Rolls-Royce
Annual Report 2013

Plain-text annual report

Rolls-Royce Holdings plc annual report 2013 better power for a changing world “ 2013 was a year of good progress in which our order book, underlying revenue and underlying profit, all grew. Our priorities remain the 4 Cs: Customer, Concentration, Cost and Cash.” John Rishton, Chief Executive Rolls-Royce Holdings plc annual report 2013 1 INTRODUCTION Rolls-Royce is a global company, providing integrated power solutions for customers in civil and defence aerospace, marine, energy and power markets. Our vision is to deliver ‘better power for a changing world’. Order book £m Underlying revenue £m Underlying profit before tax £m 2013 71,612 15,505 1,759 Underlying earnings per share 65.59p Full year payment to shareholders Reported revenue £m Reported profit before tax £m 22.0p 15,513 1,759 Restated* 2012 60,146 12,209 1,434 59.59p 19.5p 12,161 2,766 Reported earnings per share 73.26p 125.38p Net cash £m 1,939 1,317 Change +19% +27% +23% +10% +13% +28% -36% -42% * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits and the change in accounting policy for RRSAs. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Strategic report Introduction Group at a glance Chairman’s review Chief Executive’s review Our vision, business model, strategy and values Chief Financial Officer’s review Civil aerospace Defence aerospace Marine Energy Power Systems Engineering and technology Operations Sustainability Key performance indicators Principal risks and uncertainties Directors’ report Chairman’s introduction Board of directors International Advisory Board Executive Leadership Team Corporate governance report Audit committee report Nomination committee report Ethics committee report Risk committee report Safety committee report Remuneration committee report Directors’ remuneration policy Directors’ remuneration report Shareholders and share capital Other statutory information Financial statements Contents Other information Subsidiaries, jointly controlled entities and associates Independent Auditor’s report Group five-year review Additional financial information Shareholder information Glossary 1 2 4 6 8 10 14 16 18 20 22 24 25 26 30 32 35 36 38 38 39 44 47 49 51 52 53 55 62 70 72 74 127 130 136 137 139 141 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 that required under English law. 2 Strategic report Rolls-Royce Holdings plc annual report 2013 GROUP AT A GLANCE As in previous years, our business priorities remain the 4 Cs: Customer, Concentration, Cost and Cash. GROUP OVERVIEW 2013 2013 revenue by business segment (cid:337)(cid:3) The order book increased 19 per cent to £71.6 billion. This included a £1.6 billion contribution from Power Systems. (cid:337)(cid:3) Underlying profit before tax increased 23 per cent to £1.8 billion, including £257 million from Tognum. (cid:337)(cid:3) Order intake was £26.9 billion in the year. (cid:337)(cid:3) Underlying revenue increased to £15.5 billion, with 53 per cent from original equipment (OE) and 47 per cent from services revenue. 42% Civil aerospace 17% Defence aerospace 7% Energy 16% Marine 18% Power Systems CIVIL AEROSPACE Revenue mix 46% OE revenue 54% Services revenue DEFENCE AEROSPACE Revenue mix 50% OE revenue 46% Services revenue 4% Development £6,655m Underlying revenue 2013 £844m Underlying profit 2013 (cid:337)(cid:3) First flight of the Airbus A350 XWB powered by Trent XWB engines (cid:337)(cid:3) First flight of the Boeing 787-9 powered by Trent 1000 engines (cid:337)(cid:3) Major new orders from JAL, IAG, Lufthansa, United, Singapore and Etihad (cid:337)(cid:3) Delivered 3,000th BR700 series engine The Civil aerospace segment is a major manufacturer of aero engines for the airline and corporate jet markets. Rolls-Royce powers more than 30 types of commercial aircraft and has almost 13,000 engines in service around the world. £2,591m Underlying revenue 2013 £438m Underlying profit 2013 (cid:337)(cid:3) TP400-powered A400M entered service (cid:337)(cid:3) MissionCareTM contract for Saudi Arabian EJ200 engines secured (cid:337)(cid:3) 1,500th AE 2100 engine delivered (cid:337)(cid:3) Upgraded AE 1107 engines for V-22 Osprey (cid:337)(cid:3) T56 engine enhancement kits gained first sales (cid:337)(cid:3) Delivered 40th Rolls-Royce LiftFan® for F-35B Lightning II fighter programme (cid:337)(cid:3) RTM322 helicopter engine programme sold to Turbomeca Rolls-Royce is the second largest provider of defence aero-engine products and services globally, with around 16,000 engines in service with over 160 military customers in more than 100 countries. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 3 MARINE Revenue mix 57% OE revenue 43% Services revenue ENERGY Revenue mix £2,527m Underlying revenue 2013 £281m Underlying profit 2013 (cid:337)(cid:3) Range of world ‘firsts’ of LNG-powered vessel types delivered (cid:337)(cid:3) MT30 selected for new UK MoD Type 26 Frigate (cid:337)(cid:3) £800 million contract agreed with UK MoD for provision of future nuclear submarine propulsion systems (cid:337)(cid:3) New UT 830 seismic survey vessel launched (cid:337)(cid:3) COSCO ordered new wave-piercing design of offshore vessels (cid:337)(cid:3) Third service centre in China opened The Marine segment has 4,000 customers and equipment installed on over 25,000 vessels worldwide, including those of 70 navies. £1,048m Underlying revenue 2013 £26m Underlying profit 2013 (cid:337)(cid:3) 33 RB211s ordered for oil and gas applications (cid:337)(cid:3) Major service contract secured with Petrobras (cid:337)(cid:3) New Santa Cruz, Brazil, assembly plant operational (cid:337)(cid:3) Signed tripartite agreement with Rosatom and Fortum to assess nuclear reactor design for UK new build (cid:337)(cid:3) Renewed agreement with Westinghouse to provide nuclear inspection services in US 40% OE revenue 60% Services revenue To date, Energy has sold 4,600 gas turbines with 180 million operating hours recorded. Rolls-Royce has over 50 years of experience in the nuclear industry. POWER SYSTEMS Revenue mix 71% OE revenue 29% Services revenue £2,831m Underlying revenue 2013 £294m Underlying profit 2013 (cid:337)(cid:3) MTU Powerpacks ordered for UK Intercity Express Programme (cid:337)(cid:3) Fjord Line ordered Bergen engines for cruise ferries (cid:337)(cid:3) UK MoD selects MTU gensets alongside MT30 gas turbine (cid:337)(cid:3) Polish partnership created to supply and maintain cogeneration plants (cid:337)(cid:3) Mining trucks powered by MTU delivered to Rio Tinto in Australia Rolls-Royce Power Systems is headquartered in Germany and specialises in reciprocating engines, propulsion systems and distributed energy systems. 4 Strategic report Rolls-Royce Holdings plc annual report 2013 CHAIRMAN’S REVIEW In 2013, Rolls-Royce delivered another year of growth in underlying revenues, underlying profits and orders. The Board is proposing an increase in the final payment to shareholders of 13.4p bringing the full year payment to 22.0p. This is my first Chairman’s review. Before I joined Rolls-Royce I sensed that it would be an extraordinary privilege to serve such a great company with such a rich history. So it has proved to be. In the past nine months I have travelled widely and met a broad cross- section of colleagues, customers, suppliers and investors. All have been free with their time and open with their perspectives. I have two dominant initial impressions. The first is of the pride that people across the world have in the activities and achievements of the Group. We have a team that really does aspire to be ‘trusted to deliver excellence’ in everything it does, yet is under no illusions about what this will take. There is pride but no sense of complacency. The second impression is of opportunity. Some of our business segments face strong headwinds and there will be some inevitable volatility. But, overall, Rolls-Royce competes in markets characterised by long-term demand growth and the opportunity to add value. This is as true of the services we provide as it is of our products. These opportunities are increasingly global in nature. Rolls-Royce has a great British history but its future has to be as a great global company. In 2013, Rolls-Royce delivered another year of growth in revenues, profits and order book. This performance was achieved against a background of significant global economic and political uncertainty. The 13 per cent of increase in the payment to shareholders to 22.0 pence reflects the confidence that the Board has in the fundamentals of the business as well as in its future prospects. The increase in the payment to shareholders also recognises the importance that many of our investors place on annual cash returns. Nevertheless a key characteristic of Rolls-Royce is that it is a long-term business with technologies that take years to develop. This creates the necessity of a long-term view and for long-term investment, together with a commensurate attitude and mindset for risk. Our strategy must be directed towards creating a sustainable business. For Rolls-Royce that means driving profitable growth whilst achieving a positive economic, social and environmental impact. We will deliver better power to our customers, use innovation to secure a better future, and build on today’s achievements to develop a better business, ready to meet the challenges ahead. Research and development, and innovation more broadly, are crucial. They will become more so as we strive to improve the quality and performance of our power systems and services. The Trent XWB, for example, has proved to be the most efficient large civil aero engine in the world. Design and development of that engine started in 2006. In our Marine business, innovation and the development of liquefied natural gas (LNG) power systems has led to the possibility of a 40 per cent reduction in a ship’s CO2 emissions and the virtual elimination of sulphur and oxides of nitrogen emissions compared with conventional, diesel-powered craft. This presents a clear environmental and commercial opportunity. These innovations have also taken years to develop. We are committed to both the short-term performance and to the long-term health of the Group. It is a matter of ‘both-and’, not ‘either-or’. In my experience the most successful, most enduring organisations invest equivalent resource and imagination in the long-term health of their business as they do in their short to medium-term performance. Rolls-Royce Holdings plc annual report 2013 5 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Ian Davis Chairman In the Queen’s Birthday Honours, Michel Dubarry, Rolls-Royce International President – France, Head of Europe and Northern Africa, was awarded an OBE. In the New Year’s Honours, Hamid Mughal, Director of Manufacturing, received an OBE and my fellow Board member, Warren East, a CBE. Their recognition is well deserved and I congratulate each of them. I would also like, in closing, to acknowledge Sir Simon Robertson for his inspirational chairmanship and leadership of the Board. I am sure that, over time, I will forgive him for being such a hard act to follow. I feel honoured to have the opportunity to serve as Chairman of Rolls-Royce. We have, and will have, challenges. However, I would be disappointed if this review does not convey my deep sense of opportunity to improve both short-term performance and to build the long-term health of the Group. 2013 was a good year for Rolls-Royce and I would like to thank my colleagues for their hard work and efforts in making this happen. Ian Davis Chairman 12 February 2014 Dwelling on performance, I am totally supportive of John Rishton and the management team’s operational focus on the 4 Cs – customer, concentration, cost and cash. John describes the progress, and the continuing opportunities, of these 4 Cs in this report. I am particularly pleased at the progress in improving customer service and delivery reliability. Engineering and technology companies can have an inbuilt tendency to focus on product rather than on customer. Yet it is our customers who pay our bills and finance our investments. It is of the highest strategic and commercial importance that we deliver on our product and service commitments to our customers. Over and above the continuing need for investment, I would like to comment on a couple of themes relating to long-term health: diversity and good governance. I have remarked already on the need for Rolls-Royce to establish itself as an even more global Group. This will require us to become more diverse in our workforce and in our people development. To achieve our aspirations we have to attract, retain and develop the best talent everywhere we operate – commercial as much as engineering, female as much as male. We are making real progress. Our global apprenticeship programme enjoys world- wide renown. Our record graduate intake in 2013 includes 32 nationalities from 97 universities around the world. Additionally we continue to broaden internationally our network of University Technology Centres which are so important to our future. But more needs to be done. We can and need to do more to attract and, particularly, retain exceptional women. The engineering sector has not always been a favoured destination for well-qualified women and there may be cultural and historical reasons for this. For a Group like Rolls-Royce, this should be as much an opportunity as a problem. Purposeful diversity is an important part of our long-term planning. Fundamental to a healthy company are strong ethical standards and behaviours, supported by good governance. As John Rishton has repeatedly made clear, the Group will not tolerate improper conduct. We are striving to ensure that every single Rolls-Royce employee knows what is expected of them and understands the standards to be met. The Board and management are united in this endeavour. In particular, I will focus on ensuring that we have the appropriate governance arrangements and structures in place to reinforce the required conduct and behaviours, wherever we operate. Over recent years, the Board and management have been greatly assisted by the wise counsel of our International Advisory Board (IAB) whose membership is described on page 38. The IAB’s primary role is to provide context on political and economic developments around the world and to alert the Group to possible long-term opportunities, threats and risks. They are also available to provide counsel and support in specific areas of expertise. I am grateful to the IAB members for their contributions. I am also indebted to my fellow Board directors for their hard work and remarkable commitment to our Group as well as for their patience and good humour in dealing with the new Chairman. The Board has been augmented in January 2014 by Lee Hsien Yang and Warren East, both of whom bring a wealth of experience in global technology oriented industries. Further details of their careers are included on pages 36 and 37. I am delighted that they have joined the Group. 6 Strategic report Rolls-Royce Holdings plc annual report 2013 CHIEF EXECUTIVE’S REVIEW In 2013, Rolls-Royce continued to grow its order book and expand its portfolio. The Group increased its underlying profits, and underlying revenues. The order book increased to £71.6 billion. This performance demonstrates both the long-term demand for our products and services, and the confidence our customers place in us. We strive continually to improve quality, performance and cost. To that end we invest in innovation, infrastructure and in the global workforce upon whose ability and ambition our current and future success entirely depends. I am impressed every day by the commitment and professionalism of my colleagues around the world and I thank them for their hard work. The leaders of the Group have devoted considerable time and energy into articulating the vision, values, strategy and business priorities that we share, as well as setting out the standards of behaviours expected from everybody at Rolls-Royce. Providing clarity on these core beliefs, and making sure they are understood by everyone in the Group will enable us to better serve our customers and secure a profitable future for our employees and shareholders. Vision: better power for a changing world Values: trusted to deliver excellence Strategy: customer, innovation, profitable growth These are described in greater length on pages 8 and 9. Our business priorities in 2013 remained the same as in previous years, and have been characterised as ‘The 4 Cs’: Customer – deliver on the promises we have made Concentration – decide where to grow and where not to Cost and Cash – improve financial performance In 2013, we have made progress in all of these, although there remains much more to do. Customer It is essential that we deliver on the promises made to our customers. Across the business we have significantly improved on-time delivery. This foundational step will strengthen our customer relationships and drive more efficient use of resources, such as inventory. In Civil aerospace, on-time delivery to our wide-body customers was 100 per cent in 2013 for the first time. In 2013, major milestones were achieved in a number of important programmes. The Airbus A350 XWB flew for the first time powered by our Trent XWB engines. We have now received orders for more than 1,600 Trent XWBs, making this our best- selling Trent engine. The Trent 1000 engine, which powers the Boeing 787 Dreamliner, has achieved the best performance of any new wide-body engine entering service, with a 99.9 per cent despatch reliability. In June, it was selected by Singapore Airlines to power 50 Boeing 787 aircraft. In Marine, the first of our innovative Environships went to sea. This vessel combines a wave-piercing bow, gas-powered engines and advanced propulsion systems that together reduce CO2 emissions by 40 per cent, compared with equivalent diesel-powered vessels. Lastly, BAE Systems announced that the UK’s Type 26 Destroyer programme will feature four MTU diesel gensets from Power Systems, together with our Trent-derived MT30 gas turbines. Concentration Concentration means deciding where to invest for future growth and where not. We have two technology platforms: gas turbines and reciprocating engines. Within gas turbines, we have a strong Civil aerospace business, with over £60 billion in orders. We will continue to invest here, including in the next generation of narrow-body aircraft engines. We will also look for opportunities to expand in reciprocating engines. In 2013, we acquired Hyper-Therm HTC, a specialist ceramics company, to increase our capabilities in ceramic matrix materials that will, in the future, play a critical part in improving the performance of gas turbine engines. We also acquired a Norwegian company, SmartMotor AS, a leader in the permanent magnet technology employed in our Marine business. We integrated PKMJ Technical Services, a US-based nuclear engineering services business with expertise in extending the life of nuclear plants. Areas where we have decided not to grow include the sale of our 50 per cent holding in the RTM322 helicopter engine programme to Turbomeca, a Safran company. Rolls-Royce Holdings plc annual report 2013 7 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n John Rishton Chief Executive It is important that everyone at Rolls-Royce recognises that they are an ambassador for the Group. We have set out three common behaviours that will make sure we maintain high ethical standards, build trust with our customers and each other and help secure the long-term success of our business: win right – securing business fair and square; focus with firm resolve – decide what needs to be done, then focus relentlessly on delivery – refusing to be distracted; and communicate – simply, consistently and often. Every aspect of the Group’s performance results from the endeavours of the 55,000 men and women who share a vision of delivering ‘better power for a changing world’. It is their ingenuity and commitment alongside our continued investment in technology, that allows us to seize the opportunities that our changing world presents and to face the future with confidence. John Rishton Chief Executive 12 February 2014 Cost The highly regulated nature of the aerospace industry means that it will take both time and tenacity to drive cost out of the business, and we are still not where we need to be. However there are a number of areas where progress is being made. We reduced indirect headcount by 11 per cent, with further savings identified for 2014. Unit cost fell in Marine, Energy and Power Systems, although this was more than offset by an increase in Civil, where capacity growth has preceded volume growth and the cost per unit has predictably risen. We are building newer, more efficient facilities and capacity that will support a doubling of production of Trent engines. We are moving production away from high cost countries, and we are consolidating our supply chain. These actions will deliver benefits over time. We have prioritised investment that improves operational performance, adds to our technical capability and reduces cost. This includes a shop floor IT modernisation programme that will increase operational efficiency and an Integrated Production Systems programme that will improve delivery to customers while reducing cost. Cash The Group delivered a cash inflow of £359 million (£312 million excluding Tognum), after payments to shareholders, prior to acquisitions, disposals and foreign exchange. Inventory has been an area of significant focus. While substantially improving our on-time delivery to customers and preparing for the ramp-up in volumes, we have improved inventory turns from 3 times to 3.4 times, excluding Tognum. This is one of the largest one-year improvements in our stock turns. We continue to invest significantly to deliver our order book. In 2013, capital expenditure was £687 million (£590 million excluding Tognum and £491 million in 2012). This included two new aero-engine test facilities: one at the NASA Stennis Space Center in Mississippi, US, and the other at Dahlewitz, Germany. We have extended our global Marine services network with a new facility in Guangzhou, China. An advanced aerofoil machining facility at Crosspointe in Virginia, US, will begin production in 2014. In the UK, production has started at our new state-of- the-art fan disc factory in Washington, Tyne and Wear and we are also close to completing a new turbine blade factory in Rotherham. In January 2013, we appointed Lord Gold to lead a review of our process and procedures regarding compliance and business ethics. This followed our report to the Serious Fraud Office (SFO) of concerns about bribery and corruption involving intermediaries in overseas markets. In December, the SFO confirmed that it had begun a formal investigation into these matters. We have co-operated fully with the regulatory authorities and will continue to do so. During the year, we published a new Global Code of Conduct. Under a programme implemented in 2013, all employees are asked to certify they have: received a copy of the Global Code; read and understood it; will comply with it; and have received a management briefing. I have made it explicit that we will not tolerate improper business conduct of any sort. We have updated and re-launched our confidential reporting line for employees, now known as the Ethics Line, available 24 hours a day, to make sure that we can hear about and address any matters of concern. 8 Strategic report Rolls-Royce Holdings plc annual report 2013 OUR VISION, BUSINESS MODEL, STRATEGY AND VALUES Rolls-Royce is a global Group, providing integrated power solutions for customers in civil and defence aerospace, marine, energy and power markets. Our products work in mission-critical environments where safety is paramount. Read more on pages 14 to 23. OUR VISION OUR BUSINESS MODEL Better power for a changing world Since its earliest days, Rolls-Royce has been striving to achieve ever higher standards. Our vision is delivering ‘better power for a changing world’. Better: we will succeed only by continually raising standards. We constantly improve quality, performance and cost. We are inquisitive, energetic and ‘better’ every day. Even when we may be the best, we must continue to get better. Power: we are a power systems company that develops, sells and services mission-critical products. Our customers demand innovation that improves performance and reduces the environmental impact of our power systems. Changing world: the world around is changing rapidly and the pace of change is accelerating. New markets are emerging, shifting the balance of economic power. Regulation is, rightly, driving the requirement for cleaner power and setting new standards for business conduct. Our continuous investment in technology, our ingenuity and our commitment to excellence allow us to seize the opportunities that change presents and to face the future with confidence. OUR STRATEGY We operate in competitive markets. Our competitors are well-funded, ambitious and full of smart people. Our strategy will enable us to win by focusing on three powerful themes: customer; innovation and profitable growth. Our business model places emphasis on reducing costs so that we can generate the funds we need to deliver our vision of ‘better power for a changing world’. The business model is built around our core strategic themes of customer, innovation and profitable growth. We are a power systems company based on two technology platforms, gas turbines and reciprocating engines. Continuous investment in innovation delivers better products and services on behalf of customers. This allows us to meet their needs and grow profitably to the benefit of our shareholders. Around the core strategic themes of the model we: Grow sales for original equipment and the associated aftermarket through developing strong routes to market based on customer relationships, understanding and knowledge. Allocate capital in a disciplined way, choosing where to grow, and where not to. Reduce costs and generate cash, to enable profitable growth from our order book and the maintenance of a strong balance sheet. Fund research, development, infrastructure and future programmes. Our financial resilience and resources provide a firm foundation from which to invest. Risk and Revenue Sharing Arrangements are a particular feature of the civil aerospace sector as a means of sharing risk due to the scale of investment  required for large gas turbines. CUSTOMER Customer: placing the customer at the heart of our organisation is key. We need to listen to our customers, share ideas, really understand their needs and then relentlessly focus on delivering our promises. Rolls-Royce Holdings plc annual report 2013 9 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n OUR VALUES We say we are ‘trusted to deliver excellence’, but simply being Rolls-Royce does not give us the right to make that claim. Trust takes a long time to earn and can be lost in an instant. Trust: is earned by doing what we say we will. It demands care, consistency, courage and competence. Trust commits us to high ethical standards – it is central to who and what we are. Deliver: part of being trusted. We must deliver on our promises, meeting our customers’ requirements for quality, delivery, responsiveness and reliability, always recognising that the safety of our products and our people is paramount. Excellence: if we are trusted, and we deliver, then we will be regarded as excellent. t u r e r u c t s Customer Innovation Profitable growth d R&D an d in fr a n u F R e d u c e c o s t s , g e n e r ate cash a e c Al l o c a t G r o w s a l e s h wt p it al to new gro INNOVATION PROFITABLE GROWTH Innovation: is our lifeblood. We must continually innovate to remain competitive. To drive innovation, we create the right environment – curious, challenging, unafraid of failure, disciplined, open-minded and able to change with pace. But most importantly, we ensure our innovation is relevant to our customers’ needs. Profitable growth: by focusing on our customers, and offering them a competitive portfolio of products and services, we will create the opportunity to grow our market share. Of course we have got to make sure that we are not just growing, but growing profitably. That means ensuring our costs are competitive. We look after our cash and we win right. 10 Strategic report Rolls-Royce Holdings plc annual report 2013 CHIEF FINANCIAL OFFICER’S REVIEW Summary Order book £m Underlying revenue £m Underlying profit before tax £m Underlying earnings per share Full year payment to shareholders Reported revenue £m Reported profit before tax £m Reported earnings per share Net cash £m Average net cash/(debt) £m 2013 71,612 15,505 1,759 65.59p 22.0p 15,513 1,759 73.26p 1,939 350 Restated* 2012 60,146 12,209 1,434 59.59p 19.5p 12,161 2,766 125.38p 1,317 (145) Change +19% +27% +23% +10% +13% +28% -36% -42% * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits and the change in accounting policy for RRSAs. 2013 was another good year for the Group, with significant growth in our order book, good growth in underlying revenues and profits, coupled with a cash inflow, but as ever, there are some areas where progress has been slower than I would have liked. Our confidence in the future remains high, reflected in our increased final payment to shareholders but, as you would expect me to say, we have more to do on cost and cash across the Group to deliver the future performance implicit in this confidence. The results reflect the full consolidation of Rolls-Royce Power Systems AG (formerly Tognum AG) from 1 January 2013. Previously, Tognum was accounted for as a joint venture. Order intake in the year of £26.9 billion saw the order book grow yet again to reach record levels. This reflects £2.5 billion from Power Systems and £18.9 billion from our Civil business reflecting a very successful year for the Trent XWB. This vote of confidence from our customers gives good visibility and underpins our confidence to invest for the future. Underlying revenues and profit before tax increased by 27 per cent and 23 per cent respectively. Prior to the impact of consolidating Power Systems, underlying revenue growth was six per cent and profit advanced by 11 per cent. The 11 per cent growth in profits reflected strong margins in Defence, the benefit of the IAE International Aero Engines AG (IAE) restructuring which was executed in the middle of 2012 and a lower research and development charge against profits. Profits were adversely impacted by price pressure in our Marine business and the pace of cost reduction in our Civil business. Our largest business, Civil aerospace, was the backbone of the Group’s order increase and saw revenue grow steadily. The installed base saw more engines flying more hours. Profit benefited from the higher volumes, the new IAE trading arrangements and higher entry fees from our partners. However, our Civil profits were held back by higher unit costs where progress has lagged our expectations, but the actions we have taken in 2013 will yield savings in 2014. Defence aerospace performed very well in 2013, largely due to higher export sales and lower research and development (R&D) spend. Services held up well, albeit with some softness on flying hours of military transport aircraft. We expect a 15-20 per cent decline in both Defence revenue and profit in 2014 as we complete some major export delivery schedules. We expect original equipment revenue to decrease by 30-40 per cent due to fewer deliveries of engines to power the C130Js, V-22 Ospreys and Typhoons, as well as fewer Adour engine kits. As always, it is important to put this into perspective. Our Defence business has had two very good years of revenue and profit growth. Which means the numbers we are guiding for in 2014, bring us back only to 2011 revenue levels, and we expect growth again in 2015. Marine’s offshore and merchant markets continue to see intense competition driven by overcapacity and price pressure. This affected the order intake during the year that sees order cover for 2014 at a lower level than we started 2013. In this challenging environment, we made some good progress on cost, but have more to do if we are to compete more effectively. Our Naval business remains stable. Energy saw some improvement in 2013 and we continue to work hard to improve further its financial performance. Power Systems delivered a very strong second half performance, contributing £2.6 billion to revenue in 2013 (nil in 2012) and an underlying profit before tax of £257 million (2012 £77 million). We are very pleased with Power Systems and it remains a key part of our desire to go to market via two strong technology platforms: gas turbines and reciprocating engines. Our cost base can be broadly split between 85 per cent relating directly to our delivered product, ten per cent indirect (commercial and administration) and five per cent on R&D. We continue to push hard on product cost as we work with the internal and external supply chains and although Civil unit costs increased in 2013, we did realise improvements in Marine and Energy. We expect to see progress across all our segments in 2014. In terms of indirect cost, we achieved our objectives to reduce headcount by 11 per cent, primarily through voluntary severance arrangements. After taking into account the related restructuring costs during the year, the benefits to this reduction will be seen in future years. We were pleased with the cash inflow of £359 million at Group level, prior to acquisitions, disposals and foreign exchange, which included an inflow of £47 million from Power Systems. Net working capital improved slightly, reflecting a good second half performance on inventory and higher deposits, mainly in Civil, flowing from the order intake. We made good progress on inventory, improving turns from 3 to 3.4 times (excluding Power Systems), helped by a consistent focus in the second half of the year. Cost and cash remain areas of intense focus going forward. In terms of financial reporting, please note the following: 1. To better align our reporting structure with our organisation, going forward we will report as: Aerospace and Marine & Industrial Power Systems (MIPS). Aerospace comprises Civil aerospace and Defence aerospace. MIPS comprises our Marine, Power Systems, Energy and Nuclear businesses. Our Nuclear Submarines business will be reported within Energy and Nuclear. We will continue to report the same level of financial detail for our business segments as we normally do. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 11 2. Consistent with past practice and IFRS accounting standards, the Group provides both reported and underlying figures. We believe underlying figures are more representative of the trading performance, by excluding the impact of year end mark-to-market adjustments, principally the GBP/USD hedge book. In addition, post-retirement financing and the effects of acquisition accounting are excluded. The adjustments between the underlying income statement and the reported income statement are set out in more detail in note 2 to the financial statements. This basis of presentation has been applied consistently since the transition to IFRS in 2005. 3. The Group has changed its accounting policy in respect of entry fees arising from Risk and Revenue Sharing Arrangements (RRSAs) following discussions with the Conduct Committee of the Financial Reporting Council (FRC). This is covered further in note 1 to the financial statements. RRSAs with key suppliers are a feature of our Civil aerospace business. Under these arrangements the workshare partner shares in the risks and costs of developing an engine and during the production phase, supplies components and receives a share of the programme revenues over the life of the engine programme. The share of development costs borne by the workshare partner and of the revenues it receives reflect the proportionate forecast cost of providing their parts compared to the overall forecast manufacturing cost of the engine. The contribution to the development costs is achieved by the workshare partner performing their own development work, providing parts in the development phase and paying a non-refundable cash entry fee, such that both parties bear their proportionate share of the forecast non- recurring development costs. Historically, we recognised the entry fee as income when received, which we believed matched it to the recognition of non- recurring development costs incurred on behalf of the workshare partner. However, this did not take account of the fact that we capitalise some of our non-recurring development costs. Therefore, where we capitalise those costs, we will now defer the equivalent portion of the entry fee received and recognise it as the related costs are amortised in the production phase. As required by Adopted IFRS, we have made this change retrospectively; the impact of the change in policy in 2012 has been to increase profit before tax by £25 million and to reduce net assets at 31 December 2011 and 2012 by £184 million and £170 million respectively. Had the policy not been amended, profit before tax in 2013 would have been £39 million higher and at 31 December 2013 net assets £208 million higher. Adopted IFRS does not explicitly deal with payments of this nature from suppliers and so, in developing an accounting treatment for entry fees that best reflects the commercial objectives of the contractual arrangement, we have analysed key features of RRSAs in the context of relevant accounting pronouncements and have had to weigh the importance of each feature in faithfully representing the overall commercial effect. Consequently this is a judgemental area. The judgements we have taken in respect of this matter are set out in detail in note 1 to the financial statements. In summary, our view is that the Mark Morris Chief Financial Officer development and production phases of the contract should be considered separately in accounting for the RRSA, which results in the entry fee being matched against the non-recurring development costs as described above. The FRC Conduct Committee’s view is that the RRSA contract cannot be divided into separate development and production phases, as the fees and development components received by the Group during the development phase are exchanged for the obligation to pay the supplier a pre- determined share of any sales receipts during the production phase. On this basis the entry fees received would be deferred in their entirety and recognised over the period of production. The FRC Conduct Committee has confirmed that, in view of the change to the policy and the additional disclosure we have made, it does not intend to pursue its consideration of this accounting policy further. We will keep the size of the difference under review, and do not currently expect the difference between the two approaches to become material in the foreseeable future. We consider that the policy we have adopted best reflects the commercial effect of the agreements and is in accordance with Adopted IFRS. So far as we can tell, it is also aligned with the approach taken by others in our industry under both IFRS and US accounting standards (which we believe does not conflict with IFRS in this regard). The impact of the different approaches on profit before tax and net assets is as follows: Reported profit before tax £m 1,798 (39) 1,759 (37) 1,722 2013 Underlying profit before tax £m 1,798 (39) 1,759 (37) 1,722 Net assets £m 6,511 (208) 6,303 (365) 5,938 Reported profit before tax £m 2,741 25 2,766 (10) 2,756 2012 Underlying profit before tax £m 1,409 25 1,434 (10) 1,424 Net assets £m 6,166 (170) 5,996 (323) 5,673 Previous policy Difference Adopted policy Difference Alternative policy 1 1 Consistent with FRC Conduct Committee’s view 12 Strategic report Rolls-Royce Holdings plc annual report 2013 CHIEF FINANCIAL OFFICER’S REVIEW Underlying revenue increased £3.3 billion to £15.5 billion, of which £2.6 billion was due to the inclusion of Rolls-Royce Power Systems AG (RRPS) from 1 January 2013. The remaining increase (six per cent) reflects a seven per cent growth in OE revenue and a four per cent increase in services revenue. Original equipment performance included growth of 21 per cent in Energy, 13 per cent in Defence aerospace and 12 per cent in Marine. Underlying services revenue continues to represent around half (47 per cent) of the Group’s underlying revenue. In 2013, services revenue grew in all businesses, as the installed base of products continued to grow and the services network expanded. Underlying profit before financing and taxation increased 22 per cent to £1.8 billion, including £190 million from the consolidation of RRPS from 1 January 2013. Excluding RRPS, the increase was due to a number of factors: increased revenue; continued strong margins in Defence aerospace and the restructured relationship with IAE. Further discussion of trading is included in the business segment reports on pages 14 to 23. Underlying financing costs increased 18 per cent to £72 million, including £10 million from RRPS. Underlying taxation was £434 million, an underlying tax rate of 24.7 per cent compared with 22.1 per cent in 2012. The Group’s tax payments are described on page 137. Underlying EPS increased 10 per cent to 65.59 pence, lower than the increase in the underlying profit after tax due to the NCI share of RRPS. Payments to shareholders: at the AGM on 1 May 2014, the directors will recommend an issue of 134 C Shares with a total nominal value of 13.4 pence for each ordinary share. Together with the interim issue on 2 January 2014 of 86 C Shares for each ordinary share with a total nominal value of 8.6 pence, this is the equivalent of a total annual payment to ordinary shareholders of 22.0 pence for each ordinary share. Further details are on page 43. Net underlying R&D charged to the income statement increased by 18 per cent to £624 million including £174 million from RRPS, reflecting a combination of increased spend of £33 million offset by higher net capitalisation of £61 million (due to the phasing of major new programmes, in particular the certification of the Trent XWB 84k), R&D tax credits of £28 million and net deferral of RRSA entry fees of £26 million. The Group continues to expect net R&D investment to remain within four to five per cent of Group underlying revenue. Reported profit before tax has reduced from £2,766 million to £1,759 million. In addition to the changes in underlying profit before tax described above, reported profit before tax has been affected by (i) the impact of mark-to-market adjustments on derivative contracts (£497 million reduction); (ii) the impact of consolidating RRPS (£322 million reduction, comprising the unrealised profit on reclassification to a subsidiary, the additional amortisation on recognised intangible assets and the revaluation of the put option on NCI); (iii) the net impact of disposals (£483 million reduction, disposal of RTM322 in 2013 more than offset by the restructuring of IAE in 2012); and (iv) the cost of providing discretionary pension increases (£64 million). The reported tax charge is affected by the related tax impact of these items and the reduction of tax rates in the UK. This is set out in more detail in note 2 to the financial statements. Intangible assets (note 9) represent long- term assets of the Group. These assets increased by £121 million with additional development, certification and software costs being largely offset by annual amortisation charges. 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 significant impairments in 2013. Property, plant and equipment increased by £283 million due to the ongoing development and refreshment of facilities and tooling as the Group prepares for increased production volumes. Net post-retirement scheme deficits (note 19) reduced by £100 million as a result of adopting the amendments to IAS 19. During the year, the net deficit fell by £49 million, principally due to the movements in the assumptions used to Underlying income statement £ million Revenue Civil aerospace Defence aerospace Marine Energy Power Systems Intra-segment Profit before financing and taxation Civil aerospace Defence aerospace Marine Energy Power Systems Intra-segment Central costs Net financing Profit before taxation Taxation Profit for the year EPS Payments to shareholders Other items Gross R&D investment Net R&D charged to the income statement 2013 15,505 6,655 2,591 2,527 1,048 2,831 (147) 1,831 844 438 281 26 294 2 (54) (72) 1,759 (434) 1,325 65.59p 22.0p 1,118 624 Restated* 2012 12,209 6,437 2,417 2,249 962 287 (143) 1,495 743 395 294 19 109 (11) (54) (61) 1,434 (317) 1,117 59.59p 19.5p 919 531 Change +27% +3% +7% +12% +9% +886% +22% +14% +11% -4% +37% +170% -18% +23% -37% +19% +10% +13% +22% +18% * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits and the change in accounting policy for RRSAs. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 13 value the underlying assets and liabilities in accordance with IAS 19. This reduction in the deficit was after agreeing to fund additional pension increases in the Rolls-Royce Pension Fund, where there is no indexation for pre-1997 service, at a cost of £64 million. 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, and the exposure to equities is around 11 per cent of scheme assets. The Group’s funding of its defined benefit schemes is expected to increase modestly in 2014, largely as a result of funding the discretionary benefits. Net funds increased by £0.6 billion to £1.9 billion due in part to the £250 million proceeds received on the sale of the Group’s interest in the RTM322 engine. Average net funds were £350 million. Investments in joint ventures and associates increased by 15 per cent, largely as a result of retained profits in existing joint ventures. Provisions largely relate to warranties and guarantees provided to secure the sale of OE and services. Net financial assets and liabilities relate to the fair value of foreign exchange, commodity and interest rate contracts, financial RRSAs and the put option on the NCI of Rolls-Royce Power Systems Holding GmbH, set out in detail in note 17. The change largely reflects the inclusion of the put option. There is also an impact of the change in the GBP/USD exchange rate on the valuation of foreign exchange contracts and the movement in put options on NCI of £259 million. The USD hedge book increased ten per cent to US$24.7 billion. This represents around four years of net exposure and has an average book rate of £1 to US$1.59. Net TotalCare® assets relate to Long-Term Service Agreement (LTSA) contracts in the Civil aerospace business, including the flagship services product TotalCare. These assets represent the timing difference between the recognition of income and costs in the income statement and cash receipts and payments. Balance sheet £ million Intangible assets Property, plant and equipment Net post-retirement scheme deficits Net working capital Net funds Provisions Net financial assets and liabilities Joint ventures and associates Other net assets and liabilities Net assets Other items USD hedge book (US$ billion) TotalCare assets 1 TotalCare liabilities 2 Net TotalCare Assets Gross customer finance contingent liabilities Net customer finance contingent liabilities 1 January 2013 including Power Systems 4,866 3,109 (842) (819) 1,354 (741) (154) 523 (515) 6,781 Restated* 31 December 2012 2,901 2,564 (445) (1,321) 1,317 (461) (127) 1,800 (232) 5,996 22.5 1,629 (317) 1,312 569 70 2013 4,987 3,392 (793) (970) 1,939 (733) (1,587) 601 (533) 6,303 24.7 1,901 (314) 1,587 356 59 * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits and the change in accounting policy for RRSAs. 1 Included in amounts recoverable on contracts (note 13). 2 Included in accruals and deferred income (note 16). Customer financing facilitates the sale of 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 18. 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 2013, the Group’s gross exposure reduced by £213 million to £356 million, due largely to the expiry of guarantees. On a net basis, exposures reduced by £11 million. Segmental reporting During 2013, we have revised the internal structure of the business to focus on (i) aerospace; and (ii) marine and industrial markets. The internal reporting structure has been developed to reflect this. Consequently, in accordance with IFRS 8 Operating Segments, from 1 January 2014, we will report the Group’s segments as follows: Aerospace, comprising Civil aerospace and Defence aerospace; and Marine and Industrial Power Systems, comprising Marine, Power Systems, Energy and Nuclear. The 2013 figures on the revised basis are included in note 26 to the financial statements. Group 2014 guidance For the full year 2014, we expect underlying Group revenue and profit to be flat. This reflects a significant decline in Defence revenue, as we complete the delivery phase of a number of major export programmes. Additionally, the largest part of our Marine business, Offshore, will generate lower revenue in 2013. We expect growth to resume in 2015 as Civil and Defence deliveries increase. We expect profitability to be much stronger in the second half of 2014, reflecting the timing and mix of trading and cost reduction. To be more consistent with market practice, our cash guidance in the future will be based on free cash flow. We expect our 2014 free cash flow to be similar to 2013 (£781 million). Additional financial information can be found on pages 137 and 138. 14 Strategic report Rolls-Royce Holdings plc annual report 2013 CIVIL AEROSPACE We remain focused on delivering on all of our major programme commitments. Tony Wood President – Aerospace OVERVIEW Underlying revenue (£m) 4,481 4,919 5,572 6,437 6,655 2009 2010 2011 2012 2013 £6,655m Underlying revenue 2013 Revenue mix 2013 Revenue by sector 2013 46% OE revenue 54% Services revenue 57% Wide-body 32% 11% Narrow-body Corporate and regional S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 15 Highlights (cid:337)(cid:3) First flight of the Airbus A350 XWB powered by Trent XWB engines Key financial data Order book £m* (cid:337)(cid:3) First flight of the Boeing 787-9 powered by Trent 1000 engines Engine deliveries* Underlying revenue £m (cid:337)(cid:3) Major new Trent orders from JAL, IAG, Lufthansa, United, Singapore and Etihad (cid:337)(cid:3) Delivered the 3,000th BR700 series engine Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m 2009 47,102 +8% 844 4,481 0% 1,855 2,626 493 -13% 2010 48,490 +3% 846 4,919 +10% 1,892 3,027 392 -20% 2011 51,942 +7% 962 5,572 +13% 2,232 3,340 499 +27% 2012 49,608 -4% 668 6,437 +16% 2,934 3,503 743 +49% 2013 60,296 +22% 753 6,655 +3% 3,035 3,620 844 +14% * all years before 2012 include IAE order book and engine deliveries include IAE V2500. Rolls-Royce powers more than 30 types of commercial aircraft and has almost 13,000 engines in service around the world. What we do The Civil aerospace segment is a major manufacturer of aero engines for the airliner and corporate jet markets. We have particular strengths in the wide-body market where Rolls-Royce has a 54 per cent share of aircraft on order. Demand for our products and services remains robust. 2013 financial review The order book increased 22 per cent, including new orders of £18.9 billion (£10.3 billion in 2012). Trent engines and aftermarket services now constitute 73 per cent of the Civil aerospace order book. Revenue increased three per cent, including three per cent growth in OE revenue. There was a 20 per cent increase in business jet engine deliveries and a small increase in Trent engines. Profit increased 14 per cent, reflecting higher volumes, the £112 million higher benefit from the restructured trading relationship with IAE and £26 million higher RRSA entry fees. In 2014, we expect modest growth in revenue and good growth in profit. How we are performing The airline industry saw global passenger traffic up around five per cent in 2013. Airlines in developed markets benefited from a modest economic recovery. In many developing markets there were significant increases in traffic supported by economic growth and market liberalisation. Civil Large Engines: Nearly 1,400 Trent 700 engines for the Airbus A330 have been delivered to date and during 2013 Airbus delivered the 1,000th aircraft. The milestone aircraft and its Trent 700 engines were accepted by Cathay Pacific, the first airline to put the Trent 700 into service in 1995. Important milestones were achieved in two major Civil Large Engine programmes. In June, the first flight of the new Airbus A350 XWB was powered by our Trent XWB engines. Then in September, the Boeing 787-9 version of the Dreamliner took to the skies for the first time, powered by our Trent 1000 engines. Singapore Airlines Group placed a major order with us to power 50 Boeing 787 aircraft with Trent 1000 engines. In July, we celebrated the first delivery of two new Rolls-Royce powered aircraft to the British Airways fleet – the Airbus A380 and the Boeing 787 Dreamliner. In September, we announced that, due to the current regulatory environment, we would not proceed with a planned joint venture with United Technologies Corporation to develop an engine to power future mid-size aircraft. Rolls-Royce remains fully committed to this important market segment and we continue to invest in technologies that will enable us to take advantage of opportunities as they arise. The Trent XWB will enter service in 2014 with Qatar Airways. This is the best-selling Trent engine yet, with more than 1,600 engines already on order. Significant orders for the Trent XWB came from airlines in Europe, North America, the Middle East and Asia and these included a landmark first ever engine order for Rolls-Royce from Japanese airline JAL. Corporate and regional: In our corporate and regional engine business, we delivered the 3,000th BR700 series engine. This engine series powers the Gulfstream G500 and G550, the Bombardier Global 5000 and Global 6000 (BR710), the Boeing 717 (BR715) and the Gulfstream G650 (BR725). The first production version of the Cessna Citation X business jet flew in August, powered by our AE 3007C engines. Deliveries of the new aircraft are due to begin in early 2014. Services: Revenue from services for civil airliners increased by three per cent in 2013, reflecting continued growth in the fleet of widebodied engines. More than 1,100 aircraft in service are covered by TotalCare. Some 1,500 business aircraft are covered by CorporateCare® and in 2013 more than 70 per cent of customers for new Rolls-Royce powered business jets enrolled in CorporateCare. Future priorities and opportunities In 2014, particular priority will be given to supporting the smooth entry into service of the Airbus A350 XWB. Rolls-Royce is the sole engine supplier for this new aircraft, and orders for the Trent XWB represent 53 per cent of the Civil aerospace order book. Significant management attention will continue to be paid to financial performance, in particular reducing costs and improving inventory turn. Developing new technology for future engine programmes and enhancing existing products remains a major priority. Market outlook: We estimate that the global civil engine market will be worth approximately US$1,750 billion over the next 20 years, with US$1,050 billion being for original equipment and US$700 billion of aftermarket services. Over half of this value comprises engines for twin aisle airliners and large business jets, where Rolls-Royce is currently the number one engine supplier in terms of market share. Our forecasts are based on our own internal forecasting tools, data from Ascend Online Fleets and airline schedules from Official Airline Guide (OAG). 16 Strategic report Rolls-Royce Holdings plc annual report 2013 DEFENCE AEROSPACE We are focused on managing costs to ensure we can effectively compete and win in today’s challenging market. Tom Bell President – Defence aerospace OVERVIEW Underlying revenue (£m) 2,010 2,123 2,235 2,417 2,591 2009 2010 2011 2012 2013 £2,591m Underlying revenue 2013 Revenue mix 2013 Revenue by sector 2013 50% OE revenue 46% Services revenue 4% Development 38% Combat 48% Transport 14% UAV/trainer S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 Highlights (cid:337)(cid:3) TP400-powered A400M entered service (cid:337)(cid:3) MissionCare contract for Saudi Arabian EJ200 engines secured (cid:337)(cid:3) 1,500th AE 2100 engine delivered (cid:337)(cid:3) Upgraded AE 1107 engines for V-22 Osprey (cid:337)(cid:3) T56 enhancement kits gained first sales (cid:337)(cid:3) Delivered 40th Rolls-Royce LiftFan for F-35B Lightning II fighter programme (cid:337)(cid:3) RTM322 helicopter engine programme sold to Turbomeca Key financial data Order book £m Engine deliveries Underlying revenue £m Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m 2009 6,451 +17% 662 2,010 +19% 964 1,046 253 +13% 2010 6,506 +1% 710 2,123 +6% 1,020 1,103 309 +22% 2011 6,035 -7% 814 2,235 +5% 1,102 1,133 376 +22% 2012 5,157 -15% 864 2,417 +8% 1,231 1,186 395 +5% 17 2013 4,071 -21% 893 2,591 +7% 1,385 1,206 438 +11% We are the second largest provider of defence aero-engine products and services globally, with around 16,000 engines in service with over 160 military customers in more than 100 countries. What we do Our engines power aircraft in every major market sector including transport, combat, patrol, trainers, helicopters, and unmanned aerial vehicles. 