidance for Directors on the Combined Code’. Financial reporting The Group has a comprehensive budgeting system with an annual budget approved by the Board. Revised forecasts for the year are reported at least quarterly. Actual results, at both a business and Group level, are reported monthly against budget and variances reviewed. Financial managers are required to acknowledge in writing that their routine financial reporting is based on reliable data and that their results are properly stated in accordance with Group requirements. In addition, for annual reporting, business presidents and finance directors are required to acknowledge that their business has complied with the Group Finance Manual. In preparing each of the Group and parent company financial statements, the directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • for the Group financial statements, state whether they have been prepared in accordance with IFRSs as adopted by the EU; • for the parent company financial statements, state whether applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and • prepare the financial statements on the going concern basis unless it is inappropriate to presume that the Group and the parent company will continue in business. The directors are responsible for keeping adequate accounting records that are sufficient to show and explain the parent Group’s transactions and disclose with reasonable accuracy at any time the financial position of the parent company and enable them to ensure that its financial statements comply with the Companies Act 2006. They have general responsibility for taking such steps as are reasonably open to them to safeguard the assets of the group and to prevent and detect fraud and other irregularities. Under applicable law and regulations, the directors are also responsible for preparing a Directors’ report, Directors’ remuneration report and Corporate Governance statement that complies with that law and those regulations. The directors are responsible for the maintenance and integrity of the corporate and financial information included on the Group’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. Rolls-Royce Holdings plc Annual report 2011GovernanceGovernanceResponsibility statement Each of the persons who is a director at the date of approval of this report confirms that to the best of his or her knowledge: i) each of the Group and parent company financial statements, prepared in accordance with IFRS and UK Accounting Standards respectively, gives a true and fair view of the assets, liabilities, financial position and profit or loss of the issuer and the undertakings included in the consolidation taken as a whole; and ii) the Directors’ report on pages 1 to 70 includes a fair review of the development and performance of the business and the position of the Company and the undertakings included in the consolidation taken as a whole, together with a description of the principal risks and uncertainties that they face. By order of the Board Paul Davies Acting Company Secretary February 8, 2012 70 Other statutory information Going concern The Group’s business activities, together with the factors likely to affect its future development, performance and position are set out on pages 1 to 70 of the business review and a summary of the principal risks affecting the business are shown on pages 34 to 35. The financial position of the Group, its cash flows, liquidity position, borrowing facilities and financial risks are described in pages 14 to 17 and 36 to 37 of the business review. In addition, notes 1, 13, 15 and 17 of the consolidated financial statements include the Group’s objectives, policies and processes for financial risk management, details of its cash and cash equivalents, indebtedness and borrowing facilities and its financial instruments, hedging activities and its exposure to counterparty credit risk, liquidity risk, currency risk, interest rate risk and commodity pricing risk. As described on page 36, the Group meets its funding requirements through a mixture of shareholders’ funds, bank borrowings, bonds, notes and finance leases. The Group has facilities of £2.3 billion of which £1.1 billion was drawn at the year end. None of these facilities expire in 2012. The Group’s forecasts and projections, taking into account reasonably possible changes in trading performance, show that the Group has sufficient financial resources. As a consequence, the directors have a reasonable expectation that the Company and the Group are well placed to manage their business risks and to continue in operational existence for the foreseeable future, despite the current uncertain global economic outlook. Accordingly, the directors continue to adopt the going concern basis (in accordance with the guidance ‘Going Concern and Liquidity Risk: Guidance for Directors of UK Companies 2009’ issued by the FRC) in preparing the consolidated financial statements. Disclosure of information to auditors Each of the persons who is a director at the date of approval of this report confirms that: i) so far as the director is aware, there is no relevant information of which the Company’s auditors are unaware; and ii) the director has taken all steps that he or she ought to have taken as a director 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. Rolls-Royce Holdings plc Annual report 2011Governance71 Other statutory information Financial statements Consolidated financial statements 72 CONSOLIDATED INCOME STATEMENT 72 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME 73 CONSOLIDATED BALANCE SHEET 74 CONSOLIDATED CASH FLOW STATEMENT 76 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY Company financial statements 119 COMPANY BALANCE SHEET 119 RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS Accounting policies Segmental analysis Taxation Earnings per ordinary share Employee information Auditor’s remuneration Intangible assets Property, plant and equipment Investments Inventories 77 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 77 1 84 2 88 3 Net financing 88 4 91 5 91 6 92 7 92 8 94 9 95 10 96 11 96 12 Trade and other receivables 97 13 Cash and cash equivalents 97 14 Assets held for sale 98 15 Borrowings 98 16 Trade and other payables 99 17 Financial instruments 108 18 Provisions for liabilities and charges 109 19 Post-retirement benefits 113 20 Share capital 114 21 Share-based payments 116 22 Operating leases 117 23 Contingent liabilities 118 24 Related party transactions 118 25 Acquisitions Accounting policies Investments – subsidiary undertakings Financial liabilities Share capital 120 NOTES TO THE COMPANY FINANCIAL STATEMENTS 120 1 120 2 120 3 121 4 121 5 Movements in capital and reserves 121 6 121 7 Other information Contingent liabilities Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statements72 Consolidated income statement For the year ended December 31, 2011 Revenue Cost of sales Gross profit Other operating income Commercial and administrative costs Research and development costs Share of results of joint ventures and associates Operating profit Profit on disposal of businesses Profit before financing and taxation Financing income Financing costs Net financing Profit before taxation 1 Taxation Profit for the year Attributable to: Ordinary shareholders Non-controlling interests Profit for the year Earnings per ordinary share attributable to ordinary shareholders: Basic Diluted Payments to ordinary shareholders in respect of the year Per share Total 1 Underlying profit before taxation Consolidated statement of comprehensive income For the year ended December 31, 2011 Profit for the year Other comprehensive income Foreign exchange translation differences on foreign operations Movements in post-retirement schemes Share of other comprehensive income of joint ventures and associates Related tax movements Total comprehensive income for the year Attributable to: Ordinary shareholders Non-controlling interests Total comprehensive income for the year Notes 2 10 2 3 3 4 5 17 2 Notes 19 10 4 2011 £m 11,124 (8,676) 2,448 69 (984) (463) 116 1,186 3 1,189 456 (540) (84) 1,105 (257) 848 850 (2) 848 45.95p 45.33p 17.5p 328 1,157 2011 £m 848 (102) 123 (10) (54) 805 808 (3) 805 2010 £m 11,085 (8,885) 2,200 95 (836) (422) 93 1,130 4 1,134 453 (885) (432) 702 (159) 543 539 4 543 29.20p 28.82p 16.0p 299 955 2010 £m 543 22 (94) (16) 29 484 480 4 484 Rolls-Royce Holdings plc Annual report 2011Financial statements 73 Consolidated balance sheet At December 31, 2011 ASSETS Non-current assets Intangible assets Property, plant and equipment Investments – joint ventures and associates Investments – other Other financial assets Deferred tax assets Post-retirement scheme surpluses Current assets Inventories Trade and other receivables Taxation recoverable Other financial assets Short-term investments Cash and cash equivalents Assets held for sale Total assets LIABILITIES Current liabilities Borrowings Other financial liabilities Trade and other payables Current tax liabilities Provisions for liabilities and charges Liabilities associated with assets held for sale Non-current liabilities Borrowings Other financial liabilities Trade and other payables Deferred tax liabilities Provisions for liabilities and charges Post-retirement scheme deficits Total liabilities Net assets EQUITY Equity attributable to ordinary shareholders Called-up share capital Share premium account Capital redemption reserve Cash flow hedging reserve Other reserves Retained earnings Non-controlling interests Total equity Notes 8 9 10 10 17 4 19 11 12 17 13 14 15 17 16 18 14 15 17 16 4 18 19 20 2011 £m 2,882 2,338 1,680 10 327 368 503 8,108 2,561 4,009 20 91 11 1,310 313 8,315 16,423 (20) (111) (6,236) (138) (276) (135) (6,916) (1,184) (919) (1,314) (445) (226) (900) (4,988) (11,904) 4,519 374 – 173 (52) 433 3,590 4,518 1 4,519 2010 £m 2,884 2,136 393 11 371 451 164 6,410 2,429 3,943 6 250 328 2,859 9 9,824 16,234 (717) (105) (5,910) (170) (276) – (7,178) (1,135) (945) (1,271) (438) (268) (1,020) (5,077) (12,255) 3,979 374 133 209 (37) 527 2,769 3,975 4 3,979 The financial statements on pages 72 to 118 were approved by the Board on February 8, 2012 and signed on its behalf by: Sir Simon Robertson Chairman Mark Morris Finance Director Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statements 74 Consolidated cash flow statement For the year ended December 31, 2011 Reconciliation of cash flows from operating activities Profit before taxation Share of results of joint ventures and associates Profit on disposal of businesses Profit on disposal of property, plant and equipment Net financing Taxation paid Amortisation of intangible assets Depreciation and impairment of property, plant and equipment Impairment of investments (Decrease)/increase in provisions (Increase)/decrease in inventories (Increase)/decrease in trade and other receivables Increase in trade and other payables Movement in other financial assets and liabilities Net defined benefit post-retirement (credit)/cost recognised in profit before financing Cash funding of defined benefit post-retirement schemes Share-based payments Dividends received from joint ventures and associates Net cash inflow from operating activities Cash flows from investing activities Additions of unlisted investments Disposals of unlisted investments Additions of intangible assets Disposals of intangible assets Purchases of property, plant and equipment Government grants received Disposals of property, plant and equipment Acquisitions of businesses Disposals of businesses Investments in joint ventures and associates Loan to Engine Holding GmbH Net cash outflow from investing activities Cash flows from financing activities Repayment of loans Proceeds from increase in loans Net cash flow from decrease in borrowings Interest received Interest paid Decrease/(increase) in short-term investments Issue of ordinary shares (net of expenses) Purchase of ordinary shares Redemption of C Shares Net cash outflow from financing activities Net decrease in cash and cash equivalents Cash and cash equivalents at January 1 Exchange (losses)/gains on cash and cash equivalents Cash and cash equivalents at December 31 * Restated to show government grants, previously included in trade and other payables, separately. Notes 10 3 8 9 10 21 10 2011 £m 1,105 (116) (3) (8) 84 (208) 169 241 – (28) (140) (62) 416 68 (43) (304) 59 76 1,306 – 1 (363) 6 (412) 38 31 (19) 7 (1,329) (167) (2,207) (567) – (567) 19 (50) 316 (1) (57) (315) (655) (1,556) 2,851 (4) 1,291 * Restated 2010 £m 702 (93) (4) (10) 432 (168) 130 237 3 99 41 39 248 (299) 147 (282) 50 68 1,340 (1) 46 (321) – (354) 38 38 (150) 2 (19) – (721) (108) 68 (40) 23 (77) (326) 67 (124) (266) (743) (124) 2,958 17 2,851 Rolls-Royce Holdings plc Annual report 2011Financial statements75 Consolidated cash flow statement For the year ended December 31, 2011 Reconciliation of movements in cash and cash equivalents to movements in net funds Decrease in cash and cash equivalents Cash flow from decrease in borrowings Cash flow from (decrease)/increase in short-term investments Change in net funds resulting from cash flows Net funds (excluding cash and cash equivalents) of businesses acquired Exchange (losses)/gains on net funds Fair value adjustments Movement in net funds Net funds at January 1 excluding the fair value of swaps Net funds at December 31 excluding the fair value of swaps Fair value of swaps hedging fixed rate borrowings Net funds at December 31 The movement in net funds (defined by the Group as including the items shown below) is as follows: 2011 £m (1,556) 567 (316) (1,305) – (5) 92 (1,218) 1,335 117 106 223 2010 £m (124) 40 326 242 (1) 17 26 284 1,051 1,335 198 1,533 Cash at bank and in hand Money-market funds Short-term deposits Overdrafts Cash and cash equivalents Short-term investments Other current borrowings Non-current borrowings Finance leases Fair value of swaps hedging fixed rate borrowings At January 1, 2011 £m 1,266 381 1,212 (8) 2,851 328 (709) (1,134) (1) 1,335 198 1,533 Funds flow £m 26 (370) (1,201) (11) (1,556) (316) 566 1 – (1,305) Exchange differences £m (7) – 3 – (4) (1) – – – (5) (1,305) (5) Fair value adjustments £m – – – – – – 142 (50) – 92 (92) – At December 31, 2011 £m 1,285 11 14 (19) 1,291 11 (1) (1,183) (1) 117 106 223 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statements76 Consolidated statement of changes in equity For the year ended December 31, 2011 At January 1, 2010 Total comprehensive income for the year Arising on issues of ordinary shares Issues of C Shares Redemptions of C Shares Ordinary shares purchased Share-based payments – direct to equity 4 Related tax movements Other changes in equity in the year At January 1, 2011 Total comprehensive income for the year Arising on issues of ordinary shares Issues of C Shares Redemptions of C Shares Ordinary shares purchased Share-based payments – direct to equity 4 Effect of scheme of arrangement 5 Effect of capital reduction 5 Related tax movements Other changes in equity in the year At December 31, 2011 Notes 20 17 17 4 17 17 4 Share capital £m 371 – 3 – – – – – 3 374 – – – – – – 2,434 (2,434) – – 374 Share premium £m 98 – 64 (29) – – – – 35 133 – 1 (120) – – – (14) – – (133) – Attributable to ordinary shareholders Cash flow hedging reserve1 £m (19) (18) – – – – – – – (37) (15) – – – – – – – – – (52) Capital redemption reserve £m 191 – – (249) 267 – – – 18 209 – – – 317 – – (353) – – (36) 173 Other reserves2 £m 506 21 – – – – – – – 527 (94) – – – – – – – – – 433 Retained earnings3 £m 2,635 477 – 1 (267) (124) 42 5 (343) 2,769 917 – (176) (317) (57) 77 (2,069) 2,434 12 (96) 3,590 Non- controlling interests £m – 4 – – – – – – – 4 (3) – – – – – – – – – 1 Total £m 3,782 480 67 (277) – (124) 42 5 (287) 3,975 808 1 (296) – (57) 77 (2) – 12 (265) 4,518 Total equity £m 3,782 484 67 (277) – (124) 42 5 (287) 3,979 805 1 (296) – (57) 77 (2) – 12 (265) 4,519 1 See accounting policies note 1. 2 Other reserves include a merger reserve of £3m (2010 £3m, 2009 £3m) and a translation reserve of £430m (2010 £524m, 2009 £503m). 3 At December 31, 2011, 22,541,187 ordinary shares with a net book value of £116m (2010 28,320,962, 2009 7,156,497 ordinary shares with net book values of £125m and £25m respectively) were held for the purpose of share-based payment plans and included in retained earnings. During the year, 14,822,563 ordinary shares with a net book value of £66m (2010 6,586,568 shares with a net book value of £24m) vested in share-based payment plans. During the year the Company acquired 9,042,788 of its ordinary shares through purchases on the London Stock Exchange. 4 Share-based payments – direct to equity is the net of the credit to equity in respect of the share-based payment charge to the income statement and the actual cost of shares vesting, excluding those vesting from own shares. 5 On May 23, 2011, under a scheme of arrangement between Rolls-Royce Group plc, the former holding company of the Group, and its shareholders under Part 26 of the Companies Act 2006, and as sanctioned by the High Court, all the issued ordinary shares in that company were cancelled and the same number of new ordinary shares were issued to Rolls-Royce Holdings plc in consideration for the allotment to shareholders of one ordinary share in Rolls-Royce Holdings plc for each ordinary share in Rolls-Royce Group plc held on the record date (May 20, 2011). Pursuant to the scheme of arrangement, 1,872,188,709 ordinary shares of 150 pence were issued. As required by Section 612 of the Companies Act 2006, no share premium was recognised. On May 24, 2011, the share capital of Rolls-Royce Holdings plc was reduced by reducing the nominal value of the ordinary shares from 150 pence to 20 pence as sanctioned by the High Court. Rolls-Royce Holdings plc Annual report 2011Financial statements 77 Notes to the consolidated financial statements 1 Accounting policies The Company Rolls-Royce Holdings plc (the ‘Company’) is a company domiciled in the United Kingdom. The consolidated financial statements of the Company for the year ended December 31, 2011 comprise the Company and its subsidiaries (together referred to as the ‘Group’) and the Group’s interest in jointly controlled and associated entities. The financial statements were authorised for issue by the directors on February 8, 2012. Basis of preparation and statement of compliance In accordance with European Union (EU) regulations, these financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), as adopted for use in the EU effective at December 31, 2011 (Adopted IFRS). The Company has elected to prepare its parent company accounts under UK Generally Accepted Accounting Practices (GAAP). The financial statements have been prepared on the historical cost basis except where Adopted IFRS requires the revaluation of financial instruments to fair value and certain other assets and liabilities on an alternative basis – most significantly post-retirement scheme liabilities are valued on the basis required by IAS 19 Employee benefits – and on a going concern basis as described on page 70. The preparation of financial statements in conformity with Adopted IFRS requires the use of certain critical accounting judgements and estimates, which are set out below. The Group’s significant accounting policies are set out on the following pages. These accounting policies have been applied consistently to all periods presented in these consolidated financial statements and by all Group entities. Key areas of judgement The directors consider the potential key areas of judgements required to be made in applying the Group’s accounting policies to be: • A large proportion of the Group’s activities relate to long-term aftermarket contracts. The determination of appropriate accounting policies for recognising revenue and costs in respect of these contracts requires judgement, in particular (i) whether an aftermarket contract is linked, for accounting purposes, to the related sale of original equipment and (ii) the appropriate measure of stage of completion of the contract. • As set out in note 8, the Group has significant intangible assets. The decision as to when to commence capitalisation of development costs and whether sales of original equipment give rise to recognisable recoverable engine costs is a key judgement. • As set out in note 23, the Group has contingent liabilities in respect of financing support provided to customers. Judgement is required to assess the likelihood of these crystallising, in order to assess whether a provision should be recognised. Key sources of estimation uncertainty In applying the above accounting policies, management has made appropriate estimates in many areas, and the actual outcome may differ from those calculated. The key sources of estimation uncertainty at the balance sheet date, that have a significant risk of causing material adjustment to the carrying amounts of assets and liabilities within the next financial year are set out below. The estimation of the relevant assets and liabilities involves the combination of a number of assumptions. Where appropriate and practicable, sensitivities are disclosed in the relevant notes. Current economic environment The current economic environment could impact a number of estimates necessary to prepare the financial statements, in particular, the recoverable amount of assets and contingent liabilities. The Group has taken these factors into account in assessing the estimates set out below. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statements 78 Notes to the consolidated financial statements 1 Accounting policies (continued) Forecasts and discount rates The carrying values of a number of items on the balance sheet are dependent on the estimates of future cash flows arising from the Group’s operations, in particular: • The assessment as to whether there are any indications of impairment of development, participation, certification and recoverable engine costs recognised as intangible assets is dependent on forecasts of cash flows generated by the relevant assets (carrying values at December 31, 2011 £1,442m, December 31, 2010 £1,472m). • The financial liabilities arising from financial risk and revenue sharing partnerships are valued at each reporting date using the amortised cost method (carrying values at December 31, 2011 £230m, December 31, 2010 £266m). This involves calculating the present value of the forecast cash flows of the arrangement using the internal rate of return at the inception of the arrangement as the discount rate. • The realisation of the deferred tax assets (carrying values at December 31, 2011 £368m, December 31, 2010 £451m) recognised is dependent on the generation of sufficient future taxable profits. The Group recognises deferred tax assets where it is more likely than not that the benefit will be realised. Assessment of long-term contractual arrangements The Group has long-term contracts that fall into different accounting periods. In assessing the allocation of revenues and costs to individual accounting periods, and the consequential assets and liabilities, the Group estimates the total revenues and costs forecast to arise in respect of the contract and the stage of completion based on an appropriate measure of performance as described in the revenue recognition accounting policy below. Post-retirement benefits The Group’s defined benefit pension schemes and similar arrangements are assessed annually in accordance with IAS 19. The accounting valuation, which was based on assumptions determined with independent actuarial advice, resulted in a net deficit of £397m before deferred taxation being recognised on the balance sheet at December 31, 2011 (December 31, 2010 £856m). The size of the net deficit is sensitive to the market value of the assets held by the schemes and to actuarial assumptions, which include price inflation, pension and salary increases, the discount rate used in assessing actuarial liabilities, mortality and other demographic assumptions and the levels of contributions. Further details are included in note 19. Provisions As described in the accounting policy below, the Group measures provisions (carrying value at December 31, 2011 £502m, December 31, 2010 £544m) at the directors’ best estimate of the expenditure required to settle the obligation at the balance sheet date. These estimates are made, taking account of information available and different possible outcomes. Taxation The tax payable on profits is determined based on tax laws and regulations that apply in each of the numerous jurisdictions in which the Group operates. Where the precise impact of these laws and regulations is unclear then reasonable estimates may be used to determine the tax charge included in the financial statements. Basis of consolidation The Group financial statements include the financial statements of the Company and all of its subsidiary undertakings made up to December 31, together with the Group’s share of the results of joint ventures and associates up to December 31. A subsidiary is an entity controlled by the Company. Control exists when the Company has the power, directly or indirectly, to govern the financial and operating policies of the entity so as to derive benefits from its activities. A joint venture is an entity in which the Group holds a long-term interest and which is jointly controlled by the Group and one or more other venturers under a contractual arrangement. An associate is an entity, being neither a subsidiary nor a joint venture, in which the Group holds a long-term interest and where the Group has a significant influence. The results of joint ventures and associates are accounted for using the equity method of accounting. Any subsidiary undertakings, joint ventures or associates sold or acquired during the year are included up to, or from, the dates of change of control. All intra-group transactions, balances, income and expenses are eliminated on consolidation. Adjustments are made to eliminate the profit or loss arising on transactions with joint ventures and associates to the extent of the Group’s interest in the entity. Financial statements79 1 Accounting policies (continued) Significant accounting policies Revenue recognition Revenues comprise sales to outside customers after discounts, excluding value added tax. Sales of products are recognised when the significant risks and rewards of ownership of the goods are transferred to the customer, the sales price agreed and the receipt of payment can be assured. On occasion, the Group may participate in the financing of engines in conjunction with airframe manufacturers, most commonly by the provision of guarantees as described in note 23. In such circumstances, the contingent obligations arising under these arrangements are taken into account in assessing whether significant risks and rewards of ownership have been transferred to the customer. Sales of services are recognised by reference to the stage of completion based on services performed to date. The assessment of the stage of completion is dependent on the nature of the contract, but will generally be based on: costs incurred to the extent these relate to services performed up to the reporting date; achievement of contractual milestones where appropriate; or flying hours or equivalent for long-term aftermarket arrangements. Linked sales of products and services are treated as a single contract where these components have been negotiated as a single commercial package and are so closely interrelated that they do not operate independently of each other and are considered to form a single project with an overall profit margin. Revenue is recognised on the same basis as for other sales of products and services as described above. Provided that the outcome of construction contracts can be assessed with reasonable certainty, the revenues and costs on such contracts are recognised based on stage of completion and the overall contract profitability. Full provision is made for any estimated losses to completion of contracts, having regard to the overall substance of the arrangements. Progress payments received, when greater than recorded revenue, are deducted from the value of work in progress except to the extent that payments on account exceed the value of work in progress on any contract where the excess is included in trade and other payables. The amount by which recorded revenue of long-term contracts is in excess of payments on account is classified as amounts recoverable on contracts and is separately disclosed within trade and other receivables. Risk and revenue sharing partnerships (RRSPs) From time to time, the Group enters into arrangements with partners who, in return for a share in future programme revenues or profits, make cash payments that are not refundable. Cash sums received, which reimburse the Group for past expenditure, are credited to other operating income. The arrangements also require partners to undertake development work and/or supply components for use in the programme at their own expense. No accounting entries are recorded where partners undertake such development work or where programme components are supplied by partners because no obligation arises unless and until programme sales are made. Instead, payments to partners for their share in the programme are charged to cost of sales as programme revenues arise. The Group has arrangements with partners who do not undertake development work or supply parts. Such arrangements are considered to be financial instruments as defined by IAS 32 Financial Instruments: Presentation and are accounted for using the amortised cost method. Government investment Where a government or similar body has previously invested in a development programme, the Group treats payments to that body as royalty payments, which are matched to related sales. Government grants Government grants are recognised in the income statement so as to match them with the related expenses that they are intended to compensate. Where grants are received in advance of the related expenses, they are included in the balance sheet as deferred income. Non-monetary grants are recognised at fair value. Interest Interest receivable/payable is credited/charged to the income statement using the effective interest method. Where borrowing costs are attributable to the acquisition, construction or production of a qualifying asset, such costs are capitalised as part of the specific asset. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements80 1 Accounting policies (continued) Taxation The tax charge on the profit or loss for the year comprises current and deferred tax. Current tax is the expected tax payable for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries and joint ventures, except where the Group is able to control the reversal of the temporary difference and it is probable that the temporary difference will not reverse in the foreseeable future. Deferred tax is not recognised on taxable temporary differences arising on the initial recognition of goodwill or for temporary differences arising from the initial recognition of assets and liabilities in a transaction that is not a business combination and that affects neither accounting nor taxable profit. Deferred tax is calculated using the enacted or substantively enacted rates that are expected to apply when the asset or liability is settled. Deferred tax is charged or credited in the income statement or statement of comprehensive income as appropriate, except when it relates to items credited or charged directly to equity in which case the deferred tax is also dealt with in equity. Deferred tax assets are recognised only to the extent that it is probable that future taxable profits will be available against which the assets can be utilised. Foreign currency translation Transactions in overseas currencies are translated into local currency at the exchange rates ruling on the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into local currency at the rate ruling at the year end. Exchange differences arising on foreign exchange transactions and the retranslation of assets and liabilities into sterling at the rate ruling at the year end are taken into account in determining profit before taxation. The trading results of overseas undertakings are translated at the average exchange rates for the year. The assets and liabilities of overseas undertakings, including goodwill and fair value adjustments arising on acquisition, are translated at the exchange rates ruling at the year end. Exchange adjustments arising from the retranslation of the opening net investments, and from the translation of the profits or losses at average rates, are taken to equity. Financial instruments IAS 39 Financial Instruments: Recognition and Measurement requires the classification of financial instruments into separate categories for which the accounting requirement is different. The Group has classified its financial instruments as follows: • Short-term investments are classified as available for sale. • Short-term deposits (principally comprising funds held with banks and other financial institutions), trade receivables and short-term investments not designated as available for sale are classified as loans and receivables. • Borrowings, trade payables, financial RRSPs and C Shares are classified as other liabilities. • Derivatives, comprising foreign exchange contracts, interest rate swaps and commodity swaps are classified as held for trading. Financial instruments are recognised at the contract date and initially measured at fair value. Their subsequent measurement depends on their classification: • Loans and receivables and other liabilities are held at amortised cost and not revalued (except for changes in exchange rates which are included in the income statement) unless they are included in a fair value hedge accounting relationship. Where such a relationship exists, the instruments are revalued in respect of the risk being hedged, with the change in value included in the income statement. • Available for sale assets are held at fair value. Changes in fair value arising from changes in exchange rates are included in the income statement. All other changes in fair value are taken to equity. On disposal, the accumulated changes in value recorded in equity are included in the gain or loss recorded in the income statement. • Held for trading instruments are held at fair value. Changes in fair value are included in the income statement unless the instrument is included in a cash flow hedge. If the instruments are included in a cash flow hedging relationship, which is effective, changes in value are taken to equity. When the hedged forecast transaction occurs, amounts previously recorded in equity are recognised in the income statement. Financial instruments are derecognised on expiry or when all contractual rights and obligations are transferred. Financial statementsNotes to the consolidated financial statements81 1 Accounting policies (continued) Hedge accounting The Group does not generally apply hedge accounting in respect of forward foreign exchange contracts held to manage the cash flow exposures of forecast transactions denominated in foreign currencies. In 2011, the Group has applied cash flow hedge accounting in respect of foreign exchange contracts entered into to hedge the cost of its investment in Engine Holding GmbH. The Group does not apply hedge accounting in respect of commodity swaps held to manage the cash flow exposures of forecast transactions in those commodities. The Group applies hedge accounting in respect of transactions entered into to manage the fair value and cash flow exposures of its borrowings. Forward foreign exchange contracts are held to manage the fair value exposures of borrowings denominated in foreign currencies and are designated as fair value hedges. Interest rate swaps are held to manage the interest rate exposures and are designated as fair value or cash flow hedges of fixed and floating rate borrowings respectively. Changes in the fair values of derivatives designated as fair value hedges and changes in fair value of the related hedged item are recognised directly in the income statement. Changes in the fair values of derivatives that are designated as cash flow hedges and are effective are recognised directly in equity. Any ineffectiveness in the hedging relationships is included in the income statement. The amounts deferred in equity are recognised in the income statement to match the recognition of the hedged item or, in the case of the cash flow hedges of the investment in Engine Holding GmbH, included in the initial carrying value of the joint venture. Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated, exercised, or no longer qualifies for hedge accounting. At that time, for cash flow hedges and if the forecast transaction remains probable, any cumulative gain or loss on the hedging instrument recognised in equity is retained in equity until the forecast transaction occurs. If a hedged transaction is no longer expected to occur, the net cumulative gain or loss previously recognised in equity is transferred to the income statement. The portion of a gain or loss on an instrument used to hedge a net investment in a foreign operation that is determined to be an effective hedge is recognised directly in equity. The ineffective portion is recognised immediately in the income statement. Purchased goodwill Goodwill represents the excess of the fair value of the purchase consideration for shares in subsidiary undertakings, joint ventures and associates over the fair value to the Group of the net of the identifiable assets acquired and the liabilities assumed. i) To December 31, 1997: Goodwill was written off to reserves in the year of acquisition. ii) From January 1, 1998: Goodwill was recognised within intangible assets in the year in which it arose and amortised on a straight-line basis over its useful economic life, up to a maximum of 20 years. iii) From January 1, 2004, in accordance with IFRS 3 Business Combinations, goodwill is recognised as per (ii) above but is no longer amortised. Certification costs and participation fees Costs incurred in respect of meeting regulatory certification requirements for new civil aero-engine/aircraft combinations and payments made to airframe manufacturers for this, and participation fees, are carried forward in intangible assets to the extent that they can be recovered out of future sales and are charged to the income statement over the programme life, up to a maximum of 15 years from the entry into service of the product. Research and development In accordance with IAS 38 Intangible Assets, expenditure incurred on research and development, excluding known recoverable amounts on contracts, and contributions to shared engineering programmes, is distinguished as relating either to a research phase or to a development phase. All research phase expenditure is charged to the income statement. For development expenditure, this is capitalised as an internally generated intangible asset only if it meets strict criteria, relating in particular to technical feasibility and generation of future economic benefits. Expenditure that cannot be classified into these two categories is treated as being incurred in the research phase. The Group considers that, due to the complex nature of new equipment programmes, it is not possible to distinguish reliably between research and development activities until relatively late in the programme. Expenditure capitalised is amortised over its useful economic life, up to a maximum of 15 years from the entry into service of the product. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements82 1 Accounting policies (continued) Recoverable engine costs On occasion, the Group may sell original equipment to customers at a price below its cost, on the basis that this deficit will be recovered from future aftermarket sales to the original customer. Where the Group has a contractual right to supply aftermarket parts to the customer and its intellectual rights, warranty arrangements and statutory airworthiness requirements provide reasonable control over this supply, these arrangements are considered to meet the definition of an intangible asset. Such intangible assets are recognised to the extent of the deficit and amortised on a straight-line basis over the expected period of utilisation by the original customer. Software The cost of acquiring software that is not specific to an item of property, plant and equipment is classified as an intangible asset and amortised over its useful economic life, up to a maximum of five years. Property, plant and equipment Property, plant and equipment assets are stated at cost less accumulated depreciation and any provision for impairment in value. Depreciation is provided on a straight-line basis to write off the cost, less the estimated residual value, of property, plant and equipment over their estimated useful lives. No depreciation is provided on assets in the course of construction. Estimated useful lives are as follows: i) Land and buildings, as advised by the Group’s professional advisors: a) Freehold buildings – five to 45 years (average 24 years). b) Leasehold buildings – lower of advisor’s estimates or period of lease. c) No depreciation is provided on freehold land. ii) Plant and equipment – five to 25 years (average 13 years). iii) Aircraft and engines – five to 20 years (average 16 years). Operating leases Payments made and rentals received under operating lease arrangements are charged/credited to the income statement on a straight-line basis. Impairment of non-current assets Impairment of non-current assets is considered in accordance with IAS 36 Impairment of Assets. Where the asset does not generate cash flows that are independent of other assets, impairment is considered for the cash-generating unit to which the asset belongs. Goodwill and intangible assets not yet available for use are tested for impairment annually. Other intangible assets, property, plant and equipment and investments are assessed for any indications of impairment annually. If any indication of impairment is identified, an impairment test is performed to estimate the recoverable amount. Recoverable amount is the higher of value in use or fair value less costs to sell, if this is readily available. The value in use is the present value of future cash flows using a pre-tax discount rate that reflects the time value of money and the risk specific to the asset. If the recoverable amount of an asset (or cash-generating unit) is estimated to be below the carrying value, the carrying value is reduced to the recoverable amount and the impairment loss recognised as an expense. Inventories Inventories and work in progress are valued at the lower of cost and net realisable value on a first-in, first-out basis. Cost comprises direct materials and, where applicable, direct labour costs and those overheads, including depreciation of property, plant and equipment, that have been incurred in bringing the inventories to their present location and condition. Net realisable value represents the estimated selling prices less all estimated costs of completion and costs to be incurred in marketing, selling and distribution. Cash and cash equivalents Cash and cash equivalents include cash at bank and in hand, investments in money-market funds and short-term deposits with a maturity of three months or less on inception. The Group considers overdrafts (repayable on demand) to be an integral part of its cash management activities and these are included in cash and cash equivalents for the purposes of the cash flow statement. Provisions Provisions are recognised when the Group has a present obligation as a result of a past event, and it is probable that the Group will be required to settle that obligation. Provisions are measured at the director’s best estimate of the expenditure required to settle the obligation at the balance sheet date, and are discounted to present value where the effect is material. Financial statementsNotes to the consolidated financial statements83 1 Accounting policies (continued) Post-retirement benefits Pensions and similar benefits (principally healthcare) are accounted for under IAS 19 Employee Benefits. For defined benefit plans, obligations are measured at discounted present value whilst plan assets are recorded at fair value. The service and financing costs of such plans are recognised separately in the income statement; current service costs are spread systematically over the lives of employees and financing costs are recognised in the periods in which they arise. Actuarial gains and losses are recognised immediately in the statement of comprehensive income. Surpluses in schemes are recognised as assets only if they represent economic benefits available to the Group in the future. A liability is recognised to the extent that the minimum funding requirements in respect of past service will give rise to an unrecognisable surplus. Movements in unrecognised surpluses and minimum funding liabilities are included in the statement of comprehensive income. Payments to defined contribution schemes are charged as an expense as they fall due. Share-based payments The Group provides share-based payment arrangements to certain employees. These are principally equity-settled arrangements and are measured at fair value (excluding the effect of non-market based vesting conditions) at the date of grant. The fair value is expensed on a straight-line basis over the vesting period. The amount recognised as an expense is adjusted to reflect the actual number of shares or options that will vest, except where additional shares vest as a result of the TSR performance condition in the PSP. Cash-settled share options (grants in the International ShareSave plan) are measured at fair value at the balance sheet date. The Group recognises a liability at the balance sheet date based on these fair values, taking into account the estimated number of options that will actually vest and the relative completion of the vesting period. Changes in the value of this liability are recognised in the income statement for the year. The fair values of the share-based payment arrangements are measured as follows: i) ShareSave plans – using the binomial pricing model; ii) PSP – using a pricing model adjusted to reflect non-entitlement to dividends (or equivalent) and the TSR market-based performance condition; and iii) APRA plan deferred shares – share price on the date of the award. See note 21 for a further description of the share-based payment plans. Contingent liabilities In connection with the sale of its products, the Group will, on occasion, provide financing support for its customers. These arrangements fall into two categories: credit-based guarantees and asset-value guarantees. In accordance with the requirements of IAS 39 and IFRS 4 Insurance Contracts, credit- based guarantees are treated as insurance contracts. The Group considers asset-value guarantees to be non-financial liabilities and accordingly these are also treated as insurance contracts. Provision is made as described above. The Group’s contingent liabilities relating to financing arrangements are spread over many years and relate to a number of customers and a broad product portfolio, and are reported on a discounted basis. Revisions to Adopted IFRS in 2011 There were no revisions to Adopted IFRS that became applicable in 2011 which had a significant impact on the Group’s financial statements. Revisions to IFRS not applicable in 2011 Standards and interpretations issued by the IASB are only applicable if endorsed by the EU. The following may be applicable in the future: • IFRS 9 Financial Instruments will simplify the classification of financial assets for measurement purposes, but is not anticipated to have a significant impact on the financial statements. If endorsed, this will be effective for 2015. • Amendments to IAS 19 Employee Benefits will require the financing on post-retirement benefits to be calculated on the net surplus or deficit using • an ‘AA’ corporate bond rate. This will increase the net post-retirement scheme financing cost. This will be effective for 2013. IFRS 11 Joint Arrangements may result in certain entities currently classified as joint ventures being classified as joint operations. This would result in the Group’s share of the individual assets and liabilities of these entities being included in the financial statements rather than the equity method accounting adopted under the requirements of IAS 31 Interests in Joint Ventures. This will not affect the Group’s net assets or profit for the period. This will be effective for 2013. The Group does not consider that any other standards, amendments or interpretations issued by the IASB, but not yet applicable, will have a significant impact on the financial statements. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements84 2 Segmental analysis The analysis by business segment is presented in accordance with IFRS 8 Operating segments, on the basis of those segments whose operating results are regularly reviewed by the Board (the Chief Operating Decision Maker as defined by IFRS 8), as follows: – development, manufacture, marketing and sales of commercial aero engines and aftermarket services. Civil aerospace Defence aerospace – development, manufacture, marketing and sales of military aero engines and aftermarket services. Marine Energy – development, manufacture, marketing and sales of marine-power propulsion systems and aftermarket services. – development, manufacture, marketing and sales of power systems for the offshore oil and gas industry and electrical power generation and aftermarket services. Technology and operations, discussed in the business review, operate on a Group-wide basis across all the above segments. The equity accounted share of the Engine Holding GmbH business acquired during the year is shown separately. The operating results reviewed by the Board are prepared on an underlying basis, which the Board considers reflects better the economic substance of the Group’s trading during the year. The principles adopted to determine underlying results are: Underlying revenue – Where revenues are denominated in a currency other than the functional currency of the Group undertaking, these reflect the achieved exchange rates arising on settled derivative contracts. There is no inter-segment trading and hence all revenue is from external customers. Underlying profit before financing – Where transactions are denominated in a currency other than the functional currency of the Group undertaking, this reflects the transactions at the achieved exchange rates on settled derivative contracts. In addition, adjustments have also been made to exclude one-off past-service credits on post-retirement schemes and the effect of acquisition accounting. Underlying profit before taxation – In addition to those adjustments in underlying profit before financing: • Includes amounts realised from settled derivative contracts and revaluation of relevant assets and liabilities to exchange rates forecast to be achieved from future settlement of derivative contracts. • Excludes unrealised amounts arising from revaluations required by IAS 39 Financial Instruments: Recognition and Measurement, changes in value of financial RRSP contracts arising from changes in forecast payments and the net impact of financing costs related to post-retirement scheme benefits. Financial statementsNotes to the consolidated financial statements85 2 Segmental analysis (continued) This analysis also includes a reconciliation of the underlying results to those reported in the consolidated income statement. Year ended December 31, 2011 Underlying revenue from sale of original equipment Underlying revenue from aftermarket services Total underlying revenue Underlying operating profit excluding share of results of joint ventures and associates Share of results of joint ventures and associates Profit on disposal of businesses Underlying profit before financing and taxation Civil aerospace £m 2,232 3,340 5,572 384 115 – 499 Defence aerospace £m 1,102 1,133 2,235 367 9 – 376 Segment assets Investments in joint ventures and associates Segment liabilities Net assets Investment in intangible assets, property, plant and equipment and joint ventures and associates Depreciation and amortisation 8,218 403 (5,982) 2,639 620 267 Year ended December 31, 2010 Underlying revenue from sale of original equipment Underlying revenue from aftermarket services Total underlying revenue Underlying operating profit excluding share of results of joint ventures and associates Share of results of joint ventures and associates Profit on disposal of businesses Underlying profit before financing and taxation Segment assets Investments in joint ventures and associates Segment liabilities Net assets Investment in intangible assets, property, plant and equipment and joint ventures and associates Depreciation and amortisation 1,892 3,027 4,919 315 77 – 392 7,790 372 (5,435) 2,727 568 246 1,333 (22) (1,831) (520) 70 48 1,020 1,103 2,123 300 9 – 309 1,359 (15) (1,867) (523) 53 35 Marine £m 1,322 949 2,271 318 2 3 323 2,219 8 (1,544) 683 75 57 1,719 872 2,591 330 2 – 332 2,357 6 (1,548) 815 65 58 Energy £m 602 597 1,199 14 10 – 24 1,243 42 (617) 668 84 38 691 542 1,233 18 5 4 27 1,152 30 (748) 434 16 28 Engine Holding £m 36 – 36 169 1,249 – 1,418 1,317 – Total reportable segments £m 5,258 6,019 11,277 1,083 172 3 1,258 13,182 1,680 (9,974) 4,888 2,166 410 5,322 5,544 10,866 963 93 4 1,060 12,658 393 (9,598) 3,453 702 367 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements86 2 Segmental analysis (continued) Reconciliation to reported results Year ended December 31, 2011 Revenue from sale of original equipment Revenue from aftermarket services Total revenue Operating profit excluding share of results of joint ventures and associates Share of results of joint ventures and associates Profit on disposal of businesses Profit before financing and taxation Net financing Profit before taxation Taxation Profit for the year Year ended December 31, 2010 Revenue from sale of original equipment Revenue from aftermarket services Total revenue Operating profit excluding share of results of joint ventures and associates Share of results of joint ventures and associates Profit on disposal of businesses Profit before financing and taxation Net financing Profit before taxation Taxation Profit for the year 1 Central corporate costs Underlying adjustments Total reportable segments £m 5,258 6,019 11,277 1,083 172 3 1,258 Underlying central items £m – – – (52)1 – – (52) (49) (101) (261) (362) Total underlying £m 5,258 6,019 11,277 1,031 172 3 1,206 (49) 1,157 (261) 896 Underlying adjustments £m (19) (134) (153) 39 (56) – (17) (35) (52) 4 (48) 5,322 5,544 10,866 963 93 4 1,060 – – – (50)1 – – (50) (55) (105) (236) (341) 5,322 5,544 10,866 913 93 4 1,010 (55) 955 (236) 719 112 107 219 124 – – 124 (377) (253) 77 (176) Underlying performance Revenue recognised at exchange rate on date of transaction Realised (gains)/losses on settled derivative contracts 1 Net unrealised fair value changes to derivative contracts 2 Effect of currency on contract accounting Revaluation of trading assets and liabilities Financial RRSPs – foreign exchange differences and changes in forecast payments Effect of acquisition accounting 3 Post-retirement scheme past-service credits 4, 5 Net post-retirement scheme financing Related tax effect Total underlying adjustments Reported per consolidated income statement 2011 2010 Profit before financing £m 1,206 – (116) (5) 4 – – (64) 164 – – (17) 1,189 Net financing £m (49) – 24 (49) – – 2 – – (12) – (35) (84) Revenue £m 11,277 (153) – – – – – – – – – (153) 11,124 Taxation £m (261) – – – – – – – – – 4 4 (257) Profit before financing £m 1,010 – 180 – (56) – – – – – – 124 1,134 Net financing £m (55) – (7) (341) – 8 (6) – – (31) – (377) (432) Revenue £m 10,866 219 – – – – – – – – – 219 11,085 Group £m 5,239 5,885 11,124 1,070 116 3 1,189 (84) 1,105 (257) 848 5,434 5,651 11,085 1,037 93 4 1,134 (432) 702 (159) 543 Taxation £m (236) – – – – – – – – – 77 77 (159) 1 Realised (gains)/losses on settled derivative contracts include adjustments to reflect the (gains)/losses in the same period as the related trading cash flows. 2 Unrealised fair value changes to derivative contracts include those included in equity accounted joint ventures and exclude those for which the related trading contracts have been cancelled when the fair value changes are recognised immediately in underlying profit. 3 The adjustment eliminates charges recognised as a result of recognising assets in acquired businesses at fair value. 4 In 2010, the UK Government announced changes to the basis of the statutory indexation for pension increases. As a result, the relevant arrangements have been amended, resulting in a gain in the income statement of £130m, which has been excluded from underlying profit. 5 The Group has agreed revised post-retirement healthcare arrangements on certain of its overseas schemes. This has resulted in a net gain in the income statement of £34m which has been excluded from underlying profit. The reconciliation of underlying earnings per ordinary share is shown in note 5. Financial statementsNotes to the consolidated financial statements87 2 Segmental analysis (continued) Reportable segment assets Investments in joint ventures and associates Eliminations Cash and cash equivalents and short-term investments Fair value of swaps hedging fixed rate borrowings Income tax assets Post-retirement scheme surpluses Total assets Reportable segment liabilities Eliminations Borrowings Income tax liabilities Post-retirement scheme deficits Total liabilities Net assets Geographical segments The Group’s revenue by destination is shown below: United Kingdom Norway Germany Spain Italy France Russia Rest of Europe USA Canada China South Korea Middle East and South East Asia Rest of Asia Africa Australasia Other 2011 £m 13,182 1,680 (757) 1,321 106 388 503 16,423 (9,974) 757 (1,204) (583) (900) (11,904) 4,519 2011 £m 1,361 374 409 189 183 143 143 547 3,578 301 934 210 1,778 290 261 228 195 11,124 2010 £m 12,658 393 (823) 3,187 198 457 164 16,234 (9,598) 823 (1,852) (608) (1,020) (12,255) 3,979 2010 £m 1,594 486 413 231 187 101 133 830 3,096 299 890 355 1,585 228 109 153 395 11,085 In 2011, revenue (included in all reportable segments) of £1,143m (2010 £1,131m) was received from a single customer. The carrying amounts of the Group’s non-current assets, excluding financial instruments, deferred tax assets and post-employment benefit surpluses, by the geographical area in which the assets are located, are as follows: United Kingdom North America Nordic countries Germany Other 2011 £m 2,980 670 902 1,907 441 6,900 2010 £m 2,925 611 908 625 344 5,413 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements88 3 Net financing Financing income Interest receivable Financial RRSPs – foreign exchange differences and changes in forecast payments Fair value gains on commodity derivatives 2 Expected return on post-retirement scheme assets Net foreign exchange gains Financing costs Interest payable Fair value losses on foreign currency contracts 2 Financial RRSPs – foreign exchange differences and changes in forecast payments Financial charge relating to financial RRSPs Fair value losses on commodity derivatives 2 Interest on post-retirement scheme liabilities Other financing charges Note 17 17 19 17 17 17 17 19 Net financing Analysed as: Net interest payable Net post-retirement scheme financing Net other financing Net financing 1 See note 2 2 Net loss on items held for trading 4 Taxation Current tax Current tax (credit)/charge for the year Less double tax relief Adjustments in respect of prior years Deferred tax Charge/(credit) for the year Adjustments in respect of prior years Credit resulting from reduction in UK tax rate Recognised in the income statement 2011 Per consolidated income statement £m Underlying financing1 £m 2010 Per consolidated income statement £m Underlying financing1 £m 20 2 – 410 24 456 (51) (21) – (11) (28) (422) (7) (540) (84) (31) (12) (41) (84) (49) 20 – – – – 20 (51) – – (11) – – (7) (69) (49) (31) – (18) (49) – 23 – 29 400 1 453 (63) (370) (6) (13) – (431) (2) (885) (432) (40) (31) (361) (432) (341) UK 2011 £m (1) (2) (3) 1 (2) 69 2 (11) 60 58 2010 £m (2) (2) (4) 1 (3) (53) – (3) (56) (59) Overseas 2011 £m 177 – 177 (8) 169 37 (7) – 30 199 2010 £m 174 – 174 2 176 41 1 – 42 218 Total 2011 £m 176 (2) 174 (7) 167 106 (5) (11) 90 257 23 – – – – 23 (63) – – (13) – – (2) (78) (55) (40) – (15) (55) – 2010 £m 172 (2) 170 3 173 (12) 1 (3) (14) 159 Financial statementsNotes to the consolidated financial statements89 4 Taxation (continued) Other tax (charges)/credits Current tax: Share-based payments – direct to equity Deferred tax: Net investment hedge Movements in post-retirement schemes Share-based payments – direct to equity Tax reconciliation Profit before taxation Less share of results of joint ventures and associates (note 10) Profit before taxation excluding joint ventures and associates Nominal tax charge at UK corporation tax rate 26.5% (2010 28.0%) UK R&D credit Rate differences Other permanent differences Benefit to deferred tax from previously unrecognised tax losses and temporary differences Tax losses in year not recognised in deferred tax Adjustments in respect of prior years Reduction in closing deferred taxes resulting from decrease in UK tax rate Underlying items (note 2) Non-underlying items Deferred taxation assets and liabilities At January 1 Amount (charged)/credited to income statement Amount (charged)/credited to other comprehensive income Amount charged to equity Acquisition of businesses Transferred to assets held for sale Exchange differences At December 31 Deferred tax assets