Rolls-Royce
Annual Report 2015

Plain-text annual report

Rolls-Royce Holdings plc Annual Report 2015 FOCUS TRANSFORM DELIVER 2015 Annual Report ROLLS-ROYCE IS A PRE-EMINENT ENGINEERING COMPANY FOCUSED ON WORLD-CLASS POWER AND PROPULSION SYSTEMS. This page A Trent 1000 engine for the Boeing 787 Dreamliner is prepared for testing. Financial highlights Contents Order book £76,399m 2014: £73,674m Free cash flow £179m 2014: £447m Underlying* revenue Reported** revenue £13,354m 2014: £13,864m £13,725m 2014: £13,736m STRATEGIC REPORT Group at a glance Chairman’s statement Chief Executive’s review Review of 2015 Strategic priorities Business model Engineering and innovation Business review Financial review Sustainability Underlying* profit before tax Reported** profit before tax Key performance indicators £1,432m 2014: £1,620m £160m 2014: £67m Underlying* earnings per share Reported earnings per share 58.7p 2014: 65.4p 4.5p 2014: (3.9)p Full year payment to shareholders Net cash 16.37p 2014: 23.1p £(111)m 2014: £666m * Underlying explanation is in note 2 on page 122 **From continuing operations All figures in the narrative of the Strategic Report are underlying unless otherwise stated 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 guidance may be updated from time to time. This report is intended to provide information to shareholders, and 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. Latest information will be made available on the Group’s website. By their nature, these statements involve risk and uncertainty, and a number of factors could cause material differences to the actual results or developments. Principal risks Going concern and viability statements DIRECTORS’ REPORT Board of Directors Chairman’s introduction Corporate governance Committee reports Nominations & Governance Committee Remuneration Committee Audit Committee Safety & Ethics Committee Science & Technology Committee Responsibility statements Other statutory information FINANCIAL STATEMENTS Financial statements contents Group financial statements Company financial statements OTHER INFORMATION Subsidiaries, joint ventures and associates Independent auditor’s report Sustainability assurance Additional financial information Other statutory information Shareholder information Glossary 2 4 6 8 15 16 18 22 42 48 52 54 57 58 62 63 69 69 74 91 98 103 105 178 106 107 157 160 167 175 176 178 182 184 Rolls-Royce Holdings plc Annual Report 2015 1 Strategic Report Strategic Report / Group at a glance GROUP AT A GLANCE Rolls-Royce ship design The Far Samson multi-function subsea service vessel is 121.5m long and 26m wide. 2 Rolls-Royce Holdings plc Annual Report 2015 Group The Group is organised into five customer-facing businesses: Civil Aerospace, Defence Aerospace, Power Systems, Marine and Nuclear. Underlying revenue £13,354m Underlying profit before tax £1,432m Underlying revenue mix Civil Aerospace Defence Aerospace Power Systems Marine Nuclear 52% 15% 18% 10% 5% Order book £76.4bn Invested in R&D £1.2bn Patents applied for Countries 626 46 Engineers (year end) Employees (year average) 15,690 50,500 Group at a glance Civil Aerospace Defence Aerospace Underlying revenue mix Underlying revenue mix Underlying revenue £6,933m Underlying profit* £812m Underlying revenue mix Underlying revenue mix Underlying revenue £2,035m Underlying profit* £393m OE revenue Services revenue 47% 53% OE revenue Services revenue 39% 61% Power Systems Marine Underlying revenue mix Underlying revenue mix Underlying revenue mix Underlying revenue mix Underlying revenue £1,324m Underlying profit* £15m OE revenue Services revenue 68% 32% OE revenue Services revenue 58% 42% Underlying revenue £2,385m Underlying profit* £194m Nuclear Underlying revenue Underlying revenue mix Underlying revenue mix £687m Underlying profit* £70m OE revenue Services revenue 37% 63% * Underlying profit before financing and taxation Rolls-Royce Holdings plc Annual Report 2015 3 Strategic Report Strategic Report / Chairman’s statement Strategic Report / Chairman’s statement FOCUS Underlying EPS 58.73p Payment to shareholders 16.37p 4 Rolls-Royce Holdings plc Annual Report 2015 We have made some important changes to our management in 2015 and laid the groundwork for further performance improvements as we tackle some near-term challenges.” Ian Davis Chairman Rolls-Royce is a business in transition. The next few years are going to be very important as we capitalise on our outstanding portfolio of products and services and the £76.4bn order book that supports them. Underpinning this journey will be significant changes to our business. Warren East, our new Chief Executive, will talk more about these in the Strategic Report. During this period of transition we should not forget the core strengths of the business. Our products, technologies and customer relationships have been further strengthened as a result of focused investment and the continued hard work of our teams. The sustained strong growth in our order book shows that our customers recognise the value Rolls-Royce delivers. The fundamentals of our business are unchanged. We are investing today, as we have for many years, in building a strong installed base of mission-critical industrial, marine and aerospace power systems. Our market share, particularly in powering large civil airliners, will grow significantly over the next ten years providing a cash generative, sustainable platform from which to further develop the business. Investing today to secure that future is essential. Chairman’s statement In summary… Fundamental strengths of the business unchanged Continue to invest in market- leading products, technologies and customer services Lay stronger foundations to rebuild trust and confidence in a world- class engineering business At the same time, we are facing some challenges in key markets, particularly in Marine, and are managing a major change in product mix within Civil Aerospace, which has a direct impact on how we recognise revenues and profits. This meant we took the decision to undertake a major restructuring of the business. Warren’s recent review of operations, unanimously supported by the Board, highlighted a number of areas where, over time, costs have grown in an unsustainable way. This clearly needs to change. We have approved a plan to reduce our fixed cost base by £150m to £200m per annum and simplify the way we manage the business. Shareholder payments The pace of investment required to transform the business creates near-term pressure on free cash flow. At the same time, we need to sustain a healthy balance sheet to ensure we have the financial flexibility to maintain a strong investment-grade credit rating. As a result, the Board is recommending that the payment to shareholders is halved in cash terms at the full year and the next half year. We recognise the importance of a healthy ‘dividend’ to our shareholders. Subject to short-term cash needs, we intend to review the payment so that it will be rebuilt over time to an appropriate level. This reflects the Board’s long-standing confidence in the strong future cash generation of the business. As a result, the proposed final payment for 2015 is 7.1p per share, 50% of the final payment made for full year 2014. It is further proposed that the interim payment for 2016 will also be reduced to 50% of the prior year. Corporate governance 2015 has proven to be a strong test of our governance processes and, while we will take away several important learnings from different events, I have been impressed by  how your Board and senior management at Rolls-Royce have performed at a difficult time. This has not been an easy year for the Company, its employees, investors or other stakeholders. We have had to communicate some challenging messages both internally and externally about our market outlook, our performance and, very importantly, the essential changes we will be making to cut waste and restore confidence in the business. We have not taken our eye off some of the historic issues that have undermined confidence in the business in the past. Concerns about bribery and corruption involving intermediaries in overseas markets remain subject to examination by the Serious Fraud Office and other authorities and these investigations are not yet complete. We have done much to address the root of these problems and this work is being continually reinforced to ensure we all meet the high standards expected of us. engineering and manufacturing experience, after a long career at GKN and BAE Systems. Lewis Booth, a US resident and an independent Non-executive Director since 2011 has indicated his intention to relinquish his responsibility as Senior Independent Director once a successor has been appointed. He will continue as Chairman of the Audit Committee. Dame Helen Alexander, an independent Non-executive Director since 2007, will be stepping down from the Board after the AGM in May 2016 having completed her nine-year term. At that time she will be succeeded as Chairman of the Remuneration Committee by Ruth Cairnie, who joined the Board in September 2014. On behalf of the Board I would like to thank Dame Helen for her dedicated service to the Company. She has been a wise and insightful member of the Board and her well-judged advice and leadership of our Remuneration Committee have been highly valued by her colleagues. Board developments During the year there have been a number of important changes to the Board. On 22 April we announced that John Rishton had decided to retire as Chief Executive on 2 July, to be succeeded by Warren East. At the AGM on 8 May James Guyette, President and Chief Executive Officer of Rolls-Royce North America, retired and stepped down from the Board. John Neill also stood down at the AGM after six years as a Non-executive Director. Irene Dorner, formerly CEO and President of HSBC USA, joined the Board in July. Alan Davies, Chief Executive of Rio Tinto’s Diamonds and Minerals division, and Sir Kevin Smith, the former Chief Executive of GKN, the multinational automotive and aerospace business, both joined the Board from 1 November. In February 2016, Sir Kevin assumed Chairmanship of the Science & Technology Committee. Irene brings a wealth of international expertise, particularly in risk management and operational performance. Alan, as well as having a strong financial background, brings relevant experience in transforming operational performance and driving cultural change through a complex global organisation, together with a deep knowledge of China and other key emerging markets. Sir Kevin also brings recent Asian experience together with significant aerospace industry knowledge, with Rebuilding trust and confidence In the first months since his appointment last July, Warren has made an enormous impact on the business with a clear, well-structured review. This has examined the strengths and weaknesses of our businesses and highlighted the critical investment priorities required to develop our competitive advantages and market position. I have also been pleased by the steps he and his team have taken to improve communication to our investors. While it is early days, I believe his approach has been well received and has laid good foundations from which we can rebuild trust and confidence in the business. Looking forward 2016 will be another challenging year for Rolls-Royce. As Warren sets out in his review, we are doing a great deal within the business to ensure we successfully transition over the next few years to a more strongly profitable and cash-generative future. The Group is well positioned to grow strongly on the back of innovative, market-leading technology. We do have some near-term challenges but the fundamentals of the business remain strong, underpinned by a record order book and some great people across the organisation. Ian Davis Chairman 11 February 2016 Rolls-Royce Holdings plc Annual Report 2015 5 Strategic Report Strategic Report / Chief Executive’s review TRANSFORM In the context of challenging trading conditions our overall performance for the year was in line with the expectations we set out in July 2015. It was a year of considerable change for Rolls-Royce: in our management, in some market conditions and in our near-term outlook. At the same time, there were some important constants: the underlying growth of our long-term markets, the quality of our mission-critical technology and services, and strength of customer demand for these, which are reflected in our growing order book. While we have some near-term challenges, these constants provide us with confidence in a strong, profitable, cash-generative future.” Warren East Chief Executive 6 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review In this Strategic Report, I will describe the business in depth and we will provide further information on our financial position and business performance. Welcome to my first Chief Executive’s review for Rolls-Royce. My intention is that this report will share with you all, in a clear and open way, how we performed last year, the opportunities ahead of us and the clear goals and priorities we are setting ourselves to maximise value creation. We are now taking great steps to transform the business, adding pace and simplicity to what we do, a process we started in November 2015. This will be covered extensively in next year’s report. In the meantime, we have significantly enhanced the disclosure in this year’s report to present our performance in a more transparent and understandable way. I hope you find it informative. Rolls-Royce Holdings plc Annual Report 2015 7 Strategic Report Strategic Report / Chief Executive’s review Review of 2015 REVIEW OF 2015 AND BUSINESS TRANSFORMATION After an underlying tax charge of £351m (2014: £388m) and adjusting for non- controlling interests, underlying profit for the year was £1,080m (2014: £1,226m). With an average 1,839 million shares in issue, underlying earnings per share were 58.7p (2014: 65.4p). Reported profit before tax was £160m (2014: £67m), compared to an underlying profit before tax of £1,432m (2014: £1,620m). A full reconciliation of headline to underlying profit can be found in note 2 to the Consolidated Financial Statements. Free cash flow of £179m was materially higher than our third quarter expectations, reflecting strong cash collections at the end of the year from a number of key customers, a better than expected overall working capital performance and the non-recurring cash settlement arising from the intellectual property agreement mentioned above. Some of this positive variance is likely to reverse early in 2016. A more detailed review of financial performance is included in the Financial review. Order book (£bn) Performance in 2015 2014 2015 0 10 20 30 40 50 60 70 80 Underlying revenue (£m) 2014 2015 0 3,000 6,000 9,000 12,000 15,000 Underlying profit before tax (£m) 2014 2015 0 500 1,000 1,500 2,000 Our performance in 2015 was broadly in line with our early expectations, with Marine markets causing most of the weakness. At the same time we have continued to invest in products and services to support our customers and reinforce the long-term strength of our order book, valued at £76.4bn at the year end, up 4% on 2014. Group revenue was broadly unchanged on a constant currency basis with good growth in Civil Aerospace offsetting weaknesses in Marine. The combination of some difficult market conditions, sustained engineering investment and high fixed costs led to underlying profit before finance charges and tax 11% being lower at £1,492m. Civil Aerospace delivered an underlying profit before finance charges and tax of £812m (2014: £942m). Defence Aerospace delivered £393m (2014: £366m), Power Systems £194m (2014: £253m) and Marine £15m (2014: £138m). Nuclear delivered £70m (2014: £50m). More detail on each business is included in the Business review. After underlying financing costs of £60m (2014: £61m), underlying profit before tax was £1,432m (2014: £1,620m). Excluding the benefit of a one-off intellectual property settlement of £58m, triggered by the third-party acquisition of a former business partner, and a favourable £19m R&D credit benefiting our Nuclear business, underlying profit before tax would have been £1,355m, in line with the lower half of the 2015 guidance range set out in July 2015. 8 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Review of 2015 Our strategic priorities in 2015 Customer Innovation Profitable growth Placing the customer at the heart of our organisation is key. We listen to our customers, share ideas, really understand their needs and then relentlessly focus on delivering our promises. This is our lifeblood. We 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. Most importantly, we ensure our innovation is relevant to our customers’ needs. By focusing on our customers and offering them a competitive portfolio of products and services, we create the opportunity to grow our market share. We have 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. Performance in 2015 Trent XWB completes exemplary first year in service with Qatar Airways. Testing of Trent 1000 TEN and Trent XWB-97 development engines is progressing well. Our largest ever order secured: US$9.2bn from Emirates for Trent 900s. Gulfstream G650 corporate jet with BR725 engines enters service . F-35B Lightning II with Rolls-Royce LiftSystem® declared operational by US Marine Corps. MTU signs agreement with Daimler to jointly develop EU Stage 5, emissions compliant diesel engines for off-highway applications. We expand TotalCare® service offering range and our maintenance, repair and overhaul (MRO) network. We produce the world’s largest 3D component for the aerospace industry. €100m order for MTU engines to power rail locomotives for Dalian of China. US Air Force, Boeing and Embraer all name Rolls-Royce in their top supplier categories. We are leading an international research programme into remote and autonomous ship control. US$600m investment announced for re-developing our production facilities in Indianapolis, US. Underlying revenue (£m) Civil Aerospace Defence Aerospace Power Systems Marine Nuclear 8,000 6,000 4,000 2,000 0 8,000 6,000 4,000 2,000 0 8,000 6,000 4,000 2,000 0 8,000 6,000 4,000 2,000 0 8,000 6,000 4,000 2,000 0 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 Rolls-Royce Holdings plc Annual Report 2015 9 Strategic Report Strategic Report / Chief Executive’s review Review of 2015 Positive market developments continue to drive long-term growth The long-term positive market trends for our leading power systems remain unchanged despite some near-term uncertainties that are expected to impact small aerospace engine production volumes and service activity on older widebody engines over the next couple of years. The trends driving demand for growth in large passenger aircraft, corporate jets and maritime activity remain strong; in particular a growing aspirational and mobile middle-class, particularly in Asia, and globalisation in business, trade and tourism. In addition, capacity constraints at the airframe manufacturers and a strong underlying demand for newer, more fuel efficient aircraft, should provide resilience to manufacturing schedules over the next few years as the industry transitions to new airframes during a strong replacement cycle. The most significant short-term challenge that has emerged in 2015 relates to the changing demand for our Trent 700 engine as Airbus transitions production from old to new airframes. This has had a knock on effect on both demand for and pricing of the remaining engines to be delivered. Once completed, we will benefit from an exclusive position with the new Trent 7000 on the A330neo. In the near-term the profit impact of this transition is negative; the impact of lower pricing and gross margin is exacerbated by the accounting effects of changes within our large engine aerospace product mix as we transition to a portfolio increasingly comprising ‘unlinked’ platform positions. However, the roll-out of new engines will significantly grow our market share and the installed base of new engines will deliver strong aftermarket revenues for decades to come. We recognise that these changes have been exacerbated by market uncertainty as to the impact of TotalCare accounting on our financial statements. As a result, we are increasing our financial disclosure to present a simpler narrative that will more clearly describe how the key drivers of performance translate into our financial results and aid transparency and understanding. These are included in the Business review. Announced initial findings of a detailed operational review Our strategic priorities for 2015 remained largely consistent throughout the year, with a clear focus on the customer, innovation and on driving long-term profitable growth. However, with short-term market conditions around us changing, it has been appropriate to review these priorities as we look to the next three or four years. Since July 2015, we have been conducting a review of operations and presented the initial conclusions in November 2015. As part of this we shared our views on the strengths and weaknesses of our business portfolio and updated management’s future focus and priorities around delivery and transformation. Strong growth expected in installed widebody fleet 10,000 8,000 6,000 4,000 2,000 0 t f a r c r i a f o r e b m u N 1974 1979 1984 1989 1994 1999 2004 2009 2014 2019 2024 2029 2034 Year Company estimates 10 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Review of 2015 Rolls-Royce is in… growing markets. We are strongly positioned and… growing market share.” Warren East 24 November 2015 Clear areas for business improvement The review of operations also highlighted a number of opportunities to drive further performance improvements over and above the extensive restructuring programmes already underway. As we grew as an organisation we embedded costs and complexity in the business which, in periods of significant investment and product transition like now, are impacting our performance. But the higher costs also present a significant opportunity; to simplify what we do and sustainably reduce the cost of management, creating a more streamlined, resilient and sustainable business. Strategic focus going forward The review has led us to recast our priorities for 2016 onwards. As before, the overarching theme continues to be developing our products, services and order book to drive long-term profitable growth. We will do this by focusing on three common themes across all our businesses: • • • investing in and developing engineering excellence; driving a manufacturing and supply chain transformation which will embed operational excellence in lean, lower-cost facilities and processes; and leveraging our installed base, product knowledge and engineering capabilities to provide customers with outstanding service through which we can capture aftermarket value long into the future. Our ability to deliver these priorities will be enhanced by a major transformation of our organisation; to simplify our processes and management structure, to add pace to our decision making and execution, and to provide space to develop our people and create a stronger, high performance culture. These themes will become the cornerstones of our operational priorities going forward. Portfolio analysis “We have a strong portfolio of products and services with strong competitive positions and many in sustainably attractive markets. We have the opportunity to strengthen products, routes to market or to reduce their costs so they can be more competitive in the future.” Warren East 24 November 2015 Group portfolio 2015 Group portfolio 2020 High High n o i t i s o p e v i t i t e p m o C 50% n o i t i s o p e v i t i t e p m o C ~70% Low Market attractiveness High Low Market attractiveness High Rolls-Royce Holdings plc Annual Report 2015 11 Strategic Report Strategic Report / Chief Executive’s review Review of 2015 Major new transformation programme creating meaningful cost savings Restructuring initiatives started prior to November continue to make good progress We have significant opportunities to improve our operating performance and our pace, customer delivery, programme delivery, project delivery, lean manufacturing, as well as reducing our footprint.” David Smith Chief Financial Officer 24 November 2015 During 2014 and 2015 restructuring initiatives were started, largely focused on our operational footprint within Aerospace and Marine. In 2015, we consolidated our Civil Aerospace repair and overhaul activities, enabling the closure of sites in Brazil and the UK, along with further rationalisation of our UK manufacturing footprint. To date, nearly 80% of the targeted 2,600 Civil and Defence Aerospace headcount reductions have been completed, with an 11% reduction in our 2013 operational footprint. In May 2015, we announced a Marine restructuring programme to make significant reductions in both manufacturing footprint and headcount (by 600) and generate £25m in annual savings from 2016 onwards. This included work to consolidate our footprint and increase lower-cost country sourcing. At the start of October 2015, we announced an additional programme of restructuring, focused largely on back-office administrative functions. This will lead to a further 400 reduction in headcount. Good progress has been made overall, with related headcount reductions across Aerospace and Marine totalling 2,500 by the end of 2015. The objective of our new transformation programme is to simplify the organisation, streamline senior management, reduce fixed costs and add greater pace and accountability to decision making. Our target is to deliver incremental gross cost savings of between £150m and £200m per annum, with the full benefits accruing from the end of 2017 onwards. In the last two months, we have already announced a 20% reduction in the top two layers of senior management with further reductions planned for 2016 and onwards. This has included removal of the divisional structure. To date we have already identified around 50%, or £75-100m, of targeted cost savings with a related exceptional restructuring charge of £75-100m. Around £30-50m of the initial savings should be achieved in 2016 with the full run rate benefiting 2017. Further actions are underway to quantify the additional savings needed to reach our goals, together with the related costs which we expect to take in 2017. To ensure we remain focused, we have set up a transformation team which will drive change to simplify processes and activities across the Group to deliver sustainable performance improvements. The new team will ensure other restructuring programmes maintain progress. They will also help develop the comprehensive range of key performance indicators needed to support the changes we are looking to make inside the business. Several measures around site level productivity and aerospace engine unit costs have already been adopted within the business. These and other measures will be important indicators of the changing culture around productivity, cost reduction, investment efficiency and process waste. Details on new measures will be set out in further announcements. Right UltraFan is a future civil aerospace engine concept that could be ready for service from 2025. 12 Rolls-Royce Holdings plc Annual Report 2015 HOW WE ARE TRANSFORMING THE BUSINESS Chief Executive’s review / Review of 2015 My review… has highlighted a number of areas where we can simplify the way we work and inject pace into our decision making” Warren East 24 November 2015 RESTRUCTURING PROGRAMMES ANNOUNCED PRIOR TO NOVEMBER 2015 Incremental changes (as previously announced)* 2015 2016 2017 Aerospace Net improvement Headcount reduction Marine Net improvement Headcount reduction 2015 2020 Aerospace Footprint 1.4 million sqm 1.1 million sqm £0m 2,200** £80m 400 £0m – £(10)m 600 £35m 400 £40m – Output – number of widebody engines ~330 ~600 20% 80% * Overall benefits expected to be broadly in line with previously announced estimates ** Includes 545 who left the business in 2014 NOVEMBER 2015: NEW TRANSFORMATION PROGRAMME TO CREATE SIGNIFICANT INCREMENTAL SAVINGS Focus and deploy resources to maximise value to customers and add pace and simplicity to the business Engineering excellence Operational excellence Capturing aftermarket value £150–200m initial saving targeted with maximum 1-2 year payback Primarily senior level, corporate and divisional fixed costs Rolls-Royce Holdings plc Annual Report 2015 13 Strategic Report Strategic Report / Chief Executive’s review Review of 2015 Transforming our US operations In October 2015, we confirmed the decision to invest nearly US$600m in modernising our manufacturing base in Indianapolis, US. This investment is the largest by Rolls-Royce in the US since we purchased the Allison Engine Company in 1995. The new facility is part of a five-year modernisation plan and the investment is in line with the Group’s ongoing commitment to consolidate operations and significantly reduce operational costs. The new facility will be a state-of-the-art manufacturing centre that combines modern production systems and machinery together with a highly-skilled workforce. We currently employ around 4,000 people in Indianapolis, where engines are designed, assembled and tested for US defence aircraft, civil helicopters, regional and business jets and power systems for US naval vessels. Below Our re-developed facilities in Indianapolis will cover 1.5 million square feet when complete. Outlook for 2016 Looking further ahead Our outlook for 2016 is unchanged from that set out in November 2015. On a constant currency basis, Group revenue for 2016 is expected to be marginally lower than that achieved in 2015, partially reflecting the pricing and volume effects in Civil Aerospace and the continued weakness in offshore marine markets. Overall, the net profit trading headwinds discussed in previous announcements are unchanged at around £650m compared to our underlying profit before financing, excluding £58m intellectual property settlement included in ‘Other’ and £19m research and development (R&D) credit which benefited Nuclear. The successful roll-out of new engines, led in particular by the Trent XWB, Trent 1000 and Trent 7000, together with a growing aftermarket, is expected to drive significant revenue growth over the next ten years as we build toward a 50% plus share of the installed widebody passenger market. While the impact of the transition to the Trent 7000 has reduced Trent 700 deliveries, and will hold back Civil Aerospace profit in the near term, we are confident that the important investments we are making to transition our production will create a strong platform to drive customer service, improved margins and strong cash flows. Individual outlooks are provided for each business in the Business review. Our 2014 and 2015 initiatives to reduce manufacturing and back office costs within Aerospace and Marine are on track to reduce costs by £145m by the end of 2017. In addition, we have made a good start to the transformation programme that will add pace and simplify our business, and create incremental enduring cost savings of between £150m and £200m per annum from the end of 2017 onwards. These initiatives will make us a more efficient and resilient business. At the same time, we will continue to invest appropriately to strengthen our engineering and operational excellence and aftermarket products and services. We have started the journey that will return the Company to its long-term trend of profitable growth. 14 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Strategic priorities OUR STRATEGIC PRIORITIES GOING FORWARD VISION – BETTER POWER FOR A CHANGING WORLD ‘…to be the market leader in high-performance power systems where our engineering expertise, global reach and deep industry knowledge deliver outstanding customer relationships and sustainable solutions.’ STRATEGIC FOCUS – OUR PRIORITIES FOR DEVELOPING THE BUSINESS ‘…focus on differentiated, mission-critical power systems which create high barriers to entry in our chosen markets. Leverage world-leading engineering, operational and customer service excellence to drive growing market shares, capture long-term aftermarket value and deliver profitable growth.’ 1 Engineering excellence 2 Operational excellence 3 Capturing aftermarket value Investing in and developing the excellence of our engineering to produce high-performance power systems Transforming our manufacturing and supply chain to embed a lean approach across our facilities and processes Leveraging our installed base, product knowledge and capabilities to provide outstanding services to customers Underpinned by a commitment to developing our people and our culture in a safe and ethical environment. Rolls-Royce Holdings plc Annual Report 2015 15 Strategic Report Strategic Report / Chief Executive’s review Business model Chief Executive’s review / Business model OUR BUSINESS MODEL Our business model is to capture value from markets for high-performance power. We do this by developing advanced, integrated power and propulsion systems and providing long-term aftermarket support and delivery of outstanding customer services. Our long-life products operate in challenging environments where they are expected to deliver sustained levels of differentiated performance. They deliver value to customers through outstanding power or other performance capabilities, together with greater fuel efficiency and mission-critical reliability. This is often combined with a flexible service offering to best suit each customer’s operating needs. We make significant investments in advanced technology and engineering programmes to deliver market-leading products. We seek to recoup our investment through developing superior products, many of which are selected for use on major multi-year programmes. We benefit from increasingly cost-efficient manufacturing as production levels rise, and by securing strong aftermarket revenues. In certain markets we strengthen our customer relationships typically through long-term service agreements where we commit to deliver exceptional standards of service, including high levels of product operational availability. This provides significant value to customers and in return we achieve long-term predictable revenues. By growing our installed base of power systems over time and leveraging our aftermarket service activities, we enhance revenue, profit and cash flow. Cash flow is then invested to support future product development and technology programmes to drive growth while providing good shareholder returns. Invest in R&D and skilled people Developing and protecting leading-edge technology and deploying it across our businesses allows us to compete on a global basis and creates high barriers to entry. Design and make world-class products We differentiate on performance. We win and retain customers by developing and delivering products that provide more capability and offer better through-life value than those of our competitors. Manufacturing capability We manufacture cost-efficiently through a combination of economies of scale, developing a lean enterprise and integrated management of our supply chain. S t r a t e g i c R e p o r t Develop technology that anticipates customer needs Our deep understanding of customer needs drives the development of new technologies and products. 1 Engineering excellence 2 Operational excellence Industry-leading R&D Strong supply chain partnerships Proven mission-critical reliability Exceptional long-life products Differentiated product performance Sustained cost reduction Transforming to world-class production capability Cost-focused lean enterprise High-performance culture 3 Capturing aftermarket value Long-term relationships with civil and defence customers Decades of in-service experience Flexible range of service offerings Growing installed base and global service footprint Grow market share and installed base Our substantial order book for both original equipment and services provides good visibility of future revenues and provides a firm foundation to invest with confidence. Disciplined capital allocation We allocate our capital to achieve a balance of financial strength and liquidity to deliver commercial advantage and sustainable long-term shareholder returns. Investment in future programme development We make significant investment in development programmes which we believe will deliver cost-efficient and competitive next-generation products. Secure and maximise service opportunity Our equipment is in service for decades. Our deep design knowledge and in-service experience ensures that we are best placed to optimise product performance and availability. 