2013 financial review The Defence order book declined 21 per cent (15 per cent decrease in 2012) reflecting continued budgetary pressures on our major customers. The net order intake of £1.6 billion was five per cent higher than the previous year. Revenue increased seven per cent, reflecting a 13 per cent increase in OE and a two per cent increase in services. Strong OE growth was driven by higher export sales, particularly of our EJ200 and Adour engine programmes. Profit increased 11 per cent due to higher volumes and lower R&D spending. In 2014, we expect a decline in revenue and profit of between 15-20 per cent before growth resumes in 2015. This one year decline is the consequence of well publicised cuts in defence spending among major customers, and the completion of the delivery phase of a number of major export programmes. After two record years, this re-basing, supported by cost reduction programmes, will position the business well for future growth. How we are performing 2013 was a challenging year as traditional markets continued to experience unprecedented budgetary pressures. While this environment creates risks for existing business, it also presents opportunities for us to develop innovative solutions to meet the evolving needs of our customers. Nowhere is this more evident than in the area of services where we have the opportunity to help customers manage their budgets and costs more efficiently. We also continue to pursue new equipment sales opportunities in global markets such as Asia and the Middle East where budgets are less constrained. MissionCare contracts worth £492 million were secured in 2013. These included the first MissionCare contract for the support of EJ200 engines in Saudi Arabia. In order to get closer to our customers, we are expanding our presence at operational bases. During 2013, we opened a new support facility at RAF Marham in the UK and announced another at Tinker Air Force Base in the US. In-service fleets continue to benefit from technology enhancements, with the upgraded AE 1107 now providing 17 per cent more power for the V-22 Osprey aircraft. The latest T56 enhancement kits achieved Federal Aviation Authority (FAA) certification and recorded their first sales in the US, where fuel savings in the US Air Force C-130 fleet could amount to billions of dollars. Our leading position in transport was underpinned by the entry into service of the A400M powered by TP400 engines, broadening our portfolio in a market where the Rolls-Royce powered C-130 is the leading player. This year we delivered our 1,500th AE 2100 engine for the C-130J. The Rolls-Royce LiftSystem® continued to perform well as the F-35B Lightning II aircraft expanded its flight test programme and deliveries to the US Marine Corps accelerated. We delivered the 40th Rolls-Royce LiftFan and the 50th 3 Bearing Swivel Module (3BSM). In order to concentrate our resources on markets where we can add greatest value, we sold our share in the RTM322 helicopter engine programme to Turbomeca, a Safran company, in September 2013. To further improve efficiency, we have reconfigured our organisation to bring us closer to our major customers. We expect our services business to continue to grow as we continue to provide customers with greater capability. Future priorities and opportunities We are focused on managing costs to ensure we maximise our ability to compete and win in an increasingly uncertain market. Our inclusion in the Hawk Advanced Jet Training System team to pursue the US Air Force T-X training contract provides just one of several paths to growth. Customers also continue to invest in their transport aircraft fleets, where we have a strong position. Defence applications for the Trent 700 should increase as the Airbus A330 tanker aircraft is selected by more military customers. The UK’s fleet of tankers continues to expand with Rolls-Royce benefiting both as the engine supplier and as an AirTanker shareholder. Market outlook: We estimate a business opportunity over the next 20 years of US$155 billion in original equipment and US$260 billion in services. Source: Forecast International 2014. 18 Strategic report MARINE Rolls-Royce Holdings plc annual report 2013 Innovation remains an important differentiator in the sector, as technology will address the future challenges related to the environment and the cost of owning and running vessels. Lawrie Haynes President – Marine and Nuclear OVERVIEW Underlying revenue (£m) 2,589 2,591 2,271 2,249 2,527 2009 2010 2011 2012 2013 £2,527m Underlying revenue 2013 Revenue mix 2013 Revenue by sector 2013 57% OE revenue 43% Services revenue 37% Naval 15% Merchant Offshore 48% S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 Highlights (cid:337)(cid:3) A range of world ‘firsts’ of LNG-powered vessel types delivered Key financial data Order book £m (cid:337)(cid:3) MT30 selected for the new UK MoD Underlying revenue £m Type 26 Frigate (cid:337)(cid:3) £800 million contract agreed with UK MoD for provision of future nuclear submarine propulsion systems (cid:337)(cid:3) New UT 830 seismic survey vessel launched (cid:337)(cid:3) COSCO ordered new wave-piercing design of offshore vessels (cid:337)(cid:3) Third service centre in China opened Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m * 2011 figures restated due to transfer of Bergen to Power Systems segment. 2009 3,526 -32% 2,589 +17% 1,804 785 263 +44% 2010 2,977 -16% 2,591 +0% 1,719 872 332 +26% 2011* 2,737 -8% 2,271 -12% 1,322 949 287* -14% 2012 3,954 +44% 2,249 -1% 1,288 961 294 +2% 19 2013 3,996 +1% 2,527 +12% 1,438 1,089 281 -4% The Marine segment has 4,000 customers and equipment installed on over 25,000 vessels worldwide, including those of 70 navies. What we do We are leaders in the provision and integration of complex, mission-critical systems for offshore oil and gas, merchant and naval vessels. We are located in 35 countries, and have a global service network supporting our customers’ operations around the clock. Our advanced ship designs combine the latest technologies to offer highly-efficient solutions for ship owners and operators including a range of engines using liquefied natural gas (LNG). 2013 financial review The order book increased one per cent including new orders of £2.7 billion (£3.3 billion in 2012). In 2013, we saw stable order inflow in our Merchant and Naval businesses. This was offset by weaker order flow in Offshore, where the phasing of projects has slowed growth in some of our key products. Revenue increased 12 per cent, reflecting higher sales in both new equipment and in services. Growth was particularly strong in Offshore and in Naval, offset by further weakening in our Merchant business, which declined 11 per cent. Profit decreased four per cent as volume growth was more than offset by pricing pressure and a less favourable mix. In 2013, profitability was also offset by investments in Marine to better position the business for future growth, including higher spending on R&D and restructuring costs. In 2014, we expect a modest decline in revenue, with a modest increase in profit. The nuclear submarine business will be reported in the Energy and Nuclear segment going forward. How we are performing The global shipbuilding industry has had a challenging year. Important factors driving the market continue to be ship efficiency, environmental performance and value for money. Merchant: The adoption of LNG as a marine fuel is gaining momentum: the first LNG-powered cargo vessel of our Environship design took to the seas in May; the world’s first LNG-powered cruise ferry entered service during the summer; and the world’s first LNG-powered tug boat was delivered. We also won our first contract to convert a diesel-powered cargo ship to LNG. Bergen engines using LNG fuel are all provided via the Power Systems business segment. Naval: Our MT30 gas turbine was successfully installed in the Royal Navy’s new aircraft carrier, HMS Queen Elizabeth. The MT30 was also selected by BAE Systems for the UK’s new Type 26 Frigate programme and has now been selected by navies in the UK, US and South Korea, across five types of ship. We delivered a new design of water jet to the US Navy’s Littoral Combat Ship programme. This year we opened a new facility in Derby, UK, to support our Submarine business. In February, we agreed an £800 million contract with the MoD for the provision of nuclear propulsion systems for the UK’s submarine flotilla. A critical design gate was successfully passed by our new nuclear plant design, PWR 3. Offshore: We delivered one of our most advanced vessels to date, when a UT 830 seismic survey ship was launched. It features a wealth of Rolls-Royce equipment integrated into our own vessel design. It is now at work identifying oil and gas reserves around the world. Our wave-piercing hull design was chosen for the first time in Asia, when Chinese customer COSCO announced an order for two UT vessels, with options for four more. These will feature a range of Rolls-Royce equipment, and include MTU diesel gensets from our Rolls-Royce Power Systems AG subsidiary. Several contracts were won to supply our largest azimuth thrusters for drill ships. We enhanced our technology portfolio through the acquisition of a Norwegian company, SmartMotor AS, a leader in permanent magnet technology. Services: We offer customers a global service capability through a network of 37 workshops in 28 countries. With more than 1,100 service engineers, we provide round- the-clock support wherever our customers need it and offer not only repair and overhaul but also a growing number of vessel upgrades to improve efficiency. We also train our customers in the operation of our equipment in our training centres in Norway, Singapore and Brazil. This year, we opened our third workshop in southern China. Future priorities and opportunities The key priorities for the Marine segment are to increase our competitiveness in a challenging market and continue to develop innovative technologies. We will continue to develop the synergies between the Marine and Power Systems segments. We are working with a number of oil majors, in developing the availability of LNG. The aftermarket offers growth opportunities as we continue to utilise our growing global network of service engineers and workshops. In Submarines, our focus is on maintaining customer confidence by achieving our savings commitment to the MoD through increased operational efficiency. Market outlook: We see a business opportunity over the next 20 years of US$270 billion for original equipment and US$125 billion for services (not including nuclear submarine business). Based on our own forecasting tools. 20 Strategic report ENERGY Rolls-Royce Holdings plc annual report 2013 We are capitalising on oil and gas demand. We will also grow our Civil Nuclear services globally and support the UK new build programme. Andrew Heath President – Energy OVERVIEW Underlying revenue (£m) 1,233 1,028 1,083 962 1,048 2009 2010 2011 2012 2013 £1,048m Underlying revenue 2013 Revenue mix 2013 Revenue by market sector 2013 40% OE revenue 60% Services revenue 68% Oil and gas 21% Power generation Civil Nuclear/other 11% S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 Highlights (cid:337)(cid:3) 33 RB211s ordered for oil and gas applications (cid:337)(cid:3) Major service contract secured with Petrobras (cid:337)(cid:3) New Santa Cruz, Brazil, assembly plant operational (cid:337)(cid:3) Signed tripartite agreement with Rosatom and Fortum to assess nuclear reactor design for UK new build (cid:337)(cid:3) Renewed agreement with Westinghouse to provide nuclear inspection services in the US Energy has sold 4,600 gas turbines with 180 million operating hours recorded. Rolls-Royce has over 50 years of experience in the nuclear industry. What we do Our Energy segment supplies customers with aero-derivative gas turbines, compressors and related services. In Civil Nuclear, we provide products and services spanning the nuclear reactor life-cycle from concept design and installation to obsolescence management and plant life extension. We have a strong position in nuclear instrumentation and control systems. 2013 financial review The order book increased by 14 per cent with new orders of £1.1 billion (£0.8 billion in 2012). The business saw a strong recovery in order intake in oil and gas. Power generation markets remain suppressed. In Civil Nuclear, we continue to extend the suite of products and services that we offer to nuclear utilities to enable them to achieve safe, efficient and reliable lifetime reactor operations. Revenue increased nine per cent, driven by higher OE volumes in our oil and gas business. Profit increased by £7 million, reflecting higher volumes, partially offset by strong pricing pressure and continued investment in our Civil Nuclear business. We continue to work to improve the financial performance of the business. In 2014, Energy will include nuclear submarines to form our Energy and Nuclear business. We expect good growth in revenue and profit, with further improvement in the return on sales. Key financial data Order book £m Engine deliveries Underlying revenue £m Underlying OE revenue £m Underlying service revenue £m Underlying profit before financing £m 2009 1,262 +1% 87 1,028 +36% 558 470 24 +1300% 2010 1,180 -6% 95 1,233 +20% 691 542 27 +13% 2011* 1,420 +20% 48 1,083 -12% 527 556 16 -41% 2012 1,290 -9% 49 962 -11% 344 618 19 +19% 21 2013 1,469 +14% 56 1,048 +9% 415 633 26 +37% * 2011 figures restated due to transfer of Bergen to Power Systems segment. How we are performing Oil and gas: In total, 33 RB211 gas turbines were ordered for oil and gas applications, 22 of which were for pipeline compression projects. This includes a US$175 million contract from Asia Gas Pipeline for 12 units. We continued to deliver the instrumentation and control (I&C) upgrade for EDF’s fleet of 1,300MW nuclear reactors in France and provided I&C systems and components for seven new nuclear reactors currently under construction in China. Our new purpose-built packaging, assembly and test facility in Santa Cruz, Brazil, became operational and the first units were delivered to Petrobras for use in its deepwater offshore production activities. Power generation: Demand continued to be subdued for new power generation capacity in mature economies. Seven Trent 60 units were ordered, including five for the SARB offshore oilfield project in the UAE. We released enhanced power ratings for the Trent 60 gas turbine, consolidating its position as the most powerful aero derivative available. Services: We continue to strengthen both our aftermarket products and services capability as well as our penetration of the installed fleet, resulting in a six per cent year-on-year increase in aftermarket revenue. Currently 24 per cent of the core engine fleet is under long-term service agreements. During the year we received several new major service contracts including a US$138 million five-year contract from Petrobras to support 15 of its RB211 industrial gas turbine power generation units installed on four oil platforms operating in the Campos Basin. Civil Nuclear: We strengthened our strategic relationships during the year with AREVA, Westinghouse, Hitachi, EDF and Rosatom. Our acquisition of PKMJ Technical Services in the US means we now provide services to every nuclear utility in the US and Canada. Future priorities and opportunities Our focus is on growing our market position in oil and gas, including opportunities in pipelines and LNG. In power generation, we will benefit from any recovery in industrial demand for electricity. In Civil Nuclear our priorities will continue to be satisfying our customers, winning new orders and high-quality delivery. Improving operational efficiency will be a key feature for the Nuclear business during 2014. We will assess potential investments in high-value manufacturing in order to contribute positively to a successful new build programme for the UK. In international markets, we will extend the suite of products and services that we offer to nuclear utilities to enable them to achieve safe, efficient and reliable lifetime nuclear reactor operations. Market outlook: In the oil and gas, and power generation sectors, the Group’s 20-year forecast values demand for total aero-derivative gas turbine and compressor systems at more than US$60 billion and associated services at around US$60 billion. Sources: McCoy Power reports, LEK Consulting, Booz & Co., IEA, Infield Systems and our own forecasting tools. We estimate a demand for nuclear mission-critical equipment, systems, engineering and support services of US$610 billion over the next 20 years. Based on nuclear capacity forecasts from the International Energy Agency, the World Nuclear Association, the International Atomic Energy Agency and the US Department of Energy. 22 Strategic report Rolls-Royce Holdings plc annual report 2013 POWER SYSTEMS 2013 proved a challenging year. However, in 2014 we expect most markets to stabilise. John Paterson President – Marine and Industrial Power Systems OVERVIEW Underlying revenue (£m) 2,846 2,831 2012 2013 £2,831m Underlying revenue 2013 Revenue mix 2013 Revenue by market sector 2013 71% OE revenue 29% Services revenue 35% Marine 26% Industrial 27% Energy 12% Defence and other S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 23 Highlights (cid:337)(cid:3) MTU Powerpacks ordered for UK Intercity Express Programme (cid:337)(cid:3) Fjord Line ordered Bergen engines for cruise ferries (cid:337)(cid:3) Upgraded Series 1163 engines introduced (cid:337)(cid:3) UK MoD selects MTU gensets alongside MT30 gas turbine (cid:337)(cid:3) Polish partnership to be created to supply and maintain cogeneration plants (cid:337)(cid:3) Mining trucks powered by MTU delivered to Rio Tinto in Australia Rolls-Royce and Daimler AG each has a 50 per cent shareholding in Rolls-Royce Power Systems Holding GmbH. Power Systems is based in Friedrichshafen in Southern Germany and, together with its worldwide subsidiaries, employs around 11,000 people. It specialises in reciprocating engines, propulsion systems and distributed energy systems. The company previously operated under the name of Tognum AG. In 2013, Bergen Engines AS, including its subsidiaries, was contributed to the business. What we do The product portfolio includes MTU-brand high-speed engines and propulsion systems for ships, for heavy land, rail and defence vehicles, and for the oil and gas industry. Under the MTU Onsite Energy brand, the company markets diesel and gas gensets for applications such as emergency, base load, peak load or cogeneration. Bergen Engines AS manufactures medium-speed engines for marine and power generation applications. L’Orange completes the portfolio, producing fuel injection systems for large engines. 2013 financial review The order book increased 6 per cent, with new orders of £2.7 billion (£2.8 billion in 2012). The final quarter of 2013 saw strong sales, driven by the pre-purchase of engines for industrial, including agricultural, applications ahead of the introduction of tighter environmental standards in Europe. Marine revenue is well supported by demand from navies in Asia and the US. In defence, major programmes to power military tanks provide stability despite continued pressure on government spending. Revenue decreased 0.5 per cent with good growth in the Marine and Industrial divisions offset by lower revenue in oil and gas, medium-speed engines and lower aftermarket sales. Profit increased 0.3 per cent, reflecting a strong second half. Key financial data Order book £m Underlying revenue £m Underlying OE revenue £m Underlying services revenue £m Underlying profit before financing £m 2012 1,823 2,846 1,938 908 293 2013 1,927 2,831 2,004 827 294 Change +5.7% -0.5% +3.4% -8.9% +0.3% The table above shows a trading comparison as if both Tognum and Bergen Engines had been fully consolidated in 2012 as well as in 2013. In 2014, we expect modest growth in revenue and good growth in profit driven by growth in marine and land power systems markets. How we are performing 2013 proved a challenging year. Headwinds confronting the business included the Eurozone crisis, US fiscal challenges and slowing of growth in emerging countries. General nervousness about the global economic environment led to constrained order activity within the market. Despite these adverse market conditions, a number of significant orders and contracts were achieved. As outlined in the Marine segment review, Power Systems also benefited from contracts awarded by Chinese customer COSCO and from the UK MoD for the generator sets of the Royal Navy’s future Type 26 Frigate. The Type 26 propulsion system will consist of a combination of four MTU diesel gensets and a Rolls-Royce MT30 gas turbine. These examples highlight the synergies and benefits of complementary product portfolios. MTU introduced the upgraded Series 1163 marine engines for IMO Tier II and IMO Tier III emission standards. These are cleaner and more fuel-efficient than the previous generation and offer a better power-to- weight ratio. For the British Intercity Express Programme, MTU received orders of rail Powerpacks with Series 1600 engines. The Powerpacks will drive Hitachi’s future high-speed trains which are scheduled to go into service from 2017 on Great Western Main Line and East Coast Main Line routes. Twenty locomotives built by Chinese manufacturer, Dalian Locomotive & Rolling Stock and powered by MTU engines went into service in Argentina. China-based Xiangtan Electric Manufacturing Corporation shipped its first ever export of mine dump trucks to the Pilbara mine site in Australia for Rio Tinto. Each of the 230 metric-ton trucks is powered by an MTU mining engine. The Fjord Line shipping company ordered Bergen gas-powered engines. Its Stavangerfjord and Bergensfjord cruise ferries, both 170 metres long, are each to be equipped with four Bergen B-gas engines. The engines ensure that these ships already meet future IMO Tier III limits as well as satisfying mandatory EU regulations projected for 2015, for sulphur emissions from ferries. In addition to these contract wins, we continue to build capacity through joint ventures and partnerships. L’Orange has established a consortium with Hoerbiger, for the supply of equipment for large-scale diesel and dual-fuel engines for the Asian market. Onsite Energy and regional Polish energy supplier Kogeneracja Zachód intend to form a partnership for the supply and maintenance of cogeneration plants. Over the coming years, both companies plan on working exclusively with each other to supply small- to medium- sized Polish cities with environmentally- friendly energy from CHP plants. Future priorities and opportunities Our long-term growth relies on five pillars: power; propulsion; services; regional expansion and, the product portfolio. In 2014, we expect most markets to stabilise. although some segments are expected to remain difficult. This leads us to expect continued volatility in revenues. Overall we expect to see a positive performance primarily driven by marine applications. We will invest in future technologies to maintain our technological leadership. We are configuring our different engine series to meet tougher emission standards. At the same time we will improve efficiency and keep a focus on costs and cash in all other areas. Market outlook: We estimate the total market opportunity for high-speed engine original equipment over the next ten years to be €280 billion. The forecast data is taken from a range of sources including: Global Insight; Oxford Economics, Diesel and Gas Turbine Worldwide, Clarkson Research and our own internal forecasting tools. 24 Strategic report Rolls-Royce Holdings plc annual report 2013 ENGINEERING AND TECHNOLOGY We continued our commitment to recruit and develop the very best engineers and scientists. Colin Smith CBE Director – Engineering and Technology In 2013, we invested £1,118 million in gross research and development (R&D) of which £746 million was funded by the Group, prior to receipts from risk and revenue sharing arrangements. We continually pursue innovation that will improve the performance of our power systems and benefit our customers. We have developed and actively deployed a new innovation portal to improve the exchange of ideas around the world as we invest to improve the efficiency of our global R&D footprint. People We have an engineering resource inside the Group of around 16,600 engineers. Many work as integrated teams across borders on our major programmes and a number of our top engineers, or Rolls-Royce Fellows, are recognised as world-renowned experts in their fields. We continued our commitment to recruit and develop the very best engineers and scientists, and the first cohort of our evolving internal Specialist Academy has graduated in October 2013. The Academy has been designed for technologists who have the potential to join the Rolls-Royce Fellowship at the very top of our specialist career ladder. Research and technology World-class technology gives us competitive product performance. We generate the largest number of patents of any UK company, 549 new patent applications were approved for filing in 2013 (including Rolls-Royce Power Systems AG). To further expand our capabilities, we acquired Hyper-Therm HTC, a US-based specialist in ceramic materials; and SmartMotor, a world leader in permanent-magnet machines and drives technology, headquartered in Norway. In addition, we acquired from GKN the 49 per cent of Composite Technology and Applications Limited (CTAL) that we did not already own, giving us 100 per cent ownership. CTAL is engaged in the development of composite fan blades and containment cases for the next generation of advanced turbofan engines. In 2013, we further increased our investment in early-stage research and technology to about 20 per cent of the net R&D spend. We have good visibility of stable, long-term government match-funding for research investments in aerospace technologies following the creation in the UK of the Aerospace Technology Institute, and in the EU through the Clean Sky 2 Joint Technology Initiative in Horizon 2020 and continuous German support via Luftfahrtforschungsprogramm (LuFo) V. University Technology Centres In addition to our significant in-house R&D capability, we pursue advanced technologies via a global network of 29 University Technology Centre (UTC) partnerships. Each centre is part-funded by the Group and works closely with our engineering teams, undertaking specialist work led by world- class academics. In 2013, Nanyang Technological University joined this network with the launch of the Rolls-Royce@NTU Corporate Lab, a joint investment of SGD$75 million (£38.5 million) between Rolls-Royce, Nanyang University and the National Research Foundation (NRF) of Singapore. Our model of developing technology through collaboration with academia and other partners was recognised by the German Fraunhofer Institute for Production Technology which benchmarked 160 European companies: Rolls-Royce was one of five companies to receive the ‘Successful Practices’ award in technology management in 2013. Research and development Flight test results have shown the Trent XWB to be the world’s most efficient large, civil, aero engine. The Trent 1000 Package C received EASA certification in September and a few weeks later powered the newest version of the Dreamliner, the Boeing 787-9 on its first flight from Seattle, USA. The Joint Strike Fighter F-35B, with short take -off and vertical landing (STOVL) capability provided by the Rolls-Royce LiftSystem®, successfully completed its second set of carrier trials aboard the USS Wasp in August 2013. In September, the T56 engine Series 3.5 technology enhancement program received FAA approval and has now been chosen to power the ‘Hurricane Hunter’ aircraft of the US National Oceanic and Atmospheric Administration. In 2013, we received the Green Ship Technology Award for our Environship concept – a design for cargo ships that reduces CO2 emissions by up to 40 per cent compared to similar diesel powered vessels. Gross research and development (£m) 864 923 908 919 1,118 2009 2010 2011 2012 2013 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 25 OPERATIONS Record levels of investment continue to drive improvements in product and operational performance. Alain Michaelis Operations Director Our teams around the world focus on improvement in all the classical operational metrics – safety, quality, cost, on-time delivery, inventory – while at the same time ensuring that the next generation of advanced products and processes are successfully industrialised. Our operations employ 25,000 people in 17 countries at 85 Rolls-Royce facilities. In addition, 33 joint venture facilities, seven manufacturing technology partnerships and over 70 significant suppliers help us to meet customer demand. Developing our capacity This year we have extended our own capacity and capability. This included our new turbine blade factory in Rotherham, UK and our new 17,000 square metre, state-of-the-art discs manufacturing facility in Washington, UK, that has now started production. When fully operational later this year, it will have the capacity to manufacture over 2,000 fan and turbine discs annually. We are also taking steps to adjust capacity where market segments are contracting or demanding a lower price point. Although our diverse portfolio helps us balance growing and shrinking segments, we do expect an ongoing need to adjust capacity through plant renewal and closures. Advanced manufacturing We apply advanced technologies, methods and processes to deliver ‘best in class’ manufacturing performance through our Rolls-Royce Production System and the Advanced Manufacturing network, which has developed over the past five years. The advanced centres in this network bring together university, government and industrial partners to provide a realistic testing ground for new industrial techniques that improve yield and reduce costs. These have proved to be successful both for Rolls-Royce and our supplier partners. The Advanced Forming Research Centre in Glasgow, UK, the National Composites Centre in Bristol, UK and the Manufacturing Technology Centre in Coventry, UK, are expanding their facilities and the new Commonwealth Centre for Advanced Manufacturing in Richmond, USA, is now fully operational. Our future Advanced Remanufacturing and Technology Research Centre in Singapore and High Temperature Components Centre of Excellence in the UK will ensure we lead in high-performance, low-emission turbine technology. Our processes will increasingly include powder-based manufacturing, additive layer manufacturing technologies and ultra-high temperature materials. ‘Knowledge-based manufacturing’ is another developing area. Here, we will use dynamic computer models to design and verify processes. These approaches will increase design flexibility, speed of manufacture and performance. Suppliers Strong relationships with our suppliers are critical to our performance. We work closely to align our strategies as well as assessing performance through our Supplier Advanced Business Relationship (SABRE) requirements. Rolls-Royce has taken a leading role in the establishment of the Aerospace Engine Supplier Quality Committee. Through this body, gas turbine engine makers and their suppliers – with input from regulatory agencies – aim to agree a set of common industry-wide standards. These will help remove variability and waste, enabling the aerospace supply chain to be leaner and more competitive. To support UK suppliers in the global aerospace market, Rolls-Royce is sponsoring the UK Government-backed Sharing in Growth programme. It is a £110 million programme of intensive supplier development training and is expected to secure at least 5,000 high-value manufacturing jobs in aerospace. We are also supporting a £76 million Sharing in Growth programme in the nuclear industry. We continue to seek new capabilities in emerging markets across the world through our supplier development groups. These help drive competition with our existing internal plants and suppliers, and also allow us to develop new markets – Brazil (Energy) and China (Marine) being good examples. We expect the proportion of our supplier spend in emerging markets to increase. Information technology In 2013, we invested over £100 million in IT, continuing with the modernisation of our IT infrastructure and also launching our Shop Floor IT modernisation programme. We have launched an Integrated Production Systems programme to address the need for simplified, globally scalable and secure systems. The programme will improve delivery to the customer whilst improving efficiency and reducing operating costs. We are also investing in our customer systems to improve the customer experience through the use of portals and digital workflow. £687 million Expenditure in 2013 on property, plant and equipment. We are delivering customer and business benefits as we continue to invest at record levels and transform our industrial infrastructure. 26 Strategic report Rolls-Royce Holdings plc annual report 2013 SUSTAINABILITY Our strategy is to create a sustainable business, through our focus on customer, innovation and profitable growth. Our commitment is to continually improve the environmental performance of our products and services. With our customer at its heart, our strategy will deliver ‘Better power, a Better future and a Better business’. Sustainability Better power Helping our customers do more using less. Better future We are committed to innovation: powering better, cleaner, economic growth that creates value for customers, employees, investors, suppliers and wider society. Better business We invest in technology, people and ideas to improve all aspects of our performance and to drive profitable growth. Building on today’s achievements to meet the business challenges of the future. The Trent XWB is the world’s most efficient turbofan aero engine flying today. The low noise technology built into the Trent 1000 makes it the quietest engine on the Boeing 787 Dreamliner, which itself has half the noise level of the corresponding previous generation aircraft. In Defence aerospace, we have worked with the US Air Force to complete the final testing of the Series 3.5 enhancement of the T56 engine, providing fuel savings of up to ten per cent in addition to improved performance and reliability. In Marine, our Environship design together with our advanced propulsion systems can reduce CO2 emissions by up to 40 per cent compared to conventional diesel-powered vessels. The Environship concept was awarded the Green Ship Technology Award this year. Our Civil Nuclear portfolio makes a significant contribution to future low carbon electricity generation. We are strongly positioned to support growth in this industry. Better power Helping our customers do more using less. Each of our customer-facing segments provides services and customer operation solutions to improve the effectiveness of our equipment. In each of our markets, we are focused on reducing fuel consumption and emission levels. Find out more by visiting www.rolls-royce.com. Improving the environmental performance of our products Rolls-Royce has a strong track record of reducing emissions through significant investment in technology. In 2013, we invested £1,118 million in R&D, of which around two-thirds is aimed at reducing the environmental impact of our products and services. In Civil aerospace, The Advisory Council for Aviation Research and Innovation in Europe (ACARE) has set challenging goals for aviation to meet by 2050. These include reducing aircraft CO2 emissions by 75 per cent (per passenger kilometre); reducing noise by 65 per cent; and reducing oxides of nitrogen (NOx) by 90 per cent, all relative to a typical new aircraft produced in 2000. Trent 800 Trent 500 Trent 900 Trent 1000 Trent XWB CO2 (Engine) ACARE Target: 75% overall reduction in CO2 per passenger kilometre 30% engine contribution (Rolls-Royce engine long-term goals). Trent family ACARE flightpath 2050 target n r u b l e u f r o 2 O C % 0 -5 -10 -15 -20 -25 -30 2000 2010 2020 2030 2040 2050 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 27 Carbon Disclosure Project The Rolls-Royce 2013 carbon disclosure score of 85 is our highest score to date. This, along with our performance band ‘B’ rating, demonstrates our commitment to continually improving our environmental performance. Dow Jones Sustainability Index Rolls-Royce has been listed for the 12th consecutive year. We achieved an overall score of 67 in 2013, above average in all areas within the aviation and defence sector. Better future We are committed to innovation: powering better, cleaner economic growth that creates value for customers, employees, investors, suppliers and wider society. Our people Our culture fosters innovation, collaboration and continuous improvement. Developing strong people management and leadership skills alongside our technical expertise helps ensure that our employees are engaged and understand the wider role they play in the Group’s success. We work actively to attract young people to Science, Technology, Engineering and Mathematics (STEM) subjects. Content and figures do not include Rolls-Royce Power Systems AG, unless indicated. In 2013, we recruited 2,530 experienced professionals to support the growth of our business. Our graduate programme is expanding, we recruited 379 graduates through our global programmes, an increase of 21 per cent from 2012. Our graduate population is becoming more representative of the diverse and global company we are working in, with this year’s graduates representing 32 nationalities and coming from 97 universities. Our apprenticeship programme has been running for over 100 years. At any one time we have over 1,000 apprentices around the world. Average number of employees By region United Kingdom Rest of the world Total By sector Civil aerospace Defence aerospace Marine Energy Power Systems Total 2012 2013* 22,800 20,000 42,800 21,500 7,800 8,800 3,700 1,000 42,800 24,800 30,400 55,200 23,400 7,900 9,200 4,000 10,700 55,200 * Includes Rolls-Royce Power Systems AG. We retained our title as ‘The most popular graduate recruiter – Engineering, Designs and Manufacture’ in the UK TARGETjobs Awards for the fourth year running. Our position has also risen in the ‘Times Top 100 Graduate Employers’ rankings and in the ‘Guardian UK 300’ survey. Employee involvement Employee engagement is critical to our success. We use a variety of channels to communicate with our employees. We have well-established frameworks for managing employee and trade union/employee representative participation which include formal information and consultation arrangements. Our incentive schemes and all-employee share plans make sure that every employee has the opportunity to share in our success. We encourage our employees to improve their knowledge and enhance their careers by providing meaningful training and development. In 2013, we supported 49,600 employees, customers and suppliers through our learning management system. Learning investment for 2013 was £39.7 million and a total of 272,000 training course completions were delivered during the year. Human rights Our human rights policy sets out our commitment to respect the human rights of our employees through core labour standards regarding employee involvement, Left to right: Sarah Armstrong (Rolls-Royce), Ella Jakubowska and Sir Trevor McDonald at the TARGETjobs Female Undergraduate of the Year 2013 awards. diversity and equality, pay and benefits, working hours, forced labour and child labour. We set equivalent standards for our supply chain through our Supplier Code of Conduct. Diversity and inclusion A diverse workforce will help ensure our continued success as a global business and contribute towards a better future. We continue to face challenges in increasing diversity across the organisation and are working with our leadership teams to raise awareness of the need for change. Over recent years we have seen increased levels of diversity in both our early career pipeline and high potential pool, with females making up 26 per cent of our UK graduate intake in 2013 and 29 per cent of our graduate intake into countries outside the UK. Females are 24 per cent of our high potential population as compared to 15 per cent of our general population. This year, Rolls-Royce sponsored the UK Female Undergraduate of the Year 2013 awards. The winner, Ella Jakubowska, accepted a place on our Customer Management Graduate Programme. Headcount by gender* Male Female Total Full-time equivalents at 31 December 2013 46,975 8,225 55,200 * Includes Rolls-Royce Power Systems AG. Senior managers by gender* Male Female * Includes Rolls-Royce Power Systems AG. Board directors by gender Male Female 188 11 10 2 We give full and fair consideration to applications for employment made by disabled people and also support employees who become disabled during employment, helping them make the best use of their skills and potential. 28 Strategic report SUSTAINABILITY Rolls-Royce Holdings plc annual report 2013 Community investment We are committed to conducting business to the highest standards and building positive relationships within the communities where we operate. In 2013, our total contribution was £8 million. We actively work with schools and universities to increase interest and encourage diversity amongst those taking STEM subjects, and to broaden the career aspirations of individuals from under-represented groups. Working with governments National governments are often our customers and we aim to build strategic relationships with governments in our key markets. National governments and the EU also set the legislative and policy framework for doing business and they are a potential source of funding and support for research and technology (R&T), R&D, manufacturing, education and training initiatives, as well as for certain capital projects. We engage in dialogue to align our own business needs with the political, social, economic, industrial and commercial requirements of national governments and the EU. In 2013, we have worked with the UK Government on the development and implementation of the Aerospace Growth Partnership; in EU Affairs, we have focused on the Horizon 2020 EU funding programme; and in North America we focused on defence appropriations and policy issues. Globally, we are members of national industry bodies and trade associations that represent our sector and Group interests. In the UK we are members of the Confederation of British Industry (CBI) and AeroSpace, Defence and Security (ADS); in North America the Aerospace Industries Association, Organisation for International Investment and the US Chamber of Commerce; in Brussels on EU affairs we belong to The AeroSpace and Defence Industries Association of Europe (ASD) and EU Turbines, amongst others; and globally we are members of local Chambers of Commerce in our countries of operation. Rolls-Royce does not make corporate contributions or donations to political parties or to any organisations, think-tanks, academic institutions or charities closely associated to a political party or cause, as outlined in our Global Code of Conduct. Better business We invest in technology, people and ideas to improve all aspects of our performance and to drive profitable growth. Building on today’s achievements to meet the business challenges of the future. Ethics We have made a strong commitment to improving our ethical performance in line with building a better business. You will have read in the Chief Executive’s review on pages 6 and 7, about Lord Gold’s review, the SFO investigation, and the publication of our new Global Code of Conduct. We have also introduced a confidential Ethics Line which is available 24 hours a day, where individuals can ask questions or raise concerns. You can read more on these topics in the ethics committee report on pages 49 and 50. We are also refreshing our Supplier Code of Conduct for deployment in 2014. Compliance with the code will continue to be monitored through our regular supplier audits. The Group continues to be an active participant in ethical initiatives of the European and US aerospace and defence business sectors. We are a signatory to the ‘Common Industry Standards’ which were drawn up by ASD and aim to promote and enhance integrity practices among its members. The Group is also a member of the International Forum on Business Ethical Conduct’s (IFBEC) Steering Committee. This organisation includes leading US and European companies in the aerospace and defence sectors and aims to promote responsible and ethical business behaviours through the Global Principles of Business Ethics. Improving operational performance Improving the environmental performance of our operations contributes to profitable growth. We have set a three-year target to reduce energy consumption by ten per cent by the end of 2015, with 2012 as the baseline year excluding product test and development and normalised by revenue. Our energy use increased slightly in 2013, reflecting our increased levels of activity, but we are on track to reduce our overall emissions of greenhouse gases. We continue to invest in improvements to our facilities. Our total spend in 2013 amounted to almost £3 million on projects, including upgrades to compressed air systems, lighting systems and controls, and additional energy monitoring capability in our plants and offices. We are seeking to make wider use of more sustainable energy sources, where cost effective and practical to do so. Our business segments have third- party accredited certification to the environmental management systems standard ISO 14001. In addition, we have maintained our focus on requiring key suppliers to become certified to ISO 14001. For further information on how we work with suppliers please visit www.rolls-royce.com/sustainability. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 29 UK Prime Minister David Cameron meets Colin Smith CBE, Director – Engineering and Technology, and some of our apprentices at the Apprentice Academy, Derby, UK. We are helping to lead the way on REACH (Registration, Evaluation and Authorisation of Chemicals) regulations and have submitted the first ever REACH Authorisation application. This is in the final stages of the approval process with the European Chemicals Agency and European Commission. Additionally, we continue to work with our suppliers to assist them in meeting their own obligations with a focus on the managed reduction and phase out of the use of targeted substances that are hazardous to health and dangerous to the environment. Through our active participation in the International Aerospace Environment Group we are also helping to introduce new standards to facilitate efficient data sharing across the aerospace supply chain. This focuses on the uses of hazardous substances (in both manufacturing processes and included in our products) and related substitution and phase out programmes. Greenhouse gas emissions In 2013, our total greenhouse gas (GHG) emissions from our facilities, processes, product test and development was 520 kilotonnes carbon dioxide equivalent (ktCO2e). This represents a reduction of nine per cent compared with 572 ktCO2e in 2009 (see table). This reduction has been achieved, despite a growth in our global facilities footprint. We have introduced a longer term GHG target over ten years, aimed at reducing emissions by 17 per cent by the end of 2022 (baselined at 2012), excluding product test and development. The figures in the table do not include emissions associated with Rolls-Royce Power Systems AG. We expect to integrate this subsidiary into our reporting process during 2014. Power generation relates to the operation of commercial gas-fired power stations. Total GHG emissions (ktCO2e) Direct emissions – facilities, processes, product test and development (Scope 1) Indirect emissions – facilities, processes, product test and development (Scope 2) Total for facilities, processes, product test and development Direct emissions – power generation to grid (Scope 1) Indirect emissions – power generation to grid (Scope 2) Total for facilities, processes, product test and development, and power generation to grid Normalised (by revenue) emissions ratio for facilities, processes, product test and development (ktCO2e/£m) 2009 2010 2011 2012 2013 215 236 229 213 218 357 365 346 337 302 572 601 575 550 520 56 3 579 0.04 We have used the GHG Protocol Corporate Accounting and Reporting Standard (revised edition) data gathered to fulfil our requirements under the Carbon Reduction Commitment (CRC) Energy Efficiency scheme, and the UK Government’s GHG reporting guidance as the basis of our methodology and source of emissions factors for Company reporting for 2013. Further details on our methodology can be found within our ‘Basis of Reporting’, available at www.rolls-royce.com/sustainability. Safety We are committed to continually improving the standards of health and safety in the workplace. We have steadily improved performance over previous years. In 2013, there were no fatalities or significant injuries and we achieved a 17 per cent reduction in the Total Reportable Injury (TRI) rate from 0.54 in 2012 to 0.45 TRIs per 100 employees. Over the longer term, we have reduced the TRI rate by 37 per cent since 2009. We have set a new target to reduce TRIs per 100 employees by 15 per cent by 2015 (baselined at 2012). We continue to analyse high-potential incidents and each of them is investigated at business segment level, with some also included in Group level assessment. The number of high-potential incidents has declined slightly from previous years and the number of ‘near misses’ reported has significantly increased. The increased level of near miss reporting reflects greater risk awareness, overall proactive reporting, risk based investigation and other improvements. These contribute to both TRI and high potential incident reductions. Throughout the year, we continued several global safety improvement plans. The Electrical and Process Safety programmes included site reviews and training and tools for ensuring efficient implementation of control measures. Reviews have also been carried out on the use and control of exposure to a number of chemicals newly- regulated under the REACH regulations. These reviews confirmed that our controls are suitable and that they ensure occupational exposures and releases to the environment are within limits set by the new requirements. Health The current incidence of occupational illness stands at 0.86 cases per 1,000 employees. The leading causes of illness are noise- induced hearing loss, work-related upper limb disorders and stress. This reflects our global health risk profile and provides the focus for our health improvement activities. Following a prosecution in the UK by the Health and Safety Executive for one case of Hand-Arm Vibration Syndrome (HAVS), independent advice was sought from the UK Health and Safety Laboratory and we are continuing to strengthen our management of HAVS. 30 Strategic report Rolls-Royce Holdings plc annual report 2013 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. Financial indicators are shown below. The key objectives of the Board and its committees are described on pages 39 to 54 and non-financial key performance indicators are shown in the sustainability section on pages 26 to 29. Rolls-Royce Power Systems AG (RRPS), formerly Tognum AG, was fully consolidated from 1 January 2013. To aid understanding, the impact on 2013 of consolidation has been displayed separately below. Rolls-Royce RRPS CUSTOMER ORDER BOOK +19% +16% before RRPS 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. £m £bn 58.3 59.2 62.2 60.1 71.6 1.6 70.0 2009 2010 2011 2012 2013 ORDER INTAKE +67% +52% before RRPS Order intake is a measure of new business secured during the year and represents new firm orders, net of the movement in the announced order book between the start and end of the period. Any orders which were recorded in previous periods and which are subsequently cancelled, reducing the order book, are included as a reduction to intake. Order intake is measured at constant exchange rates and list prices and consistent with the order book policy of recording the first seven years’ revenue of long-term aftermarket contracts. Order intake for any given year includes the seventh year of revenue. £bn 26.9 2.4 24.5 14.1 12.3 16.3 16.1 2009 2010 2011 2012 2013 UNDERLYING REVENUE +27% +6% before RRPS 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. £m The Group measures foreign currency revenue at the actual exchange rate achieved as a result of settling foreign exchange contracts from forward cover. 10,108 10,866 11,277 15,505 2,586 12,209 12,919 2009 2010 2011 2012 2013 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 31 INNOVATION NET R&D EXPENDITURE AS A PROPORTION OF UNDERLYING REVENUE +4.5% before RRPS 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 R&D although this proportion will fluctuate depending 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. % 4.7 4.7 4.6 4.7 4.8 CAPITAL EXPENDITURE +40% +20% before RRPS 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. Annual capital expenditure is measured as the cost of property, plant and equipment acquired during the period. 2009 2010 2011 2012 2013 £m 687 97 590 467 491 361 291 2009 2010 2011 2012 2013 PROFITABLE GROWTH UNDERLYING PROFIT BEFORE FINANCING +22% +10% before RRPS 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. £m 1,831 267 1,564 1,495 77 1,418 983 1,010 1,206 2009 2010 2011 2012 2013 AVERAGE CASH/DEBT +£380m before RRPS CASH FLOW +£539m before RRPS The Group reports the balance of net funds/debt on a weekly basis and average cash is therefore the average of these weekly net balances. These balances are reported at prevailing exchange rates and in recent periods, year-on- year movements in average cash balances reflect the significant acquisitions and disposals which have taken place, most notably RRPS in 2011 and IAE restructuring in 2012. The impact on average cash balances will depend on when these transactions took place during the year. 