Deferred tax liabilities OCI 2011 £m – (1) (53) – (54) 2010 £m – (2) 31 – 29 Equity 2011 £m 6 – – 6 12 2011 £m 1,105 (116) 989 262 (29) 40 8 (1) – (12) (11) 257 261 (4) 257 2011 £m 13 (90) (54) 6 (3) 46 5 (77) 368 (445) (77) 2010 £m – – – 5 5 2010 £m 702 (93) 609 171 (29) 16 2 (5) 3 4 (3) 159 236 (77) 159 2010 £m (6) 14 29 5 (32) – 3 13 451 (438) 13 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements 90 4 Taxation (continued) The analysis of the deferred tax position is as follows: Intangible assets Property, plant and equipment Other temporary differences Amounts recoverable on contracts Pensions and other post-retirement scheme benefits Foreign exchange and commodity financial assets and liabilities Losses Advance corporation tax Intangible assets Property, plant and equipment Other temporary differences Amounts recoverable on contracts Pensions and other post-retirement scheme benefits Foreign exchange and commodity financial assets and liabilities Losses Advance corporation tax At January 1, 2011 £m (282) (150) (64) (229) 263 94 317 64 13 At January 1, 2010 £m (250) (160) (22) (243) 265 54 286 64 (6) Recognised in income statement £m (9) 16 (3) (21) (111) 27 11 – (90) Recognised in income statement £m (19) 10 (25) 14 (39) 40 33 – 14 Recognised in OCI £m – – (1) – (53) – – – (54) Recognised in equity £m – – 6 – – – – – 6 Acquisition of businesses £m – – (3) – – – – – (3) Transferred to assets held for sale £m 46 – – – – – – – 46 Exchange differences £m 2 (1) 4 – – – – – 5 Recognised in OCI £m – – – – 31 – (2) – 29 Recognised in equity £m – – 5 – – – – – 5 Acquisition of businesses £m (11) – (21) – – – – – (32) Transferred to assets held for sale £m – – – – – – – – – At December 31, 2011 £m (243) (135) (61) (250) 99 121 328 64 (77) At December 31, 2010 £m (282) (150) (64) (229) 263 94 317 64 13 2010 £m 118 51 169 Exchange differences £m (2) – (1) – 6 – – – 3 2011 £m 118 41 159 Advance corporation tax Losses and other unrecognised deferred tax assets Deferred tax not recognised on unused tax losses and other items on the basis that future economic benefit is uncertain The 2010 Emergency Budget and the 2011 Budget announced that the UK corporation tax rate will reduce from 28 per cent to 23 per cent over a period of four years from 2011. The reductions to 26 per cent effective from April 1, 2011 and 25 per cent effective from April 1, 2012 were substantively enacted on March 29, 2011 and July 5, 2011 respectively. As the rate change to 25 per cent was substantively enacted prior to the year end, the closing deferred tax assets and liabilities have been calculated at this rate. The resulting charges or credits have been recognised in the income statement except to the extent that they relate to items previously charged or credited to OCI or equity. Accordingly, in 2011, £11m has been credited to the income statement, £5m has been charged to the OCI and £3m has been charged directly to equity. Had the further tax rate changes been substantively enacted on or before the balance sheet date it would have had the effect of reducing the deferred tax asset by £23m and reducing the deferred tax liability by £22m. There are no unrecognised deferred tax liabilities arising on the aggregate temporary differences associated with investments in subsidiaries, branches, associates and joint ventures (2010: £nil). Any withholding tax due on the remittance of future earnings is expected to be insignificant. Financial statementsNotes to the consolidated financial statements91 5 Earnings per ordinary share Basic earnings per ordinary share (EPS) are calculated by dividing the profit attributable to ordinary shareholders by the weighted average number of ordinary shares in issue during the year, excluding ordinary shares held under trust, which have been treated as if they had been cancelled. Diluted EPS are calculated by adjusting the weighted average number of ordinary shares in issue during the year for the bonus element of share options. Profit attributable to ordinary shareholders (£m) Weighted average number of ordinary shares (millions) EPS (pence) The reconciliation between underlying EPS and basic EPS is as follows: Underlying EPS/Underlying profit attributable to ordinary shareholders Total underlying adjustments to profit before tax (note 2) Related tax effects EPS/Profit attributable to ordinary shareholders Diluted underlying EPS 6 Employee information Average number of employees United Kingdom Rest of the world Civil aerospace Defence aerospace Marine Energy Group employment costs 1 Wages and salaries Social security costs Share-based payments (note 21) Pensions and other post-retirement scheme benefits (note 19) 1 Remuneration of key management personnel is shown in note 24. 2011 Potentially dilutive share options 25 (0.62) Basic 850 1,850 45.95 2010 Potentially dilutive share options 24 (0.38) Diluted 850 1,875 45.33 Basic 539 1,846 29.20 2011 2010 Pence 48.54 (2.81) 0.22 45.95 47.89 £m 898 (52) 4 850 Pence 38.73 (13.70) 4.17 29.20 38.24 2011 Number 21,600 18,800 40,400 20,600 6,800 9,400 3,600 40,400 £m 2,037 245 59 23 2,364 Diluted 539 1,870 28.82 £m 715 (253) 77 539 2010 Number 21,000 17,900 38,900 19,500 6,900 9,000 3,500 38,900 £m 1,847 212 50 221 2,330 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements92 7 Auditor’s remuneration Fees payable to the Company’s auditors and its associates were as follows: Fees payable to the Company’s auditors for the audit of the Company’s annual financial statements 1 Fees payable to the Company’s auditors and its associates for the audit of the Company’s subsidiaries pursuant to legislation Total fees payable for audit services Fees payable to the Company’s auditors and its associates for other services: Other services pursuant to legislation Other services relating to taxation All other services Fees payable in respect of the Group’s pension schemes: Audit Other services relating to taxation 2011 £m 0.2 4.3 4.5 1.0 0.5 0.2 6.2 0.2 – 2010 £m 0.1 4.3 4.4 0.5 0.5 – 5.4 0.2 0.1 1 The level of fees payable to the Company’s auditors for the audit of the Company’s annual financial statements reflects the fact that limited incremental work is required in respect of the audit of these financial statements. Rolls-Royce plc, a subsidiary of the Company, is also required to prepare consolidated financial statements and the fees payable to the Company’s auditors for the audit of those financial statements, including the audit of the sub-consolidation, is included in the audit of the Company’s subsidiaries pursuant to legislation. 8 Intangible assets Cost: At January 1, 2010 Exchange differences Additions Acquisitions of businesses Disposals At January 1, 2011 Exchange differences Additions Acquisitions of businesses Transferred to assets held for sale Disposals At December 31, 2011 Accumulated amortisation: At January 1, 2010 Charge for the year 1 Disposals At January 1, 2011 Charge for the year 1 Transferred to assets held for sale Disposals At December 31, 2011 Net book value: At December 31, 2011 At December 31, 2010 At January 1, 2010 Certification costs and participation fees £m Goodwill £m Development expenditure £m Recoverable engine costs £m Software and other £m 991 6 – 118 – 1,115 (20) – 11 – – 1,106 7 – – 7 – – – 7 1,099 1,108 984 631 (2) 57 – – 686 (2) 44 – – (8) 720 177 13 – 190 15 – (8) 197 523 496 454 751 – 111 – – 862 (1) 93 – – – 954 205 27 – 232 36 – – 268 686 630 546 586 – 111 – – 697 – 135 – (368) – 464 296 55 – 351 62 (182) – 231 233 346 290 273 (1) 46 96 (1) 413 (2) 95 8 – (24) 490 75 35 (1) 109 56 – (16) 149 341 304 198 Total £m 3,232 3 325 214 (1) 3,773 (25) 367 19 (368) (32) 3,734 760 130 (1) 889 169 (182) (24) 852 2,882 2,884 2,472 1 Charged to cost of sales except development costs, which are charged to research and development costs. Financial statementsNotes to the consolidated financial statements93 8 Intangible assets (continued) Goodwill In accordance with the requirements of IAS 36 Impairment of Assets, goodwill is allocated to the Group’s cash-generating units (CGUs), or groups of CGUs, that are expected to benefit from the synergies of the business combination that gave rise to the goodwill as follows: CGU or group of CGUs Rolls-Royce Deutschland Ltd & Co KG Commercial marine – arising from the acquisitions of Vinters plc and Scandinavian Electric Holding AS Commercial marine – arising from the acquisition of ODIM ASA Other Primary reporting segment Civil aerospace Marine Marine Various 2011 £m 230 645 112 112 1,099 2010 £m 236 657 114 101 1,108 Goodwill has been tested for impairment during 2011 on the following basis: • The carrying value of goodwill has been assessed by reference to value in use. These have been estimated using cash flows from the most recent forecasts prepared by management, which are consistent with past experience and external sources of information on market conditions. Given the long-term and established nature of many of the Group’s products (product lives are often measured in decades), these forecast the next ten years. Growth rates for the period not covered by the forecasts are based on a range of growth rates (2.0-2.5 per cent) that reflect the products, industries and countries in which the relevant CGU or group of CGUs operate. • The key assumptions for the impairment tests are the discount rate and, in the cash flow projections, the programme assumptions, the growth rates and the impact of foreign exchange rates on the relationship between selling prices and costs. Impairment tests are performed using prevailing exchange rates. • The pre-tax cash flow projections have been discounted at 13 per cent (2010 13 per cent), based on the Group’s weighted average cost of capital. The principal value in use assumptions for goodwill balances considered to be individually significant are: • Rolls-Royce Deutschland Ltd & Co KG – Volume of engine deliveries, flying hours of installed fleet and cost escalation, these are based on current and known future programmes, estimates of customers’ fleet requirements and long-term economic forecasts. The principal foreign exchange exposure is on translating US dollar income into euros. For the purposes of the impairment test only, cash flows beyond the ten-year forecasts are assumed to grow at 2.5 per cent (2010 2.5 per cent). The directors do not consider that any reasonably possible change in the key assumptions would cause the value in use of the goodwill to fall below its carrying value. The overall level of business would need to reduce by more than 75 per cent to cause an impairment of this balance. • Vinters plc – Volume of equipment deliveries, capture of aftermarket and cost escalation, these are based on current and known future programmes, estimates of customers’ fleet requirements and long-term economic forecasts. The principal foreign exchange exposures are on translating income in a variety of non-functional currencies into Norwegian kroner. For the purposes of the impairment test only, cash flows beyond the ten-year forecasts are assumed to grow at 2.5 per cent (2010 two per cent). The directors do not consider that any reasonably possible change in the key assumptions would cause the value in use of the goodwill to fall below its carrying value. The overall level of business would need to reduce by more than 80 per cent to cause an impairment of this balance. Other intangible assets Certification costs and participation fees, development costs and recoverable engine costs have been reviewed for impairment in accordance with the requirements of IAS 36 Impairment of Assets. Where an impairment test was considered necessary, it has been performed on the following basis: • The carrying values have been assessed by reference to value in use. These have been estimated using cash flows from the most recent forecasts prepared by management, which are consistent with past experience and external sources of information on market conditions over the lives of the respective programmes. • The key assumptions underlying cash flow projections are assumed market share, programme timings, unit cost assumptions, discount rates, and foreign exchange rates. • The pre-tax cash flow projections have been discounted at 11 per cent (2010 11 per cent), based on the Group’s weighted average cost of capital. • No impairment is required on this basis. However, a combination of changes in assumptions and adverse movements in variables that are outside the Group’s control (discount rate, exchange rate and airframe delays), could result in impairment in future years. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements94 9 Property, plant and equipment Land and buildings £m Plant and equipment £m Aircraft and engines £m In course of construction £m Cost: At January 1, 2010 Exchange differences Additions Acquisitions of businesses Reclassifications Disposals/write-offs At January 1, 2011 Exchange differences Additions Acquisitions of businesses Reclassifications Transferred from/(to) assets held for sale Disposals/write-offs At December 31, 2011 Accumulated depreciation: At January 1, 2010 Exchange differences Charge for the year 1 Disposals/write-offs At January 1, 2011 Exchange differences Charge for the year 1 Impairment Reclassifications Transferred from/(to) assets held for sale Disposals/write-offs At December 31, 2011 Net book value: At December 31, 2011 At December 31, 2010 At January 1, 2010 806 6 11 17 41 (4) 877 (4) 17 – 78 15 (2) 981 231 4 37 (1) 271 (2) 39 – 3 6 (2) 315 666 606 575 2,387 16 94 7 108 (74) 2,538 (13) 80 2 123 – (84) 2,646 1,358 11 190 (62) 1,497 (7) 185 – (3) – (74) 1,598 1,048 1,041 1,029 163 – 35 – 5 (14) 189 – 52 – 5 (13) (17) 216 34 – 10 (2) 42 – 15 – – (7) (6) 44 172 147 129 1 Depreciation charged during the year is presented in the income statement or included in the cost of inventory as appropriate. Property, plant and equipment includes: Net book value of finance leased assets: Land and buildings Plant and equipment Assets held for use in operating leases: Cost Depreciation Net book value Capital expenditure commitments Cost of fully depreciated assets The group’s share of equity accounted entities’ capital commitments is £25m (2010 £24m). 276 1 221 – (154) (2) 342 1 318 – (206) – (1) 454 – – – – – – – 2 – – – 2 452 342 276 2011 £m 7 5 235 (60) 175 196 655 Total £m 3,632 23 361 24 – (94) 3,946 (16) 467 2 – 2 (104) 4,297 1,623 15 237 (65) 1,810 (9) 239 2 – (1) (82) 1,959 2,338 2,136 2,009 2010 £m 8 5 159 (35) 124 215 584 Financial statementsNotes to the consolidated financial statements95 10 Investments At January 1, 2010 Exchange differences Additions Taxation paid by the Group Impairment Share of retained profit Transferred to subsidiary Disposals Share of OCI of joint ventures and associates At January 1, 2011 Exchange differences Additions 1 Taxation paid by the Group Share of retained profit Transferred to assets held for sale Disposals Share of OCI of joint ventures and associates At December 31, 2011 Joint ventures £m 363 4 16 3 (1) 24 – – (16) 393 (62) 1,329 3 40 (13) – (10) 1,680 Associates £m 74 2 – – – 1 (77) – – – – – – – – – – – Total equity accounted £m 437 6 16 3 (1) 25 (77) – (16) 393 (62) 1,329 3 40 (13) – (10) 1,680 Other – unlisted £m 58 – 1 – (2) – – (46) – 11 – – – – – (1) – 10 1 On August 25, 2011, Rolls-Royce and Daimler AG (Daimler) received all the relevant regulatory approvals for the acquisition of Tognum AG (Tognum). The public tender offer by Engine Holding GmbH (Engine Holding – the jointly held acquisition vehicle) was concluded in September 2011. At December 31, 2011, Engine Holding held 99 per cent of the Tognum shares, giving the Group an effective interest of 49.5 per cent. The results for the four month period from September 2011 have been included, after taking account of acquisition fair value adjustments. Subject to certain conditions being fulfilled, the Group has the option to exercise rights that would result in Engine Holding being classified as a subsidiary and consolidated. It is anticipated that these conditions will be fulfilled during 2012. As part of the Engine Holding shareholders’ agreement, Daimler has the option to sell, for a specified period at a specified price, its shares in Engine Holding to Rolls-Royce. The value of this option was not significant at December 31, 2011. The summarised aggregated financial information of the Group’s share of equity accounting investments is as follows: Assets: Non-current assets Current assets Liabilities: 2 Current liabilities Non-current liabilities 2 Liabilities include borrowings of: Revenue Profit before financing and taxation Net financing Taxation Results recognised in the consolidated income statement Dividends received Retained profit Engine Holding 1,687 818 (477) (779) 1,249 (176) 491 (13) (12) 10 (15) – (15) Joint ventures Other 1,529 891 (793) (1,196) 431 (1,176) 3,055 165 (19) (15) 131 (76) 55 2011 £m 3,216 1,709 (1,270) (1,975) 1,680 (1,352) 3,546 152 (31) (5) 116 (76) 40 2010 £m 1,405 1,161 (1,151) (1,022) 393 (1,043) 2,914 128 (19) (17) 92 (68) 24 Associates 2011 £m 2010 £m Total 2011 £m – – – – – – – – – – – – – – – – – – – 26 1 – – 1 – 1 3,216 1,709 (1,270) (1,975) 1,680 (1,352) 3,546 152 (31) (5) 116 (76) 40 2010 £m 1,405 1,161 (1,151) (1,022) 393 (1,043) 2,940 129 (19) (17) 93 (68) 25 The principal joint ventures and associates at December 31, 2011 are listed on pages 123 and 124. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements 96 11 Inventories Raw materials Work in progress Long-term contracts work in progress Finished goods Payments on account Inventories stated at net realisable value Amount of inventory write-down Reversal of inventory write-down 12 Trade and other receivables Trade receivables Amounts recoverable on contracts 1 Amounts owed by joint ventures and associates Loan to Engine Holding GmbH Other receivables Prepayments and accrued income Analysed as: Financial instruments (note 17): Trade receivables and similar items Other non-derivative financial assets Non-financial instruments Trade and other receivables expected to be recovered in more than one year: Trade receivables Amounts recoverable on contracts Amounts owed by joint ventures and associates Other receivables Prepayments and accrued income 2011 £m 319 921 12 1,267 42 2,561 169 114 3 2011 £m 1,123 1,665 421 169 475 156 4,009 1,655 550 1,804 4,009 4 1,314 20 60 28 1,426 2010 £m 377 943 42 1,024 43 2,429 202 135 2 2010 £m 1,210 1,580 518 – 449 186 3,943 1,801 419 1,723 3,943 7 1,176 5 56 27 1,271 1 The balance at December 31, 2011 includes an allowance of £63m (2010 £55m), being the directors’ best estimate of the loss that will occur from the Group’s contract with EPI Europrop International GmbH to participate in the development of the TP400 engine for the Airbus A400M military transport aircraft. Financial statementsNotes to the consolidated financial statements97 13 Cash and cash equivalents Cash at bank and in hand Money-market funds Short-term deposits Overdrafts (note 15) Cash and cash equivalents per cash flow statement (page 74) Cash held as collateral against third party obligations (note 23) 14 Assets held for sale Intangible assets – Recoverable engine costs Property, plant and equipment Investment in joint venture Amounts recoverable on contracts Amounts owed by joint ventures Assets held for sale Accruals and deferred income Other payables Provisions for liabilities and charges Deferred tax liabilities Liabilities associated with assets held for sale 2011 £m 1,285 11 14 1,310 (19) 1,291 67 2011 £m 186 6 13 59 49 313 (54) (26) (9) (46) (135) 2010 £m 1,266 381 1,212 2,859 (8) 2,851 68 2010 £m – 9 – – – 9 – – – – – On October 12, 2011, the Group announced an agreement to form a new partnership with Pratt & Whitney, a United Technologies Corporation company, to develop new engines for the next generation of mid-size aircraft (120-230 seats). As part of this agreement, the Group and Pratt & Whitney will restructure their participation in IAE, which produces the V2500 engine for the Airbus A320 family of aircraft. Under the terms of the agreement, which is subject to regulatory approvals, Rolls-Royce will sell its equity, programme share and related goodwill in IAE to Pratt & Whitney for US$1.5 billion. The assets and liabilities shown above are those, included in the civil aerospace segment, that will be derecognised on the completion of the transaction. However, as Rolls-Royce will continue to be responsible for the manufacture of high-pressure compressors, fan blades as well as the provision of engine support and final assembly of 50 per cent of V2500 engines, the transaction is not considered to give rise to a discontinued operation. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements98 15 Borrowings Unsecured Overdrafts Bank loans 73/8% Notes 2016 £200m 6.38% Notes 2013 US$230m 1 6.55% Notes 2015 US$83m 1 41/2% Notes 2011 €750m 2 6.75% Notes 2019 £500m Secured Obligations under finance leases: 3 Current 2011 £m 19 1 – – – – – – 20 2010 £m 8 67 – – – 642 – – 717 Non-current 2011 £m – 204 200 160 62 – 557 1 1,184 2010 £m – 206 200 162 60 – 506 1 1,135 Total 2011 £m 19 205 200 160 62 – 557 1 1,204 2010 £m 8 273 200 162 60 642 506 1 1,852 1 These notes are the subject of interest rate swap agreements under which the Group has undertaken to pay floating rates of interest, and currency swaps which form a fair value hedge. 2 These notes are the subject of swap agreements under which counterparties have undertaken to pay amounts at fixed rates of interest and exchange in consideration for amounts payable at variable rates of interest and at fixed exchange rates. 3 Obligations under finance leases are secured by related leased assets. 16 Trade and other payables Payments received on account 1 Trade payables Amounts owed to joint ventures and associates Other taxation and social security Other payables Accruals and deferred income 1 Includes payments received on account from joint ventures and associates Current 2011 £m 1,396 1,028 215 88 1,623 1,886 6,236 358 2010 £m 1,560 891 267 81 1,294 1,817 5,910 258 Non-current 2011 £m 487 – 1 – 58 768 1,314 147 2010 £m 475 – 7 – 94 695 1,271 243 Included within trade and other payables are government grants of £104m (2010 £44m). During the year, £2m (2010 £2m) of government grants were released to the income statement. Trade and other payables are analysed as follows: Financial instruments (note 17): Trade payables and similar items Other non-derivative financial liabilities Non-financial instruments 2011 £m 2,356 718 4,476 7,550 2010 £m 2,212 521 4,448 7,181 Financial statementsNotes to the consolidated financial statements99 17 Financial instruments Carrying values and fair values of financial instruments At December 31, 2011 Unlisted non-current asset investments Trade receivables and similar items Other non-derivative financial assets Derivative financial assets Short-term investments Cash and cash equivalents Borrowings Derivative financial liabilities Financial RRSPs C Shares Trade payables and similar items Other non-derivative financial liabilities At December 31, 2010 Unlisted non-current asset investments Trade receivables and similar items Other non-derivative financial assets Derivative financial assets Short-term investments Cash and cash equivalents Borrowings Derivative financial liabilities Financial RRSPs C Shares Trade payables and similar items Other non-derivative financial liabilities Assets Liabilities Basis for determining fair value Notes Held for trading £m Loans and receivables £m Available for sale £m 10 12 12 13 15 16 16 10 12 12 13 15 16 16 A B B C B B D C D B B B A B B C B B D C D B B B – – – 418 – – – – – – – – 418 – – – 621 – – – – – – – – 621 10 1,655 550 – 11 14 – – – – – – 2,240 11 1,801 419 – 328 1,212 – – – – – – 3,771 – – – – – 11 – – – – – – 11 – – – – – 381 – – – – – – 381 Cash £m – – – – – 1,285 – – – – – – 1,285 – – – – – 1,266 – – – – – – 1,266 Held for trading £m – – – – – – – (796) – – – – (796) – – – – – – – (761) – – – – (761) Other £m – – – – – – (1,204) – (230) (4) (2,356) (718) (4,512) – – – – – – (1,852) – (266) (23) (2,212) (521) (4,874) Total £m 10 1,655 550 418 11 1,310 (1,204) (796) (230) (4) (2,356) (718) (1,354) 11 1,801 419 621 328 2,859 (1,852) (761) (266) (23) (2,212) (521) 404 Fair values equate to book values for both 2011 and 2010, with the following exceptions: Borrowings Financial RRSPs 2011 Book value £m (1,204) (230) Fair value £m (1,371) (254) 2010 Book value £m (1,852) (266) Fair value £m (1,963) (296) The fair value of a financial instrument is the price at which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction. Fair values have been determined with reference to available market information at the balance sheet date, using the methodologies described below. A These primarily comprise floating rate convertible loan stock. The conversion conditions are such that fair value approximates to the book value. B Fair values are assumed to approximate to cost either due to the short-term maturity of the instruments or because the interest rate of the investments is reset after periods not exceeding six months. C Fair values of derivative financial assets and liabilities are estimated by discounting expected future contractual cash flows using prevailing interest rate curves. Amounts denominated in foreign currencies are valued at the exchange rate prevailing at the balance sheet date. These financial instruments are included on the balance sheet at fair value, derived from observable market prices (Level 2 as defined by IFRS 7 Financial Instruments: Disclosures). D Borrowing and financial RRSPs are carried at amortised cost. Fair values are estimated by discounting expected future contractual cash flows using prevailing interest rate curves. Amounts denominated in foreign currencies are valued at the exchange rate prevailing at the balance sheet date. For financial RRSPs, the contractual cash flows are based on future trading activity, which is estimated based on latest forecasts. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements100 17 Financial instruments (continued) Carrying values of other financial assets and liabilities At December 31, 2011 Non-current assets Current assets Current liabilities Non-current liabilities At December 31, 2010 Non-current assets Current assets Current liabilities Non-current liabilities Foreign exchange contracts £m Commodity contracts £m Interest rate contracts £m Total derivatives £m Financial RRSPS £m C Shares £m Total £m 237 84 321 (85) (683) (768) (447) 317 98 415 (38) (713) (751) (336) 7 7 14 (7) (19) (26) (12) 18 10 28 (5) (2) (7) 21 83 – 83 – (2) (2) 81 36 142 178 – (3) (3) 175 327 91 418 (92) (704) (796) (378) 371 250 621 (43) (718) (761) (140) – – – (15) (215) (230) (230) – – – (39) (227) (266) (266) – – – (4) – (4) (4) – – – (23) – (23) (23) 327 91 418 (111) (919) (1,030) (612) 371 250 621 (105) (945) (1,050) (429) Derivative financial instruments The Group uses various financial instruments to manage its exposure to movements in foreign exchange rates. Where the effectiveness of a hedging relationship in a cash flow hedge is demonstrated, changes in the fair value that are deemed effective are included in the cash flow hedge reserve and released to match actual payments on the hedged item. The Group uses commodity swaps to manage its exposure to movements in the price of commodities (jet fuel and base metals). To hedge the currency risk associated with a borrowing denominated in US dollars, the Group has currency derivatives designated as part of fair value hedges. The Group uses interest rate swaps, forward rate agreements and interest rate caps to manage its exposure to movements in interest rates. Movements in the fair values of derivative financial assets and liabilities were as follows: At January 1, 2010 Movements in fair value hedges 1 Movements in other derivative contracts 2 Contracts settled 3 At January 1, 2011 Movements in fair value hedges 1 Movements in cash flow hedges Movements in other derivative contracts 2 Contracts settled 3 At December 31, 2011 1 Loss on related hedged items £85m (2010 £14m net gain). 2 Included in financing. 3 Includes contracts settled in fair value hedges £1m loss (2010 £10m gain). Foreign exchange instruments £m (144) 7 (370) 171 (336) 2 (1) (21) (91) (447) Commodity instruments £m (11) – 29 3 21 – – (28) (5) (12) Interest rate instruments £m 199 (21) (1) (2) 175 83 – 1 (178) 81 Total £m 44 (14) (342) 172 (140) 85 (1) (48) (274) (378) Financial statementsNotes to the consolidated financial statements101 17 Financial instruments (continued) Financial risk and revenue sharing partnerships (RRSPs) The Group has financial liabilities arising from financial RRSPs. These financial liabilities are valued at each reporting date using the amortised cost method. This involves calculating the present value of the forecast cash flows of the arrangements using the internal rate of return at the inception of the arrangements as the discount rate. Movements in the amortised cost values of financial RRSPs were as follows: At January 1 Cash paid to partners Exchange adjustments included in OCI Financing charge 1 Excluded from underlying profit: Exchange adjustments 1 Changes in forecast payments 1 At December 31 1 Included in financing. 2011 £m (266) 46 (1) (11) 1 1 (230) 2010 £m (363) 114 2 (13) (6) – (266) Risk management policies and hedging activities The principal financial risks to which the Group is exposed are: foreign currency exchange rate risk; liquidity risk; credit risk; interest rate risk; and commodity price risk. The Board has approved policies for the management of these risks. Foreign currency exchange rate risk – The Group has significant cash flows (most significantly US dollars, followed by the euro) denominated in currencies other than the functional currency of the relevant trading entity. To manage its exposures to changes in values of future foreign currency cash flows, so as to maintain relatively stable long-term foreign exchange rates on settled transactions, the Group enters into derivative forward foreign currency transactions. For accounting purposes, these derivative contracts are not designated as hedging instruments. The Group also has exposures to the fair values of non-derivative financial instruments denominated in foreign currencies. To manage the risk of changes in these fair values, the Group enters into derivative forward foreign exchange contracts, which are designated as fair value hedges for accounting purposes. The Group regards its interests in overseas subsidiary companies as long-term investments. The Group aims to match its translational exposures by matching the currencies of assets and liabilities. Where appropriate, foreign currency financial liabilities may be designated as hedges of the net investment. Liquidity risk – The Group’s policy is to hold financial investments and maintain undrawn committed facilities at a level sufficient to ensure that the Group has available funds to meet its medium-term capital and funding obligations and to meet any unforeseen obligations and opportunities. The Group holds cash and short-term investments, which together with the undrawn committed facilities, enable the Group to manage its liquidity risk. The profile of the maturity of the Group’s committed facilities is discussed in additional financial information on page 36. Credit risk – The Group is exposed to credit risk to the extent of non-payment by either its customers or the counterparties of its financial instruments. The effective monitoring and controlling of credit risk is a key component of the Group’s risk management activities. The Group has credit policies covering both trading and financial exposures. Credit risks arising from treasury activities are managed by a central treasury function in accordance with the Group credit policy. The objective of the policy is to diversify and minimise the Group’s exposure to credit risk from its treasury activities by ensuring the Group transacts strictly with ‘BBB+’ or higher rated financial institutions based on pre-established limits per financial institution. At the balance sheet date, there were no significant concentrations of credit risk to individual customers or counterparties. The maximum exposure to credit risk at the balance sheet date is represented by the carrying value of each financial asset, including derivative financial instruments. Interest rate risk – The Group’s interest rate risk is primarily in relation to its fixed rate borrowings (fair value risk), floating rate borrowings and cash and cash equivalents (cash flow risk). Interest rate derivatives are used to manage the overall interest rate profile within the Group policy, which is to maintain a higher proportion of net debt at floating rates of interest as a natural hedge to the net cash position. These are designated as either fair value or cash flow hedges as appropriate. Commodity risk – The Group has exposures to the price of jet fuel and base metals arising from business operations. To minimise its cash flow exposures to changes in commodity prices, the Group enters into derivative commodity transactions. For accounting purposes, these derivative contracts are not designated as hedging instruments. Other price risk – The Group’s cash equivalent balances represent investments in money market instruments, with a term of up to three months. The Group does not consider that these are subject to significant price risk. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements102 17 Financial instruments (continued) Derivative financial instruments The nominal amounts, analysed by year of expected maturity, and fair values of derivative financial instruments are as follows: At December 31, 2011 Foreign exchange contracts: Fair value hedges Non-hedge accounted Interest rate contracts: Fair value hedges Non-hedge accounted Commodity contracts: Non-hedge accounted At December 31, 2010 Foreign exchange contracts: Fair value hedges Non-hedge accounted Interest rate contracts: Fair value hedges Non-hedge accounted Commodity contracts: Non-hedge accounted Expected maturity Between one and two years £m Within one year £m Between two and five years £m After five years £m Nominal amount £m Fair value Assets £m Liabilities £m 175 17,563 – 5,438 129 3,625 46 7,568 701 43 – – 148 – 53 43 – 932 500 – 220 18,702 68 5,506 59 3,961 93 7,803 – 1,432 175 15,561 1,200 46 138 17,120 – 3,806 500 – 60 4,366 – 3,285 – – 43 3,328 175 7,427 200 46 35 7,883 – 1,043 500 – – 1,543 23 298 83 – 14 418 20 395 178 – 28 621 – (768) – (2) (26) (796) – (751) – (3) (7) (761) As described above, all derivative financial instruments are entered into for risk management purposes, although these may not be designated into hedging relationships for accounting purposes. Currency analysis Derivative financial instruments related to foreign exchange risks are denominated in the following currencies: At December 31, 2011 Currencies sold forward: Sterling US dollar Euro Other At December 31, 2010 Currencies sold forward: Sterling US dollar Euro Other Currencies purchased forward Sterling £m US dollar £m – 14,401 – 36 – 13,195 – 76 814 – – 26 175 – – 35 Euro £m – 1,193 – 67 – 1,161 – 106 Other £m Total £m 147 834 197 23 35 642 285 26 961 16,428 197 152 210 14,998 285 243 Financial statementsNotes to the consolidated financial statements103 17 Financial instruments (continued) Other derivative financial instruments are denominated in the following currencies: Sterling US dollar Euro Other Non-derivative financial instruments Non-derivative financial instruments are denominated in the following currencies: Sterling £m US dollar £m At December 31, 2011 Assets Unlisted non-current investments Trade receivables and similar items Other non-derivative financial assets Short-term investments Cash and cash equivalents Liabilities Borrowings Financial RRSPs C Shares Trade payables and similar items Other non-derivative financial liabilities At December 31, 2010 Assets Unlisted non-current investments Trade receivables and similar items Other non-derivative financial assets Short-term investments Cash and cash equivalents Liabilities Borrowings Financial RRSPs C Shares Trade payables and similar items Other non-derivative financial liabilities 1 204 112 5 50 372 (977) – (4) (1,095) (252) (2,328) (1,956) 1 312 155 325 1,299 2,092 (972) – (23) (1,040) (211) (2,246) (154) – 1,201 87 – 657 1,945 (222) (173) – (812) (308) (1,515) 430 – 1,120 46 – 634 1,800 (222) (208) – (705) (166) (1,301) 499 2011 £m 510 421 – 33 2010 £m 514 337 500 33 Other £m Total £m 5 117 134 6 236 498 – – – (174) (140) (314) 184 6 159 178 3 453 799 (2) – – (248) (109) (359) 440 10 1,655 550 11 1,310 3,536 (1,204) (230) (4) (2,356) (718) (4,512) (976) 11 1,801 419 328 2,859 5,418 (1,852) (266) (23) (2,212) (521) (4,874) 544 Euro £m 4 133 217 – 367 721 (5) (57) – (275) (18) (355) 366 4 210 40 – 473 727 (656) (58) – (219) (35) (968) (241) Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements104 17 Financial instruments (continued) Currency exposures The Group’s actual currency exposures after taking account of derivative foreign currency contracts, which are not designated as hedging instruments for accounting purposes are as follows: Functional currency of Group operation At December 31, 2011 Sterling US dollar Euro Other At December 31, 2010 Sterling US dollar Euro Other Ageing beyond contractual due date The ageing beyond contractual due date of the Group’s financial assets is: At December 31, 2011 Unlisted non-current asset investments Trade receivables and similar items Other non-derivative financial assets Derivative financial assets Short-term investments Cash and cash equivalents At December 31, 2010 Unlisted non-current asset investments Trade receivables and similar items Other non-derivative financial assets Derivative financial assets Short-term investments Cash and cash equivalents Sterling £m US dollar £m Euro £m Other £m Total £m – 3 (1) 1 – 1 – 1 Within terms £m 10 1,377 532 418 11 1,310 3,658 11 1,505 396 621 328 2,859 5,720 1 – (1) 4 3 – (1) – – (2) – 1 1 (1) – 1 3 10 – 3 1 16 (1) 2 Up to three months overdue £m Between three months and one year overdue £m More than one year overdue £m – 184 15 – – – 199 – 180 19 – – – 199 – 68 – – – – 68 – 86 1 – – – 87 – 26 3 – – – 29 – 30 3 – – – 33 4 11 (2) 9 5 16 (2) 4 Total £m 10 1,655 550 418 11 1,310 3,954 11 1,801 419 621 328 2,859 6,039 Financial statementsNotes to the consolidated financial statements105 17 Financial instruments (continued) Contractual maturity analysis of financial liabilities At December 31, 2011 Borrowings Derivative financial liabilities Financial RRSPs C Shares Trade payables and similar items Other non-derivative financial liabilities At December 31, 2010 Borrowings Derivative financial liabilities Financial RRSPs C Shares Trade payables and similar items Other non-derivative financial liabilities Within one year £m (85) (92) (37) (4) (2,353) (715) (3,286) (812) (43) (47) (23) (2,199) (516) (3,640) Gross values Between one and two years £m Between two and five years £m After five years £m Discounting £m Carrying values £m (213) (199) (37) – (1) (2) (452) (68) (110) (39) – (7) (3) (227) (608) (419) (91) – (1) – (1,119) (575) (525) (110) – (4) (1) (1,215) (603) (48) (127) – (1) (1) (780) (887) (8) (152) – (2) (1) (1,050) 305 (38) 62 – – – 329 490 (75) 82 – – – 497 (1,204) (796) (230) (4) (2,356) (718) (5,308) (1,852) (761) (266) (23) (2,212) (521) (5,635) Interest rate risk In respect of income earning financial assets and interest bearing financial liabilities, the following table indicates their effective interest rates and the periods in which they reprice. The value shown is the carrying amount. Short-term investments 1 Cash and cash equivalents 2 Unsecured bank loans €2m floating rate loan €5m floating rate loan Overdrafts 3 Interest rate swaps £200m floating rate loan Unsecured bond issues 73/8% Notes 2016 £200m 6.38% Notes 2013 US$230m Effect of interest rate swaps 6.55% Notes 2015 US$83m Effect of interest rate swaps 6.75% Notes 2019 £500m Effect of interest rate swaps Other secured Obligations under finance leases Effective interest rate % 4.3782% 0.5000% EURIBOR +0.75 10.8775% GBP LIBOR + 0.267 7.3750% 6.3800% USD LIBOR + 1.26 6.5500% USD LIBOR + 1.24 6.7500% GBP LIBOR + 2.9824 5.0000% 2011 Period in which interest rate reprices 6 months or less £m 9 1,310 6-12 months £m 2 – 1-2 years £m – – 2-5 years £m – – More than 5 years £m – – – (3) (19) 10 (200) – – (160) – (62) – (557) – 328 – – – – – – – – – – – – – 2 – – – – – – (160) 160 – – – – – – – – – (10) – (200) – – (62) 62 – – – (210) (2) – – – – – – – – – (557) 557 (1) (3) Total £m 11 1,310 (2) (3) (19) – (200) (200) (160) – (62) – (557) – (1) 117 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements107 17 Financial instruments (continued) Sensitivity analysis The Group is exposed to a number of foreign currencies. The most significant transactional currency exposures are US dollar with sterling and US dollar with euro. At December 31, 2011 if sterling had weakened ten per cent against the US dollar with all other variables held constant, profit after tax for the year and equity would have been £1,083m lower (2010 £989m). If sterling had strengthened ten per cent against the US dollar with all other