16 Rolls-Royce Holdings plc Annual Report 2015 Rolls-Royce Holdings plc Annual Report 2015 17 Strategic Report / Chief Executive’s review Engineering and innovation ENGINEERING OUR FUTURE INVESTING IN PEOPLE AND SKILLS 18 Rolls-Royce Holdings plc Annual Report 2015 Our investment in technology and skilled people is vital for a company that has advanced engineering at its core. Ultimately it delivers the differentiated, high-technology products that attract our customers.” Colin Smith Group President Director – Engineering & Technology throughout 2015 CREATING WORLD- CLASS TECHNOLOGY In 2015, we invested £1.2bn in gross R&D, which includes funding from governments and other bodies. £831m was from our own funds. As a result, we applied for 626 patents during the year. It is this investment that creates the intellectual property we then develop and embed in our products. We leverage our own scientific and engineering talent globally to create world-class technology and also partner with leading academic institutions. This ensures we benefit from the knowledge of renowned experts in their fields, and get the best value from our investment. READ MORE AT ROLLS-ROYCE.COM We seek to attract and retain the best and brightest engineers. We then create a culture of innovation that allows them to develop their skills. We encourage all employees to contribute to our Innovation Portal via the Company intranet. In 2015, this generated well over 1,000 ideas from which we conducted dozens of challenges. Graduates recruited in 2015 Apprentices recruited in 2015 228 277 Chief Executive’s review / Engineering and innovation £1.2bn Gross R&D investment in 2015 RESEARCH AND TECHNOLOGY CENTRES We have a network of 31 University Technology Centres (UTCs) dedicated to advancing our understanding in specialist science and technologies that are core to our business. 2015 marked the 25th anniversary of our UTC network. University Technology Centres 31 SCIENCE & TECHNOLOGY COMMITTEE REPORT P104 EXPERT KNOWLEDGE Within our engineering community, we have some of the world’s most knowledgeable people in specialist disciplines. There are over 100 members of the Rolls-Royce Fellowship (fellows and associate fellows) – each recognised as an expert in a particular field of science and technology. STEM SUPPORT We are actively engaged in supporting the study and teaching of science, technology, engineering and mathematics (STEM) subjects. The Rolls-Royce Science Prize is a prime example. This is an annual award programme that rewards excellence in science teaching – this year, we received 2,000 entries. OTHER ENGINEERS (SAFETY/TEST/ TRANSFORMATION) 2,108 ELECTRICAL ENGINEERS 1,614 MANUFACTURING ENGINEERS 3,204 SERVICES ENGINEERS 1,554 TOTAL ENGINEERS 15,690 YEAR-END DESIGN ENGINEERS 7,210 Rolls-Royce Holdings plc Annual Report 2015 19 Strategic Report Strategic Report / Chief Executive’s review Engineering and innovation ENGINEERING EXCELLENCE ...THROUGH DESIGN Structured development Lean thinking Our latest Product Development System, introduced in 2015, provides an even more rigorous and structured method for developing game-changing capabilities and embedding these across the Group. It allows us to substantially improve our performance. We further increased focus on lean thinking and behaviours during 2015, with the aim of transforming our business into a true lean enterprise. By a relentless pursuit of efficiency and continuous improvement we are seeking to empower our people to reduce waste in all its forms and deliver products and services efficiently. Our Vision 20 approach to research and development of technology over a 20-year horizon VISION 5Near-term technologies ready to embed into new products VISION 10Leading-edge and validated technologies VISION 20Emerging and as yet unproven technologies LATEST MARINE THRUSTERS Permanent magnet tunnel thrusters are now entering service. These improve efficiency and response, while reducing vibration, noise and emissions. 20 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Engineering and innovation FUTURE MAKING ...THROUGH MANUFACTURING An important part of the design process is to consider the most effective way of manufacturing the often complex components that go into our products. These considerations are an intrinsic part of design engineering for any Rolls-Royce product. Teams of design and manufacturing engineers work closely on the development of future products. Advanced Manufacturing Research Centres (AMRCs) Our growing network of seven AMRCs forms a unique resource to bridge the gap between early research and industrial application, delivering step-change improvements in product competitiveness and business performance. The network supports all our key manufacturing process technologies including additive layer manufacturing (3D printing) and advanced composites. These highly collaborative public/private partnerships are a national asset, supported by long-term government commitment and delivering benefits through the entire supply chain for both original equipment and aftermarket activities. A Trent fan disc being manufactured at our new facility in Washington, Tyne and Wear, UK. Advanced Manufacturing Research Centres 7 Rolls-Royce Holdings plc Annual Report 2015 21 Strategic Report Strategic Report / Chief Executive’s review Business review BUSINESS REVIEW Summary The Civil Aerospace business is a major manufacturer of aero engines for the commercial large aircraft and corporate jet markets. We power 35 types of commercial aircraft and have more than 13,000 engines in service around the world. CIVIL AEROSPACE Key highlights Underlying revenue mix Underlying revenue mix Underlying revenue up 3%; solid growth in aftermarket revenues offset lower new engine sales. Underlying profit before financing 14% lower than 2014; largely reflecting lower gross margins, due to adverse mix effects and higher R&D charges, partially offset by the impact of life-cycle cost improvements, retrospective long-term contract accounting benefits, a reversal of impairment of contractual aftermarket rights and lower restructuring costs. £3.8bn order book growth; led by Trent 900 and Trent XWB orders – Trent XWB now nearly 50% of order book. New Trent engines, 1000 TEN, XWB-97 and 7000, on track for entry into service in 2017 and 2018. Good progress modernising supply chain to reduce costs and increase capacity for Trent XWB ramp up over next four years. OE revenue Services revenue 47% 53% Underlying revenue by sector Underlying revenue by sector Large engines Small & medium 63% 37% Trent 1000 in service A Trent 1000 engine seen here on an Air New Zealand Boeing 787-9 aircraft. 22 Rolls-Royce Holdings plc Annual Report 2015 OPERATIONAL REVIEW Overall, underlying revenue for Civil Aerospace grew 3% on a constant currency basis (up 1% at actual rates) with steady growth in services (up 9% at constant rates, including a £189m one-off benefit discussed below) which more than offset the reduction in original equipment (down 3% at constant rates). Second-half growth was particularly strong as the business improved original equipment delivery performance on a number of programmes, notably in corporate jets. Original equipment revenues from widebody engines: linked and other reduced 11% reflecting a slow-down in linked Trent 700 deliveries for the Airbus A330 ahead of the introduction of the Trent 7000 for the A330neo, together with reduced sales of linked Trent 900 engines for the Airbus A380, partly offset by increased linked Trent 1000 engine sales for the Boeing 787 Dreamliner. In addition, sales of spare engines to joint ventures generated revenue of £189m (2014: £138m). Original equipment revenues from unlinked widebody engines increased by 29%, largely a result of an increase in unlinked Trent XWB and other Trent engine deliveries. The 17% increase in widebody services revenue was mainly driven by increased flying hours from our growing fleet of installed Trent 700, Trent 900 and Trent 1000 engines and a £189m one-off benefit resulting from refining the basis for taking account of risk in our forecasts of future revenue on long-term contracts. This was partially offset by lower utilisation of some of our more mature engine types, notably the Trent 500 and Trent 800. Chief Executive’s review / Business review proportion of linked Trent 700 engine sales, weaker corporate jet engine volumes and a declining regional aftermarket, partially offset by £16m higher gross margin contribution from sales of spare engines to joint ventures (£67m in 2015 compared to £51m in 2014). In addition, these factors were partially offset by a number of contract accounting adjustments and reversals of impairments and provisions. The in-year benefit of retrospective long-term contract accounting adjustments as expected was a net positive of £222m (2014: total benefit of £150m). Of this, £189m was a one-off benefit resulting from refining the basis for taking account of risk in our forecasts of future revenue. In 2012, it was agreed with the Group Audit Committee that a comprehensive review would be completed during 2015. The new enhanced methodology should better reflect risk, current experience and expected long-term performance. Other long-term contract accounting adjustments totalled a net benefit of £33m (2014: total benefit of £150m). This comprised a retrospective charge of £107m (2014: benefit of £90m), reflecting reduced customer fleet utilisation, mainly in respect of the Trent 500 and Trent 800, other commercial changes and technical risks, offset by the benefit of £140m (2014: benefit of £60m) from life-cycle cost improvements. Full-year performance also benefited from the reversal of previously recognised impairments on contractual aftermarket rights (CARs) and release of a related provision with a profit of £65m being recognised (2014: impairment charge of £19m). This reflected a significantly more positive outlook for future maintenance costs for a Trent 1000 launch customer which enabled the reversal of a previous impairment. This also resulted in the capitalisation of £22m of 2015 CARs that would otherwise have been impaired. Costs below gross margin were £5m lower than the previous year. Within this, R&D charges were £64m higher, reflecting increased spend on key programmes, particularly in respect of the Trent 1000 TEN, the Trent 7000 and the Trent XWB-97. These engines, now in their final stages of preparation before flight testing, are due to enter service in 2017 and 2018. They represent a significant advance on previous Trent designs, providing substantial fuel burn improvements. The Trent 7000 and Trent XWB-97 programmes have yet to reach a point at which their costs can be capitalised. In addition, following its successful entry into service, continuing investment in the Trent XWB-84 engine can no longer be capitalised. Investment also increased to develop future corporate jet engine technology. 2014 63,229 739 6,837 3,463 3,374 1,675 24.5% (283) (82) (461) 93 942 13.8% Underlying change 3,800 (27) 201 +3% (117) -3% 318 +9% (139) -270 bps (14) 75 (65) 8 (135) -14% -230 bps Acquisitions & disposals – – – – – – – – – – – – – – – – – Foreign exchange – – (105) -2% (88) -3% (17) +1% (10) – 1 – 11 3 5 – – 2015 67,029 712 6,933 +1% 3,258 -6% 3,675 +9% 1,526 22.0% (296) (7) (515) 104 812 -14% 11.7% Within our corporate engine business we had good revenue growth from our BR725 engine which powers the Gulfstream G650 and G650ER. This was offset by lower volumes for our other products due to weaker demand from Chinese, Russian and Brazilian customers. As a result, corporate original equipment revenues declined 1%. Despite a reduction in new corporate engine deliveries, our installed base of corporate jet engines continued to grow, contributing to a 13% increase in services revenues from these products. Services revenues from our regional jet engines declined 14%, reflecting retirements and reduced utilisation of relevant fleets by North American operators. On the V2500 programme, original equipment revenues declined 9% due to reduced demand from International Aero Engines (IAE) for V2500 modules to power the Airbus A320ceo, reflecting a mix change in engine types powering the aircraft ahead of the introduction of the A320neo. Despite continued growth in the installed base of engines, services revenues on the V2500 were down 1% overall reflecting a combination of fewer overhauls, lower spare parts sales and reduced engine flying hours. Overall gross margins for Civil Aerospace were 22.0% (2014: 24.5%). The year-on-year reduction in margin of £139m reflected the lower CIVIL AEROSPACE / KEY FINANCIAL DATA Order book Engine deliveries Underlying revenue Change Underlying OE revenue* Change Underlying services revenue* Change Underlying gross margin Gross margin % Commercial and administrative costs Restructuring costs Research and development costs Joint ventures and associates Underlying profit before financing Change Underlying operating margin * The methodology basis for the allocation of Civil Aerospace revenues on linked TotalCare contracts between original equipment and aftermarket has been reviewed and amendments made to reflect better the commercial substance of the combined contracts. Historically, the allocation has resulted in original equipment revenue and aftermarket revenue reflecting the contractual terms rather than the commercial substance of the contracts. The 2014 figures have been restated on the same basis; the impact was an increase in original equipment revenue of £198m and an equal decrease in aftermarket revenue Rolls-Royce Holdings plc Annual Report 2015 23 Strategic Report Strategic Report / Chief Executive’s review Business review The R&D charge was reduced by £94m (2014: £71m) by the recognition of entry fees receivable from risk and revenue sharing arrangements (RRSA). Underlying corporate, administration and other costs were £14m higher. Restructuring costs were £75m lower reflecting the significant charges taken in 2014. As a result, profit before financing and tax was 14% down, reflecting a combination of lower overall gross margins, increased R&D and reduced restructuring costs. Taking account of foreign exchange effects, underlying profit before financing and tax was £812m (2014: £942m). Trading cash flow before working capital movements improved year-on-year by £48m, despite the headline drop in underlying profit before financing of £130m and the higher level of CARs additions. This is largely due to a reduced level of property, plant and equipment additions and a lower spend on certification costs and participation fees. The £286m year-on-year difference in working capital movements was largely due to differences in the timing of payments to suppliers and increased draw down of deposits in 2015. Investment and business development Order intake of £12.8bn in 2015 for Civil Aerospace was £1.1bn up on the previous year. As a result, the order book closed at £67.0bn, up £3.8bn or 6% on the previous year. Significant orders during the year included our largest ever order by value to provide Trent 900 engines and TotalCare service support for 50 Airbus A380s for Emirates worth $9.2bn of which $6.1bn is recognised within the order book. Other major orders included Trent 1000 engines to power 21 Boeing 787 Dreamliner aircraft and long-term TotalCare support for Air China and Ethiopian Airlines, and a $2.4bn order for engines and services with HNA Group. Engineering excellence remains the cornerstone of our value to Civil Aerospace customers Several important engineering milestones were achieved during 2015. For widebody engines, the focus has been on completing the development and testing of the new Trent 1000 TEN and the Trent XWB-97. The results of initial tests on both engines are broadly in line with expectations. In December 2015, the Trent XWB-97 flew for the first time and has since undergone rigorous testing in a number of conditions. The Trent 1000 TEN has also completed several major milestones. In addition, a hybrid Trent 7000, produced to de-risk the development programme, ran for the first CIVIL AEROSPACE / NEW DISCLOSURE ON REVENUE SEGMENTATION Underlying revenue Underlying OE revenue Widebody engines: linked and other Widebody engines: unlinked installed Corporate (and other small engines) V2500 Underlying services revenue Widebody engines Corporate Regional V2500 2014 % 100% 51% 26% 6% 14% 5% 49% 30% 6% 6% 7% £m 6,837 3,463 1,766 392 974 331 3,374 2,029 383 427 535 Underlying change 201 (117) (191) 114 (9) (31) 318 336 50 (61) (7) CIVIL AEROSPACE / NEW DISCLOSURE ON TRADING CASH FLOW £m Underlying profit before financing Depreciation and amortisation Sub-total CARs additions Property, plant, equipment and other intangibles Other timing differences* Trading cash flow pre-working capital movements Net long-term contract debtor movements Other working capital movements Trading cash flow** Foreign exchange (105) (88) (5) (2) (62) (19) (17) 6 (8) (6) (9) 2015 812 410 1,222 (161) (502) (75) 484 (406) (78) 0 2015 % 100% 48% 23% 7% 14% 4% 52% 34% 6% 5% 7% 2014 942 381 1,323 (86) (748) (53) 436 (463) 208 181 £m 6,933 3,258 1,570 504 903 281 3,675 2,371 425 360 519 Change (130) 29 (101) (75) 246 (22) 48 57 (286) (181) * Includes timing differences between underlying profit before financing and cash associated with: joint venture profits less dividends received; provision charges higher/ (lower) than cash payments; non-underlying cash and profit timing differences (including restructuring); and financial assets and liabilities movements ** Trading cash flow is cash flow before: deficit contributions to the pension fund; taxes; payments to shareholders; foreign exchange on cash balances; and acquisitions and disposals 24 Rolls-Royce Holdings plc Annual Report 2015 time and is now being put through its paces with a series of rigorous tests. bringing us closer to our customers, working in their time-zones. For corporate jets, developments in the year were more modest. Strong orders for the BR725 have sustained steady original equipment volumes as the new Gulfstream G650ER entered service, despite a weakening market. Failure in past years to secure new positions on some important new corporate jet platforms contributed to a weak order intake in the year which will impact future volumes and revenues adversely. As part of our technology strategy, investments are being made to secure future opportunities and regain its position as the leading provider to the important market of large-cabin, long-range corporate jets. Investing in new aerospace supply chain capabilities to help drive operational excellence As part of the supply chain transformation underway in the business, several important new facilities were completed during the year. These included the opening of our Advanced Blade Casting Facility in Rotherham, UK, which will halve the time it takes to manufacture turbine blades, and an expansion of our Trent XWB production centre in Derby. We also announced plans to invest in our facility in Inchinnan to create a new Centre of Competence for manufacturing aerofoils and established a joint venture with Liebherr to develop manufacturing capability and capacity for the power gearbox for our UltraFan™ demonstrator programme. Strengthening our aerospace aftermarket service offering During 2015, we broadened our service offering and strengthened our support network to provide customers with greater choice, flexibility and capability at all stages of the engine lifecycle, supporting a growing installed base. This included making improvements to our Trent service network which will result in increased competition among our Approved Maintenance Centres (AMCs) and the announcement of our first independent AMC, Delta TechOps. We have also set up a global network of Customer Service Centres, We launched a new service, SelectCare™, which fits between our comprehensive TotalCare and general maintenance, repair and overhaul services, where customers contract for individual shop visit support. At the same time, we announced American Airlines as the launch customer. We also announced our first customers for TotalCare Flex®, a new service targeting owners and operators of more mature engines. Cathay Pacific, AerCap, South African Airways and BMI Regional chose the service for Trent 800, Trent 500 and AE 3007 engines. Civil Aerospace outlook As we set out in November 2015, we believe the long-term outlook for Civil Aerospace remains very good, led by a strong widebody order book for fuel efficient engines. Key to the long-term success of the business is converting this exceptional order book into a large installed base of engines that meet customer demands for safe, reliable, efficient operation while driving profitable engine flying hour revenues. The next few years will be very important as we ramp up production of new engines – in new, efficient facilities – and invest in the development of future engine platforms that will benefit the order book from 2020 onwards. As a result, until we gain additional aftermarket scale, or complete our industrial transformation and improve unit costs and cash margins, the business will continue to be a net investor of cash. Over the next few years the transition from ‘linked’ to ‘unlinked’ contracts creates a headwind to reported profit but no change to cash flows. In the future, an increasing proportion of our new engines will be sold to the airframer on a sole-source basis, in particular the new Trent XWB and Trent 7000 for use on the Airbus A350 and A330neo respectively. As a result, a significantly larger proportion of our sales in the future will be accounted for on an ‘unlinked’ basis. While this does not change cash flows, it does change the timing of when profit is recognised across the OE and aftermarket contracts. Under ‘unlinked’ accounting, the engine sale and aftermarket contracts are accounted for separately. Chief Executive’s review / Business review Engines delivered in 2015 >700 This typically results in lower upfront profit recognition on engine delivery, with significantly higher proportion of profit in the aftermarket period. This is in comparison to ‘linked’ accounting, where a blended margin is applied across the engine sale and aftermarket contracts. Near-term conditions in some segments remain challenging. We continue to expect our Civil Aerospace business to underperform 2015 underlying profit before finance and tax by around £550m. The significant headwinds related to Trent 700 volume reductions and the non-recurrence of a number of one-off benefits seen in 2015 remain broadly unchanged. In addition, we still expect to see weaker demand for new corporate jets and declines in demand within our regional jet aftermarket. The aftermarket benefit of higher levels of engine deliveries and increased installed thrust is expected to be largely offset by the underutilisation of older large engines. However, the business will benefit from reduced costs from the restructuring initiatives started in 2014. We now expect the TotalCare net asset to grow from £2.2bn and peak at around £2.5bn, allowing for a more positive demand outlook for our ‘linked’ accounted engines and the benefit of further life-cycle cost improvements now being seen in engine performance. Rolls-Royce Holdings plc Annual Report 2015 25 Strategic Report Strategic Report / Chief Executive’s review Business review Market dynamics • Overall there has been a slowdown in all major geographical markets for new aircraft orders reflecting a period of higher than normal order placement for new airframe products in recent years (principally Airbus A350 and A330neo, and Boeing 787 and 777X). • Long-term growth in the number of widebody aircraft in the global fleet has historically been strongly correlated to global GDP growth. • Asia and the Middle East are strong drivers of growth, correlating to their regional GDP growth. • Historically, growth has recovered quickly following major economic shocks. • Our current share in the widebody engine market is at 31% of the installed widebody passenger fleet and is expected to reach 50% early in the next decade. • Older widebody aircraft are experiencing reduced utilisation by certain airlines, in particular Boeing 777s and Airbus A340s. • The re-engining of the A330, announced in summer 2014, reduced Trent 700 sales ahead of the new Trent 7000 entering service in 2017 as the sole source engine for A330neo. • Over 90% of Rolls-Royce large engine fleet is covered by our TotalCare service agreements. • We are the market leader in large business jet aircraft engines, with 55% market share of the large/very large business jet market in 2015. • Over 65% of Rolls-Royce business jet engines are covered by our CorporateCare® service agreements. • Demand for large business jets is related to global economic growth and increases in the number of high net-worth individuals; the sector has historically been fairly resilient to financial shocks. • The current business jet market is slowly recovering in the US (our largest market), but is currently going through a slowdown elsewhere due to political tensions and customer anticipation of new models about to enter into service. Overall, this sector is expected to grow faster than global GDP in the long term. • In the regional sector, aftermarket demand for engines on 50-70 seat aircraft is reducing as aircraft approach the end of their lives. Business risks Competition • If we experience a major product failure in service, then this could result in loss of life and critical damage to our reputation. • If an external event or severe economic downturn significantly reduces air travel, then our financial performance may be impacted. • If our airframer customers significantly delay their production rates, then our financial performance may be impacted. • If we fail to achieve cost reductions at the necessary pace, then our ability to invest in future programmes and technology may be reduced. • If we experience significant pricing pressure from increased competitor challenge in our key markets, then our financial performance may be impacted. • If we suffer a major disruption in our supply chain, then our delivery schedules may be delayed, damaging our financial performance and reputation. • If there are significant changes to the regulatory environment for the airline industry, then our market position may be impacted. • GE is the main competitor supplying engines in the widebody sector. In 2015, deliveries of engines for widebody passenger aircraft were split Rolls-Royce 38%, GE 54%, Pratt & Whitney 2%, and Engine Alliance 6%. • Rolls-Royce is well positioned on all Airbus widebody airliner programmes and competes with GE on the Boeing 787 family. • Rolls-Royce is the sole engine provider on the Airbus A350 XWB family where 775 aircraft have been ordered so far. • GE is the sole engine provider on the Boeing 777X aircraft, scheduled to enter into service in 2020 where 306 have been ordered so far. • In large business jets the main competition is GE, Pratt & Whitney and Safran; in 2015 the GE-Honda joint venture entered the market in very low thrust engines. • Rolls-Royce has 3,100 powered business jets flying, representing 55% market share of the large/very large business jet fleet. MARKET REVIEW Rolls-Royce is one of the world’s leading civil aero-engine manufacturers with particular strengths in engines for civil widebody aircraft and large business jets, underpinned by our strength and continued investment in technology. We are market leaders in the large business jet fleet market powering aircraft from most of the main airframers. We have a strong market position on widebody aircraft produced by the world’s two major airframers: Boeing and Airbus, who are broadly consistent in forecasting traffic growth (Revenue Passenger Kilometres) of approximately 5% CAGR over the next 20 years. In the engine market for narrowbody aircraft, we continue to supply some parts and services for the IAE V2500 engine family. Potential for OE and services over the next 20 years Civil Aerospace – all sectors $1,720bn Original equipment $1,110bn Aftermarket $610bn 26 Rolls-Royce Holdings plc Annual Report 2015 Opportunities • Our position and long-term prospects in the widebody sector are strong across our Trent family. • The Trent XWB has successfully completed its first year in service and the new Trent XWB-97 engine made its first test flight in November 2015 and is on schedule to enter into service in 2017. • The new Trent 7000 is scheduled to enter into service in 2017 on the A330neo. We have sole source on this platform which will replace the A330, on which we are one of three engine providers. • We will be introducing the new Trent 1000 TEN in 2017 for the Boeing 787. On the 787, Rolls-Royce engines have been selected for 42% of the current order book. • A potential significant new entrant into the civil sector is China’s COMAC which is developing a narrowbody aircraft for entry into service towards the end of the decade. COMAC is also planning a joint programme with Russia’s UAC to develop a widebody aircraft, targeting entry into service around 2025. We remain in close dialogue with COMAC and UAC to understand their plans and whether their widebody programme presents an opportunity for Rolls-Royce. • Our business jet market share is likely to fall in the medium term with the success of new entrants into the large/very large sector, but the market remains attractive and we will continue to invest to improve our position and retain leadership. Key Rolls-Royce differentiators • Barriers to entry are extremely high in the civil sector. We invest heavily to maintain market leading technologies and system level integration capabilities to deliver the best engine performance for our customers. We offer a wide range of aftermarket services which provide flexible and cost-effective options to our customers and build long-term customer relationships. Chief Executive’s review / Business review Exemplary year for Trent XWB On 15 January 2016, the world’s most efficient aero engine completed its first year in service. The Trent XWB on the A350 XWB airliner achieved the milestone in style having delivered outstanding performance over its first 12 months of operation, with launch customer Qatar Airways. The engine lived up to its credentials in terms of being the most efficient engine ever and the Trent XWB also managed to claim the crown of being the most reliable engine with a dispatch rate of 99.83%. Designed as the next generation of medium-/long-haul airliners, the A350 is an all-new family of aircraft from Airbus. The Trent XWB engine represents the largest single element of our £76.4bn order book by some margin. Over 1,500 of the engines have been ordered by more than 40 airlines, from important existing customers and from new Rolls-Royce customers all over the world. READ MORE AT ROLLS-ROYCE.COM Rolls-Royce Holdings plc Annual Report 2015 27 Strategic Report Strategic Report / Chief Executive’s review Business review Summary We are a leading engine maker for the military transport market and the second largest provider of defence aero-engine products and services globally. Defence has 16,000 engines in service with 160 customers in over 100 countries. DEFENCE AEROSPACE Key highlights Underlying revenue mix Underlying revenue mix Underlying revenue 5% lower; revenues impacted by weaker helicopter and trainer volumes, partially offset by higher combat original equipment sales. Underlying profit before financing up 4%; steady gross margin and lower restructuring costs offset higher R&D charges. Strong positions in transport and patrol, and combat underpin outlook for a steady performance in 2016. Major five-year $600m investment in Indianapolis, US, to improve cost base and benefit long-term growth. OE revenue Services revenue 39% 61% Underlying revenue by sector Underlying revenue by sector F-35B Lightning II The F-35B aircraft, which employs the Rolls-Royce LiftSystem, was declared operational in 2015. Combat Transport and patrol Other 36% 43% 21% OPERATIONAL REVIEW Underlying revenue at £2,035m was 5% lower on a constant currency basis (down 2% at actual exchange rates). Lower original equipment volumes for helicopters and trainers were partially offset by growth in LiftSystem™ volumes. Aftermarket revenues reflected lower volumes on helicopter spares partially offset by higher revenues related to long-term service agreements for UK combat aircraft. Despite the reduced revenues, gross margin improved to 28.5%. Lower helicopter volumes and lower margins on some transport contract extensions were offset by higher LiftSystem volumes and increased retrospective margin improvements of £101m (2014: £53m) on existing long-term contracts. These relate to various combat platforms, where overall profitability has been improved by changed flying patterns and lower service costs, including approximately £40m (2014: £nil) due to one-off contract and scope variations. Overall R&D costs were £20m higher in 2015 reflecting increased investment in new programmes. Restructuring costs were lower due to reduced level of severance costs and lower costs related to changing our operational footprint. Underlying profit before financing of £393m was 4% up on the prior year on a constant currency basis, reflecting the lower volumes, the one-off margin improvements, increased R&D charges and lower restructuring charges. As a result, operating margin improved by 170 basis points to 19.3%. 28 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Business review Free cash flow from Defence Aerospace is expected to remain strong in the longer term, reflecting the high proportion of aftermarket revenues. However, in the coming year free cash flow is expected to be lower reflecting the increased cost of investment and the run out of costs on key UK programmes where deposits have been received in advance of delivery. Investment in US facilities $600m Long term, it remains essential that we have a cost-efficient supply chain to support the profitable growth of our business in a competitive market. To support future business competitiveness we initiated a major $600m investment in the upgrading of our Indianapolis facility, which will bring a combination of cost reductions, operational efficiencies and greater development capabilities for defence technologies. This investment recognises the importance of the US market and our strong position there. Defence Aerospace outlook The long-term outlook for Defence Aerospace remains positive with good opportunities to capitalise on its strong positions in transport and patrol and combat. Investment in developing new advanced technologies will be a feature of R&D for the next few years as the business ensures it can compete for new opportunities. The outlook for revenues in 2016 remains steady. Operating profit will be adversely impacted by the lower level of expected long-term contract benefits in 2016, together with higher R&D and operational restructuring costs. 