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 for 2011 includes investment of £1,496 million in RRPS. £m 635 960 320 350 (145) 2009 2010 2011 2012 2013 £m 258 1,094 (183) (1,310) 622 83 539 2009 2010 2011 2012 2013 32 Strategic report Rolls-Royce Holdings plc annual report 2013 PRINCIPAL RISKS AND UNCERTAINTIES The Group places great importance on the identification and effective management of risks. Our approach to enterprise risk management helps us to deliver our objectives and maximise the returns of the Group. The following table describes the risks that the risk committee, with endorsement from the Board, considers to have the most material potential impact on the Group. They are specific to the nature of our business notwithstanding that there are other risks that may occur and may impact the achievement of the Group’s objectives. The risk committee discussions have been focused on these risks and the actions being taken to manage them. Risk or uncertainty and potential impact How we manage it PRODUCT FAILURE Product not meeting safety expectations, or causing significant impact to customers or the environment through failure in quality control. BUSINESS CONTINUITY Breakdown of external supply chain or internal facilities that could be caused by destruction of key facilities, natural disaster, regional conflict, financial insolvency of a critical supplier or scarcity of materials which would reduce the ability to meet customer commitments, win future business or achieve operational results. COMPETITOR ACTION The presence of large, financially strong competitors in the majority of our markets means that the Group is susceptible to significant price pressure for original equipment or services even where our markets are mature or the competitors are few. Our main competitors have access to significant government funding programmes as well as the ability to invest heavily in technology and industrial capability. (cid:337)(cid:3) Operating a safety first culture (cid:337)(cid:3) Our engineering design and validation process is applied from initial design, through production and into service (cid:337)(cid:3) The safety committee reviews the scope and effectiveness of the Group’s product safety policies to ensure that they operate to the highest industry standards (see safety committee report on page 52) (cid:337)(cid:3) A safety management system (SMS) has been established by a dedicated team. This is governed by the Product Safety Review Board and is subject to continual improvement based on experience and industry best practice. Product safety training is an integral part of our SMS (cid:337)(cid:3) Crisis management team led by the Director – Engineering and Technology or General Counsel as appropriate (cid:337)(cid:3) Continued investment in adequate capacity and modern equipment and facilities (see operations section on page 25) (cid:337)(cid:3) Identifying and assessing points of weakness in our internal and external supply chain, our IT systems and our people skills (cid:337)(cid:3) Selection and development of stronger suppliers (see operations section on page 25) (cid:337)(cid:3) Developing dual sources or dual capability (cid:337)(cid:3) Developing and testing site-level incident management and business recovery plans (cid:337)(cid:3) Crisis management team led by the Director – Engineering and Technology or General Counsel as appropriate (cid:337)(cid:3) Customer excellence centres provide improved response to supply chain disruption (cid:337)(cid:3) Accessing and developing key technologies and service offerings which differentiate us competitively (see engineering and technology section on page 24) (cid:337)(cid:3) Focusing on being responsive to our customers and improving the quality, delivery and reliability of our products and services (cid:337)(cid:3) Partnering with others effectively (cid:337)(cid:3) Driving down cost and improving margins (see Chief Executive’s review on pages 6 and 7 and Chief Financial Officer’s review on page 10) (cid:337)(cid:3) Protecting credit lines (see additional financial information on pages 137 and 138) (cid:337)(cid:3) Investing in innovation, manufacturing and production (see operations section on page 25) (cid:337)(cid:3) Understanding our competitors S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 33 Risk or uncertainty and potential impact How we manage it INTERNATIONAL TRADE FRICTION Geopolitical factors that lead to significant tensions between major trading parties or blocs which could impact the Group’s operations. For example: explicit trade protectionism; differing tax or regulatory regimes; potential for conflict; or broader political issues. MAJOR PRODUCT PROGRAMME DELIVERY Failure to deliver a major product programme on time, to specification or technical performance falling significantly short of customer expectations would have 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. COMPLIANCE Non-compliance by the Group with legislation or other regulatory requirements in the regulated environment in which it operates (for example: export controls; offset; use of controlled chemicals and substances; and anti-bribery and corruption legislation) compromising our ability to conduct business in certain jurisdictions and exposing the Group to potential: reputational damage; financial penalties; debarment from government contracts for a period of time; and/or suspension of export privileges or export credit financing, any of which could have a material adverse effect. (cid:337)(cid:3) Where possible, locating our domestic facilities in politically stable countries and/or ensuring that we maintain dual capability (cid:337)(cid:3) Diversifying global operations to avoid excessive concentration of risks in particular areas (cid:337)(cid:3) Network of regional directors proactively monitors local situations (cid:337)(cid:3) Maintaining a balanced business portfolio in markets with high technological barriers to entry and a diverse customer base (cid:337)(cid:3) Understanding our supply chain risks (cid:337)(cid:3) Proactively influencing regulation where it affects us (see sustainability on page 28) (cid:337)(cid:3) Major programmes are subject to Board approval (see additional financial information on page 137) (cid:337)(cid:3) Major programmes are reviewed at levels and frequencies appropriate to their performance against key financial and non-financial deliverables and potential risks throughout a programme’s life cycle (see additional financial information on page 137) (cid:337)(cid:3) Technical audits are conducted at pre-defined points performed by a team that is independent from the programme (cid:337)(cid:3) Programmes are required to address the actions arising from reviews and audits and progress is monitored and controlled through to closure (cid:337)(cid:3) Knowledge management principles are applied to provide benefit to current and future programmes (cid:337)(cid:3) An uncompromising approach to compliance is now, and should always be, the only way to do business (cid:337)(cid:3) The Group has an extensive compliance programme. This programme and the Global Code of Conduct are promulgated throughout the Group and are updated and reinforced from time-to-time, to ensure their continued relevance, and to ensure that they are complied with both in spirit and to the letter. The Global Code of Conduct and the Group’s compliance programme are supported by appropriate training (see ethics committee report on pages 49 and 50) (cid:337)(cid:3) A legal and compliance team has been put in place to manage the current specific issue (see ethics committee on pages 49 and 50) through to a conclusion and beyond (cid:337)(cid:3) Lord Gold has reviewed the Group’s current compliance procedures and an improvement plan is being implemented 34 Strategic report Rolls-Royce Holdings plc annual report 2013 PRINCIPAL RISKS AND UNCERTAINTIES Risk or uncertainty and potential impact How we manage it MARKET SHOCK The Group is exposed to a number of market risks, some of which are of a macro-economic nature, for example, foreign currency exchange rates, and some which are more specific to the Group, for example liquidity and credit risks, reduction in air travel or disruption to other customer operations. Significant extraneous market events could also materially damage the Group’s competitiveness and/ or credit worthiness. This would affect operational results or the outcomes of financial transactions. (cid:337)(cid:3) Maintaining a strong balance sheet, through healthy cash balances and a continuing low level of debt (cid:337)(cid:3) Providing financial flexibility by maintaining high levels of liquidity and an investment grade ‘A’ credit rating (see additional financial information on page 138) (cid:337)(cid:3) The portfolio effect from our business interests, both in terms of original equipment to aftermarket split and our different segments provide a natural shock absorber since the portfolios are not correlated (cid:337)(cid:3) Deciding where and what currencies to source in, where and how much credit risk is extended or taken and hedging residual risk through the financial derivatives markets (foreign exchange, interest rates and commodity price risk – see additional financial information on page 137) IT VULNERABILITY Breach of IT security causing controlled data to be lost, made inaccessible, corrupted or accessed by unauthorised users. (cid:337)(cid:3) Establishing ‘defence in depth’ through deployment of multiple layers of software and processes including web gateways, filtering, firewalls, intrusion, advanced persistent threat detectors and integrated reporting (cid:337)(cid:3) Security and network operations centres have been established (cid:337)(cid:3) Active sharing of information through industry, government and security forums (see risk committee report on page 51) The strategic report was approved by the Board on 12 February 2014. By order of the Board Nigel T Goldsworthy Company Secretary S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 35 DIRECTORS’ REPORT CHAIRMAN’S INTRODUCTION We will regularly review and develop our governance arrangements to ensure that the right decisions are made by the right people. Ian Davis Chairman We require high standards of ethical behaviour wherever we do business and for that behaviour to be second nature for every employee. With over 55,000 employees operating in many business sectors, regions and cultures across the world, we are well aware that this is not something that can be achieved overnight but only by relentless pursuit over time. Further details on ethics related matters can be found in the ethics committee report on pages 49 and 50. Remuneration Our remuneration report reflects the new reporting regulations. At the 2014 AGM shareholders shall, for the first time, have the right to vote on the policy section of the remuneration report separately and that vote is binding. The remuneration report can be found on pages 53 to 69. At the 2014 AGM, we will be proposing to renew our long-term incentive plan, the Performance Share Plan (PSP). We are also taking the opportunity to ask shareholders to approve our Deferred Share Bonus Plan. Further details are set out in the remuneration report. I believe that Rolls-Royce benefits from a strong Board though we will continue to look for opportunities to further strengthen and diversify, as discussed in the nomination committee report on page 47. I look forward to continuing to work with and support my colleagues at Rolls-Royce as we face the challenges and opportunities ahead. Ian Davis Chairman As Chairman, I am responsible for leading the Board and for ensuring its effectiveness in all aspects of its role. Strong governance is vital to this and I was reassured, when I joined Rolls-Royce, to find a robust governance foundation already in place. The challenge ahead is to build upon this foundation and ensure that the Group’s values ‘trusted to deliver excellence’ apply not just to our products but also to the way that we conduct and govern our business. Governance structure In November, I led a discussion on governance with the non- executive directors. We will regularly review and develop our governance arrangements to ensure that the right decisions are made by the right people. My instinct from my discussions to date is to allow as much time as possible at Board meetings for discussion on strategic and operational issues. With regard to committees, I have concluded that merging the work of the separate safety and ethics committees into one broader-based safety and ethics committee will give greater focus to our sustainability agenda. I agree with the Association of British Insurers (ABI) that good governance enhances a company’s sustainable performance and so helps underpin long-term economic growth. Sustainability has to be part of everything we do if our business is to endure in the long term. Further details on sustainability are on pages 26 to 29. We must provide excellent products which are safe, reliable, kinder to the environment and provide the right solutions for our customers at the right price. We can only endure if we are trusted by the world to deliver excellence in everything we do. Board changes During the year, Sir Simon Robertson retired as Chairman and Peter Byrom and Ian Strachan retired as non-executive directors at the conclusion of the AGM on 2 May 2013. I was appointed as a non- executive director on 1 March 2013 and was appointed Chairman on 2 May 2013. Lee Hsien Yang and Warren East were appointed as non-executive directors on 1 January 2014. Having served for nine years as a non-executive director, Iain Conn has decided to retire and will not be standing for re-election at the AGM on 1 May 2014. Business ethics In January 2013, we appointed Lord Gold to lead a review of our compliance procedures. Lord Gold presented an interim report to the Board in July 2013, having spent time immersing himself in the culture and systems of the Company. 36 Directors’ report Rolls-Royce Holdings plc annual report 2013 BOARD OF DIRECTORS 1 5 2 6 3 7 4 8 1. Ian Davis 2* Chairman, appointed March 2013 Skills and experience: Ian spent his early career at Bowater, moving to McKinsey & Company in 1979. He was managing partner of McKinsey’s practice in the UK and Ireland from 1996 to 2003. In 2003, he was appointed as Chairman and worldwide Managing Director of McKinsey, serving in this capacity until 2009. During his career with McKinsey, Ian served as a consultant to a range of global organisations across the private, public and not-for-profit sectors. He retired as senior partner of McKinsey & Company on 30 July 2010. External appointments: Ian serves as a non- executive director on the boards of Johnson & Johnson Inc, BP p.l.c. and as a non-executive member of the Cabinet Office Board. He is also senior adviser to Apax Partners LLP. 2. John Rishton 5* Chief Executive, appointed March 2011 Skills and experience: John began his career in 1979 at Ford Motor Company where he held a variety of positions in the UK and in Europe. In 1994 he joined British Airways Plc, where he was Chief Financial Officer from 2001 to 2005. In 2006, he was appointed CFO at Royal Ahold and became CEO in 2007. John was appointed as a non- executive director of Rolls-Royce in 2007 and served as chairman of the audit committee and a member of the ethics and nomination committees until his appointment as Chief Executive. He is a former non-executive director of Allied Domecq. External appointments: John was appointed as a non-executive director of Unilever NV and Unilever plc in May 2013. 3. Iain Conn 1,2,4*,6 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 Chief Executive of Refining and Marketing, BP p.l.c. He is a member of The Imperial College Council and of the CBI’s Energy and Climate Change Board. He is also a member of the Development Advisory Board of the RAE and of the advisory boards of the Centre for European Reform, the Centre for China in the World Economy at Tsinghua University and of the Schwarzman School at Tsinghua University. 4. Dame Helen Alexander 2,3*,4 Non-executive director, appointed September 2007 Skills and experience: Dame Helen was Chief Executive of the Economist Group until 2008 which she joined in 1985. She was President of the CBI until 2011; she has also been a non-executive director of Northern Foods plc, BT Group plc and Centrica plc. She was awarded a DBE in 2011 for services to business. External appointments: Dame Helen is Chairman of UBM plc, the Port of London Authority and Incisive Media. She is also deputy chairman of esure Group plc and senior adviser to Bain Capital. Dame Helen is Chancellor of the University of Southampton and she is involved with a number of other not-for-profit organisations in media, the internet, the arts and education. 5. Lewis Booth CBE 1*,2,4 Non-executive director, appointed May 2011 Skills and experience: Lewis is the former Executive Vice President and Chief Financial Officer of Ford Motor Company, a position he held for over three years until his retirement from the company in April 2012. During his 34-year career at Ford he held a series of senior positions in Europe, Asia, Africa and the United States. Lewis began his career with British Leyland, before joining Ford in 1978. He was awarded a CBE in June 2012 for services to the UK automotive and manufacturing industries. External appointments: Lewis is a director of Mondelez International, Inc., Gentherm Inc. and of University of Liverpool in America Inc. 6. Sir Frank Chapman 2,3,6* Non-executive director, appointed November 2011 Skills and experience: Sir Frank has worked in the oil and gas industry for 38 years including appointments within Royal Dutch Shell plc and BP p.l.c. He was Chief Executive of BG Group plc for 12 years until December 2012. Sir Frank is a Fellow of the Royal Academy of Engineering, the Institution of Mechanical Engineers and the Energy Institute. 7. Warren East CBE 1,2 Non-exec utive director, appointed January 2014 Skills and experience: Warren joined ARM Holdings in 1994 and was appointed Chief Executive in 2001. Under his leadership the company became the world’s leading semiconductor IP licensing company. He retired from ARM Holdings in 2013. He is a Fellow of the Institute of Engineering and Technology, a Fellow of the Royal Academy of Engineering and a Distinguished Fellow of the BCS. He was awarded a CBE in 2014 for services to the technology industry. External appointments: Warren is a non- executive director and chairman of the audit committee of De La Rue plc, and a non-executive director of Dyson Ltd, BT Group plc and Micron Technology Inc. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 9 13 10 14 11 15 37 12 Committee membership 1 Audit committee 2 Nomination committee 3 Remuneration committee 4 Ethics committee 5 Risk committee 6 Safety committee * Denotes chairman of committee 8. L ee Hsien Yang 2,4,6 Non-executive director, appointed January 2014 Skills and experience: Hsien Yang was Chief Executive of Singapore Telecommunications Limited for 11 years. He served as Chairman and non-executive director of Fraser and Neave Limited from 2007 until February 2013. External appointments: Hsien Yang serves as a Special Advisor of General Atlantic LLC. He is Chairman of the Civil Aviation Authority of Singapore, General Atlantic Singapore Fund Pte Ltd. and The Islamic Bank of Asia Private Limited, The Australian and New Zealand Banking Group Ltd. and the Lee Kuan Yew School of Public Policy. He is also President of the INSEAD South East Asia Council. 10. John Neill CBE 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 formerly a director of the Bank of England and a non-executive director of Royal Mail and Charter International plc. He was awarded a CBE in June 1994. External appointments: John is the Chairman and Group Chief Executive of the Unipart Group of Companies Limited and was appointed Chairman of Atlantis Resources Limited in December 2013. 9. John McAdam 2,3,6 Non-executive director, appointed February 2008 11. Jasmin Staiblin 2, 4 Non-executive director, appointed May 2012 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 and Unichema International businesses and is a former non-executive director of Severn Trent plc and Sara Lee Corporation. External appointments: John is Chairman of United Utilities Group PLC and Rentokil Initial plc and the Senior Independent Director of J Sainsbury plc. Skills and experience: Jasmin is the CEO of Alpiq Holding AG and was CEO of ABB Switzerland Ltd until December 2012. She has lived and worked in Switzerland, Sweden and Australia. External appointments: Jasmin is a non- executive director of Georg Fischer AG and a member of the board of the Federal Institute of Technology, the ETH Domain. 12. James Guyette 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 lead independent director of priceline.com Inc of Norwalk, Connecticut. He is also Chairman Emeritus of the Smithsonian National Air & Space Museum, Washington DC. 13. Mark Morris 5 Chief Financial Officer, appointed January 2012 Skills and experience: Mark joined Rolls-Royce in 1986. He has held a number of senior positions throughout the Company and before his appointment as Chief Financial Officer was Group Treasurer from 2001. 14. Colin Smith CBE 5 Director – Engineering and Technology, appointed July 2005 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. He is also a Member of the Council for Science and Technology. In June 2012 he was awarded a CBE for services to UK engineering. 15. Nigel T Goldsworthy Company Secretary & Head of Legal, appointed December 2012 Skills and experience: A solicitor, Nigel has held a number of senior legal and company secretary roles within the Company and, before his appointment as Company Secretary & Head of Legal, was Deputy General Counsel from 2008. Before joining Rolls-Royce in 2004, Nigel was a partner in the banking group of Lovells (now Hogan Lovells). 38 Directors’ report Rolls-Royce Holdings plc annual report 2013 INTERNATIONAL ADVISORY BOARD (IAB) The IAB, formed in 2006, advises the Board on political and economic developments around the world and alerts the Company to possible long-term opportunities, threats and risks. Its members are: Lord Powell of Bayswater (Chairman of the IAB) Former Foreign Affairs and Defence Adviser to Prime Ministers Baroness Thatcher and Sir John Major Vladimír Dlouhý International advisor to Goldman Sachs for Central and Eastern Europe, European deputy chairman of the Trilateral  Commission and a former member of the Czech Government Sir Rod Eddington Chairman of JP Morgan (Australia & New Zealand) and former Chief Executive of British Airways Plc Dr Fan Gang Professor at China’s Academy of Social Sciences and Director of National Economic Research Institute Mustafa Koç Chairman of Koç Holding, A.Ş. Akio Mimura Senior Advisor, Honorary Chairman Nippon Steel & Sumitomo Metal Corporation Lubna Olayan CEO and Deputy Chairperson of the Olayan Financing Company Ratan Tata Former Chairman of Tata Sons Limited Ambassador Robert B. Zoellick Chairman of Goldman Sachs International Advisors, Senior Fellow at the Belfer Center at Harvard University, former President of World Bank Group, US Deputy Secretary of State and US Trade Representative THE EXECUTIVE LEADERSHIP TEAM (ELT) During 2013, John Rishton chaired meetings of the ELT, an executive forum at which his first line reports (the Group’s most senior business and functional leaders) review, communicate and agree on issues and actions of group-wide significance. In addition to John Rishton, its other members are: Miles Cowdry Corporate Development Director Kath Durrant Human Resources Director James Guyette President and Chief Executive Officer – Rolls-Royce North America Inc. Lawrie Haynes President – Marine and Nuclear John Paterson President – Marine and Industrial Power Systems Colin Smith Director – Engineering and Technology Robert Webb General Counsel Tony Wood President – Aerospace Andrew Heath President – Energy Alain Michaelis Operations Director Mark Morris Chief Financial Officer S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 39 CORPORATE GOVERNANCE REPORT Board members and attendance There are currently 14 directors on the Board comprising the non-executive Chairman, the Chief Executive, three other executive directors and nine non-executive directors. Ian Davis (Chairman) (appointed 1 March 2013) Dame Helen Alexander Lewis Booth CBE Peter Byrom (retired 2 May 2013) Sir Frank Chapman Iain Conn Warren East CBE (appointed 1 January 2014) James Guyette Lee Hsien Yang (appointed 1 January 2014) John McAdam Mark Morris John Neill CBE Sir Simon Robertson (retired 2 May 2013) John Rishton Colin Smith CBE Jasmin Staiblin Ian Strachan (retired 2 May 2013) Attendance in 2013 7/7 8/9 9/9 4/4 8/9 8/9 n/a 9/9 n/a 8/9 9/9 9/9 3/4 9/9 9/9 4/9 4/4 The General Counsel and the Company Secretary are also invited to attend meetings. Jasmin Staiblin who is based in Switzerland was unable to attend two scheduled meetings during pregnancy and three due to unavoidable diary clashes in respect of commitments entered into before her appointment to the Board. Key objective: (cid:337)(cid:3) create long-term success for the Group within an acceptable risk profile and provide value for the long-term investor. Responsibilities: (cid:337)(cid:3) ensure the safety of its products and people; (cid:337)(cid:3) ensure the development of strategy; (cid:337)(cid:3) monitor implementation of the strategy; (cid:337)(cid:3) ensure necessary resources are in place; (cid:337)(cid:3) ensure controls exist to manage risk; (cid:337)(cid:3) safeguard values, brand and reputation; (cid:337)(cid:3) oversee performance of management; (cid:337)(cid:3) ensure effective succession planning; (cid:337)(cid:3) agree remuneration policy; and (cid:337)(cid:3) maintain effective governance. Governance principle: leadership Board membership The directors biographical details are on pages 36 and 37 which demonstrate the skills and experience of the Board. The experience and knowledge of each of the directors gives them the ability to constructively challenge strategy and scrutinise performance. On 12 February 2014, the Board noted that Iain Conn intended to retire as the Senior Independent Director and as a non-executive director and would therefore not seek re-election at the AGM on 1 May 2014. The Board has resolved that Lewis Booth, subject to re-election at the AGM, will succeed Iain Conn as the Senior Independent Director at the conclusion of the AGM. UK Corporate Governance Code (the Code) This report explains how the Company discharges its corporate governance responsibilities. In the year to 31 December 2013, the revised principles and provisions of the Code (published in September 2012 by the Financial Reporting Council (FRC) applied to the Company. Throughout the 2013 financial year, the Company did not fully comply with the provisions of the Code for the following reasons: Code provision Explanation C.3.5 – 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. C.3.7 – The audit committee should have primary responsibility for making a recommendation on the appointment, reappointment and removal of the external auditors. FTSE 350 companies should put the external audit contract out to tender at least every ten years. The Board considered it appropriate that this provision of the Code be the primary responsibility of the ethics committee. The ethics committee is, however, required to refer concerns about possible improprieties in matters of financial reporting to the audit committee. The audit committee has considered the requirement to put the audit out to tender every ten years. In line with the FRC’s transitional arrangements, the committee will do so during the tenure of the current lead partner which expires in 2017. The committee concluded that, in order to ensure that a potential change in auditor is managed effectively, it would not be in the Company’s interests to put the audit out to tender in 2013. More detail can be found in the audit committee report on page 46. 40 Directors’ report Rolls-Royce Holdings plc annual report 2013 CORPORATE GOVERNANCE REPORT In accordance with the Code and the Company’s Articles of Association, all directors will retire and put themselves forward for election or re-election at the AGM in 2014 with the exception of Iain Conn who is not seeking re-election and will retire from the Board at the conclusion of that meeting. The process for succession planning is discussed in the nomination committee report on page 47. The work of the Board in 2013 During 2013, the Board held nine meetings, eight of which were scheduled and a further one called at short notice. In addition, two formal resolutions were passed by consent of all directors using electronic means. Non-executive directors communicate directly with executive directors and senior management between formal Board meetings. At each scheduled meeting, executive directors supplied reports on business and financial performance including the usual approval of financial statements and budgets. The Board also received regular updates on health, safety and environment (HS&E) and employee and legal issues, including a review of its governance arrangements. In addition, the chairman of each of the Board committees provided reports on matters discussed by that committee since the previous Board meeting. The Board holds an annual day-long strategy meeting, which provides a forum for directors to challenge strategy and help develop it for the future. The strategy meeting held in September 2013 included discussions on the ten-year financial plan and the strategic context including market structure, competitor positioning, cost challenges, technology and with a focus on the Civil aerospace and the Marine and Industrial Power Systems businesses. In addition to its routine business, matters considered by the Board in 2013 included: (cid:337)(cid:3) Marine strategy focused on markets, costs, supply chain, product development and alignment with the Rolls-Royce Power Systems and Bergen engines businesses; (cid:337)(cid:3) the closure of the proposed joint venture with Pratt & Whitney; (cid:337)(cid:3) updates on the referral to the Serious Fraud Office; (cid:337)(cid:3) discussion on Lord Gold’s interim findings, the adoption of a new Global Code of Conduct and the roll-out of a comprehensive ethics training programme to all employees; (cid:337)(cid:3) relocation to new Group headquarters; (cid:337)(cid:3) the effect of sequestration on US defence spending; (cid:337)(cid:3) Civil Nuclear business strategy; (cid:337)(cid:3) investors’ view on our AGM business; (cid:337)(cid:3) restructuring of the Aerospace business; (cid:337)(cid:3) liquidity and additional funding; (cid:337)(cid:3) the renewal of the Euro Medium Term Note programme; (cid:337)(cid:3) preliminary discussions with Wärtsilä regarding a possible offer for the company; and (cid:337)(cid:3) cyber security. Board committees The Board has established a number of committees, the principal ones being audit, remuneration, nomination, ethics, risk and safety. Terms of reference for each committee are available on the Group’s website at www.rolls-royce.com. Reports by committee chairmen on the activities of each of the principal committees are on pages 44 to 54. The Chairman’s introduction provides more detail on page 35 of changes to the committee structures. Senior management and advisers are invited to attend Board and committee meetings where appropriate to contribute to discussions and advise members of the Board and committees on relevant matters. The involvement of senior management additionally helps strengthen the relationship between the Board and senior management and helps to provide the Board with a greater understanding of operations and strategy. Internal control 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. Our risk management process is a key element of the Group’s internal control system. This system of internal control is designed to identify and 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 processes we use to identify and manage risk are set out in the risk committee report on page 51. The Board’s report on the Group’s principal risks and actions taken to mitigate them is on pages 32 to 34. Turnover from joint ventures constitutes an increasingly large part of our reported group activity. Responsibility for internal control procedures in joint ventures where we do not have a control agreement lies with the managers of those operations. We seek to exert influence over such ventures by board representation and regularly review the activities of these ventures. The audit committee has reviewed the effectiveness of the systems of internal control for the year under review. Further information can be found in the audit committee report on page 45. The Board confirms that the processes and systems currently in place ensure that the Group continues to be compliant with the ‘Turnbull guidance’ as contained in ‘Internal Control: Revised Guidance for Directors on the Combined Code’ issued by the Financial Reporting Council in 2005. 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 are kept under scrutiny. Financial managers are required to acknowledge in writing that their routine financial reporting is based on reliable data and that results are properly stated in accordance with Group requirements. In addition, for annual reporting, business presidents and finance directors are required to confirm that their business has complied with the Group’s Finance Manual. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 41 Roles and responsibilities The Board has a written remit for the Chairman, Ian Davis, who has responsibility for the running of the Board and ensuring its effectiveness, and the Chief Executive, John Rishton, who has responsibility for running the business. This division of responsibility ensures that no one individual has unfettered powers of decision. In addition, the Board has agreed a set of guiding principles to govern the relationship between the Chairman and Chief Executive which, for example, requires that the two roles are structured in a complementary manner and demands that the relationship between the two be based on mutual respect and trust and be frank and open. The Senior Independent Director, Iain Conn, acts as a sounding board for the Chairman and can act as an intermediary for other directors. He led the nomination committee in the process which resulted in the appointment of Ian Davis as Chairman in May 2013. Each year, the Senior Independent Director leads a separate meeting of the Board excluding the Chairman to review the Chairman’s performance. Role and operation 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 provides value for the long-term investor. To achieve its long-term success the Board must: (cid:337)(cid:3) ensure the safety of its products and its people; (cid:337)(cid:3) oversee and approve the development of the Group’s strategy, monitoring both its achievement and the Group’s risk appetite; (cid:337)(cid:3) uphold the values of the Group, including its brand and corporate reputation; (cid:337)(cid:3) oversee the quality and performance of management and ensure it is maintained at world-class standards, through effective succession planning and remuneration policies; and (cid:337)(cid:3) maintain an effective corporate governance framework, with transparent reporting. The Board has established a formal schedule of matters reserved for its approval, generally being those items 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. This schedule of matters reserved is reviewed annually. John Rishton, as the Chief Executive, is responsible for the day-to-day leadership, operational and performance management of the Group within the confines of the strategy, business plans and budgets agreed by the Board. The delegation of responsibilities to the executive team is set out in a detailed schedule approved by the Chief Executive. Information is supplied to directors in a manner which enables them to fulfil their responsibilities. This includes the circulation of papers to be discussed, generally one week before meetings. Presentations are made by senior management at Board meetings on business, financial and operating issues. Directors are expected to attend all meetings of the Board and the committees on which they sit and to devote sufficient time to the Company’s affairs to enable them to fulfil their duties as directors. If directors are unable to attend a meeting, their comments on the papers to be considered are discussed in advance with the Chairman so that their contribution can be included in the wider Board discussion. Executive Leadership Team (ELT) The ELT is the senior decision-making executive committee and met 26 times during the year. Its membership is described on page 38. It developed detailed strategic options for the Group culminating in approval of strategy by the Board in September. It reviewed HS&E performance, customer relations, governance, financial and operational performance. It also reviewed acquisitions and disposals and recommended them to the Board where required. Each business segment holds executive meetings to review operational performance of its business, assisting the business president in taking such decisions as fall within his remit and reviewing proposals before presentation to the ELT or the Board for approval as appropriate. Governance principle: effectiveness Board evaluation The Code requires that the Board undertakes an annual evaluation of its own performance and that of its committees and individual directors and to do so externally at least every three years. In 2013, the evaluation process was again conducted internally, full external reviews having been carried out by Jan Hall Associates in 2010 and 2011. Initially, directors were asked to complete a confidential survey covering the areas set out as best practice published by the Financial Reporting Council’s ‘Guidance on Board Effectiveness’. The Company Secretary then produced a report which consolidated the responses following which the Chairman conducted one-to-one interviews with each director and the Senior Independent Director interviewed the Chairman. The findings were considered by the Board and actions to be taken were agreed. The evaluation concluded that the Board was proving to be effective under the leadership of Ian Davis and John Rishton and that relationships and Board discussions work well. The principal recommendation was that succession planning for senior executive positions could be improved. Other areas for improvement identified included risk processes, mitigation plans, Board papers and governance. Directors’ terms of appointment Executive directors are employees who have day-to-day responsibilities as executives of the Group in addition to their duties as directors. Each executive director receives a service contract on appointment (see pages 60 and 61 for further information). Non-executive directors are generally independent of the Company, are not employees and do not participate in the daily business management of the Group. On appointment, each non-executive director receives a letter setting out the conditions of his or her appointment. 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. Their term of office is also subject to annual re-election by shareholders at the AGM and will terminate without compensation if they fail to be re-elected (see page 60 for further information). 42 Directors’ report Rolls-Royce Holdings plc annual report 2013 CORPORATE GOVERNANCE REPORT Director training Newly appointed directors participate in a structured induction programme as detailed in the table below and receive a comprehensive data pack providing detailed information on the Group. An existing executive director can act as a mentor to each newly appointed non-executive director, giving guidance and advice as required. Issues Facilitated by Operation of the Board and governance Group strategy development and current issues Financial structure Risk strategy Operational strategy Technology and engineering issues Key site visits Committee technical requirements Chairman and Company Secretary Chief Executive Chief Financial Officer General Counsel Operations Director Director – Engineering and Technology Company Secretary Committee chairmen, internal or external experts Further training is available for directors, including presentations by the executive team on particular aspects of the business. In 2013, the Board received training in ethics conducted by our Head of Business Ethics. In December 2013, our corporate lawyers, Slaughter and May, held a seminar immediately following the Board meeting to update the Board on developments in corporate law and regulation. In addition, there is a procedure for directors to take independent professional advice at the Company’s expense and every director has access to the General Counsel and to the Company Secretary who is responsible to the Board on corporate governance. All directors are advised of changes in legislation, regulation and changing risks with the assistance of the Company’s advisers where necessary. In-house training is provided to directors of the Company’s subsidiaries and joint ventures. Independence of the non-executive directors The Board conducts a rigorous review of the independence of the non-executive directors every year, based on the criteria in the Code. This review was undertaken in November 2013 and the Board concluded that all the non-executive directors remained independent in character and judgement. The Chairman met the Code’s independence criteria upon his election as Chairman in May 2013. His other external commitments are described on page 36. Non-executive directors are advised of the time required to fulfil the role and are asked to confirm that they can make the required commitment before the appointment is made. The Board is satisfied that each of the non-executive directors is able to devote sufficient time to the Company’s business. The Board believes it can be appropriate for executive directors to take non-executive positions in other companies and organisations, as such appointments should broaden their experience. The appointment to such positions is subject to the approval of the Chairman and the Board and must not conflict with a director’s duties and commitments to the Company. 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 nomination 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. Governance principle: accountability The directors consider the annual report and accounts, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy. Investor relations Communications with shareholders regarding business strategy and financial performance are co-ordinated by a dedicated Investor Relations department that reports to the Chief Financial Officer. Communications regarding the general administration of shareholdings are co-ordinated by the Company Secretary. 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 these 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 meet members of the senior management team. Examples of these events in 2013 were: the preliminary and half-year results announcements; the AGM; the update given at the Paris Air Show on trends in the Civil and Defence aerospace businesses; visits to certain of 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. In 2013, over 380 meetings took place with over 340 separately identifiable institutional investors. The majority of meetings took place in the UK (273), 81 meetings were in the USA and Canada, and a further 26 meetings took place in Europe. The Chairman also meets institutional investors from time-to-time. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 43 Shareholder communications Information about the Group is available on the Group’s website (www.rolls-royce.com) and in the published annual report, an online version of which is also available on the website. The website contains financial and other information about the Group including current business strategy, historical financial data, and recent presentation materials together with information on the Group’s businesses, products and services. Over 20,000 Rolls-Royce shareholders have registered their email addresses with etree so that they benefit from immediate communication of the posting of our preliminary results and of the publication of our notice of meetings and our online annual report. This reduces our printing and mailing costs as well as our carbon footprint. We would encourage other shareholders to register for this service by following the instructions on the etree website at www.etreeuk.com/rolls-royce. Annual general meeting (AGM) All holders of ordinary shares are invited to attend the Company’s AGM. The Chief Executive gives a presentation highlighting key business developments during the year and shareholders have an opportunity to ask questions. All directors normally attend the AGM and the chairmen of the audit, nomination, remuneration, ethics, safety and risk committees are available to answer any questions from shareholders on the work of their committees. The Company sends the AGM notice and relevant documentation to all shareholders at least 20 working days before the date of the AGM. For 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. This year’s AGM will be held at 11.00am on Thursday, 1 May 2014 at the QEII Conference Centre, Broad Sanctuary, Westminster, London SW1P 3EE. The AGM notice and the annual report will be available to view on the Group’s website. Shareholders unable to attend the AGM can vote on the business of the meeting either by post or online. Shareholders and share capital Information on shareholders and share capital, which also forms part of the Corporate Governance report, is detailed on pages 70 and 71. 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. The terms of those 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 31 December 2013 these facilities were less than 35 per cent drawn (2012 30 per cent). 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 if 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: (cid:337)(cid:3) PSP – awards would vest pro rata to service in the performance period, subject to remuneration committee judgement of Group performance; (cid:337)(cid:3) APRA deferred shares – the shares would be released from trust immediately; (cid:337)(cid:3) ShareSave – options would become exercisable immediately. The new company might offer an equivalent option in exchange for cancellation of the existing option; and (cid:337)(cid:3) Share Incentive Plan (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. Payment to shareholders At the AGM on 1 May 2014, the directors will recommend an issue of 134 C Shares with a total nominal value of 13.4 pence for each ordinary share. The final issue of C Shares will be made on 1 July 2014 to shareholders on the register on 25 April 2014 and the final day of trading with entitlement to C Shares is 22 April 2014. Together with the interim issue on 2 January 2014 of 86 C Shares for each ordinary share with a total nominal value of 8.6 pence, this is the equivalent of a total annual payment to ordinary shareholders of 22 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 5.00pm on 2 June 2014. Redemption will take place on 3 July 2014. 44 Directors’ report Rolls-Royce Holdings plc annual report 2013 AUDIT COMMITTEE REPORT Our committee is focused on ensuring the integrity of the Group’s financial reporting and improving the financial controls framework. Lewis Booth CBE Chairman of the audit committee Committee members and attendance The audit committee consists exclusively of independent non-executive directors and met four times in 2013. Lewis Booth CBE (Chairman) Iain Conn Warren East CBE (appointed 1 January 2014) John Neill CBE Ian Strachan (retired 2 May 2013) Attendance in 2013 4/4 4/4 n/a 4/4 2/2 The external auditors KPMG Audit Plc (KPMG), the Director of Internal Audit, the General Counsel, the Director of Risk, the Company Secretary, the Chairman of the Board, the Chief Executive and the Chief Financial Officer are also invited to attend meetings. Other Board members, including the remuneration committee chairman and senior executives attended meetings during the year at the invitation of the committee chairman. Key objective: (cid:337)(cid:3) to assist the Board in ensuring the integrity of its financial statements. Responsibilities: (cid:337)(cid:3) to review the financial results announcements and financial I am pleased to present the report of the audit committee for the year. I would like to thank committee members, the executive management team and KPMG for the open discussions that take place at our meetings and the importance they all attach to its work. Work of the committee in 2013 At our meetings during 2013, we focused on financial reporting, internal control, internal audit and external audit. We received presentations from senior executives from the Civil aerospace, Defence aerospace and Civil Nuclear businesses. These presentations covered key accounting judgements and estimates, internal control and risk management. We also reviewed the committee’s own terms of reference. Financial reporting In addressing our key objective, which is to assist the Board in ensuring the integrity of its financial statements, we reviewed financial announcements and financial statements with both management and the external auditor, concentrating on: (cid:337)(cid:3) compliance with financial reporting standards and governance reporting requirements; (cid:337)(cid:3) areas requiring significant judgements to be made in applying accounting policies; (cid:337)(cid:3) the appropriateness of accounting policies; (cid:337)(cid:3) the procedures and controls around estimates that are key in applying accounting policies; statements, monitoring compliance with relevant regulations; (cid:337)(cid:3) whether the annual report and accounts, taken as a whole, is fair, (cid:337)(cid:3) to review the appropriateness of accounting policies and the supporting key judgements and estimates; (cid:337)(cid:3) to assess the scope and effectiveness of the systems to identify, manage and monitor financial and non-financial risks; (cid:337)(cid:3) to review the procedures for detecting, monitoring and managing the risk of fraud; (cid:337)(cid:3) to oversee the relationship with the external auditor and make recommendations to the Board regarding the external auditor’s appointment; and (cid:337)(cid:3) to review the scope, resources, results and effectiveness of Internal Audit. balanced and understandable and provides the information necessary for shareholders to assess the Group’s business model, strategy and performance; and (cid:337)(cid:3) any relevant correspondence from regulators. Our committee is focused on ensuring integrity of the Group’s financial reporting and improving the financial controls framework, including the restructuring of business audit committees which now report directly to this committee. During the year, we encouraged and supported the development of an enhanced business audit committee process. Under this process, management of each of the Group’s businesses consider the appropriateness and related governance of accounting policies, judgements and estimates and the control environment relating to their businesses including internal audit findings and the robustness of the processes used to execute their risk management responsibilities. We receive reports on the results of these reviews. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 45 Our business is complex; in particular the development of gas turbines for use in civil aircraft applications requires large upfront investments, a long period of sale of original equipment, and a very long period over which we generate profits and cash flows from the aftermarket by the sale of spare parts and engine maintenance work. The in-service period could be longer than 25 years for any engine, and the total life cycle of an engine could be more than 40 years from initial concept, through production, and then through the in-service life. Much of the aftermarket repair and overhaul is provided through long-term service agreements. Given this long exposure, the amount of revenue and profit recognised during any period requires a significant number of accounting judgements and estimates, supported by engineering and business assessments. Consequently, one of our primary responsibilities is to ensure that the bases for these judgements and estimates are robust. In 2013, our work focused on: (cid:337)(cid:3) carrying values of the principal intangible assets in Civil aerospace – we considered the business plans for the relevant engine programmes, including the key assumptions on which they are based, and which support the value in use assessments for the intangible assets. We were satisfied that no impairments were required; (cid:337)(cid:3) long-term contractual arrangements in Civil aerospace – we reviewed the forecasts of future contract performance on which the accounting is based. We also considered performance to date against these forecasts and the results of a detailed review of certain aspects of the processes supporting these forecasts. Where the accounting results in a contract asset, we assessed the recoverability of the asset against agreed criteria. We were satisfied that the forecasts have been prepared on an appropriate and consistent basis; (cid:337)(cid:3) risk and revenue sharing arrangements (RRSAs) in Civil aerospace – (as described in the Chief Financial Officer’s review on page 11), during the year and following discussions with the Conduct Committee of the Financial Reporting Council (FRC), the Group has reassessed its accounting policy for entry fees received from workshare partners. Adopted IFRS does not contain requirements that are specific to arrangements of this type and we assessed possible alternative policies developed by management. We reviewed the revised policy, considered the FRC’s and KPMG’s views and I attended a meeting with the FRC. On balance, we agreed with management’s view that the revised policy fairly reflects the nature of the transaction and that it should be adopted retrospectively; (cid:337)(cid:3) we reviewed the contractual arrangements that resulted in the Group consolidating Rolls-Royce Power Systems AG from 1 January 2013. We also reviewed the accounting for the business combination, based on a third-party valuation of the intangible assets acquired, and the valuation of the Daimler put option on the non-controlling interest. We were satisfied that appropriate judgements and estimates have been made; (cid:337)(cid:3) customer financing liabilities in Civil aerospace – we considered the adequacy of provisions for these liabilities. We considered the likelihood of the liabilities crystallising, based on an assessment of customers’ fleet plans and their creditworthiness. We also considered the value of any security held, based on third-party valuations. We were satisfied that provisions have been made on an appropriate basis; (cid:337)(cid:3) contingent liabilities – we considered the adequacy of the disclosures. In particular, we considered legal advice in respect of the possible outcome of the SFO enquiries. We were satisfied that the disclosures appropriately reflect the current position; and (cid:337)(cid:3) segmental reporting – we considered the changes in management structure and internal reporting described on page 10 and the implications for reporting in accordance with IFRS 8. We were satisfied with the appropriateness of the revised segmental reporting from 1 January 2014. Since the year end, we have reviewed the form and content of the Group’s 2013 annual report. The committee has reported to the Board that it considers the annual report, taken as a whole, to be fair, balanced and understandable. Internal control The Director of Internal Audit provided a report setting out an overview of the Group’s control environment and we reviewed the processes by which the control environment is assessed and any identified weaknesses resolved. We considered control weaknesses identified by the auditors in accounting for Civil aerospace long- term aftermarket contracts, and management’s plans to address these. We also received reports of any identified frauds that are significant or demonstrate significant weakness in internal control. We also reviewed a report on compliance with the Group’s policies in respect of expenses incurred by the directors and other senior executives, which did not identify any significant issues. Internal Audit The Director of Internal Audit presented two updates on audit activities and findings covering six-month periods, the resolution of control weaknesses, progress against the agreed plan and the resourcing of the department. We are continuing to develop with him a simplified metrics-driven approach to the reporting, focusing on the closure of open items on a timely basis and the identification of recurring themes. We were satisfied that the scope, extent and effectiveness of Internal Audit are appropriate for the Group. I meet the Director of Internal Audit in private before each meeting and the committee as a whole has a private meeting with him at least once a year. External auditor The external audit is a continuous process. At the start of the audit cycle, KPMG presented their audit strategy, identifying their assessment of the key risks for the purposes of the audit and the scope of their work. For 2013, these risks were: the implementation of a new consolidation system; the business combination and Daimler’s put option in respect of Rolls-Royce Power Systems Holding GmbH; impairment of intangible assets; long-term contractual arrangements; warranties and guarantees; RRSAs; customer financing arrangements; contingent liabilities; valuation of derivatives; valuation of pension liabilities; recoverability of tax assets and adequacy of tax provisions; the adjustments between the reported results and the Group’s underlying performance; and the form and content of the annual report. More detail is set out in KPMG’s report on pages 130 to 135. 46 Directors’ report Rolls-Royce Holdings plc annual report 2013 Audit tendering The Group is a complex and technologically advanced business with a long cycle from the development of an engine to its eventual retirement. We believe that KPMG’s knowledge of this, built up over a number of years, enhances the effectiveness of the audit and that the existing professional requirements, such as the rotation of audit personnel, maintain independence. However, the UK Corporate Governance Code now requires the external audit contract be tendered at least every ten years. The FRC has proposed non-binding transitional arrangements with respect to audit tendering, including a suggestion that tendering should normally fit the five-yearly cycle with respect to the lead partner. We plan to recommend a tender of the audit during the tenure of the current lead partner which, subject to KPMG’s annual reappointment, is due to end following the 2017 audit. This will also satisfy the requirements proposed by the Competition Commission. However, before we make such a recommendation, we will satisfy ourselves that, if the tender resulted in a change of auditor: (i) it would not be unnecessarily disruptive, taking account of any other activities; and (ii) appropriate plans are in place to ensure audit effectiveness is maintained. During the year, we approved a tender plan prepared by management to be used when the audit is tendered but we do not plan to tender the audit during 2014. The EU is also finalising requirements which would require mandatory rotation of auditors. the draft proposals would require us to appoint a different firm by 2020 at the latest. Once finalised, we will take account of the EU requirements in our assessment of when to recommend an audit tender. Lewis Booth CBE Chairman of the audit committee AUDIT COMMITTEE REPORT KPMG reports to the committee at both the half and full-year setting out their assessment of the Group’s judgements and estimates in respect of these risks and the adequacy of the reporting. I meet the lead audit partner in private before each meeting and the whole committee meets with KPMG in private at least once a year. Non-audit services provided by KPMG In order to safeguard auditors’ independence and objectivity, we do not engage KPMG for any non-audit services, except where it is work that they must, or are clearly best suited to perform. Fees paid to KPMG for audit, audit related and other services are set out in note 8 to the financial statements. Excluding Rolls-Royce Power Systems (see below), the main non-audit related services provided by KPMG during the year were in respect of grant claims and tax compliance and were 11 per cent of the audit fee. The nature and level of all services provided by the external auditor is a factor taken into account by the audit committee in its annual review of the external auditor. All proposed services must be pre-approved in accordance with an agreed policy. We review the non-audit fees charged by KPMG at each meeting and annually review the approval limits. Following the consolidation of Rolls-Royce Power Systems on 1 January 2013, we took the decision to allow the completion of engagements already in progress. As a result, Rolls-Royce Power Systems incurred fees on non-audit services provided by KPMG in 2013 of £2.1 million, 210 per cent of its audit fee. This will reduce in 2014. Reappointment of auditor Following the completion of the audit, we reviewed the effectiveness and performance of KPMG with feedback from committee members, senior finance personnel and Internal Audit, covering overall quality, independence and objectivity, business understanding, technical knowledge, quality and continuity of personnel, responsiveness and cost effectiveness. We also considered the reports on KPMG by the FRC’s Audit Quality Review Team. The audit of Rolls-Royce was not subject to their review in 2013. KPMG were appointed as auditors in 1990 and this appointment has not been subject to a tender process since that date. The lead audit partner is required to rotate every five years and other key audit partners are required to rotate every seven years. Jimmy Daboo took over as lead audit partner in 2013 and has had no previous involvement with Rolls-Royce in any capacity. No contractual obligations restrict our choice of external auditors. We concluded that KPMG provides an effective audit and the committee and the Board have recommended their reappointment at the 2014 AGM. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 47 NOMINATION COMMITTEE REPORT We must continue to appoint the best candidates but we will show an increasing emphasis on recruiting candidates from more diverse backgrounds. Ian Davis Chairman of the nomination committee Committee members and attendance The nomination committee consists of all of the non-executive directors and met six times in 2013. Ian Davis (Chairman) (appointed 1 March 2013) Dame Helen Alexander Lewis Booth CBE Peter Byrom (retired 2 May 2013) Sir Frank Chapman Iain Conn Warren East CBE (appointed 1 January 2014) Lee Hsien Yang (appointed 1 January 2014) John McAdam John Neill CBE John Rishton Sir Simon Robertson (retired 2 May 2013) Jasmin Staiblin Ian Strachan (retired 2 May 2013) Attendance in 2013 4/4 6/6 5/5 2/2 4/6 5/6 n/a n/a 6/6 6/6 2/2 2/2 4/6 2/2 The committee decided on July 2013 that the committee should only consist of non-executive directors and John Rishton therefore ceased to be a member. Key objective: (cid:337)(cid:3) to lead the process for appointments to the Rolls-Royce Board. Responsibilities: (cid:337)(cid:3) monitor the composition and performance of the Board and its committees; (cid:337)(cid:3) evaluate the balance of skills and experience on the Board and the diversity of its members; (cid:337)(cid:3) consider and recommend the appointment and removal of directors; (cid:337)(cid:3) monitor executive development and succession planning; (cid:337)(cid:3) evaluate any conflicts of interest that directors might have; and (cid:337)(cid:3) evaluate the independence of the non-executive directors and their time commitments. I am pleased to present my first report as chairman of the nomination committee. During the year, the committee continued to develop its succession plans for new non-executive directors taking into account their respective tenures of office, analysing the skills which were either missing or could be missing in future and how different personalities would fit around the Board table. We are very clear that we must continue to appoint the best candidates but we will show an increasing emphasis on recruiting candidates from more diverse backgrounds and with international experience. We are pleased that Lee Hsien Yang has joined the Board as a non-executive director. Hsien Yang was already known to the Board as a valued member of the IAB (a role that he has relinquished upon his appointment to the Board). The committee did not therefore engage search consultants in connection with his appointment. Hsien Yang will bring to our Board a wealth of business experience in the Asian marketplace. His biography can be found on page 37. The Board has been further bolstered by the appointment of Warren East as a non-executive director. Warren has extensive experience in the global technology sector and an outstanding record of business achievement that will be of great value to Rolls-Royce. His biography can be found on page 36. Both Warren and Hsien Yang took up their posts from 1 January 2014. Sciteb was engaged as search consultant for Warren’s appointment. The firm has no other connection with the Company. The topic of boardroom diversity has received much attention over the past two years. In September 2011, we issued our response to the Davies Report on women on boards stating that we expected to make demonstrable progress in this area by 2015. Maintaining the right balance on the Board and getting the succession policy right is high on my agenda and the Board is clear that purposeful diversity is a valuable goal. Gender diversity is an important part of that although we do not consider it appropriate to fix a specific target. 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 and we have comprehensive programmes in place to increase the diversity of our internal pipeline of future leaders. We have also issued guidance to executive search companies outlining the importance of diverse candidate short lists. Further details of our gender representation can be found in sustainability on page 27. 48 Directors’ report Rolls-Royce Holdings plc annual report 2013 NOMINATION COMMITTEE REPORT During the year, the committee reviewed the use of executive search consultants and concluded that the existing agency relationships were working well and should continue. The overarching brief is to find candidates of international stature, with international mindsets and relevant experience who could demonstrate sound judgement and board skills with an emphasis towards greater diversity. MWM Consulting was engaged in the search for the vacant chairman’s post earlier in 2013. A detailed brief was approved by the Board covering both the responsibilities of the role and the desired profile which formed the blueprint against which candidates were identified and assessed. The search was broad and global in outlook, constrained only by the requirements of the brief. Seventy candidates from ten different countries were actively considered. MWM Consulting has no other connection with the Company. In addition to the work described above, the committee also carried out the following tasks during the year: (cid:337)(cid:3) considered time commitments and potential conflicts faced by directors who wished to take up non-executive positions on the boards of other companies; (cid:337)(cid:3) authorised John Rishton’s acceptance of a non-executive role at Unilever; (cid:337)(cid:3) reviewed its own terms of reference; (cid:337)(cid:3) considered the independence of the non-executive directors; (cid:337)(cid:3) considered the standing schedule of directors’ conflicts of interest and recommended to the Board that the schedule be approved; (cid:337)(cid:3) recommended the appointment of a new Chairman and two new non-executive directors and renewed terms of office for Dame Helen Alexander, John McAdam and Iain Conn; (cid:337)(cid:3) discussed governance arrangements for the Group and the Board evaluation process; (cid:337)(cid:3) reviewed the Board’s diversity policy; and (cid:337)(cid:3) since the year end, the committee has reviewed and approved the form of this report. Ian Davis Chairman of the nomination committee S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 49 ETHICS COMMITTEE REPORT The Board has a firm belief that the only way we can succeed as a Group is by applying sound and ethical business practices wherever we operate. Iain Conn Chairman of the ethics committee Committee members and attendance The ethics committee consists exclusively of independent non-executive directors and met four times in 2013. Iain Conn (Chairman) Dame Helen Alexander Lewis Booth CBE Peter Byrom (retired 2 May 2013) Lee Hsien Yang (appointed 1 January 2014) Jasmin Staiblin Ian Strachan (retired 2 May 2013) Attendance in 2013 3/3 4/4 4/4 1/1 n/a 3/4 1/1 The Chairman of the Board, the Chief Executive, the General Counsel, the Director of Risk and the Head of Business Ethics are also invited to attend meetings on a regular basis. Key objective: (cid:337)(cid:3) review compliance with Rolls-Royce ethics policies. Responsibilities: (cid:337)(cid:3) review compliance with and recommend changes to the Global Code of Conduct; (cid:337)(cid:3) monitor evolving practice and requirements of regulatory bodies and recommend how they should be applied in the Group; (cid:337)(cid:3) establish bribery prevention policies and procedures; (cid:337)(cid:3) review arrangements by which staff may raise concerns and ensure such concerns are handled effectively; and (cid:337)(cid:3) ensure that ethical policies and practices are subject to an appropriate level of independent internal scrutiny. The ethics committee was formed in 2008 in response to the publication of the Woolf Committee report. It is responsible, on behalf of the Board, for reviewing compliance with the Group’s Global Code of Conduct, for improving bribery and corruption prevention policies and for reviewing arrangements by which staff may raise ethical concerns in confidence. It considers recommendations on ethical matters made by external regulatory authorities or other bodies and makes recommendations to the Board on how they should be applied in Rolls-Royce. I would like to thank Ian Strachan for his chairmanship of this committee from November 2008 to May 2013. Referral to Serious Fraud Office (SFO) On 6 December 2012, we announced that we had passed information to the SFO relating to concerns in overseas markets. Since that date we have continued our investigations and are engaging with the SFO and other authorities in the UK, the USA and elsewhere. In December 2013, we announced that we had been informed by the SFO that it had commenced a formal investigation. The consequence of these disclosures will be decided by the regulatory authorities. It remains too early to predict the outcomes, but these could include the prosecution of individuals and of the Group. Accordingly, the potential for fines, penalties or other consequences (including debarment from government contracts, suspension of export privileges and reputational damage) cannot currently be assessed. As the investigation is ongoing, it is not yet possible to identify the timescale in which these issues might be resolved. We continue to demand the highest standards of behaviour from our people. John Rishton has stated unequivocally that neither he nor the Board will tolerate improper business conduct of any sort and all necessary action will be taken to ensure compliance. Lord Gold’s review The Group has taken significant further action to strengthen and enhance its ethics and compliance programme. In January 2013, the Group appointed Lord Gold to review its ethical and compliance procedures and make recommendations. Lord Gold began his work in 2013 reporting directly to the ethics committee and attending its meetings. In July 2013, he presented an interim report, having interviewed over 80 senior managers across the Group. In addition to a number of detailed recommendations, the report drew attention to the need for further strengthening of the Group’s ethics and compliance function in the following three areas: develop and implement an integrity and values communication strategy; provide integrity and values training for all employees; and reorganise the compliance function. The ethics committee, the Board and the ELT have all reviewed and accepted Lord Gold’s interim report and the recommendations made in it and the Group has started to implement those recommendations. The Group has 50 Directors’ report Rolls-Royce Holdings plc annual report 2013 ETHICS COMMITTEE REPORT developed an holistic ethics and compliance improvement programme, overseen by a newly appointed Director of Risk, clarifying, with a new Global Code of Conduct, what is expected from all individuals in the Group, defining processes to combat bribery and corruption and strengthening oversight and review of the Group’s performance in these areas. The following is a summary of some of the Group’s major activities undertaken in 2013: Global Code of Conduct (Global Code) In July 2013, the Board and the ELT approved a revised version of the Group’s Global Code of Conduct which is a condensed, updated and more readable version of the previous Global Code of Business Ethics. The Global Code is being used as a platform for the Group’s enhanced ethics and compliance programme and its rollout is being supported by manager-led face-to-face awareness briefings for all employees and a detailed programme of training which will continue. The Board and the ELT received the awareness briefing and supporting ethics training in July 2013 and provided feedback and input into the materials. The Board agreed that the training programme would be compulsory for all employees. The rollout programme started in September 2013 and will be delivered to all employees and all new starters. All employees are being asked to certify they have: received a copy of the Global Code; read and understood it; will comply with it; and have received a management briefing. In future years, periodic refresher training will continue and will also be compulsory. Ethics Line Since 2008, employees have been able to access a confidential reporting line to report any concerns they might have. In 2013, the Group has reviewed, updated and re-launched its confidential reporting line (now known as the Ethics Line). Today we have contact numbers in 48 countries in addition to a web-based reporting tool which enables employees to ask questions or raise concerns 24 hours a day wherever they are based in the world. The ethics committee receives reports and questions raised through the Ethics Line. In July 2013, it was agreed that an oversight committee would be established to monitor the detailed operation of the Ethics Line and ensure it remains effective and efficient. Anti-bribery and corruption policies (ABC policies) Much progress has been made in developing policies to govern the use of intermediaries since the formation of the ethics committee in 2008. The number of intermediaries used by our businesses has continued to fall dramatically during the year. Businesses now have greater ownership and direct responsibility for the marketing, sales and support of the Group’s products and services. An updated and simpler version of the Global Gifts and Hospitality Policy was introduced in October 2012 and work has continued in the year to capture data, develop a reporting regime and develop key metrics. In July 2013, following the issue of Lord Gold’s interim report, the Director of Risk undertook to carry out a further thorough review of all ABC policies, taking account of Lord Gold’s recommendations. This review is underway and the Group has started the process of updating and modifying its suite of anti-bribery and corruption policies so that they are robust, simpler, meet the current needs of the business and are embedded as a core part of the Group’s processes for winning new business. All revised and enhanced ABC policies and procedures will meet the recommendations made by Lord Gold and will be supported by a training programme. ABC compliance team The ABC compliance organisation’s remit is to embed the ABC policies in the businesses, take the ABC programme into a ‘business as usual’ mode and make compliance a central part of the Group’s processes for winning new business. The ABC compliance team has been reorganised during the year to ensure team members remain independent of the businesses they are policing. The team has been strengthened with the creation of several new roles and broader areas of responsibility including offset compliance. A new role of Head of Risk Training has been created to ensure that there is a robust and effective training programme to support all risk policies including compliance and ethics. In response to Lord Gold’s recommendations, a protocol is being developed which will ensure that the Group’s Legal, HR, Compliance and Ethics functions work in a co-ordinated manner when investigating potential ethics and compliance breaches, ensuring that any proposed disciplinary action is reported to the Director of Risk. Ethics team The ethics team manages the Global Code and the reporting Helplines. It works closely with the compliance team. The team has been strengthened by the creation of the new role of Group Ethics Officer responsible for establishing and co-ordinating a network of trained ethics officers across all business sectors to act as a local point of contact for ethical issues. Conclusion When I took up the post of chairman of the ethics committee in 2013, I was well aware of the huge amount of effort and resource that this Group had already dedicated to improving the way our employees conduct our business. The Board has a firm belief that the only way we can succeed as a Group is by applying sound and ethical business practices wherever we operate. We are equally aware that there will always be more to do and we must always seek to improve. Iain Conn Chairman of the ethics committee S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 51 RISK COMMITTEE REPORT We have benefited from the work we did in 2012 to concentrate our focus on a smaller number of risks. John Rishton Chairman of the risk committee Committee members and attendance The risk committee consists of all of the executive directors and met three times in 2013. John Rishton (Chairman) Jim Guyette Mark Morris Colin Smith CBE Attendance in 2013 3/3 3/3 3/3 2/3 Other members of the Executive Leadership Team, the Director of Risk, the Company Secretary and the Head of Enterprise Risk Management are also invited to attend meetings. Key objective: (cid:337)(cid:3) to assist the Board in determining the nature and extent of the principal risks it is willing to take in achieving its strategic objectives. Responsibilities: (cid:337)(cid:3) develop and implement the Company’s Risk Management strategy and policy; (cid:337)(cid:3) review reports on key risks and monitor the total level of risk across the Group; and (cid:337)(cid:3) assess the adequacy of management plans to address the risks. Introduction Each of the Group’s principal risks are owned by specific members of my executive team. We continually review and challenge ourselves as to whether these continue to be our principal risks and whether our management of those risks remains effective. This year, in addition to executive directors, all members of my executive team were invited to attend the meetings to ensure there was enhanced visibility of the principal risks affecting the business and good communication of the outcomes of our discussions to each of the businesses and functions. Work of the committee in 2013 The committee discussed all of the key risks in depth in advance of the annual and half-year results process and produced a report on principal risks for the Board’s approval. It also discussed the work of the Crisis Management Team and agreed to hold more frequent crisis management exercises. During the year, work continued on the development of meaningful indicators to measure the principal risks. More focus was given to our key business continuity risks and the committee considered and assessed each of the key business continuity risks identified by the businesses and their mitigation plans. Our discussion on IT vulnerability led us to have an in-depth review of our IT Operations Centre and give detailed consideration to how IT security risks, including the growing global threat of cyber attack, are managed. We also reviewed the committee’s own terms of reference. Risk process The Director of Risk leads our risk team across the Group which is responsible for implementing risk policy and processes. Line ownership for risk management is devolved to our business units and functions, supported by a network of risk champions and risk managers. Each business maintains a risk register which comprises those risks that it considers are material to its objectives and operations. The businesses regularly review the effectiveness and consistency of risk management activity via their assurance framework and the application of the risk management process, all of which are subject to review by the business audit committees. Each business formally reviews their risks at least twice yearly taking account of work carried out by the underlying business units, programmes and functions. Business continuity plans are put in place by the businesses to mitigate continuity risks. Every six months, as part of the full- and half-year results process, the risk committee reviews the key risks that the businesses and functions report in accordance with our enterprise-wide risk management system. The committee cross-checks the risks identified by the business with those risks it has identified from its own assessments and concludes a list of principal risks. During the year, the committee discusses how the risks have changed and how each risk is managed, identifying where further action is required. We have benefited from the work we did in 2012 to concentrate our focus on a smaller number of risks. I am particularly pleased with the way the quality of discussion at these meetings has improved as a result of this focus. The attendance of business presidents at meetings has provided greater visibility across the Group of the principal risks and has enabled the Group to better manage and mitigate such risks. John Rishton Chairman of the risk committee 52 Directors’ report Rolls-Royce Holdings plc annual report 2013 SAFETY COMMITTEE REPORT The safety of our products and our people will always remain a central pillar of our business. Sir Frank Chapman Chairman of the safety committee Committee members and attendance The safety committee consists exclusively of independent non-executive directors and met twice in 2013. Sir Frank Chapman (Chairman) Iain Conn Lee Hsien Yang (appointed 1 January 2014) John McAdam Attendance in 2013 2/2 2/2 n/a 2/2 The Chairman of the Board, the Chief Executive, the General Counsel, the Director – Engineering and Technology, the Company Secretary, the Technical and Quality Director and the Head of Product Safety Assurance are also invited to attend meetings. Key objective: (cid:337)(cid:3) review and assure the Board on all safety policies, practices and procedures and ensure that these operate reliably and to appropriate industry standards. Responsibilities: (cid:337)(cid:3) keep product safety, HS&E, and personnel security policies under review; (cid:337)(cid:3) make recommendations as to content and communication of those policies; (cid:337)(cid:3) measure and review safety performance; and (cid:337)(cid:3) review external issues which relate to safety policies and practices. Product safety In all sectors, the Group supplies high value capital products that are strictly regulated with regard to safety. Civil aerospace products are required to meet relevant airworthiness authority standards, whilst defence operators define their own standards for military aerospace and naval products. Our Marine and Energy businesses need to meet industry specific standards with our Nuclear business being particularly highly regulated. In June 2013, the committee reviewed a Trent case study which demonstrated how the Company’s product safety process operates in practice both in the design stage and during the operational life of an engine. The committee found this product safety process to be very thorough and of a very high standard. At its meeting in July 2013, the committee considered how the Group applied judgements in product safety beyond the levels defined in legislation. It received an update on the product safety management system and on recent developments in safety in the aerospace industry. It also examined the findings of the Australian Transport Safety Bureau in respect of the Qantas QF32 event and the actions taken by the Group. In September, the committee was briefed by senior manufacturing and quality managers from the supply chain units (SCUs), the Technical and Quality Director and the Head of Product Safety Assurance on the Rolls-Royce Management System as it applies to safety. This was followed by an in-depth look at the compressor SCU and the design to manufacture process for wide-chord fan blades as well as the process for monitoring on-going blade production. At our meeting in December, the committee reviewed how the Director – Engineering and Technology executes his accountability for product safety on behalf of the Chief Executive through the Company Product Safety Review Board and the Quality System. The committee also reviewed its own terms of reference. Health, safety and environment In July, the committee considered how the As Low as Reasonably Practical (ALARP) approach is applied to HS&E risks, and received updates on the global improvement programmes being implemented in relation to process safety management and electrical safety. In December, we received an update on 2013 HS&E activity, including briefings on the global improvement programmes related to process safety, electrical safety and occupational health. Further information on our HS&E performance can be found in sustainability on pages 28 and 29. Overall the committee made good progress in 2013, particularly in relation to examining the processes that manage product safety. Alongside this central theme, the areas of asset integrity, occupational safety, occupational health, environmental performance and personnel security arrangements for staff working in difficult environments were reviewed. In 2014, we intend to establish a framework for a structured cyclical review of all HS&E and personnel security matters. This is a Company built on a brand promise of being ‘trusted to deliver excellence’ and the safety of our products and our people will always remain a central pillar of our business. Sir Frank Chapman Chairman of the safety committee S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 53 REMUNERATION COMMITTEE REPORT We believe that our remuneration policy is aligned with our strategy to enhance long-term value for our stakeholders. Dame Helen Alexander Chairman of the remuneration committee Committee members and attendance The remuneration committee consists exclusively of independent non-executive directors and met five times in 2013. Dame Helen Alexander Sir Frank Chapman John McAdam Attendance in 2013 5/5 4/5 5/5 The Chairman, the Chief Executive, the Director – Human Resources, the HR Director – Reward & Pensions, the Company Secretary and the Chief Financial Officer are also invited to attend meetings. None of these executives were present during any discussion of their own remuneration packages. Key objective: (cid:337)(cid:3) to develop a remuneration policy capable of attracting and retaining individuals necessary for business success. Responsibilities: (cid:337)(cid:3) to consider and make recommendations to the Board on the policy for the remuneration of the executive directors, members of the Executive Leadership Team and other direct reportees to the Chief Executive (collectively the Senior Executives) and the Chairman; (cid:337)(cid:3) to determine the whole remuneration package for Senior Executives and recommend to the Board the whole remuneration package for the Chairman; (cid:337)(cid:3) to determine the terms and conditions of service contracts for Senior Executives; (cid:337)(cid:3) to determine the design, conditions and coverage of any annual and long-term incentive schemes for Senior Executives and to approve total and individual payments under these schemes; (cid:337)(cid:3) to determine targets for any annual and long-term incentive schemes; (cid:337)(cid:3) to determine the issue and terms of all share-based plans available to all employees; (cid:337)(cid:3) to determine compensation (if any) in the event of termination of service contracts of any of the Senior Executives; and (cid:337)(cid:3) to approve the appointment of former executive directors by the Company as consultants. On behalf of the Board, I am pleased to present our directors’ remuneration report that has been prepared in accordance with the new reporting regulations which became effective on 1 October 2013. The report is divided into two sections. A policy report which sets out the approach to remuneration, and a remuneration report which details what has been paid to the directors during 2013. Each report will be proposed as a separate resolution at the AGM. The vote on the policy report is a binding vote. The remuneration policy must be approved at least every three years if it remains unchanged, or sooner in the event the policy needs revising. The policy will become effective on 1 May 2014 subject to shareholder approval at the AGM. We have a clearly defined strategy to win in competitive markets through our focus on the customer, innovation and profitable growth. Our remuneration policy supports the delivery of this strategy and aligns the interests of our directors with that of our shareholders. This is achieved by short-term and long-term incentive plans which focus on delivering business objectives, profitable growth and strong shareholder returns. Annual incentives are also based on personal performance which will include the progress made on longer-term strategic objectives. An important principle of the annual bonus plan is that no bonus can be paid unless the entire Group has achieved a base level of business performance. For the first time, the bonus and PSP targets we set in 2014 will include both profit and cash contributions from Rolls-Royce Power Systems. We believe this is appropriate now that Rolls-Royce Power Systems is being integrated into the Rolls-Royce business. Our overall remuneration policy remains relatively conservative which has served us well in recent years. There will be no increase in basic pay for most of the senior leadership team in 2014. We remain satisfied that the existing remuneration arrangements continue to align with the Group’s strategy and there are no plans to change the current arrangements significantly. The committee will continue to monitor our market competitiveness in order to ensure we are able to attract and retain the best talent. Annual bonus For executive directors and all senior managers, a proportion of any annual bonus is made in deferred shares. The committee has agreed to allow flexibility to allot new shares to satisfy awards and this provision will be part of the new Rolls-Royce plc Deferred Share Bonus Plan which will be proposed at this year’s AGM. 54 Directors’ report Rolls-Royce Holdings plc annual report 2013 REMUNERATION COMMITTEE REPORT Performance Share Plan The current Performance Share Plan (PSP), approved by shareholders ten years ago, expires in 2014. A new PSP will be put forward for approval at the AGM. This will be broadly unchanged with the following two exceptions which we believe increase the link to shareholder interests: (cid:337)(cid:3) the new plan will contain malus and clawback provisions to enable the withdrawal or amendment of share grants before vesting and the right to reclaim awards that have vested or their proceeds in the case of serious non-compliance with the Group’s Global Code of Conduct, reputational damage or gross misconduct; and Summary of activity during 2013 During 2013, amongst other things, the committee: (cid:337)(cid:3) endorsed the out-turn of the 2012 annual bonus and 2010 PSP; (cid:337)(cid:3) reviewed executive directors’ base salary levels; (cid:337)(cid:3) set 2013 annual bonus targets and performance targets for the PSP 2013 – 2015; (cid:337)(cid:3) recommended the approval of the 2012 remuneration report to the Board; (cid:337)(cid:3) approved PSP grants to certain senior management; (cid:337)(cid:3) considered the structure of the annual bonus for 2014; (cid:337)(cid:3) considered the new BIS regulations in respect of drafting the (cid:337)(cid:3) the directors will be obliged to retain half of all PSP shares released remuneration report; to them until a multiple of salary is reached. The shareholding requirement has been increased to 250 per cent of salary for the Chief Executive and 200 per cent of salary for the other executive directors. The share retention policy is explained on page 66. Annual bonus outcome This year’s bonus reflects on-target performance. Group underlying profit was £1,500 million which met the base level performance, and there was a net cash inflow of £312 million which resulted in an annual bonus outcome of 60 per cent. The targets and results exclude Rolls-Royce Power Systems AG (previously named Tognum AG). PSP outcome Over the three-year performance period for the 2011 PSP grant, earnings per share growth was 60 per cent, which exceeded the OECD index of consumer prices of six per cent, and cash flow per share was 86p. This resulted in 100 per cent of the shares conditionally granted being released. The Company’s Total Shareholder Return (TSR) performance was ninth in the FTSE 100 over the three-year performance period which resulted in a 50 per cent increase in the number of shares released to executive directors. (cid:337)(cid:3) considered the projected out-turns for the 2013 annual bonus, All-Employee Bonus Scheme and the 2011 PSP; (cid:337)(cid:3) considered a benchmarking report for the executive salary review in 2014; and (cid:337)(cid:3) reviewed its own terms of reference. We believe our current remuneration practices are in line with the new reporting regulations and we welcome the structure and transparency introduced by the new requirements. Overall, we believe that our remuneration policy is aligned with our strategy to enhance long-term value for our stakeholders. Dame Helen Alexander Chairman of the remuneration committee Rolls-Royce Holdings plc annual report 2013 55 DIRECTORS’ REMUNERATION POLICY Remuneration policy framework 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 believes that an effective remuneration strategy plays an essential part in the future success of the Group. Accordingly, the remuneration policy will continue to reflect the following broad principles: (cid:337)(cid:3) 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; (cid:337)(cid:3) remuneration must be capable of attracting and retaining the individuals necessary for business success; (cid:337)(cid:3) remuneration policy must be sufficiently flexible to take account of changes in the Group’s business environment and market practices; (cid:337)(cid:3) total remuneration should be based on Group and individual performance, both in the short and long term; (cid:337)(cid:3) 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 (cid:337)(cid:3) when determining remuneration, the committee will take into account pay and employment conditions elsewhere in the Group. Policy report The policy will start on 1 May 2014, subject to shareholder approval at the AGM. Executive directors’ remuneration policy Element Salary Purpose and link to strategy Operation Maximum opportunity Performance measures None, although individual performance is the primary consideration in setting salary alongside overall Company affordability and market competitiveness. It is essential that the Company provides competitive salaries, suitable to attract and retain individuals of the right calibre to develop and execute the business strategy. Salary levels are set using careful judgement, taking into account the scope of the role and responsibilities, performance, experience, potential, retention issues and salaries elsewhere in the Group. Judgement will be informed, but not led, by reference to companies of a similar size, complexity and internationality. Salaries are reviewed annually and normally fixed for 12 months from 1 March each year. However, salary increases are not automatic. Exceptionally, salaries may be increased on other dates in the year. Executive directors may be appointed at salaries below the target level to enable pay progression commensurate with growth in the new role. Annual salary increases will not normally exceed average increases for employees in other appropriate parts of the Group. On occasion, increases may be larger where the committee considers this to be necessary. Circumstances where this may apply include: growth into a role; to reflect a change in scope of role and responsibilities; where market conditions indicate a level of under competitiveness and the committee judges that there is a risk in relation to attracting or retaining executives. Where the committee exercises its discretion to award increases above the average for other employees, the resulting salary will not exceed the competitive market range. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 56 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION POLICY Executive directors’ remuneration policy Element Benefits Purpose and link to strategy To provide market- competitive benefits sufficient to recruit and retain, and to support the executive to give maximum attention to their role. Pension To provide market- competitive pensions sufficient to recruit and retain. Operation Benefits provided include a car or car allowance, contribution to the cost of fuel, use of a driver, financial planning assistance, life assurance and medical insurance. Other appropriate benefits may be provided from time-to-time at the discretion of the committee. Certain benefits, such as accommodation or use of a driver, are to enable an executive to devote maximum time and attention to their role. Club membership fees may also be provided. The Group may pay any tax due on these benefits. The Group offers relocation for executives to be located within reasonable reach of their place of work. Where relocation is not practical or a preferred option, or where work is mainly split between two locations, support for accommodation and travel may be provided. Relocation support may include items such as transaction and legal fees, removals, disturbance allowance and temporary travel and subsistence costs. International relocation support may include items such as school fees, tax equalisation and home visits. New executives to the Company are offered membership of a defined contribution pension plan. Pension contributions are based on base salary only. There are a number of legacy pension arrangements, including defined benefit plans, which were in place before 27 June 2012 and have not changed since. Commitments to these arrangements will be honoured. Executives may opt to receive a cash allowance in lieu of pension. Performance measures None. Maximum opportunity Benefits will be market competitive taking into account the role and the local market. Benefits excluding any accommodation, relocation and associated tax costs will not exceed £100,000 per annum. The value of benefits provided for international and domestic relocation and any ongoing accommodation and travel support will be appropriate to the individual circumstances of the executive and only expenses that the committee considers necessary and appropriate will be supported. None. The maximum employer contribution to defined contribution pension arrangements is 38% of base salary. Under the Group’s legacy defined benefit arrangements, the pension due is the higher of a pension based on the executive’s final salary, with a maximum annual accrual rate of 2.5%, or based on career average salary with a maximum annual accrual rate of 3.3%. The resulting pension is limited so that the maximum pension at normal retirement age is two thirds of the executive’s final remuneration. The benefits under these arrangements include a lump sum payable on death in service and pensions for surviving spouses, civil partners and certain dependants. Rolls-Royce Holdings plc annual report 2013 57 Executive directors’ remuneration policy Purpose and link to strategy Operation Maximum opportunity Performance measures Element Pension continued S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Executives may opt to receive a cash allowance in lieu of pension. The cash allowance is calculated to be equivalent to the employer’s defined contribution pension contributions, reduced to allow for the additional National Insurance cost incurred by the employer. James Guyette participates in qualified and non-qualified defined benefit and defined contribution pension arrangements in the US. Under these various arrangements combined it is expected that the benefits provided by the Company will be equivalent in value to a pension of two thirds of salary, with post retirement increases similar to those required by statute in the UK. The current maximum annual bonus, linked to business performance, is 135% of salary for the Chief Executive and 125% for other executive directors. This is based on achieving the highest targets set for business performance. However, the committee may adjust the bonus to reflect personal performance as described in the previous column, giving an overall maximum of 162% and 150% respectively. The committee has the discretion to increase the overall maximum bonus level to 200% of salary for the Chief Executive and 175% for other executive directors, subject to this not being above the competitive market range. The bonus payout level is determined primarily by Group financial performance but the committee may introduce non-financial metrics and/or adjust the payout level to reflect other factors as appropriate. The final bonus awarded to each director is also linked to their personal performance. Any non-financial metrics used in the annual bonus plan will be linked to the Group’s strategy and will not be weighted more than 50% of the whole bonus. A principle applies that no bonus is payable unless the base financial targets are achieved and this also applies if non-financial measures are introduced. Based on the current bonus opportunity: Chief Executive: Bonus generated by business performance is 40% of salary for achieving the base level targets and 135% of salary for achieving the highest level of targets. Bonus may then be adjusted for personal performance in a range 0-120% at committee discretion with 100% typically applying for good performance and a 20% uplift available for outstanding personal performance. Other executive directors: Bonus generated by business performance is 37% of salary for achieving the base level targets and 125% of salary for achieving the highest level of targets. Bonus may then be adjusted for personal performance as above. Annual bonus To incentivise and reward execution of the business strategy, delivery of financial performance targets and achievement of personal objectives. Compulsory deferral of part of any bonus encourages retention and provides alignment with shareholders. The committee sets Group financial targets and agrees personal objectives for each executive director at the start of the financial year. At the end of the year, business performance determines the Company bonus payout level and the committee considers whether any adjustment to the payout level is appropriate. Each executive director’s bonus is also dependent on the achievement of their personal objectives and wider contribution to the Group. The committee may apply an uplift of up to 20% or a reduction, potentially to zero, as appropriate. A portion of the bonus paid, in a range 30% to 50%, is compulsorily deferred into the Company’s shares for a period of two years and is subject to continued employment (with early release in certain circumstances). There are no further performance conditions. Deferred shares may receive a bonus issue of C Shares or equivalent during the deferral period. The bonus plan is non-contractual and may be offered on a year-by-year basis. The committee has the right to apply the malus provision on an individual or group basis and amend or withdraw the bonus before payment. From 2014, the same right over deferred shares will apply as will the right to clawback bonuses paid or vested shares on an individual basis if it can be demonstrated that individuals have acted in an improper manner. Malus and/or clawback provisions may apply in exceptional cases such as: material misstatement of results; a material failure of risk management; serious reputational damage; serious individual wrongdoing such as non-compliance with the Company’s Code of Conduct; or gross misconduct. 58 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION POLICY Executive directors’ remuneration policy Element Purpose and link to strategy Operation Performance Share Plan (PSP) Post 2014 AGM onwards To incentivise and reward development and execution of the business strategy over the longer term. The plan provides alignment with shareholder interests through the performance measures chosen and a retention element through the plan timescale. A shareholding requirement is linked to the PSP in order to further provide alignment with shareholders. The link between the performance measures and the Company’s strategy is explained in the notes to this table on page 59. Executive directors are granted awards over shares annually at the start of a three-year performance period. The proportion of the those awards that vest is determined at the end of the period according to a set of Company performance measures. Vesting of awards is subject to continued employment until vesting date with the exception of certain leaver circumstances, in which case vesting is subject to Company performance and pro-rating for service. The plan rules contain malus and clawback provisions. The committee has the right to amend and withdraw share grants before vesting for individuals and groups and the right to reclaim vested shares or their proceeds from individuals where it has been demonstrated that they acted in an improper manner. Situations where the provisions will apply are as described in the bonus section on page 57. Executive directors are required to hold a level of shareholding as described on page 66. Performance Share Plan (PSP) Legacy awards – 2004 plan The purpose of the 2004 share plan is fully consistent with the purpose of the 2014 plan described above. The operation of the 2004 plan is as described above with the exception of malus and clawback elements which will apply for 2014 grants. ShareSave Plan Share Incentive Plan (SIP) This savings-related share option plan provides all employees worldwide an interest in the performance of Rolls-Royce shares. UK employees may elect to receive part of any annual bonus in shares. UK employees may elect to make regular monthly purchases of shares from pre-tax income. Executive directors may participate on the same terms as other employees. The option price may be discounted by up to 20%. Accumulated savings may be used to exercise an option to acquire shares. UK-based executive directors may participate on the same terms as all other UK employees. Shares held in the SIP for five years will vest free from income tax and National Insurance contributions. Maximum opportunity Performance measures The Chief Executive is granted awards each year over shares to the value of 120% of salary. Other executive directors are granted 100% of salary. Subject to the earnings per share (EPS) condition being met, these shares vest at the end of the performance period if the Company has achieved the maximum target set for cash flow per share (CPS). The number of shares vesting can be increased by 25% for above median TSR ranking rising to 50% increase for upper quartile TSR ranking. Maximum face values of annual awards are therefore 180% of salary for the Chief Executive and 150% of salary for other executive directors. The three corporate performance measures are: 1. EPS – condition. The increase in EPS over the three-year period must exceed an appropriate index of consumer prices for the same period. If this condition is not met share vesting is zero. 2. CPS – prime measure. The aggregate CPS over the performance period will determine the number of shares which vest. Achieving a base target of CPS will result in 30% of the shares vesting and achieving a maximum CPS target will cause 100% of the shares to vest. The number of shares which may vest is determined on a straight-line basis between the 30% and 100% level. 3. Total Shareholder Return (TSR) relative to FTSE 100 or other appropriate index. The number of shares vesting will be increased by 25% if the Company’s TSR is ranked above the median of the FTSE 100, or other appropriate index, over the same periods and by 50% if ranked at or above the upper quartile of the same group. Intermediate TSR ranking will increase the number of shares released on a straight-line basis. As above. As above. The maximum savings amount is currently £250 per month over a three- or five-year period. This may be increased in accordance with changes to UK legislation. No performance measures are permitted by UK legislation applicable to this type of plan. Currently, up to £3,000 of the annual cash bonus can be applied to purchase shares. The maximum monthly amount of £125 may be used to purchase shares. The above limits may be increased in accordance with changes to UK legislation. The award of any bonus will depend on performance conditions (see page 57) but no further conditions apply once the employee elects to participate in the SIP. Rolls-Royce Holdings plc annual report 2013 59 Non-executive directors’ remuneration policy Purpose and link to strategy Operation Maximum opportunity Performance measures None Element Fees To reward individuals for fulfilling the relevant role and to attract individuals of the skills and calibre required. Benefits To devote maximum time and attention to the requirements of the role. The Articles of Association require the Company to set a maximum ceiling on the total remuneration payable to non-executive directors including the non-executive Chairman. A resolution to increase this to £1,400,000 will be proposed at the 2014 AGM. Fees are set at a level appropriate for the role and are reviewed regularly, taking in to account fees payable to non-executive directors of companies of a similar size and complexity. None The maximum value for chauffeur services will not exceed £25,000 per annum. The maximum contribution towards tax advice and filing is £5,000 per annum. The committee makes recommendations to the Board on the remuneration of the Chairman. The Chairman and the executive directors determine the remuneration for the non-executive directors. The level of remuneration is set within a limit approved from time-to-time by shareholders. The Chairman is paid a single consolidated fee. Other non- executive directors are paid a base fee covering Board and committee membership. Committee chairmen and the Senior Independent Director receive an additional fee. The Chairman has occasional use of chauffeur services. Travel, hotel and subsistence expenses incurred in attending Board meetings and committee meetings or otherwise required to attend the Company’s offices are reimbursed by the Company. The Group may pay any tax due on such benefits. Where a non-executive director is based outside the UK and has to file a UK tax return, the Company may pay towards tax advice and filing. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Performance measures and targets The annual bonus measures are primarily based on Group financial performance but may contain non-financial measures as detailed in the above table. condition is varied or replaced, the amended performance conditions must, in the opinion of the committee, be fair, reasonable and materially no more or less difficult than the original condition when set. The committee will set the Group financial targets with reference to the prior year and to the budgets and business plans for the coming year, ensuring the levels to achieve base, on-target and maximum bonus payout are appropriately challenging. The PSP performance measures set out in the policy table support the Group’s strategy as follows: (cid:337)(cid:3) the EPS growth hurdle ensures any payout is supported by sound profitability; (cid:337)(cid:3) the aggregate CPS measure incentivises the generation of cash flow in line with the Group’s strategy. This measure is set in line with the principles described for the annual bonus; and (cid:337)(cid:3) the TSR performance measure aligns interests with shareholders by rewarding TSR out-performance. The TSR is measured with reference to constituents of an appropriate index such as the FTSE 100. In accordance with the rules of the PSP, the performance condition may be replaced or varied if an event occurs or circumstances arise which cause the committee to determine that the performance conditions have ceased to be appropriate. If the performance Shareholders’ views This statement of remuneration policy is largely a consolidation of policies which have enjoyed the support of shareholders for many years. We have considered the guidance provided by the GC 100 and shareholder advisory groups in preparing this policy and have followed this insofar as it is appropriate in the context of our business. Prior to finalising the policy, we have shared it with a selection of major shareholders. Looking ahead, we welcome an open dialogue with shareholders and intend to continue to consult with major shareholders before implementing any significant change. Group employee considerations When setting remuneration for executive directors the committee takes into account contextual information about pay and conditions within the Group, including the following: (cid:337)(cid:3) salary increases for the all-employee population; (cid:337)(cid:3) bonus awards for the all-employee population; and (cid:337)(cid:3) pay ratios between executive directors and other employees. 60 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION POLICY Rolls-Royce employs over 55,000 people in more than 50 countries. Inevitably remuneration arrangements differ to reflect local markets, but some common themes apply to employees at all levels worldwide: (cid:337)(cid:3) we aim to offer competitive levels of remuneration, benefits and incentives to attract and retain employees; (cid:337)(cid:3) all employees participate in bonus arrangements where the bonus is determined by the same financial measures as that applicable to executive directors; and (cid:337)(cid:3) all employees have the opportunity to participate in a savings related share option plan. At more senior levels, remuneration is increasingly long term and larger proportions are dependent on both Group and individual performance and paid in the form of shares. Given the scale of the employee population, the committee considered that it would be impractical to consult all employees when drawing up the policy. Illustrations of remuneration policy application The bar chart below illustrates projected executive remuneration for 2014 at four different levels of performance showing payments from minimum to maximum. The table below the chart explains performance levels one to four and the associated remuneration. £000* James Guyette Mark Morris John Rishton Colin Smith 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 500 0 30% 11% 22% 13% 20% 25% 34% 13% 24% 16% 25% 29% 39% 30% 16% 18% 25% 29% 30% 10% 21% (cid:345)(cid:337)(cid:346)(cid:384) 13% 20% 25% 100% 76% 58% 45% 100% 71% 51% 37% 100% 66% 45% 32% 100% 77% 59% 45% 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 * Salary values are as at 31 December 2013 Salary, plus pension and benefits Potential value of bonus depending on the performance scenario Potential value of PSP depending on the performance scenario Remuneration achieved for key levels of performance are: 1. Minimum Fixed remuneration only. No bonus or PSP paid. 2. Base level 3. On-target 4. Maximum Bonus and PSP resulting from base level of business performance. Bonus at 30% of maximum payment assuming no adjustment for personal performance. PSP vesting at 30% of maximum from achieving base CPS target with no TSR multiplier. Bonus and PSP resulting from performance in line with Company expectations. Bonus at 60% of maximum assuming no adjustment for personal performance. PSP vesting mid-way between base and maximum levels with 25% TSR multiplier. Maximum annual bonus based on achieving the highest targets set for business performance and outstanding individual performance: PSP vesting from achieving maximum CPS target and with maximum 50% TSR multiplier. Service contracts UK-based executive directors’ contracts include the following provisions: (cid:337)(cid:3) 12 months’ notice of termination from Rolls-Royce; (cid:337)(cid:3) 6 months’ notice of termination from the executive; and (cid:337)(cid:3) reimbursement of reasonable business expenses. 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 policy on exit payments is set out in the next section. The following table summarises the terms of the executive directors’ service contracts: James Guyette Mark Morris John Rishton Colin Smith CBE Date of contract 29 Sep 1997 Notice period Company 30 days 1 Jan 2012 12 months 10 Mar 2011 12 months 1 July 2005 12 months Notice period individual 30 days 6 months 6 months 6 months James Guyette has a contract with Rolls-Royce North America Inc., drawn up under the laws of the State of Virginia, US. This provides that, on termination without cause, he is entitled to 12 months’ severance pay without mitigation and, in addition, appropriate costs incurred in relocating household and personal effects. The contract also provides for the payment of club membership fees and for tax and financial planning up to a maximum of US$15,000 per annum and the Group will gross up any amounts to cover any applicable taxes arising. All contracts also include the entitlement to paid holidays, sick pay and other standard employee terms. 