variables held constant, profit after tax for the year and equity would have been £886m higher (2010 £809m). There would have been no change to the underlying results that exclude unrealised gains and losses on foreign exchange derivatives. At December 31, 2011 if the euro had weakened ten per cent against the US dollar with all other variables held constant, profit after tax and equity for the year would have been £93m lower (2010 £82m). If the euro had strengthened ten per cent against the US dollar with all other variables held constant, profit after tax for the year and equity would have been £78m higher (2010 £66m). There would have been no change to the underlying results that exclude unrealised gains and losses on foreign exchange derivatives. At December 31, 2011 if the price of commodities had been ten per cent lower, with all other variables remaining constant, profit after tax for the year and equity would have been £15m lower (2010 £11m). If the price of commodities had been ten per cent higher, with all other variables remaining constant, profit after tax and equity would have been £15m higher (2010 £11m). There would have been no change to the underlying results that exclude unrealised gains and losses on commodity derivatives. At December 31, 2011 the Group had no material sensitivity to changes in interest rates on that date. The main interest rate sensitivity for the Group arises as a result of the gross up of net cash and this is mitigated as described under the interest rate risk management policies on page 101. C Shares and payments to shareholders The Company (and Rolls-Royce Group plc, the previous holding company) issues non-cumulative redeemable preference shares (C Shares) as an alternative to paying a cash dividend. C Shares in respect of a year are issued in the following year. Shareholders are able to redeem any number of their C Shares for cash. Any C Shares retained attract a dividend of 75 per cent of LIBOR on the 0.1p nominal value of each share, paid on a twice-yearly basis, and have limited voting rights. In certain circumstances the Company has the option to compulsorily redeem the C Shares, at any time, if the aggregate number of C Shares in issue is less than ten per cent of the aggregate number of C Shares issued, or on the acquisition or capital restructuring of the Company. As part of the scheme of arrangement described on page 76, all outstanding C Shares were compulsiorly redeemed on April 6, 2011. Movements in the C Shares during the year were as follows: Issued and fully paid At January 1 Issued Redeemed Held in employee share trust At December 31 2011 Millions Nominal value £m 23,380 299,522 (316,531) (1,999) 4,372 23 300 (317) (2) 4 2010 Millions 12,577 278,115 (267,312) – 23,380 Nominal value £m 13 278 (267) – 23 Payments to shareholders in respect of the year represent the value of C Shares to be issued in respect of the results for the year. Issues of C Shares prior to the scheme of arrangement (May 23, 2011) were made by Rolls-Royce Group plc and subsequently by Rolls-Royce Holding plc. Issues of C Shares were declared as follows: Interim Final 2011 Pence per share 6.9 10.6 17.5 2010 Pence per share 6.4 9.6 16.0 £m 129 199 328 £m 119 180 299 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements108 18 Provisions for liabilities and charges Warranty and guarantees Contract loss Restructuring Customer financing Insurance Other Current liabilities Non-current liabilities Transferred to assets held for sale £m – – – (9) – – (9) Acquisitions of businesses £m – 1 – – – – 1 Exchange differences £m (5) – – – – – (5) Unused amounts reversed £m (21) (1) (5) – – (7) (34) Charged to income statement £m 72 11 1 14 7 10 115 At January 1, 2011 £m 298 72 14 78 55 27 544 276 268 Utilised £m (59) (31) (4) (2) (11) (3) (110) At December 31, 2011 £m 285 52 6 81 51 27 502 276 226 Provisions for warranties and guarantees primarily relate to products sold and generally cover a period of up to three years. Provisions for contract loss and restructuring are generally expected to be utilised within two years. Customer financing provisions cover guarantees provided for asset value and/or financing. These guarantees are considered to be insurance contracts in nature and provision is made in accordance with IFRS 4 Insurance Contracts and IAS 37 Provisions, Contingent Liabilities and Contingent Assets. These guarantees, the risks arising and the process used to assess the extent of the risk are described under the heading ‘Customer financing’ in the Finance Director’s review on page 16. The related contingent liabilities arising from these guarantees and the sensitivity to movements in the value of the underlying security are discussed in note 23. It is estimated that the provision will be utilised as follows: Potential claims with specific claim dates: In one year or less In more than one year but less than five years In more than five years Potential claims that may arise at any time up to the date of expiry of the guarantee: Up to one year Up to five years Thereafter 2011 £m 12 62 6 – 1 – 81 2010 £m 8 47 6 9 5 3 78 The Group’s captive insurance company retains a portion of the exposures it insures on behalf of the remainder of the Group. Significant delays occur in the notification and settlement of claims and judgement is involved in assessing outstanding liabilities, the ultimate cost and timing of which cannot be known with certainty at the balance sheet date. The insurance provisions are based on information currently available, however it is inherent in the nature of the business that ultimate liabilities may vary. Provisions for outstanding claims are established to cover the outstanding expected liability as well as claims incurred but not yet reported. Other provisions comprise a number of liabilities with varying expected utilisation rates. Financial statementsNotes to the consolidated financial statements 109 19 Post-retirement benefits The Group operates a number of defined benefit and defined contribution schemes. For the UK defined benefit schemes, the assets are held in separate trustee administered funds and employees are entitled to retirement benefits based on either their final or career average salaries and length of service. Overseas defined benefit schemes are a mixture of funded and unfunded plans. Additionally in the US, and to a lesser extent in some other countries, the Group’s employment practices include the provision of healthcare and life insurance benefits for retired employees. These schemes are unfunded. The valuations of the defined benefit schemes are based on the most recent funding valuations, updated by the scheme actuaries to December 31, 2011. The most recent funding valuations of the main UK schemes were: Scheme Rolls-Royce Pension Fund Rolls-Royce Group Pension Scheme Vickers Group Pension Scheme Amounts recognised in the income statement Defined benefit schemes: Current service cost Past-service (credit)/cost Curtailment Defined contribution schemes Operating cost Financing in respect of defined benefit schemes: Expected return on assets Interest on liabilities Total income statement charge The operating cost is charged as follows: Cost of sales – included in underlying profit Cost of sales – excluded from underlying profit Commercial and administrative costs Research and development Valuation date March 31, 2009 April 5, 2010 March 31, 2010 UK schemes £m 2011 Overseas schemes £m 119 (126) – (7) 16 9 (381) 372 (9) – 34 (68) (2) (36) 38 2 (29) 50 21 23 Total £m 153 (194) (2) (43) 54 11 (410) 422 12 23 UK schemes £m 2010 Overseas schemes £m 118 – – 118 11 129 (374) 375 1 130 34 1 (6) 29 32 61 (26) 56 30 91 Defined benefit Defined contribution Total 2011 £m 114 (204) 36 11 (43) 2010 £m 106 – 31 10 147 2011 £m 38 – 12 4 54 2010 £m 31 – 9 3 43 2011 £m 152 (204) 48 15 11 Total £m 152 1 (6) 147 43 190 (400) 431 31 221 2010 £m 137 – 40 13 190 The Group operates a PaySave scheme in the UK. This is a salary sacrifice scheme under which employees elect to stop making employee contributions and the Group makes additional contributions in return for a reduction in gross contractual pay. As a result, there is a decrease in wages and salaries and a corresponding increase in pension costs of £35m (2010 £35m) in the year. Amounts recognised in the other comprehensive income Actuarial gain on scheme assets Experience losses on scheme liabilities Movement in unrecognised surplus Movement in minimum funding liability 2011 £m 1,426 (720) (683) 100 123 2010 £m 460 (303) (300) 49 (94) Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements110 19 Post-retirement benefits (continued) Defined benefit schemes Assumptions The principal actuarial assumptions used at the balance sheet date were as follows: Rate of increase in salaries Rate of increase of pensions in payment Discount rate Expected rate of return on scheme assets Inflation assumption 1 2011 2010 UK schemes % 4.2 1.7 4.7 3.4 3.1 Overseas schemes % 4.0 1.7 4.5 5.6 2.5 UK schemes % 4.7 3.0 5.5 5.0 3.6 Overseas schemes % 3.9 1.7 5.4 7.2 2.5 1 For the UK schemes, this is the assumption for the Retail Price Index. The Consumer Price Index is assumed to be one per cent lower. The discount rates are determined by reference to the market yields on AA rated corporate bonds. For the main UK schemes, the rate is determined by using the profile of forecast benefit payments to derive a weighted average discount rate from the yield curve. For overseas schemes, the rate is determined as the market yield at the average duration of the forecast benefit payments. The discount rates above are the weighted average of those for each scheme, based on the value of their respective liabilities. The overall expected rate of return is calculated by weighting the individual returns expected from each asset class (see below) in accordance with the actual asset balance in the schemes’ investment portfolios. The mortality assumptions adopted for the UK pension schemes are derived from the SAP actuarial tables, with 80 per cent of long cohort and an underpin of one per cent, published by the Institute of Actuaries, projected forward and, where appropriate, adjusted to take account of the relevant scheme’s actual experience. The resulting range of life expectancies in the principal UK schemes are as follows: Life expectancy from age 65 Current pensioner Future pensioner currently aged 45 22.2 years 24.3 years Other demographic assumptions have been set on advice from the relevant actuary, having regard to the latest trends in scheme experience and other relevant data. The assumptions are reviewed and updated as necessary as part of the periodic actuarial valuation of the schemes. Assumptions in respect of overseas schemes are also set in accordance with advice from local actuaries. The future costs of healthcare benefits are based on an assumed healthcare costs trend rate of 8.4 per cent grading down to five per cent over 6.3 years. Financial statementsNotes to the consolidated financial statements111 19 Post-retirement benefits (continued) Amounts recognised in the balance sheet Present value of funded obligations Fair value of scheme assets Present value of unfunded obligations Unrecognised past-service credit 1 Unrecognised surplus 2 Minimum funding liability 3 Net asset/(liability) recognised in the balance sheet Post-retirement scheme surpluses Post-retirement scheme deficits UK schemes £m (7,713) 9,519 1,806 – – (1,318) (236) 252 495 (243) 2011 Overseas schemes £m (557) 497 (60) (495) (94) – – (649) 8 (657) Total £m (8,270) 10,016 1,746 (495) (94) (1,318) (236) (397) 503 (900) UK schemes £m (7,039) 7,783 744 – – (628) (336) (220) 164 (384) 2010 Overseas schemes £m (484) 434 (50) (579) – (7) – (636) – (636) Total £m (7,523) 8,217 694 (579) – (635) (336) (856) 164 (1,020) 1 The unrecognised past-service credit has arisen as a result of revisions to post-retirement healthcare schemes. It will be amortised over the remaining service lives of the participants (12.3 years). 2 Where a surplus has arisen on a scheme, in accordance with IAS 19 and IFRIC 14, the surplus is recognised as an asset only if it represents an unconditional economic benefit available to the Group in the future. Any surplus in excess of this benefit is not recognised in the balance sheet. 3 A minimum funding liability arises where the statutory funding requirements require future contributions in respect of past service that will result in a future unrecognisable surplus. Changes in present value of defined benefit obligations At January 1 Exchange differences Current service cost Past-service credit/(cost) Finance cost Contributions by employees Benefits paid out Actuarial losses Curtailment At December 31 Funded schemes Unfunded schemes Changes in fair value of scheme assets At January 1 Exchange differences Expected return on assets Contributions by employer Contributions by employees Benefits paid out Actuarial gains At December 31 Actual return on scheme assets UK schemes £m (7,039) – (119) 126 (372) (4) 312 (617) – (7,713) (7,713) – UK schemes £m 7,783 – 381 256 4 (312) 1,407 9,519 1,788 2011 Overseas schemes £m (1,063) – (34) 162 (50) (3) 37 (103) 2 (1,052) (557) (495) 2011 Overseas schemes £m 434 1 29 48 3 (37) 19 497 48 Total £m (8,102) – (153) 288 (422) (7) 349 (720) 2 (8,765) (8,270) (495) Total £m 8,217 1 410 304 7 (349) 1,426 10,016 1,836 UK schemes £m (6,714) – (118) – (375) (3) 313 (142) – (7,039) (7,039) – UK schemes £m 7,048 – 374 227 3 (313) 444 7,783 818 2010 Overseas schemes £m (823) (27) (34) (1) (56) (2) 35 (161) 6 (1,063) (484) (579) 2010 Overseas schemes £m 354 16 26 55 2 (35) 16 434 42 Total £m (7,537) (27) (152) (1) (431) (5) 348 (303) 6 (8,102) (7,523) (579) Total £m 7,402 16 400 282 5 (348) 460 8,217 860 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements113 19 Post-retirement benefits (continued) History of defined benefit schemes The history of the schemes for the current and prior years is as follows: Balance sheet Present value of defined benefit obligations Fair value of scheme assets Unrecognised past-service credit Unrecognised surpluses Minimum funding liabilities Deficit Experience gains/(losses) Actuarial gain/(loss) on scheme assets Experience (losses)/gains on scheme liabilities Movement in unrecognised surpluses Recognition of minimum funding liability on January 1, 2008 Movement in minimum funding liabilities Total amount recognised in OCI Cumulative amounts recognised in OCI since January 1, 2004 20 Share capital 2010 £m (8,102) 8,217 – (635) (336) (856) 460 (303) (300) – 49 (94) (192) 2009 £m (7,537) 7,402 – (335) (385) (855) (270) (878) 707 – 40 (401) (98) 2008 £m (6,546) 7,446 – (1,042) (425) (567) 178 766 (928) (491) 66 (409) 303 2007 £m (6,912) 6,903 – (114) – (123) 161 350 (112) – – 399 712 Non-equity Equity 2011 £m (8,765) 10,016 (94) (1,318) (236) (397) 1,426 (720) (683) – 100 123 (69) Special Share of £1 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements114 21 Share-based payments Effect of share-based payment transactions on the Group’s results and financial position Total expense recognised for equity-settled share-based payments transactions Total expense recognised for cash-settled share-based payments transactions Share-based payments recognised in the consolidated income statement Liability for cash-settled share-based payment transactions 2011 £m 52 7 59 9 2010 £m 47 3 50 5 Share-based payment plans in operation during the year Performance Share Plan (PSP) This plan involves the award of shares to participants subject to performance conditions. Vesting of the performance shares is based on the achievement of both non-market based conditions (EPS and cash flow per share) and a market based performance condition (Total Shareholder Return – TSR) over a three-year period. ShareSave share option plan (ShareSave) Based on a three or five-year monthly savings contract, eligible employees are granted share options with an exercise price of up to 20 per cent below the share price when the contract is entered into. Vesting of the options is not subject to the achievement of a performance target. In the UK, the plan is HM Revenue & Customs approved. Overseas, employees in 33 countries participate in cash-settled ShareSave plans through arrangements which provide broadly comparable benefits to the UK plan. Executive Share Option Plan (ESOP) This plan involved the grant of market value share options to participants. It terminated in 2009 and no further grants may be made. Remaining options under the plan are subject to a non-market based performance condition (growth in EPS) and have a maximum contractual life of ten years. Annual Performance Related Award (APRA) plan deferred shares A proportion of the APRA annual incentive scheme is delivered in the form of a deferred share award. The release of deferred share awards is not dependent on the achievement of any further performance conditions other than that participants remain employed by the Group for two years from the date of the award in order to retain the full number of shares. During the two-year deferral period, participants are entitled to receive dividends, or equivalent, on the deferred shares. Movements in the Group’s share-based payment plans during the year Outstanding at January 1, 2010 Granted Additional entitlements arising from TSR performance Additional shares accrued from reinvestment of C Shares Forfeited Exercised Outstanding at December 31, 2010 Exercisable at December 31, 2010 Outstanding at January 1, 2011 Granted Additional entitlements arising from TSR performance Additional shares accrued from reinvestment of C Shares Forfeited Exercised Outstanding at December 31, 2011 Exercisable at December 31, 2011 ShareSave ESOP PSP APRA Weighted average exercise price Pence 384 – – – 395 366 384 – 384 525 – – 387 357 447 – Number Millions 27.4 – – – (0.8) (0.1) 26.5 – 26.5 10.6 – – (0.9) (8.7) 27.5 – Weighted average exercise price Pence 154 – – – – 190 125 125 125 – – – – 207 100 100 Number Millions 1.2 – – – – (0.5) 0.7 0.7 0.7 – – – – (0.2) 0.5 0.5 Number Millions 18.4 5.5 0.6 – (0.4) (4.6) 19.5 – 19.5 5.3 1.1 – (0.7) (5.7) 19.5 – Number Millions 3.4 1.1 – 0.1 (0.1) (1.4) 3.1 – 3.1 2.6 – 0.1 (0.1) (2.4) 3.3 – Financial statementsNotes to the consolidated financial statements115 21 Share-based payments (continued) As share options are exercised throughout the year, the weighted average share price during the year of 642p (2010 579p) is representative of the weighted average share price at the date of exercise. The closing price at December 31, 2011 was 746.5p, (2010 623p). The average remaining contractual life of exercisable options is one year (2010 1.7 years). Share options outstanding Exercise prices (pence) At December 31, 2011 0 – 99 100 – 199 300 – 399 400 – 499 500 – 599 At December 31, 2010 0 – 99 100 – 199 200 – 299 300 – 399 400 – 499 ShareSave ESOP Total Weighted average remaining contractual life Years Number Millions Weighted average remaining contractual life Years Number Millions Weighted average remaining contractual life Years Number Millions – – 10.8 6.0 10.7 27.5 – – 4.5 11.6 10.4 26.5 – – 2.3 1.1 4.2 2.7 – – 0.1 3.2 1.3 2.0 0.4 0.1 – – – 0.5 0.4 0.1 0.2 – – 0.7 1.2 0.2 – – – 1.0 2.2 1.2 0.3 – – 1.7 0.4 0.1 10.8 6.0 10.7 28.0 0.4 0.1 4.7 11.6 10.4 27.2 1.2 0.2 2.3 1.1 4.2 2.7 2.2 1.2 0.1 3.2 1.3 1.9 The range of exercise prices of options outstanding at December 31, 2011 was: for ShareSave between 387p and 525p (2010 298p and 416p); and for ESOP it was between 77p and 188p (2010 77p and 218p). Under the terms of the Rolls-Royce 1999 Executive Share Option Plan, options granted to 20 directors and senior executives were outstanding at December 31, 2011. Fair values of share-based payment plans The weighted average fair value per share of equity-settled share-based payment plans granted during the year, estimated at the date of grant, are as follows: PSP – 25% TSR uplift PSP – 50% TSR uplift ShareSave – 3 year grant ShareSave – 5 year grant APRA 2011 662p 737p 210p 238p 612p 2010 586p 654p n/a n/a 537p Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements116 21 Share-based payments (continued) In estimating these fair values, the following assumptions were used: Weighted average share price Exercise price Expected dividends Expected volatility Correlation Expected life – PSP Expected life – 3 year ShareSave Expected life – 5 year ShareSave Risk free interest rate PSP 2011 612p n/a 15.4p 32% 36% 3 years n/a n/a 1.9% 2010 545p n/a 14.6p 33% 35% 3 years n/a n/a 1.9% ShareSave 2011 691p 525p 16.0p 30% n/a n/a 3.3 – 3.8 years 5.3 – 5.8 years 1.9% Expected volatility is based on the historical volatility of the Company’s share price over the seven years prior to the grant or award date. Expected dividends are based on the Company’s payments to shareholders in respect of the previous year. PSP The fair value of shares awarded under the PSP is calculated using a pricing model that takes account of the non-entitlement to dividends (or equivalent) during the vesting period and the market-based performance condition based on expectations about volatility and the correlation of share price returns in the group of FTSE 100 companies and which incorporates into the valuation the interdependency between share price performance and TSR vesting. This adjustment increases the fair value of the award relative to the share price at the date of grant. ShareSave The fair value of the options granted under the ShareSave plan is calculated using a binomial pricing model that assumes that participants will exercise their options at the beginning of the six-month window if the share price is greater than the exercise price. Otherwise it assumes that options are held until the expiration of their contractual term. This results in an expected life that falls somewhere between the start and end of the exercise window. APRA The fair value of shares awarded under APRA is calculated as the share price on the date of the award, excluding expected dividends. 