2014 4,564 744 2,069 816 1,253 567 27.4% (112) (55) (50) 16 366 17.7% Underlying change (248) (95) (101) -5% (45) -6% (56) -5% (9) +90bps (7) 48 (20) 3 15 +4% +170bps Acquisitions & disposals – – – – – – – – – – – – – – – – – Foreign exchange – – 67 +3% 30 +4% 37 +3% 21 – (5) (1) (3) – 12 – – 2015 4,316 649 2,035 -2% 801 -2% 1,234 -2% 579 28.5% (124) (8) (73) 19 393 +7% 19.3% Rolls-Royce Holdings plc Annual Report 2015 29 Investments and business development Overall, the Defence order book declined 5%, in large part reflecting the 2014 benefit of the significant multi-year order for engines to power C-130J aircraft. With a major focus within defence budgets on cost control, 2015 saw significant interest in availability-based service contracts and also on offering efficiency upgrades. New contracts included an extension of the UK’s Hercules Integrated Operational Support contract and commitment to the UK’s Future Combat Air System (FCAS) programme. After successful first flights on US ‘Hurricane Hunter’ P-3 aircraft in May, we received strong international interest including an initial USAAF order for the T56 3.5 technology insertion kit upgrade delivering both fuel saving and performance benefits for an engine programme which has been in existence for over 50 years. Outside the UK and US markets, our particular focus has been on positioning ourselves to be competitive for forthcoming combat programmes. We had success in South Korea in conjunction with Airbus, with the contract being awarded to power the A330 tanker fleet with Trent 700 engines, as well as agreeing an order for our largest ever number of engines – a ten-year order with Robinson to supply at least 1,000 RR300 engines. DEFENCE AEROSPACE / KEY FINANCIAL DATA £m Order book Engine deliveries Underlying revenue Change Underlying OE revenue Change Underlying services revenue Change Underlying gross margin Gross margin % Commercial and administrative costs Restructuring costs Research and development costs Joint ventures and associates Underlying profit before financing Change Underlying operating margin Strategic Report Strategic Report / Chief Executive’s review Business review Market dynamics Competition • Defence budgets are expected to show modest growth, flat in real terms in the US and UK, partially offset by growth in other emerging markets. • Western customers are seeking to reduce and minimise costs by delaying or deferring purchases, improving asset availability and extending lifecycles of aircraft/engines. • Increasing levels of economic affluence and political tension in the Asia Pacific and Middle East regions are leading to increases in both original equipment and services spend. • Revenue has historically been broadly balanced between original equipment sales and aftermarket services, biased towards the latter. • GE, Pratt & Whitney, Honeywell and Safran are the main competition in our sectors. • In Europe, large defence programmes tend to be addressed by consortia of two or more companies due to the political environment. Examples include our collaboration with ITP, MTU and Safran on the TP400 engine for the Airbus A400M and with GE Avio, ITP and MTU on the EJ200 engine for the Eurofighter Typhoon. • We support/lead sales campaigns globally on behalf of Eurojet for export sales opportunities of Eurofighter Typhoon. • Barriers to entry are high and we do not envisage the competitive landscape changing significantly in the near future. Business risks Opportunities • If we experience a major product failure in service, then this could result in loss of life and critical damage to our reputation. • The UK’s FCAS potentially a joint programme with France, presents a longer-term combat opportunity to Rolls-Royce. • If global defence spending experiences a further downturn, then our financial performance may be impacted. • Our LiftFan™ system for the F-35B is only just entering service and we expect to deliver over 400 systems in the next 20 years. • If we do not continue to invest to improve the performance and cost of our products, then we may lose market share. • If we suffer a major disruption in our supply chain, then our delivery schedules may be delayed, damaging our financial performance and reputation. • If we do not secure new applications, then our capabilities may be eroded in the long term. • Emerging markets, such as India, Turkey and South Korea are inviting bids on new combat aircraft. We estimate a potential of over 300 aircraft for these programmes. • In transport, we believe the Airbus A400M transport aircraft and V-22 Osprey have overseas sales opportunities. • We see strong growth potential for increased service provision to the military and we are well positioned with programmes such as MissionCare®. Key Rolls-Royce differentiators • We are investing heavily in technology, integration capabilities and facility modernisation to deliver capable, affordable engines for our customers. Additionally, we leverage our large installed base and strong services capabilities to provide superior and affordable service solutions. MARKET REVIEW Rolls-Royce is a market leader in defence aero engines for military transport aircraft and has strong positions in other sectors, including combat, trainer aircraft and helicopters. We are pursuing new opportunities emerging in Asia and the Middle East to mitigate flat defence budgets in the established North American and European markets. Potential for OE and services over the next 20 years Defence Aerospace – all sectors $400bn Original equipment $125bn Aftermarket $275bn 30 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Business review World leader in transport engines A KC-130J tanker-transport aircraft is seen here (above left) preparing to refuel a V-22 tiltrotor Osprey transporter. Both aircraft are in service with the US Marine Corps and both are powered by Rolls-Royce. The Lockheed Martin C-130J is one of the most reliable and versatile transport aircraft in the world (the KC-130J being the tanker version). Powered by the Rolls-Royce AE 2100 engine, the C-130J family of aircraft follows on from the original, venerable, C-130, which is still giving sterling service all over the world with its Rolls-Royce T56 powerplants. In fact, Rolls-Royce has breathed further life into the T56 by developing a new version of the engine which is delivering significant fuel savings and which the Group believes will see the T56 continue in service for many years to come. In December 2015, we announced that Rolls-Royce was one of three companies to benefit from a £369m contract to support the RAF’s C-130 fleet. The C-130J has also seen developments beyond its transport and refuelling role. One of the lessons learned in Afghanistan was the constant demand for airborne video surveillance and the requirement for a ‘quick strike’ weapon to help protect troops on the ground. The US Marine Corps turned to the KC-130J. The aircraft can loiter in the air for over ten hours thanks to the performance of its AE 2100 engines and so they armed it with a quick strike weapon that would not affect the core mission of aerial refuelling. In its tanker role, the aircraft has the ability to refuel both low-speed helicopters and high-speed jet aircraft by changing the basket on the drogue system. The aerial refuelling pods can deliver more than 12,000 US gallons of fuel and can refuel two aircraft simultaneously. In addition to the V-22 and C-130J families, Rolls-Royce also powers the Airbus A330 Voyager tanker/transport with Trent 700 engines and we are a major partner in the Europrop International consortium responsible for the design and build of the TP400 engine for the new A400M military transport aircraft. The first A400M began active service with the RAF during 2015. Rolls-Royce Holdings plc Annual Report 2015 31 Strategic Report Strategic Report / Chief Executive’s review Business review Summary Power Systems is a leading provider of high- and medium-speed reciprocating engines, complete propulsion and drive systems, distributed energy solutions and fuel injection systems. The business serves the marine, naval, land defence, rail, mining, oil & gas, construction & agriculture and power generation markets through its core brands MTU, MTU Onsite Energy, Bergen and L’Orange. Key highlights Underlying revenue mix Underlying revenue 3% lower; weaker original equipment partially offset by good growth in services. Underlying profit before financing 15% lower; led by lower gross margin. Positive outlook for 2016; healthy closing order book with good positions in key market segments. Long-term R&D investments to increase cost competitiveness in higher volume engine applications . OE revenue Services revenue 68% 32% Underlying revenue by sector POWER SYSTEMS OPERATIONAL REVIEW Underlying revenue of £2,385m was 3% lower on a constant currency basis (12% lower at actual rates). Original equipment revenue was 5% lower, reflecting weaker oil & gas markets and weaker governmental demand which peaked in 2014. This was partially offset by an improved luxury yacht demand and some recovery in our sections of the construction and agriculture market where new emissions regulations increased demand. Underlying service revenues were up 3% despite some weakness in spare parts sales in North America and Europe. Gross margins were slightly lower at 26.6% (2014: 27.3%) reflecting a change in product mix and lower overall volumes as expected. Underlying profit declined 15% as a result of the lower gross margins. On a constant currency basis costs below gross margin were unchanged. MTU diesel engine Our MTU brand is a world leader in high-speed diesel engine power. Marine Industrial Energy Defence and other 37% 21% 30% 12% 32 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Business review Closing order book £1.9bn The energy segment generated an increased order intake in 2015 reflecting good growth in gas gensets, particularly in Asia. In addition, the easing of the trading embargo with Iran is enabling the business to secure a good foothold in the country. As a result, we enjoy a strong market position within back-up power, particularly for larger mission-critical applications, which is a growing market. Recent notable orders came from Kuwait, Turkey and Bangladesh for the provision of back-up power for hospital modernisations and continuous power for a steel mill. Power Systems outlook The outlook for Power Systems remains steady. The business finished the year with a healthy order book for many of its key markets. As a result, while some markets remain difficult, we continue to expect the business to deliver modest growth in revenue and profit in 2016. 2014 1,971 2,720 1,893 827 742 27.3% (296) (7) (183) (3) 253 9.3% Underlying change (43) (72) -3% (97) -5% 25 +3% (37) -70bps (9) 3 3 3 (37) -15% -110bps Acquisitions & disposals – – – – – – – – – – – – – – – Foreign exchange – (263) -10% (178) -9% (85) -10% (70) – 30 – 18 – (22) – – 2015 1,928 2,385 -12% 1,618 -15% 767 -7% 635 26.6% (275) (4) (162) – 194 -23% 8.1% Rolls-Royce Holdings plc Annual Report 2015 33 Investment and business development Our Power Systems business serves a variety of markets ranging from marine, industrial, construction & agriculture to defence and power generation. This diversity enabled the business to mitigate some of the weak environment, particularly that linked to oil and commodities. 2015 order intake was £2.5bn (2014: £2.6bn) with the closing order book broadly unchanged at £1.9bn. Within this, the defence sector demonstrated greater resilience with a combination of a higher proportion of long-term service contracts together with the winning of the first order worth approximately €80m from the British Army for 589 MTU diesel engines for the new Scout Specialist Vehicle. Within the broad range of industrial applications, while a number of markets deteriorated through the year, there was positive news. This included contract wins from a Chinese company for 232 MTU Series 4000 engines for freight locomotives bound for South Africa, and further orders for luxury yacht engines. An extension to our longstanding co-operation with Daimler was also agreed for the development of a new range of industrial engines, which comply with new EU off-highway regulations for reduced soot emissions. POWER SYSTEMS / KEY FINANCIAL DATA £m Order book Underlying revenue Change Underlying OE revenue Change Underlying services revenue Change Underlying gross margin Gross margin % Commercial and administrative costs Restructuring costs Research and development costs Joint ventures and associates Underlying profit before financing Change Underlying operating margin Strategic Report Strategic Report / Chief Executive’s review Business review Market dynamics Competition • Population growth and increasing urbanisation • Fragmented competitor landscape in are driving rising demands for energy, resources and food and continuous infrastructure developments. ‘off-highway’ engine markets which varies depending on specific market segments – many players although a few dominate. • Global GDP development with particular • Continuing industry consolidation results growth in Asia. in strong, large scale and integrated players. • Increasing global and regional trade • Expansion of western competitors in our and transport of goods. specific core engine markets. • Competition from Asia increasingly focusing on higher power ranges where MTU operates. • While traditional competition has been limited to engine suppliers, solution providers are becoming more relevant. • Geopolitics and an increasing multipolar world are driving modest defence budget growth (1-2%) in NATO countries with more growth in emerging markets. • Increasing focus on renewable energy sources requires decentralised and clean energy solutions (eg. continuous gas and back-up power generation solutions). • Increasing environmental legislation and efficiency requirements drive emission and efficiency technologies. • Current weak environment in certain markets (eg. oil & gas and mining), due to current low oil and commodity price levels. Business risks Opportunities • Economic: some markets are currently • Regional growth, eg. Asia, through leveraging affected by low oil and commodity prices (oil & gas, mining) while some regional markets show challenges due to the current economic situation. • Political: increasing political tensions and sanctions might limit levels of global trade and customer access. • Competitive: upcoming competitors from Asia and new entrants into our existing markets can potentially put pressure on volumes and margins. • Technological: complementary technologies might replace existing solutions eg. energy storage for back-up power. partner companies. • Continuous development into clean propulsion and energy solutions which are compliant with new emissions regulations. • Development of efficiency solutions, eg. e-drive/ hybrid drives and fuel diversification towards gas/dual-fuel. • Enhancement of system competence and solutions to create customer value through optimised total system functionality and performance. • Expansion of service portfolio, customised offerings and intelligent applications and services. Key Rolls-Royce differentiators • Technology leadership and reputation with market-leading performance and system approach especially in mission-critical applications; new product innovation (eg. hybrid/e-drive); and high level of customisation. MARKET REVIEW The markets served by Power Systems are driven by global megatrends such as increasing population growth, rising energy, resource and food demand, increasing and stricter emissions legislation and government defence budgets. Despite the current market downturn in some of our markets, most noticeably in oil & gas and offshore, we expect long-term recovery in these and continuous growth in all of our markets. We estimate that Power Systems ‘off-highway’ reciprocating engine markets offer an opportunity of £650bn. Potential for OE and services over the next 20 years Power Systems – all sectors £650bn 34 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Business review High-efficiency power for trains Hybrid rail technology is the energy-saving combination of a conventional diesel engine and an electric drive system. The recovery of the kinetic energy in braking mode is extremely energy- and cost-efficient, particularly in stop-and-go situations on local public transport lines where there are a large number of stops and on inclined rail sections on hilly terrains. In 2015, for the first time, MTU performed its own tests on a hybrid train. During the tests, fuel consumption was shown to be reduced by more than 23% compared to straightforward diesel mode. Under optimum conditions, MTU believes fuel savings of 25% or more are possible. During 2015, Rolls-Royce completed further trials on its hybrid drive power system, the result of five years of pioneering work. A conventional MTU railway PowerPack combines all the individual elements needed for power and efficiency into a single functional unit mounted on a supporting frame. MTU has delivered more than 6,000 of these PowerPacks to the rail industry. The MTU hybrid PowerPack combines the benefits of a conventional diesel system with an electric propulsion module, energy storage and propulsion control system. The basic idea of hybrid rail technology is that the kinetic energy initially generated by the diesel engine is recovered via an electric motor operating as an electric brake. This energy is stored chemically in a powerful battery for later use. Rolls-Royce Holdings plc Annual Report 2015 35 Strategic Report Strategic Report / Chief Executive’s review Business review Summary Marine is a leading provider of complex and integrated propulsion and handling systems to the maritime offshore, merchant and naval markets. The product offering ranges from individual items of equipment to integrated systems and flexible mission-critical solutions, including complete vessel designs. The business has more than 4,000 customers. Seventy naval forces and over 30,000 commercial vessels use our equipment. Key highlights Underlying revenue mix Underlying revenue down 16%; weak offshore markets impacting both OE and aftermarket revenues. Underlying profit before financing down 94%; significant reduction in gross margin, led by lower volumes, and higher restructuring costs only partially offset by reduced commercial and administration costs. Challenging outlook for 2016; led by reduced demand in offshore oil & gas markets. Launched two restructuring programmes in 2015 focused on manufacturing footprint and back-office functions; expected benefits to start to accrue from 2016 onwards. OE revenue Services revenue 58% 42% Underlying revenue by sector MARINE OPERATIONAL REVIEW Underlying revenue of £1,324m was 16% lower on a constant currency basis (down 23% at actual rates). Within this, original equipment revenues were 19% down at £773m. Service revenues were more robust, although still declined 10%. This reflected weaknesses in offshore and merchant, as ship owners deferred overhaul and maintenance on the back of reduced utilisation of their vessels. As a result of the revenue weaknesses, price pressure and cost under-recovery, gross margins declined 500 basis points to 19.6% and overall gross margin was £260m, £139m lower than in 2014. As a result, with only modest reductions to date being achieved in corporate, administration and other costs, underlying profit was £15m, 94% down on a constant currency basis. Around £15m of restructuring charges were incurred in 2015 and excluding these, underlying profit declined 83%. In the first half we took a non-underlying charge of £69m for the impairment of goodwill on two of our businesses owing to a less favourable business outlook, partly driven by the impact of market deteriorations on our offshore businesses. Latest bridge designs Our Unified Bridge is ergonomically designed to be intuitive for crews. Merchant Offshore Naval 24% 56% 20% 36 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Business review Closing order book 26% > Marine outlook Overall the outlook for Marine remains cautious. We expect that the market will continue to be hit by low oil prices which will impact on demand for our products and services. As a result we will sustain our cost reduction programmes, focusing on manufacturing facilities, supply chain and overhead costs, in order to drive a more competitive business while also adapting to volume risks. As set out in November 2015, we expect the net impact of weak trading conditions and cost saving initiatives to result in 2016 profits being between £75m and £100m lower than those achieved in 2015. As a result, the business is expected to be significantly loss making in 2016. ship equipment for a dive support vessel. We also saw demand from non-oil related sectors such as wind farm support and fishing trawlers. Activity within our target merchant sectors was subdued, but we made progress in our strategy of developing markets for offshore derived technologies within specialist areas such as azimuth propulsion systems for double-ended ferries. We also delivered Asia’s first LNG-powered tug and the first of two all-gas powered cargo vessels for a Norwegian transport company. The naval business was focused on further development work and deliveries against contracts in both the UK and US. These included the first DDG 1000 multi-mission destroyer class for the US Navy and the world’s largest, gas turbine engines, the MT30 for the UK’s two new aircraft carriers. We also signed a contract to supply MT30s for operation on the first three of the Royal Navy’s new Type 26 Global Combat Ship. Product development work within the business included expanding the range of permanent magnet-based propulsion systems, as well as spearheading research into our pioneering ship intelligence technology focused on data-driven value- added services. 2014 1,567 1,709 1,070 639 425 24.9% (254) (4) (29) 138 8.1% Underlying change (403) (269) -16% (204) -19% (65) -10% (139) -500bps 27 (16) (2) (130) -94% -750bps Acquisitions & disposals – – – – – – – – – – – – – – – Foreign exchange – (116) -7% (93) -9% (23) -4% (26) – 26 4 3 7 – – 2015 1,164 1,324 -23% 773 -28% 551 -14% 260 19.6% (201) (16) (28) 15 -89% 1.1% Rolls-Royce Holdings plc Annual Report 2015 37 Investment and business development The focus in 2015 has been on repositioning the Marine business to reflect the very challenging market environment and outlook. During the year, we also announced a number of restructuring programmes that will in total lead to the loss of around 1,000 employees in operations and back-office functions as we shrink our Northern European footprint, reduce indirect headcount, and consolidate manufacturing activity. This will deliver projected cost savings of £65m per annum from 2017 onwards and create a business better able to compete in an increasingly cost-conscious market place which is geographically shifting towards Asia. Overall, the Marine order book declined 26% during the year, mainly reflecting a very weak offshore market, particularly in Northern Europe. Orders for new vessels, projects and services were all sharply lower than 2014 and as a result order intake was only £997m, 45% down on the previous year. The offshore market was extremely weak reflecting a low oil price and reduced capital expenditure within the upstream oil exploration and related services sectors. Targeted investment in R&D and improving our Asian position saw progress later in the year with two major orders from China. These comprised an equipment contract for nine tug supply vessels and a package of advanced MARINE / KEY FINANCIAL DATA £m Order book Underlying revenue Change Underlying OE revenue Change Underlying services revenue Change Underlying gross margin Gross margin % Commercial and administrative costs Restructuring costs Research and development costs Underlying profit before financing Change Underlying operating margin Strategic Report Strategic Report / Chief Executive’s review Business review MARKET REVIEW In Marine, where we offer integrated ship solutions (including design, propulsion, deck machinery, automation and control, and power electrics), we forecast the market opportunity across the offshore, merchant and naval market segments to be £250bn. Market dynamics Competition • Increasing environmental legislation and system efficiency requirements. • Population growth is leading to an increasing energy and resources demand for cargo and passenger transportation in the long term. • Increasing global and regional trade and transport of goods with effects on short- sea shipping. • Major competitors fall into two groups – focus on strengthening systems capability or focus on product and technology. • Industry consolidation within recent years has resulted in the establishment of large market players. • Increasing competition from Asia, especially China. • Strong shift from traditional markets towards Asia, both in shipbuilding and operation. • Geopolitics and an increasing multipolar world • Increasing competition from industrial and electric companies driven by more focus on efficiency and electrification. results in increasing defence expenditures especially in emerging markets which stimulates demand for naval vessels. • Increased technology requirements for harsher environments, eg. deepwater. • Currently significant challenges in offshore markets due to low oil prices and weak investment signals. Business risks Opportunities • Markets: significant reduction in oil price • Capture value on more advanced vessels in offshore. • Grow in tugs, ferries and workboats and short-sea shipping in merchant segments. • Continue to leverage the joint value proposition in naval markets together with MTU. • Continue to develop clean propulsion solutions which are emission compliant to new regulations, including alternative fuels (eg. gas/dual-fuel). • Grow in integrated propulsion and electric systems. • Establish a leading position in ship intelligence. • Leverage local partnerships to generate regional growth in Asia, especially China. creates pressure in the offshore market with all customer groups seeking to reduce costs and capital commitments. • Order delays and cancellations impact our revenue, cash and profit but also put our supply chain under financial stress. • Competition: competitors react to a depressed market by cutting costs, pricing aggressively and partnering with other players. • Business continuity: the main risk is our key suppliers remaining solvent. We monitor and manage this to ensure no supplier has critical mass and maintain business continuity plans for these risks and other operational risks such as IT. • Technology: failure to invest in the right technologies to meet customer demand in the future. • Risk of product failure in the field resulting in the need for intervention to rectify the issue with financial consequences. Key Rolls-Royce differentiators • Unique domain knowledge; unique system portfolio including vessel design; joint value proposition within naval together with MTU; continuous innovation and technology leadership; and leadership in ship intelligence. Potential for OE and services over the next 20 years Marine – all sectors £250bn 38 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Business review Waterjets for fast cats These Watercat M18 multi-purpose vessels use Rolls-Royce Steel Series Kamewa waterjets to propel them at speeds of over 40 knots. These lightweight, agile boats from Marine Alutech of Finland are ideal for fast patrol and troop transportation roles. Rolls-Royce Holdings plc Annual Report 2015 39 Strategic Report Strategic Report / Chief Executive’s review Business review Summary Nuclear is a leader in propulsion system design and development for the Royal Navy’s nuclear submarine fleet and is the sole provider and technical authority, managing all aspects of plant design, safety, manufacture, performance and through-life support. In civil nuclear we provide nuclear reactor vendors and utility operators with integrated, long-term support services and solutions spanning the whole reactor lifecycle, from concept design through to obsolescence management and plant-life extension. Safety-critical systems have been supplied to around 50% of the global nuclear power plants in service. We have been a key player in the nuclear industry for more than 50 years. Key highlights Underlying revenue mix Underlying revenue 9% higher; strong service revenues led by increased submarine work. Underlying profit before financing unchanged, excluding the benefit from a £19m R&D credit; volume benefit offset by lower margins. 2016 outlook steady; focus on improving delivery performance and developing civil nuclear opportunities. Investing in the business to extend systems offering and increase service scope. Potential for OE and services in civil nuclear over the next 20 years £360bn Submarine nuclear power The Royal Navy Astute class is the latest to enter service with a Rolls-Royce designed nuclear propulsion plant. OE revenue Services revenue 37% 63% Underlying revenue by sector Submarines Civil 80% 20% 40 Rolls-Royce Holdings plc Annual Report 2015 NUCLEAR OPERATIONAL REVIEW Underlying revenue increased 9% on a constant currency basis, led by growth in both original equipment and services. In particular, growth in submarine activities was strong. Revenue growth for our instrumentation and controls businesses was also good, particularly in Europe. Despite the growth in revenue, gross margin declined by 240 basis points to 16.2% or £111m. This was largely due to increased costs on a number of projects with lower margin. Gross margin was also impacted by a reclassification of site costs from commercial, administration and other of around £7m. This favourably benefited costs below gross margin which also benefited from lower R&D charges as a result of an R&D credit of £19m which covered the current and the two previous years. Excluding this, underlying profit before tax was £50m, in line with the prior year. After the release, underlying profit of £70m is 40% up on the prior year. Investment and business developments The order book fell around 13%, reflecting delivery of our long-term contracts across both submarines and civil nuclear businesses. New orders were biased to the second half of the year, benefiting from the expansion of our business reach and capabilities. Our civil nuclear business focuses on multi-year projects and specialist services for what is a growing global industry. We were selected as preferred bidder by EDF to work on heat exchangers and waste treatment for the Hinkley Point C project in the UK and we were selected by Hitachi to be part of the Wylfa power station delivery team, the second nuclear power station scheduled in the UK’s new-build programme. We also won a contract to supply safety measurement systems for the entire French fleet of 900MW reactors. These mandates help to further consolidate our significant position in the European marketplace and position us well to seek further opportunities for partnerships in growing nuclear markets. In the US our acquisition of R.O.V. Technologies Inc. in March 2015 expanded our nuclear services portfolio, bringing complementary Boiling Water Reactor expertise and broadening our existing Pressurised Water Reactor remote inspection capability. Our submarine activities have concentrated on delivering against long-term contracts for the Royal Navy’s nuclear submarine fleet, including delivery of the nuclear propulsion system to power HMS Artful, the third Astute-class submarine, which was launched in August 2015. Our work on the Vanguard class included work on a refuelling programme and also the first successful upgrade to the reactor control and instrumentation update for HMS Vengeance. At the Naval Reactor Test Establishment, HMS Vulcan, the PWR2 test facility reactor was safely shut down having completed its prototyping role. Development work on the new PWR3 power plant for the Successor submarine fleet continues with contract extensions agreed in preparation ahead of the government final investment decision. MARKET REVIEW All respected global energy forecasts predict that nuclear power will continue to play a significant role in providing low-carbon, continuous and secure power. The demand for mission-critical equipment, systems and engineering services and the associated reactor support services for the civil nuclear market is forecast to be £360bn over the next 20 years. Market dynamics • Population growth and improved living standards in emerging markets are driving a rise in demand for electricity. • Within the future energy mix, low-carbon energy is expected to increase, with nuclear energy accounting for a significant share. • Growth in nuclear power generation is predominantly driven by non-OECD countries; strong growth is expected especially in China. • Solid growth in mature markets based on current operations and plant life extensions. Nuclear outlook Competition • In civil nuclear the competitor landscape is fragmented and comprises reactor vendors, original equipment manufacturers, multi-skilled companies and nuclear operators in service. • Plant operators increasingly outsource service activities. The outlook for Nuclear remains steady. Both submarines and civil nuclear enjoy long-term secure aftermarket revenues. While business development opportunities remain modest in the near-term, new power plants for the Successor together with long-term opportunities to develop relevant products for civil nuclear applications should provide incremental growth. NUCLEAR / KEY FINANCIAL DATA £m Order book Underlying revenue Change Underlying OE revenue Change Underlying services revenue Change Underlying gross margin Gross margin % Commercial and administrative costs Restructuring costs Research and development costs Underlying profit before financing Change Underlying operating margin Chief Executive’s review / Business review Business risks • Delivery: failure to meet customer expectations or regulatory requirements. • Markets: if nuclear markets do not grow as anticipated due to external or other political events then business will be diminished. • Customer strategy: if programmes are cancelled as a result of strategic decisions, such as abandonment of the UK nuclear deterrent, or vertical integration by reactor vendors, then future revenues will be diminished. • If we experience a major product failure in service, then this could result in loss of life and critical damage to our reputation. • If we suffer a major disruption in our supply chain, then our delivery schedules may be delayed, damaging our financial performance and reputation. Opportunities • Increasing the pace of growth of the civil nuclear business. • Focusing on growth regions beyond current core markets. • Strengthening our position with the rapidly growing importance of China in the civil nuclear market. • Capturing a higher share of the nuclear service market through extension of our geographic reach. Key Rolls-Royce differentiators • Unique key technology capability in defence and civil nuclear with substantial credibility (more than 50 years’ experience); broad mix of offerings over the whole lifecycle; reactor independent portfolio, capable of global reach. 