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 or if they fail to be re-elected at an AGM. Dame Helen Alexander Lewis Booth CBE Sir Frank Chapman Iain Conn Ian Davis Warren East CBE Lee Hsien Yang John McAdam John Neill CBE Jasmin Staiblin Appointment date 1 Sep 2007 25 May 2011 10 Nov 2011 20 Jan 2005 1 Mar 2013 1 Jan 2014 1 Jan 2014 19 Jan 2008 13 Nov 2008 21 May 2012 Current letter of appointment end date 31 Aug 2016 24 May 2014 9 Nov 2014 19 Jan 2015 29 Feb 2016 31 Dec 2016 31 Dec 2016 18 Feb 2017 12 Nov 2014 20 May 2015 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 61 Policy on exit payments The notice period the Company is required to give to executive directors under their contracts of employment is 12 months. Payment in lieu of notice will not exceed the value of 12 months’ salary, benefits and pension contributions. Both mitigation and the staggering of payments through the notice period will be considered by the committee where appropriate, as will the funding of reasonable outplacement and other professional fees. Should additional compensation matters arise, such as a settlement or compromise agreement, the committee will exercise judgement and will take into account the specific commercial circumstances. Pension benefits on early retirement should be payable in accordance with the normal rules of the relevant pension plan. Under legacy UK defined benefit pension arrangements, accrued pension is reduced to reflect early receipt in accordance with factors set by the trustees from time-to-time and is limited to a maximum pension of two thirds of the executive’s final remuneration, pro-rated by actual service to potential service. Policy on new appointments The committee will normally award newly appointed executive directors with a remuneration package which is consistent with the policy and principles as set out in this report. Base salary may be set at a level higher or lower than previous incumbents and in certain circumstances, to facilitate the recruitment of individuals of the required calibre, the committee may use its discretion to make individual additional incentive awards up to a maximum of 100 per cent of annual salary. Incentive levels may also be increased by up to 30 per cent of salary per annum for incentives commencing within two years of joining. This level of discretion is considered appropriate given the current conservative market positioning of Rolls-Royce and our potential need to recruit from other market sectors or countries outside of the UK. In addition, remuneration forfeited on resignation from a previous employer may be compensated. The form of this compensation would be considered on a case-by-case basis and may comprise either cash or shares. Generally: The committee has the discretion to preserve incentive awards pro-rated to service and to release deferred shares. In exercising this discretion, the committee will have regard to performance and the circumstances of leaving. For deferred shares these are usually released in cases such as retirement, death, injury, ill-health and redundancy. For PSP, the rules state that unvested awards may be preserved at the committee’s discretion according to the circumstances. In such cases vesting will be at the normal date, subject to the established performance conditions, and pro rata to employment in the performance period. In cases such as death and terminal illness, the committee also has the discretion to vest the awards immediately using an estimate of future out-turn. (cid:337)(cid:3) if such remuneration was in the form of shares, compensation will be in the Company’s shares; (cid:337)(cid:3) if remuneration was subject to achievement of performance conditions, compensation will be subject to Rolls-Royce performance conditions; and (cid:337)(cid:3) the timing of any compensation will, where practicable, match the vesting schedule of the remuneration forfeited. A newly appointed executive director may be provided with reasonable relocation support as set out in the policy table. Internal appointments would receive a remuneration package that is consistent with the remuneration policy. Legacy terms and conditions would be honoured, including pension entitlements and any outstanding incentive awards. The treatment of leavers in the Company’s ShareSave and SIP plans is governed by the plan rules. The UK rules are HMRC approved. An executive director who has ShareSave options who retires or who leaves the Company through ill-health, disability or redundancy will be entitled to exercise their options, pro rata to the savings made, within six months of leaving the Company. An executive director who leaves in any other manner such as dismissal would only be entitled to have their savings returned to them. Participants in the SIP who leave the Company for the same reasons listed above will have their shares released to them free of tax and National Insurance contributions. In the event of a change of control of the Company, PSP awards will vest based on the extent to which the committee determines the performance conditions have been or would have been met. Pro-rating for service in the performance period will apply. Deferred shares earned under APRA would vest in full. ShareSave options would immediately be exercisable pro rata to savings made. Consideration received as shares would be held in the SIP, if possible, otherwise the consideration would be treated as a disposal from the SIP. If awards are made on recruitment (such as buy-outs) the treatment on leaving would be determined at the time at the committee’s discretion. If an executive director is appointed following a merger or an acquisition of a company by Rolls-Royce, of which the executive director was employed, legacy terms and conditions may be honoured. Legacy commitments Contractual commitments made before 27 June 2012 and before the policy comes into effect will be honoured. This will include grants made under the old PSP arrangement which will vest, subject to the performance criteria being achieved after the adoption of this policy, as well as previous contractual provisions relating to the defined benefit pension scheme. The committee may make minor amendments to the policy set out above (for regulatory, exchange control, tax, administrative purposes or to take account of a change in legislation) without obtaining shareholder approval for that amendment. The remuneration policy report was approved by the Board on 12 February 2014 and signed on its behalf. Dame Helen Alexander Chairman of the remuneration committee 62 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION REPORT Single figure of remuneration (subject to audit) The total remuneration for the directors of the Company for the financial year ending 31 December 2013 is detailed below: Salary/fees (a) £000 Benefits (b) £000 Bonus (c) £000 LTIP (d) £000 Other (e) £000 Sub-total £000 Pension (f) £000 Total £000 James Guyette Mark Morris John Rishton Colin Smith CBE Dame Helen Alexander Lewis Booth CBE Peter Byrom Sir Frank Chapman Iain Conn Ian Davis John McAdam John Neill CBE Sir Simon Robertson Jasmin Staiblin Ian Strachan Total 2013 535 506 921 523 75 80 20 75 82 292 60 60 126 60 26 3,441 2012 517 482 896 506 75 80 60 75 72 – 60 60 370 37 75 3,365 2013 107 159 125 128 – 10 – 3 – 2 – 2 2 2 – 540 2012 100 189 126 23 – 4 – – – – – 2 7 – – 2013 423 383 824 394 – – – – – – – – – – – 451 2,024 2012 2013 663 1,464 445 464 1,239 4,055 596 1,329 – – – – – – – – – – – 7,293 – – – – – – – – – – – 2,962 2012 1,399 333 1,998 1,194 – – – – – – – – – – – 4,924 2013 – 6 – – – – – – – – – – – – – 6 2012 2013 2013 2012 532 – 2,529 2,679 162 – 1,499 1,468 303 4,259 – 531 2,319 – – 75 – – 84 – – 60 – – 75 – – 72 – – – – – 60 – – 62 – – 377 – – 37 – – – 75 – 13,304 11,702 1,528 5,925 2,374 75 90 20 78 82 294 60 62 128 62 26 2012 2013 2012 472 3,061 3,151 719 1,661 2,187 318 6,228 4,577 1,034 2,905 3,353 75 84 60 75 72 – 60 62 377 37 75 2,543 14,832 14,245 75 90 20 78 82 294 60 62 128 62 26 – – – – – – – – – – – Notes to the table (a) (b) Salary/fees – cash paid in the year. James Guyette was paid in US dollars translated at £1 = US$1.565 (2012 US$1.585). Benefits – taxable value of all benefits paid in the year. The benefits for the non-executive directors relate to travel and subsistence associated with attending board meetings with the exception of Sir Simon Robertson which was related to the use of a chauffeur. James Guyette £000 Mark Morris £000 John Rishton £000 Colin Smith CBE £000 Benefits Car or car allowance including fuel allowance Chauffeur services Financial planning Medical insurance Life assurance Club membership fees Travel and subsistence Housing costs Total 2013 11 – 19 – 38 23 – 16 107 2012 11 – 16 – 37 20 – 16 100 2013 24 – – 1 – – 30 104 159 2012 24 – – 1 – – 36 128 189 2013 18 13 – 1 – – – 93 125 2012 18 8 – 1 – – – 99 126 2013 21 – – 1 – – 3 103 128 2012 22 – – 1 – – – – 23 (c) (d) (e) (f) Bonus. This is the total APRA bonus earned in 2013. The bonus, based on Group profit and cash performance, was 60 per cent of the maximum as detailed on page 57. Personal performance is taken into account in determining individual bonuses payable. The awards made to John Rishton and James Guyette included a modification for personal performance of 110 per cent and 105 per cent respectively. 60 per cent of the bonus is paid as cash and 40 per cent is deferred into shares for two years subject to continuous employment with the Group. Long-term incentives. This is the estimated value of the PSP shares that are due to vest in March 2014 (2013 being the final year of the performance period) and for John Rishton, as well as his PSP shares, the performance related shares he received on joining the Company. It is based on the number of shares that will vest multiplied by the average share price of 1184.52p over the quarter ending 31 December 2013 (as the vesting price is not known at the date of approval of the remuneration report). Performance has already been determined for these awards as detailed on page 64 and 150 per cent of the original award will vest, based on achievement of the EPS growth hurdle, the maximum CPS target and TSR performance in the upper quartile of FTSE 100 companies. The share price at the date of vesting for the PSP in 2013 was 1020.52p. The vesting price for John Rishton’s release of the performance related and restricted shares in 2013 was 1048p. Value of the gain made on the exercise of ShareSave options is the difference between the exercise price of 387p and the mid-market price of 1062p on the date of exercise. ShareSave is not subject to performance conditions and the UK plan rules are HMRC approved. Pensions. For defined benefit plans, this is the increase in pension benefit net of inflation for the current year and applying the HMRC methodology multiplier of 20. Cash in lieu of pension accrual is also included. Rolls-Royce Holdings plc annual report 2013 63 Implementation of remuneration policy Information on the elements of remuneration and how the Company intends to implement the remuneration policy in 2014 are set out below and on pages 64 to 66. Base salary The committee reviewed the salary levels of executive directors and decided not to award any increases for 2014. Name James Guyette Mark Morris John Rishton Colin Smith CBE Base salary $840,000 £510,000 £925,000 £525,000 Annual bonus The annual bonus pool is delivered under APRA. In 2013, executive directors were eligible for award levels as detailed in the policy report on page 57. APRA 2013 performance measures The APRA bonus is determined by Group financial performance and personal performance. For 2013, the Group financial measures were cash-flow performance and profit. Targets for both measures were set as follows: Base Target Maximum % of maximum bonus 15% 30% 50% The Group financial performance is the addition of the cash and profit out-turns, provided a specified minimum level is achieved on both, after deduction of the cost of bonus from profit, otherwise no bonus is payable. The 2013 financial performance which resulted in the APRA bonus out-turn of 60 per cent was as follows: Group underlying profit Group underlying profit* was £1,500 million which matched the base level but fell short of the on-target level of £1,530 million. The profit performance resulted in achievement of 15%. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n The extent of this disclosure reflects the Board’s view that APRA profit and cash targets are commercially sensitive. This will be kept under review. Deferred APRA awards in March 2013 (subject to audit) For executive directors and other senior executives, 40 per cent of APRA was delivered in deferred shares. As detailed on page 57, ordinary shares held as deferred shares may receive a bonus issue of C Shares during the deferral period. Name James Guyette Mark Morris John Rishton Colin Smith CBE Number of shares 25,770 18,057 48,250 23,207 Face value £000 264 185 494 237 Vesting date 01/03/2015 01/03/2015 01/03/2015 01/03/2015 APRA 2014 The committee have determined that the bonus in respect of 2014 will be operated on similar terms to 2013. There will be no change to the maximum bonus opportunities for executive directors. As described above, bonus targets are not disclosed. Long-term incentives – PSP The PSP is designed to reward and incentivise selected senior executives who can influence the long-term performance of the Group. PSP 2013 In 2013, executive directors received PSP grants in line with the policy report on page 58. PSP awards made in March 2013 (subject to audit) The targets were as follows: Aggregate CPS over the three-year period Less than 56p 56p 94p % of maximum award released 0% 30% 100% Straight line vesting will apply between these points. Face value (at maximum vesting) £000 794 765 1,665 788 Minimum % vesting (as a % of maximum) 20 20 20 20 % of salary 100 100 120 100 Performance period end date 31/12/2015 31/12/2015 31/12/2015 31/12/2015 Number of shares awarded 51,714 49,838 108,470 51,304 Cash flow Overall award Cash flow* for the year was £312 million which exceeded both the on-target level of break-even and the maximum target of £200 million. The cash flow performance resulted in the achievement of 50%. James Guyette Mark Morris John Rishton Colin Smith CBE The minimum level of profit after the cost of bonus, necessary to enable payment of bonus was £1,500 million. To ensure this was achieved the bonus earned through the separate profit and cash elements was limited to 60% of the maximum. All awards are made as performance shares based on a percentage of salary and the value is divided by the average share price over a three-day period which was 1023.33p before to the date of grant. The face value is the maximum number of shares that would vest (150 per cent of the award) multiplied by the share price at the date of grant. If the base EPS or CPS targets are not achieved, no shares vest. * Group underlying profit and cash flow excludes the results of Rolls-Royce Power Systems AG (previously named Tognum AG), the impact of acquisitions and disposals in the year and unbudgeted foreign exchange translation effects where material. 64 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION REPORT PSP awards vesting in March 2014 The following sets out details in respect of the March 2011 PSP award, for which the final year of performance was the 2013 financial year. EPS growth (hurdle) Aggregate CPS (100% of award) TSR performance (multiplier of up to 50%) Targets for 2011 – 2013 period Performance against targets Awards may vest if EPS growth exceeds the OECD index of consumer prices. Awards will lapse if hurdle not met. EPS growth of 60% over the three-year period exceeded the hurdle which was 6%. Aggregate CPS over three-year period of less than 56p – zero vesting. Aggregate CPS over three-year period of 56p – 30% vesting. Aggregate CPS over three-year period of 83p – 100% vesting. Straight-line vesting between these points. TSR below median of FTSE 100 – no additional vesting. TSR above median of FTSE 100 – 25% increase. TSR at upper quartile of FTSE 100 – 50% increase. Straight-line basis between these points. Aggregate CPS performance over three years of 86p. 100% vesting. TSR performance was ninth best amongst the FTSE 100. 50% increase. Total 150% of shares will vest during March 2014. PSP awards to be made in March 2014 The performance targets in respect of the 2014 to 2016 performance period under the Aggregate CPS measure will be as follows: Aggregate CPS over the three-year period Less than 125p 125p 155p % of maximum award released 0% 30% 100% CPS is calculated as reported cash flow before the cost of business acquisitions or proceeds of disposals, foreign exchange translation effects, special payments into pension schemes and payments to shareholders, divided by the weighted average number of shares in issue. We believe that the combination of EPS, CPS and TSR 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. Non-executive directors’ fees paid The Chairman and the other 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. Non-executive directors’ base fees Chairman 2 Other non-executive directors Chairman of audit committee Chairman of ethics committee Chairman of remuneration committee Chairman of safety committee Senior Independent Director 2014 1 £000 425 70 25 20 20 20 15 2013 £000 425 60 20 15 15 15 12 2012 £000 370 60 20 15 15 15 12 1 Subject to approval at the AGM, the base fees will be increased with effect from 1 May 2014. 2 Sir Simon Robertson retired as Chairman on 2 May 2013. The fee was increased on the appointment of the new Chairman, Ian Davis. Payments to past directors (not subject to audit) John Cheffins retired from the Board on 30 September 2007. He continued in his role as Chairman of Rolls-Royce Fuel Cell Systems Limited and provided non-executive advice to the Energy business until 28 September 2013. He was paid £35,811 and benefits totalling £2,051 in 2013 (paid in Canadian dollars and translated at £1=CAD$1.612). Dr Mike Howse retired from the Board on 30 June 2005. Following his retirement, he has continued to be retained by the Company for his expertise in engineering and was paid £23,310 in 2013. Payments to past directors (subject to audit) Mike Terrett retired from the Board on 31 December 2012. The PSP award, granted to him on 1 March 2010, for the performance period 1 January 2010 to 31 December 2012 vested on 1 March 2013 at a vesting price of 1020.52p. The value of the PSP released to him was £1.4 million (2012 £2.4 million) before tax and National Insurance contributions. PSP awards that will vest in 2014 and may vest in 2015, subject to meeting the performance criteria, will be pro-rated to the length of service during the performance period. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 65 Loss of office payments (subject to audit) There were no payments in respect of loss of office during the year. External directorships The directors retained the payments detailed below from serving on the boards of these companies: James Guyette 1,2 John Rishton 3 Directorships held PrivateBancorp Inc. and priceline.com Unilever PLC and Unilever N.V. Payments received £000 128 56 1 James Guyette was paid in US dollars translated at £1=US$1.565. 2 James Guyette received 2,548 Restricted Stock Units (RSUs) at US$19.63 per share in PrivateBank, in addition to an annual fee. He also received 359 shares of restricted stock at US$695.62 per share in priceline.com. John Rishton was appointed as a director of Unilever PLC and Unilever N.V. on 15 May 2013. Part of his fee was paid in Euro’s translated at £1 = EUR 1.178. 3 Pension entitlements (subject to audit) The Group’s UK pension schemes are funded, registered schemes and were approved under the regime applying until 6 April 2006. They include both defined contribution and defined benefit pension schemes. In the defined benefit pension schemes normal retirement age is 62. John Rishton is a member of one of the Group’s UK defined contribution pension schemes and received employer contributions 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. Mark Morris opted out of future pension accrual and salary linkage with effect from 16 August 2012 and receives a cash allowance in lieu of future pension accrual. Colin Smith CBE opted out of future pension accrual with effect from 1 April 2006 and receives a cash allowance in lieu of future pension accrual. 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. 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. Under the defined benefit plans, the earliest age at which benefits can be taken without consent and without actuarial reduction by James Guyette is age 65. Details of the pension benefits of the executive directors as at 31 December 2013, in the Group’s UK and US pensions schemes are given below: Mark Morris Colin Smith James Guyette 1 1 Benefits are translated at £1 = US$1.6542. Total accrued annual pension entitlement at 31 December 2013 £000 167 391 Total accrued retirement lump sum entitlement at 31 December 2013 £000 1,181 Details of the defined contribution pension contributions paid by the Group on behalf of the following executive directors are given below: James Guyette 1 John Rishton 1 Benefits are translated at £1=US$1.565 (2012 US$1.585). 2013 £000 395 50 2012 £000 394 123 66 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION REPORT Share retention policy (subject to audit) We believe 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 the percentage of salary shown in the table below. When this level is reached it must be maintained until retirement or departure from the Group. The director’s total shareholding, for the purposes of comparing it with the minimum shareholding requirement, includes shares held: by their connected persons; in the SIP; APRA deferred shares that have not vested; and PSP shares that have vested but does not included unvested PSP awards. The shareholding requirement will increase in 2014 to 250 per cent of salary for the Chief Executive and 200 per cent of salary for the other executive directors. APRA deferred shares will no longer count towards their minimum shareholding requirement. As at 31 December 2013, the executive directors each complied with the 2013 minimum shareholding requirement as detailed in the table below: James Guyette 2 Mark Morris John Rishton Colin Smith CBE 1 Salary divided by the March 2013 PSP grant price of 1023.33p multiplied by percentage of salary. 2 Translated at £1 = US$1.6542. Base salary £000 508 510 925 525 Total shareholding 447,868 86,954 293,947 346,466 Minimum shareholding requirement as % of salary 150 150 200 150 Minimum shareholding requirement 1 74,462 74,756 180,782 76,954 Actual shareholding as % of minimum requirement 601 116 163 450 Directors’ interests in shares (subject to audit) The directors and their connected persons had the following interests in the ordinary shares and C Shares 1 of the Company at 31 December 2013, or at date of retirement if earlier, are shown in the table below: James Guyette Mark Morris John Rishton Colin Smith CBE Dame Helen Alexander Lewis Booth CBE Peter Byrom (retired 2 May 2013) Sir Frank Chapman Iain Conn Ian Davis Dr John McAdam John Neill CBE Sir Simon Robertson (retired 2 May 2013) Jasmin Staiblin Ian Strachan (retired 2 May 2013) 1 Non-cumulative redeemable preference shares of 0.1p each. Unvested awards Vested awards Conditional shares not subject to performance conditions (APRA) 53,931 24,202 92,650 50,192 – – – – – – – – – – – Conditional shares subject to performance conditions (PSP) 198,503 134,776 510,681 189,104 – – – – – – – – – – – Options over shares subject to savings contracts (ShareSave) – 541 1,450 – – – – – – – – – – – – Vested shares and options exercised in year 174,265 41,713 190,691 150,678 – – – – – – – – – – – Ordinary shares 393,937 62,752 201,297 296,274 2,442 12,500 229,910 4,832 27,353 6,595 2,174 41,426 43,072 – 11,500 C Shares – 12,676,120 – – 605,377 950,000 – 358,759 11,178 – – 12,722,692 – – – S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 67 Changes in interests (subject to audit) James Guyette Mark Morris John Rishton Colin Smith CBE Dame Helen Alexander Lewis Booth CBE Sir Frank Chapman Iain Conn Ian Davis Dr John McAdam John Neill CBE Directors’ interests in unvested and vested awards Ordinary shares C Shares Changes from 31 December 2013 to 12 February 2014 2,609 6 1,335 1,951 204 – 534 580 361 39 442 Changes from 31 December 2013 to 12 February 2014 – 2,362,936 – – (605,377) (950,000) 354,062 – – – 12,722,692 (12,722,692) 31 December 2013 – 12,676,120 – – 605,377 950,000 358,759 11,178 – – 31 December 2013 393,937 62,752 201,297 296,274 2,442 12,500 4,832 27,353 6,595 2,174 41,426 James Guyette PSP 2010 PSP 2011 PSP 2012 PSP 2013 APRA 2010 APRA 2011 APRA 2012 Mark Morris PSP 2010 PSP 2011 PSP 2012 PSP 2013 APRA 2010 APRA 2011 APRA 2012 ShareSave (options) ShareSave (options) 31 December 2012 91,383 82,404 64,385 – 238,172 35,595 28,161 – 63,756 31 December 2012 26,085 25,039 59,899 – 111,023 7,881 6,145 – 14,026 872 541 1,413 TSR uplift at vesting/ dividend enhancement 45,692 – – – 45,692 1,595 – – 1,595 TSR uplift at vesting/ dividend enhancement 6,522 – – – 6,522 353 – – 353 – – – Granted during year – – – 51,714 51,714 – – 25,770 25,770 Granted during year – – – 49,838 49,838 – – 18,057 18,057 – – – Vested awards 137,075 – – – 137,075 37,190 – – 37,190 31 December 2013 – 82,404 64,385 51,714 198,503 – 28,161 25,770 53,931 Vested awards 32,607 – – – 32,607 8,234 – – 8,234 872 – 872 31 December 2013 – 25,039 59,899 49,838 134,776 – 6,145 18,057 24,202 – 541 541 Market price at date of award (p) Date Date of grant of vesting 544.70 01/03/2010 01/03/2013 601.50 09/03/2011 09/03/2014 809.70 01/03/2012 01/03/2015 1023.33 01/03/2013 01/03/2016 Market price at vesting (p) 1020.52 – – – 601.00 11/03/2011 11/03/2013 808.80 01/03/2012 01/03/2014 1023.33 01/03/2013 01/03/2015 1048.00 – – Market price at date of award (p) Date Date of grant of vesting 544.70 01/03/2010 01/03/2013 601.50 09/03/2011 09/03/2014 809.70 01/03/2012 01/03/2015 1023.33 01/03/2013 01/03/2016 Market price at vesting/ exercise (p) 1020.52 – – – 601.00 11/03/2011 11/03/2013 808.80 01/03/2012 01/03/2014 1023.33 01/03/2013 01/03/2015 1048.00 – – 387.00* 01/02/2010 01/02/2013 525.00 01/02/2012 01/02/2015 1062.00 – * For ShareSave, the share price shown is the exercise price which was 85 per cent of the market price at the date of award. 68 Directors’ report Rolls-Royce Holdings plc annual report 2013 DIRECTORS’ REMUNERATION REPORT John Rishton PSP 2011 PSP 2012 PSP 2013 Performance related shares Performance related shares Performance related shares APRA 2011 APRA 2012 Restricted shares ShareSave (options) 31 December 2012 164,866 133,383 – 298,249 76,365 63,397 40,565 180,327 44,400 – 44,400 76,143 1,450 TSR uplift at vesting/ dividend enhancement – – – – 38,183 – – 38,183 – – – – – Granted during year – – 108,470 108,470 – – – – – 48,250 48,250 – – Vested awards – – – – 114,548 – – 114,548 – – – 76,143 – 31 December 2013 164,866 133,383 108,470 406,719 – 63,397 40,565 103,962 44,400 48,250 92,650 – 1,450 Market price at date of award (p) Date Date of grant of vesting 601.50 09/03/2011 09/03/2014 809.70 01/03/2012 01/03/2015 1023.33 01/03/2013 01/03/2016 Market price at vesting/ exercise (p) – – – 601.50 09/03/2011 11/03/2013 601.50 09/03/2011 01/03/2014 601.50 09/03/2011 01/03/2015 808.80 01/03/2012 01/03/2014 1023.33 01/03/2013 01/03/2015 601.50 09/03/2011 01/03/2013 525.00* 01/02/2012 01/02/2017 1048 – – – – 1048 – * For ShareSave, the share price shown is the exercise price which was 85 per cent of the market price at the date of award. Colin Smith CBE PSP 2010 PSP 2011 PSP 2012 PSP 2013 APRA 2010 APRA 2011 APRA 2012 31 December 2012 78,025 74,813 62,987 – 215,825 32,197 26,985 – 59,182 TSR uplift at vesting/ dividend enhancement 39,013 – – – 39,013 1,443 – – 1,443 Granted during year – – – 51,304 51,304 – – 23,207 23,207 Vested awards 117,038 – – – 117,038 33,640 – – 33,640 31 December 2013 – 74,813 62,987 51,304 189,104 – 26,985 23,207 50,192 Market price at date of award (p) Date Date of grant of vesting 544.70 01/03/2010 01/03/2013 601.50 09/03/2011 09/03/2014 809.70 01/03/2012 01/03/2015 1023.33 01/03/2013 01/03/2016 Market price at vesting (p) 1020.52 – – – 601.00 11/03/2011 11/03/2013 808.80 01/03/2012 01/03/2014 1023.33 01/03/2013 01/03/2015 1048.00 – – Chief Executive pay, TSR and all-employee pay This section of the report enables our remuneration arrangements to be seen in context by providing: (cid:337)(cid:3) a five-year history of our Chief Executive’s remuneration; (cid:337)(cid:3) our TSR performance over the same period; (cid:337)(cid:3) a comparison of the year-on-year change in our Chief Executive’s remuneration with the change in average remuneration across the Group; and (cid:337)(cid:3) a year-on-year comparison of the total amount spent on pay across the Group with profit before tax and dividends paid. Chief Executive pay Year 2013 2012 2011 2011 2010 2009 Chief Executive 1, 2 John Rishton John Rishton John Rishton Sir John Rose Sir John Rose Sir John Rose Single figure of total remuneration £000 6,228 4,577 3,677 3,832 3,914 2,409 Annual bonus as a % of maximum 55 85 63 – 100 29 PSP as a % of maximum 100 – – 75 100 93 Five-year TSR performance The Company’s TSR performance over the previous five years compared to a broad equity market index is shown in the graph opposite. The FTSE 100 has been chosen as the comparator because it contains a broad range of other UK listed companies. The graph shows the growth in value of a hypothetical £100 holding in the Company’s 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 £432.40 and £183.10 respectively. 1 On 31 March 2011, Sir John Rose retired as Chief Executive and John Rishton was appointed. 2 The remuneration for Sir John Rose does not include any pension accrual or contribution as he was receiving his pension from 1 February 2008. John Rishton received a special grant of shares on joining the Company on 1 March 2011 to mirror the shares he forfeited on resigning from his previous employer. The share price has increased from 483.50p at the time this grant was made to 1275p at the end of 2013. These are the main reasons why John Rishton’s remuneration exceeds that of his predecessor. Rolls-Royce Holdings plc annual report 2013 69 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Advisers to the committee During the year, the committee had access to advice from Deloitte LLP’s executive compensation advisory practice. Total fees for advice provided to the committee during the year by Deloitte were £120,850. Deloitte also advised the Company on tax, assurance, pensions and corporate finance and Deloitte MCS Limited provides consulting services. Deloitte is a founding member of the Remuneration Consultants Group and adheres to its code in relation to executive remuneration consulting. The committee requests Deloitte to attend meetings periodically during the year. The committee is satisfied that the advice it has received has been objective and independent. Statutory requirements The remuneration report has been prepared on behalf of the Board by the remuneration committee. We adopt the principles of good governance as set out in the UK Corporate Governance Code and comply with the regulations contained in the Schedule 8 of the Large and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, the Listing Rules of the Financial Conduct Authority and the relevant schedules of the Companies Act 2006. The Companies Act 2006 and the Listing Rules require the Company’s auditor to report on the audited information in their report on page 135 and to state that this section has been properly prepared in accordance with these regulations. The remuneration policy report and the annual remuneration report are subject to shareholder approval at the AGM on 1 May 2014. The directors’ remuneration report was approved by the Board on 12 February 2014 and signed on its behalf. Dame Helen Alexander Chairman of the remuneration committee Rolls-Royce – five year TSR data Rolls-Royce (rebased to 100) FTSE 100 (rebased to 100) 450 400 350 300 250 200 150 100 2008 2009 2010 2011 2012 2013 Percentage change in Chief Executive remuneration The following table compares the percentage change in the Chief Executive’s remuneration to the average percentage change in remuneration for all UK employees from 2012 to 2013. Chief Executive UK employees average Salary 2.8% 3.2% Benefits -0.8% 0.6% Annual bonus -33% -12% UK employees were chosen as a comparator group in order to avoid the impact of exchange rate movements over the year. UK employees make up approximately 45 per cent of the total employee population. Relative spend on pay The following table sets out the percentage change in payments to shareholders and overall expenditure on pay across the Group. Payments to shareholders (note 17 – financial statements) Group employment costs (note 7 – financial statements) 2013 £m 366 2012 £m 328 3,675 2,762 Change % 11.6 34.7 Statement of shareholder voting For Against Votes withheld Approval of 2012 remuneration report Percentage of votes (%) Number of votes cast 98.41 1.59 1,297,319,180 20,981,975 0.58 7,611,187 We monitor carefully shareholder voting on our remuneration policy and implementation. We recognise the importance of ensuring that our shareholders continue to support our remuneration arrangements. 70 Directors’ report Rolls-Royce Holdings plc annual report 2013 SHAREHOLDERS AND SHARE CAPITAL Share capital and voting rights On 31 December 2013, there were 1,880,301,654 ordinary shares of 20 pence each, 16,286,039,565 redeemable C Shares of 0.1 pence each and one Special Share of £1 in issue. The ordinary shares are listed on the London Stock Exchange. Payments to shareholders Payments to shareholders will, as before, be made in the form of redeemable C Shares and at the AGM on 1 May 2014, the directors will recommend an issue of 134 C Shares with a total nominal value of 13.4 pence for each ordinary share. The C Shares will be issued on 1 July 2014. Together with the interim issue on 2 January 2014 of 86 C Shares for each ordinary share with a total nominal value of 8.6 pence, this is the equivalent of a total annual payment to ordinary shareholders of 22 pence for each ordinary share. You can find out more about payments to shareholders by going to the ‘Shareholder information’ section of this report on page 139 or by visiting the Group’s website www.rolls-royce.com/investors/ share_information. Share class rights The rights and obligations attaching to the different classes of shares are summarised below. The full rights are set out in the Company’s Articles of Association, the latest copy of which can be found on the Group’s website at www.rolls-royce.com. 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. C Shares The Company issues non-cumulative redeemable preference shares (C Shares) as an alternative to paying a cash dividend. Shareholders can choose to: (cid:337)(cid:3) redeem all C Shares for cash; (cid:337)(cid:3) redeem all C Shares for cash and reinvest the proceeds in additional ordinary shares using the CRIP operated by the Registrar; or (cid:337)(cid:3) keep the C Shares.  Any C Shares retained have limited voting rights and attract a dividend of 75 per cent of LIBOR on the 0.1p nominal value of each share, paid on a twice-yearly basis. The Company has the option to redeem the C Shares compulsorily, 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 are 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 has been accrued but not 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 must be repaid at its nominal value in priority to any other shares. Certain Articles that relate to the rights attached to the Special Share may only be altered with the consent of the Special Shareholder. Such Articles include: (i) the foreign shareholding limit provisions whereby a foreign person cannot hold more than a 15 per cent voting interest in the Company; and (ii) the nationality of directors provisions whereby at least the Chairman or the Chief Executive must be a British citizen and at least half of the number of directors must be British citizens. The Special Shareholder is not entitled to vote at any general meeting or any other meeting of any class of shareholders. Rolls-Royce Holdings plc annual report 2013 71 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. The Special Share may only be issued to, held by and transferred to the Special Shareholder or his successor or nominee. Authority to purchase own shares At the 2013 AGM, the Company was authorised by shareholders to purchase up to 187,231,677 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 2013. The authority for the Company to purchase its own shares expires at the conclusion of the AGM or 18 months from 2 May 2013, whichever is the earlier. A resolution to renew it will be proposed at the AGM. 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. 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. 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. Authority to issue shares At the AGM in 2013, authority was given to the directors to allot new ordinary shares up to a nominal value of £124,821,118, 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 2014, and the directors propose to renew these authorities at that AGM. It is proposed to seek a further authority, at the AGM in 2014 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 to respond to circumstances and opportunities as they arise; and to allot new C Shares up to a nominal value of £500 million as an alternative to a cash dividend. Such authority expires at the conclusion of the AGM. The directors propose to renew the authority to allot new C Shares at the AGM. Major shareholdings At 31 December 2013, the following companies had notified an interest in the issued ordinary share capital of the Company in accordance with the Financial Conduct Authority’s Disclosure and Transparency Rules: Company BlackRock Inc. Invesco Limited Capital Research and Management Company Date notified 03 Sep 2010 04 Feb 2008 16 May 2013 % of issued ordinary share capital 5.02 6.91 3.03 The Company had not received any further notifications from 31 December 2013 to 12 February 2014. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 72 Directors’ report Rolls-Royce Holdings plc annual report 2013 OTHER STATUTORY INFORMATION Political donations In line with its established policy, the Group made no political donations pursuant to the authority granted at the 2013 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. A resolution will therefore be proposed at the AGM seeking shareholder approval for the directors to be given authority to make donations and incur expenditure which might otherwise fall within 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 US was US$69,430 (2012 US$44,161). PACs are a common feature of the US political system and are governed by the Federal Election Campaign Act. The RRNAPAC is independent of the Group and independent of any political party. The RRNAPAC 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. Indemnity The Company has entered into separate Deeds of Indemnity in favour of its directors, which were in force during the financial year and remain in force at the date of this report. 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. Disclosures in the strategic report The Board has taken advantage of section 414C(11) of the Companies Act 2006 to include disclosures in the strategic report on: (cid:337)(cid:3) greenhouse gas emissions on page 29; (cid:337)(cid:3) disabled people and employee involvement on page 27; (cid:337)(cid:3) the future development, performance and position of the Group throughout pages 1 to 34; (cid:337)(cid:3) the financial position of the Group on pages 10 to 13; (cid:337)(cid:3) the R&D and net R&D expenditure as a proportion of underlying revenue on pages 24 and 31; and (cid:337)(cid:3) the summary of principal risks on pages 32 to 34. In addition, notes 1, 14, 15 and 17 to 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. Going concern As described on page 138, the Group meets its funding requirements through a mixture of shareholders’ funds, bank borrowings, bonds and notes. The Group has facilities of £3.6 billion of which £2.4 billion was drawn at the year end. £200 million of these facilities mature in 2014. The Group’s forecasts and projections, taking into account reasonably possible changes in trading performance, show that the Group has sufficient financial resources. If the put option on Rolls-Royce Power Systems Holding GmbH (formerly named Engine Holding GmbH) is exercised by Daimler AG, (estimated cost £1.9 billion), the directors consider that the Group would be able to raise additional resources in the necessary timeframe to meet this commitment. 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. Responsibility statements Statement of directors’ responsibilities in respect of the annual report and the financial statements The directors as listed on pages 36 to 37 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). 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. Rolls-Royce Holdings plc annual report 2013 73 Responsibility statements under the Disclosure and Transparency Rules and the UK Corporate Governance Code 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; ii) the strategic report on pages 1 to 34 and pages 137 to 138 of the directors’ report include 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; and iii) the annual report, taken as a whole, is fair, balanced and understandable and provides the information necessary for shareholders to assess the Company’s performance, business model and strategy. By order of the Board Nigel T Goldsworthy Company Secretary 12 February 2014 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n In preparing each of the Group and parent company financial statements, the directors are required to: (cid:337)(cid:3) select suitable accounting policies and then apply them consistently; (cid:337)(cid:3) make judgements and estimates that are reasonable and prudent; (cid:337)(cid:3) for the Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; (cid:337)(cid:3) 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 (cid:337)(cid:3) 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 and 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 strategic report and a directors’ report (including the directors’ remuneration report and corporate governance statement) that comply 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. 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 auditor is 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 auditor is 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. 74 Financial statements Rolls-Royce Holdings plc annual report 2013 CONSOLIDATED FINANCIAL STATEMENTS 75 CONSOLIDATED INCOME STATEMENT 75 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME 76 CONSOLIDATED BALANCE SHEET 77 CONSOLIDATED CASH FLOW STATEMENT 79 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY COMPANY FINANCIAL STATEMENTS 124 COMPANY BALANCE SHEET 124 RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS Investments Inventories Accounting policies Segmental analysis Other income and expenses Net financing Taxation Earnings per ordinary share Employee information Auditors’ remuneration Intangible assets 80 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 80 89 93 93 94 96 97 97 98 100 101 102 102 102 103 103 104 112 113 118 118 119 120 120 121 123 1 2 3 4 5 6 7 8 9 10 Property, plant and equipment 11 12 13 Trade and other receivables 14 Cash and cash equivalents 15 Borrowings 16 Trade and other payables 17 Financial instruments 18 Provisions for liabilities and charges 19 Post-retirement benefits 20 Share capital 21 Share-based payments 22 Operating leases 23 Contingent liabilities 24 Related party transactions 25 Acquisitions and disposals 26 Segmental analysis from 1 January 2014 Accounting policies Investments – subsidiary undertakings Financial liabilities Share capital 125 NOTES TO THE COMPANY FINANCIAL STATEMENTS 125 125 125 126 126 126 126 1 2 3 4 5 Movements in capital and reserves 6 7 Contingent liabilities Other information Rolls-Royce Holdings plc annual report 2013 CONSOLIDATED INCOME STATEMENT For the year ended 31 December 2013 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 transfer of joint ventures to subsidiaries Profit on disposal of businesses (2012 IAE International Aero Engines AG restructuring £699 million) 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 (NCI) 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 75 Restated* 2012 £m 12,161 (9,432) 2,729 – (993) (531) 173 1,378 – 699 2,077 797 (108) 689 2,766 (431) 2,335 2,321 14 2,335 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 2013 £m 15,513 (12,197) 3,316 65 (1,323) (683) 160 1,535 119 216 1,870 327 (438) (111) 1,759 (380) 1,379 1,367 12 1,379 73.26p 72.44p 125.38p 123.73p 22.0p 414 19.5p 365 Notes 2 3 3 11 25 2 4 4 5 6 17 1 Underlying profit before taxation 2 1,759 1,434 CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the year ended 31 December 2013 Profit for the year Other comprehensive income (OCI) Items that will not be reclassified to profit or loss Movements in post-retirement schemes Share of OCI of joint ventures and associates Related tax movements Items that may be reclassified to profit or loss Foreign exchange translation differences on foreign operations Share of OCI 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 19 11 5 11 5 2013 £m 1,379 48 – 10 58 (64) (6) 1 (69) 1,368 1,356 12 1,368 Restated* 2012 £m 2,335 (305) (46) 105 (246) (118) (12) (1) (131) 1,958 1,945 13 1,958 * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits – see note 19, and the change in the accounting policy for RRSAs – see note 1. 76 Financial statements Rolls-Royce Holdings plc annual report 2013 CONSOLIDATED BALANCE SHEET At 31 December 2013 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 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 Tax liabilities 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 Restated* 2013 £m 31 December 2012 £m 1 January 2012 £m Notes 9 10 11 11 17 5 19 12 13 17 14 15 17 16 18 15 17 16 5 18 19 20 4,987 3,392 601 27 674 316 248 10,245 3,319 5,092 16 74 321 3,990 6 12,818 23,063 (207) (1,976) (7,045) (204) (348) – (9,780) (2,164) (360) (2,138) (10) (882) (385) (1,041) (6,980) (16,760) 2,901 2,564 1,800 6 592 342 348 8,553 2,726 4,119 33 115 11 2,585 4 9,593 18,146 (149) (312) (6,401) (126) (220) – (7,208) (1,234) (418) (1,672) – (584) (241) (793) (4,942) (12,150) 2,882 2,338 1,680 10 327 387 520 8,144 2,561 4,009 20 91 11 1,310 313 8,315 16,459 (20) (111) (6,263) (138) (276) (135) (6,943) (1,184) (919) (1,533) – (445) (226) (807) (5,114) (12,057) 6,303 5,996 4,402 376 80 163 (68) 250 4,804 5,605 698 6,303 374 – 169 (63) 314 5,185 5,979 17 5,996 374 – 173 (52) 433 3,473 4,401 1 4,402 * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits – see note 19, and the change in the accounting policy for RRSAs – see note 1. The financial statements on pages 75 to 123 were approved by the Board on 12 February 2014 and signed on its behalf by: Ian Davis Chairman Mark Morris Chief Financial Officer Rolls-Royce Holdings plc annual report 2013 CONSOLIDATED CASH FLOW STATEMENT For the year ended 31 December 2013 Reconciliation of cash flows from operating activities Operating profit Loss/(profit) on disposal of property, plant and equipment Share of results of joint ventures and associates Dividends received from joint ventures and associates Amortisation and impairment of intangible assets Depreciation and impairment of property, plant and equipment Impairment of investments Decrease in provisions Decrease/(increase) in inventories Increase in trade and other receivables Increase in trade and other payables Cash flows on other financial assets and liabilities held for operating purposes Net defined benefit post-retirement cost recognised in profit before financing Cash funding of defined benefit post-retirement schemes Share-based payments Net cash inflow from operating activities before taxation Taxation paid 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 Reclassifications of joint ventures to subsidiaries Acquisitions of preference shares in subsidiary Restructuring of IAE International Aero Engines AG Disposals of businesses Investments in joint ventures and associates Repayment of loan to Rolls-Royce Power Systems Holding GmbH Transfer of subsidiary to associate Net cash (outflow)/inflow from investing activities Cash flows from financing activities Repayment of loans Proceeds from increase in loans Net cash flow from increase in borrowings Interest received Interest paid Increase in short-term investments Issue of ordinary shares and cash received on share-based payments vesting Purchase of ordinary shares Dividend to NCI Redemption of C Shares Net cash inflow/(outflow) from financing activities Net increase in cash and cash equivalents Cash and cash equivalents at 1 January Exchange losses on cash and cash equivalents Cash and cash equivalents at 31 December Notes 11 11 9 10 11 21 11 11 9 9 25 25 25 25 20 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 77 Restated* 2012 £m 1,378 (9) (173) 129 231 256 2 (40) (158) (284) 242 (29) 173 (299) 55 1,474 (219) 1,255 – 4 (250) 1 (435) 10 30 (20) – – 942 – (24) 167 (1) 424 (99) 221 122 11 (52) – – (94) – (318) (331) 1,348 1,291 (54) 2,585 2013 £m 1,535 7 (160) 99 428 372 – (17) 119 (533) 376 9 279 (315) 79 2,278 (238) 2,040 (1) 1 (503) – (669) 21 7 (37) 245 (34) – 273 (43) – – (740) (133) 1,013 880 15 (58) (313) 32 (3) (60) (357) 136 1,436 2,585 (34) 3,987 * 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits – see note 19, and the change in the accounting policy for RRSAs – see note 1. 78 Financial statements Rolls-Royce Holdings plc annual report 2013 CONSOLIDATED CASH FLOW STATEMENT Reconciliation of movements in cash and cash equivalents to movements in net funds Increase in cash and cash equivalents Cash flow from increase in borrowings Cash flow from 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 on net funds Fair value adjustments Movement in net funds Net funds at 1 January excluding the fair value of swaps Net funds at 31 December excluding the fair value of swaps Fair value of swaps hedging fixed rate borrowings Net funds at 31 December 2013 £m 1,436 (880) 313 869 (204) (43) 105 727 1,213 1,940 (1) 1,939 2012 £m 1,348 (122) – 1,226 (78) (54) 2 1,096 117 1,213 104 1,317 The movement in net funds (defined by the Group as including the items shown below) is as follows: Cash at bank and in hand Money market funds Short-term deposits Overdrafts Cash and cash equivalents Short-term investments Current borrowings excluding overdrafts Non-current borrowings Finance leases Net funds excluding fair value of swaps Fair value of swaps hedging fixed rate borrowings Net funds At 1 January 2013 £m 674 408 1,503 – 2,585 11 (149) (1,233) (1) 1,213 104 1,317 Funds flow £m 333 754 352 (3) 1,436 313 133 (1,013) – 869 869 Net funds of businesses acquired £m – (4) (200) – (204) (204) Exchange differences £m (25) (5) (4) – (34) (3) – (6) – (43) (43) Fair value adjustments £m – – – – – – 17 88 – 105 (105) – Reclassifications £m – – – – – – (201) 201 – – – At 31 December 2013 £m 982 1,157 1,851 (3) 3,987 321 (204) (2,163) (1) 1,940 (1) 1,939 Rolls-Royce Holdings plc annual report 2013 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2013 Attributable to ordinary shareholders At 1 January 2012, as previously reported Effect of amendments to IAS 19 Effect of change in accounting policy for RRSAs At 1 January 2012, as restated Profit for the year Foreign exchange translation differences on foreign operations Movement on post-retirement schemes Share of OCI of joint ventures and associates Related tax movements Total comprehensive income for the year Issue of C Shares Redemption of C Shares Ordinary shares purchased Share-based payments – direct to equity 4 Transactions with NCI 5 Initial recognition of put option on NCI 6 Related tax movements Other changes in equity in the year At 1 January 2013 Profit for the year Foreign exchange translation differences on foreign operations Movement on post-retirement schemes Share of OCI of joint ventures and associates Related tax movements Total comprehensive income for the year Arising on issues of ordinary shares Issue of C Shares Redemption of C Shares Ordinary shares purchased Share-based payments – direct to equity 4 Reclassification of Rolls-Royce Power Systems AG Transactions with NCI 7 Initial recognition of put option on NCI 6 Related tax movements Other changes in equity in the year At 31 December 2013 Notes 19 1 Share capital £m 374 – – 374 – Share premium £m – – – – – Capital redemption reserve £m 173 – – 173 – 19 11 5 17 17 5 19 11 5 20 17 17 25 17, 25 5 – – – – – – – – – – – – – 374 – – – – – – 2 – – – – – – – – 2 376 – – – – – – – – – – – – – – – – – – – – 80 – – – – – – – – 80 80 – – – – – (328) 324 – – – – – (4) 169 – – – – – – – (366) 360 – – – – – – (6) 163 Cash flow hedging reserve 1 Other reserves 2 Retained earnings 3 £m (52) – – (52) – – – (11) – (11) – – – – – – – – (63) – – – (5) – (5) – – – – – – – – – – (68) £m 433 – – 433 – (117) – (1) (1) (119) – – – – – – – – 314 – (64) – (1) 1 (64) – – – – – – – – – – 250 £m 3,590 67 (184) 3,473 2,321 – (305) (46) 105 2,075 4 (324) (94) 47 116 (121) 9 (363) 5,185 1,367 – 48 – 10 1,425 (81) 3 (360) (3) 99 – – (1,477) 13 (1,806) 4,804 Non- controlling interests £m 1 – – 1 14 (1) – – – 13 – – – – 48 (45) – 3 17 12 – – – – 12 – – – – – 669 (45) 45 – 669 698 Total £m 4,518 67 (184) 4,401 2,321 (117) (305) (58) 104 1,945 (324) – (94) 47 116 (121) 9 (367) 5,979 1,367 (64) 48 (6) 11 1,356 1 (363) – (3) 99 – – (1,477) 13 (1,730) 5,605 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 79 Total equity £m 4,519 67 (184) 4,402 2,335 (118) (305) (58) 104 1,958 (324) – (94) 47 164 (166) 9 (364) 5,996 1,379 (64) 48 (6) 11 1,368 1 (363) – (3) 99 669 (45) (1,432) 13 (1,061) 6,303 1 See accounting policies note 1. 2 Other reserves include a merger reserve of £3m (2012 £3m, 2011 £3m) and a translation reserve of £247m (2012 £311m, 2011 £430m). 3 At 31 December 2013, 11,960,535 ordinary shares with a net book value of £91m (2012 20,365,787, 2011 22,541,187 ordinary shares with net book values of £125m and £116m respectively) were held for the purpose of share-based payment plans and included in retained earnings. During the year, 16,603,840 ordinary shares with a net book value of £118m (2012 13,533,646 shares with a net book value of £85m) vested in share-based payment plans. During the year, the Company acquired 298,588 of its ordinary shares via reinvestment of dividends received on its own shares. In addition, the Company issued 7,900,000 new ordinary shares to the Group’s share trust for its employees share-based payment plans with a net book value of £81m. 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 2 January 2012, the Group contributed its interest in Bergen Engines AS to Rolls-Royce Power Systems Holding GmbH (RRPSH – previously Engine Holding GmbH), a company jointly held by Rolls-Royce and Daimler AG. Under the terms of agreement with Daimler, Rolls-Royce retained certain rights such that Bergen Engines continued to be classified as a subsidiary and consolidated. 6 As part of the RRPSH shareholders’ agreement, Daimler has the option to sell its shares in RRPSH to Rolls-Royce for a period of six years from 1 January 2013. The initial fair value of the exercise price of this option in respect of Bergen Engines AS (£166m) was recognised in 2012 and that amount in respect of RRPS (£1,432m) has been recognised in 2013 and charged to retained earnings. In addition, £45m of the initial recognition of the put option on NCI relating to Bergen Engine AS, recognised in 2012, has been reclassified from NCI to retained earnings. Subsequent movements in the value of this liability are included in the income statement, but excluded from the underlying results. 7 On 1 January 2013, the Group exercised rights in RRPSH that resulted in Rolls-Royce Power Systems AG (RRPS – formerly Tognum AG) being classified as a subsidiary and consolidated – see note 25. 80 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Accounting policies The Company The consolidated financial statements of Rolls-Royce Holdings plc (the ‘Company’) for the year ended 31 December 2013 consist of the consolidation of the financial statements of the Company and its subsidiaries (together referred to as the ‘Group’) and include the Group’s interest in jointly controlled and associated entities. 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 31 December 2013 (Adopted IFRS). The Company has elected to prepare its parent company financial statements under UK Generally Accepted Accounting Practices (GAAP). These are set out on pages 124 to 126 and the accounting policies in respect of Company financial statements are set out on page 125. These consolidated 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 72. The consolidated financial statements are presented in pound sterling which is the Company’s functional currency. The preparation of financial statements in conformity with Adopted IFRS requires management to make estimates and judgements that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period; the key areas of judgement and key sources of estimation uncertainty are described below. Actual results could differ from those estimates. 