22 Operating leases Operating leases Leases as lessee Rentals paid – hire of plant and machinery – hire of other assets Non-cancellable operating lease rentals are payable as follows: Within one year Between one and five years After five years 2011 £m 104 29 117 401 479 997 2010 £m 82 20 92 265 215 572 Financial statementsNotes to the consolidated financial statements 117 22 Operating leases (continued) Leases as lessor Rentals received – credited within revenue from aftermarket services Non-cancellable operating lease rentals are receivable as follows: Within one year Between one and five years After five years 2011 £m 36 3 8 2 13 2010 £m 29 3 10 3 16 The Group acts as lessee and lessor for both land and buildings and gas turbine engines, and acts as lessee for some plant and equipment. • Sublease payments of £3m (2010 £23m) and sublease receipts of £23m (2010 £11m) were recognised in the income statement in the year. • Purchase options exist on aero engines, land and buildings and plant and equipment with the period to the purchase option date varying between one to five years. • Renewal options exist on aero engines, land and buildings and plant and equipment with the period to the renewal option varying between one to 21 years at terms to be negotiated upon renewal. • Escalation clauses exist on some leases and are linked to LIBOR. • The total future minimum sublease payments expected to be made is £5m (2010 £18m) and sublease receipts expected to be received is £4m (2010 £3m). 23 Contingent liabilities In connection with the sale of its products the Group will, on some occasions, provide financing support for its customers. The Group’s contingent liabilities relating to financing arrangements are spread over many years and relate to a number of customers and a broad product portfolio. Contingent liabilities are disclosed on a discounted basis. As the directors consider the likelihood of these contingent liabilities crystallising to be remote, this amount does not represent a value that is expected to crystallise. However, the amounts are discounted at the Group’s borrowing rate to reflect better the time span over which these exposures could arise. The contingent liabilities are denominated in US dollars. As the Group does not generally adopt cash flow hedge accounting for forecast foreign exchange transactions, this amount is reported, together with the sterling equivalent at the reporting date spot rate. The discounted values of contingent liabilities relating to delivered aircraft and other arrangements where financing is in place, less insurance arrangements and relevant provisions, were: Gross contingent liabilities Contingent liabilities net of relevant security 1 Contingent liabilities net of relevant security reduced by 20% 2 1 Security includes unrestricted cash collateral of: 2011 £m 612 124 201 67 $m 951 192 312 104 2010 £m 633 121 200 68 $m 991 190 314 106 2 Although sensitivity calculations are complex, the reduction of relevant security by 20 per cent illustrates the sensitivity of the contingent liability to changes in this assumption. There are also net contingent liabilities in respect of undelivered aircraft, but it is not considered practicable to estimate these as deliveries can be many years in the future, and the relevant financing will only be put in place at the appropriate time. Contingent liabilities exist in respect of guarantees provided by the Group in the ordinary course of business for product delivery, performance and reliability. The Group has, in the normal course of business, entered into arrangements in respect of export finance, performance bonds, countertrade obligations and minor miscellaneous items. Various Group undertakings are parties to legal actions and claims which arise in the ordinary course of business, some of which are for substantial amounts. As a consequence of the insolvency of an insurer as previously reported, the Group is no longer fully insured against known and potential claims from employees who worked for certain of the Group’s UK based businesses for a period prior to the acquisition of those businesses by the Group. While the outcome of some of these matters cannot precisely be foreseen, the directors do not expect any of these arrangements, legal actions or claims, after allowing for provisions already made, to result in significant loss to the Group. The Group’s share of equity accounted entities’ contingent liabilities is £68m (2010 £24m). Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statementsNotes to the consolidated financial statements119 Company balance sheet At December 31, 2011 Fixed assets Investments – subsidiary undertakings Creditors – amounts falling due within one year Financial liabilities Amounts owed to subsidiary undertakings due within one year Net current assets Total assets less current liabilities Capital and reserves Called-up share capital Merger reserve Capital redemption reserve Other reserve Profit and loss account Equity shareholders’ funds The financial statements on pages 119 to 121 were approved by the Board on February 8, 2012 and signed on its behalf by: Sir Simon Robertson Chairman Mark Morris Finance Director Reconciliation of movements in shareholders’ funds For the period ended December 31, 2011 On formation As a result of scheme of arrangement Issue of C Shares Ordinary shares purchased Share-based payments – direct to equity At December 31 Notes 2 3 4 5 5 5 5 2011 £m 11,921 (6) (175) (181) (181) 11,740 374 8,897 173 31 2,265 11,740 2011 £m – 11,885 (180) (1) 36 11,740 Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statements 120 Notes to the Company financial statements 1 Accounting policies Basis of accounting The financial statements have been prepared in accordance with applicable UK Accounting Standards on the historical cost basis. As permitted by section 408 of the Companies Act 2006, a separate profit and loss account for the Company has not been included in these financial statements. As permitted by the audit fee disclosure regulations, disclosure of non-audit fees information is not included in respect of the Company. As permitted by FRS 1 Cash flow statements, no cash flow statement for the Company has been included. As permitted by FRS 8 Related party disclosures, no related party disclosures in respect of transactions between the Company and its wholly owned subsidiaries have been included. Investments in subsidiary undertakings Investments in subsidiary undertakings are reported at cost less any amounts written off. Share-based payments As described in the Directors’ remuneration report on pages 55 to 65, the Company grants awards of its own shares to employees of its subsidiary undertakings, (see note 21 of the consolidated financial statements). The costs of share-based payments in respect of these awards are accounted for, by the Company, as an additional investment in its subsidiary undertakings. The costs are determined in accordance with FRS 20 Share-based payment. Any payments made by the subsidiary undertakings in respect of these arrangements are treated as a return of this investment. Financial instruments In accordance with FRS 25 Financial instruments: Presentation, the Company’s C Shares are classified as financial liabilities and held at amortised cost from the date of issue until redeemed. Taxation Provision for taxation is made at the current rate and, in accordance with FRS 19 Deferred tax, for deferred taxation at the projected rate on timing differences that have originated, but not reversed at the balance sheet date. 2 Investments – subsidiary undertakings Cost: On formation As a result of scheme of arrangement Additions Cost of share-based payments in respect of employees of subsidiary undertakings less receipts from subsidiaries in respect of those payments At December 31, 2011 3 Financial liabilities C Shares Movements in C Shares during the year were as follows: Issued and fully paid On formation Shares issued Shares redeemed At December 31, 2011 The rights attaching to C Shares are set out on page 66. C Shares of 0.1p Millions – 179,730 (173,359) 6,371 £m – 11,888 2 31 11,921 Nominal value £m – 180 (173) 6 Rolls-Royce Holdings plc Annual report 2011Financial statements 121 Notes to the Company financial statements 4 Share capital Issued and fully paid On formation Issued as a result of the scheme of arrangement (ordinary shares of 150p each) Capital reduction to 20p each Redemption of preference shares At December 31, 2011 The rights attaching to each class of share are set out on page 66. Non-equity Preference shares of £1 each 50,000 – – (50,000) – Special Share of £1 – 1 – – 1 Nominal value £m – – – – – Equity Ordinary shares of 20p each Millions – 1,872 – – 1,872 Nominal value £m – 2,808 (2,434) – 374 In accordance with FRS 25 Financial instruments: Presentation, the Company’s non-cumulative redeemable preference shares (C Shares) are classified as financial liabilities. Accordingly, movements in C Shares are included in note 3. 5 Movements in capital and reserves On formation Scheme of arrangement 2 Capital reduction 2 Issue of C Shares Redemption of C Shares Ordinary shares purchased Ordinary shares vesting in share-based payment plans Share-based payments – direct to equity At December 31, 2011 Non-distributable reserves Merger reserve £m – 9,077 – (180) – – – – 8,897 Capital redemption reserve £m – – – – 173 – – – 173 Other reserve1 £m – – – – – – – 31 31 Own shares reserve £m – – – – – (1) 1 – – Share capital £m – 2,808 (2,434) – – – – – 374 Profit and loss account £m – – 2,434 – (173) – (1) 5 2,265 Total £m – 11,885 – (180) – (1) – 36 11,740 1 The ‘Other reserve’ represents the value of share-based payments in respect of employees of subsidiary undertakings for which payment has not been received. 2 On May 23, 2011, under a scheme of arrangement between Rolls-Royce Group plc, the former holding company of the Group, and its shareholders under Part 26 of the Companies Act 2006, and as sanctioned by the High Court, all the issued ordinary shares in that company were cancelled and the same number of new ordinary shares were issued to Rolls-Royce Holdings plc in consideration for the allotment to shareholders of one ordinary share in Rolls-Royce Holdings plc for each ordinary share in Rolls-Royce Group plc held on the record date (May 20, 2011). Pursuant to the scheme of arrangement, 1,872,188,709 ordinary shares of 150 pence were issued. As required by Section 612 of the Companies Act 2006, no share premium was recognised. On May 24, 2011, the share capital of Rolls-Royce Holdings plc was reduced by reducing the nominal value of the ordinary shares from 150 pence to 20 pence as sanctioned by the High Court. 6 Contingent liabilities Where the Company enters into financial guarantee contracts to guarantee the indebtedness of other companies within its group, the Company considers these to be insurance arrangements, and accounts for them as such. In this respect, the Company treats the guarantee contract as a contingent liability until such time as it becomes probable that the Company will be required to make a payment under the guarantee. At December 31, 2011 these guarantees amounted to £1,101m. 7 Other information Emoluments of directors The remuneration of the directors of the Company is shown in the Directors’ remuneration report on pages 55 to 65. Employees The Company had no employees in 2011. Share-based payments Shares in the Company have been granted to employees of the Group as part of share-based payment plans, and are charged in the employing company. Rolls-Royce Holdings plc Annual report 2011Financial statementsFinancial statements122 Other matters Subsidiaries, jointly controlled entities and associates At December 31, 2011 Incorporated within the UK – held by Rolls-Royce Holdings plc Rolls-Royce Group plc Holding company Incorporated within the UK – held by Rolls-Royce Group plc Rolls-Royce plc Principal trading company Incorporated within the UK – indirectly held Optimized Systems and Solutions Limited Rolls-Royce Fuel Cell Systems Limited Rolls-Royce International Limited Rolls-Royce Leasing Limited Rolls-Royce Marine Electrical Systems Limited Rolls-Royce Marine Power Operations Limited Rolls-Royce Power Development Limited Rolls-Royce Power Engineering plc Rolls-Royce Total Care Services Limited Tidal Generation Limited Equipment health management and advanced data management services Development of fuel cell systems International support and commercial information services Engine leasing Marine electrical systems Nuclear submarine propulsion systems Generation of electricity from independent power projects Energy and marine systems Aero engine aftermarket support services Development of tidal generation systems The above companies operate principally in the UK and the effective Group interest is 100 per cent, other than Rolls-Royce Fuel Cell Systems Limited in which it is 80 per cent. Incorporated overseas – indirectly held Rolls-Royce Brasil Limitada Rolls-Royce Canada Limited Rolls-Royce Marine (Shanghai) Limited Rolls-Royce OY AB Rolls-Royce Civil Nuclear SAS Rolls-Royce Technical Support SARL Rolls-Royce Deutschland Ltd & Co KG Brazil Canada China Finland France France Germany Guernsey Nightingale Insurance Limited Rolls-Royce India Private Limited India Rolls-Royce Operations (India) Private Limited India Europea Microfusioni Aerospaziali S.p.A. Italy Rolls-Royce Marine AS Norway Norway Scandinavian Electric Holding AS Singapore Rolls-Royce Singapore Pte Limited Sweden US US US US US US US US US US Rolls-Royce AB Data Systems & Solutions LLC Optimized Systems and Solutions Inc. R. Brooks Associates Inc. Rolls-Royce Commercial Marine Inc. Rolls-Royce Corporation Rolls-Royce Crosspointe LLC Rolls-Royce Energy Systems Inc. Rolls-Royce Engine Services – Oakland Inc. Rolls-Royce Defense Services Inc. Rolls-Royce Naval Marine Inc. Industrial gas turbines and aero engine repair and overhaul, energy and marine aftermarket support services Industrial gas turbines and aero engine sales, service and overhaul Manufacture and supply of marine equipment Manufacture of marine winches and propeller systems Instrumentation and control systems and life-cycle management for nuclear power plants Aero engine project support Aero engine design, development and manufacture Insurance services Diesel engine project management and customer support Engineering support services Manufacture of gas turbine engine castings Design and manufacture of ship equipment Marine electrical systems Aero engine parts manufacturing and engine assembly, energy and marine aftermarket support services Manufacture of marine propeller systems Instrumentation and control systems and life-cycle management for nuclear power plants Equipment health management and advanced data management services Specialist civil nuclear reactor services Marine aftermarket support services Design, development and manufacture of gas turbine engines Manufacturing facility for aero engine parts Energy turbine generator packages Aero engine repair and overhaul Aero engine repair and overhaul Design and manufacture of marine equipment The above companies operate principally in the country of their incorporation and the effective Group interest is 100 per cent. Rolls-Royce Holdings plc Annual report 2011123 Other matters Subsidiaries, jointly controlled entities and associates At December 31, 2011 Incorporated within the UK – indirectly held Airtanker Holdings Limited Strategic tanker aircraft PFI project Airtanker Services Limited Provision of aftermarket services for strategic tanker aircraft Alpha Partners Leasing Limited Aero engine leasing Composite Technology and Applications Limited Development of aero engine fan blades and fan cases Genistics Holdings Limited Trailer-mounted field mobile generator sets Rolls-Royce Goodrich Engine Control Systems Limited Development and manufacture of aero engine controls Rolls-Royce Snecma Limited (UK & France) Aero engine collaboration Rolls-Royce Turbomeca Limited (UK & France) Adour and RTM322 aero engine collaboration Rolls Wood Group (Repair and Overhauls) Limited Industrial gas turbine repair and overhaul TRT Limited Aero engine turbine blade repair services Turbine Surface Technologies Limited Aero engine turbine surface coatings Turbo-Union Limited (UK, Germany & Italy) RB199 engine collaboration Class Ordinary Ordinary A Ordinary B Ordinary A Ordinary B Ordinary A Ordinary B Ordinary Ordinary A Shares B Shares A Shares B Shares A Ordinary B Ordinary A Ordinary B Ordinary A Ordinary B Ordinary Ordinary A Shares % of class held 20 % of total equity held 20 22 100 – 100 – 100 – 50 – 100 – 100 100 – – 100 – 100 40 37.5 22 50 51 50 50 50 50 50 49.5 50 40 The above companies operate principally in the country of their incorporation. The countries of principal operations are stated in brackets after the name of the company, if not the country of their incorporation. s r e t t a m r e h t O Rolls-Royce Holdings plc Annual report 2011 124 Other matters Subsidiaries, jointly controlled entities and associates At December 31, 2011 Incorporated overseas – indirectly held China Germany Germany Germany Germany Germany Xian XR Aero Components Co Limited Manufacturing facility for aero engine parts EPI Europrop International GmbH (effective interest 35.5%) A400M engine collaboration EUROJET Turbo GmbH (UK, Germany, Italy & Spain) (effective interest 39%) EJ200 engine collaboration MTU, Turbomeca, Rolls-Royce GmbH (UK, France & Germany) MTR390 engine collaboration N3 Engine Overhaul Services GmbH & Co KG Aero engine repair and overhaul Engine Holding GmbH Supplier of engines and power trains for marine propulsion, distributed power generation and industrial ‘off highway’ sectors. Holding company for Tognum AG. Hong Kong Hong Kong Aero Engine Services Limited India Israel Malaysia Singapore Singapore Spain Switzerland Aero engine repair and overhaul International Aerospace Manufacturing Private Limited Manufacture of compressor shrouds, compressor rings, turbine blades and nozzle guide vanes Techjet Aerofoils Limited Manufacture of compressor aerofoils for gas turbines Advanced Gas Turbine Solutions Sdn Bhd Industrial gas turbine aftermarket services International Engine Component Overhaul Pte Limited Aero engine repair and overhaul Singapore Aero Engine Services Private Limited (effective interest 39%) Aero engine repair and overhaul Industria de Turbo Propulsores SA Aero engine component manufacture and maintenance IAE International Aero Engines AG (UK, Germany, Japan & US) V2500 engine collaboration US US US US US Alpha Leasing (US) LLC, Alpha Leasing (US) (No.2) LLC, Alpha Leasing (US) (No.4) LLC, Alpha Leasing (US) (No.5) LLC, Alpha Leasing (US) (No.6) LLC, Alpha Leasing (US) (No.7) LLC, Alpha Leasing (US) (No.8) LLC, Rolls-Royce & Partners Finance (US) LLC, Rolls-Royce & Partners Finance (US) (No.2) LLC Aero engine leasing Exostar LLC Business to business internet exchange GE Rolls-Royce Fighter Engine Team LLC F136 development engine for the Joint Strike Fighter Texas Aero Engine Services, LLC Aero engine repair and overhaul Williams-Rolls Inc. (UK & US) FJ44 engine collaboration Unincorporated overseas – held by subsidiary undertaking Class Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary A Ordinary B Ordinary Ordinary Ordinary Ordinary Ordinary A Shares B Shares C Shares D Shares Partnerships Partnership Partnership Partnership Common % of class held 49 % of total equity held 49 28 33 33.3 50 50 45 50 50 50 49 50 30 46.9 100 – – – 50 18.5 40 50 15 28 33 33.3 50 50 45 50 50 49 50 30 46.9 32.5 – – – – 15 US Light Helicopter Turbine Engine Company (LHTEC) Rolls-Royce Corporation has a 50 per cent interest in this unincorporated partnership which was formed to develop and market jointly the T800 engine The above companies operate principally in the country of their incorporation. The countries of principal operations are stated in brackets after the name of the company, if not the country of their incorporation. In accordance with Section 410 of the Companies Act 2006, the subsidiaries, jointly controlled entities and associates listed on pages 122 to 124 whose results or financial position, in the opinion of the directors, principally affect the financial statements. A list of all related undertakings will be included in the Company’s annual return to Companies House. Rolls-Royce Holdings plc Annual report 2011125 Other matters Independent Auditor’s report to the Members of Rolls-Royce Holdings plc We have audited the financial statements of Rolls-Royce Holdings plc for the year ended December 31, 2011, set out on pages 72 to 124. The financial reporting framework that has been applied in the preparation of the Group financial statements is applicable law and International Financial Reporting Standards (IFRSs) as adopted by the EU. The financial reporting framework that has been applied in the preparation of the parent company financial statements is applicable law and UK Accounting Standards (UK Generally Accepted Accounting Practice). This report is made solely to the Company’s members, as a body, in accordance with Chapter 3 of Part 16 of the Companies Act 2006. Our audit work has been undertaken so that we might state to the Company’s members those matters we are required to state to them in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Company and the Company’s members, as a body, for our audit work, for this report, or for the opinions we have formed. Respective responsibilities of directors and auditors As explained more fully in the Directors’ responsibilities statement set out on pages 69 and 70, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. Our responsibility is to audit, and express an opinion on, the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s (APB’s) Ethical Standards for Auditors. Scope of the audit of the financial statements A description of the scope of an audit of financial statements is provided on the APB’s website at www.frc.org.uk/apb/scope/private.cfm. Opinion on financial statements In our opinion: • the financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at December 31, 2011 and of the Group’s profit for the year then ended; • the Group financial statements have been properly prepared in accordance with IFRSs as adopted by the EU; • the parent company financial statements have been properly prepared in accordance with UK Generally Accepted Accounting Practice; and • the financial statements have been prepared in accordance with the requirements of the Companies Act 2006; and, as regards the Group financial statements, Article 4 of the IAS Regulation. Opinion on other matters prescribed by the Companies Act 2006 In our opinion: • the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006; and • the information given in the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. Matters on which we are required to report by exception We have nothing to report in respect of the following: Under the Companies Act 2006 we are required to report to you if, in our opinion: • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or • the parent company financial statements and the part of the Directors’ remuneration report to be audited are not in agreement with the accounting records and returns; or • certain disclosures of directors’ remuneration specified by law are not made; or • we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: • the directors’ statement, set out on page 70, in relation to going concern; • the part of the corporate governance statement on page 42 relating to the Company’s compliance with the nine provisions of the UK Corporate Governance Code specified for our review; and • certain elements of the report to shareholders by the Board on Directors’ remuneration. A J Sykes (Senior Statutory Auditor) for and on behalf of KPMG Audit Plc, Statutory Auditor Chartered Accountants 15 Canada Square London E14 5GL February 8, 2012 Rolls-Royce Holdings plc Annual report 2011Other matters126 Other matters Group five-year review For the years ended December 31 Income statement Revenue Profit before net research and development and share of results of joint ventures and associates Research and development (net)1 Share of results of joint ventures and associates Profit before financing Net financing Profit/(loss) before taxation2 Taxation Profit/(loss) for the year Attributable to: Equity shareholders of the parent Non-controlling interests Profit/(loss) 1 Research and development (gross) 2 Underlying profit before taxation Earnings per ordinary share: Underlying Basic Payments to shareholders per ordinary share Balance Sheet Assets Liabilities Called-up share capital Reserves Equity attributable to equity holders of the parent Non-controlling interests Cash flow Cash inflow from operating activities Cash outflow from investing activities Cash (outflow)/inflow from financing activities (Decrease)/increase in cash and cash equivalents Net funds 2011 £m 11,124 1,536 (463) 116 1,189 (84) 1,105 (257) 848 850 (2) 848 (908) 1,157 48.54p 45.95p 17.50p 2011 £m 16,423 (11,904) 4,519 374 4,144 4,518 1 4,519 2011 £m 1,306 (2,207) (655) (1,556) 223 2010 £m 11,085 1,463 (422) 93 1,134 (432) 702 (159) 543 539 4 543 (923) 955 38.73p 29.20p 16.00p 2010 £m 16,234 (12,255) 3,979 374 3,601 3,975 4 3,979 2010 £m 1,378 (759) (743) (124) 1,533 2009 £m 10,414 1,458 (379) 93 1,172 1,785 2,957 (740) 2,217 2,221 (4) 2,217 (864) 915 39.67p 120.38p 15.00p 2009 £m 15,422 (11,640) 3,782 371 3,411 3,782 – 3,782 2009 £m 859 (606) 384 637 1,275 2008 £m 9,082 1,191 (403) 74 862 (2,754) (1,892) (547) (1,345) (1,340) (5) (1,345) (885) 880 36.70p (73.63p) 14.30p 2008 £m 15,348 (13,123) 2,225 369 1,847 2,216 9 2,225 2008 £m 1,015 (645) (221) 149 1,458 2007 £m 7,435 827 (381) 66 512 221 733 (133) 600 606 (6) 600 (824) 800 34.06p 33.67p 13.00p 2007 £m 11,459 (7,910) 3,549 364 2,815 3,179 12 3,191 2007 £m 705 (572) (473) (340) 888 Rolls-Royce Holdings plc Annual report 2011127 Shareholder information Financial calendar 2012 – 2013 May 4, 11:00am Annual General Meeting QEII Conference Centre London July 2 Payment of C Share dividend July 2 Allotment of C Shares July 4 Payment of C Share redemption monies July 12 Purchase of ordinary shares for CRIP participants (at the latest) July 26 Announcement of interim results November 16 Record date for C Share dividend January 2 Payment of C Share dividend January 2 Allotment of C Shares January 4 Payment of C Share redemption monies Apr 2012 May 2012 Jun 2012 Jul 2012 Aug 2012 Sep 2012 Oct 2012 Nov 2012 Dec 2012 Jan 2013 Feb 2013 April 25 Ex-entitlement to C Shares April 27 Record date for entitlement to C Shares June 1, 5:00pm Deadline for receipt of C Share elections June 1 Record date for C Share dividend October 24 Ex-entitlement to C Shares October 26 Record date for entitlement to C Shares December 3 Deadline for receipt of C Share elections December 31 2012 financial year end February Preliminary announcement – 2012 full year results February Annual report published Share administration and share dealing The administration of our shareholder register is managed by the Registrar, who also provides both internet and telephone share dealing services. When making contact with the Registrar quote your Shareholder Reference Number (SRN), an 11 digit number on the right hand side of your share certificate. You can manage your shareholding online at www.investorcentre.co.uk, speak to the Registrar on +44 (0)870 703 0162 (8.30am to 5.30pm Monday to Friday) or you can write to them at Computershare Investor Services PLC, The Pavilions, Bridgwater Road, Bristol, BS13 8AE. Only existing shareholders can deal either over the telephone (+44 (0)870 703 0084) or online at www-uk.computershare.com/Investor/ShareDealing.asp (8.00am to 4.30pm Monday to Friday excluding Bank holidays). Please note that stamp duty of 0.5 per cent is also payable on all purchases, in addition to the any other dealing fees. There are many other share dealing facilities available and we always recommend that you use a firm regulated by the Financial Services Authority (FSA). You can visit the FSA website and check the FSA register at www.fsa.gov.uk . Before selling shares, via either internet or telephone dealing, you must ensure that you have a valid Rolls-Royce Holdings plc share certificate. Without a valid share certificate you will be unable to complete any transaction and will be responsible for any costs incurred by the broker. Payments to shareholders If you are one of the many shareholders who have chosen to receive cash then we strongly recommend that you arrange for payments to be credited direct to your bank account. This removes the risk of a cheque going astray and also means that cleared payments are credited to your bank account on the payment date. If you have registered to use www.investorcentre.co.uk you can update your bank details online. Alternatively you can request a form by phone from the Rolls-Royce shareholder helpline on +44 (0)870 703 0162. Keeping in touch and unclaimed payments It’s very important that you keep the Registrar informed of any change to your contact details, especially your postal address. If the Registrar receives two items of undelivered mail from a shareholder’s registered address, no further mail will be sent until you confirm or update your registered address. However, the Registrar will securely retain all future mail, issued by the Company, on your behalf. The Company recently authorised Georgeson, a company that specialises in tracing lost shareholders, to contact shareholders that we have been unable to contact for many years and has so far been able to transfer 323,541 ordinary shares (currently worth over £2.5 million) to 1,155 shareholders and pay over £280,000 to current and former shareholders. Additional claims continue to be processed in order to pay a further estimated £2 million to current and former shareholders. s r e t t a m r e h t O Rolls-Royce Holdings plc Annual report 2011Other matters 128 Shareholder information Warning to shareholders We are aware some shareholders receive unsolicited phone calls or correspondence concerning investment matters, typically from overseas based ‘brokers’ who target UK shareholders, offering to sell them what often turn out to be worthless or high risk shares in US or UK investments. Such operations are commonly known as ‘boiler rooms’ and these ‘brokers’ can be very persistent and extremely persuasive. If you receive any unsolicited investment advice: • check that they are properly authorised by the FSA before getting involved via the following web link: www.fsa.gov.uk/register/home.do • don’t pay any money up front • report the matter to the FSA (UK 0845 606 1234 and overseas +44 207 066 1000) and, if the calls persist, hang up. • If you deal with an unauthorised firm, you will not be eligible to receive payment under the Financial Services Compensation Scheme. IF IT SOUNDS TOO GOOD TO BE TRUE, IT PROBABLY IS! American Depositary Receipts (ADR) Rolls-Royce ordinary shares are traded in the US in the form of a sponsored ADR facility with The Bank of New York Mellon as the depositary. Each ADR represents five ordinary shares. For further information about the US ADR programme, please contact your broker or write to: BNY Mellon Shareholder Services PO Box 358516 Pittsburgh PA 15252-8516 Phone: +1 888 269 2377 or +1888 BNY ADRS (toll free within the US) Phone outside the US: +1 201 680 6825 Email: shrrelations@bnymellon.com Website: www.adrbnymellon.com ShareGift The Orr Mackintosh Foundation operates a charity donation scheme for shareholders with small numbers of shares which may be uneconomic to sell. Details of the scheme are available from ShareGift at www.sharegift.org or you can write to Orr Mackintosh Foundation, 17 Carlton House Terrace, London SW1Y 5AH (telephone +44 (0)20 7930 3737). Dividends paid on C Shares held C Share calculation period July 1, 2011 – December 31, 2011 January 1, 2011 – April 5, 2011* C Share dividend rate (%) 0.414 0.204 Record date for C Share dividend November 18, 2011 April 5, 2011 Payment date January 3, 2012 April 15, 2011 * The C Share dividend was prorated due to the compulsory redemption of all Rolls-Royce Group plc C Shares on April 6, 2011 prior to the corporate restructure. There were no C Shares in issue between April 7, 2011 and June 30, 2011. Previous C Share issues Apportionment values CGT apportionment No of C Shares issued per ordinary share 69 Record date for entitlement to C Shares October 28, 2011 Issue date January 3, 2012 Latest date for receipt of Payment Instruction Forms by Registrar December 5, 2011 Price of ordinary shares on first day of trading (p) 755.25 Value of C Share issues per ordinary shares (p) 6.90p Ordinary shares (%) 99.09 C Shares (%) 0.91 Date of redemption of C Shares January 5, 2012 CRIP purchase date January 10, 2012 CRIP purchase price (p) 756.62 July 1, 2011 96 April 26, 2011 June 6, 2011 647.75 9.60p 98.54 1.46 July 5, 2011 July 6, 2011 654.29 For previous C Share issues, please refer to the Group’s website. Analysis of ordinary shareholders at December 31, 2011 Type of holder: Individuals Institutional and other investors Total Size of holding: 1 – 150 151 – 500 501 – 10,000 10,001 – 100,000 100,001 – 1,000,000 1,000,001 and over Total Number of shareholders 214,392 5,727 220,119 % of total shareholders 97.40 2.60 100.00 68,052 113,385 36,738 1,338 420 186 220,119 30.92 51.51 16.69 0.61 0.19 0.08 100.00 Number of shares 110,941,253 1,761,298,759 1,872,240,012 6,687,131 29,942,853 60,049,391 35,073,218 152,884,275 1,587,603,144 1,872,240,012 % of total shares 6.15 93.85 100.00 0.37 1.64 3.28 1.87 7.49 85.35 100.00 Rolls-Royce Holdings plc Annual report 2011Other matters Contents Civil aerospace Defence aerospace p18 p20 Marine Energy p22 p24 Technology Operations p26 p28 Visit Rolls-Royce online Below are some examples of the type of information and services available:  The Group’s business  Governance  Sustainability  News/updates  People  Investors  Heritage www.rolls-royce.com/investors Business review Introduction 1 2 Chairman’s statement 4 Chief Executive’s review 6 Our business model and strategy 8 Our business segments 9 Market opportunities 10 Key performance indicators 14 Finance Director’s review 18 Civil aerospace 20 Defence aerospace 22 Marine 24 Energy 26 Excellence in technology 28 Excellence in operations 30 Sustainability 34 Principal risks and uncertainties 36 Additional financial information Governance 38 Board of directors 40 International Advisory Board 40 The Group Leadership Team 41 Chairman’s introduction 42 UK Corporate Governance Code 46 Audit committee report 48 Nominations committee report 50 Ethics committee report 51 Risk committee report 52 55 Directors’ remuneration report 66 Shareholders and share capital 68 Other statutory information Remuneration committee report Financial statements Contents listed on page 71 Other matters 122 Subsidiaries, jointly controlled entities and associates 125 Independent Auditor’s report 126 Group five-year review 127 Shareholder information 129 Glossary Directors’ report The Directors’ report which includes the Business review is set out on pages 1 to 70. Forward-looking statements This Annual report contains forward- looking statements. Any statements that express forecasts, expectations and projections are not guarantees of future performance and will not be updated. By their nature, these statements involve risk and uncertainty, and a number of factors could cause material differences to the actual results or developments. This report is intended to provide information to shareholders, is not designed to be relied upon by any other party, or for any other purpose and the Company and its directors accept no liability to any other person other than under English law. 129 Glossary Glossary ABC ABI ACARE ADR ADVENT AEBS AFRL AGM ANA APB APRA ASD BDI BIS BitC CAD CDP CEO CGU CO2 CPI CPS CRIP DJSI EASA EFE EPS ESOP EU FSA GBP GDP GHG GLT HR HS&E I&C IAB IAE IAS IASB IFBEC IFRIC Anti-bribery and corruption Association of British Insurers Advisory Council for Aviation Research and Innovation in Europe American Depositary Receipts Programme Adaptive Versatile Engine Technology All-Employee Bonus Scheme US Air Force Research Lab Annual General Meeting All Nippon Airways Auditing Practices Board Annual Performance Related Award plan Aerospace and Defence Industries Association of Europe Federation of German Industries Department for Business, Innovation and Skills Business in the Community Corporate Responsibility Index Canadian dollar Carbon Disclosure Project Chief Executive Officer Cash-generating unit Carbon dioxide Consumer Price Index Cash flow per share C Share Reinvestment Plan Dow Jones Sustainability World and European Indexes European Aviation Safety Agency Environmentally Friendly Engine Earnings per ordinary share Executive Share Option Plan European Union Financial Services Authority Great British pound or pound sterling Gross domestic product Greenhouse gas Group Leadership Team Human Resources Health, Safety and Environment Instrumentation and control International Advisory Board IAE International Aero Engines AG International Accounting Standards International Accounting Standards Board International Forum on Business Ethical Conduct International Financial Reporting Interpretations Committee International Financial Reporting Standards IFRS Integrated Vehicle Energy Technology INVENT Integrated Power and Thermal Management System Development IPTMSD International Standards Organisation ISO Liability-driven investment LDI London Inter-bank Offered Rate LIBOR Limited Liability Partnership LLP Long-Term Service Agreement LTSA UK Ministry of Defence MoD Memorandum of Understanding MoU Megawatt hours MWh North Atlantic Treaty Organisation NATO Nitrogen oxides NOx Other comprehensive income OCI Original Equipment OE Organisation for Economic Cooperation and Development OECD Over-the-counter OTC Political Action Committee PAC Product Introduction and Lifecycle Management PILM Public Limited Company PLC Performance Share Plan PSP Pressurised Water Reactor PWR Research and Development R&D Research and Technology R&T RCF Revolving credit facility Registrar Computershare Investor Services PLC Rolls-Royce North America RRNA Risk and Revenue Sharing Partnerships RRSPs Restricted stock units RSUs Systems, applications and products SAP Supply Chain Relationships in Aerospace SCRIA Strategic Defence and Security Review SDSR Share Incentive Plan SIP Sulphur oxides SOx Shareholder Reference Number SRN Science, technology, engineering and maths STEM Short Take-Off and Vertical Landing STOVL Total reportable injuries TRI TSR Total Shareholder Return UK GAAP UK Generally Accepted Accounting Practices USD VDA United States dollar Verband der Automobilindustrie (German Association of the Automotive Industry) Vice President VP Designed and produced by conran design group The paper used in the report contains 75% recycled content, of which 75% is de-inked post-consumer. All of the pulp is bleached using an elemental chlorine free process (ECF). environmental printing technology, Printed in the UK by PurePrint using their and and vegetable inks were used throughout. PurePrint is a CarbonNeutral® company. Both manufacturing mill and the printer are registered to the Environmental Management System ISO 14001 and are Forest Stewardship Council® (FSC) chain-of-custody certified. s t n e m e t a t s l i a c n a n F i Rolls-Royce Holdings plc Annual report 2011 Trusted to deliver excellence R o l l s - R o y c e H o d n g s p c l l i A n n u a l r e p o r t 2 0 1 1 ® ® © Rolls-Royce plc 2012 Rolls-Royce Holdings plc Registered office: 65 Buckingham Gate London SW1E 6AT T +44 (0)20 7222 9020 www.rolls-royce.com Company number 7524813 T r u s t e d t o d e l i v e r e x c e l l e n c e

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