2014 2,499 638 230 408 119 18.7% (61) (1) (7) 50 7.8% Underlying change (331) 56 +9% 27 +12% 29 +7% (6) -240bps 6 (1) 21 20 +40% +230bps Acquisitions & disposals – – – – – – – – – – – – – – Foreign exchange – (7) -1% (6) -3% (1) – (2) – 2 – – – – – 2015 2,168 687 +8% 251 +9% 436 +7% 111 16.2% (53) (2) 14 70 +40% 10.2% Rolls-Royce Holdings plc Annual Report 2015 41 Strategic Report Strategic Report / Chief Executive’s review Financial review DELIVER Consistent with the plans we laid out in November 2015, we have enhanced the financial disclosures for all our reporting segments to include gross margin, R&D and other costs below gross margin, as well as restructuring charges. In addition, within Civil Aerospace we have provided additional revenue segmentation and a trading cash flow breakdown. These disclosures apply to both 2014 and 2015 and should help further analysis of trading performance. Order book and order intake Underlying trading We have significantly enhanced this year’s Annual Report with additional disclosures to increase transparency and understanding.” David Smith Chief Financial Officer During the year our order book increased by £2.7bn to £76.4bn. Key orders included our record single order from Emirates for 200 Trent 900 engines which contributed $6.1bn to the order book. Throughout the year new order intake in our Marine business was very weak, driven by significant market deterioration in offshore. Overall, orders were lower in Defence and Nuclear, although we view the prospects for these businesses as unchanged, reflecting long-term orders won in previous years. Underlying Group revenue declined 1% in 2015 compared to 2014 on a constant currency basis. This reflects a 5% decline in revenue from original equipment, partially offset by a 4% increase in services revenue, led by Civil Aerospace. By business on a constant currency basis, Civil Aerospace revenue increased 3%, Defence Aerospace revenue decreased 5%, Power Systems revenue decreased 3%, Marine revenue decreased 16% and Nuclear revenue increased 9%. Underlying profit before financing of £1,492m (2014: £1,681m) was 11% lower on a constant currency basis, led by a significant reduction in Marine profit, driven by weak offshore markets in particular. Civil Aerospace was down year-on-year, although performance was helped by around £222m of retrospective benefits (2014: £150m) led by refining the basis for taking account of risk in our forecasts of GROUP TRADING SUMMARY £m Order book Underlying revenue Change Underlying OE revenue Change Underlying services revenue Change Underlying gross margin Gross margin % Corporate and administrative costs Restructuring costs Research and development costs Joint ventures and associates Underlying profit before financing Change Underlying operating margin 42 Rolls-Royce Holdings plc Annual Report 2015 2014 73,674 13,864 7,418 6,446 3,523 25.4% (1,069) (149) (730) 106 1,681 12.1% Underlying change 2,725 (96) -1% (363) -5% 267 +4% (251) -160bps 11 107 (64) 10 (187) -11% -130bps Acquisitions & disposals – – – – – – – – – – – – – – – – Foreign exchange – (414) -3% (331) -5% (83) -1% (90) – 54 3 29 2 (2) – – 2015 76,399 13,354 -4% 6,724 -9% 6,630 +3% 3,182 23.8% (1,004) (39) (765) 118 1,492 -11% 11.2% Chief Executive’s review / Financial review Underlying revenue Underlying operating margin Underlying profit before financing £13,354m 11.2% £1,492m 2014 exc £13,864m 2014 inc £14,588m £15,505m £12,209m 2013 2012 2011 y g r e n E c n i y g r e n E c x e 2014 2015 2014 exc 2014 inc 2013 2012 2011 12.1% 11.5% 11.8% 12.0% 10.7% y g r e n E c n i 2011 2012 2013 2014 y g r e n E c x e 2014 2014 exc £1,681m 2014 inc £1,678m 2013 2012 2011 2015 £1,831m £1,495m £11,277m 2011 2012 2013 2014 £1,206m 2011 2012 2013 2014 y g r e n E c n i y g r e n E c x e 2014 2015 future revenue on long-term contracts, and the reversal of previously recognised impairment on contractual aftermarket rights (CARs) and release of a related provision. Defence Aerospace delivered an improved year-on-year profit which included one-time contract benefits, led by contract extensions and reduced long-term costs. Power Systems was down year-on-year in line with our expectations on a constant currency basis as the business managed well within a number of weaker markets. Marine, as expected, was sharply lower, reflecting the weak oil & gas offshore sector and Nuclear was in line, after excluding the positive R&D credit. The R&D charge increased 11% over 2014 on a constant currency basis, largely reflecting ongoing investments in Civil Aerospace for the Trent 1000 TEN and Trent XWB-97, together with higher spending on the Trent 7000 and corporate jet programmes. In addition, we increased investment in future technology demonstrator programmes and improved emissions solutions for Power Systems applications. In addition, capitalisation of R&D declined significantly largely due to the entry Debt retirement (£m) into service of the Trent XWB-84 in January 2015 and increased recognition of entry fees. Net debt Underlying financing charges were £60m (2014: £61m). Underlying profit before tax was £1,432m (2014: £1,620m). The underlying tax charge was £351m, with an effective tax rate of 24.5% (2014: 24.0%). Free cash flow Cash capital expenditure in 2015 reduced to £479m (2014: £616m), largely reflecting lower spend on new aerospace facilities. Cash taxes were £160m (2014: £265m excluding Energy). The cash cost of defined benefit pension schemes in excess of the earnings charge was £46m (2014: £154m excluding Energy). Overall, the free cash inflow for the year was £179m (2014: inflow of £447m, adjusted for Energy). The significant decline from 2014 primarily reflects lower trading margins and adverse working capital movements. The TotalCare net asset movement year-on- year was slightly higher than expectations. The Group is committed to maintaining a robust balance sheet and a strong, investment-grade credit rating, which it believes are important when selling products which will be in service for decades. Standard & Poor’s updated its rating in January 2016 to A/negative outlook and Moody’s maintained a rating of A3/stable. At the end of 2015, the Group’s net cash balance reduced from £666m to a net debt position of £111m, reflecting the £179m positive free cash inflow, share repurchases totalling £414m and shareholder payments of £421m. Other items include residual payments related to the divestment of the Energy business and non-cash foreign exchange movements. On 6 July 2015, we announced that we had curtailed the share buyback associated with the Energy business sale at the to-date total of £500m, including the shares purchased in 2014. During the year we refinanced our revolving credit facility, increasing it to £1.5bn, and issued two new US bonds, totalling US$1.5bn. 2,000 1,500 1,000 500 0 Undrawn Drawn 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 Rolls-Royce Holdings plc Annual Report 2015 43 Strategic Report Strategic Report / Chief Executive’s review Financial review FINANCIAL REVIEW CONTINUED Results broadly in line with the expectations set out in July 2015 UNDERLYING INCOME STATEMENT £m Revenue Gross profit Commercial and administrative costs Restructuring Research and development costs Share of results of joint ventures and associates Profit before financing Net financing Profit before tax Tax Profit for the year Earnings per share (EPS) Payment to shareholders Gross R&D investment Net R&D charge SEGMENTAL ANALYSIS 2015 13,354 3,182 (1,004) (39) (765) 118 1,492 (60) 1,432 (351) 1,081 58.73p 16.37p (1,240) (765) 2014 13,864 3,523 (1,069) (149) (730) 106 1,681 (61) 1,620 (388) 1,232 65.42p 23.10p (1,249) (730) Revenue Gross profit Profit before financing £m Civil Defence Aerospace Division Power Systems Marine Nuclear Other Intra-segment Land & Sea Division Central costs Group 2015 6,933 2,035 8,968 2,385 1,324 687 96 (106) 4,386 2014 6,837 2,069 8,906 2,720 1,709 638 46 (155) 4,958 Change +96 -34 +62 -335 -385 +49 +50 +49 -572 13,354 13,864 -510 2015 1,526 579 2,105 635 260 111 64 7 1,077 3,182 2014 1,675 567 2,242 742 425 119 8 (13) 1,281 3,523 Change -149 +12 -137 -107 -165 -8 +56 +20 -204 -341 2015 812 393 1,205 194 15 70 52 7 338 (51) 1,492 2014 942 366 1,308 253 138 50 (2) (13) 426 (53) 1,681 Change -510 -341 +65 +110 -35 +12 -189 +1 -188 +37 -151 -6.69p -6.73p +9 -35 Change -130 +27 -103 -59 -123 +20 +54 +20 -88 +2 -189 Reported revenue £13,725m Reported profit before taxation £160m Net R&D as a proportion of underlying revenue 6.2% 2014 2013 2012 2011 £13,736m £15,513m £12,161m £11,124m 2011 2012 2013 2014 2015 2014 2013 2012 2011 £67m £1,759m £2,705m £1,105m 2011 2012 2013 2014 2015 2014 exc 2014 inc 2013 2012 2011 5.9% 5.8% 4.8% 4.7% 4.6% y g r e n E c n i 2011 2012 2013 2014 y g r e n E c x e 2014 2015 44 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Financial review Underlying income statement PROFIT BEFORE TAXATION £m Underlying profit before tax Mark-to-market of derivatives and related adjustments Movements on other financial instruments Effects of acquisition accounting Exceptional restructuring Acquisitions and disposals Impairment of goodwill Post-retirement scheme financing Other Reported profit before tax from continuing operations 2015 1,432 (1,065) 8 (124) (49) 2 (75) 32 (1) 160 2014 1,620 (1,258) (87) (142) (39) 8 – (29) (6) 67 Mark-to-market adjustments are principally driven by movements in the GBP:USD exchange rate which moved from 1.56 to 1.48 during 2015. Movements in other financial instruments relate entirely to financial risk and revenue sharing arrangements. The put option on the non-controlling interest in Power Systems was exercised in 2014, so this had no impact in 2015. The effects of acquisition accounting in accordance with IFRS 3 are excluded from underlying profit so that all businesses are measured on an equivalent basis. Impairment of goodwill principally relates to the Marine business. Costs associated with the substantial closure, or exit from, a site, facility or activity are classified as exceptional restructuring and excluded. Profits and losses arising on acquisitions and disposals during the year are excluded. Net financing on post-retirement schemes is excluded from underlying profit. Appropriate tax rates are applied to these adjustments, the net effect of which was an increase of £275m in the reported tax charge (2014: £237m increase, including a £64m reduction in the amount of recoverable advance corporation tax recognised). The 2014 reported results also included £142m relating to discontinued operations. Balance sheet Intangible assets (note 9) represent long-term assets of the Group. These assets decreased by £159m in the year, with additions of £408m being more than offset by amortisation of £407m, impairments to goodwill of £75m (including £69m Marine impairment reported in the first half) and exchange losses of £134m (largely relating to euro-denominated intangible assets arising from the acquisition of Rolls-Royce Power Systems AG). The CARs balance increased by £156m to £405m. The increase included £50m arising from the reversal of previously recognised impairments. During the year, following analysis of the first major overhauls of Trent 1000 engines, the recoverable amount of certain CARs has been reassessed. This demonstrated that aftermarket cash flows from these engines are better than originally assumed, arising from both operational and contractual performance improvements. Accordingly, cumulative impairments prior to 2015 of £50m have been reversed. This has resulted in the capitalisation of £22m of CARs in 2015 that would otherwise have been impaired, including £16m recognised in the interim results. The ‘Other’ category in the segmental analysis includes residual retained assets relating to the Energy business which were not included in the sale to Siemens in 2014 and a one-off intellectual property settlement of £58m. The value of these is not material to the Group. Underlying profit before financing and taxation is discussed in the Business review on pages 22 to 41. Underlying financing costs were stable versus 2014. An increase in net interest of £13m was offset by changes in other underlying financing costs. An underlying foreign exchange gain of £34m is included, arising from realised gains on foreign exchange contracts settled to translate overseas dividends into sterling. Underlying taxation was £351m, an underlying tax rate of 24.5% compared with 24.0% in 2014. Underlying EPS was lower reflecting the reduction in underlying profit after tax, partially offset by a reduction in the average number of shares as a result of the share buyback. At the Annual General Meeting on 5 May 2016, the Directors will recommend an issue of 71 C Shares with a total nominal value of 7.1p for each ordinary share. Together with the interim issue on 4 January 2016 of 92.7 C Shares for each ordinary share with a total nominal value of 9.27p; this is the equivalent of a total annual payment to ordinary shareholders of 16.37p for each ordinary share. Further details are included on page 178. Reported results 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, financing of post-retirement benefits, effects of acquisition accounting and impairment of goodwill are also excluded. Adjustments between underlying profit and reported profit in the income statement are set out in more detail in note 2 to the Consolidated Financial Statements. This basis of presentation has been applied consistently. Rolls-Royce Holdings plc Annual Report 2015 45 Strategic Report Strategic Report / Chief Executive’s review Financial review FINANCIAL REVIEW CONTINUED SUMMARY BALANCE SHEET £m Intangible assets Property, plant and equipment Joint ventures and associates Net working capital Net funds Provisions Net post-retirement scheme (deficits)/surpluses Net financial assets and liabilities Other net assets and liabilities Net assets Other items US$ hedge book (US$bn) TotalCare assets TotalCare liabilities Net TotalCare assets Customer financing contingent commitments: Gross Net Carrying values of 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. Other than noted above, there have been no significant impairments in 2015. Property, plant and equipment (note 10) increased by £44m. Capital expenditure of £494m was largely offset by depreciation of £373m, disposals of £34m and foreign exchange movements of £32m. Investments in joint ventures and associates (note 11) increased modestly, principally as the share of retained profit exceeded dividends received. Net post-retirement scheme (deficits)/ surpluses (note 19) decreased by £632m, comprising a reduction of £692m in the UK and an increase of £60m overseas. The reduction in UK schemes is principally due to relative movements in assumptions used to value the underlying assets and liabilities in the UK schemes in accordance 46 Rolls-Royce Holdings plc Annual Report 2015 2015 4,645 3,490 576 (501) (111) (640) (77) (1,883) (483) 5,016 28.8 2,994 (783) 2,211 269 54 2014 4,804 3,446 539 (1,134) 666 (807) 555 (855) (827) 6,387 25.6 2,492 (687) 1,805 388 59 with IAS 19. While the corporate bond yields used to measure the liabilities remained broadly stable, gilt yields which are the principal driver of asset valuations increased, reducing the value of the assets. The schemes adopt a low risk investment strategy that reduces funding volatility (for which both assets and liabilities are measured on a gilt basis); interest rate and inflation risks are largely hedged and the exposure to equities is around 9% of scheme assets. The increase in overseas schemes arose largely due to higher discount rates in Germany and the US. Provisions (note 18) largely relate to warranties and guarantees provided to secure the sale of OE and services. The decrease is largely a result of the utilisation of warranty and restructuring provisions. Net financial assets and liabilities (note 17) include the fair value of derivatives, financial RRSAs and C Shares. The increase in liabilities primarily reflects the impact on the US$ hedge book of the GBP:USD exchange rate falling to 1.48 from 1.56 at the beginning of the year. The Group hedges transactional foreign exchange exposures to reduce volatility. The most significant exposure is net US$ income. The US$ hedge book increased by 12.5% to US$28.8bn, which represents around five 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 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. The net asset increased in 2015 by £406m (2014: £463m), reflecting accounting for new ‘linked’ engines of £521m (2014: £588m) and retrospective TotalCare accounting adjustments of £222m (2014: £150m) taken in the year, offset by cash flows and other items of £337m (2014: £275m). 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 almost exclusively to customers of the Civil Aerospace business and takes the form of various types of credit Chief Executive’s review / Financial review Free cash flow £179m 2014 exc 2014 inc 2013 2012 2011 447 254 781 548 581 y g r e n E c n i 2011 2012 2013 2014 y g r e n E c x e 2014 2015 and asset value guarantees. These exposures produce contingent liabilities that are outlined in note 18. 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 2015, the Group’s gross exposure on delivered aircraft reduced by £119m, mainly due to guarantees expiring. Pensions: contributions to defined benefit pension schemes in 2015 reduced by £63m, which included a reduction in the UK deficit funding payments of £36m and the non- recurrence of discretionary increase contributions of £33m. The total operating charge increased by £43m largely due to past service credits of £8m in 2015 compared to £31m in 2014. Funding of defined benefit schemes is expected to be similar in 2016. Shareholder payments: the reduction reflects the fact that no dividend was paid by Power Systems to Daimler AG (2014: £76m), offset by an increase in the redemption of C Shares of £15m. Discontinued operations in 2015 reflect a sales price adjustment of £42m paid in 2015 on the 2014 disposal of the Energy business and wind-down costs. Summary funds flow Movement in working capital includes an increase in the net TotalCare asset of £406m and a reduction in the amount of net customer deposits of £143m. The reduction in customer deposits is largely in the Marine business as a result of lower order intake in the offshore market and lower government spend. Expenditure on property, plant and equipment and intangible assets: the decrease reflects reductions in additions to property, plant and equipment (£174m), participation fees and certification costs (£86m) and capitalised development costs (£45m), offset by increased expenditure on contractual aftermarket rights (£68m) and foreign exchange movements of £51m. SUMMARY FUNDS FLOW £m Opening net funds Closing net funds Change in net funds Underlying profit before tax Depreciation and amortisation Movement in net working capital Expenditure on property, plant and equipment and intangible assets Other Trading cash flow Contributions to defined benefit post-retirement schemes in excess of PBT charge Tax Free cash flow Shareholder payments Share buyback Acquisitions and disposals Net funds of businesses acquired Discontinued operations Foreign exchange Change in net funds 2015 666 (111) (777) 1,432 613 (544) (887) (229) 385 (46) (160) 179 (421) (414) (3) – (121) 3 (777) Previously reported 1,939 666 (1,273) 1,617 600 (509) (1,114) 88 682 (152) (276) 254 (482) (69) (965) (30) – 19 (1,273) 2014 Energy Excluding Energy Change (3) 18 (152) (30) (17) (184) 2 (11) (193) – – – – 193 – – 1,620 582 (357) (1,084) 105 866 (154) (265) 447 (482) (69) (965) (30) (193) 19 (1,273) -188 +31 -187 +197 -334 -481 +108 +105 -268 +61 -345 +962 +30 +72 -16 Rolls-Royce Holdings plc Annual Report 2015 47 Strategic Report Strategic Report / Chief Executive’s review Sustainability DEVELOPING A SUSTAINABLE BUSINESS As a leading power systems provider we have a fundamental role in meeting the environmental and societal opportunities and challenges that the world faces. WHAT MATTERS MOST Understanding and prioritising the issues that matter most to the Group and our stakeholders enables us to manage our business effectively for the long term. This informs our strategy, approach and reporting. We have policies, processes, targets and governance in place to manage the most important issues. Better power Better future Better business EXTERNAL RECOGNITION BUSINESS ETHICS ABC AND EXPORT CONTROL SUPPLIER ETHICS EMPLOYEE SAFETY MATERIAL STEWARDSHIP DIVERSITY AND INCLUSION EMPLOYEE WELLBEING HUMAN RIGHTS INNOVATION EMPLOYEE ENGAGEMENT TALENT MANAGEMENT DATA AND CYBER SECURITY PRODUCT SAFETY PRODUCT PERFORMANCE PRODUCT COMPLIANCE CUSTOMER SATISFACTION RITICAL C H I G H OUR MATERIAL ISSUES MODERAT E TRANSPARENCY AND DISCLOSURE GHG EMISSIONS FROM OUR OPERATIONS AND FACILITIES ENERGY CONSUMPTION WASTE AND RECYCLING TAXATION SUPPLIER OPERATIONS EXTERNAL PARTNERSHIPS COMMUNITY INVESTMENT LOCAL ECONOMIC DEVELOPMENT STEM EDUCATION OUTREACH Dow Jones Sustainability Index We have been awarded Industry Leader, Industry Mover and Gold Class award for the Aerospace and Defense sector in the Dow Jones Sustainability Index. Achieving an overall score of 77, we have been listed in the DJSI World and DJSI Europe indexes. CDP Climate Change Index Our score of 99B in the CDP is our highest to date and has earned us a place in the FTSE 350 Climate Disclosure Leadership Index. This reflects our commitment to continuously improve our environmental performance and disclosure. 48 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Sustainability OUR APPROACH Better power Helping our customers do more, using less Our engineering expertise helps us to deliver more efficient products for our customers. Our commitment is to improve continuously the environmental performance of our products and services. Each year we invest over £1.2bn in gross R&D, two thirds of which is aimed at improving environmental performance. Our environment strategy focuses on three areas: supporting our customers by further reducing the environmental impact of our products and services; developing new technology for future low emissions products; and maintaining our drive to reduce the environmental impact of our business activities. We work with our customers to ensure optimal performance from our products throughout their operational life. We deliver a broad range of learning solutions, ranging from product operations and maintenance to simulation activities. We have an extensive range of field service personnel and service operations centres that ensure we have the expertise and equipment available to service our products with minimal disruption. Our products and services are designed to the highest standards of product safety, and we consistently pursue proactive opportunities for improvement. Product safety and environmental requirements are an integral part of each stage of the product lifecycle. Better future Better business Committed to innovation, powering better, cleaner economic growth Investing in technology, people and ideas to improve all aspects of performance Innovation is embedded in all of our products and services and is a key competitive advantage. The skills, knowledge and passion of our workforce help us to innovate and to deliver on behalf of customers. We are working towards creating an environment where everyone can reach their full potential. We encourage diversity, engagement and development. We are committed to protecting the human rights of our employees. Our Global Human Rights policy sets out this commitment through employment standards covering: employee involvement; diversity and equality; pay and benefits; working hours; forced labour and child labour. Compliance is assessed on a regular basis. Employee health and wellbeing are the foundation of high performance. We focus our health improvement programmes on key areas in accordance with our risk profile: health risk management; resilience and wellbeing. A diverse workforce will help ensure our continued success as a global business and contribute towards a better future. More information on our approach to diversity and gender distribution can be found in the Nominations & Governance Committee report, on pages 71 and 72. We use a variety of channels to communicate with employees and encourage participation and engagement. Our community investment and education outreach programmes are a key component of our employee involvement activities. We are committed to conducting every aspect of our business to the highest ethical standards and ensuring we are in line with all applicable laws. We have a zero tolerance approach to any form of ethical misconduct, bribery or corruption. We have a Global Code of Conduct that applies to all employees of Rolls-Royce, our subsidiaries and controlled joint ventures, wherever they are located. We set equivalent standards for our supply chain through our Global Supplier Code of Conduct. We regard the health and safety of our employees and those working on our premises, or on our behalf, as paramount. We continue to focus on managing the health and safety risks through risk-based improvement programmes, strengthening leadership and cultural change. Reducing the environmental impact of our business activities is a key part of our environment strategy. We continue to invest in improving the performance of our operations by reducing energy use, greenhouse gas emissions and waste. We are committed to optimising material and resource efficiency. We are working to better manage the use of chemicals in our processes and to phase out the use of substances that are considered dangerous to the environment or harmful to health. Average number of employees per region* Average number of employees by business unit* UK USA Canada 23,200 Germany 10,700 6,400 1,100 Nordic countries 3,800 Rest of world 5,300 Civil Aerospace 23,200 Marine Defence Aerospace 6,400 Nuclear Power Systems 10,600 Other 6,000 4,100 200 *Headcount data is calculated in terms of average full-time employees for 2015 See note 7 Employee information on page 131 for comparative data Rolls-Royce Holdings plc Annual Report 2015 49 Strategic Report Strategic Report / Chief Executive’s review Sustainability SUSTAINABILITY PERFORMANCE INDICATORS We launched our dashboard of sustainability performance indicators in 2015, with higher stretching targets base-lined on our 2014 performance. Better power Description Why we measure it How we have performed Improving efficiency levels of each generation of the Trent engine family to meet the ACARE Flightpath 2050 goals The Advisory Council for Aviation Research and Innovation in Europe (ACARE) has set challenging goals for aviation to meet by 2050. These include developing technologies and procedures to: This chart shows the improved efficiency levels of each generation of Trent engine from the Trent 800 onwards. • Reduce aircraft CO2 emissions by 75% (per passenger kilometre) • Reduce noise by 65% • Reduce oxides of nitrogen (NOx) by 90%. This is all relative to a typical new aircraft produced in 2000. Improving emissions levels of each generation of the MTU Series 4000 C&I engines to meet future emissions regulations Our MTU Series 4000 C&I engines meet the strictest current regulations for NOx and particulates reduction. This is achieved through field-tested and proven technology such as two-stage turbocharging and exhaust gas recirculation. We continue to invest in product R&D to meet future emissions regulations. Trent 800 Trent 500 Trent 900 Trent 1000 Trent XWB Advance UltraFan n r u b l e u f r o 2 O C % -5 -10 -15 -20 -25 -30 2000 2010 2020 Entry into service 2030 2040 2050 CO1 0 -20 -40 -60 -80 -100 CO3 CO4 CO5 1998 2003 2008 2013 2018 2023 Entry into service ) h W k / g ( n o i s s i m e n i e g n a h c % Trent family Technology demonstrator engine targets Rolls-Royce contribution to ACARE Flightpath 2050 target This chart shows the improved emissions levels of each generation of the MTU Series 4000 C&I engine. % change in particulates (g/kWh) % change in NOx (g/kWh) Future trend Better future Description Why we measure it How we have performed STEM Reach 6 million people through our STEM education programmes and activities by 2020 We aim to inspire future generations in Science, Technology, Engineering and Mathematics (STEM) through education outreach programmes and activities that demonstrate the life-long opportunities that STEM careers can offer. Our programmes reached 1.6 million people worldwide in 2015, 70% of whom were actively engaged in one or more STEM activity. Many programmes were aimed at groups currently under-represented in engineering careers, reflecting our commitment to encouraging greater diversity in the workplace. Employee wellbeing All sites to achieve our employee health and wellbeing LiveWell accreditation by 2020 Employee engagement Ensure our Sustainable Employee Engagement Index is greater than, or equal to, the Global High Performance Norm1 by 2020 Our goal is to enhance the personal health and wellbeing of our people to help them reach their full potential. The Rolls-Royce LiveWell accreditation programme will help to create a culture where healthy choices are encouraged and rewarded, including; smoke-free site policies, healthy food choices and exercise facilities. Sites are also required to establish local employee wellbeing committees with annual objectives. We want all of our employees to be able to perform to their best ability and encourage open collaboration, engagement and involvement. During 2015, all sites were required to complete an initial LiveWell accreditation gap analysis. One site, Bristol UK, met the criteria for accreditation and was awarded the LiveWell award. The introduction of our Global Smoke Free Campus policy in 2016 will enable more sites to obtain LiveWell accreditation. Our Sustainable Engagement Score declined slightly, from 84 in 2014 to 81 in 2015, as we continue to undergo significant change as a business. As a result, our Executive Leadership Team has committed to and is driving a programme of improvement actions relating to leadership, communication and enablement. These are aimed at improving our work environment and strengthening our climate for success. Number of people reached (million) 6 5 4 3 2 1 0 2015 2016 2017 2018 2019 2020 target LiveWell site accreditation (%) 100 80 60 40 20 0 2015 2016 2017 2018 2019 2020 target Sustainable Employee Engagement Score 100 80 60 40 20 0 2015 2016 2017 2018 2019 2020 2014 baseline Score High performance norm 1 Employee Engagement survey, Sustainable Employee Engagement Index and Global High Performance Norm provided independently by Towers Watson 50 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Sustainability Better business Description Why we measure it How we have performed Ethics All employees to complete year-on-year Global Code of Conduct certification and mandatory ethics training Energy Reduce energy use in our operations and facilities by 30%, normalised by revenue, by 2020 (excluding product test and development) GHG emissions4 Reduce greenhouse gas (GHG) emissions in our operations and facilities by 50%, absolute, by 2025 (excluding product test and development) Our Global Code of Conduct sets out the ethical principles that underpin our values and the way we do business. It also provides guidance on how to apply these principles in everything we do. During the year, 100% of our managers have certified that they have access to, understand and will comply with our Global Code of Conduct. Our ethics training continued to require managers to lead ethical discussions around dilemmas with their teams. During 2015, 97% of employees completed dilemma-based training. Understanding our energy use helps us to identify inefficiency and opportunities for improvement across our global operations and activities. Upgrading existing facilities and investing in energy efficient technology helps us to reduce energy consumption and cost. We continue to invest in energy efficient technology to reduce our energy consumption and cost. Our energy use in 2015 was 112 MWh/£m. This represents a decrease of 3% compared to 2014. We have invested in upgrading lighting systems, variable speed drives and voltage optimisation. We have also introduced more efficient cooling systems. Investing in renewable energy sources and other opportunities to reduce our GHG emissions reduces cost and mitigates risk associated with energy price volatility. Our total GHG emissions for 2015, excluding product test and development, was 455 ktCO2e. This represents an 8% reduction from 2014. We continue to drive energy efficiency and have developed a number of low carbon and renewable energy projects across our global facilities. These include combined heat and power, tri-generation power systems and solar. Waste Reduce total solid and liquid waste in our operations and facilities by 25%, normalised by revenue, by 2020 We recognise that improving the environmental performance of our operations contributes to profitable growth. The four principal waste streams that contribute to our waste production are: recyclable solid wastes; liquid wastes sent for disposal; recyclable metals; and solid wastes sent for landfill. We have seen a modest reduction in the amount of waste that we dispose of from our sites. Our total solid and liquid waste, normalised by revenue, was 4.31 t/£m in 2015. This represents a 3% reduction compared to 2014. New programmes launched in 2015 and continuing into 2016 are expected to accelerate waste reduction across our global operations. Ethics employee certification and training (% of employees)2 100 75 50 25 0 2015 2016 2017 2018 2019 2020 2014 baseline Certification Training Energy use (MWh/£m)3 120 100 80 60 40 20 0 2014 baseline 2015 2016 2017 2018 2019 2020 target Absolute GHG emissions (ktCO2e)3 500 400 300 200 100 0 2015 2016 2017 2018 2019 2020 2014 baseline 2025 target Total solid and liquid waste (t/£m)3 5 4 3 2 1 0 2015 2016 2017 2018 2019 2014 baseline 2020 target Recycling Zero waste to landfill in our operations and facilities, by 2020 (excluding hazardous waste) Safety Reduce total reportable injury (TRI) rate to 0.3 per 100 employees by 2020, to achieve first quartile performance Suppliers All suppliers aligned to our own ambitions: all suppliers agree adherence to the Global Supplier Code of Conduct by 2016 We are committed to both increasing our recycling rates and achieving zero waste to landfill from our manufacturing and office facilities. We are concentrating on the recycling of metals and packaging. Hazardous waste will continue to be managed in a safe and controlled manner. The amount of waste sent to landfill has increased from 6,700 tonnes in 2014 to 7,200 tonnes in 2015. This is due in part to an increase in waste from our Power Systems business and improved waste reporting across the Group. Since 2009, we have reduced our waste to landfill by 3,000 tonnes and remain confident that more sites will achieve zero waste to landfill. Waste to landfill (000 tonnes)3 8 6 4 2 0 2014 baseline 2015 2016 2017 2018 2019 2020 target We are dedicated to providing a safe and healthy place of work for all our employees, contractors and visitors to our facilities and wherever they may work on our behalf. Our TRI rate deteriorated in 2015 to 0.82, compared to 0.64 in 2014. This is primarily due to the inclusion of Power Systems data and improved reporting of safety incidents across the Group. We continue to focus our improvement programmes on high consequence activities in accordance with our risk profile, for example electrical safety and process safety management. Our Global Supplier Code of Conduct sets out the minimum standards of behaviour and practices we require of our suppliers. We work to align them to our own ambitions in ethics, and support suppliers in managing their energy and waste, and in completing submissions to the CDP. We released a revision to our Global Supplier Code of Conduct at the start of 2015. Our terms of business now include agreement to the Code, which makes our compliance expectations clear. 75% of our suppliers have now contractually agreed adherence. We plan to launch strategic supplier monitoring programmes in 2016. TRI rate (per 100 employees)3 1.0 0.75 0.50 0.25 0 2014 baseline 2015 2016 2017 2018 2019 2020 target Power Systems Rest of Group Suppliers agreed adherence to the Global Supplier Code of Conduct (%) 2016 target 2015 0 20 40 60 80 100 2 2015 certification by managers only 3 2014 data has been restated to reflect the inclusion of Power Systems 4 Regulatory GHG emissions data detailed on page 180 Limited external assurance provided by Bureau Veritas, using the assurance standards ISAE 3000 and ISAE 3410, over the energy, GHG, and TRI data as indicated. More information detailed on page 175 Rolls-Royce Holdings plc Annual Report 2015 51 Strategic Report Strategic Report / Chief Executive’s review Key performance indicators KEY PERFORMANCE INDICATORS Financial performance indicators are shown below. The areas of focus of the Board and its committees are described on pages 63 to 104, and other non-financial performance indicators are shown in the Sustainability section on pages 50 and 51. Description Why we measure it Order book +4% Order intake -4% The order book provides an indicator of future business. We measure it at constant exchange rates and list prices and include 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. Conservatively, we only include the first seven years’ revenue of long-term aftermarket contracts. Order intake is a measure of new business secured during the year and represents new firm orders, adjusted for 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. We measure order intake 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, include the addition of the following year of revenue on long-term aftermarket contracts. How we have performed The order book grew by £2.7bn. An increase of £3.8bn in Civil Aerospace was offset by a reduction of £0.4bn in Marine, reflecting the current weak market conditions. £bn 62.2 60.1 71.6 73.7 76.4 An increase of £0.9bn in Civil Aerospace order intake was offset by weaker intake in Defence Aerospace and Marine. 