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. Amendment to accounting policy As explained in the Chief Financial Officer’s review on page 11, following discussions with the Conduct Committee of the FRC, the Group has reassessed its policy for the recognition of entry fees received under Risk and Revenue Sharing Arrangements (RRSAs). Whilst the impact on our historical results is not significant, the directors believe that the change represents an improvement in the policy. In prior years, entry fees were recognised as other operating income when they were received, on the basis that this matched it to the recognition of non-recurring development costs incurred on behalf of the workshare partner. This policy has been revised, to reflect better the fact that some of these non-recurring development costs are capitalised. Under the amended policy, where the relevant costs in the development programme are capitalised (ie development costs incurred between engine certification and entry into service and certification costs and participation fees paid to airframers), an equivalent portion of the entry fee received is deferred and recognised as the related costs are amortised after entry into service. In addition, the amount of entry fees recognised in the year will be presented as a contribution to research and development expenses, rather than other operating income. As required by IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, this change has been made retrospectively; the impact of the change in policy in 2012 was to increase profit before tax by £25 million and to reduce net assets at 31 December 2011 and 2012 by £184 million and £170 million respectively. Had the policy not been amended, profit before tax in 2013 would have been £39 million higher and at 31 December 2013 net assets £208 million higher. The FRC Conduct Committee’s view is that the RRSA contract cannot be divided into separate development and production phases, as the fees and development components received by the Group during the development phase are exchanged for the obligation to pay the supplier a pre-determined share of any sales receipts during the production phase. On this basis, the entry fees received would be deferred in their entirety and recognised over the period of production. As explained in the Chief Financial Officer’s review, on page 11, the FRC Conduct Committee has confirmed that, in view of the change to the policy and the additional disclosure the Group has made, it does not intend to pursue its consideration of this accounting policy further. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 81 1 Accounting policies (continued) 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: (cid:337)(cid:3) Assessing whether or not the Group controls Rolls-Royce Power Systems Holding GmbH (RRPSH) requires judgement. The shares of RRPSH are held equally by the Group and Daimler AG and the rights of each shareholder are encapsulated in shareholder agreements which set out, amongst other things, key matters on which the Group has the casting vote at the Shareholders’ Committee of RRPSH. These most important matters subject to casting vote which are relevant to assessing whether RRPSH is controlled include (a) setting the annual budget and operating and financial plan, (b) appointing, removing and setting the remuneration of key management personnel (though removal of the CEO or the CFO requires joint agreement), (c) entering into contracts in the ordinary course of business and (d) establishing management procedures and responsibilities. The Group considers that these provisions are sufficient to give it control over RRPSH. Daimler AG has protective rights covering matters such as: (i) significant changes to the scale, scope and financing of RRPSH’s business; (ii) certain significant supplier relationships; and (iii) changes to contractual arrangements between RRPSH and Rolls-Royce. These are not considered sufficient to prevent the Group from directing the activities of RRPSH. (cid:337)(cid:3) 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: (cid:337)(cid:3) i) whether a long-term aftermarket contract is linked, for accounting purposes, to the related sale of original equipment – where the long-term aftermarket contract is agreed (or agreed in principle) at the same time as the original equipment contract, these are considered to be linked for accounting purposes and treated as a single contract – or whether it should be treated separately; and (cid:337)(cid:3) ii) the appropriate measure of stage of completion of the contract – this will vary depending on the precise nature of the arrangements. Where the service provided is assessed to be continuous, the stage of completion is measured by reference to the flying hours, or equivalent, under the contract. Other aftermarket contracts are overhaul event based and the stage of completion is measured accordingly. (cid:337)(cid:3) The Group has significant intangible assets. In deciding whether certain intangible assets should be recognised, judgement is required: (cid:337)(cid:3) i) IAS 38 Intangible Assets requires that internally-generated development costs should only be recognised if strict criteria are met, in particular relating to technical feasibility and generation of future economic benefits. The directors consider that, due to the complex nature of new equipment programmes, these criteria are not met until relatively late in the programme – Civil aerospace programmes represent 54 per cent of development costs; for these, the criteria are generally satisfied at the time of the initial engine certification; (cid:337)(cid:3) ii) on delivery of engines without a linked long-term aftermarket contract, the Group has contractual rights to supply aftermarket parts to the customers and its intellectual rights, warranty arrangements and, where relevant, statutory airworthiness or other regulatory requirements provide reasonable control over this supply. Accordingly the directors consider that these rights meet the definition of an intangible asset in IAS 38. However, the directors do not consider that it is possible to determine a reliable fair value for this intangible asset. Accordingly, an intangible asset (recoverable engine cost or REC) is only recognised on the occasions where the contractual price of the engine is below the cost of manufacture and then only to the extent of this deficit, as this amount is a reliable value. (cid:337)(cid:3) RRSAs with key suppliers (workshare partners) are a feature of our Civil aerospace business. Under these contractual arrangements the key commercial objectives are that: (i) during the development phase the workshare partner shares in the risks of developing an engine by performing its own development work, providing development parts and paying a non-refundable cash entry fee; and (ii) during the production phase it supplies components in return for a share of the programme revenues as a ‘life of type’ supplier. The share of development costs borne by the workshare partner and of the revenues it receives reflect a jointly agreed forecast of the proportionate cost of providing its production parts compared to the overall forecast manufacturing cost of the engine. These arrangements are complex and have features that could be indicative of: a collaboration agreement, including sharing of risk and cost in a development programme; a long-term supply agreement; sharing of intellectual property; or a combination of these. There is no directly applicable IFRS to determine an accounting policy for the recognition of entry fees of this nature in the income statement. Consequently, in developing an accounting treatment for such entry fees that best reflects the commercial objectives of the contractual arrangement, the directors have analysed these features in the context of relevant accounting pronouncements (including those of other standard setters where these do not conflict with IFRS) and have weighed the importance of each feature in faithfully representing the overall commercial effect. The most important considerations that need to be balanced are: the transfer of development risk; the workshare partner receiving little standalone value from the payment of the entry fee; and the overall effect being collaboration between the parties which falls short of being a joint venture as the Group control the programme. Also important in the analysis is the fact that, whilst the Group and the workshare partner share risks and rewards through the life of the contract, these risks and rewards are very different during the development and production phases. In this context, the entry fee might be considered to represent: an amount paid as an equalisation of development costs; a payment to secure a long-term supply arrangement; a purchase of intellectual property; or some combination thereof. The accounting under these different scenarios could include: recognition of the entry fee to match the associated costs in the income statement; being spread over the life of the programme as a reduction in the cost of supply during production; or being spread over the time period of the access to the intellectual property by the workshare partner. 82 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Accounting policies (continued) The directors consider that the most important features of the arrangement are the risk sharing and that the entry fee represents a contribution to the development costs that the Group incurs in excess of its proportionate programme share. The key judgements taken in reaching this view are: the entry fee is determined by the parties on that basis and the contract specifies that, in the event that a derivative engine is to be developed further, entry fees will also be calculated on this basis; the workshare partners describe the entry fee in this way; although the workshare partner receives little stand-alone value from paying the entry fee, the entry fee together with its own development activities represent its aggregate investment in the collaboration; the amount of the entry fee does not include any amount in excess of that necessary to equalise forecast development costs; the Group is not ‘on risk’ for the full development costs it incurs but for that amount less the entry fees received; and, as far as can be determined, this appears to be common industry accounting for arrangements of this type, under both Adopted IFRS and US accounting standards (which we believe do not conflict with IFRS in this regard). The resulting accounting policy (described below) represents the commercial effect of the contractual arrangements in that the Group recognises only those development costs to which it is exposed (and thus reflects the significant transfer of development risk to the workshare partner) and the costs of supply of parts during the production phase is measured at the workshare partner’s share of programme revenues (which we consider to be a commercial fair value). The directors do not consider that accounting which would result in entry fees only being recognised in the production phase would appropriately reflect the sharing of development risk. Accordingly, the directors believe that the policy adopted best reflects the commercial objectives of the arrangements, the nature of the relationship with the workshare partner and is in accordance with Adopted IFRS. (cid:337)(cid:3) The Group has contingent liabilities in respect of financing support provided to customers. In order to assess whether a provision should be recognised, judgement as to the likelihood of these crystallising is required. This judgement is based on an assessment on the knowledge of the customers’ fleet plans, the underlying value of the security provided and, where appropriate, the customers’ creditworthiness. Key sources of estimation uncertainty In applying the accounting policies, estimates are made in many areas; the actual outcome may differ from that 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. Sensitivities are disclosed in the relevant notes where this is appropriate and practicable. Intangible assets arising on consolidation of Rolls-Royce Power Systems AG and put option on Rolls-Royce Power Systems Holding GmbH The fair value of intangible assets of RRPS at 1 January 2013 involved the use of valuation techniques and the estimation of future cash flows to be generated by RRPS over a considerable period of time. The Group engaged a specialist valuer to assist with these. For a period of six years from 1 January 2013, the Group is obliged to acquire, at Daimler AG’s option, the latter’s 50 per cent interest in RRPSH. The estimated exercise price of this option has been recognised as a liability. The exercise price of the option is based on averaging three valuations at the date the option is exercised, which are based on both internal metrics, requiring estimation of future performance of the business, and external metrics. 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: (cid:337)(cid:3) The assessment of whether the goodwill and other intangible assets (carrying value at 31 December 2013 £1,864 million) arising on the consolidation of RRPSH is impaired is dependent of the present value of the future cash flows expected to be generated by the business. These cash flows are based on the business plan jointly agreed by the shareholders. (cid:337)(cid:3) The assessment as to whether there are any indications of impairment of development, participation, certification, recoverable engine costs and customer relationships recognised as intangible assets (carrying values at 31 December 2013 £2,499 million, 31 December 2012 £1,457 million) is dependent on estimates of cash flows generated by the relevant assets and the discount rate used to calculate a present value. These estimates include the performance of long-term contractual arrangements as described below, as well as estimates for future market share, pricing and unit cost for uncontracted business. The risk of impairment is generally higher for newer programmes and, for customer specific intangible assets (RECs), for launch customers. Assessment of long-term contractual arrangements The Group has long-term contracts that fall into different accounting periods and which can extend over significant periods – the most significant of these are long-term service arrangements in the Civil aerospace business. The estimated revenues and costs are inherently imprecise and significant estimates are required to assess: engine flying hours, time on wing and other operating parameters; the pattern of future maintenance activity and the costs to be incurred; and life cycle cost improvements over the term of the contracts. The estimates take account of the inherent uncertainties and the risk of non-recovery of any resulting contract balances. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 83 1 Accounting policies (continued) 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 £793 million before deferred taxation being recognised on the balance sheet at 31 December 2013 (31 December 2012 £445 million). 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 on page 87, the Group measures provisions (carrying value at 31 December 2013 £733 million, 31 December 2012 £461 million) at the directors’ best estimate of the expenditure required to settle the obligation at the balance sheet date. These estimates take 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 consolidated financial statements include the financial statements of the Company and all of its subsidiary undertakings together with the Group’s share of the results of joint ventures and associates made up to 31 December. 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. Transactions with non-controlling interests are recorded directly in equity. Where the Group has issued a put option over shares held by a non-controlling interest, the Group recognises a liability for the estimated exercise value of that option. Movements in the estimated liability after initial recognition are recognised in the income statement. 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. Significant accounting policies Revenue recognition Revenues comprise sales to outside customers after discounts, excluding value added taxes. Sales of products (both original equipment and spare parts) 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 – this is generally on delivery. On occasion, the Group may participate in the financing of OE, most commonly by the provision of guarantees as described in note 18. In such circumstances, the contingent obligations arising under these arrangements are taken into account in assessing when the significant risks and rewards of ownership have been transferred to the customer. As described on page 81, a sale of OE at a contractual price below its cost of manufacture is considered to give rise to an intangible asset, a recoverable engine cost. In these circumstances, revenue is recognised to the same value as the recoverable engine cost. Sales of services are recognised by reference to the stage of completion based on services performed to date. As described on page 81, the assessment of the stage of completion is dependent on the nature of the contract, but will generally be based on: flying hours or equivalent for long-term aftermarket arrangements where the service is provided on a continuous basis; costs incurred to the extent these relate to services performed up to the reporting date; or achievement of contractual milestones where relevant. 84 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Accounting policies (continued) As described on page 81, sales of products and services are treated as though they are 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 transaction with an overall profit margin. The total revenue is allocated between the two components such that the total agreed discount to list prices is allocated to revenue for each of the two components pro rata, based on the list prices. This revenue is then recognised for each component on this basis as the products are delivered and services provided, as described above. Where the contractual price of the OE component is below the revenue allocated from the combined arrangement, this will give rise to an asset included in ‘amounts recoverable on contracts’. This asset reduces as services are provided, increases as costs are incurred, and reduces to zero by the end of the contract. Where the overall balance is a liability, it is recognised in ‘accruals and deferred income’. 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 accruals and deferred income within 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 arrangements (RRSAs) As described on page 81, the Group enters into arrangements with certain workshare partners under which these suppliers: (i) contribute to the forecast costs of developing an engine by performing their own development work, providing development parts and paying a non-refundable cash entry fee; and (ii) supply components for the production phase for which they receive consideration, which is an agreed proportion of the total programme revenues. Both the suppliers’ contributions to the forecast non-recurring development costs and their consideration are determined by reference to their proportionate forecast scopes of supply relative to that of the engine overall. Once the forecast costs and the scopes of supply have been agreed at the inception of the contract, each party is then accountable for its own incurred costs. No accounting entries are recorded when the suppliers undertake development work or when development components are supplied. Cash sums received are recognised in the income statement, as a reduction in research and development costs incurred, to match the expensing of the Group’s related costs – where the cash sums are received in advance of the related costs being expensed or where the related costs are capitalised as intangible assets, the recognition of the cash received is deferred (in accruals and deferred income) to match the recognition of the related expense or the amortisation of the related intangible asset respectively. The payments to suppliers of their shares of the programme revenues for their production components 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. Taxation The tax charge/credit on the profit or loss for the year comprises current and deferred tax: (cid:337)(cid:3) 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. (cid:337)(cid:3) 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 and is calculated using the enacted or substantively enacted rates that are expected to apply when the asset or liability is settled. Tax is charged or credited in the income statement or other comprehensive income (OCI) 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. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 85 1 Accounting policies (continued) 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 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. Accruals for tax contingencies require management to make judgements and estimates of exposures in relation to tax audit issues. Tax benefits are not recognised unless the tax positions will probably be sustained. Once considered to be probable, management reviews each material tax benefit to assess whether a provision should be taken against full recognition of that benefit on the basis of potential settlement through negotiation and/or litigation. All provisions are included in current liabilities. Foreign currency translation Transactions denominated in currencies other than the functional currency of the transacting Group undertaking (foreign currencies) are translated into the functional currency at the exchange rates ruling on the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the rate ruling at the year end. Exchange differences arising on foreign exchange transactions and the retranslation of assets and liabilities into functional currencies at the rate ruling at the year end are taken into account in determining profit before taxation. The trading results of Group undertakings are translated into sterling 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 recognised in OCI. The cumulative amount of exchange adjustments was, on transition to IFRS in 2004, deemed to be nil. 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: (cid:337)(cid:3) short-term investments are generally classified as available for sale; (cid:337)(cid:3) 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; (cid:337)(cid:3) borrowings, trade payables, financial RRSAs, put options on NCI and C Shares are classified as other liabilities; and (cid:337)(cid:3) derivatives, comprising foreign exchange contracts, interest rate swaps, and commodity swaps are classified as fair value through profit or loss. Financial instruments are recognised at the contract date and initially measured at fair value. Their subsequent measurement depends on their classification. (cid:337)(cid:3) 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. (cid:337)(cid:3) Loans and receivables and other liabilities are held at amortised cost and not revalued (except for changes in exchange rates and forecast contractual cash flows, which are included in the income statement) unless they are included in a fair value hedge accounting relationship. Where such a hedging relationship exists, the instruments are revalued in respect of the risk being hedged, with the change in value included in the income statement. (cid:337)(cid:3) Fair value through profit or loss items 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 an effective cash flow hedging relationship, 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. Hedge accounting The Group does not generally apply hedge accounting in respect of forward foreign exchange contracts or commodity swaps held to manage the cash flow exposures of forecast transactions denominated in foreign currencies or in commodities respectively. 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. 86 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Accounting policies (continued) Changes in the fair values of derivatives designated as fair value hedges and changes in the 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. 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. Gains and losses accumulated in the translation reserve will be recycled to profit when the foreign operation is sold. Business combinations and goodwill On the acquisition of a business, fair values are attributed to the identifiable assets and liabilities and contingent liabilities unless the fair value cannot be measured reliably, in which case the value is subsumed into goodwill. Where fair values of acquired contingent liabilities cannot be measured reliably, the assumed contingent liability is not recognised but is disclosed in the same manner as other contingent liabilities. Goodwill recognised represents the excess of the fair value of the purchase consideration over the fair value to the Group of the net of the identifiable assets acquired and the liabilities assumed. On transition to IFRS on 1 January 2004, business combinations were not retrospectively adjusted to comply with Adopted IFRS and goodwill was recognised based on the carrying value under the previous accounting policies. Goodwill in respect of the acquisition of a subsidiary is recognised as an intangible asset. Goodwill arising on the acquisition of joint ventures and associates is included in the carrying value of the investment. Certification costs and participation fees Costs incurred in respect of meeting regulatory certification requirements for new civil aero-engine/aircraft combinations including 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 is distinguished as relating either to a research phase or to a development phase. All research phase expenditure is charged to the income statement. Development expenditure 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. As described on page 81, the Group considers that it is not possible to distinguish reliably between research and development activities until relatively late in the programme. Expenditure capitalised is amortised on a straight-line basis over its useful economic life, up to a maximum of 15 years from the entry into service of the product. The fair value of research and development recognised during a business combination relate to the acquired company’s technology. Amortisation occurs on a straight-line basis over its useful economic life, up to a maximum of 15 years. Recoverable engine costs The Group may sell OE to customers at a price below its cost, on the basis that this deficit will be recovered from the profits of highly probable future aftermarket sales. As described on page 81, this sale is considered to give rise to an intangible asset, which, subject to an impairment review, is recognised at the time of delivery and amortised on a straight-line basis over the period that highly probable aftermarket sales are expected to be earned. Customer relationships The fair value of customer relationships recognised during a business combination relate to the acquired company’s established relationships with its existing customers that result in repeat purchases and customer loyalty. Amortisation occurs on a straight-line basis over its useful economic life, up to a maximum of 15 years. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 87 1 Accounting policies (continued) 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 advisers: a) freehold buildings – five to 45 years (average 24 years) b) leasehold buildings – lower of adviser’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 15 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. 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. The 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. 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 directors’ 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. 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. 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. The service and financing costs of such plans are recognised separately in the income statement: (cid:337)(cid:3) current service costs are spread systematically over the lives of employees; (cid:337)(cid:3) past service costs are recognised immediately; and (cid:337)(cid:3) financing costs are recognised in the periods in which they arise. 88 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Accounting policies (continued) Actuarial gains and losses and movements in unrecognised surpluses and minimum funding liabilities are recognised immediately in OCI. 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 Total Shareholder Return (TSR) performance condition in the Performance Share Plan (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 cost of shares of Rolls-Royce Holdings plc held by the Group for the purpose of fulfilling obligations in respect of employee share plans is deducted from equity in the consolidated balance sheet. See note 21 for a further description of the share-based payment plans. Sales financing support 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. As described on page 82, the directors consider the likelihood of crystallisation is assessing whether provision is required for any contingent liabilities. 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 2013 With effect from 1 January 2013, the Group has adopted the amendments to IAS 19 Employee Benefits issued by the IASB in June 2011. A description of these amendments and their effect is set out in note 19. In summary, the amendments require: (cid:337)(cid:3) recognition of certain administrative costs as operating costs rather than being included in net financing; (cid:337)(cid:3) net financing to be calculated on the net asset or liability recognised on the balance sheet using an AA corporate bond rate rather than using an expected rate of return for scheme assets; and (cid:337)(cid:3) immediate recognition of previously unrecognised past-service credits. Had these amendments not been adopted, the results would have been affected as follows: (cid:337)(cid:3) profit before financing £15 million higher (2012 £22 million higher); (cid:337)(cid:3) net post-retirement financing £107 million higher (2012 £56 million higher); and (cid:337)(cid:3) net assets £73 million lower (2012 £100 million lower). Revisions to IFRS not applicable in 2013 Standards and interpretations issued by the IASB are only applicable if endorsed by the EU. Under Adopted IFRS, IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosure of Interests in Other Entities and amendments to IAS 17 Separate Financial Statements are effective for 2014. The principal potential effect is that certain entities previously classified as joint ventures might be classified as joint operations, requiring the Group’s share of the individual assets and liabilities of these entities to be included in the financial statements rather than the equity accounting method previously applied. The Group has reviewed its material joint ventures and has concluded that none are to be classified as joint operations under the requirements of IFRS 11. If endorsed, 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. 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. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 89 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: Civil aerospace Defence aerospace Marine Energy – development, manufacture, marketing and sales of commercial aero engines and aftermarket services. – development, manufacture, marketing and sales of military aero engines and aftermarket services. – 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 Power Systems – development, manufacture, marketing and sales of diesel engines. electrical power generation and aftermarket services. Engineering and technology and Operations, discussed in the strategic report, operate on a Group-wide basis across all the above segments. 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 revenues – 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. 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 been made to exclude one-off past-service costs and 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: (cid:337)(cid:3) includes amounts realised from settled derivative contracts and revaluation of relevant assets and liabilities to exchange rates forecast (cid:337)(cid:3) to be achieved from future settlement of derivative contracts; and (cid:337)(cid:3) excludes unrealised amounts arising from revaluations required by IAS 39 Financial Instruments: Recognition and Measurement, changes in value of financial RRSA contracts arising from changes in forecast payments, changes in the value of put options on NCI and the net impact of financing costs related to post-retirement scheme benefits. This analysis also includes a reconciliation of the underlying results to those reported in the consolidated income statement. Year ended 31 December 2013 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 Underlying profit before financing and taxation Segment assets Investments in joint ventures and associates Segment liabilities Net assets/(liabilities) Investment in intangible assets, property, plant and equipment and joint ventures and associates Depreciation, amortisation and impairment Civil aerospace £m 3,035 3,620 6,655 Defence aerospace £m 1,385 1,206 2,591 708 136 844 9,587 495 (6,243) 3,839 891 349 424 14 438 1,437 17 (1,660) (206) 103 53 Marine £m 1,438 1,089 2,527 281 – 281 1,910 6 (1,312) 604 37 75 Energy £m 415 633 1,048 15 11 26 1,407 54 (688) 773 66 51 Power Systems £m 2,004 827 2,831 296 (2) 294 3,927 29 (3,034) 922 142 272 Inter- segment £m (72) (75) (147) 2 – 2 (744) – 733 (11) – – Total reportable segments £m 8,205 7,300 15,505 1,726 159 1,885 17,524 601 (12,204) 5,921 1,239 800 90 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 2 Segmental analysis (continued) Year ended 31 December 2012 (restated – see note 1) 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 Underlying profit before financing and taxation Segment assets Investments in joint ventures and associates Segment liabilities Net assets/(liabilities) Investment in intangible assets, property, plant and equipment and joint ventures and associates Depreciation, amortisation and impairment Reconciliation to reported results Year ended 31 December 2013 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 transfer of joint ventures to subsidiaries Profit on disposal of businesses Profit before financing and taxation Net financing Profit before taxation Taxation Profit for the year Ordinary shareholders Non-controlling interests Profit for the year Year ended 31 December 2012 (restated – see note 1) 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 Ordinary shareholders Non-controlling interests Profit for the year 1 Central corporate costs. Inter- segment £m (22) (121) (143) Total reportable segments £m 5,893 6,316 12,209 Civil aerospace £m 2,934 3,503 6,437 Defence aerospace £m 1,231 1,186 2,417 613 130 743 8,683 440 (5,819) 3,304 581 322 382 13 395 1,434 (22) (1,797) (385) 126 46 Marine £m 1,288 961 2,249 295 (1) 294 2,059 4 (1,467) 596 101 55 Energy £m 344 618 962 7 12 19 1,279 50 (570) 759 94 42 Power Systems £m 118 169 287 32 77 109 150 1,328 (282) 1,196 11 4 (11) – (11) (682) – 671 (11) – – 1,318 231 1,549 12,923 1,800 (9,264) 5,459 913 469 Group £m 8,275 7,238 15,513 1,375 160 119 216 1,870 (111) 1,759 (380) 1,379 1,367 12 1,379 Group £m 5,934 6,227 12,161 1,205 173 699 2,077 689 2,766 (431) 2,335 2,321 14 2,335 Total reportable segments £m 8,205 7,300 15,505 Underlying central items £m – – – Total underlying £m 8,205 7,300 15,505 Underlying adjustments £m 70 (62) 8 1,726 159 – – 1,885 (54) 1 – – – (54) (72) (126) (434) (560) 1,672 159 – – 1,831 (72) 1,759 (434) 1,325 1,224 101 1,325 (297) 1 119 216 39 (39) – 54 54 143 (89) 54 Total reportable segments £m 5,893 6,316 12,209 Underlying central items £m – – – Total underlying £m 5,893 6,316 12,209 Underlying adjustments £m 41 (89) (48) 1,318 231 – 1,549 (54) 1 – – (54) (61) (115) (317) (432) 1,264 231 – 1,495 (61) 1,434 (317) 1,117 1,103 14 1,117 (59) (58) 699 582 750 1,332 (114) 1,218 1,218 – 1,218 Rolls-Royce Holdings plc annual report 2013 91 2 Segmental analysis (continued) Underlying adjustments Underlying performance Revenue recognised at exchange rate on date of transaction Realised gains on settled derivative contracts 1 Net unrealised fair value changes to derivative contracts 2 Effect of currency on contract accounting Put option on NCI and financial RRSAs – foreign exchange differences and other unrealised changes in value Effect of acquisition accounting 3 Profit on reclassification of joint ventures to subsidiaries Pensions discretionary increase 4 Net post-retirement scheme financing Profit on disposal of businesses Other 5 Related tax effect IAE restructuring Total underlying adjustments Reported per consolidated income statement 2013 Revenue £m 15,505 Profit before financing £m 1,831 Net financing £m (72) Taxation £m (434) 8 – – – – – – – – – – – – 8 15,513 – (10) – (18) – (265) 119 (64) – 216 61 – – 39 1,870 – (5) 250 – (251) – – – (26) – (7) – – (39) (111) – – – – – – – – – – – 54 – 54 (380) Revenue £m 12,209 (48) – – – – – – – – – – – – (48) 12,161 2012* Profit before financing £m 1,495 Net financing £m (61) Taxation £m (317) – (25) – (23) – (69) – – – – – – 699 582 2,077 – – 747 – 11 – – – (8) – – – – 750 689 – – – – – – – – – – – (151) 37 (114) (431) 1 Realised gains on settled derivative contracts include adjustments to reflect (gains)/losses in the same period as the related trading cash flows. 2 Unrealised fair value changes to derivative contracts: (i) include those included in equity accounted joint ventures; and (ii) 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 Discretionary increase of £64m on unindexed pensions – see Chief Financial Officer’s review on page 12. 5 Other includes the exclusion of other operating income of £63m and the revaluation of preference shares in RRPS, which have now been acquired. The reconciliation of underlying earnings per ordinary share is shown in note 6. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Reportable segment assets Investments in joint ventures and associates 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 Borrowings Fair value of swaps hedging fixed rate borrowings Income tax liabilities Post-retirement scheme deficits Total liabilities Net assets * Restated – see note 1. Restated* 2013 £m 17,524 601 4,311 47 332 248 23,063 (12,204) (2,371) (48) (1,096) (1,041) (16,760) 6,303 31 December 2012 £m 12,923 1,800 2,596 104 375 348 18,146 (9,264) (1,383) – (710) (793) (12,150) 5,996 1 January 2012 £m 12,425 1,680 1,321 106 407 520 16,459 (9,463) (1,204) – (583) (807) (12,057) 4,402 92 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 2 Segmental analysis (continued) Geographical segments The Group’s revenue by destination is shown below: United Kingdom Norway Germany Switzerland Spain Italy France Russia Rest of Europe USA Canada South America Saudi Arabia Rest of Middle East India China South Korea Japan Malaysia Singapore Rest of Asia Africa Australasia Other 1 2013 £m 1,803 520 977 871 178 236 259 114 670 3,972 507 393 547 426 244 1,087 452 244 292 558 772 139 174 78 15,513 2012 £m 1,641 446 319 63 177 151 182 165 613 3,999 351 303 308 389 148 1,117 194 158 322 333 376 123 240 43 12,161 1 Other revenue mainly originates from Central America. In 2012, revenue (included in all reportable segments other than Power Systems) of £1,203 million was received from a single customer. In 2013, no single customer represented ten per cent or more of the Group’s revenue. The carrying amounts of the Group’s non-current assets, excluding financial instruments, deferred tax assets and post-retirement benefit surpluses, by the geographical area in which the assets are located, are as follows: United Kingdom North America Nordic countries Germany Other 2013 £m 3,649 872 823 2,739 924 9,007 2012 £m 3,139 723 889 2,023 497 7,271 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 93 3 Other income and expenses In October 2011, Rolls-Royce and United Technologies Corp. (UTC) announced their intention to form a new joint venture to develop an engine to power future mid-size (120–230 passenger) aircraft. In September 2013, the parties agreed not to proceed with the partnership. Other operating income includes £63 million received by the Group as a result of this. Research and development costs Expenditure in the year Capitalised as intangible assets Amortisation of capitalised costs Net research and development cost Entry fees received Entry fees deferred in respect of charges in future years Recognition of previously deferred entry fees Net cost recognised in the income statement Underlying adjustments relating to effects of acquisition accounting and foreign exchange Net underlying cost recognised in the income statement * Restated – see note 1. 4 Net financing Financing income Interest receivable Fair value gains on foreign currency contracts 2 Put options on NCI and financial RRSAs – foreign exchange differences and other unrealised changes in value Financing income on post-retirement scheme surpluses Financing costs Interest payable Fair value losses on foreign currency contracts 2 Put options on NCI and financial RRSAs – foreign exchange differences and other unrealised changes in value Financial charge relating to financial RRSAs Fair value losses on commodity derivatives 2 Financing costs on post-retirement scheme deficits Net foreign exchange losses Other financing charges Net financing Analysed as: Net interest payable Net post-retirement scheme financing Net other financing Net financing 1 See note 2 2 Net gain on fair value items through profit or loss 2013 £m (750) 110 (130) (770) 126 (50) 11 (683) 59 (624) 2012* £m (572) 38 (55) (589) 33 (5) 30 (531) – (531) 2013 2012 Per consolidated income statement £m Note Per consolidated income statement £m Underlying financing 1 £m Underlying financing 1 £m 17 17 19 17 17 17 17 19 15 287 8 17 327 (58) (3) (259) (9) (34) (43) (5) (27) (438) (111) (43) (26) (42) (111) 250 15 – – – 15 (58) – – (9) – – – (20) (87) (72) (43) – (29) (72) – 10 750 11 26 797 (51) – – (10) (3) (34) – (10) (108) 689 (41) (8) 738 689 747 10 – – – 10 (51) – – (10) – – – (10) (71) (61) (41) – (20) (61) – 94 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 5 Taxation Current tax Current tax charge/(credit) 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 tax rates Recognised in the income statement Other tax (charges)/credits Current tax: Share-based payments – direct to equity Deferred tax: Net investment hedge Movement in post-retirement schemes Share-based payments – direct to equity Tax reconciliation UK 2013 £m 7 (1) 6 2 8 224 (8) (59) 157 165 2012* £m (3) (1) (4) (7) (11) 216 1 (19) 198 187 Overseas 2013 £m 290 – 290 29 319 (66) (37) (1) (104) 215 2012* £m 218 – 218 (18) 200 38 6 – 44 244 OCI Items that will not be reclassified 2013 £m 2012* £m Items that may be reclassified 2012 £m 2013 £m 10 10 105 105 1 1 (1) (1) Profit before taxation Less share of results of joint ventures and associates (note 11) Profit before taxation excluding joint ventures and associates Nominal tax charge at UK corporation tax rate 23.25% (2012 24.5%) UK R&D credit Rate differences Profit on reclassification of joint ventures to subsidiaries Changes in value of put option on NCI Restructuring of IAE 1 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 tax rates Underlying items (note 2) Non-underlying items * Restated – see note 1. 1 Pursuant to the Substantial Shareholdings Exemption, the majority of the upfront proceeds received on the IAE restructuring were not subject to tax. Total 2013 £m 297 (1) 296 31 327 158 (45) (60) 53 380 Equity 2013 £m 5 8 13 2013 £m 1,759 (160) 1,599 372 (13) 51 (27) 60 – 12 (7) 6 (14) (60) 380 434 (54) 380 2012* £m 215 (1) 214 (25) 189 254 7 (19) 242 431 2012 £m 3 6 9 2012* £m 2,766 (173) 2,593 635 (26) 59 – – (209) 9 – – (18) (19) 431 317 114 431 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 5 Taxation (continued) Deferred taxation assets and liabilities At 1 January, as previously reported Effect of amendments to IAS 19 – see note 19 Effect of amendment to RRSAs – see note 1 At 1 January as restated Amount charged to income statement Amount credited to other comprehensive income Amount credited to equity Acquisition of businesses Transferred to assets held for sale Exchange differences At 31 December Deferred tax assets Deferred tax liabilities The analysis of the deferred tax position is as follows: 95 2012 £m (77) (43) 62 (58) (242) 104 6 (1) (46) (5) (242) 342 (584) (242) 2013 £m (242) (53) 11 8 (282) – (8) (566) 316 (882) (566) 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 R&D expenditure credit 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 * Restated – see note 1. At 1 January 2013 £m (232) (158) 12 (351) Recognised in income statement £m 34 17 9 (29) Recognised in OCI £m – – 1 – Recognised in equity £m – – 3 – Acquisition of businesses £m (311) (70) 60 – Transferred from assets held for sale £m – – – – Exchange differences £m (2) 1 (5) – At 31 December 2013 £m (511) (210) 80 (380) 110 (56) 369 – 64 (242) At 1 January 2012 £m (243) (135) 1 (250) 56 121 328 64 (58) – (36) (55) 7 – (53) Restated* Recognised in income statement £m 58 (25) 10 (101) (41) (177) 34 – (242) 10 – – – – 11 – – 5 – – 8 36 – 3 – – (282) – – – – – – (3) – 1 – – (8) 153 (92) 323 7 64 (566) Recognised in OCI £m – – (1) – Recognised in equity £m – – – – Acquisition of businesses £m – 1 – – Transferred to assets held for sale £m (46) – – – Exchange movements £m (1) 1 2 – At 31 December 2012 £m (232) (158) 12 (351) 105 – – – 104 – – 6 – 6 (2) – – – (1) – – – – (46) 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 (8) – 1 – (5) 2013 £m 118 39 157 110 (56) 369 64 (242) 2012 £m 118 39 157 96 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 5 Taxation (continued) Deferred taxation assets and liabilities The 2013 Budget announced that the UK corporation tax rate will reduce to 21 per cent from 1 April 2014 and to 20 per cent from 1 April 2015. These reductions were substantively enacted on 2 July 2013. As the reduction to 20 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 2013, £59 million has been credited to the income statement, £1 million has been charged to the OCI and £9 million has been charged directly to equity. The temporary differences associated with investments in subsidiaries, joint ventures and associates, for which a deferred tax liability has not been recognised, aggregate to £573 million (2012 £144 million). No deferred tax liability has been recognised on the potential withholding tax due on the remittance of undistributed profits as the Group is able to control the timing of such remittances and it is probable that consent will not be given in the foreseeable future. 6 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. 2012 figures have been restated to reflect the adoption of amendments to IAS 19 Employee Benefits – see note 19, and the change in the accounting policy for RRSAs – see note 1. The impact of the restatement on the previously reported EPS of 123.23p was an increase of 1.40p relating to the IAS 19 amendments and an increase of 0.75p relating to the change in the accounting policy for RRSAs. 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 Related NCI effects EPS/Profit attributable to ordinary shareholders Excluding IAE restructuring IAE restructuring Diluted underlying EPS 2013 Potentially dilutive share options 21 (0.82) Basic 1,367 1,866 73.26 Diluted 1,367 1,887 72.44 Basic 2,321 1,851 125.38 2012 Potentially dilutive share options 25 (1.65) 2013 2012* Pence 65.59 – 2.89 4.78 73.26 73.26 – 64.86 £m 1,224 – 54 89 1,367 1,367 – Pence 59.59 71.96 (6.17) – 125.38 85.62 39.76 58.80 Diluted 2,321 1,876 123.73 £m 1,103 1,332 (114) – 2,321 1,585 736 * The impact of the restatement on the previously reported underlying EPS of 59.27p was a decrease of 0.71p relating to the IAS 19 amendments and an increase of 1.03p relating to the change in the accounting policy for RRSAs. Rolls-Royce Holdings plc annual report 2013 97 7 Employee information Average number of employees United Kingdom United States Canada Germany Rest of world Civil aerospace Defence aerospace Marine Energy Power Systems 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. 8 Auditors’ 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 2: Audit related assurance services 3 Taxation compliance services Taxation advisory services Internal audit services 4 Information technology services 4 All other services Fees payable in respect of the Group’s pension schemes: Audit Taxation compliance services S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 2013 Number 2012 Number 24,800 8,500 1,600 10,500 9,800 55,200 23,400 7,900 9,200 4,000 10,700 55,200 22,800 7,200 1,700 2,800 8,300 42,800 21,500 7,800 8,800 3,700 1,000 42,800 £m £m 2,843 374 79 379 3,675 2,163 265 55 245 2,728 2013 £m 0.2 5.6 5.8 0.8 0.8 0.1 0.2 – 1.0 8.7 0.2 0.1 2012 £m 0.2 4.5 4.7 0.6 0.3 0.2 0.6 0.4 0.1 6.9 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. 2 As described on page 46, in 2013, fees for other services to KPMG in respect of Rolls-Royce Power Systems AG (RRPS) were £2.1m. Following the consolidation of RRPS on 1 January 2013, the audit committee approved the continuation of engagements already in progress at that date. 3 This includes £0.3m (2012 £0.3m) for the review of the half-year report. 4 In 2012, as part of the Group’s IT modernisation programme, KPMG provided specialist internal audit support while the Group recruited its own personnel. In addition, consulting services were provided by a firm which was acquired by KPMG after being engaged by the Group. 98 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 9 Intangible assets Cost: At 1 January 2012 Exchange differences Additions Acquisitions of businesses Transferred from subsidiary to associate Disposals At 1 January 2013 Exchange differences Additions Acquisitions of businesses Disposals of businesses At 31 December 2013 Accumulated amortisation: At 1 January 2012 Charge for the year 2 Impairment Disposals At 1 January 2013 Exchange differences Charge for the year 2 Impairment Disposal of businesses At 31 December 2013 Net book value: At 31 December 2013 At 31 December 2012 At 1 January 2012 Certification costs and participation fees £m Goodwill £m Development expenditure1 £m Recoverable engine costs £m Customer relationships1 £m Software1 £m Other1 £m 1,106 (4) – 10 – (1) 1,111 (18) – 773 (5) 1,861 7 – 3 (1) 9 (1) – 17 (2) 23 1,838 1,102 1,099 720 (2) 28 – – (6) 740 3 185 – – 928 197 34 – (6) 225 – 40 – – 265 663 515 523 998 (1) 38 – (1) (6) 1,028 5 110 508 (5) 1,646 274 55 – (6) 323 (7) 130 3 (5) 444 1,202 705 724 464 – 35 – – – 499 – 52 – – 551 231 64 – – 295 – 28 – – 323 228 204 233 45 – – – – – 45 (3) – 433 – 475 7 5 – – 12 (8) 61 4 – 69 406 33 38 267 (1) 119 2 – (2) 385 (1) 69 – – 453 104 41 – (1) 144 – 54 – – 198 255 241 163 134 (3) 5 7 – (1) 142 17 87 286 – 532 32 10 – (1) 41 5 91 – – 137 395 101 102 Total £m 3,734 (11) 225 19 (1) (16) 3,950 3 503 2,000 (10) 6,446 852 209 3 (15) 1,049 (11) 404 24 (7) 1,459 4,987 2,901 2,882 1 Following the acquisition of RRPS on 1 January 2013, intangible assets relating to R&D, customers relationships and software have been reclassified from ‘other’ into their respective categories from 1 January 2012 onwards. 2 Charged to cost of sales except development costs, which are charged to research and development costs. Goodwill In accordance with the requirements of IAS 36 Impairment of Assets, goodwill is allocated to the Group’s cash-generating units, or groups of cash-generating units, that are expected to benefit from the synergies of the business combination that gave rise to the goodwill as follows: Cash-generating unit (CGU) or group of CGUs Rolls-Royce Deutschland Ltd & Co KG Commercial marine – arising from the acquisitions of Vinters Limited and Scandinavian Electric Holding AS Commercial marine – arising from the acquisition of ODIM ASA Rolls-Royce Power Systems AG Other Primary reporting segment Civil aerospace Marine Marine Power Systems Various 2013 £m 230 620 88 785 115 1,838 2012 £m 223 649 115 – 115 1,102 Rolls-Royce Holdings plc annual report 2013 99 9 Intangible assets (continued) Goodwill has been tested for impairment during 2013 on the following basis: (cid:337)(cid:3) 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 – 2.75 per cent) that reflect the products, industries and countries in which the relevant CGU or group of CGUs operate. (cid:337)(cid:3) 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. (cid:337)(cid:3) The pre-tax cash flow projections have been discounted at 13 per cent (2012 13 per cent), based on the Group’s weighted average cost of capital, adjusted for specific risk where appropriate. The principal value in use assumptions for goodwill balances considered to be individually significant are: (cid:337)(cid:3) Rolls-Royce Power Systems AG – Volume of equipment deliveries, pricing achieved and cost escalation. These are based on current and known future programmes, estimates of capture of market share and long-term economic forecasts. The principal foreign exchange exposures are on translating income in a variety of non-functional currencies into euros. For the purposes of the impairment only, cash flows beyond the ten-year forecasts are assumed to grow at two per cent. Following the recognition of RRPS at fair value on 1 January 2013, reasonably possible changes in the key assumptions could cause the value of goodwill to fall below its carrying value, such as a reduction in the level of cash generation of nine per cent, a reduction in the assumed long-term growth rate to 0.8 per cent or an increase in the assumed discount rate of 0.7 per cent. (cid:337)(cid:3) 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 (2012 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 85 per cent to cause an impairment of this balance. (cid:337)(cid:3) Vinters Limited – 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 (2012 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. Other intangible assets Certification costs and participation fees, customer relationships, technology, patents and licences, order backlog, trademark, 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: (cid:337)(cid:3) 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. (cid:337)(cid:3) The key assumptions underlying cash flow projections are assumed market share, programme timings, unit cost assumptions, discount rates, and foreign exchange rates. (cid:337)(cid:3) The pre-tax cash flow projections have been discounted at 11 per cent (2012 11 per cent), based on the Group’s weighted average cost of capital. (cid:337)(cid:3) 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. 100 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 10 Property, plant and equipment Land and buildings £m Plant and equipment £m Aircraft and engines £m In course of construction £m Cost: At 1 January 2012 Exchange differences Additions Acquisitions of businesses Disposals of businesses Reclassifications Disposals/write-offs At 1 January 2013 Exchange differences Additions Acquisitions of businesses Disposals of businesses Reclassifications Disposals/write-offs At 31 December 2013 Accumulated depreciation: At 1 January 2012 Exchange differences Charge for the year 1 Reclassifications Disposals of businesses Disposals/write-offs At 1 January 2013 Exchange differences Charge for the year 1 Reclassifications Disposals of businesses Disposals/write-offs At 31 December 2013 Net book value: At 31 December 2013 At 31 December 2012 At 1 January 2012 981 (14) 50 – – 60 (5) 1,072 (11) 17 202 – 19 (2) 1,297 315 (3) 39 7 – (3) 355 (9) 48 (8) – – 386 911 717 666 2,646 (25) 124 45 (4) 168 (65) 2,889 (28) 150 300 (1) 242 (62) 3,490 1,598 (13) 196 (7) (2) (58) 1,714 (22) 301 8 (1) (51) 1,949 1,541 1,175 1,048 216 (1) 18 – – 4 (14) 223 (2) 83 – – 21 (1) 324 44 – 20 – – (2) 62 (1) 23 – – 84 240 161 172 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 £150 million (2012 £31 million). 454 (9) 299 – – (232) (1) 511 (8) 437 44 – (282) (2) 700 2 – – – – (2) – – – – – – 700 511 452 2013 £m 7 4 320 (79) 241 317 899 Total £m 4,297 (49) 491 45 (4) – (85) 4,695 (49) 687 546 (1) – (67) 5,811 1,959 (16) 255 – (2) (65) 2,131 (32) 372 – (1) (51) 2,419 3,392 2,564 2,338 2012 £m 7 4 242 (65) 177 258 721 Rolls-Royce Holdings plc annual report 2013 11 Investments At 1 January 2012 Exchange differences Additions Taxation paid by the Group Transfer to subsidiary Impairment Share of retained profit Transferred from subsidiary to associate Disposals Share of OCI – will not be reclassified to profit and loss Share of OCI – may be reclassified to profit or loss At 1 January 2013 Exchange differences Additions Taxation paid by the Group Transfers to subsidiaries1 Acquisition of businesses Share of retained profit Disposals Share of OCI – will not be reclassified to profit and loss Share of OCI – may be reclassified to profit or loss At 31 December 2013 101 Other Unlisted £m 10 – – – – – – – (4) – – 6 1 1 – – 20 – (1) – – 27 Equity accounted Joint ventures £m 1,680 (58) 191 6 (5) (2) 44 – – (46) (12) 1,798 (4) 43 6 (1,327) 30 61 (2) – (6) 599 Associates £m – – – – – – – 2 – – – 2 – – – – – – – – – 2 Total £m 1,680 (58) 191 6 (5) (2) 44 2 – (46) (12) 1,800 (4) 43 6 (1,327) 30 61 (2) – (6) 601 1 At 31 December 2012, Rolls-Royce Power Systems GmbH (a 50:50 joint holding company with Daimler AG) held 99 per cent of the RRPS AG shares. As part of the shareholders’ agreement, certain conditions allowed the Group to classify RRPS AG as a subsidiary and consolidate it. These conditions were fulfilled and the rights exercised on 1 January 2013, resulting in £1,328m being transferred to subsidiaries. The summarised aggregated financial information of the Group’s share of equity accounted investments is as follows: Assets: Non-current assets Current assets Liabilities: Current liabilities Non-current liabilities Liabilities include borrowings of: Revenue Profit before financing and taxation Net financing Taxation Results recognised in the consolidated income statement Dividends received Retained profit Joint ventures 2012 Power Systems £m 1,590 718 (421) (559) 1,328 (103) 1,223 33 (10) (1) 22 (28) (6) 2012 Other £m 1,717 818 (655) (1,410) 470 (1,271) 2,827 189 (22) (16) 151 (101) 50 2013 Other £m 1,839 852 (623) (1,469) 599 (1,291) 2,343 188 (16) (12) 160 (99) 61 2012 £m 3,307 1,536 (1,076) (1,969) 1,798 (1,374) 4,050 222 (32) (17) 173 (129) 44 Associates Total 2013 £m 2012 £m 1 2 (1) – 2 – 1 – – – – – – 1 2 (1) – 2 – 3 – – – – – – 2013 £m 1,840 854 (624) (1,469) 601 (1,291) 2,344 188 (16) (12) 160 (99) 61 2012 £m 3,308 1,538 (1,077) (1,969) 1,800 (1,374) 4,053 222 (32) (17) 173 (129) 44 The principal joint ventures at 31 December 2013 are listed on pages 128 and 129. 