2011 2012 2013 2014 2015 £bn 26.9 16.3 16.1 19.4 19.0 18.2 y g r e n E c n i y g r e n E c x e 2011 2012 2013 2014 2014 2015 Underlying revenue -4% -1% excluding FX Monitoring of revenue provides a measure of business growth. Underlying revenue is used as it reflects the impact of our FX hedging policy by valuing foreign currency revenue at the actual exchange rates achieved as a result of settling FX contracts. This provides a clearer measure of the year-on-year trend. The reduction reflects a 9% reduction in OE revenue, offset by a 3% increase in services revenue. Marine revenue fell by 23%, reflecting the weak market conditions. £m 12,209 11,277 15,505 14,588 13,864 13,354 Net R&D expenditure as a proportion of underlying revenue 6.2% This measure reflects the need to generate current returns as well as to invest for the future. We measure R&D as the self-funded expenditure before both amounts capitalised in the year and amortisation of previously-capitalised balances. We expect to spend approximately 5% of underlying revenues on R&D although this proportion will fluctuate depending on the stage of development of current programmes. We expect this proportion will reduce modestly over the medium term. The increase is largely due to changes in net capitalisation, reflecting the phasing of new Civil Aerospace programmes, in particular the Trent XWB-84 and the Trent 1000 TEN. 52 Rolls-Royce Holdings plc Annual Report 2015 y g r e n E c n i y g r e n E c x e 2011 2012 2013 2014 2014 2015 % 4.6 4.7 4.8 5.8 5.9 6.2 y g r e n E c n i y g r e n E c x e 2011 2012 2013 2014 2014 2015 Chief Executive’s review / Key performance indicators Description Why we measure it Capital expenditure as a proportion of underlying revenue 3.7% 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. We measure annual capital expenditure as the cost of property, plant and equipment acquired during the period and, over the medium term, expect a proportion of around 4%. How we have performed Expenditure reduced to £494m (2014: £668m) principally reflecting the major investment in Civil Aerospace facilities nearing completion. % 4.1 4.0 4.6 4.7 4.4 3.7 y g r e n E c n i y g r e n E c x e 2011 2012 2013 2014 2014 2015 Underlying profit before financing -11% We measure underlying profit before financing on a basis that shows the economic substance of the Group’s hedging strategies in respect of the transactional exchange rate and commodity price movements. In particular: (a) revenues and costs denominated in US dollars and euros are presented on the basis of the exchange rates achieved during the year; (b) similar adjustments are made in respect of commodity derivatives; and (c) consequential adjustments are made to reflect the impact of exchange rates on trading assets and liabilities and long-term contracts on a consistent basis. The reduction reflects the reduction in revenues and the Group’s high level of fixed costs, which the transformation programme is addressing. £m 1,206 1,831 1,678 1,681 1,495 1,492 y g r e n E c n i y g r e n E c x e 2011 2012 2013 2014 2014 2015 Free cash flow £179m In a business requiring significant investment, we monitor cash flow to ensure that profitability is converted into cash generation, both for future investment and as a return to shareholders. We measure free cash flow as the movement in net funds/debt during the year, before movements arising from payments to shareholders, acquisitions and disposals, and FX. The reduction reflects the lower profits and the utilisation of provisions. £m 781 581 548 y g r e n E c n i 254 447 y g r e n E c x e 179 2011 2012 2013 2014 2014 2015 Average cash is no longer being monitored as a key performance indicator, as the focus is now on the free cash flow. Non-financial KPIs As we undertake significant restructuring, reorganisation and transformation, it is imperative that we do not lose focus on our customers, and that we ensure our employees are fully engaged in the transformation. So for 2016, we are introducing two non-financial measures to the Annual Performance Related Award relating to customers and employees. In line with our remuneration policy, financial performance will still be required for any payout, as the non-financial measures will be subject to achieving a profit before taxation threshold. Description How performance is measured Customer satisfaction This is measured by the percentage of ‘on-time to purchase order’ and includes measures for new equipment, spare parts, equipment repair and overhaul. This is tracked Group-wide in our scheduling and order fulfilment system. Employee engagement This is measured through our Employee Opinion Survey which produces a composite engagement score. The targets will be based on absolute scores. Rolls-Royce Holdings plc Annual Report 2015 53 Strategic Report Strategic Report / Chief Executive’s review Principal risks PRINCIPAL RISKS Risk management Risk management is built into our daily activities and is an integral part of how we work: from our engineering design, through to engine production, servicing and how we run our operations. The Board is responsible for the Group’s risk management and internal control system and reviewing its effectiveness. The system 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. More information about our internal control system can be found in the Audit Committee report on page 95. Our risk management system (RMS) helps us make better decisions and to deal with problems if they occur. It is implemented through: a Group-wide framework mandated in the Group risk management policy; a network of trained risk management facilitators; and a software tool. In 2015, we performed a comprehensive review of our RMS and are implementing a programme of work to enhance our RMS which will continue to be embedded throughout 2016. This activity is sponsored by the General Counsel and Chief Financial Officer and is regularly reviewed by the Audit Committee. The enhancements touch all areas of our RMS including: categorisation, governance, operating model, reporting and infrastructure. Our RMS is designed so that principal risks can be identified from multiple sources. Key bottom-up risks are identified by businesses and functions and the detail of risks that meet the Group threshold are subject to review and challenge by the Executive Leadership Team (ELT) and the Board during their risk reviews. This includes monitoring the status of mitigation actions, adequacy of controls and any incidents that have occurred since the last review. Risks are also captured during the strategy and business planning activities to inform the development of the principal risks. The Board, assisted by the ELT, has carried out a robust assessment of, and reviewed our appetite for, the principal risks facing the Group. These include those that threaten the business model, future performance, solvency and liquidity. These reviews have been complemented by financial scenario modelling of our principal risks which is also used to support our viability statement on page 57. The Board, or the most appropriate Board committee, undertakes periodic in-depth reviews of our principal risks in which it assesses our material controls and the effectiveness of our risk management and mitigation activities. Business units and functions are accountable for identifying and managing risk in line with the Group risk management policy. Business continuity plans are in place to mitigate continuity risks. The Group’s enterprise risk team, led by the Director of Risk, is responsible for disseminating risk policy and processes and co-ordinating the effective operation of the RMS. Progress of actions to mitigate risks and the adequacy of risk controls are also now regularly reviewed by the sector audit committees. Joint ventures constitute an increasingly large part of the Group’s activities. Responsibility for risk and internal control in joint ventures lies with the managers of those operations. We seek to exert influence over such joint ventures through board representation. Management and internal audit regularly review the activities of these joint ventures. The Board is aware that the effectiveness of risk management is highly dependent on behaviours, as a good process does not automatically lead to a good outcome. Our ethics and compliance improvement programme, aimed at securing compliance with our ethical standards, and the Global Code of Conduct are reinforcing the values and behaviours required, which in turn will continue to strengthen our risk management culture. Principal risks During the year, the Board and ELT focused on the principal risks and the actions and controls in place to manage them. This involved: discussing changes to the risks; reviewing the risk indicators for principal risks; and hearing from management about how risks will be managed. This ongoing review of risks has resulted in a further principal risk being added this year: talent and capability. This risk has been added to reflect the significant transformation agenda ahead and our future growth requirements and plans. Management of principal risks Our risk framework ensures that risks are identified, managed and communicated at every level of the Group. Identify principal risks (PRs) Governance of PRs Impact of PRs on long- term viability Set risk appetite for PRs Monitor mitigation and control of PRs Reporting Assess effectiveness of risk management system (RMS) 54 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Principal risks Risk or uncertainty and potential impact How we manage it Strategic priorities Product failure Product not meeting safety expectations, or causing significant impact to customers or the environment through failure in quality control. • Embedding and operating a safety-first culture. • Applying our engineering design and validation process from initial design through production and into service. • The Safety & Ethics Committee reviewing the scope and effectiveness of the Group’s product safety policies to ensure that they operate to the highest industry standards (see Safety & Ethics Committee report on page 99). • Operating a safety management system (SMS), governed by the product safety review board, and subject to continual improvement based on experience and industry best practice. Product safety training is an integral part of our SMS. (see Safety & Ethics Committee report on page 100 for details of the SMS). • Improving our supply chain quality. • Crisis management team jointly chaired by the Group President and the General Counsel. This principal risk is subject to review by the Safety & Ethics Committee. Business continuity Breakdown of external supply chain or internal facilities that could be caused by destruction of key facilities, natural disaster, regional conflict, 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. • Continued investment in adequate capacity and modern equipment and facilities. • Identifying and assessing points of weakness in our internal and external supply chain, our IT systems and our people skills. • Selecting and developing stronger suppliers. • Developing dual sources or dual capability. • Developing and testing incident management and business continuity plans. • Crisis management team jointly chaired by the Group President and the General Counsel. • Customer excellence centres providing improved response to supply chain disruption. This principal risk is subject to review by the Audit Committee. Competitive position 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. Political risk Geopolitical factors that lead to an unfavourable business climate and 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. • Accessing and developing key technologies and service offerings which differentiate us competitively (see Engineering and innovation on page 18). • Focusing on being responsive to our customers and improving the quality, delivery and reliability of our products and services. • Partnering with others effectively. • Driving down cost and improving margins (see Chief Executive’s review on page 12). • Protecting credit lines. • Investing in innovation, manufacturing and production, and continuing governance of technology programmes (see Engineering and innovation on page 18 and Science & Technology Committee report on page 103). • Maintaining a strong balance sheet to enable access to cost-effective sources of third-party funding. • Understanding our competitors. This principal risk is subject to review by the Board. • Where possible, locating our facilities and supply chain in countries with a low level of political risk and/or ensuring that we maintain dual capability. • Diversifying global operations to avoid excessive concentration of risks in particular areas. • The international network of Rolls-Royce and its business units proactively monitoring local situations. • Maintaining a balanced business portfolio with high barriers to entry and a diverse customer base (see Chief Executive’s review on page 8). • Proactively influencing regulation where it affects us. This principal risk is subject to review by the Board. Major programme delivery Failure to deliver a major programme on time, within budget, to specification, or technical performance falling significantly short of customer expectations, or not delivering the planned business benefits, 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. • Major programmes are subject to Board approval (see Additional financial information on page 176). • Reviewing major programmes at levels and frequencies appropriate to their criticality and performance, against key financial and non-financial deliverables and potential risks throughout the programme’s life cycle (see Additional financial information on page 176). • Conducting technical audits at pre-defined points which are performed by a team that is independent from the programme. • Requiring programmes to address the actions arising from reviews and audits and monitoring and controlling progress through to closure. • Applying knowledge management principles to provide benefit to current and future programmes. This principal risk is subject to review by the Board. 1 Engineering excellence 2 Operational excellence 3 Capturing aftermarket value 1 2 3 2 3 1 2 3 2 1 2 Rolls-Royce Holdings plc Annual Report 2015 55 Strategic Report Strategic Report / Chief Executive’s review Principal risks PRINCIPAL RISKS CONTINUED Risk or uncertainty and potential impact How we manage it Compliance Non-compliance by the Group with legislation or other regulatory requirements in the regulated environment in which it operates (eg. 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. Market and financial shock The Group is exposed to a number of market risks, some of which are of a macro-economic nature (eg. foreign currency, oil price, exchange rates) and some of which are more specific to the Group (eg. 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 creditworthiness. This would affect operational results or the outcomes of financial transactions. IT vulnerability Breach of IT security causing controlled or critical data to be lost, made inaccessible, corrupted or accessed by unauthorised users. Talent and capability Inability to attract and retain the critical capabilities and skills needed in sufficient numbers and to effectively organise, deploy and incentivise our people to deliver our strategy, business plan and projects. • Taking an uncompromising approach to compliance. • Operating an extensive compliance programme. This programme and the Global Code of Conduct are disseminated throughout the Group and are updated 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 Safety & Ethics Committee report on page 102). • Strengthening of the ethics, anti-bribery and corruption, compliance and export control teams. • A legal team is in place to manage any ongoing regulatory investigations. • Implementing a comprehensive REACH compliance programme. This includes establishing appropriate data systems and processes, working with our suppliers, customers and trade associations and conducting research on alternative materials. This principal risk is subject to review by the Safety & Ethics Committee. • Maintaining a strong balance sheet, through managing cash balances and debt levels (see Financial review on page 42). • Providing financial flexibility by maintaining high levels of liquidity and an investment grade credit rating. • Sustaining a balanced portfolio through earning revenue both from the sale of original equipment and aftermarket services, providing a broad product range and addressing diverse markets that have differing business cycles (see Chief Executive’s review on page 8). • Deciding where and what currencies to source in, and where and how much credit risk is extended or taken. The Group has a number of treasury policies that are designed to hedge residual risks using financial derivatives (foreign exchange, interest rates and commodity price risk). This principal risk is subject to review by the Audit Committee. • Implementing ‘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 (see Audit Committee report on page 95). • Running security and network operations centres. • Actively sharing IT security information through industry, government and security forums. This principal risk is subject to review by the Audit Committee. • Attracting, rewarding and retaining the right people with the right skills globally in a planned and targeted way, including regular benchmarking of remuneration. • Developing and enhancing organisational, leadership, technical and functional capability to deliver global programmes. • Continuing a strong focus on individual development and succession planning. • Proactively monitoring retirement in key areas and actively managing the development and career paths of our people with a special focus on employees with the highest potential. • Embedding a lean, agile high performance culture that tightly aligns Group strategy with individual and team objectives. • Retaining, incentivising and effectively deploying the critical capabilities, skills and people needed to deliver our strategic priorities, plans and projects whilst implementing the Group’s major programme to transform its business, to be resilient and to act with pace and simplicity. • Tracking engagement through our annual employee opinion survey and a commitment to drive year-on-year improvement to the employee experience and communications (see Sustainability on page 50). This principal risk is subject to review by the Nominations & Governance Committee. 1 Engineering excellence 2 Operational excellence 3 Capturing aftermarket value Strategic priorities 2 2 3 1 2 1 2 3 56 Rolls-Royce Holdings plc Annual Report 2015 Chief Executive’s review / Going concern and viability GOING CONCERN AND VIABILITY STATEMENTS Introduction Rolls-Royce operates an annual planning process which includes strategic (greater than five years), medium-term (five year) and short-term (one year) financial forecasts, based on the inputs from each of the businesses. These plans and risks to their achievement are reviewed by the Board as part of its strategy review and budget approval processes. Once approved these plans are cascaded throughout the Group and are used as the basis for monitoring our performance, incentivising employees and providing external guidance to our shareholders. The processes for identifying and managing the principal risks are described on pages 54 to 56. As also described there, the risk management process, and in consequence the going concern and viability statements, are designed to provide reasonable but not absolute assurance. Going concern The going concern assessment considers whether it is appropriate to prepare the financial statements on a going concern basis. As described on page 177, the Group meets its funding requirements through a mixture of shareholders’ funds, bank borrowings, bonds and notes. At 31 December 2015, the Group had borrowing facilities of £5.1bn and total liquidity of £5.0bn, including cash and cash equivalents of £3.2bn and undrawn facilities of £1.8bn. £419m of the facilities mature in 2016. The Group’s forecasts and projections, taking into account reasonably possible changes in trading performance, show that the Group has sufficient financial resources. The Directors have reasonable expectations that the Company and the Group are well placed to manage business risks and to continue in operational existence for the foreseeable future (which accounting standards require to be at least a year from the date of this report) and have not identified any material uncertainties to the Company’s and the Group’s ability to do so. On the basis described above, the Directors consider it appropriate to adopt the going concern basis in preparing the consolidated financial statements (in accordance with the ‘Guidance on Risk Management, Internal Control and Related Financial and Business Reporting’ published by the Financial Reporting Council in September 2014). Viability The viability assessment considers solvency and liquidity over a longer period than for the purposes of the going concern assessment above. Inevitably, the degree of certainty reduces over this longer period. In making the assessment, severe but plausible scenarios have been considered that estimate the potential impact of each of the principal risks arising over the assessment period, for example: the loss of a key element of the supply chain; the impact on aircraft travel of a global pandemic; or, a failure to achieve planned cost reductions. The scenarios assume an appropriate management response to the specific event, but not broader mitigating actions which could be undertaken, which were considered separately. The impacts of these scenarios were overlaid on the medium-term forecast to assess how the Group’s liquidity and solvency would be affected. The assessment took account of the Group’s current funding, forecast requirements and existing committed borrowing facilities. It assumed that existing facilities could be refinanced as they mature. There are modest maturities over the first three years of the medium-term forecast with more significant maturities in 2019 and 2020. On the basis described above, the Board confirms that it has a reasonable expectation that the Company will be able to continue in operation and meet its liabilities as they fall due over the next five years, consistent with the period of the medium-term forecast. In making this statement, the Directors have made the following key assumptions: • that maturing facilities will be refinanced. The Group currently has access to global debt markets and expects to be able to refinance these facilities on commercially acceptable terms. The Group’s medium- and long-term financing plans are designed to allow for periods of adverse conditions in world capital markets but not a prolonged (say 12 month) period where debt markets were effectively closed to the Group; • that in the event of multiple risks occurring and having a particularly severe effect on the Group, all potential actions, such as constraining capital spending and reducing or suspending payments to shareholders, would be taken on a timely basis. The Group believes it has the early warning mechanisms to identify the need for such actions and the ability to implement them on a timely basis if necessary; • that implausible scenarios, whether involving multiple risks occurring at the same time or the impact of individual risks occurring that cannot be mitigated by management actions to the degree assumed, do not occur. For instance, whilst the Directors have considered a scenario where cost reductions are not achieved and a major programme is delayed, they have not considered it plausible that any other of the key risks would crystallise in a way that would create a worse outcome over the five-year assessment period. Warren East Chief Executive 11 February 2016 Rolls-Royce Holdings plc Annual Report 2015 57 Strategic Report Directors’ Report / Board of Directors BOARD OF DIRECTORS Ian Davis Chairman NG Appointment to the Board Appointed to the Board in March 2013 and as Chairman in May 2013 Current directorships and business interests • Johnson & Johnson Inc, non-executive director • BP p.l.c., non-executive director • UK Cabinet Office Board non-executive member (stepping down in March 2016) • Apax Partners LLP, senior adviser • Temasek, European Advisory Panel member • Teach for All Inc, director • Majid Al Futtaim Holdings LLC, director Career, 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 and retiring as senior partner in 2010. 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 is now senior partner emeritus of McKinsey. Warren East CBE Chief Executive David Smith Chief Financial Officer Colin Smith CBE Group President Appointment to the Board Appointed as an Executive Director in November 2014 Appointment to the Board Appointed as an Executive Director in July 2005 Current directorships and business interests • Motability Operations Group plc, Current directorships and business interests • Council for Science and Technology, non-executive director member • Warwick Business School, advisory board member • Chartered Institute of Management Accountants, member of Advisory Panel Career, skills and experience David joined Rolls-Royce in January 2014 as Chief Financial Officer for the Aerospace Division. Before joining Rolls-Royce he was chief financial officer for technology group, Edwards. He has spent over 25 years in the automotive industry at Ford and Jaguar Land Rover. Career, skills and experience Colin joined Rolls-Royce in 1974. He has held a variety of key positions within the Group, including: Director – Research & Technology; Director of Engineering & Technology – Civil Aerospace; and, Group Director – Engineering & Technology, before being appointed as Group President in January 2016. Colin is a fellow of the Royal Society, the Royal Academy of Engineering, the Royal Aeronautical Society and the Institution of Mechanical Engineers. In June 2012 he was awarded a CBE for services to UK engineering. Appointment to the Board Appointed as an independent Non-executive Director in January 2014 and as Chief Executive in July 2015 Current directorships and business interests • Dyson Ltd, non-executive director • A member of the UK Government’s Business Advisory Group • Trustee of the Institute of Engineering and Technology Career, skills and experience Warren held various senior appointments at ARM Holdings plc from 1994 including CEO from 2001 to 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, the Chartered Institute for IT. He was awarded a CBE in 2014 for services to the technology industry. Prior to his appointment as Chief Executive, Warren was Chairman of the Science & Technology Committee and a member of the Audit Committee and the Nominations & Governance Committee. 58 Rolls-Royce Holdings plc Annual Report 2015 Board of Directors Dame Helen Alexander Independent Non-executive Director Lewis Booth CBE Senior Independent Non-executive Director Ruth Cairnie Independent Non-executive Director Sir Frank Chapman Independent Non-executive Director R NG SE A NG ST NG R ST SE NG R Appointment to the Board Appointed as an independent Non-executive Director in September 2007 Current directorships and business interests • UBM plc, chairman • Huawei Technologies (UK) Co. Appointment to the Board Appointed as an independent Non-executive Director in May 2011 Current directorships and business interests • Mondelez International Inc, non-executive director Appointment to the Board Appointed as an independent Non-executive Director in September 2014 Current directorships and business interests • Associated British Foods plc, • Gentherm Inc., non-executive non-executive director Limited, non-executive director director • Keller Group plc, non-executive Career, 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 US. 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. • Bain Capital, senior adviser • EDF Energy’s Stakeholder Advisory Panel, member • University of Southampton, chancellor • She is also involved in not-for-profit organisations in media and the arts Career, skills and experience Dame Helen was chief executive of the Economist Group until 2008, having joined the company in 1985, and was managing director of the Economist Intelligence Unit from 1993 to 1997. She was president of the CBI from 2009 to 2011; she has also been chairman of Incisive Media and Port of London Authority, and 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. director • Rotterdam School of Management, member of the advisory board • Cambridge University, finance committee member Career, skills and experience Ruth was executive vice president strategy and planning at Royal Dutch Shell Plc until 2014, before which she held a number of other senior international roles at Shell, including managing its global commercial fuels business from 2005 to 2011. Ruth served on the boards of Shell Pakistan Ltd and joint venture companies in Germany and Thailand. She also chairs the POWERful women initiative, supporting the progression of women to senior positions in the energy sector. Appointment to the Board Appointed as an independent Non-executive Director in November 2011 Current directorships and business interests • Myeloma UK, vice chairman Career, skills and experience Sir Frank has worked in the oil & 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 and chairman of Golar LNG Ltd from 2014 to 2015. Sir Frank is a fellow of the Royal Academy of Engineering, the Institution of Mechanical Engineers and the Energy Institute. He was knighted in 2011 for services to the oil & gas industry. Committee membership A Audit Committee NG Nominations & Governance Committee R Remuneration Committee SE ST Safety & Ethics Committee Science & Technology Committee Denotes Chairman Rolls-Royce Holdings plc Annual Report 2015 59 Directors’ Report Directors’ Report / Board of Directors Alan Davies Independent Non-executive Director Irene Dorner Independent Non-executive Director Lee Hsien Yang Independent Non-executive Director John McAdam Independent Non-executive Director NG A NG A SE NG A SE NG R SE Appointment to the Board Appointed as an independent Non-executive Director in November 2015 Current directorships and business interests • Rio Tinto Diamonds and Minerals Appointment to the Board Appointed as an independent Non-executive Director in July 2015 Current directorships and business interests • OUTleadership Advisory Board, member division, chief executive • South East Asia Rainforest Research Career, skills and experience Alan joined Rio Tinto in 1997 and has held a number of senior positions in Australia, London and the US, predominantly in Rio Tinto’s iron ore product group where he has served as CFO, managing director global development and as president international operations. Alan is a fellow of the Institute of Chartered Accountants in Australia. Partnership, trustee Career, skills and experience Irene was CEO and president of HSBC, US, until December 2014 where she was responsible for all of HSBC’s operations in the US and played a key role in strengthening the financial institution’s risk processes. During a 29-year career at HSBC, she held a number of international roles including as the first woman to lead HSBC in Malaysia and launching its Islamic banking unit. Irene was a consultant at PwC until February 2016. She is a fellow of St. Anne’s College, Oxford. Appointment to the Board Appointed as an independent Non-executive Director in January 2014 Appointment to the Board Appointed as an independent Non-executive Director in February 2008 Current directorships and business interests • General Atlantic LLC and associated Current directorships and business interests • J. Sainsbury plc, senior independent funds, special adviser • Civil Aviation Authority of Singapore, chairman director • Rentokil Initial plc, chairman • United Utilities Group PLC, • The Islamic Bank of Asia Private chairman Career, skills and experience John was the chief executive of ICI plc until ICI’s acquisition by Akzo Nobel in 2008. He held a number of positions at Unilever, within its Birds Eye Walls, Quest International and Unichema International businesses and is a former non-executive director of Severn Trent plc and Sara Lee Corporation. Limited, chairman • The Australian and New Zealand Banking Group Ltd, director • Lee Kuan Yew School of Public Policy, member of the Board of governors • INSEAD SE Asia Council, president • Singapore Exchange Ltd, director • Capital International Inc, consultant to advisory board Career, skills and experience Hsien Yang was chief executive of Singapore Telecommunications Limited for 12 years until 2007. He served as chairman and non-executive director of Fraser and Neave Limited from 2007 until February 2013. Board members by gender Balance of the Board Tenure of Non-executive Directors Nationalities of Directors* Male Female 10 4 Executive Directors Non-executive Directors 3 11 0 - 3 years 3 - 6 years 6 - 9 years 6 3 2 British German Singaporean Australian 11 1 1 1 * According to the Company’s Articles of Association, at least 50% of all Directors must be British citizens 60 Rolls-Royce Holdings plc Annual Report 2015 Board of Directors Sir Kevin Smith CBE Independent Non-executive Director Jasmin Staiblin Independent Non-executive Director Pamela Coles Company Secretary ST NG R NG ST Appointment to the Board Appointed as an independent Non-executive Director in May 2012 Appointment Appointed as Company Secretary in October 2014 Current directorships and business interests • Alpiq Holding AG, CEO • Georg Fischer AG, non-executive director • Federal Institute of Technology, the ETH Domain, board member Career, skills and experience Jasmin is the CEO of Alpiq Holding AG. She held a number of senior positions at ABB Switzerland Ltd, a subsidiary of the ABB Group, culminating in her serving as CEO of ABB Switzerland Ltd until December 2012. She has lived and worked in Switzerland, Sweden and Australia. Career, skills and experience Pamela has been a fellow of the Institute of Chartered Secretaries and Administrators since 1997, and is an expert in governance and company law. She has held a variety of company secretary roles throughout her career. She joined Rolls-Royce from Centrica plc, where she was head of secretariat. Pamela’s previous roles also include group company secretary and a member of the executive committee at The Rank Group plc and company secretary & head of legal at RAC plc. Appointment to the Board Appointed as an independent Non-executive Director in November 2015 Current directorships and business interests • Unitas Capital, senior adviser Career, skills and experience Sir Kevin joined Unitas Capital in 2012 and served as partner and chairman of its operating advisor group until October 2015. He was chief executive officer of GKN plc until 31 December 2011, having led GKN’s Aerospace division from 1999 to 2003. Before joining GKN, he spent nearly 20 years with British Aerospace (BAe plc), becoming group managing director of BAe’s New Business division. Sir Kevin served as a non-executive director of Scottish and Southern Energy plc between June 2004 and July 2008. He was knighted in 2006 for services to industry and is a fellow of the University of Central Lancashire, The Royal Aeronautical Society and The Chartered Institute of Management. EXECUTIVE LEADERSHIP TEAM The Executive Leadership Team is the executive forum in which the Group’s senior leaders come together to communicate, review and agree on issues and actions of Group-wide significance, and assist the Chief Executive in the performance of his duties. Warren East CBE Chief Executive Colin Smith CBE Group President David Smith Chief Financial Officer Chris Barkey Group Director – Engineering & Technology Marion Blakey President & CEO Rolls-Royce North America Chris Cholerton President – Defence Aerospace Mary Humiston Group Human Resources Director Miles Cowdry Corporate Development Director Mikael Makinen President – Marine Dr Ulrich Döhle CEO – Power Systems Mark Gregory General Counsel Harry Holt Group Operations Strategy Director (Transitional support) President – Nuclear Eric Schulz President – Civil Aerospace Lawrie Haynes Executive (Transitional support) Tony Wood Executive (Transitional support) Rolls-Royce Holdings plc Annual Report 2015 61 Directors’ Report Directors’ Report / Chairman’s introduction CHAIRMAN’S INTRODUCTION Early in the year we adopted and published on our website a new Board governance document that recognises the requirements of the UK Corporate Governance Code 2014 (the Code). It contains the terms of reference of our principal Board committees and the matters reserved to the Board, and was further updated by the Board to reflect best practice in December 2015. However, we did not stop at Code compliance. Our governance improvement work went much deeper this year by steering and supporting an update of internal governance arrangements at executive and operational levels. As a result, a new internal governance framework document is being rolled out to employees in 2016 to provide a clear and common understanding about how Rolls-Royce works and what is expected across the key governance areas. You can read about this important milestone project in the Nominations & Governance Committee report on page 73. The following Board committees met for the first time under their new mandates: • • the Nominations & Governance Committee, with an expanded remit to provide more dedicated time and focus on corporate governance in addition to traditional nominations matters; our combined Safety & Ethics Committee, created as a dedicated and focused oversight forum in acknowledgement of the critical emphasis we place on: – promoting the highest standards of ethical behaviours throughout our organisation and with our partners, – the safety of our products and our workforce which can be jeopardised by inappropriate behaviours as well as other factors, and – the continuing development of a sustainable, socially and environmentally responsible business; • the new Science & Technology Committee, formed to provide greater oversight of the Group’s innovation strategy and the direction of research, technology and development activities taking into account scientific and technological trends. I led a review that resulted in some changes to the composition of our committees during 2015. The changes reflected the diversity of skills and experience amongst our Non-executive Directors (including those who joined the Board during 2015) and the value that they could each bring to the particular work of the committees. More information on the experience of our Directors is contained in the Nominations & Governance Committee report on page 71. Our current committee memberships are set out on pages 58 to 61 and on page 65, and you can read about the remit and work of each committee during the year in the reports which follow on pages 69 to 104. The Board is satisfied that all committees are working effectively to deliver strong oversight and governance over their respective areas of responsibility, and are reporting appropriately to the Board, in accordance with their terms of reference. The Board and each of its committees have also worked during the year to implement the recommendations made by Independent Audit in its 2014 Board effectiveness review. Independent Audit returned to conduct a follow-on survey and review in 2015 of how this work had progressed. You can read more about this on page 66. This was a useful independent assessment of improvements made throughout the year and also served to identify further areas for our continued focus into 2016. Strong corporate governance sets the right tone to drive appropriate conduct and behaviour across all that we do.” Ian Davis Chairman In its stewardship of Rolls-Royce, the Board recognises that excellence in corporate governance is essential in order to generate and protect value for our investors. This requires continuous focus but is particularly important in times of change and transformation. It is not just a matter of ensuring compliance with the latest regulatory guidance; strong corporate governance is the over-arching principle which gives management the confidence to run a sustainable business within an agreed framework of strategic direction and risk appetite. It sets the right tone to drive appropriate conduct and behaviour across all that we do. This year we have taken steps to improve the frequency and quality of our interactions with major shareholders and will continue to work on this. You can read more about this activity on page 68. 62 Rolls-Royce Holdings plc Annual Report 2015 Corporate governance CORPORATE GOVERNANCE The Board The role of the Board providing leadership, knowledge and experience overseeing and monitoring business performance, to support and guide the Executive Leadership Team setting Group strategy and objectives, considering internal controls, governance and risk management recommendations from the Executive Leadership Team shareholder engagement Chairman* Ian Davis effective running of the Board and its committees in accordance with the highest standards of corporate governance setting the Board agenda managing the Board to ensure adequate time for discussion of all agenda items ensuring the Board receives accurate, timely and clear information Senior Independent Director* Lewis Booth being available to major shareholders if they have concerns which have not been resolved through the normal channels of the Chairman, Chief Executive or other Executive Directors conducting an annual review of the performance of the Chairman providing a sounding board for the Chairman Other Non-executive Directors providing skills and external experience to support the Chairman and management Chief Executive* Warren East overseeing the day-to-day operation of the Group’s business establishing and maintaining formal and appropriate delegations of authority developing and implementing the Group’s maintaining a close working relationship strategy as approved by the Board with the Chairman Other Executive Directors providing management perspective to support the Board’s decision making Company Secretary* Pamela Coles providing governance, advisory and administrative support to all Directors acting as Secretary to the Board and its committees ensuring compliance with Board procedures and corporate governance requirements administering the process for Directors to access external independent advice at the Company’s expense assisting the Nominations & Governance Committee with plans for Directors’ induction and ongoing training * These roles are set out in writing and have been agreed by the Board. The Board committees Nominations & Governance Committee Remuneration Committee Audit Committee Safety & Ethics Committee Science & Technology Committee Board composition Remuneration policy Financial reporting S&E governance framework R&T/R&D strategy Succession planning Board nominations Board evaluation Corporate governance Incentive design and setting of targets Executive remuneration review Internal controls S&E policies and practices E&T processes Risk management S&E training Internal audit S&E risk management External auditor S&E investigations Cyber security Sustainability Technology capabilities and skills R&D investments Technology trends and risks Rolls-Royce Holdings plc Annual Report 2015 63 Directors’ Report Directors’ Report / Corporate governance CORPORATE GOVERNANCE CONTINUED The UK Corporate Governance Code 2014 (the Code) Key matters reserved to the Board: The Board considered the Company’s compliance with the Code during the year. Please see our compliance statement on page 67. • the Group’s long-term objectives, strategy and risk appetite • shareholder engagement and general meetings The Board The Board is ultimately responsible to shareholders for the direction, management and performance of the Company. Details of the Board are set out on pages 58 to 61 and on page 63. Details of the Executive Directors’ service contracts and the Non-executive Directors’ letters of appointment are on page 85. Details of their remuneration and share interests are set out in the Directors’ Remuneration Report on pages 77 and 86. The Board has a schedule of matters reserved for its approval, generally being those items which affect the shape, risk profile or strategic direction of the Group, as well as key financial items. The schedule of reserved matters was reviewed during the year and is contained within our Board governance document available on the Group’s website. • overall corporate governance arrangements including Board composition, committee terms of reference and Directors’ independence and conflicts of interest • internal controls, governance and risk management frameworks • changes to the corporate or capital structure of the Company • annual report and accounts, and financial and regulatory announcements • significant changes in accounting policies or practices • policy on, and declarations of, payments to shareholders • annual budgets and financial expenditure and commitments above levels set by the Board • remuneration policy and remuneration of Directors and senior executives • new share incentive or pension plans or major changes to existing plans Area of focus Matters considered Outcome Strategy and risk Merits of maintaining a balanced portfolio of power systems businesses; markets, technology and product strategy; risks to the strategy; effectiveness of risk management system and review of principal risks with detailed review of export control compliance, business continuity, competitive position, talent and capability, and major programme delivery principal risks. Strategic priorities endorsed and re-set; considered approach to risk appetite; enhanced risk management system and principal risks approved. Individual principal risks considered in detail and the Board was assured that they are managed appropriately. Key areas of focus for 2016 Driving new strategic priorities towards future return to growth. Enhanced internal controls and assurance framework. Shareholder engagement Need to improve shareholder communications; ValueAct’s acquisition of significant shareholding. More detail provided in investor presentations; greater level of engagement with investors; constructive dialogue with ValueAct. Continued engagement to rebuild investor confidence. Financial and operational performance Changes to capital structure Payments to shareholders Board composition Financial performance and outlook; product incidents in service; health, safety and the environment. Updates to trading outlook; oversight of management information project. Share buyback; levels of access to debt capital; ADR programme; new US bond programme; new EIB loan; update of EMTN programme and refinancing of revolving credit facility (RCF). Share buyback halted. Approved revised ADR programme, US bond, EIB loan, update to EMTN programme and refinancing of RCF. Driving operational performance improvements and better forecasting. New share plans and updated remuneration policy for adoption in 2017. Progressive payment policy and level of payment declared in February 2015. Approved final payment to shareholders in respect of financial year 2014 and interim payment for 2015. Review of policy on payments to shareholders. Succession planning for Chief Executive and Non-executive Directors. Appointment of a representative of ValueAct as a director. Appointments of Warren East as Chief Executive, and Irene Dorner, Alan Davies and Sir Kevin Smith as Non-executive Directors approved. Executive succession and retention planning. Considered appointing a representative of ValueAct under usual nomination process, which continued into 2016. Further consideration of balance of Board and its committees in light of Directors’ terms of office. Corporate governance Committee terms of reference, Directors’ independence, Chairman’s evaluation. Changes to composition of committees and updates to committee terms of reference approved. Embedding new internal governance framework into the businesses. New internal governance framework. Internal governance framework approved subject to reflecting changes to organisational design. Further implementation of Board evaluation recommendations. Annual budgets 2016 budget in light of 2015 financial performance and headwinds. Budget approved. Capital investments Investment in new facilities in Indianapolis. Investment approved subject to State funding. Delivering competitively to our customers’ needs. Continuing transformation of our infrastructure. 64 Rolls-Royce Holdings plc Annual Report 2015 Corporate governance Board and committee meetings held in 2015 NG R A SE B B NG R IAB B NG R B NG R A ST AGM B SE B January February March April May June NG A SE B July B B NG R A SE ST B NG R A B NG B NG R B August September October November December Committee meetings Other meetings NG Nominations & Governance Committee SE Safety & Ethics Committee B Board R Remuneration Committee ST Science & Technology Committee IAB International Advisory Board A Audit Committee AGM Annual General Meeting Denotes unscheduled meeting The unscheduled meetings were held to consider: • Warren East’s selection and appointment as Chief Executive (March and April) • ValueAct’s acquisition of a major shareholding in the Company (September and November) • Board committee composition arising from director changes (May) • Sir Kevin Smith’s appointment as a Non-executive Director (September) • the Group’s trading outlook and market updates (July and November) Some of the Directors were unable to participate in the unscheduled meetings of the Nominations & Governance Committee held in April and November and the unscheduled Board meetings in July and November as these meetings were called on short notice. Board and committee attendance at scheduled meetings Number of meetings Current Directors Ian Davis Warren East 1 (appointed Chief Executive on 3 July 2015) Dame Helen Alexander 2 Lewis Booth Ruth Cairnie Sir Frank Chapman Alan Davies (appointed 1 November 2015) Irene Dorner (appointed 27 July 2015) Lee Hsien Yang (joined Audit Committee 2 March 2015) John McAdam 3 Colin Smith David Smith Sir Kevin Smith (appointed 1 November 2015) Jasmin Staiblin Former Directors James Guyette (left 8 May 2015) John Neill (left 8 May 2015) John Rishton (left 2 July 2015) Board (9) 9/9 9/9 6/9 9/9 9/9 8/9 2/2 4/4 9/9 8/9 9/9 9/9 2/2 8/9 4/4 4/4 5/5 Audit (5) – 2/2 – 5/5 – – 2/2 3/3 4/4 – – – – – – 2/2 – Nominations & Governance (4) 4/4 1/1 3/4 4/4 4/4 4/4 2/2 2/2 Remuneration (5) – – 5/5 – 5/5 5/5 – – Safety & Ethics (4) – – 1/4 – – 4/4 – 2/2 Science & Technology (2) – 1/1 – 2/2 2/2 – – – 4/4 4/4 – – 2/2 4/4 – – – – 5/5 – – – – – – – 4/4 2/4 – – – – – – – – – – – 1/1 2/2 – – – 1 Warren East stepped down from the Nominations & Governance, Audit and Science & Technology Committees upon his appointment as Chief Executive on 3 July 2015. 2 Dame Helen Alexander missed the scheduled Board meetings in January, March and July, the scheduled Nominations & Governance Committee meeting in July and the Safety & Ethics Committee meetings in February and July for medical reasons. She also missed the Safety & Ethics Committee meeting in December due to an unavoidable diary clash with a board meeting of UBM plc, of which she is chairman. 3 John McAdam missed the scheduled meetings of the Board and Safety & Ethics Committee in June and the Safety & Ethics Committee meeting in July due to unavoidable diary clashes with board meetings of J. Sainsbury plc, of which he is the senior independent director. The clashes in June were caused by the Company needing to reschedule to an alternative date at short notice. Rolls-Royce Holdings plc Annual Report 2015 65 Directors’ Report Directors’ Report / Corporate governance CORPORATE GOVERNANCE CONTINUED Appointments and re-appointments We refreshed the composition of the Board with the appointment of three new Non-executive Directors; Irene Dorner, Alan Davies and Sir Kevin Smith. Warren East, who was previously a Non-executive Director, became the Chief Executive in July. Details of the appointment process are set out in the Nominations & Governance Committee report on pages 70 and 71. Board induction and development Newly appointed Directors follow a tailored induction programme, facilitated by the Company Secretary, which includes dedicated time with Group executives and scheduled trips to a variety of business sites. All Directors are encouraged to visit the Group’s facilities and to undertake additional training. Details are set out in the Nominations & Governance Committee report on page 72, which includes information on Warren East’s induction into the role of Chief Executive. Independence of the Non-executive Directors The Board conducts a review of the independence of the Non-executive Directors every year, based on the criteria in the Code and following consideration by the Nominations & Governance Committee as detailed on page 73. This review was undertaken in December 2015 and the Board concluded that all the Non-executive Directors remained independent in character and judgement. The Code does not consider the test of independence to be appropriate to the chairman of a company. However, Ian Davis did meet the Code’s independence criteria upon his appointment as Chairman in May 2013. His other external commitments are described on page 58. We are satisfied that, based on the Directors’ current declared interests, the Board will comply with the Financial Reporting Council’s (FRC) forthcoming independence requirements on the maximum number of external directorships. Board evaluation The Board and its committees undertake an annual evaluation of their performance. At least once every three years this is conducted by external consultants. In 2014, the evaluation was conducted by Independent Audit who returned in 2015 to conduct a follow-up review of progress made. During the year, the Company subscribed to an online service from Independent Audit which was used to support the Board’s review. Independent Audit also acted as an external sounding board in support of the Company’s review of its internal governance, risk management, controls and assurance frameworks and in supporting an online survey of the effectiveness of the external audit process. Independent Audit does not have any other connection to the Company. The original Board evaluation included; a review of Board and committee papers; interviews with Directors and others who have significant interaction with the Board or its committees including external auditors and remuneration advisors; and observations of a number of the meetings. In 2015, Independent Audit were engaged to conduct a follow-up review of progress towards the 2014 recommendations. This was not a full independent board evaluation assessment but, as an externally-facilitated review, it involved the Directors completing an online, tailored, self-assessment questionnaire and Independent Audit speaking with the Chairman, the Chief Executive and each of the Board committee chairs. Independent Audit also observed the November Board and Audit Committee meetings with a review of the papers for those meetings. The meetings observed were heavily focused on the Company’s revised financial outlook, resulting in the market update given on 12 November 2015. Independent Audit presented the results of the 2015 follow-up review to the Board in December 2015. In the context of 2015 having been a particularly challenging year for the Company and its shareholders, Independent Audit noted that progress had been made in certain areas, including the Board’s overall composition and clearer risk management processes. There were several areas identified as needing further attention. These were generally related to making the most effective use of the Board’s time, and included: • making sure the Board’s discussions and agenda focus on and align to the transformation agenda and near-term priorities; • ensuring that the Board devotes sufficient time to support this focus through discussion, and minimises lengthy management presentations; • drawing out clear conclusions from Board discussions more effectively to guide management activity; • giving due time and attention to people development, talent and succession; and • better use of metrics and risk reporting in Board papers. Having gone through the effectiveness review described above, and acknowledging the disappointing and difficult financial position that dominated discussions at the November Board and Audit Committee meetings, with the consequential market update, the Directors are satisfied that the Board and each of its committees operated effectively during 2015. Nonetheless, based on Independent Audit’s observations, the Board is continuing to work on actions to improve its effectiveness for the future. Lewis Booth, as the Senior Independent Director, led the Board’s annual review of the Chairman’s performance. Lewis obtained input from each of the Directors individually and then led a review at the Board meeting in December (without the Chairman present). The Board unanimously agreed that the Chairman’s performance continued to be very strong through a difficult year for the Group, with him showing particular leadership and commitment in the process to select and appoint a new Chief Executive and further Non-executive Directors. The Board noted the Chairman’s exceptional level of dedication to his role and to his engagement with the other Directors in keeping them informed and soliciting their views. 66 Rolls-Royce Holdings plc Annual Report 2015 Corporate governance Executive Leadership Team (ELT) International Advisory Board (IAB) The ELT is an executive-level forum of the Group’s most senior leaders, chaired by the Chief Executive. It helps to develop, implement and monitor strategic and operational plans, considers the continuing applicability, appropriateness and impact of risks, leads the Group’s culture and aids the decision making of the Chief Executive in managing the business. Following the initial results of the Chief Executive’s operational review announced in November, the ELT membership was restructured under the oversight of the Nominations & Governance Committee to reflect the transformation agenda. The current ELT composition is set out on page 61. Directors’ indemnities and insurance In accordance with the Articles, and to the extent permitted by law, the Company has entered into separate deeds of indemnity with its Directors, which were in force during the financial year and remain in force at the date of this report. The Company also maintains directors’ and officers’ liability insurance cover for its Directors and officers. This cover also extends to directors of subsidiary companies. Internal control and risk management In developing our internal governance framework we looked at how the Company’s risk management and internal control systems work together. You can read about our risk management system on page 54 and details of our internal control system are in the Audit Committee report on page 95. As noted on page 54, these systems are designed to manage, rather than eliminate, the risk of failure to achieve objectives and so can only provide reasonable and not absolute assurance against material misstatement or loss. The Board, with the advice of the Audit Committee, has reviewed the effectiveness of the risk management and internal control systems, including controls in relation to the financial reporting process, for the year under review and to the date of this report. The Board confirms that the Group continues to be compliant with the standards in the Code and with the Financial Conduct Authority’s (FCA) Disclosure Rules and Transparency Rules in this regard. 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. Since his appointment in November 2014, the Chief Financial Officer has undertaken an in-depth review of our management reporting and budgeting processes to ensure that they fully provide what we need, taking into account the size and shape of the Group and the structure of our operations. 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. The IAB meets annually with the Board in order to provide perspective and to guide strategy development through discussions on the geo-political and global economic landscape that may present risks or opportunities to the Group’s current or future activities. The members of the IAB during the year were as follows: 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, president, Czech Chamber of Commerce 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, China *Mustafa Koç Chairman of Koç Holding, A.Ş., Turkey * Mr Koç passed away on 21 January 2016 Dr Pedro Sampaio Malan Chairman of Itaú Unibanco’s international advisory board and a member of the boards of EDP – Energias do Brasil, Souza Cruz, Brazil, Mills Engenharia, a director of Thomson Reuters Founders Share Company and a member of the Temasek international panel Akio Mimura Senior advisor, honorary chairman Nippon Steel & Sumitomo Metal Corporation, Japan, chairman of The Japan Chamber of Commerce and Industry Lubna Olayan CEO and deputy chairperson of the Olayan Financing Company, Saudi Arabia Ratan Tata Chairman Emeritus of Tata Sons Limited, India 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 Trade Representative and US Deputy Secretary of State Compliance with the UK Corporate Governance Code 2014 (the Code) The Company is subject to the provisions of the Code, a copy of which is available from the FRC’s website. The Board considers that the Company complied in all material respects with the Code for the whole of the year to 31 December 2015. The Board has agreed that arrangements by which staff may raise concerns in confidence are considered and reviewed by the Safety & Ethics Committee. Matters relating to financial reporting, the integrity of financial management or fraud are also reported to the Audit Committee. The Audit Committee has again considered the requirement to put the audit out to tender every ten years and in line with the FRC’s transitional arrangements will do so during the tenure of the current lead partner which expires in 2017. The current auditors will not be invited to tender. More detail is in the Audit Committee report on page 96. Rolls-Royce Holdings plc Annual Report 2015 67 Directors’ Report Directors’ Report / Corporate governance Directors’ Report / Corporate governance CORPORATE GOVERNANCE CONTINUED Shareholder engagement The Board recognises and values the importance of building strong investor relations through a proactive communication programme. During 2015, various steps have been taken to improve performance in this area. These have included strengthening our investor relations function with the addition of experienced professionals and enhancing our disclosure and transparency through improved reporting. In addition, the frequency of meetings with investors has significantly increased under the new management team. As a result, we have also been proactive in obtaining an understanding of shareholder views on key matters affecting the Group and have incorporated these into our Board deliberations around strategy, performance improvement and governance. In addition, we have benefited from a review of investor opinion undertaken by an independent investor representative body towards the end of the year. Our Investor Relations department plays a key role in building stronger, clearer discussions with current and potential investors and the sell-side analysts that help inform them. During the year, the team have undertaken an extensive investor relations programme involving formal events, smaller group and one-on-one investor meetings. The purpose of the larger events is to highlight particular issues, themes or announcements that the Group believes develop a better understanding of the business or which warrant further explanation or clarification. The events also provide opportunities for shareholders to meet members of the senior management team. The one-to-one and group meetings provide an opportunity for investors to ask more detailed questions that can improve individual knowledge or clarify areas of misunderstanding. This is a critical process in ensuring market participants make decisions based on a consistent understanding of the information available. In this way, shareholders should be able to consistently and fairly value the Group’s businesses. As a matter of best practice, the Chairman and Senior Independent Director, together with other members of the Board, make themselves available to meet with investors at their request and regularly attend key investor relations events. During the year, it has been necessary to provide material updates on performance and expectations to the market alongside regular results communications. This included a capital markets presentation in London on 24 November 2015, attended by over 200 investors and analysts. At the same time, the team have held over 500 one-to-one and group meetings, led by the Chief Executive, Chief Financial Officer, the Director of Investor Relations or members of the Investor Relations team. In addition, the Chairman has undertaken 20 meetings or detailed discussions with investors, five at their request. Lewis Booth, our Senior Independent Director, has met with a further six investors, two at their request. Both the Chairman and Senior Independent Director, together with other 68 Rolls-Royce Holdings plc Annual Report 2015 members of the Board, attended various formal meetings, including the capital markets presentation on 24 November 2015. In early 2016, Dame Helen Alexander, as chair of the Remuneration Committee, consulted with a number of investors on proposed changes to the 2016 annual bonus and Performance Share Plan (PSP). You can read more about this in the Remuneration Committee report on pages 74 to 76. The Group’s website rolls-royce.com contains up-to-date information for shareholders, including an online version of the Annual Report, share price information, news releases, presentations to the investment community and information on shareholder services. It also contains factual data about the Group’s businesses, products and services. Annual General Meeting (AGM) All holders of ordinary shares may attend the Company’s AGM at which the Chairman and Chief Executive present a review of the key business developments during the year. This year’s AGM will be held at 11.00am on 5 May 2016 at the East Midlands Conference Centre, University Park, Nottingham NG7 2RJ. Shareholders can ask questions of the Board on the matters put to the meeting, including the Annual Report and the running of the Company generally. All Directors are invited to attend each AGM. Unless unforeseen circumstances arise, all committee chairmen will be present to take questions at the AGM. The Company intends to send the AGM notice and any relevant related papers to shareholders at least 20 working days before the meeting. The AGM notice will be available to view on the Group’s website. A poll is conducted on each resolution at the AGM and at all other Company general meetings. Shareholders have the opportunity to cast their votes in respect of proposed resolutions either in person at the general meeting, or by appointing a proxy to vote on their behalf. Proxy appointments can be made either electronically or by post. Following the AGM, the voting results for each resolution are published and made available on our website. Information included in the Directors’ report Certain additional information can be found in the section headed ‘Other statutory information’ on pages 178 to 181 and is incorporated into and forms part of this Corporate Governance report by reference. Committee reports / Nominations & Governance Committee NOMINATIONS & GOVERNANCE COMMITTEE Highlights Warren East appointed as Chief Executive Three new independent Non-executive Directors appointed Board governance document adopted and published Development of internal governance framework Committee members and attendance The members of the committee are shown on pages 58 to 61 and their attendance is shown on page 65. The Chief Executive may attend meetings of the committee by invitation. The committee met nine times during 2015 and focused in particular on the composition of the Board resulting in the appointments of three new Non-executive Directors and the appointment of a new Chief Executive. The committee also oversaw the restructuring of the ELT. 2015 overview Introduction In January 2015, the Nominations Committee’s remit was widened to include governance issues and was renamed the Nominations & Governance Committee. This committee is now responsible for advising the Board on governance best practice, ensuring that the Group policies are appropriate and for keeping the composition and balance of the Board and senior executive team under review. The committee also has responsibility for the identification of the future composition needs of the Board in light of the business strategy and for maintaining the Group’s position on diversity and inclusion. The committee reports to the Board on Directors’ conflicts and regularly reviews the Non-executive Directors’ independence. The committee has been allocated responsibility on behalf of the Board for overseeing the Group’s principle risk relating to talent and capability. Principal responsibilities The key areas of responsibility of the committee are: to review the structure, size and composition (including skills, knowledge, experience and diversity) of the Board and its committees, to ensure that it remains appropriate, and to make recommendations to the Board of any changes; to consider and formulate succession plans for Directors and senior executives; to evaluate any conflicts of interest that the Directors may have; to review the Board’s diversity policy and its implementation; to report to the Board on the Company’s corporate governance practices and procedures to ensure that they remain appropriate for a group of the size and complexity of Rolls-Royce, taking account of best practice principles; to oversee the induction plans for Directors; to review the results of the annual Board performance evaluation; to review the independence of the Non-executive Directors; and to conduct an annual evaluation of the Chief Executive. Rolls-Royce Holdings plc Annual Report 2015 69 Directors’ Report Directors’ Report / Committee reports Directors’ Report / Corporate governance Nominations & Governance Committee NOMINATIONS & GOVERNANCE COMMITTEE CONTINUED At a glance Area of focus Matters considered Outcome Succession planning and talent management The selection and appointment of a new Chief Executive following John Rishton’s decision to retire. Identifying the need for, and leading the process to select and recruit, additional Non-executive Directors. The committee recommended the appointment of Warren East as Chief Executive and the appointments of Irene Dorner, Alan Davies and Sir Kevin Smith as Non-executive Directors during 2015. Pages 58 to 61 set out their biographies. Succession planning below Board level, including the composition of the current ELT. Changes to the ELT were agreed during 2015, resulting in the composition shown on page 61. Committee membership Committee refreshment arising from the retirement of one Non-executive Director and from the appointment of Warren East as Chief Executive. The Board committees were restructured, and care was taken during the recruitment process to ensure the skills and experience of the new Non-executive Directors were closely matched to the needs of the committees. The revised committee membership is shown on pages 58 to 61 and on page 65. Governance framework The implementation of the revised governance framework and the extension of the framework below Board level. Approval of the new framework, including new delegated authorities, and a process for rolling out the framework across the business. Security clearance Management of sensitive information to ensure good oversight and control. Shareholder engagement Liaison with ValueAct, a major shareholder, and consideration of its request for a seat on the Board. The committee established a sub-committee of Non-executive Directors who have received appropriate clearance to enable them to review highly sensitive and secure data. The committee agreed appropriate levels of engagement with the board of Rolls-Royce North America following the departure of James Guyette. A constructive dialogue was established with ValueAct and the committee initiated a nomination process to consider the proposed candidacy. This process continued into 2016. Conflicts of interest Directors are required to declare any potential or actual conflicts of interest that could interfere with their ability to act in the best interests of the Group. The committee considered the schedule of Directors’ conflicts of interests and recommended that the schedule be approved by the Board. Reviewed its own terms of reference Evaluation of how well the members and the committee operated during the year. The committee reviewed and updated its terms of reference. In November 2015, it reviewed whether it had undertaken all the work required under its terms of reference and concluded that it had done so. Principal risk Board composition A principal risk to the business is the inability to attract, retain and incentivise sufficiently talented individuals to deliver our strategy. The committee is responsible for reviewing talent and capability management and it held two sessions during 2015 which looked at the processes to develop and maintain talent. These discussions focused around the need to reconfigure the ELT and resulted in its new composition to deliver business transformation, as shown on page 61. The committee reviews the balance and composition of the Board, its committees and the senior executive team on a regular basis. This review is not just to identify current needs, but also to consider longer term succession planning. To this end a sub-committee of the Nominations & Governance Committee was formed in February 2015 to look specifically at contingency planning for senior positions. This sub-committee reported back to the committee in February 2015 and in April 2015, when the committee considered the appointment of a new Chief Executive. 