102 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 12 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 13 Trade and other receivables Trade receivables Amounts recoverable on contracts Amounts owed by joint ventures and associates 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 14 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 77) Cash held as collateral against third-party obligations (note 18) 2013 £m 593 1,177 15 1,426 108 3,319 447 89 5 2013 £m 1,601 2,239 380 637 235 5,092 2,118 527 2,447 5,092 51 1,751 – 41 84 1,927 2013 £m 982 1,157 1,851 3,990 (3) 3,987 50 2012 £m 336 1,056 10 1,282 42 2,726 136 64 1 2012 £m 1,182 1,902 351 479 205 4,119 1,662 364 2,093 4,119 40 1,473 3 63 32 1,611 2012 £m 674 408 1,503 2,585 – 2,585 64 Cash and cash equivalents at 31 December 2013 includes £286 million (2012 £78 million) that is not available for general use by the Group. This balance relates to cash held in non-wholly owned subsidiaries and the Group’s captive insurance company. Rolls-Royce Holdings plc annual report 2013 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 6.75% Notes 2019 £500m 2 2.125% Notes 2021 €750m 1 3.375% Notes 2026 £375m 2 Secured Obligations under finance leases 3 103 2012 £m – 406 200 147 58 571 – – Non-current 2013 £m – 412 200 – 55 535 611 350 2012 £m – 404 200 – 58 571 – – Total 2013 £m 3 616 200 – 55 535 611 350 1 2,164 1 1,234 1 2,371 1 1,383 Current 2013 £m 3 204 – – – – – – – 207 2012 £m – 2 – 147 – – – – – 149 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 interest rate swap agreements under which the Group has undertaken to pay floating rates of interest which form a fair value hedge. 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 2013 £m 1,594 1,370 191 101 1,820 1,969 7,045 2012* £m 1,361 1,109 202 107 1,574 2,048 6,401 Non-current 2013 £m 750 16 – – 143 1,229 2,138 2012* £m 609 – 1 – 95 967 1,672 Total 2013 £m 2,344 1,386 191 101 1,963 3,198 9,183 2012* £m 1,970 1,109 203 107 1,669 3,015 8,073 180 262 151 162 331 424 Included within trade and other payables are government grants of £100 million (2012 £89 million). During the year, £26 million (2012 £16 million) of government grants were released to the income statement. Included in accruals and deferred income are deferred receipts from RRSA workshare partners of £260 million (2012 £221 million). 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 * Restated – see note 1. 2013 £m 2,989 806 5,388 9,183 2012* £m 2,571 704 4,798 8,073 104 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 17 Financial instruments Carrying values and fair values of financial instruments Assets Liabilities Total At 31 December 2013 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 Exercise prices of put options on NCI Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities At 31 December 2012 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 Exercise price of put option on NCI Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities Basis for determining fair value Notes Fair value through profit or loss £m Loans and receivables £m Available for sale £m 11 13 13 14 15 16 16 11 13 13 14 15 16 16 A B B C B B D C E F B B B A B B C B B D C E F B B B – – – 748 – – – – – – – – – 748 – – – 707 – – – – – – – – – 707 27 2,118 527 – 321 1,851 – – – – – – – 4,844 6 1,662 364 – 11 1,503 – – – – – – – 3,546 – – – – – 1,157 – – – – – – – 1,157 – – – – – 408 – – – – – – – 408 Fair values equate to book values for both 2013 and 2012, with the following exceptions: Borrowings Financial RRSAs Fair value through profit or loss £m – – – – – – – (295) – – – – – (295) – – – – – – – (360) – – – – – (360) Cash £m – – – – – 982 – – – – – – – 982 – – – – – 674 – – – – – – – 674 Other £m – – – – – – (2,371) – (1,858) (167) (16) (2,989) (806) (8,207) – – – – – – (1,383) – (167) (193) (10) (2,571) (704) (5,028) £m 27 2,118 527 748 321 3,990 (2,371) (295) (1,858) (167) (16) (2,989) (806) (771) 6 1,662 364 707 11 2,585 (1,383) (360) (167) (193) (10) (2,571) (704) (53) 2013 2012 Book value £m (2,371) (167) Fair value £m (2,495) (184) Book value £m (1,383) (193) Fair value £m (1,542) (215) 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 unconsolidated companies where 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 13 Fair Value Measurement). D Borrowings are carried at amortised cost. Amounts denominated in foreign currencies are valued at the exchange rate prevailing at the balance sheet date (Level 2 as defined by IFRS 13). E The value of the put option on NCI is determined in accordance with the contractual terms, which requires averaging three valuations, covering forecasts of the business performance and external metrics of comparable business and transactions. F The fair value of RRSAs is estimated by discounting expected future cash flows. The contractual cash flows are based on future trading activity, which is estimated based on latest forecasts (Level 3 as defined by IFRS 13). IFRS 13 defines a three-level valuation hierarchy: Level 1 – quoted prices for similar instruments; Level 2 – directly observable market inputs other than Level 1 inputs; and Level 3 – inputs not based on observable market data. Rolls-Royce Holdings plc annual report 2013 105 17 Financial instruments (continued) Carrying values of other financial assets and liabilities Derivatives At 31 December 2013 Non-current assets Current assets Current liabilities Non-current liabilities At 31 December 2012 Non-current assets Current assets Current liabilities Non-current liabilities Foreign exchange contracts £m Commodity contracts £m Interest rate contracts £m Total derivatives £m Exercise price of put options on NCI £m Financial RRSAs £m C Shares £m Total £m 631 72 703 (63) (142) (205) 498 498 104 602 (97) (233) (330) 272 – 2 2 (16) (25) (41) (39) 4 6 10 (8) (15) (23) (13) 43 – 43 (1) (48) (49) (6) 90 5 95 – (7) (7) 88 674 74 748 (80) (215) (295) 453 592 115 707 (105) (255) (360) 347 – – – (1,858) – (1,858) (1,858) – – – (167) – (167) (167) – – – (22) (145) (167) (167) – – – (30) (163) (193) (193) – – – (16) – (16) (16) – – – (10) – (10) (10) 674 74 748 (1,976) (360) (2,336) (1,588) 592 115 707 (312) (418) (730) (23) 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 1 January 2012 Movements in fair value hedges 1 Movements in cash flow hedges Movements in other derivative contracts 2 Contracts settled 3 At 1 January 2013 Business acquisitions Movements in fair value hedges 1 Movements in other derivative contracts 2 Contracts settled 3 At 31 December 2013 Foreign exchange instruments £m (447) (8) (4) 750 (19) 272 4 3 284 (65) 498 Commodity instruments £m (12) – – (3) 2 (13) (1) – (34) 9 (39) Interest rate instruments £m 81 6 – 1 – 88 – (91) – (3) (6) Total £m (378) (2) (4) 748 (17) 347 3 (88) 250 (59) 453 1 Gain on related hedged items £88m (2012 £2m net gain). 2 Included in financing. 3 Includes contracts settled in fair value hedges £17m (2012 nil) and cash flow hedges £nil (2012: £4m loss). Exercise price of put option on non-controlling interests and financial RRSAs The Group has agreed a put option with Daimler AG, such that Daimler can sell its interest in Rolls-Royce Power Systems Holding GmbH (RRPSH) to the Group. The exercise price of this option is included as a financial liability. The Group has financial liabilities arising from financial RRSAs. 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. 106 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 17 Financial instruments (continued) Movements in the carrying values were as follows: At 1 January Cash paid to partners Business acquisitions Additions Exchange adjustments included in OCI Financing charge 1 Excluded from underlying profit: Changes in put options exercise prices 1 Exchange adjustments 1 Changes in forecast payments 1 At 31 December 1 Included in financing. Put options on NCI Financial RRSAs 2013 £m (167) – (2) (1,432) – – (212) (45) 2012 £m – – – (167) – – (5) 5 (1,858) (167) 2013 £m (193) 33 – – (4) (9) 4 2 (167) 2012 £m (230) 35 – – 1 (10) 9 2 (193) 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. 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 2013 107 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 31 December 2013 Foreign exchange contracts: Fair value hedges Non-hedge accounted Interest rate contracts: Fair value hedges Non-hedge accounted Commodity contracts: Non-hedge accounted At 31 December 2012 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 Fair value Nominal amount £m Within one year £m Between one and two years £m Between two and five years £m After five years £m Assets £m Liabilities £m 46 19,654 1,550 5 262 21,517 175 17,701 692 7 286 18,861 – 4,759 – – 79 4,838 129 4,585 141 – 76 4,931 46 4,530 50 5 62 4,693 – 3,542 51 – 68 3,661 – 9,493 – – 80 9,573 46 9,029 – 7 – 872 1,500 – 41 2,413 – 545 500 – 99 9,181 43 1,088 3 700 43 – 2 748 15 587 89 6 10 707 – (205) (48) (1) (41) (295) – (330) – (7) (23) (360) 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: Currencies purchased forward Sterling £m US dollar £m Euro £m Other £m Total £m At 31 December 2013 Currencies sold forward: Sterling US dollar Euro Other At 31 December 2012 Currencies sold forward: Sterling US dollar Euro Other – 15,936 4 22 – 14,407 – 21 429 – – 23 495 – – 11 – 2,036 – 75 – 1,817 – 70 Other derivative financial instruments are denominated in the following currencies: Sterling US dollar Euro Other 10 913 249 3 23 840 177 15 2013 £m 880 300 637 – 439 18,885 253 123 518 17,064 177 117 2012 £m 506 479 – – 108 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 17 Financial instruments (continued) Non-derivative financial instruments are denominated in the following currencies: At 31 December 2013 Assets Unlisted non-current investments Trade receivables and similar items Other non-derivative financial assets Short-term investments Cash and cash equivalents Liabilities Borrowings Exercise prices of put options on NCI Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities At 31 December 2012 Assets Unlisted non-current investments Trade receivables and similar items Other non-derivative financial assets Short-term investments Cash and cash equivalents Liabilities Borrowings Exercise price of put option on NCI Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities Sterling £m US dollar £m Euro £m Other £m Total £m – 199 289 282 1,619 2,389 (1,490) – – (16) (1,501) (208) (3,215) (826) 1 234 121 5 495 856 (1,173) – – (10) (1,254) (250) (2,687) (1,831) – 995 48 – 1,080 2,123 (55) – (114) – (641) (328) (1,138) 985 – 1,176 75 – 1,038 2,289 (205) – (139) – (825) (320) (1,489) 800 26 829 89 4 980 1,928 (826) (1,858) (53) – (653) (158) (3,548) (1,620) 4 169 40 – 606 819 (5) (167) (54) – (289) (17) (532) 287 1 95 101 35 311 543 – – – – (194) (112) (306) 237 1 83 128 6 446 664 – – – – (203) (117) (320) 344 27 2,118 527 321 3,990 6,983 (2,371) (1,858) (167) (16) (2,989) (806) (8,207) (1,224) 6 1,662 364 11 2,585 4,628 (1,383) (167) (193) (10) (2,571) (704) (5,028) (400) 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 31 December 2013 Sterling 1 US dollar Euro Other At 31 December 2012 Sterling 1 US dollar Euro Other Sterling £m US dollar £m Euro £m Other £m Total £m – 8 (1) (5) – 4 (1) 6 13 – (2) 41 22 – (2) 1 (1,855) – – (11) (166) (6) – (5) 12 7 – (4) 4 5 – 1 (1,830) 15 (3) 21 (140) 3 (3) 3 1 Included in the £1,855m liability (2012 £166m liability) euro currency exposure is a £1,858m liability (2012 £167m liability) relating to the put option on Daimler’s interest in RRPSH – see page 105. Rolls-Royce Holdings plc annual report 2013 109 17 Financial instruments (continued) Ageing beyond contractual due date of financial assets At 31 December 2013 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 31 December 2012 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 Contractual maturity analysis of financial liabilities At 31 December 2013 Borrowings Derivative financial liabilities Exercise prices of put options on NCI Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities At 31 December 2012 Borrowings Derivative financial liabilities Exercise price of put option on NCI Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities Up to three months overdue £m Between three months and one year overdue £m More than one year overdue £m – 240 1 – – – 241 – 132 18 – – – 150 – 90 1 – – – 91 – 43 1 – – – 44 – 19 2 – – – 21 – 17 2 – – – 19 Within terms £m 27 1,769 523 748 321 3,990 7,378 6 1,470 343 707 11 2,585 5,122 Total £m 27 2,118 527 748 321 3,990 7,731 6 1,662 364 707 11 2,585 5,335 Gross values Between one and two years £m Between two and five years £m After five years £m Discounting £m Carrying value £m (140) (76) – (34) – (17) (28) (295) (257) (103) – (32) – (1) (10) (403) (609) (146) – (65) – – (16) (836) (403) (138) – (75) – (1) – (617) (1,894) (90) – (75) – – (11) (2,070) (778) (14) – (100) – (1) – (893) 562 104 – 40 – – – 706 265 3 – 49 – – – 317 (2,371) (295) (1,858) (167) (16) (2,989) (806) (8,502) (1,383) (360) (167) (193) (10) (2,571) (704) (5,388) Within one year £m (290) (87) (1,858) (33) (16) (2,972) (751) (6,007) (210) (108) (167) (35) (10) (2,568) (694) (3,792) 110 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 17 Financial instruments (continued) 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. 2013 Short-term investments 1 Cash and cash equivalents 2 Unsecured bank loans Other borrowings Interest rate swaps £200m floating rate loan £200m floating rate loan €125m fixed rate loan €75m fixed rate loan €50m fixed rate loan Unsecured bond issues 73/8% Notes 2016 £200m 6.55% Notes 2015 US$83m Effect of interest rate swaps 6.75% Notes 2019 £500m Effect of interest rate swaps 2.125% Notes 2021 €750m Effect of interest rate swaps 3.375% Notes 2026 £375m Effect of interest rate swaps Other secured Obligations under finance leases 2012 Short-term investments 1 Cash and cash equivalents 2 Unsecured bank loans Other borrowings Interest rate swaps £200m floating rate loan £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 % 5.3225% GBP LIBOR + 0.267 GBP LIBOR + 1.26 2.6000% 2.0600% 2.3500% 7.3750% 6.5500% USD LIBOR + 1.24 6.7500% GBP LIBOR + 2.9824 2.1250% GBP LIBOR + 0.7005 3.3750% GBP LIBOR + 0.8330 Total £m 321 3,990 (10) – (200) (200) (104) (63) (42) (200) (55) – (535) – (611) – (350) – 5.0000% (1) 1,940 Effective interest rate % 5.3225% GBP LIBOR + 0.267 GBP LIBOR + 1.26 7.3750% 6.3800% USD LIBOR + 1.26 6.5500% USD LIBOR + 1.24 6.7500% GBP LIBOR + 2.9824 5.0000% Total £m 11 2,585 (6) – (200) (200) (200) (147) – (58) – (571) – (1) 1,213 Period in which interest rate reprices 6 months or less £m 318 3,990 6–12 months £m 3 – (5) 5 (200) (200) – – – – – (55) – (535) – (611) – (350) (1) – – – – – – – – – – – – – – – – – Period in which interest rate reprices 6 months or less £m 9 2,585 6–12 months £m 2 – (4) 7 (200) (200) – – (147) – (58) – (571) – – – – – – – – – – – – 1 Interest on the short-term investments are at fixed rates. 2 Cash and cash equivalents comprise bank balances and demand deposits and earn interest at rates based on daily deposit rates. Rolls-Royce Holdings plc annual report 2013 111 17 Financial instruments (continued) Some of the Group’s borrowings are subject to the Group meeting certain obligations, including customary financial covenants. If the Group fails to meet its obligations these arrangements give rights to the lenders, upon agreement, to accelerate repayment of the facilities. There are no rating triggers contained in any of the Group’s facilities that could require the Group to accelerate or repay any facility for a given movement in the Group’s credit rating. In addition, the Group has undrawn committed borrowing facilities available as follows: Expiring in one to two years Expiring after two years Sensitivity analysis Sensitivities at 31 December (all other variables held constant) – impact on profit after tax and equity Sterling 10% weaker against the US dollar Sterling 10% stronger against the US dollar Euro 10% weaker against the US dollar Euro 10% stronger against the US dollar Sterling 10% weaker against the Euro Sterling 10% stronger against the Euro Commodity prices 10% lower Commodity prices 10% higher 2013 £m – 1,250 1,250 2013 £m (1,177) 963 (128) 100 (95) 78 (16) 16 2012 £m – 1,000 1,000 2012 £m (1,073) 878 (146) 118 – – (20) 20 At 31 December 2013 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 106. C Shares and payments to shareholders The 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 0.1 pence 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 C Shares issued, or on the acquisition or capital restructuring of the Company. Movements in the C Shares during the year were as follows: 2013 2012 Millions Nominal value £m Millions Nominal value £m Issued and fully paid At 1 January Issued Redeemed At 31 December 10,418 366,041 (360,173) 16,286 10 366 (360) 16 6,371 327,643 (323,596) 10,418 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 were declared as follows: Interim Final 2013 2012 Pence per share 8.6 13.4 22.0 £m 162 252 414 Pence per share 7.6 11.9 19.5 6 328 (324) 10 £m 142 223 365 112 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 18 Provisions for liabilities and charges Warranty and guarantees Contract loss Restructuring Customer financing Insurance Other Current liabilities Non-current liabilities Exchange differences £m 1 – – – – 1 2 Acquisitions of businesses £m 201 27 4 – – 48 280 Disposals of businesses £m (2) – 9 – – – 7 Unused amounts reversed £m (39) (13) (6) (11) (7) (11) (87) Charged to income statement £m 1501 24 17 23 31 48 293 At 1 January 2013 £m 247 54 4 82 47 27 461 220 241 Utilised £m (139)1 (25) (3) (21) (9) (26) (223) At 31 December 2013 £m 419 67 25 73 62 87 733 348 385 1 The amount of warranty and guarantee provision charged to the income statement and utilised by RRPS was £86m and £78m respectively. 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. In connection with the sale of its products the Group will, on some occasions, provide financing support for its customers – generally in respect of civil aircraft. The Group’s commitments relating to these financing arrangements are spread over many years, relate to a number of customers and a broad product portfolio and are generally secured on the asset subject to the financing. Customer financing provisions cover guarantees provided for asset value and/or financing. 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 Chief Financial Officer’s review on page 13. 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 2013 £m 2012 £m 29 38 5 1 – 73 30 43 8 – 1 82 Commitments on delivered aircraft in excess of the amounts provided are shown in the table below. These are reported on a discounted basis at the Group’s borrowing rate to reflect better the time span over which these exposures could arise. These amounts do not represent values that are expected to crystallise. The commitments are denominated in US dollars. As the Group does not generally adopt cash flow hedge accounting for future foreign exchange transactions, this amount is reported, together with the sterling equivalent at the reporting date spot rate. The estimated values of aircraft providing security are based on advice from a specialist aircraft appraiser. Gross commitments Value of security 1 Indemnities Net commitments Net commitments with security reduced by 20% 2 1 Security includes unrestricted cash collateral of: £m 356 (217) (80) 59 78 50 2013 $m 589 (360) (132) 97 129 83 £m 569 (381) (118) 70 133 64 2012 $m 925 (620) (191) 114 216 104 2 Although sensitivity calculations are complex, the reduction of relevant security by 20 per cent illustrates the sensitivity to changes in this assumption. There are also commitments 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. 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. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 113 19 Post-retirement benefits The Group operates a number of defined benefit and defined contribution schemes: (cid:337)(cid:3) UK defined benefit schemes are funded, with the assets held in separate trustee administered funds. Employees are entitled to retirement benefits based on either their final or career average salaries and length of service; and (cid:337)(cid:3) overseas defined benefit schemes are a mixture of funded and unfunded plans and provide benefits in line with local practice. 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, where relevant, updated by the scheme actuaries to 31 December 2013. The defined benefit schemes expose the Group to actuarial risks such as longevity, interest rate, inflation and investment risks. In the UK, and in the principal US pension schemes, the Group has adopted an investment policy to mitigate some of these risks. This involves investing a significant proportion of the scheme assets in liability driven investment (LDI) portfolios, which hold investments designed to offset interest rate and inflation rate risks. In addition, in the UK, the Rolls-Royce Pension Fund has invested in a longevity swap, which is designed to offset longevity risks in respect of existing pensioners. The Group has adopted amendments to IAS 19 Employee Benefits with effect from 1 January 2013. The impact is described further below. 2012 figures have been restated to put them on a comparable basis. Amounts recognised in the income statement Defined benefit schemes: Current service cost and administrative expenses Past-service cost Defined contribution schemes Operating cost Net financing (income)/charge in respect of defined benefit schemes Total income statement charge The operating cost is charged as follows: Cost of sales – included in underlying profit Commercial and administrative costs Research and development UK schemes £m 2013 Overseas schemes £m 153 66 219 30 249 (12) 237 55 5 60 44 104 38 142 UK schemes £m 2012 Overseas schemes £m 129 2 131 23 154 (17) 137 42 – 42 41 83 25 108 Total £m 208 71 279 74 353 26 379 Defined benefit Defined contribution Total 2013 £m 144 106 29 279 2012 £m 124 38 11 173 2013 £m 49 15 10 74 2012 £m 46 14 4 64 2013 £m 193 121 39 353 Total £m 171 2 173 64 237 8 245 2012 £m 170 52 15 237 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 £37 million (2012 £36 million) in the year. Net financing comprises: Financing on scheme obligations Financing on scheme assets Financing on unrecognised surpluses and minimum funding liability Net financing (income)/charge in respect of defined benefit schemes Financing income on scheme surpluses Financing costs on scheme deficits UK schemes £m 371 (431) 48 (12) (16) 4 2013 Overseas schemes £m 59 (21) – 38 (1) 39 Total £m 430 (452) 48 26 (17) 43 UK schemes £m 354 (444) 73 (17) (26) 9 2012 Overseas schemes £m 47 (22) – 25 – 25 Total £m 401 (466) 73 8 (26) 34 114 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 19 Post-retirement benefits (continued) Amounts recognised in OCI in respect of defined benefit schemes Actuarial gains and losses arising from demographic assumptions Actuarial gains and losses arising from financial assumptions Actuarial gains and losses arising from experience adjustments Return on scheme assets excluding financing income Movement in unrecognised surplus and related finance cost Movement in minimum funding liability and related finance cost UK schemes £m (87) (200) 65 (363) 407 133 (45) Amounts recognised in the balance sheet in respect of defined benefit schemes Present value of funded obligations Fair value of scheme assets Net asset/(liability) on funded schemes Present value of unfunded obligations Unrecognised surplus 1 Minimum funding liability 2 Net asset/(liability) recognised in the balance sheet Post-retirement scheme surpluses Post-retirement scheme deficits UK schemes £m (9,046) 9,776 730 – (488) (46) 196 242 (46) 2013 Overseas schemes £m (12) 116 31 (42) – – 93 2013 Overseas schemes £m (558) 504 (54) (935) – – (989) 6 (995) UK schemes £m (27) (639) 7 (155) 529 72 (213) UK schemes £m (8,569) 9,794 1,225 – (853) (173) 199 336 (137) 2012 Overseas schemes £m (1) (104) (13) 26 – – (92) 2012 Overseas schemes £m (609) 534 (75) (569) – – (644) 12 (656) Total £m (99) (84) 96 (405) 407 133 48 Total £m (9,604) 10,280 676 (935) (488) (46) (793) 248 (1,041) Total £m (28) (743) (6) (129) 529 72 (305) Total £m (9,178) 10,328 1,150 (569) (853) (173) (445) 348 (793) 1 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. 2 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. Overseas schemes are located in the following countries: Canada Germany US pension schemes US healthcare schemes Other Net asset/(liability) recognised in the balance sheet Assets £m 135 – 347 – 22 504 2013 Obligations £m (181) (500) (420) (352) (40) (1,493) Net £m (46) (500) (73) (352) (18) (989) Assets £m 139 – 369 – 26 534 2012 Obligations £m (200) (86) (449) (399) (44) (1,178) Defined benefit schemes Assumptions Significant actuarial assumptions for UK schemes (weighted average by size of the obligation) used at the balance sheet date were as follows: Discount rate Inflation assumption 1 Rate of increase in salaries Male life expectancy – current pensioner – future pensioner currently aged 45 2013 4.4% 3.5% 4.5% 22.5 24.2 Net £m (61) (86) (80) (399) (18) (644) 2012 4.4% 3.0% 4.1% 22.6 24.4 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. Discount rates are determined by reference to the market yields on AA rated corporate bonds. The rate is determined by using the profile of forecast benefit payments to derive a weighted average discount rate from the yield curve. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 115 19 Post-retirement benefits (continued) The inflation assumption is determined by the market implied assumption based on the yields on long-term indexed linked government securities and increases in salaries are based on actual experience, allowing for promotion, of the real increase above inflation. The mortality assumptions adopted for the UK pension schemes are derived from the SAP actuarial tables, with future improvements in line with the CMI 2013 core projections and long-term improvements of 1.25 per cent. Where appropriate, these are adjusted to take account of the relevant scheme’s actual experience. Other assumptions have been set on advice from the relevant actuary, having regard to the latest trends in scheme experience and the assumptions used in the most recent funding valuation. The rate of increase of pensions in payment is based on the rules of the relevant scheme, combined with the inflation assumption where the increase is capped. Assumptions for overseas schemes are less significant and are based on advice from local actuaries. The principal assumptions are the discount rate, 4.5 per cent (2012 3.9 per cent) and inflation, 2.3 per cent (2012 2.4 per cent). Changes in present value of defined benefit obligations At 1 January, as previously reported Effect of amendments to IAS 19 At 1 January, as restated Exchange differences Current service cost Past-service cost Finance cost Contributions by employees Benefits paid out Acquisition of businesses Actuarial (losses)/gains Settlement/curtailment Other movements At 31 December Funded schemes Unfunded schemes The defined benefit obligations are in respect of: Active plan participants Deferred plan participants Pensioners Weighted average duration of obligations Changes in fair value of scheme assets At 1 January Exchange differences Administrative expenses Financing Return on plan assets excluding financing Contributions by employer Contributions by employees Benefits paid out Acquisition of businesses Settlements/curtailment At 31 December Total return on scheme assets UK schemes £m 2013 Overseas schemes £m (8,569) – (147) (66) (371) (4) 334 (1) (222) – – (9,046) (9,046) – (3,492) (1,647) (3,907) 16 UK schemes £m 9,794 – (6) 431 (363) 249 4 (334) 1 – 9,776 68 (1,178) 16 (53) (4) (59) (4) 63 (402) 134 – (6) (1,493) (558) (935) (849) (74) (570) 13 2013 Overseas schemes £m 534 (19) (2) 21 (42) 66 4 (63) 5 – 504 (21) Total £m (9,747) 16 (200) (70) (430) (8) 397 (403) (88) – (6) (10,539) (9,604) (935) (4,341) (1,721) (4,477) 16 Total £m 10,328 (19) (8) 452 (405) 315 8 (397) 6 – 10,280 47 UK schemes £m (7,713) 17 (7,696) – (122) (2) (354) (4) 322 (54) (659) – (8,569) (8,569) – (3,129) (1,583) (3,857) UK schemes £m 9,519 – (7) 444 (155) 252 4 (322) 59 – 9,794 289 2012 Overseas schemes £m (1,052) (1) (1,053) 42 (40) – (47) (2) 38 – (118) 2 (1,178) (609) (569) Total £m (8,765) 16 (8,749) 42 (162) (2) (401) (6) 360 (54) (777) 2 (9,747) (9,178) (569) (915) (15) (248) (4,044) (1,598) (4,105) 2012 Overseas schemes £m 497 (18) (2) 22 26 47 2 (38) – (2) 534 48 Total £m 10,016 (18) (9) 466 (129) 299 6 (360) 59 (2) 10,328 337 116 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 19 Post-retirement benefits (continued) Fair value of scheme assets at 31 December Sovereign debt Derivatives on sovereign debt Corporate debt instruments Interest rate swaps Inflation swaps Cash and similar instruments Liability driven investment (LDI) portfolios 1 Longevity swap 2 Listed equities Unlisted equities Sovereign debt Corporate debt instruments Cash Other UK schemes £m 5,929 (987) 1,045 1,361 (13) 257 7,592 3 994 172 215 540 253 7 9,776 2013 Overseas schemes £m 231 2 190 – – 44 467 – 3 – 4 4 4 22 504 UK schemes £m 6,088 (1,225) 969 1,922 (289) 429 7,894 (126) 1,126 – 245 334 – 321 9,794 2012 Overseas schemes £m – – – – – – – – 119 – 313 74 – 28 534 Total £m 6,160 (985) 1,235 1,361 (13) 301 8,059 3 997 172 219 544 257 29 10,280 Total £m 6,088 (1,225) 969 1,922 (289) 429 7,894 (126) 1,245 – 558 408 – 349 10,328 1 A portfolio of gilt and swap contracts, backed by LIBOR generating assets, that is designed to hedge the majority of the interest rate and inflation risks associated with the schemes’ obligations. 2 Under the longevity swap, the Rolls-Royce Pension Fund (RRPF) has agreed an average life expectancy of pensioners with a counterparty. If pensioners live longer than expected the counterparty will make payments to the RRPF to offset the additional cost of paying pensioners. If the reverse applies the cost of paying pensioners will be reduced but the scheme will be required to make payments to the counterparty. Following the adoption of the amendments to IAS 19 and the interaction with IFRS 13 from 2013 the longevity swap has been valued on an external fair market basis, rather than using the same assumptions as used for the valuation of the scheme’s liabilities. As the surplus on the RRPF is restricted, this has had no impact on the net surplus/deficit recognised in the balance sheet. Had the longevity swap been valued on the same basis as 2012, its value would have been a liability of £156m, the movement since 2012 largely reflecting the changes in mortality and discount rate assumptions. The valuation is based on an estimate of the assumptions that a hypothetical third party would use for the future mortality and premium. The scheme assets do not include any of the Group’s own financial instruments, nor any property occupied by, or other assets used by, the Group. The longevity swap is valued by the scheme actuaries based on the difference between the agreed longevity assumptions at inception and actual longevity experience. All other fair values are provided by the fund managers. Where available, the fair values are quoted prices (eg listed equity, sovereign debt and corporate bonds). Unlisted investments (private equity) are included at values provided by the fund manager in accordance with relevant guidance. Other significant assets are valued based on observable inputs such as yield curves. Movements in unrecognised surplus and minimum liability At 1 January, as previously reported Effect of amendments to IAS 19 At 1 January, as restated Movements in unrecognised surplus through OCI Movements in minimum funding liability through OCI Related finance costs At 31 December UK schemes £m (1,026) 407 133 (48) (534) 2013 Overseas schemes £m – – – – – Total £m (1,026) 407 133 (48) (534) UK schemes £m (1,554) – (1,554) 529 72 (73) (1,026) 2012 Overseas schemes £m (94) 94 – – – – – Total £m (1,648) 94 (1,554) 529 72 (73) (1,026) Future contributions The Group expects to contribute approximately £325 million to its defined benefit schemes in 2014. In the UK, the funding is set on the basis of a triennial funding valuation by the actuaries for which the assumptions may differ from those above. In particular, the discount rate used to value the obligations takes account of the investment strategy, rather than being based on market yields of AA corporate bonds. As a result of these valuations, the Group and the scheme trustees agree a Schedule of Contributions (SoC), which sets out the required contributions from the employer and employees for current service. Where the scheme is in deficit, the SoC also includes required contributions from the employer to eliminate the deficit. The most recent agreed triennial valuations for the principal schemes are: Rolls-Royce Pension Fund Rolls-Royce Group Pension Scheme Vickers Group Pension Scheme Obligations at 31 December 2013 £m 6,543 1,540 637 Valuation date 31 March 2012 5 April 2013 31 March 2013 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 117 19 Post-retirement benefits (continued) Sensitivities The calculations of the defined benefit obligations are sensitive to the assumptions set out on page 114. The following table summarises the estimated impact of a change in the assumption on the UK defined benefit obligation at 31 December 2013, while holding all other assumptions constant. This sensitivity analysis may not be representative of the actual change in the defined benefit obligation as it is unlikely that the change in assumptions would occur in isolation of one another as some of the assumptions may be correlated. For the most significant funded schemes, the investment strategies are designed to hedge the risks from interest rates, inflation on an economic basis and in the Rolls-Royce Pension Fund in the UK, the longevity of pensioners. Where appropriate, the table also includes the corresponding movement in the value of the plan assets. Reduction in the discount rate of 0.25% 1 Increase in inflation of 0.25% Increase in real increase in salaries of 0.25% One year increase in life expectancy Obligations Plan assets (LDI portfolio) Obligations Plan assets (LDI portfolio) Obligations Obligations Plan assets (longevity swap) £m (412) 465 (201) 185 (88) (212) 86 1 The difference arises largely due to differences in the methods used to value the obligations for accounting and economic purposes. On an economic basis the correlation is approximately 97 per cent. Amendments to IAS 19 Prior period figures have been restated to reflect the adoption of the amendments to IAS 19. Consequential tax effects have been reflected in deferred tax. At 1 January 2012 Exchange adjustments Current service cost and administrative expenses Past-service cost Net financing Contributions by employer Acquisition of business Actuarial losses Return on plan assets excluding financing Movement in unrecognised surplus Movement on minimum funding liability At 31 December 2012 Post-retirement scheme surpluses Post-retirement scheme deficits Notes A B A C C C C C As previously reported UK £m 252 – (123) (2) (41) 250 5 (659) (30) 465 63 180 317 (137) Overseas £m (649) 24 (38) 12 (23) 47 – (118) 20 – – (725) 12 (737) Total £m (397) 24 (161) 10 (64) 297 5 (777) (10) 465 63 (545) 329 (874) Amendments Overseas £m 93 – (4) (12) (2) – – – 6 – – 81 UK £m 17 – (6) – 58 2 – – (125) 64 9 19 Total £m 110 – (10) (12) 56 2 – – (119) 64 9 100 As restated Overseas £m (556) 24 (42) – (25) 47 – (118) 26 – – (644) 12 (656) UK £m 269 – (129) (2) 17 252 5 (659) (155) 529 72 199 336 (137) Total £m (287) 24 (171) (2) (8) 299 5 (777) (129) 529 72 (445) 348 (793) A An unrecognised past-service credit related to the restructuring of certain overseas healthcare schemes in 2011. This has now been recognised in full at 1 January 2012. As a consequence, the amortisation of this past-service credit in 2012 is eliminated. In addition, an adjustment has been made in the calculation of the defined benefit obligation on one of the UK schemes to put it on a consistent basis with the other schemes. B Previously all administrative costs were offset against the expected return on scheme assets. The amendments only allow this in respect of the costs of managing scheme assets; other administrative expenses are now included in the current service cost. C Previously net financing comprised the actual expected return on scheme assets based on the underlying assets and a financing charge on scheme liabilities calculated using a ‘AA’ corporate bond rate. The amendments require net financing to be calculated on the net asset or liability recognised on the balance sheet using an AA corporate bond rate. This has a consequential impact on amounts recognised in OCI: (i) the change in assumed return on scheme assets affects the related actuarial gains or losses; and (ii) implicit financing on movements in the unrecognised surplus and the minimum funding liability is not included in the income statement. 118 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 20 Share capital Issued and fully paid At 1 January 2012 Proceeds from shares issued for share option schemes At 31 December 2012 Proceeds from shares issued for share option schemes At 31 December 2013 Non-equity Equity Special Share of £1 Nominal value £m 1 1 1 – – – Ordinary shares of 20p each Millions 1,872 – 1,872 8 1,880 Nominal value £m 374 – 374 2 376 The rights attaching to each class of share are set out on page 70. During 2013, the Group also received £30 million from participants in ShareSave schemes. Shares to satisfy these options were issued from those already held by the Group for this purpose, as described on page 79. In accordance with IAS 32 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 17. 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 A description of the share-based payment plans is included in the remuneration report on pages 57 to 58. Movements in the Group’s share-based payment plans during the year 2013 £m 61 18 79 19 2012 £m 49 6 55 18 Outstanding at 1 January 2012 Granted Additional entitlements arising from TSR performance Forfeited Exercised Outstanding at 1 January 2013 Granted Additional entitlements arising from TSR performance Additional shares accrued from reinvestment of C Shares Forfeited Exercised Outstanding at 31 December 2013 Exercisable at 31 December 2013 Exercisable at 31 December 2012 ShareSave ESOP PSP APRA Weighted average exercise price Pence 447 – – 446 409 447 961 – – 483 404 660 – – Number Millions 27.5 – – (0.6) (0.1) 26.8 10.0 – – (0.6) (10.2) 16.0 – – Weighted average exercise price Pence 100 – – – 103 77 – – – – 77 – – 77 Number Millions 0.5 – – – (0.4) 0.1 – – – – (0.1) – – 0.1 Number Millions 19.5 4.3 2.8 (0.8) (11.8) 14.0 2.8 0.6 – (0.6) (4.8) 12.0 – – Number Millions 3.3 2.0 – (0.1) (1.2) 4.0 1.6 – 0.1 (0.1) (2.5) 3.1 – – As share options are exercised throughout the year, the weighted average share price during the year of 1123 pence (2012 836 pence) is representative of the weighted average share price at the date of exercise. The closing price at 31 December 2013 was 1275 pence (2012 873.5 pence). There were no exercisable options as at 31 December 2013. The average remaining contractual life of the exercisable options as at 31 December 2012 was 0.2 years. Rolls-Royce Holdings plc annual report 2013 119 21 Share-based payments (continued) 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 – three year grant ShareSave – five year grant APRA 2013 1128p 1254p 287p 349p 1027p 2012 885p 985p n/a n/a 809p 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. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 22 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 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 2013 £m 134 55 179 545 507 1,231 2013 £m 56 19 48 23 90 2012 £m 94 34 147 490 526 1,163 2012 £m 30 2 7 1 10 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. (cid:337)(cid:3) Sublease payments of £1 million (2012 £4 million) and sublease receipts of £27 million (2012 £17 million) were recognised in the income statement in the year. (cid:337)(cid:3) Purchase options exist on aero engines, land and buildings and plant and equipment with the period to the purchase option date varying from one to eight years. (cid:337)(cid:3) Renewal options exist on aero engines, land and buildings and plant and equipment with the period to the renewal option varying between one to 28 years at terms to be negotiated upon renewal. (cid:337)(cid:3) Escalation clauses exist on some leases and are linked to LIBOR. (cid:337)(cid:3) The total future minimum sublease payments expected to be made is £8 million (2012 £10 million) and sublease receipts expected to be received is £42 million (2012 £9 million). 120 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 23 Contingent liabilities On 6 December 2012, the Company announced that it had passed information to the SFO relating to concerns in overseas markets. Since that date the Company has continued its investigations and is engaging with the SFO and other authorities in the UK, the USA and elsewhere. In December 2013, the Company announced that it had been informed by the SFO that it had commenced a formal investigation. The consequence of these disclosures will be decided by the regulatory authorities. It remains too early to predict the outcomes, but these could include the prosecution of individuals and of the Group. Accordingly, the potential for fines, penalties or other consequences (including debarment from government contracts, suspension of export privileges and reputational damage) cannot currently be assessed. As the investigation is ongoing, it is not yet possible to identify the timescale in which these issues might be resolved. 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 £13 million (2012 £48 million). Contingent liabilities in respect of customer financing commitments are described in note 18. 24 Related party transactions Sales of goods and services to joint ventures and associates Purchases of goods and services from joint ventures and associates Operating lease payments to joint ventures and associates Guarantees of joint ventures’ and associates’ borrowings Dividends received from joint ventures and associates RRSA receipts from joint ventures and associates Other income received from joint ventures and associates 2013 £m 3,149 (3,269) (69) 7 99 4 1 2012 £m 2,937 (3,082) (57) 12 129 13 2 The aggregated balances with joint ventures are shown in notes 13 and 16. Transactions with Group pension schemes are shown in note 19. In the course of normal operations, related party transactions entered into by the Group have been contracted on an arms-length basis. Key management personnel are deemed to be the directors and the members of the ELT as set out on page 38. Remuneration for key management personnel is shown below: Salaries and short-term benefits Post-retirement schemes Share-based payments 2013 £m 11 1 7 19 2012 £m 15 1 8 24 More detailed information regarding the directors’ remuneration, shareholdings, pension entitlements, share options and other long-term incentive plans is shown in the remuneration report on pages 53 to 69. Rolls-Royce Holdings plc annual report 2013 121 25 Acquisitions and disposals Acquisitions Rolls-Royce Power Systems AG (RRPS – formerly Tognum AG) From 25 August 2011 to 31 December 2012 the Group’s interest in RRPS was classified as a joint venture and equity accounted. On 1 January 2013, conditions were fulfilled which gave the Group certain rights that result in RRPS being classified as a subsidiary and consolidated. Accordingly, the Group’s joint venture interest in Rolls-Royce Power Systems Holding GmbH (RRPSH) has been reclassified as a subsidiary. The fair values of the identifiable assets and liabilities assumed are £1,339 million, giving rise to goodwill of £773 million, as set out in the table below. Rolls-Royce and Daimler AG (Daimler) each hold 50 per cent of the shares of RRPSH, which itself held over 99 per cent of the shares of RRPS. During 2013, RRPSH acquired the remaining 1 per cent of shares of RRPS. RRPS is a premium supplier of engines, propulsion systems and components for marine, energy, defence, and other industrial applications (often described as ‘off- highway’ applications). Other On 30 April 2013, the Group acquired 100 per cent of the issued share capital of Hyper-Therm High-Temperature Composites, Inc., a producer of state-of-the-art composite materials, including ceramic matrix composites, engineered coatings and thermal-structural components.  On 15 August 2013, the Group acquired 100 per cent of SmartMotor AS, a leading specialist in the development of permanent magnet technology. On 24 December 2013, the Group acquired the remaining 49 per cent of shares not held in Composite Technology and Applications Limited, a business engaged in the development of composite fan blades and containment cases for the next generation of advanced turbofan engines. For each of the other acquisitions noted, the acquisition cost (net of cash and borrowings acquired) has been allocated to identifiable assets and liabilities – principally technology, patents and licences, customer relationships, trademark, order backlog and other intangible assets. Recognised amounts of identifiable assets acquired and liabilities assumed S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Intangible assets Property, plant and equipment Investments in joint ventures, associates and other unlisted investments Inventory Trade and other receivables Taxation recoverable Cash and cash equivalents Trade and other payables Current tax payables Borrowings Other financial assets and liabilities Deferred tax Provisions Post-retirement schemes Total identifiable assets and liabilities Goodwill arising Total consideration Exercise price of put option on NCI Consideration satisfied by: Cash consideration Existing shareholding NCI RRPS £m 1,192 545 50 737 487 48 240 (693) (77) (203) (27) (283) (280) (397) 1,339 773 2,112 (1,432) 680 – 1,443 669 2,112 Other £m 35 1 – – 2 – 5 (3) – (1) – 1 – – 40 – 40 – 40 37 3 – 40 Total £m 1,227 546 50 737 489 48 245 (696) (77) (204) (27) (282) (280) (397) 1,379 773 2,152 (1,432) 720 37 1,446 669 2,152 122 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 25 Acquisitions and disposals (continued) Net cash outflow arising on acquisition: Cash consideration Less: cash and cash equivalents acquired Cash (inflow)/outflow per cash flow statement Identifiable intangible assets comprise: Technology, patents and licences Customer relationships Trademark Order backlog In-process development Other RRPS £m – (240) (240) 420 433 105 94 53 87 1,192 Other £m 37 (5) 32 35 – – – – – 35 Total £m 37 (245) (208) 455 433 105 94 53 87 1,227 In accordance with the provisions of IFRS 3 Business Combinations, the Group has opted not to recognise goodwill in respect of the non- controlling interest in RRPS. The previous joint venture investment holding in RRPSH of £1,328 million was revalued, giving rise to a gain of £115 million. As part of the RRPSH shareholders’ agreement, Daimler AG has the option to sell its shares in RRPSH to Rolls-Royce for a period of six years from 1 January 2013. The initial fair value of the exercise price of this option in respect of RRPS has been recognised as a liability (£1,432 million), which has been charged to NCI and retained earnings. The goodwill arising on the acquisition of RRPS amounting to £773 million (which is not tax deductible) consists of anticipated synergies and the assembled workforce. The anticipated synergies principally arise from: (cid:337)(cid:3) increases in revenue from the combination of the routes to market; and (cid:337)(cid:3) cost savings from the combination of the supply chain and central functions. The gross contractual value of trade receivables acquired is £446 million. At the acquisition date, it was estimated that contractual cash flows of £24 million would not be collected. The acquisition of the controlling interest in RRPS contributed £2,593 million of revenue and profit before tax of £10 million (including amortisation of intangible assets arising on acquisition) to the Group’s results for the year. Disposals On 29 January 2013, Alstom acquired Tidal Generation Limited. On 2 September 2013, Turbomeca (a Safran company) acquired the Group’s 50 per cent shareholding and interest in the RTM322 helicopter engine programme for which it has received a cash consideration of €293 million. Rolls-Royce will progressively transfer its operational responsibilities in the engine programme to Turbomeca over a multi-year period. Assets and liabilities disposed Intangible assets – goodwill Investment in joint venture Cash and cash equivalents Trade and other payables Provisions for liabilities and charges Net assets Profit on disposal of businesses Disposal costs Proceeds deferred in respect of transitional services and retained obligations Disposal proceeds Cash and cash equivalents disposed Cash inflow per cash flow statement RTM322 £m – 2 – – (2) – 194 3 53 250 – 250 Tidal Generation £m 3 – 2 (2) – 3 22 – – 25 (2) 23 Total £m 3 2 2 (2) (2) 3 216 3 53 275 (2) 273 Rolls-Royce Holdings plc annual report 2013 123 25 Acquisitions and disposals (continued) During 2012, the Group acquired: (cid:337)(cid:3) on 19 June 2012, Superstructure Capital Limited, a business engaged in marketing and sale of safety and risk management software to the aerospace industry; (cid:337)(cid:3) on 13 July 2012, PFW Aerospace UK, a business engaged in the manufacture of precision components for the aerospace industry; (cid:337)(cid:3) on 13 December 2012, Rolls-Royce Goodrich Engine Control Systems Limited (acquisition of 50 per cent not already held), a business engaged in the development and manufacture of aero-engine controls; and (cid:337)(cid:3) 27 December 2012, PKMJ Technical Services, Inc., a nuclear engineering services business in the US. and disposed of: (cid:337)(cid:3) on 27 June 2012, Rolls-Royce Fuel Cell Systems Inc. (dilution of existing shareholding to 49 per cent); and (cid:337)(cid:3) on 29 June 2012, for US$1.5 billion, the equity, programme share and related goodwill of IAE International Aero Engines AG, which gave rise to a profit before tax of £699 million. 26 Segmental analysis from 1 January 2014 As described in the Chief Financial Officer’s review on page 13, the management structure of the business has been revised and the internal reporting structure has been developed to reflect this. These changes will be reflected in the segmental analysis with effect from 1 January 2014. Had they been in place during 2013, the segmental analysis shown in note 2 would be as follows: Aerospace MIPS Civil £m Defence £m Total £m Marine £m Power Systems £m Nuclear & Energy £m Intra- segment £m Inter- segment £m Total £m Total reportable segments £m Year ended 31 December 2013 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 Underlying profit before financing and taxation 3,035 3,620 6,655 1,385 1,206 2,591 708 136 844 424 14 438 4,420 4,826 9,246 1,132 150 1,282 1,236 801 2,037 2,004 827 2,831 617 921 1,538 (72) (75) (147) 3,785 2,474 6,259 233 – 233 296 (2) 294 63 11 74 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 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, amortisation and impairment 9,587 495 (6,243) 3,839 1,437 11,024 512 (7,903) 3,633 17 (1,660) (206) 1,701 5 (985) 721 3,927 29 (3,034) 922 1,616 55 (1,015) 656 891 349 103 53 994 402 23 63 142 272 80 63 – – – – – – 8,205 7,300 15,505 1,726 159 1,885 (734) 17,524 601 (12,204) 5,921 – 733 (1) 1,239 800 2 – 2 (10) – – (10) – – 594 9 603 7,234 89 (5,034) 2,289 245 398 124 Financial statements Rolls-Royce Holdings plc annual report 2013 COMPANY BALANCE SHEET At 31 December 2013 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 liabilities Total assets less current liabilities Capital and reserves Called-up share capital Share premium account Merger reserve Capital redemption reserve Other reserve Profit and loss account Equity shareholders’ funds Notes 2013 £m 2012 £m 2 3 4 5 5 5 5 5 12,000 11,954 (16) (995) (1,011) 10,989 376 80 8,203 857 109 1,364 10,989 (10) (595) (605) 11,349 374 – 8,569 497 63 1,846 11,349 The financial statements on pages 124 to 126 were approved by the Board on 12 February 2014 and signed on its behalf by: Ian Davis Chairman Mark Morris Chief Financial Officer Company’s registered number: 7524813 RECONCILIATION OF MOVEMENTS IN SHAREHOLDERS’ FUNDS For the year ended 31 December 2013 At 1 January 2013 Profit for the year Arising on issue of ordinary shares Issue of C Shares Share-based payments – direct to equity At 31 December 2013 £m 11,349 (1) 82 (366) (75) 10,989 Rolls-Royce Holdings plc annual report 2013 125 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 remuneration report on pages 53 to 69, 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. 2 Investments – subsidiary undertakings Cost: At 1 January 2013 Cost of share-based payments in respect of employees of subsidiary undertakings less receipts from subsidiaries in respect of those payments At 31 December 2013 3 Financial liabilities C Shares Movements in C Shares during the year were as follows: Issued and fully paid At 1 January 2013 Shares issued Shares redeemed At 31 December 2013 The rights attaching to C Shares are set out on page 70. £m 11,954 46 12,000 C Shares of 0.1p Millions Nominal value £m 10,418 366,041 (360,173) 16,286 10 366 (360) 16 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n 126 Financial statements Rolls-Royce Holdings plc annual report 2013 NOTES TO THE COMPANY FINANCIAL STATEMENTS 4 Share capital Issued and fully paid At 1 January 2013 Proceeds from shares issued for share options schemes At 31 December 2013 Non-equity Equity Special Share of £1 Preference shares of £1 each Nominal value £m 1 – 1 – – – – – – Ordinary shares of 20p each Millions 1,872 8 1,880 Nominal value £m 374 2 376 The rights attaching to each class of share are set out on page 70. 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 At 1 January 2013 Profit for the year Proceeds from shares issued for share option schemes Shares issued to share trust Issue of C Shares Redemption of C Shares Share-based payments – direct to equity At 31 December 2013 Non-distributable reserves Share capital £m 374 – – 2 – – – 376 Share premium – – – 80 – – – 80 Merger reserve £m 8,569 – – – (366) – – 8,203 Capital redemption reserve £m 497 – – – – 360 – 857 Other reserve1 £m 63 – – – – – 46 109 Profit and loss account £m 1,846 (1) – – – (360) (121) 1,364 Total £m 11,349 (1) – 82 (366) – (75) 10,989 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. 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 31 December 2013, these guarantees amounted to £1 billion (2012 £nil). 7 Other information Emoluments of directors The remuneration of the directors of the Company is shown in the directors’ remuneration report on pages 62 to 69. Employees The Company had no employees in 2013. 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. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 127 SUBSIDIARIES, JOINTLY CONTROLLED ENTITIES AND ASSOCIATES At 31 December 2013 Subsidiaries incorporated within the UK – directly held Rolls-Royce Group plc Holding company Subsidiaries incorporated within the UK – indirectly held Composite Technology and Applications Limited MTU UK Limited Optimized Systems and Solutions Limited Rolls-Royce Controls and Data Services Limited Rolls-Royce International Limited Rolls-Royce Leasing Limited Rolls-Royce Marine Electrical Systems Limited Rolls-Royce Marine Power Operations Limited Rolls-Royce plc Rolls-Royce Power Development Limited Rolls-Royce Power Engineering plc Rolls-Royce Total Care Services Limited Vinters Engineering Limited Development of aero engine fan blades and fan cases Sales and service of off-highway diesel engines (50%) Equipment health management and advanced data management services Development and manufacture of aero engine controls International support and commercial information services Engine leasing Marine electrical systems Nuclear submarine propulsion systems Principal trading company Generation of electricity from independent power projects Energy and marine systems Aero engine aftermarket support services Production, repair and overhaul of power generation, transmission and conversion equipment for military and commercial activities The above companies operate principally in the UK and the effective Group interest is 100 per cent unless otherwise stated. Subsidiaries incorporated overseas – indirectly held Brazil Rolls-Royce Brasil Limitada Canada China China Finland France France Germany Germany Germany Germany Germany 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 Rolls-Royce Canada Limited MTU Engineering (Suzhou) Company Limited Service centre and spare parts (50%) Rolls-Royce Marine Manufacturing (Shanghai) Limited Rolls-Royce OY AB Rolls-Royce Civil Nuclear SAS Rolls-Royce Technical Support SARL L’Orange GmbH MTU Friedrichshafen GmbH MTU Onsite Energy GmbH Rolls-Royce Deutschland Ltd & Co KG Rolls-Royce Power Systems AG Manufacture and supply of marine equipment and marine aftermarket support services Manufacture of marine winches and propeller systems Instrumentation and control systems and life-cycle management for nuclear power plants Aero engine project support Development and production of high-pressure injection systems for diesel engines (50%) Development, production and distribution of gas turbines and engines (50%) Sales and service of gas engines (50%) Aero engine design, development and manufacture Supplier of engines and power trains for marine propulsion, distributed power generation and industrial off-highway sectors (50%) Insurance services Distributor for off-highway products and after-sales service (50%) Diesel engine project management and customer support Provision of marine support services Nightingale Insurance Limited Rolls-Royce India Private Limited Rolls-Royce Marine India Private Limited Rolls-Royce Operations (India) Private Limited Engineering support services Europea Microfusioni Aerospaziali S.p.A. MTU Italia S.r.l Manufacture of gas turbine engine castings Distributor for all off-highway applications and after-sales service (50%) Sales and after-sales support for diesel engines (50%) Design and manufacture of ship equipment Design and manufacture of medium-speed diesel engines (50%) Aero engine parts manufacturing and engine assembly, energy and marine aftermarket support services Distributor of diesel engines and spare parts (50%) Sales and service of transmission equipment with diesel and gas engines (50%) Manufacture of marine propeller systems Production of diesel engines and manufacturer of control systems (50%) Guernsey Hong Kong MTU Hong Kong Limited India India India Italy Italy Netherlands MTU Benelux B.V. Norway Norway Singapore Rolls-Royce Marine AS Bergen Engines AS Rolls-Royce Singapore Pte. Limited Singapore Spain Sweden Turkey Tognum Asia Pte. Limited MTU Ibérica Propulsión y Energía S.L. Rolls-Royce AB MTU Motor Türbin Sanayi ve Tic. A.S. 128 Other information Rolls-Royce Holdings plc annual report 2013 SUBSIDIARIES, JOINTLY CONTROLLED ENTITIES AND ASSOCIATES Subsidiaries incorporated overseas – indirectly held (continued) US US US US US US US US US US US US Data Systems & Solutions LLC Optimized Systems and Solutions Inc. PKMJ Technical Services, Inc. R. Brooks Associates 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 High Temperature Composites Inc. Production of state-of-the-art composite materials Rolls-Royce Marine North America Inc. MTU America Inc. Instrumentation and control systems and life-cycle management for nuclear power plants Equipment health management and advanced data management services Nuclear engineering services and software solutions Specialist civil nuclear reactor 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 and marine aftermarket support services Sales and service of engines and systems (50%) The companies above and on page 127 operate principally in the country of their incorporation and the effective Group interest is 100 per cent unless otherwise stated. Jointly controlled entities and associates 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 Genistics Holdings Limited Trailer-mounted field mobile generator sets Rolls-Royce Snecma Limited (UK & France) 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 and Italy) RB199 engine collaboration The above companies are incorporated and operate in the UK unless otherwise stated. Class Ordinary Ordinary A Ordinary B Ordinary A Ordinary B Ordinary A Shares B Shares A Ordinary B Ordinary A Ordinary B Ordinary A Ordinary B Ordinary Ordinary A Shares % of class held 20 % of equity held 20 22 100 – 100 – – 100 100 – – 100 – 100 40 37.5 22 50 50 50 50 49.5 50 40 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 129 Jointly controlled entities and associates incorporated overseas – indirectly held Australia China China Germany Germany Germany Germany Germany Hong Kong India Israel Malaysia Singapore Singapore Spain US US US US MTU Detroit Diesel Australia Pty. Limited (effective interest 25%) Sales and servicing of diesel engines Xian XR Aero Components Co Limited Manufacturing facility for aero engine parts Shanxi North MTU Diesel Co. Ltd (effective interest 24.5%) Manufacture and sale of MTU engines 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 MTU Onsite Energy Systems GmbH (effective interest 37.5%) Manufacturing and distribution of diesel-powered generating sets N3 Engine Overhaul Services GmbH & Co KG Aero engine repair and overhaul Hong Kong Aero Engine Services Limited 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 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 LG Fuel Cell Systems Inc. Development of fuel cells Texas Aero Engine Services, LLC Aero engine repair and overhaul Class Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary A Ordinary B Ordinary Ordinary Ordinary Ordinary Ordinary Partnerships Partnership Common Stock Partnership % of class held 50 % of equity held 50 49 49 28 33 33.3 75.1 50 45 50 50 50 49 50 30 46.9 50 18.5 39.9 50 49 49 28 33 33.3 75.1 50 45 50 50 49 50 30 46.9 – – 39.9 – Unincorporated overseas – indirectly held US Light Helicopter Turbine Engine Company (LHTEC) Rolls-Royce Corporation has a 50% 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 127 to 129 is of those 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. 130 Other information Rolls-Royce Holdings plc annual report 2013 INDEPENDENT AUDITOR’S REPORT to the members of Rolls-Royce Holdings plc only Opinions and conclusions arising from our audit 1 Our opinion on the financial statements is unmodified We have audited the financial statements of Rolls-Royce Holdings plc for the year ended 31 December 2013 set out on pages 75 to 129. In our opinion: The measurement of revenue and profit in the Civil aerospace business Refer to page 81 (Key areas of judgement – Long-term aftermarket contracts), page 83 (Significant accounting policies – Revenue recognition) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) 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 31 December 2013 and of the Group’s profit for the year then ended; (cid:337)(cid:3) the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union (Adopted IFRS); (cid:337)(cid:3) the parent company financial statements have been properly prepared in accordance with UK Accounting Standards; and (cid:337)(cid:3) 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. 2 Our assessment of risks In arriving at our opinions set out in this report, the risks that had the greatest effect on our audit and the key procedures we applied to address them are set out below. Those procedures were designed in the context of the financial statements as a whole and, consequently, where we set out findings we do not express any opinion on these individual risks. The basis of accounting for revenue and profit in the Civil aerospace business Refer to page 81 (Key areas of judgement – Long-term aftermarket contracts), page 83 (Significant accounting policies – Revenue recognition) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) The risk The amount of revenue and profit recognised in a year on the sale of engines and aftermarket services is dependent, inter alia, on the appropriate assessment of whether or not each long-term aftermarket contract for services is linked to or separate from the contract for sale of the related engines. As the commercial arrangements can be complex, significant judgement is applied in selecting the accounting basis in each case. The most significant risk is that the Group might inappropriately account for sales of engines and long term service agreements as a single arrangement for accounting purposes as this would usually lead to revenue and profit being recognised too early because the margin in the long term service agreement is usually higher than the margin in the engine sale agreement. (cid:337)(cid:3) Our response We made our own independent assessment, with reference to the relevant accounting standards, of the accounting basis that should be applied to each long-term aftermarket contract entered into during the year and compared this to the accounting basis applied by the Group. (cid:337)(cid:3) Our findings We found that the Group has developed a framework for selecting the accounting basis to be used which is consistent with accounting standards and has applied this consistently. For almost all the agreements entered into during this year, it was clear which accounting basis should apply. Where there was room for interpretation, we found the Group’s judgement to have been balanced. (cid:337)(cid:3) The risk The amount of revenue and profit recognised in a year on the sale of engines and aftermarket services is dependent, inter alia, on the assessment of the percentage of completion of long-term aftermarket contracts and the forecast cost profile of each arrangement. As long-term aftermarket contracts can extend over significant periods and the profitability of these arrangements typically assumes significant life-cycle cost improvement over the term of the contracts, the estimated outturn requires significant judgement to be applied in assessing engine flying hours, time on wing and other operating parameters, the pattern of future maintenance activity and the costs to be incurred. The inherent nature of these estimates means that their continual refinement can have an impact on the profits of the Civil aerospace business that can be significant in an individual financial year. The assessment of the estimated outturn for each arrangement involves detailed calculations using large and complex databases with a significant level of manual intervention. (cid:337)(cid:3) Our response We tested the controls designed and applied by the Group to provide assurance that the estimates used in assessing revenue and cost profiles are appropriate and that the resulting estimated cumulative profit on such contracts is accurately reflected in the financial statements; these controls operated over both the inputs and the outputs of the calculations. We challenged the appropriateness of these estimates for each programme and assessed whether or not the estimates showed any evidence of management bias. Our challenge was based on our assessment of the historical accuracy of the Group’s estimates in previous periods, identification and analysis of changes in assumptions from prior periods and an assessment of the consistency of assumptions across programmes, detailed discussions and assessments of the achievability of the Group’s plans to reduce life-cycle costs and an analysis of the impact of these plans on forecast cost profiles taking account of contingencies and analysis of the impact of known technical issues on cost forecasts. Our analysis considered each significant airframe that is powered by the Group’s engines and was based on our own experience supplemented by discussions with an aircraft valuation specialist engaged by the Group. We assessed whether the valuer was objective and suitably qualified. We also checked the mathematical accuracy of the revenue and profit for each arrangement and considered the implications of identified errors and changes in estimates. (cid:337)(cid:3) Our findings Our testing identified weaknesses in the design and operation of controls. In response to this we assessed the effectiveness of the Group’s plans for addressing these weaknesses and we increased the scope and depth of our detailed testing and analysis from that originally planned. We found no significant errors in calculation. Overall, our assessment is that the assumptions and resulting estimates (including appropriate contingencies) resulted in mildly cautious profit recognition. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 131 Recoverability of intangible assets (certification costs and participation fees, development expenditure and recoverable engine costs) and amounts recoverable on contracts primarily in the Civil aerospace business Refer to page 82 (Key sources of estimation uncertainty – Forecasts and discount rates), pages 86 and 87 (Significant accounting policies – Certification costs and participation fees, Research and development, Recoverable engine costs and Impairment of non-current assets), page 99 (Note 9 to the financial statements – Intangible assets) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) The risk The recovery of these assets depends on a combination of achieving sufficiently profitable business in the future as well as the ability of customers to pay amounts due under contracts often over a long period of time. Assets relating to a particular engine programme are more prone to the risk of impairment in the early years of a programme as the engine’s market position is established. In addition, the pricing of business with launch customers makes assets relating to these engines more prone to the risk of impairment. (cid:337)(cid:3) Our response We tested the controls designed and applied by the Group to provide assurance that the assumptions are regularly updated, that changes are monitored, scrutinised and approved by appropriate personnel and that the final assumptions used in impairment testing have been appropriately approved. We challenged the appropriateness of the key assumptions in the impairment test (including market size, market share, pricing, engine and aftermarket unit costs, individual programme assumptions, price and cost escalation, discount rate and exchange rates ) focusing particularly on those assets with a higher risk of impairment (those relating to the Trent 900 programme and launch customers on the Trent 900 and 1000 programmes). Our challenge was based on our assessment of the historical accuracy of the Group’s estimates in previous periods, our understanding of the commercial prospects of key engine programmes, identification and analysis of changes in assumptions from prior periods and an assessment of the consistency of assumptions across programmes and customers and comparison of assumptions with publicly available data where this was available. We considered the appropriateness of the related disclosures in note 9 to the financial statements. (cid:337)(cid:3) Our findings Our testing did not identify any deviation in the operation of controls which would have required us to amend the nature or scope of our planned detailed test work. We found that the assumptions and resulting estimates were balanced and that the disclosures in note 9 appropriately describe the inherent degree of subjectivity in the estimates and the potential impact on future periods of revisions to these estimates. We found no errors in calculations. Accounting for the consolidation of Rolls-Royce Power Systems Holding GmbH and valuation of Daimler AG’s put option Refer to page 81 (Key areas of judgement – Rolls-Royce Power Systems Holding GmbH), page 82 (Key sources of estimation uncertainty – Intangible assets arising on consolidation of Rolls-Royce Power Systems AG and put option on Rolls-Royce Power Systems Holding GmbH), page 83 (Accounting policies – Basis of consolidation) and page 44 (Audit committee report – Financial reporting) Control of Rolls-Royce Power Systems Holding GmbH (cid:337)(cid:3) The risk Rolls-Royce Power Systems Holding GmbH (a special purpose vehicle owned equally by the Group and Daimler AG (RRPSH)) acquired a controlling interest in Rolls-Royce Power Systems AG (RRPS) on 25 August 2011. From that date, the Group equity accounted for its joint venture interest in RRPSH as control was shared with Daimler AG. On 1 January 2013, conditions were fulfilled which the Group considered gave it control over RRPSH and from that date the Group’s 50 per cent interest has been classified as a subsidiary and RRPSH has been consolidated in the Group financial statements. Assessing whether or not the Group controls RRPSH is a critical accounting judgement. The rights of the Group and Daimler AG are encapsulated in shareholder agreements and assessing whether the Group’s rights are sufficient to give it control over RRPSH requires detailed consideration of the relevant provisions and a commercial assessment as to which rights are most important. (cid:337)(cid:3) Our response We analysed the shareholder agreements with particular reference to rights relating to key matters including the existence of a casting vote in respect of key matters described on page 81 at the shareholders meeting and Shareholders’ Committee of RRPSH. (cid:337)(cid:3) Our findings We found that the terms of the agreements provide the Group with the power to establish key operating and capital decisions of RRPSH and to appoint, remove and set the remuneration of key management personnel. The agreements also provide Daimler AG with rights (in particular over matters that would significantly change the scale, scope and financing of RRPSH’s business, certain significant supplier relationships and changes to contractual arrangements between RRPSH with Rolls-Royce) which we have determined provide protection to Daimler AG over its interest in RRPSH but are not sufficient to prevent the Group from controlling RRPSH. On that basis, we consider that it is appropriate that RRPSH (and hence RRPS) has been consolidated from 1 January 2013. 132 Other information Rolls-Royce Holdings plc annual report 2013 Liabilities arising from sales financing arrangements Refer to page 82 (Key areas of judgement – financing support), page 88 (Significant accounting policies – Sales financing support, page 112 (Note 18 to the financial statements – Provisions for liabilities and charges) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) The risk The Group has contingent liabilities in respect of financing and asset value support provided to customers. This support typically takes the form of either a guarantee with respect to the value of an aircraft at a future date or a guarantee of a customer’s future payments under an aircraft financing arrangement. Judgement is required to assess the likelihood of these liabilities crystallising, in order to assess whether a provision should be recognised and if so the amount of that provision. The total potential liability is significant and can be affected by the assessment of the residual value of the aircraft and the creditworthiness of the customers. (cid:337)(cid:3) Our response We analysed the terms of guarantees on aircraft delivered during the year in detail and obtained aircraft values from and held discussions with aircraft valuation specialists engaged by the Group. We assessed whether the valuer was objective and suitably qualified, had been appropriately instructed and had been provided with complete, accurate data on which to base its evaluation. For all contracts on delivered aircraft, we assessed the commercial factors relevant to the likelihood of the guarantees being called, including the credit ratings and recent financial performance of the relevant customers and their fleet plans, and critically assessed the Group’s estimate of the required provisions for those liabilities. We considered movements in aircraft values and potential changes in the assessed probability of a liability crystallising since the previous year end and considered whether the evidence supported the Group’s assessment as to whether or not a liability needs to be recognised and the amount of the liability recognised or contingent liability disclosed. We considered the appropriateness of the related disclosure in note 18 to the financial statements. (cid:337)(cid:3) Our findings We found that the assumptions and estimates were balanced and that note 18 appropriately discloses the potential liability in excess of the amount provided for in the financial statements for delivered aircraft and highlights the significant but unquantifiable contingent liability in respect of aircraft which will be delivered in the future. INDEPENDENT AUDITOR’S REPORT Consolidation of Rolls-Royce Power Systems Holding GmbH (cid:337)(cid:3) The risk Estimating the fair value of intangible assets of RRPS at the date of consolidation involved the use of complex valuation techniques and the estimation of future cash flows over a considerable period of time. To the extent that greater or lesser value is attributed to intangibles (which are subject to amortisation), lesser or greater value is attributed to goodwill (which is not). (cid:337)(cid:3) Our response We evaluated the basis upon which the Directors identified and assessed the fair value of each significant asset, liability and contingent liability of RRPS and its subsidiaries having regard to the relevant accounting standards. For the intangible assets, we assessed whether the measurement basis and assumptions underlying the estimate of the fair values were reasonable, taking account of our experience of similar assets in other comparable situations and of the work performed by a valuer engaged by the Group. We assessed whether the valuer was objective and suitably qualified, had been appropriately instructed and had been provided with complete, accurate data on which to base its evaluation. We also assessed whether or not the estimates showed any evidence of management bias with a focus on whether there was any indication of value being inappropriately attributed to goodwill rather than depreciable assets. (cid:337)(cid:3) Our findings We found that the intangible assets identified were typical for acquisitions of similar businesses and that the valuation bases used were in accordance with accounting standards. We have no concerns with the basis on which the valuer had been instructed by the Group and found that (i) the valuer was objective and competent, (ii) the estimates used in the valuations were balanced and did not result in either too much or too little goodwill being recognised and (iii) the valuations arrived at by the valuer had been adopted by the Group without adjustment. Valuation of Daimler AG’s put option (cid:337)(cid:3) The risk As part of the shareholder agreements, for a period of six years from 1 January 2013 Daimler AG has the option to require the Group to purchase its 50 per cent interest in RRPSH. The estimated amount of the purchase price of this option has been recognised as a financial liability on the Group balance sheet. The purchase price is based on averaging three valuations, which are based on both internal and external metrics, at the date the option is exercised. The external metrics include price/earnings ratios for comparable companies and those implicit in comparable transactions. There is judgement involved in choosing appropriate comparable companies and transactions and in predicting what these might be at a future date. (cid:337)(cid:3) Our response We analysed the shareholder agreements and tested the reasonableness of the estimate of the purchase price of the option, including assessing whether the Group’s judgement as to which external metrics should be used was appropriate, and the accuracy of its calculation. We also assessed whether or not the estimates showed any evidence of management bias with a particular focus on the risk that the liability might be understated given its visibility. (cid:337)(cid:3) Our findings We found that the resulting estimate was acceptable but mildly optimistic resulting in a somewhat lower liability being recorded than might otherwise have been the case. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 133 Accounting for risk and revenue sharing arrangements Refer to page 81 (Key areas of judgement – Risk and revenue sharing arrangements), page 84 (Significant accounting policies – Risk and revenue sharing arrangements), page 11 (Chief Financial Officer’s review) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) The risk The Group receives non-refundable cash payments under risk and revenue sharing arrangements (which are referred to as entry fees). The assessment of when these entry fees should be recognised in the income statement involves analysis of their commercial substance in the context of the agreement as a whole. As there is no single accounting standard that directly addresses these types of agreements, management has to apply very significant judgement in deciding how to apply the various provisions of accounting standards that are relevant to different aspects of the agreements. These arrangements are complex and have features that could be indicative of: a collaboration agreement, including sharing of risk and cost in a development programme; a long-term supply agreement; sharing of intellectual property; or a combination of these. (cid:337)(cid:3) Our response We independently analysed the agreements under which significant entry fees have been received to establish the range of possible accounting treatments that could be adopted and to assess which of these would in our view most appropriately reflect the requirements of accounting standards. The most significant accounting standards considered were IAS 8 Accounting policies, changes in accounting estimates and errors, IAS 18 Revenue, IFRS 11 Joint arrangements in terms of the timing of recognition of the entry fees and IAS 1 Presentation of financial statements in respect of their presentation as an offset against the expenditure to which they relate. We also had regard to the definitions of assets, liabilities, income and expenses in the IFRS Framework and, to the extent they did not conflict with Adopted IFRS, to pronouncements of other standard-setting bodies that more explicitly address accounting for payments from suppliers and collaborative arrangements. We examined correspondence between the Group and the Financial Reporting Council and attended meetings between them. We sought to identify the accounting applied in similar circumstances by other companies including the Group’s direct competitors and compare these to the approach adopted by the Group and the requirements of Adopted IFRS. We assessed whether the change to the accounting policy made in the year was appropriate and recalculated the resulting amounts in the financial statements. We considered the appropriateness of the related disclosures. (cid:337)(cid:3) Our findings Our analysis indicated that in substance, from the point of view of both the Group and the risk and revenue sharing workshare partners, the entry fees represent the reimbursement of expenditure incurred by the Group as part of an engine development programme and that this represented a significant transfer of development risk from the Group to the partners that should be reflected in the income statement at the time the reimbursed expenditure is recognised. On that basis, we found that the revised accounting policy most appropriately reflects the commercial substance of the entry fees. So far as it was possible to tell, we found that the accounting applied by the Group was similar to the approach taken by others. We found that the change to the accounting policy made by the Group was appropriate given the incidence of entry fees in the year and the costs capitalised on the programmes to which these entry fees relate. We found that the disclosures in the financial statements properly describe the accounting treatment adopted by the Group and the directors’ basis for applying that treatment. Bribery and corruption Refer to page 120 (Note 23 to the financial statements – Contingent liabilities) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) The risk A large part of the Group’s business is characterised by competition for individually significant contracts with customers which are often directly or indirectly associated with governments and the award of individually significant contracts to suppliers. The procurement processes associated with these activities are highly susceptible to the risk of corruption. In addition the Group operates in a number of territories where the use of commercial intermediaries is either required by the government or is normal practice. The Group is currently under investigation by law enforcement agencies, primarily the Serious Fraud Office in the UK and the US Department of Justice. Breaches of laws and regulations in this area can lead to fines, penalties, criminal prosecution, commercial litigation and restrictions on future business. (cid:337)(cid:3) Our response We evaluated and tested the Group’s policies, procedures and controls over the selection and renewal of intermediaries, contracting arrangements, ongoing management, payments and responses to suspected breaches of policy. We sought to identify and tested payments made to intermediaries during the year, made enquiries of appropriate personnel and evaluated the tone set by the Board and the Executive Leadership Team and the Group’s approach to managing this risk. Having enquired of management, the audit committee and the Board as to whether the Group is in compliance with laws and regulations relating to bribery and corruption, we made written enquiries of the Group’s legal advisers to corroborate the results of those enquiries and maintained a high level of vigilance to possible indications of significant non-compliance with laws and regulations relating to bribery and corruption whilst carrying out our other audit procedures. We discussed the areas of potential or suspected breaches of law, including the ongoing investigation, with the audit committee and the Board of directors as well as the Group’s legal advisers and assessed related documentation. We assessed whether the financial effects of potential or suspected breaches of law or regulation have been properly disclosed in note 23 to the financial statements. (cid:337)(cid:3) Our findings We found that the disclosures in note 23 to the financial statements reflect appropriately the matters required to be disclosed by accounting standards and highlighted that, as the investigation is at too early a stage to assess the consequences (if any), including in particular the size of any possible fines, no provision can be made at year end. 134 Other information Rolls-Royce Holdings plc annual report 2013 INDEPENDENT AUDITOR’S REPORT The presentation of ‘underlying’ profit Refer to page 10 (Chief Financial Officer’s review), page 89 (Note 2 to the financial statements – Segmental analysis) and page 44 (Audit committee report – Financial reporting) (cid:337)(cid:3) The risk In addition to its Adopted IFRS financial statements, the Group presents an alternative income statement on an ‘underlying’ basis. The directors believe the ‘underlying’ income statement reflects better the Group’s trading performance during the year. The basis of adjusting between the Adopted IFRS and ‘underlying’ income statements and a full reconciliation between them is set out in note 2 to the financial statements on pages 89 and 91. A significant recurring adjustment between the Adopted IFRS income statement and the ‘underlying’ income statement relates to the foreign exchange rate used to translate foreign currency transactions. The Group uses forward foreign exchange contracts to manage the cash flow exposures of forecast transactions denominated in foreign currencies but does not generally apply hedge accounting in its Adopted IFRS income statement. The ‘underlying’ income statement translates these amounts at the achieved foreign exchange rate on forward foreign exchange contracts settled in the period, retranslates assets and liabilities at exchange rates forecast to be achieved from future settlement of such contracts and excludes unrealised gains and losses on such contracts which are included in the Adopted IFRS income statement. In addition, adjustments are made to exclude one-off past-service credits on post-retirement schemes and the effect of acquisition accounting and a number of other items. Alternative performance measures can provide investors with appropriate additional information if properly used and presented. In such cases, measures such as these can assist investors in gaining a better understanding of a company’s financial performance and strategy. However, when improperly used and presented, these kinds of measures might mislead investors by hiding the real financial position and results or by making the profitability of the reporting entity seem more attractive. (cid:337)(cid:3) Our response We assessed the appropriateness of the basis for the adjustments between the Adopted IFRS income statement and the ‘underlying’ income statement and recalculated the adjustments with a particular focus on the impact of the foreign exchange rate used to translate foreign currency amounts in the ‘underlying’ income statement. As the Group has discretion over which forward foreign exchange contracts are settled in each financial year, which could impact the achieved rate both for the period and in the future, we assessed whether or not this showed any evidence of management bias. We also assessed: (i) the extent to which the prominence given to the ‘underlying’ financial information and related commentary in the annual report compared to the Adopted IFRS financial information and related commentary could be misleading; (ii) whether the Adopted IFRS and ‘underlying’ financial information are reconciled with sufficient prominence given to that reconciliation; (iii) whether the basis of the ‘underlying’ financial information is clearly and accurately described and consistently applied; and (iv) whether the ‘underlying’ financial information is not otherwise misleading in the form and context in which it appears in the annual report. (cid:337)(cid:3) Our findings We have no concerns regarding the basis of the ‘underlying’ financial information or its calculation and found no indication of management bias in the way the Group managed forward foreign exchange contracts during the year. We consider that there is sufficient appropriate disclosure of the nature and amounts of the adjustments to allow shareholders to understand the implications of the two bases on the financial measures being presented. We consider that the ‘underlying’ financial information is useful to shareholders as an adjunct to the Adopted IFRS financial information particularly in the context of isolating trends resulting from trading performance from trends that result from other factors. We found the presentation of the ‘underlying’ financial information to be balanced. In addition to these key audit risks, we also focused on the recognition of revenue and profit on other long-term contracts; the implementation of a new consolidation system; warranties and guarantees; valuation of derivative contracts; valuation of post-retirement scheme liabilities; and the recoverability of tax assets and the adequacy of provisions for tax contingencies. 3 Our application of materiality and an overview of the scope of our audit The materiality for the Group financial statements as a whole was set at £86 million. This has been calculated with reference to a benchmark of profit before taxation (representing 4.9% of reported and ‘underlying’ profit before taxation) which we consider to be one of the principal considerations for members of the company in assessing the financial performance of the Group. We agreed with the audit committee to report to it the following misstatements that we identified through our audit: (i) all material corrected misstatements; (ii) uncorrected misstatements with a value in excess of £4 million for income statement items (or £8 million for balance sheet reclassifications); and (iii) other misstatements below that threshold that we believe warranted reporting on qualitative grounds. In order to gain appropriate audit coverage of the risks described above and of each individually significant reporting component: (a) audits for Group reporting purposes were carried out at 13 key reporting components located in the following countries: United Kingdom (9 key reporting components), USA (1), Germany (2) and Norway (1). In addition, audits for Group reporting purposes were performed at a further 20 reporting components. Together these covered 90 per cent of revenue, 87 per cent of underlying profit before taxation and 85 per cent of total assets; and (b) specified reporting procedures were carried out over key risk areas at a further 12 reporting components, none of which are considered to be key. In total our procedures covered 98 per cent of revenue, 99 per cent of underlying profit before taxation and 94 per cent of total assets. Rolls-Royce Holdings plc annual report 2013 135 Under the Listing Rules we are required to review: (cid:337)(cid:3) the directors’ statement, set out on page 72, in relation to going concern; and (cid:337)(cid:3) the part of the corporate governance report on page 39 relating to the Company’s compliance with the nine provisions of the UK Corporate Governance Code (2010) specified for our review. We have nothing to report in respect of the above responsibilities. Scope of report and responsibilities As explained more fully in the Directors’ responsibilities statement set out on pages 72 and 73, the directors are responsible for the preparation of the financial statements and for being satisfied that they give a true and fair view. A description of the scope of an audit of accounts is provided on the Financial Reporting Council’s website at www.frc.org.uk/auditscopeukprivate. This report is made solely to the Company’s members as a body and is subject to important explanations and disclaimers regarding our responsibilities, published on our website at www.kpmg.com/uk/auditscopeukco2013a, which are incorporated into this report as if set out in full and should be read to provide an understanding of the purpose of this report, the work we have undertaken and the basis of our opinions. Jimmy Daboo (Senior Statutory Auditor) for and on behalf of KPMG Audit Plc, Statutory Auditor Chartered Accountants 15 Canada Square London E14 5GL 12 February 2014 S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Detailed audit instructions were sent to the auditors of all these reporting components. These instructions covered the significant audit areas that should be covered by these audits (which included the relevant risks of material misstatement detailed above) and set out the information required to be reported back to the group audit team. The group audit team visited the following locations: United Kingdom, USA, Germany, Norway and Singapore. Telephone meetings were also held with the auditors at these locations and the majority of the other locations that were not physically visited. The audits undertaken for Group reporting purposes at the reporting components were all performed to materiality levels set by, or agreed with, the group audit team. These materiality levels were set individually for each such component and ranged from £0.5 million to £50 million. 4 Our opinion on other matters prescribed by the Companies Act 2006 is unmodified In our opinion: (cid:337)(cid:3) the part of the directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006; and (cid:337)(cid:3) the information given in the Strategic report and Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. 5 We have nothing to report in respect of the matters on which we are required to report by exception Under ISA (UK and Ireland) we are required to report to you if, based on the knowledge we acquired during our audit, we have identified other information in the annual report that contains a material inconsistency with either that knowledge or the financial statements, a material misstatement of fact, or that is otherwise misleading. In particular, we are required to report to you if: (cid:337)(cid:3) we have identified material inconsistencies between the knowledge we acquired during our audit and the directors’ statement that they consider that the annual report and financial statements taken as a whole is fair, balanced and understandable and provides the information necessary for shareholders to assess the Group’s performance, business model and strategy; or (cid:337)(cid:3) the audit committee report does not appropriately address matters communicated by us to the audit committee. Under the Companies Act 2006 we are required to report to you if, in our opinion: (cid:337)(cid:3) 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 (cid:337)(cid:3) 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 (cid:337)(cid:3) certain disclosures of directors’ remuneration specified by law are not made; or (cid:337)(cid:3) we have not received all the information and explanations we require for our audit. 136 Other information Rolls-Royce Holdings plc annual report 2013 GROUP FIVE-YEAR REVIEW For the years ended 31 December 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 before taxation 2 Taxation Profit for the year Attributable to: Equity shareholders of the parent Non-controlling interests Profit for the year 1 Research and development (gross) 2 Underlying profit before taxation Earnings per ordinary share: Underlying Basic 2013 £m 15,513 2,393 (683) 160 1,870 (111) 1,759 (380) 1,379 1,367 12 1,379 (1,118) 1,759 Restated* 2012 £m 12,161 2,435 (531) 173 2,077 689 2,766 (431) 2,335 2,321 14 2,335 (919) 1,434 2011 £m 11,124 2010 £m 11,085 2009 £m 10,414 1,536 (463) 116 1,189 (84) 1,105 (257) 848 850 (2) 848 (908) 1,157 1,463 (422) 93 1,134 (432) 702 (159) 543 539 4 543 (923) 955 1,458 (379) 93 1,172 1,785 2,957 (740) 2,217 2,221 (4) 2,217 (864) 915 65.59p 73.26p 59.59p 125.38p 48.54p 45.95p 38.73p 29.20p 39.67p 120.38p Payments to shareholders per ordinary share 22.00p 19.50p 17.50p 16.00p 15.00p 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)/inflow from investing activities Cash inflow/(outflow) from financing activities Increase/(decrease) in cash and cash equivalents Net funds 2013 £m 23,063 (16,760) 6,303 376 5,229 5,605 698 6,303 2013 £m 2,040 (740) 136 1,436 1,939 Restated* 2012 £m 18,146 (12,150) 5,996 374 5,605 5,979 17 5,996 2012 £m 1,255 424 (331) 1,348 1,317 2011 £m 16,423 (11,904) 4,519 2010 £m 16,234 (12,255) 3,979 2009 £m 15,422 (11,640) 3,782 374 4,144 4,518 1 4,519 2011 £m 1,306 (2,207) (655) (1,556) 223 374 3,601 3,975 4 3,979 2010 £m 1,378 (759) (743) (124) 1,533 371 3,411 3,782 – 3,782 2009 £m 859 (606) 384 637 1,275 * Restated for the adoption of the amendments to IAS 19 Employee Benefits on 1 January 2013 and the change to the accounting policy for RRSAs – see note 1. It is not practicable to restate prior years on a comparable basis. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 137 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 2013 1.65 1.56 1.20 1.18 2012 1.63 1.59 1.23 1.23 Change +1% -2% -2% -4% The Group’s approach to managing its tax affairs The Board is involved in setting the Group’s tax policies which govern the way its tax affairs are managed. In summary, this means: i) ii) the Group manages its tax costs through maximising the tax efficiency of business transactions. This includes taking advantage of available tax incentives and exemptions; this must be done in a way which is aligned with the Group’s commercial objectives and meets its legal obligations and ethical standards; iii) the Group also has regard for the intention of the legislation concerned rather than just the wording itself; iv) the Group is committed to building constructive working relationships with tax authorities based on a policy of full disclosure in order to remove uncertainty in its business transactions and to allow the authorities to review possible risks; where appropriate and possible, the Group enters into consultation with tax authorities to help shape proposed legislation and future tax policy; and v) vi) the Group seeks to price transactions between Group companies as if they were between unrelated parties, in compliance with the OECD Transfer Pricing Guidelines and the laws of the relevant jurisdictions. The Group’s global corporate income tax contribution Over 95 per cent of the Group’s underlying profit before tax (excluding joint ventures) is generated in the United Kingdom, United States of America, Germany, Norway, Finland and Singapore. The remaining profits are generated across more than 40 other countries. This reflects the fact that the majority of the Group’s business is undertaken, and employees are based, in the above countries. In common with most multinational groups, the total of all profits in respect of which corporate tax is paid is not the same as the consolidated profit before tax reported on page 75. The main reasons for this are: i) the consolidated income statement is prepared under IFRS whereas tax is paid on the profits of each Group company, which are determined by local accounting rules; ii) iii) accounting rules require certain income and costs relating to our commercial activities to be eliminated from, or added to, the aggregate of all the profits of the Group companies when preparing the consolidated income statement (‘consolidation adjustments’); and specific tax rules including exemptions or incentives as determined by the tax laws in each country. The Group’s total corporation tax payments in 2013 were £238 million. The level of tax paid in each country is impacted by the above. In most cases, (i) and (ii) are only a matter of timing and therefore tax will be paid in an earlier or later year. As a result they only have a negligible impact on the Group’s underlying tax rate which, excluding joint ventures, would be 27.1 per cent (the underlying tax rate including joint ventures can be found on page 12). This is due to deferred tax accounting, details of which can be found in note 5 to the financial statements. The impact of (iii) will often be permanent depending on the relevant tax law. 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. 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. Financial risk management The Board has established a 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. The Frc is chaired by the Chief Financial Officer. 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. 138 Other information Rolls-Royce Holdings plc annual report 2013 ADDITIONAL FINANCIAL INFORMATION Capital structure £ million Total equity Cash flow hedges Group capital Net funds 2013 6,303 68 6,371 1,939 Restated 2012 5996 63 6,059 1,317 Operations are funded through various shareholders’ funds, bank borrowings, bonds and notes. 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. During the year, the Group issued €750 million 2.125% Notes maturing in 2021 and £375 million 3.375% Notes maturing in 2026. At year end, the Group retained aggregate liquidity of £5.6 billion. This liquidity comprised net funds of £1.9 billion and aggregate borrowing facilities of £3.6 billion, of which £1.2 billion remained undrawn. 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. The only facility to mature in 2014 is a £200 million EIB loan. 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 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 debt is further outlined in note 11. Credit rating Moody’s Investors Service Standard & Poor’s Rating Outlook Grade A3 A Stable Stable Investment Investment The Group subscribes to both Moody’s Investors Service and Standard & Poor’s for independent long-term credit ratings. At 31 December 2013, 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 2013, the Group has adopted Amendments to IAS 19 Employee Benefits. There were no other revisions to IFRS that became applicable in 2013 which had a significant impact on the Group’s financial statements. A summary of changes which have not been adopted in 2013 is included within the accounting policies in note 1. As explained in the Chief Financial Officer’s review on page 11, following discussions with the Conduct Committee of the FRC, the Group has reassessed its policy for the recognition of entry fees received under RRSAs. Governments and regulators around the world continue to implement reforms to the financial markets with the aim of improving transparency and reducing systemic risk. Although the reforms are predominantly directed at financial institutions, they will also affect non-financial institutions such as the Group. The primary concern was the reform of the over-the-counter (OTC) derivatives market, and in particular a proposal in the EU European Market Infrastructure Regulation (EMIR) that parties to future OTC derivative transactions would be required to use an exchange to clear the transactions and post cash collateral to reduce counterparty risk. The proposal could have adversely affected the Group’s future funding requirements and made cash flow more volatile. The final EMIR rules have now been released, which exempt non-financial institutions engaged in hedging activity from this requirement. Share price During the year, the share price increased by 46 per cent from 873.5 pence to 1275 pence, compared to a 38 per cent increase in the FTSE aerospace and defence sector and 14 per cent increase in the FTSE 100. The Company’s share price ranged from 873.5 pence in January to 1275 pence in December. S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n Rolls-Royce Holdings plc annual report 2013 139 SHAREHOLDER INFORMATION Financial calendar 2014-2015 1 May 11.00am AGM QEII Conference Centre London 1 July Payment of C Share dividend 1 July Allotment of C Shares 3 July Payment of C Share redemption monies 11 July Purchase of ordinary shares for CRIP participants (at the latest) 31 July Announcement of interim results 14 November Record date for C Share dividend 2 January Payment of C Share dividend 2 January Allotment of C Shares 6 January Payment of C Share redemption monies 13 January Purchase of ordinary sh ares for CRIP participants (at the latest) Apr 2014 May 2014 Jun 2014 Jul 2014 Aug 2014 Sep 2014 Oct 2014 Nov 2014 Dec 2014 Jan 2015 Feb 2015 23 April Ex-entitlement to C Shares 25 April Record date for entitlement to C Shares 2 June 5.00pm Deadline for receipt of C Share elections 2 June Record date for C Share dividend 23 October Ex-entitlement to C Shares 24 October Record date for entitlement to C Shares 1 December 5.00pm Deadline for receipt of C Share elections 31 December Financial year end February Preliminary announcement – 2014 full year results March Annual report published Managing your shareholding Your shareholding is managed by Computershare Investor Services PLC (the Registrar). When making contact with the Registrar please quote your Shareholder Reference Number (SRN), an 11-digit number that can be found on the right-hand side of your share certificate or in any other shareholder correspondence. It is very important that you keep your shareholding account details up to date by notifying the Registrar of any changes in your circumstances. You can manage your shareholding 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. Payments to shareholders The Company makes payments to shareholders by issuing redeemable C Shares of 0.1 pence each. You can still receive cash or additional ordinary shares from the Company providing you complete a payment instruction form, which is available from the Registrar. Once you have submitted your payment instruction form, you will receive cash or additional ordinary shares each time the Company issues C Shares. If you choose to receive cash we recommend that you include your bank details on the payment instruction form and have payments credited directly to your bank account. This removes the risk of a cheque going astray in the post and means that cleared payments will be credited to your bank account on the payment date. Share dealing The Registrar offers existing shareholders an internet dealing service at www-uk.computershare.com/investor/sharedealing.asp and a telephone dealing service (+44 (0)870 703 0084). The service is available during market hours, 8.00am to 4.30pm, Monday to Friday excluding Bank holidays. The fee for internet dealing is 1 per cent of the transaction value subject to a minimum fee of £30. The fee for telephone dealing is 1 per cent of the transaction plus £35. Please note that, in addition to dealing fees, stamp duty of 0.5 per cent is payable on all purchases. Other share dealing facilities are available but we recommend that you only use a firm regulated by the Financial Conduct Authority (FCA). You can check the FCA register at www.fca.org.uk/register. Your share certificate If you sell or transfer your shares you must ensure that you have a valid share certificate in the name of Rolls-Royce Holdings plc. If you place an instruction to sell your shares and cannot provide a valid share certificate the transaction cannot be completed and you will be liable for any costs incurred by the broker. Share certificates previously issued by either Rolls-Royce Group plc or Rolls-Royce plc are invalid and should be destroyed. If you are unable to locate your share certificates please inform the Registrar immediately. American Depositary Receipts (ADR) ADR holders should contact the depositary, The Bank of New York Mellon by calling +1 888 269 2377 (toll free within the US) or emailing shrrelations@cpushareownerservices.com. 140 Other information Rolls-Royce Holdings plc annual report 2013 SHAREHOLDER INFORMATION Warning to shareholders – boiler room fraud We are aware that some shareholders might have received unsolicited phone calls or correspondence concerning investment matters. These are typically from overseas based ‘brokers’ who offer to sell them what often turn out to be worthless or high risk shares in US or UK investments. Such operations are known as ‘boiler rooms’ and these ‘brokers’ can be very persistent and extremely persuasive. You should always check that any firm calling you about investment opportunities is properly authorised by the FCA using the following web link www.fca.org.uk/register or by calling their Consumer Helpline on 0800 111 6768 (overseas callers dial +44 20 7066 1000). If you deal with an unauthorised firm, you will not be eligible to receive payment under the Financial Services Compensation Scheme. You will find lots of useful advice and information about protecting yourself from investment scams on the FCA website www.fca.org.uk/consumers. Remember the golden rule – IF IT SOUNDS TOO GOOD TO BE TRUE IT PROBABLY IS. Available as a free download from the app store for iPad users Visit Rolls-Royce online Visit www.rolls-royce.com/investors to find out more about the latest financial results, the share price, payments to shareholders, the financial calendar and shareholder services. Keeping up to date You can sign up to receive the latest news to your phone or inbox. You can also download the Rolls-Royce Investor Relations iPad app which provides the latest media and financial information. Dividends paid on C Shares held C Share calculation period 1 July 2013 – 31 December 2013 1 January 2013 – 30 June 2013 Previous C Share issues No of C Shares issued per ordinary share 86 119 Latest date for receipt of Payment Instruction Forms by Registrar 2 December 2013 3 June 2013 Record date for entitlement to C Shares 25 October 2013 24 April 2013 Issue date 2 January 2014 2 July 2013 For earlier C Share issues, please refer to the Group’s website. C Share dividend rate (%) 0.225 0.25 Record date for C Share dividend 15 November 2013 3 June 2013 Payment date 2 January 2014 3 July 2013 Apportionment values CGT apportionment Price of ordinary shares on first day of trading (p) Value of C Share issues per ordinary shares (p) Ordinary shares (%) C Shares (%) 1265.50 1151.50 8.6 11.9 99.33 98.98 0.67 1.02 Date of redemption of C Shares 6 January 2014 3 July 2013 CRIP purchase date 7 January 2014 9 July 2013 CRIP purchase price (p) 1287.3621 1192.7275 Analysis of ordinary shareholders at 31 December 2013 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 197,937 7,101 205,038 64,735 103,476 34,806 1,344 464 213 205,038 % of total shareholders 96.54 3.46 100.00 31.57 50.47 16.98 0.65 0.23 0.10 100.00 Number of shares 101,503,370 1,778,798,284 1,880,301,654 6,216,673 27,720,381 56,638,725 36,159,598 158,602,026 1,594,964,251 1,880,301,654 % of total shares 5.40 94.60 100.00 0.33 1.47 3.01 1.92 8.44 84.83 100.00 Rolls-Royce Holdings plc annual report 2013 141 GLOSSARY ABC ACARE AGM APRA C Shares CO2 Company CPS CRIP EASA ELT EPS EU FAA FCA FRC GBP GC 100 anti-bribery and corruption Advisory Council for Aviation Research and Innovation in Europe annual general meeting Annual Performance Related Award plan non-cumulative redeemable preference shares carbon dioxide Rolls-Royce Holdings plc cash flow per share C Share Reinvestment Plan European Aviation Safety Agency Executive Leadership Team earnings per ordinary share European Union Federal Aviation Administration Financial Conduct Authority Financial Reporting Council Great British pound or pound sterling Association of general counsel and company secretaries of FTSE 100 companies greenhouse gas GHG Global Code Global Code of Conduct Group HMRC HS&E I&C IAB IAE IAG Rolls-Royce Holdings plc and its subsidiaries HM Revenue & Customs health, safety and environment instrumentation and control International Advisory Board IAE International Aero Engines AG International Airlines Group (parent company of British Airways) IAS International Accounting Standards S t r a t e g i c r e p o r t D i r e c t o r s ’ r e p o r t F i n a n c i a l s t a t e m e n t s O t h e r i n f o r m a t i o n International Financial Reporting Interpretations Committee IFRIC International Financial Reporting Standards IFRS Japan Airlines JAL key performance indicator KPI London Inter-Bank Offered Rate LIBOR Long-Term Service Agreement LTSA liquefied natural gas LNG UK Ministry of Defence MoD non-controlling interest NCI other comprehensive income OCI original equipment OE Organisation for Economic Cooperation and Development OECD Performance Share Plan PSP research and development R&D Registration, Evaluation and Authorisation of Chemicals REACH recoverable engine cost REC Registrar Computershare Investor Services PLC RRPSH RRPS RRSAs RSUs SFO SIP SRN STEM STOVL TRI TSR UAV UK GAAP UK Generally Accepted Accounting Practices USD Rolls-Royce Power Systems Holding GmbH Rolls-Royce Power Systems AG (previously named Tognum AG) Risk and Revenue Sharing Arrangements restricted stock units Serious Fraud Office Share Incentive Plan Shareholder Reference Number Science, Technology, Engineering and Mathematics short take-off and vertical landing total reportable injuries Total Shareholder Return unmanned aerial vehicle United States dollar Designed and produced by C O N R A N D E S I G N G R O U P 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, using Printed in the UK by PurePrint using their and vegetable inks throughout. PurePrint is a CarbonNeutral® company. Both the paper manufacturing mill and the printer are registered to the Environmental Management System ISO 14001 and are Forest Stewardship Council® (FSC) chain-of-custody certified. © Rolls-Royce plc 2014 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 

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