70 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Nominations & Governance Committee At the start of the year, the committee discussed James Guyette’s wish to retire and recommended to the Board that he step down at the end of the 2015 Annual General Meeting. As part of the Board evaluation carried out in 2014, the current Board mix was discussed and it had been agreed that, subsequent to James leaving the Board, his role as CEO & President of Rolls-Royce North America would no longer be a Board position, although his successor would still be a member of the Executive Leadership Team. In early 2014, the committee had carried out work with Korn Ferry on succession planning. Korn Ferry provides services of this nature, including the recruitment of senior executives, for the Group but does not have any other relationship with the Group. When, in 2015, John Rishton indicated his desire to retire as Chief Executive, Korn Ferry’s work was revisited by a sub-committee of the Nominations & Governance Committee. This sub-committee comprised the Chairman, the Senior Independent Director and three other independent Non-executive Directors. Specific criteria for the role were drawn up and approved by the full committee and a comprehensive international search was undertaken with assistance from Korn Ferry. This search identified a small number of suitable candidates, each of whom was assessed against the objective criteria. The members of the Nominations & Governance Committee met each of the candidates on the shortlist and, as a result of this process and following formal meetings with the remaining Board members, Warren East was confirmed as the preferred candidate. Warren has been a Non-executive Director of Rolls-Royce since January 2014 and he was CEO of ARM Holdings from 2001 to 2013. On becoming Chief Executive of Rolls-Royce on 3 July 2015, Warren stepped down from the Audit, Nominations & Governance and Science & Technology Committees. The Chairman led the evaluation of Warren’s performance as Chief Executive, including obtaining the individual views of the other Directors and certain members of the ELT, before a discussion at the committee’s meeting in December 2015. It was recognised that in his first few months in the role Warren had made a strong start. He very quickly identified the need for improvements in operational performance and cost reduction, set the priorities and communicated these effectively both internally and with investors, and is reshaping the leadership team to support the transformation agenda. The committee started the process for recruiting additional Non- executive Directors during 2014 by considering the areas of expertise that should be added to the Board. An external search consultant was appointed and a wide range of high calibre independent candidates was considered and a number of interviews were carried out. As a result of this process, Irene Dorner joined the Board as a Non-executive Director in July 2015 and joined the Audit Committee, the Safety & Ethics Committee and the Nominations & Governance Committee. Irene has considerable international and risk management experience and is a powerful advocate for diversity and inclusion in the workplace. The committee considered that strengthening the level of financial and technical accounting knowledge on the Board would be beneficial and, again following the process outlined above, Alan Davies joined the Board as Non-executive Director with effect from 1 November 2015 and joined the Audit and Nominations & Governance Committees. Alan is a fellow of the Institute of Chartered Accountants in Australia. As well as his strong financial background which includes serving as CFO of Rio Tinto’s iron ore division, Alan brings with him a wealth of leadership experience, including transforming operational performance and driving cultural change through a complex global organisation. He has deep knowledge of China and key emerging markets. Alan’s appointment also adds further expertise in safety and operations to the Rolls-Royce Board. Dame Helen Alexander will be stepping down from the Board after the AGM in May 2016, having served on the Board for nine years. At that time, she will be succeeded as Chairman of the Remuneration Committee by Ruth Cairnie. Being mindful of the need for progressive refreshing of the Board and committees, the committee recommended to the Board the appointment of a further Non-executive Director in 2015 to ensure that there was scope for an orderly hand over. Sir Kevin Smith was appointed on 1 November 2015 as a Non-executive Director, joining the Remuneration, Nominations & Governance and Science & Technology committees. Sir Kevin was a full-time partner at Unitas Capital, a leading Asian private equity firm, having served for nine years as CEO of GKN plc, the global engineering and manufacturing company. Before then, Sir Kevin spent nearly 20 years with British Aerospace (BAE plc). In February 2016, Sir Kevin was appointed as chairman of the Science & Technology Committee. Kevin’s knowledge of Asia and of complex technological and engineering companies is extremely relevant to Rolls-Royce and we look forward to his contribution. In February 2016, Lewis Booth indicated his intention to relinquish his responsibility as Senior Independent Director once a successor has been appointed. Lewis will continue as Chairman of the Audit Committee. Details of the Non-executive Directors’ experience are on pages 58 to 61. MWM Consulting was engaged as the search consultant for the new Non-executive Directors. The committee set out the particular skills required in its brief, and this resulted in the appointment of Irene, Alan and Sir Kevin. MWM does not provide any other services to, and is not otherwise connected with, the Company. Each of the Directors continues to be effective and able to devote sufficient time to the business of the Company and the Board will continue to keep its composition under review. Succession planning and diversity The Board fully recognises and embraces the benefits of diversity throughout the Group as it brings a broader and more rounded perspective to decision making. Increasing diversity influences our approach to succession planning and training and development. The percentage of women on the Board has increased to 29% (2014: 21%). We believe a wide range of people and experiences is beneficial to achieving a high performance culture and enables innovation helping us to deliver excellence. Rolls-Royce is a founder patron of the FTSE 100 Cross-Company Mentoring Programme which aims to widen the pool of eligible female board candidates. Rolls-Royce Holdings plc Annual Report 2015 71 Directors’ Report Directors’ Report / Committee reports Directors’ Report / Corporate governance Directors’ Report Nominations & Governance Committee NOMINATIONS & GOVERNANCE COMMITTEE CONTINUED We will continue to consider candidates for future Board appointments from the widest possible pool and will only engage executive search firms that have signed up to the Voluntary Code of Conduct for Executive Search Firms in relation to gender diversity on corporate boards. We acknowledge the challenges of increasing diversity within our industry, and during 2015 we have introduced a refreshed global diversity and inclusion policy and a revised anti-discrimination policy. These policies aim to ensure that all employees are treated with respect and are empowered to deliver without fear of bullying or harassment. We recognise that succession planning includes nurturing our own talent pool and giving opportunities to those who are capable of growing into more senior roles. We give full and fair consideration to all employment applications from people with disabilities, and support disabled employees, helping them to make the best use of their skills and potential. We have continued to roll out High Performance Culture training across the globe to help employees increase their personal effectiveness. We have established several Employee Resource Groups (ERGs) to support our diversity and inclusion strategy. These include Women’s ERGs in Germany, US and the UK, a Lesbian, Gay, Bisexual and Transgender ERG and an African Caribbean ERG, both in the UK. The committee held two focused sessions during the year to consider succession planning at a senior level including the re-organisation of the ELT announced in December 2015. Board induction and development The Company Secretary is responsible for ensuring that new Directors have a thorough and appropriate induction. Each of the newly appointed Non-executive Directors has participated in a structured induction programme and received a comprehensive data pack providing detailed information on the Group. Each induction has been based on the individual Director’s requirements and included meetings with relevant employees, committee members and external advisers to ensure that each new Director understands the Group’s governance structure. Warren East received a comprehensive induction when he was appointed as Chief Executive. Before he took over as Chief Executive, Warren met with a number of key customers, suppliers and partners. He also spent several weeks visiting Rolls-Royce sites and meeting the senior personnel as well as Board members. In gaining an understanding of the business challenges, he listened to feedback from most areas of the business. Since joining, Warren has conducted town hall meetings at sites he has visited and introduced a blog on the Group’s intranet which has been well received as it opens up a constructive dialogue with employees on the issues that affect the businesses. In 2015, the training programme was improved to ensure that all Directors had the opportunity to visit our operations. We regard visits by Board members to our operating sites as an important part of continuing education as well as an essential part of the induction process. They help Directors understand the business through direct experience of operating processes with employees at different levels. This also gives the Non-executive Directors the chance to spend time with their fellow Directors in a less formal setting, which helps them to understand the concerns of their colleagues. In 2015, Irene Dorner and Sir Kevin Smith visited operational sites in Derby, UK and Irene visited production sites in the US (Indianapolis and Crosspointe); Ian Davis spent time with the supply chain team in Derby, UK and visited customers and suppliers in Japan, Singapore, Dubai and Washington, DC. Ruth Cairnie visited Friedrichshafen, Germany and Singapore, and Dame Helen Alexander visited our operations in Alesund, Norway. The members of the Audit Committee visited the Company’s IT security operations centre to better understand the Group’s preventative and reactive cyber security measures. Metrics to support cyber security assurance have since been developed and are periodically reviewed by the Audit Committee. Further training is available for all Directors, as appropriate, including presentations by the executive team on particular aspects of the business. For example, all Non-executive Directors undertook the Group’s ethics training programme during the year. Board members by gender Senior managers by gender Employee headcount by gender Female Male 2014 2015 4 (29%) 10 (71%) 2014 2015 Female Male 14 (7%) 177 (93%) 2014 2015 Female Male 7,700 (15%) 42,800 (85%) 72 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Nominations & Governance Committee There is a procedure for Directors to take independent professional advice at the Company’s expense and every Director has independent access to the Company Secretary. Governance The committee has taken on responsibility for corporate governance. Early in the year, we adopted the Company’s Board governance document which sets out the roles and responsibilities of the Board members, the matters reserved to the Board and the terms of reference of the Board committees. This was revised for best practice in December 2015. We also oversaw the development of the Company’s internal governance framework, which documents how the Group is run, and recommended its adoption by the Board. It sets out the mandatory policies, processes and procedures that must be observed by all employees, clarifies the way in which we take decisions, and sets out our system of internal controls, risk management and assurance. Greater clarification around these issues is important in strengthening our governance and ensuring that all employees know what is expected of them. We reviewed an updated schedule of delegated authorities and recommended it to the Board for adoption. The revised authority levels are better aligned with business needs, helping the Group to eliminate unnecessary bureaucracy whilst still providing sufficient control to manage the business responsibly at appropriate levels. The committee reviewed the process through which sensitive information is handled and recommended the formation of a sub-committee, comprising only Directors who have received security clearance, to ensure proper oversight and control of classified information. This sub-committee will meet whenever necessary. During 2015, an executive-level Disclosure Committee was established to review all significant market announcements and to oversee the process for handling any price-sensitive information. At its first meeting in October 2015, the committee members agreed its terms of reference, and received a refresher training session on inside information from the Company’s external legal counsel. The committee met in November 2015 to consider the operating review update and interim management statement before their release to the market, and again in February 2016 to review at executive level this Annual Report (including as to whether it is fair, balanced and understandable) and our draft preliminary results announcement. A key challenge has been to improve the quality and timeliness of information going to the Board and its committees. The Company has worked to develop better information systems, creating a more consistent and thoughtful approach to presenting technical materials. This has included the creation of templates and the introduction of a new board portal for easier and more timely access to key information. As recommended in the 2014 Board evaluation, we have encouraged more frequent conversations between senior management and the Directors, resulting in greater and more constructive challenge, although the latest Board evaluation indicated that we can do more in this area, see page 66. We reviewed Board committee membership during the year, following Warren East’s appointment as Chief Executive, John Neill’s departure from the Board and the appointments of Irene Dorner, Alan Davies and Sir Kevin Smith. The committee took care to ensure that the skills and experience of the new Board members were closely aligned with the needs of the Board committees. Committee membership is set out on pages 58 to 61 and on page 65. The Nominations & Governance Committee is satisfied with the composition of the committees and confident that they are appropriately resourced to carry out their work. The committee also reviewed and recommended to the Board that Jasmin Staiblin, who has served on the Board for three years, be reappointed for a further three-year term, subject to shareholder support at the AGM. As part of its consideration of Board governance, the committee discussed the implications of ValueAct increasing its shareholding in the Company and encouraged engagement with ValueAct to better understand its views. Conflicts of interest and independence The Nominations & Governance Committee reviews the Non-executive Directors’ external interests every year to determine whether each Non-executive Director continues to be independent. In undertaking this evaluation, the committee considers among other things the criteria set out in the UK Corporate Governance Code. It also reviews any potential conflicts of interest as they arise and recommends to the Board whether these should be authorised and whether any conditions should be attached to any such authorisation. Additionally, an annual review of conflicts of interest is undertaken to ensure that any previously authorised conflicting situations are still being dealt with appropriately. Having carried out a rigorous review, the committee advised the Board that it considered that each of the Non-executive Directors, with the exception of the Chairman for whom the test is not appropriate, continued to be independent and recommended to the Board that each of the Directors’ potential conflicts of interest be authorised, without attaching any conditions. Looking forward Good progress has been made on governance during the year. For 2016, the key focus for the committee will be the development of succession plans to ensure that the transformation of the business is adequately supported below Board level and underpinned by the internal governance framework. Ian Davis Chairman of the Nominations & Governance Committee Rolls-Royce Holdings plc Annual Report 2015 73 Directors’ Report Directors’ Report / Committee reports Remuneration Committee REMUNERATION COMMITTEE REPORT Highlights No salary increases in 2016 No annual bonus payout for 2015 Amended 2016 Performance Share Plan (PSP) awards, including reduction in value New operational measures for annual bonus Principal responsibilities The key areas of responsibility of the committee are: to set and monitor the strategy and policy for the remuneration of the Executive Directors, the Chairman and members of the ELT; to determine the design, conditions and coverage of annual and long-term incentive plans for senior executives and approve total and individual payments under the plans; to determine targets for any performance-related pay plans; to determine the issue and terms of all share-based plans available to all employees; and to oversee any major changes in remuneration. Committee members and attendance The committee membership and attendance throughout 2015 is shown on page 65. In addition to the committee members, the Chief Executive, the Chief Financial Officer and any of the Non-executive Directors may attend one or more meetings at the committee’s invitation, although none was present during any discussions of his or her own remuneration package. The committee is supported by the Company Secretary, the Senior Reward Consultant, the Group Human Resources Director, and the Global Performance, Reward & Pensions Director. The committee is advised by Deloitte LLP, an independent reward adviser. 2015 overview Introduction On behalf of the Board, I am pleased to introduce our 2015 Directors’ Remuneration Report, for which we seek your support at our forthcoming AGM, in May 2016. This report is designed to demonstrate the link between the Group’s strategy, its performance, and the remuneration outcomes for our executives, in particular the Executive Directors. 2015 has been a challenging year for the Group and this is reflected in the performance outcomes for Executive Directors under the annual bonus and Performance Share Plan (PSP). At the beginning of 2016, we consulted with shareholders on proposed changes to the 2016 annual bonus and PSP. These changes are within the terms of the approved policy, but we nevertheless considered it important to receive input from shareholders to maintain an open dialogue on remuneration and inform our judgement. The changes were driven by our desire to ensure we properly motivate our Executive Directors to deliver the transformation of the business, whilst balancing the interests of shareholders and other stakeholders. Following Warren East’s appointment as Chief Executive and the changes he is introducing to the business, we will be reviewing our Group-wide remuneration policies in the second half of 2016. 74 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Remuneration Committee At a glance Area of focus Matters considered Outcome Base salaries Base salaries, in accordance with the remuneration policy. Increases to salaries for Colin Smith and David Smith March 2015. There will be no salary increases for Executive Directors in 2016. Bonus outcome Performance against bonus targets under the Annual Performance Related Award (APRA). No bonus was paid in 2015 for 2014 performance and there will be no awards for 2015 performance. The maximum bonus opportunity for the Chief Executive was 180% of salary, and for the other Executive Directors 150% of salary. Performance Share Plan award Performance under the 2012 and 2013 PSP. The 2012 PSP awards vested at 67% of the maximum award. The 2013 PSP awards will lapse in their entirety in March 2016 based on performance to 31 December 2015. Leadership team changes The terms of appointment for Warren East, who was appointed as Chief Executive on 3 July 2015. The committee agreed the terms for Warren East’s appointment. His base salary on appointment was £925,000 (equivalent to his predecessor) with a maximum annual bonus opportunity of 180% of salary, a maximum PSP opportunity of 180% of salary and a pension allowance of 25% of salary. James Guyette retired from the Board on 8 May 2015 and John Rishton retired as Chief Executive on 2 July 2015. Neither James Guyette nor John Rishton participated in the 2015 annual bonus. No bonus was paid in respect of 2014 and therefore no entitlement to shares arose on retirement. The deferred portion of their 2013 APRA awards was released following retirement. 2016 Annual Performance Related Award Performance measures for the APRA to align better with the operational strategy for 2016. As Rolls-Royce enters a year of transformation it is important that the Group does not lose focus on the customer, and that employees are fully engaged in the transformation. 2016 PSP award Performance conditions for the 2016 PSP award. Governance matters Terms of reference to ensure their adequacy and we assessed whether all the requirements of the terms of reference had been satisfied during the year. PSP awards made in 2013 and 2014 remained subject to performance targets with any vesting time-apportioned for the period that they were employed by the Group. The 2013 award has now lapsed in full based on Company performance. The committee agreed that for 2016, the weightings of the bonus performance measures will be: • 37.5% Profit and 37.5% Cash performance • 12.5% Customer performance (measured through on-time delivery percentage) • 12.5% People engagement (measured through our Employee Opinion Survey) Any bonus payments in relation to non-financial measures will be subject to achieving a PBT threshold. Awards earned based on the above measures will continue to be subject to the personal performance assessment which allows an uplift of up to 20% or a reduction, potentially to zero. The maximum opportunities will remain 180% of salary for the Chief Executive and 150% of salary for other Executive Directors. For 2016 our PSP will continue to be based on CPS and TSR measures with an EPS hurdle. The EPS hurdle will be measured over the period 2017-2018. This change reflects the current business circumstances and the intended level of stretch of the EPS hurdle which is used as an underpin rather than as a primary performance measure. In recognition of the change, the maximum 2016 PSP award level will be reduced from 180% to 150% of salary for the Chief Executive and from 150% to 130% for other Executive Directors. The terms of reference for the committee were reviewed and minor amendments made. The committee was satisfied that it had covered all the requirements of the terms of reference during the year. Rolls-Royce Holdings plc Annual Report 2015 75 Directors’ Report Directors’ Report / Committee reports Remuneration Committee Remuneration policy This year we have sought to improve the design and content of this report to include a summary of our remuneration policy, which remains unchanged. It is shown on page 90 and the full policy is available on the Group’s website at rolls-royce.com. The remuneration policy is designed to attract, retain and motivate executives of the highest quality, incentivising them to deliver exceptional business performance aligned with the interests of shareholders, and to deliver the Group’s strategy and objectives. The committee has taken care to ensure any change or decision made around remuneration potential for Executive Directors remains consistent and in line with the policy as approved by shareholders. We value shareholder comments on our remuneration policy and its implementation. We strive to ensure that the policy is aligned to our strategy to enable the Group to attract and keep the experts and expertise it needs to deliver business success. To this end, the committee will begin a review of the policy in 2016 and propose any changes necessary to ensure that it continues to support our strategy. We will consult with shareholders on any proposed changes before bringing a revised policy to the 2017 AGM for approval. Committee composition I was delighted to welcome Sir Kevin Smith as a new member to the committee when he joined the Company as a Non-executive Director in November 2015. With his operational experience, Sir Kevin is well placed to offer challenge and support in ensuring that our remuneration is aligned to our strategy and incentivises exceptional performance. We reviewed our annual bonus plan to ensure that it will support the transformation of the business. As a result, and following consultation with shareholders, we have introduced two new metrics into the APRA, relating to on-time delivery to customers and to employee engagement, that reflect the strategic priorities of the business over the next year. Underlying financial performance will still be required in order for the bonus to pay out. The introduction of the measures will support the work being carried out on business transformation and operational effectiveness. In recognition that 2016 is set to be a challenging year, and to ensure that our incentives are motivating for the management team during the transformation of the business, the committee reviewed the PSP. Following consultations with shareholders, we agreed that, for awards made in 2016 only, the EPS condition which underpins the award would measure growth over two years (2017-2018) against a baseline set in 2016. In recognition of this, the 2016 awards will be scaled back so that the maximum PSP award for the Chief Executive will be reduced from 180% to 150% of salary, and from 150% to 130% of salary for other Executive Directors. 2015 outturn Group underlying profit and cash flow were below the base level performance targets and therefore no bonus will be paid for 2015. Over the three-year performance period for the 2013 PSP grant, earnings per share growth was -13.7% which was below the growth measured by the OECD index of consumer prices of 3.8%. Cash flow per share was 45p against a threshold of 53p. As EPS growth and CPS were below the performance targets the awards have not vested and have lapsed. The committee composition is shown on page 65. 2016 salary review The committee has reviewed the salary levels of the Executive Directors in accordance with the remuneration policy and concluded that no increases to Executive Directors’ base salaries will be made in 2016. 2016 Annual General Meeting (AGM) The main part of this report sets out the way in which our remuneration policy was implemented during the year ended 31 December 2015 and shows how we intend to apply it in 2016. This will be subject to an advisory shareholder vote at the AGM. Having served for nine years, I will be stepping down from the Board after the AGM in May 2016 and Ruth Cairnie will become chairman of the Remuneration Committee at that point. We look forward to your continuing support. Dame Helen Alexander Chairman of the Remuneration Committee Activities No substantial changes have been made to Directors’ remuneration in 2015 and all payments made have been in line with the approved remuneration policy. We reviewed the executive reward framework as a precursor to the review of the remuneration policy and considered the high-level assumptions that would be used for the review. We set the package terms for the appointment of Warren East as Chief Executive and delegated authority to the Chairman to finalise the terms of his contract within the agreed parameters. Details of his terms of appointment are shown on page 75. We also considered and agreed the overall remuneration proposals for the new members of the ELT who were appointed during the year. John Rishton and James Guyette both retired during the year, and the committee considered the terms of their departures. The committee agreed that neither should participate in the 2015 APRA, and that the deferred shares under the 2013 APRA be released to them after retirement. Their existing PSP awards remained, subject to performance conditions and time apportionment for the period that they were employed by the Group, in accordance with the rules of the PSP. 76 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT The table below shows how we have applied the remuneration policy during the year. It discloses all the elements of remuneration received by the Executive and Non-executive Directors during 2015. SINGLE FIGURE OF REMUNERATION (AUDITED) Salary/fees (A) £000 Benefits (B) £000 Bonus (C) £000 LTIP (D)12 £000 Other (E) £000 Sub-total £000 Pension (F) £000 Total £000 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 421 546 535 274 – 519 Executive Directors Warren East1 – 525 Colin Smith David Smith2 84 James Guyette3 510 Mark Morris4 429 John Rishton5 925 2,295 2,473 Sub-total Chairman and Non-executive Directors 425 Ian Davis 85 Dame Helen Alexander 100 Lewis Booth Ruth Cairnie6 23 85 Sir Frank Chapman Alan Davies7 – Irene Dorner8 – Warren East1 67 67 Lee Hsien Yang 67 John McAdam 67 Jasmin Staiblin Sir Kevin Smith9 – Iain Conn10 29 John Neill11 67 1,119 1,082 Sub-total 3,555 3,414 Total 425 90 110 70 90 12 30 45 70 70 70 12 – 25 8 140 35 47 – 82 312 1 – 11 3 4 – – – 8 – 7 – – 3 37 349 – 138 2 108 149 151 548 3 1 6 – 3 – – – 2 – 1 – – 2 18 566 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 395 – – – 404 – – – – 1,217 – 2,016 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 2,016 – – – – 597 – 597 – – – – – – – – – – – – – – – 597 – – – – – – – – – – – – – – – – – – – – – – – 429 – 686 1,058 86 570 321 1,022 597 578 601 2,293 5,037 3,204 426 90 121 73 94 12 30 45 78 70 77 12 – 28 428 86 106 23 88 – – 67 69 67 68 – 29 69 1,156 1,100 4,360 6,137 – 114 131 140 27 171 504 262 137 – 153 303 840 1,102 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – 840 1,102 543 – 826 1,189 113 741 583 1,526 597 715 754 2,596 4,044 6,139 426 90 121 73 94 12 30 45 78 70 77 12 – 28 428 86 106 23 88 – – 67 69 67 68 – 29 69 1,156 1,100 5,200 7,239 1 Warren East was appointed as Chief Executive on 3 July 2015, having served as a Non-executive Director since 1 January 2014 2 David Smith was appointed on 4 November 2014 3 James Guyette left the Board on 8 May 2015. His 2014 pension contributions have been restated to allow for the 2014 employer true up match contribution paid in March 2015 of £42,000 4 Mark Morris left the Board on 4 November 2014 5 John Rishton stepped down as Chief Executive, and left the Board, on 2 July 2015 6 Ruth Cairnie was appointed on 1 September 2014 7 Alan Davies was appointed as a Non-executive Director on 1 November 2015 8 Irene Dorner was appointed as a Non-executive Director on 27 July 2015 9 Sir Kevin Smith was appointed as a Non-executive Director on 1 November 2015 10 Iain Conn left the Board on 1 May 2014 11 John Neill left the Board on 8 May 2015 12 The 2014 LTIP has been recalculated using the actual vesting prices of 935.19p per share for James Guyette and Colin Smith and 1042.00p per share for John Rishton. The original calculation used a share price of 863.65p per share, the average share price over the quarter ended 31 December 2014, as the vesting price was not known at the date of approval of the 2014 Directors’ Remuneration Report. Rolls-Royce Holdings plc Annual Report 2015 77 Directors’ Report Directors’ Report / Committee reports Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT CONTINUED Notes to the table A. Salary and fees BASE SALARY The Executive Directors’ salaries are normally reviewed, but not necessarily increased, with effect from 1 March each year. The committee reviewed the salary levels of Executive Directors during the year and the result of the review is shown below. David Smith’s increase reflected that his salary on appointment was positioned to allow scope for progression in the role and the increase made in the year reflects that progression. The increase in March 2015 for Colin Smith reflected the importance of the role to the business along with the current modest positioning compared to the external market range. No salary increases will be made for any Executive Directors in 2016. EXECUTIVE DIRECTORS’ BASE SALARY Name Warren East1 Colin Smith David Smith2 1 Warren East’s salary level was effective from the date of his appointment on 3 July 2015 2 David Smith’s salary level was effective from the date of his appointment on 4 November 2014 Base salary as at 1 March 2016 £925,000 £550,000 £540,000 Base salary as at 1 March 2015 or date of appointment if later £925,000 £550,000 £540,000 Base salary as at 1 March 2014 or date of appointment if later n/a £525,000 £510,000 NON-EXECUTIVE DIRECTORS’ FEES The Chairman’s fee is reviewed by the Board as a whole on the recommendation of the Remuneration Committee and the review of the Non-executive Directors’ fees is reserved to the Executive Directors, who take recommendations from the Chairman. No individual may be involved in setting his or her own fee. The Non-executive Directors’ fees were last increased with effect from 1 May 2014. The Chairman and Non-executive Directors are not eligible to participate in any of the Group’s share schemes, incentive arrangements or pension schemes. We have in place a facility to enable 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. Dame Helen Alexander, Ruth Cairnie, Sir Frank Chapman, Ian Davis, Lee Hsien Yang and John McAdam participate in this facility. NON-EXECUTIVE DIRECTORS’ BASE FEES Chairman Other Non-executive Directors Chairman of the Audit Committee Chairman of the Safety & Ethics Committee Chairman of the Remuneration Committee Chairman of the Science & Technology Committee Senior Independent Director 2015 £000 425 70 25 20 20 20 15 2014 £000 425 70 25 20 20 – 15 OUR APPROACH TO SALARY AND FEES IN 2016 The committee reviewed Executive Directors’ salaries in early 2016 and agreed that no increases would be made in 2016 No increases will be made to Non-executive Directors’ fees in 2016 78 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Directors’ Remuneration Report B. Benefits Benefits are provided to ensure that remuneration packages remain sufficiently competitive to recruit and retain directors and to enable them to devote themselves fully to their roles. The benefits for the Non-executive Directors relate predominantly to travel and subsistence associated with attending Board meetings, although for Directors who are based outside the UK, the Company may pay towards tax advice and filing. Additionally, the Chairman has occasional use of a chauffeur service to enable him to undertake his duties. The taxable value of all benefits paid to Executive Directors in the year is shown below. BENEFITS PAID TO EXECUTIVE DIRECTORS Car or car allowance including fuel allowance £000 Chauffeur services £000 Financial planning £000 Medical insurance £000 Life assurance £000 Club membership fees £000 Travel and subsistence £000 Housing costs £000 Total £000 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 2015 2014 7 30 16 5 – 14 72 – 24 2 11 21 21 79 – – – – – 14 14 – – – – – 14 14 – 6 – 20 – 6 32 – 5 – 18 5 5 33 1 2 2 – – 1 6 – 2 – 7 1 2 12 – – – – – – – – – – 33 – – 33 – – – 6 – – 6 – – – 24 – – 24 – 4 5 – – – 9 – 3 – – 23 3 29 – 98 12 16 – 47 173 – 104 – 15 99 106 324 8 140 35 47 – 82 312 – 138 2 108 149 151 548 Executive Directors Warren East1 Colin Smith David Smith2 James Guyette3 Mark Morris4 John Rishton5 Total 1 Warren East was appointed as Chief Executive on 3 July 2015, having served as a Non-executive Director since 1 January 2014 2 David Smith was appointed on 4 November 2014 3 James Guyette left the Board on 8 May 2015 4 Mark Morris left the Board on 4 November 2014 5 John Rishton stepped down as Chief Executive, and left the Board, on 2 July 2015 OUR APPROACH TO BENEFITS IN 2016 There will be no change to our approach to benefits in 2016. C. Annual bonus Annual bonuses may be awarded under the Annual Performance Related Award plan (APRA). Executive Directors receive any annual bonus awarded in March following the performance period. The bonus is paid partially in cash and partially in deferred shares. The deferred shares are held in trust for two years before being released, subject to the recipient being still employed by the Group. Ordinary shares held as deferred shares may receive a bonus issue of C Shares during the deferral period. Malus and clawback provisions apply from the date of deferral until three years after the release of shares where there is: a material misstatement of the audited results; failure of risk management; serious reputational damage to the Company as a result of misconduct; serious breach of the Company’s global code of conduct; or gross misconduct. APRA 2015 The Remuneration Committee reviewed the 2015 outturn against the performance measures, which are shown overleaf, and determined that bonuses would not be payable this year in respect of performance in 2015. The APRA bonus is determined by Group financial performance and personal performance. The Group financial performance is based on the addition of the cash and profit outturns, with a specified minimum level to be achieved on both, after deduction of the cost of bonus from profit. For 2015, the Group financial measures were cash flow performance and group underlying profit. Levels for both of these measures and their outcome are shown overleaf. Rolls-Royce Holdings plc Annual Report 2015 79 Directors’ Report Directors’ Report / Corporate governance Directors’ Report / Committee reports Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT CONTINUED APRA 2015 PERFORMANCE MEASURES Base Target Maximum 2015 performance measures Profit1 Cash1 % 15 30 50 £m 1,526 1,526 1,536 % 15 30 50 £m 250 350 500 2015 outcome Profit £m 1,339 Cash £m 123 Total bonus £m – 1 Group underlying profit and cash flow, after deduction of the cost of bonus, and excludes the impact of acquisitions and disposals in the year and unbudgeted foreign exchange translation effects where material. To reflect the disposal of the Energy business, the December 2014 forecast cash and profit were added back to the 11 month actual results for bonus purposes. For 2015 the base level of profit was set to be equivalent to target profit. This was to take into account the cost of the all-employee bonus plan which was aligned to the base and target profit levels. OUR APPROACH TO APRA IN 2016 Following consultation with shareholders at the start of 2016, the committee has determined that the bonus in respect of 2016 will be operated on similar terms to 2015, but with the introduction of two new measures relating to customer and employee engagement. Any bonus in relation to the non-financial targets will be subject to achieving the underlying profit threshold. The maximum bonus opportunities for Executive Directors will remain at 180% for the Chief Executive and 150% of salary for other Executive Directors. 2016 WEIGHTINGS OF ANNUAL BONUS MEASURES Target Profit % 37.5 Cash % 37.5 Customer % 12.5 Employee engagement % 12.5 Maximum business outturn % 100 Base, target and maximum performance levels are set for all business measures and result in 30%, 60% and 100% outturns respectively. The individual performance multiplier can increase or decrease the business outturn in a range of 0-120%. D. Long-term incentives – Performance Share Plan The PSP is designed to attract, reward and incentivise selected senior executives who can influence the long-term performance of the Group and execute the business strategy. Under the PSP, awards of shares are made annually at the start of a three-year performance period. Vesting is subject to continued employment and achievement of Group performance conditions. The number of shares vesting will be determined by the growth in aggregate cash flow per share (CPS) over the performance period. 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. CPS is cumulative over a three-year period. A further performance measure is growth in TSR relative to the FTSE 100 or other appropriate index. Where the Company’s TSR is ranked above median in the comparator group, the shares vesting will be increased by 25%. Where the ranking is at or within upper quartile, the vesting will be increased by 50%. Between these two points, the increase will be on a straight-line basis. The above measures are underpinned by growth in earnings per share (EPS). Growth in EPS must exceed the growth in an appropriate consumer price index over the performance period for any shares to vest. PSP awards are conditional share awards and are usually made in March with the release date being in March of the year following the completion of the three-year performance period, subject to the performance criteria being met. Malus and clawback provisions apply where: there has been a material misstatement of audited results; serious financial irregularity which invalidates the targets set; reputational damage; material failure of risk management; a serious breach of the Company’s global code of conduct; or individual gross misconduct. Clawback will apply for three years after the vesting of an award. 80 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Directors’ Remuneration Report PSP 2015 AWARD CPS TARGETS (AUDITED) The cash flow per share targets for awards made in 2015 were as follows and straight-line vesting will apply between these points. Aggregate cash flow per share over the three-year period Less than 60p 60p 100p Maximum award released % 0 30 100 PSP AWARDS MADE IN MARCH AND SEPTEMBER 2015 In 2015, Executive Directors received PSP awards in line with the remuneration policy as follows: Warren East Colin Smith David Smith Date of award 01/09/2015 02/03/2015 02/03/2015 Number of shares awarded 126,643 58,263 57,204 % of salary 100 100 100 Performance period end date 31/12/2017 31/12/2017 31/12/2017 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 before the date of grant, being 944p for the award on 2 March 2015 and 730p for the award on 1 September 2015. The face value is the maximum number of shares that would vest (150% of the award) multiplied by the share price at the date of grant. If the EPS and base CPS targets are not achieved, no shares vest. PSP AWARDS VESTING IN MARCH 2016 The following sets out details in respect of the March 2013 PSP award, for which the final year of performance was the 2015 financial year. Subject to performance conditions, these shares would be due to vest in March 2016, three years after the award was made. EPS growth (hurdle) Aggregate CPS (100% of award) Outcome Targets for 2013 – 2015 period Awards may vest if EPS growth exceeds the OECD index of consumer prices. Awards will lapse if hurdle not met. Aggregate CPS over three-year period of less than 56p – zero vesting. Aggregate CPS over three-year period of 94p – 100% vesting. Performance against targets EPS growth of -13.7% over the three-year period underperformed the hurdle which was 3.8%. Aggregate CPS performance over three years of 45p. None of the 2013 shares will vest in March 2016. OUR APPROACH TO PSP IN 2016 Following consultation with shareholders in early 2016, the committee has confirmed that CPS and TSR measures will continue to determine the vesting level of PSP awards for 2016 as described on page 80. The EPS hurdle will also apply, although we have adjusted the calculation of the EPS hurdle to reflect the very significant changes in our business environment and our financial forecasts, so that the measurement will be based on two years’ performance from 2016. Without such adjustments, the awards would have been inappropriate as they would be unlikely to vest. To balance this, we have reduced the PSP award levels from a maximum of 180% to 150% of salary for the Chief Executive and from a maximum of 150% to 130% of salary for other Executive Directors. These targets have been chosen to ensure that the participants maintain focus on people and customers during the transformation of our business. The performance targets in respect of the 2016 to 2018 performance period under the aggregate CPS measure will be as follows: PSP AWARDS TO BE MADE IN MARCH 2016 Aggregate CPS over the three-year period Less than 10p 10p 50p Maximum award released % 0 30 100 The stretch of these targets reflects that, during this period, we will be investing in ramping up Trent production, IT, new product technology and aftermarket capability, while at the same time implementing cost reductions and inventory and working capital improvements. We believe that the combination of the EPS hurdle, 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 future performance. Rolls-Royce Holdings plc Annual Report 2015 81 Directors’ Report Directors’ Report / Committee reports Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT CONTINUED E. Other items As reported last year, loss of office payments were made to Mark Morris who left the Group on 4 November 2014. The contractual payments were made in accordance with his service agreement. The total amount paid to him in 2015 in respect of the termination of his employment was £597,000. 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 £21,420 in 2015 (2014: £27,720). F. Pension entitlements (audited) 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 schemes. In the defined benefit schemes, normal retirement age is 62. Warren East and David Smith receive a cash allowance in lieu of a defined contribution pension accrual. Colin Smith, who opted out of future pension accrual with effect from 1 April 2006 and opted out of salary linkage with effect from 30 November 2015, receives a cash allowance in lieu of future pension accrual. John Rishton, who left the Group and started to receive his pension on 2 July 2015, was 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 was calculated as equivalent to the cost of the pension contributions allowing for National Insurance costs. James Guyette, who retired and started to receive his pension on 8 May 2015, participated in pension plans sponsored by Rolls-Royce North America Inc (RRNA). He was a member of two defined benefit plans in the US, one qualified and one non-qualified. He accrued a retirement lump sum in both of these plans. In addition, he was a member of two 401(k) Savings Plans in the US, one qualified and one non-qualified, to which both he and RRNA contributed. He was also a member of an unfunded non-qualified deferred compensation plan in the US, to which RRNA made notional contributions. Under the defined benefit plans, the earliest age at which benefits could be taken without consent and without actuarial reduction was 65. Details of the defined benefits of the Executive Directors as at 31 December 2015 in the Group’s UK and US pensions schemes are given below. DEFINED BENEFITS SCHEMES Year Colin Smith (UK pension funds) James Guyette1 (US pension funds) 2015 £000 385 – 2014 £000 393 1,380 1 James Guyette retired on 8 May 2015 and received his full accrued lump sum entitlement amounting to £1,577,000, translated at £1=US$1.4833 Details of defined contribution pension contributions paid by the Group on behalf of the following Executive Directors are given below. DEFINED CONTRIBUTION SCHEMES James Guyette1 (left 8 May 2015) John Rishton (left 2 July 2015) 2015 £000 183 20 2014 £000 391 42 1 Benefits are translated at £1=US$1.5292 (2014: US$1.6477). There has been an adjustment to the defined pension contributions over 2014 to allow for the 2014 employer true up match contribution paid in March 2015 of £42,000 82 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Directors’ Remuneration Report OUR APPROACH TO PENSIONS IN 2016 We will continue to operate both defined benefit and defined contributions pension plans on the basis outlined above. We will continue to allow Directors to receive a cash allowance in lieu of contributions to the defined contribution pension scheme. Where a Director has opted out of future accrual under the defined benefit pension scheme, we will continue to pay a cash allowance in lieu of that accrual. OTHER INFORMATION A. CHIEF EXECUTIVE PAY, TSR AND ALL-EMPLOYEE PAY This section of the report enables our remuneration arrangements to be seen in context by providing: • a seven-year history of our Chief Executive’s remuneration; • our TSR performance over the same period; • a comparison of the year-on-year change in our Chief Executive’s remuneration with the change in average remuneration across the Group; and • a year-on-year comparison of the total amount spent on employment costs across the Group and shareholder payments. CHIEF EXECUTIVE PAY Year 2015 2015 2014 2013 2012 2011 2011 2010 2009 Single figure of total remuneration £000 543 754 2,596 6,228 4,577 3,677 3,832 3,914 2,409 Annual bonus as a % of maximum – – – 55 85 63 – 100 29 Chief Executive1 Warren East John Rishton2 John Rishton John Rishton John Rishton John Rishton Sir John Rose3 Sir John Rose Sir John Rose PSP as a % of maximum – – 45 100 – – 75 100 93 1 On 31 March 2011, Sir John Rose retired and John Rishton was appointed. John Rishton retired on 2 July 2015 and Warren East was appointed on 3 July 2015. 2 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 had increased from 483.50p at the time this grant was made to 870p at the end of 2014. These are the main reasons why John Rishton’s remuneration in 2012 and 2013 exceeded that of his predecessor. The remuneration for Sir John Rose does not include any pension accrual or contribution as he received his pension from 1 February 2008. 3 Rolls-Royce Holdings plc Annual Report 2015 83 Directors’ Report Directors’ Report / Committee reports Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT CONTINUED TSR PERFORMANCE The Company’s TSR performance over the previous seven years compared to a broad equity market index is shown in the graph below. 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 seven years, relative to the FTSE 100 index. e c n e P 500 400 300 200 100 2008 2009 2010 2011 2012 2013 2014 2015 Rolls-Royce TSR FTSE 100 TSR PERCENTAGE CHANGE IN CHIEF EXECUTIVE REMUNERATION The following table compares the percentage change in the Chief Executive’s salary, bonus and benefits to the average percentage change in salary, bonus and benefits for all UK employees from 2014 to 2015. CHANGE IN REMUNERATION Chief Executive UK employees average Salary –% 3.2% Benefits (40)% 0.6% Annual bonus –% –% 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 46% of the total employee population. RELATIVE SPEND ON PAY The following chart sets out the percentage change in payments to shareholders and overall expenditure on pay across the Group. Payments to shareholders (£m)* (note 17 – Financial Statements) Group employment costs (£m) (note 7 – Financial Statements) 2014 2014 2015 2015 414 430 +4% 2014 2015 3,357 3,080 -8% 0 0 100 100 200 200 300 300 400 400 500 500 0 500 1,000 1,500 2,000 2,500 3,000 3,500 * Value of C Shares issued during the year 84 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Directors’ Remuneration Report B. CONTRACTUAL ARRANGEMENTS The Executive Directors have service agreements that set out the contract between each Executive Director and the Company. Executive Directors retain payments received from serving on the boards of external companies, the details of which are given below. The Chairman and other Non-executive Directors have letters of appointment. Each Non-executive Director serves for a term of three years, which may be extended twice up to a total of nine years. EXECUTIVE DIRECTORS’ SERVICE CONTRACTS Warren East Colin Smith David Smith PAYMENTS RECEIVED FOR SERVING ON EXTERNAL BOARDS Warren East1 David Smith 1 Warren East stepped down from the board of De La Rue Holdings plc on 23 July 2015 NON-EXECUTIVE DIRECTORS’ LETTERS OF APPOINTMENT Ian Davis Dame Helen Alexander Lewis Booth Ruth Cairnie Sir Frank Chapman Alan Davies Irene Dorner Lee Hsien Yang John McAdam Jasmin Staiblin Sir Kevin Smith Date of contract 21 April 2015 1 July 2005 19 November 2014 Notice period Company 12 months 12 months 12 months Notice period individual 6 months 6 months 6 months Directorships held Dyson Limited, De La Rue Motability Operations Group plc Payments Received £000 44 43 Date of appointment letter 1 March 2013 1 September 2007 25 May 2011 1 September 2014 10 November 2011 29 July 2015 12 February 2015 1 January 2014 19 January 2008 21 May 2012 1 October 2015 Current letter of appointment end date 29 February 2016 31 August 2016 24 May 2017 31 August 2017 9 November 2017 31 October 2018 26 July 2018 31 December 2016 18 February 2017 20 May 2018 31 October 2018 Rolls-Royce Holdings plc Annual Report 2015 85 Directors’ Report Directors’ Report / Committee reports Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT CONTINUED C. DIRECTORS’ INTERESTS IN SHARES (AUDITED) 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. Each Executive Director’s total shareholding, for the purposes of comparing it with the minimum shareholding requirement, includes shares held: by connected persons; in the all-employee Share Incentive Plan; and PSP shares that have vested, but does not include unvested PSP awards. The shareholding requirement is 250% of salary for the Chief Executive and 200% of salary for the other Executive Directors. APRA deferred shares do not count towards their minimum shareholding requirement. Each Executive Director has built towards compliance with the minimum shareholding requirement as detailed in the table below. MINIMUM SHAREHOLDINGS Year Warren East Colin Smith David Smith Base salary £000 925 550 540 Total shareholding 24,990 208,105 20,328 Minimum shareholding requirement as % of salary 250 200 200 Minimum shareholding requirement1 244,969 116,526 114,407 Actual shareholding as % of minimum requirement 10 179 18 1 Salary divided by the March 2015 PSP grant price of 944.00p multiplied by percentage of salary The Directors and their connected persons had the following interests in the ordinary shares and C Shares of the Company at 31 December 2015, or at date of leaving or retirement if earlier, as shown in the table below. DIRECTORS’ SHARE INTERESTS Conditional shares not subject to performance conditions (APRA) Unvested awards Conditional shares subject to performance conditions (PSP) Vested awards Options over shares subject to savings contracts (ShareSave) Vested shares and options exercised in year – 16,000 – 16,307 33,490 126,643 162,903 75,491 103,484 221,238 1,264 758 758 – 1,745 – 66,427 – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – – C Shares1 – – – – – – – – – 1,515,481 – – – – – – – Ordinary shares 24,990 208,105 20,328 388,846 503,807 37,476 4,969 60,000 7,482 14,948 10,370 5,000 2,170 2,803 – 20,000 46,616 Executive Directors Warren East (appointed 3 July 2015) Colin Smith David Smith James Guyette (left 8 May 2015) John Rishton (left 2 July 2015) Chairman and Non-executive Directors Ian Davis Dame Helen Alexander Lewis Booth Ruth Cairnie Sir Frank Chapman Alan Davies Irene Dorner Lee Hsien Yang John McAdam Jasmin Staiblin Sir Kevin Smith John Neill (left 8 May 2015) 1 Non-cumulative redeemable preference shares of 0.1p each 86 Rolls-Royce Holdings plc Annual Report 2015 CHANGES IN INTERESTS (AUDITED) Executive Directors Warren East Colin Smith David Smith Chairman and Non-executive Directors Ian Davis Dame Helen Alexander Lewis Booth Ruth Cairnie Sir Frank Chapman Alan Davies Irene Dorner Lee Hsien Yang John McAdam Jasmin Staiblin Sir Kevin Smith Committee reports / Directors’ Remuneration Report Ordinary shares C Shares 31 December 2015 Changes from 31 December 2015 to February 2016 31 December 2015 Changes from 31 December 2015 to February 2016 24,990 208,105 20,328 37,476 4,969 60,000 7,482 14,948 10,370 5,000 2,170 2,803 – 20,000 126 3,403 260 1,362 413 – 782 1,502 – 83 404 89 – – – – – – – – – 1,515,481 – – – – – – – – – – – – – 1,273,883 – – – – – – DIRECTORS’ INTERESTS IN UNVESTED AND VESTED AWARDS WARREN EAST 31 December 2014 – – Granted during year 126,643 126,643 TSR uplift/ dividend enhancement – – PSP 2015 Total ShareSave (options)1 Total – – 1,264 1,264 – – Vested awards – – – – Lapsed – – 31 December 2015 126,643 126,463 – – 1,264 1,264 1 For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award Market price at date of award (p) 730.00 Date of grant 01/09/2015 Date of vesting 01/09/2018 Market price at vesting (p) – 616.80 12/10/2015 01/02/2021 – COLIN SMITH PSP 2012 PSP 2013 PSP 2014 PSP 2015 Total APRA 2012 APRA 2013 Total 31 December 2014 Granted during year TSR uplift/ dividend enhancement 62,987 51,304 53,336 – 167,627 23,207 16,000 39,207 – – – 58,263 58,263 – – – 758 758 11,420 – – – 11,420 936 – 936 – – Vested awards 42,284 – – – 42,284 24,143 – 24,143 – – Lapsed 32,123 – – – 32,123 – – – – – 31 December 2015 Market price at date of award (p) Date of grant Date of vesting Market price at vesting (p) – 51,304 53,336 58,263 162,903 – 16,000 16,000 758 758 809.70 1023.33 984.33 944.00 01/03/2012 01/03/2013 07/05/2014 02/03/2015 02/03/2015 01/03/2016 03/03/2017 02/03/2018 935.19 – – – 1023.33 984.40 01/03/2013 07/05/2014 02/03/2015 03/03/2016 935.19 – 616.80 12/10/2015 01/02/2019 – ShareSave (options)1 Total – – 1 For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award Rolls-Royce Holdings plc Annual Report 2015 87 Directors’ Report Directors’ Report / Committee reports Directors’ Remuneration Report DIRECTORS’ REMUNERATION REPORT CONTINUED DAVID SMITH PSP 2014 PSP 2015 Total 31 December 2014 18,287 – 18,287 Granted during year – 57,204 57,204 TSR uplift/ dividend enhancement – – – ShareSave (options)1 Total – – 758 758 – – Vested awards – – – – – Lapsed – – – 31 December 2015 18,287 57,204 75,491 – – 758 758 Market price at date of award (p) 984.33 944.00 Date of grant 03/03/2014 02/03/2015 Date of vesting 03/03/2017 02/03/2018 Market price at vesting (p) – – 616.80 12/10/2015 01/02/2019 – 1 For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award JAMES GUYETTE1 31 December 2014 64,385 51,714 51,770 167,869 25,770 16,307 42,077 Granted during year – – – – TSR uplift/ dividend enhancement 11,674 – – 11,674 – – – 1,039 – 1,039 PSP 2012 PSP 2013 PSP 2014 Total APRA 2012 APRA 2013 Total 1 James Guyette stepped down from the Board on 8 May 2015 JOHN RISHTON1 PSP 2012 PSP 2013 PSP 2014 Total Performance related shares2 Total APRA 2012 APRA 2013 Total ShareSave (options)3 ShareSave (options)3 Total 31 December 2014 133,383 108,470 112,768 354,621 Granted during year – – – – TSR uplift/ dividend enhancement 24,183 – – 24,183 40,565 40,565 48,250 33,490 81,740 1,450 295 1,745 – – – – – – – – 7,355 7,355 1,946 – 1,946 – – – Vested awards 43,223 – – 43,223 26,809 – 26,809 Vested awards 89,541 – – 89,541 27,232 27,232 50,196 – 50,196 – – – Lapsed 32,836 – – 32,836 – – – Lapsed 68,025 – – 68,025 20,688 20,688 – – – – – – Market price at date of award (p) 809.70 1023.33 984.33 Date of grant 01/03/2012 01/03/2013 07/05/2014 Date of vesting 02/03/2015 01/03/2016 03/03/2017 Market price at vesting (p) 935.19 – – 1,023.33 984.40 01/03/2013 07/05/2014 02/03/2015 01/03/2016 935.19 – 8 May 2015 – 51,714 51,770 103,484 – 16,307 16,307 Market price at date of award (p) 809.70 1023.33 984.33 02 July 2015 – 108,470 112,768 221,238 Date of grant Date of vesting 01/03/2012 23/04/2015 01/03/2016 01/03/2013 03/03/2017 07/05/2014 Market price at vesting (p) 1042.00 – – – – – 33,490 33,490 1,450 295 1,745 601.50 09/03/2011 23/04/2015 1042.00 1,023.33 984.40 01/03/2013 23/04/2015 03/03/2016 07/05/2014 1042.00 – 525.00 01/02/2012 01/02/2014 961.60 01/02/2017 01/02/2017 – – 1 John Rishton stepped down as Chief Executive, and from the Board, on 2 July 2015 2 The performance related shares were awarded as part of a special grant of shares to John Rishton on joining the Company and were intended to mirror the fair value and vesting profile of incentives he forfeited on leaving his previous employer 3 For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award 88 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Directors’ Remuneration Report D. ADDITIONAL INFORMATION 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 £125,150 (2014: £81,432). Deloitte also advised the Company on tax, assurance, pensions and corporate finance and Deloitte MCS Limited provided consulting services. The committee is exclusively responsible for reviewing, selecting and appointing its advisers. The committee reviewed its appointment of Deloitte LLP during the year and confirmed its reappointment as adviser. 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. Statement of shareholder voting Results of the resolution approving the 2014 remuneration report at the AGM held on 8 May 2015 Percentage of votes (%) Number of votes cast For Against Votes withheld 98.11 1,228,258,116 1.89 23,643,321 4.38 54,797,128 The remuneration policy was approved by shareholders at the 2014 AGM. 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 and have consulted with shareholders even on changes within the policy. Statutory requirements The Directors’ 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 2014 and comply with the regulations contained in 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 173 and to state that this section has been properly prepared in accordance with these regulations. The Directors’ Remuneration Report is subject to shareholder approval at the AGM on 5 May 2016. The Directors’ Remuneration Report was approved by the Board on 11 February 2016 and signed on its behalf. Dame Helen Alexander Chairman of the Remuneration Committee A summary of the remuneration policy is shown on page 90 and the full policy is available on our website, rolls-royce.com. Rolls-Royce Holdings plc Annual Report 2015 89 Directors’ Report Directors’ Report / Committee reports Remuneration policy summary REMUNERATION POLICY SUMMARY Fixed remuneration Purpose Base salaries The Company provides competitive salaries, suitable to attract and retain individuals of the right calibre to develop and execute the business strategy. Salaries are set using careful judgement taking into account a range of factors including experience, role and responsibilities, performance and salaries elsewhere in the Group. Decisions on salary are informed but not led by reference to companies of a similar size, complexity and international reach. Salaries are reviewed, although not necessarily increased, annually. Any salary increases will not normally exceed average increases for employees in other appropriate parts of the Group. The committee may exercise discretion to make larger increases in circumstances where it is necessary to address particular issues or risks, although in exercising such discretion the resulting salary will not exceed the competitive market range. Executive Directors may be appointed at salaries below the target level to enable pay progression commensurate with growth in the new role. Benefits Benefits include car or car allowance and related costs, financial planning assistance and certain insurances and other appropriate benefits at the discretion of the committee. Relocation support, or support for accommodation and travel, may be offered to executives where necessary. Benefits excluding any accommodation, relocation and associated tax costs will not exceed £100,000 per annum. Pension The maximum employer contribution to defined contribution pension arrangements is 38% of base salary. Pension contributions are based on base salary only. A cash allowance may be paid in lieu of pension contributions, reduced to allow for the additional NI incurred. A number of legacy plans are also in operation, including defined benefits plans which are closed to new members under which a maximum of two thirds of final salary may be accrued. A cash allowance may be paid in lieu of pension contributions. At risk remuneration Purpose Annual bonus The annual bonus is designed to incentivise execution of the business strategy, delivery of financial targets and the achievement of personal objectives. 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 personal performance. No bonus is payable unless the base financial targets are achieved and this also applies if non-financial measures are introduced. The committee also has discretion to increase the bonus to 200% for the Chief Executive and 175% for other Executive Directors respectively subject to this not being above the competitive market range. Between 30% and 50% of the bonus is compulsorily deferred into shares for a period of two years and released subject to continued employment. Performance Share Plan The PSP is designed to reward the development and execution of the business strategy over the longer term, providing alignment with shareholder interests through the performance conditions and a retention element through the plan timescale. Executive Directors are granted awards over shares annually at the start of a three-year performance period. The proportion of award that vests is determined at the end of the period according to a set of Company performance measures. The three corporate performance measures are CPS (the prime measure), TSR (relative to the FTSE 100 or other appropriate index) and EPS. Maximum face values of annual awards are 180% of salary for the Chief Executive and 150% for the other Executive Directors. The Executive Directors may participate in the ShareSave and Share Incentive plans on the same terms as other employees. All employee share plans 90 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Audit Committee AUDIT COMMITTEE REPORT Highlights Accounting policies and key judgements and estimates are appropriate Procedures in place to identify, manage and review principal risks Internal control system meets Code requirements KPMG recommended for re-appointment Audit will be tendered in 2016, in line with EU directive 2015 overview Introduction I am pleased to present the 2015 report of the Audit Committee which describes how the committee has carried out its responsibilities during the year. I would like to thank the members of the committee, 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. All members of the committee are independent Non-executive Directors. There have been a number of changes to the committee’s composition during the year. Lee Hsien Yang joined the committee in March 2015. John Neill stood down from the Board in May and Warren East stepped down before taking on the role of Chief Executive in July 2015. Irene Dorner joined the committee on 27 July 2015. Irene’s background in banking gives her a strong understanding of complex financial issues and risk management processes. Alan Davies joined the committee on 1 November 2015. Alan is a fellow of the Institute of Chartered Accountants in Australia and through his career at Rio Tinto has amassed considerable financial experience, including serving as CFO of its Iron Ore group. Lewis Booth, Alan Davies and Irene Dorner are considered by the Board to have recent and relevant financial experience. Their biographies are on page 59 and 60. Principal responsibilities The key areas of responsibility of the committee are: Financial reporting review financial results announcements and financial statements, focusing on: – the appropriateness of critical accounting policies, judgements and estimates and consistent application of those accounting policies; – inclusion of appropriate disclosures; – compliance with relevant regulations; – reporting to the Board as to whether the Annual Report, as a whole, is fair, balanced and understandable. Risk and control environment assess the scope and effectiveness of the systems to identify, manage and monitor financial and non-financial risks; assess the management of principal risks allocated to the committee: business continuity, market and financial shock and IT vulnerability; review the procedures for detecting, monitoring and managing the risk of fraud; review the system of internal control over the business processes and the risks identified through the risk management process. Internal audit review the scope, resources, results and effectiveness of internal audit. External auditors oversee the relationship with the external auditor, reviewing the effectiveness of the external audit process and making recommendations to the Board for the external auditor’s appointment and fees. Areas of focus in 2015 reviewing key accounting judgements and estimates and the consistent application of accounting policies which had the most significant impacts on the financial results in 2015; overseeing the activities undertaken to maintain compliance with the UK Corporate Governance Code 2014 (the Code) requirements, including enhancements to the risk management and internal control systems to improve oversight by the Board and its committees; assessing the effectiveness of internal control over financial reporting and agreeing an improvement plan; overseeing the development of the Group’s approach to the viability statement; agreeing an audit tender plan, scheduled for 2016; monitoring the project to assess the impact of IFRS 15 and implement its requirements; detailed reviews of cyber security and business continuity risks; supporting the implementation of the new management information system. Rolls-Royce Holdings plc Annual Report 2015 91 Directors’ Report Directors’ Report / Corporate governance Directors’ Report / Committee reports Audit Committee AUDIT COMMITTEE REPORT CONTINUED At a glance: Area of focus Matters considered Outcome Financial reporting The appropriateness of accounting policies and key accounting judgements and estimates, including: • reversal of impairment on contractual aftermarket rights; • estimates used in accounting for long-term contractual arrangements, including the regular review of the methodologies for taking account of uncertainties in these estimates and the financial impact; • impairment of goodwill in Marine; • adequacy of warranty provisions in Marine; • carrying value of goodwill in Rolls-Royce Power Systems AG; and • disclosures of contingent liabilities. The form and content of the 2015 Annual Report. The requirements and necessary judgements of IFRS 15 Revenue from Contracts with Customers. Improvements to the risk management and internal controls systems to address new requirements of the Code. Management’s assessment of the risk of a disruptive event. The procedures for monitoring and combatting breaches of the IT system. The processes for identifying and managing risks. The model for assessing the effectiveness of the Group’s systems of internal control. The process and assumptions underlying the viability statement. Risk and control environment The accounting policies and key judgements and estimates are appropriate and key estimates used are balanced. The Annual Report, taken as a whole, is fair, balanced and understandable. Recommended that the Group should seek, as far as possible, to implement IFRS 15 in a way which appropriately reflects the underlying business drivers and the interpretations of other aerospace and defence companies. Appropriate procedures are in place to identify and manage principal risks and all of these have been subject to a review by the Board or an appropriate Board committee. Appropriate procedures are in place to manage business continuity and cyber-security risks. The internal control system is sufficient to meet the requirements of the Code. It will continue to be enhanced during 2016. Reported to the Board that an appropriate process is in place to make the viability statement. Internal audit The effectiveness of the internal audit function, its key findings and trends arising, and the resolution of these matters. The scope, extent and effectiveness of internal audit are appropriate. External audit The approach and scope of external audit and the effectiveness and independence of the external auditor. Assessed KPMG as effective and independent and recommended their re-appointment at the 2016 AGM. Plans for the tendering of the external audit to meet the requirements of the EU directive. The extent of non-audit services provided by KPMG. Agreed plan to tender the audit during 2016, with new auditor to be appointed to report in the 2018 Annual Report. No concerns over the nature and scale of the non-audit services provided. 92 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Audit Committee Operation of the committee The committee’s responsibilities are outlined in its terms of reference which can be found in the Board governance document on the Group’s website. We review these annually and refer them to the Board for approval. During 2015, we made revisions to clarify our interaction with other committees in meeting the requirements of the Code. Following the changes agreed in 2014, which gave us additional responsibilities for the oversight of risk management, the committee has worked closely with the Director of Risk to enhance the Group’s risk management system. As described on page 66, the performance of the committee was independently assessed in 2014, with a follow-up in 2015. Sector audit committees In support of our work, each of the Group’s businesses has its own sector audit committee, each of which comprises senior finance personnel and is attended by KPMG. These committees: • allow the review of accounting policies and their consistent application, risk management, internal systems and issues arising at a more detailed level; • give us further assurance as to the extent of management control and accountability; • promote the governance culture within the Group; and • inform areas for further consideration at our meetings. In 2015, additional committees were established to cover central functions including group finance, treasury, tax, transaction processing shared-service centres, property, human resources, engineering and technology, information technology, and our regional offices. These additional committees provide assurance that all key areas are covered. In particular, they consider issues arising from the interactions between the businesses and central functions. All the committees meet twice a year to consider the accounting policies, judgements and estimates and the internal control environment. They are chaired by the Director of Internal Audit, who then reports to us. In 2015, the sector audit committees have focused on internal control and risk management processes in support of the new requirements of the Code. We expect this to continue in 2016, as we seek to enhance these processes, making them as effective and efficient as possible. Business and function presentations We have a regular schedule of presentations from each of the Group’s businesses and its key functions. During 2015, we received presentations from the following: • Civil Aerospace business – key business risks (including major product failure, on-time and profitable delivery of new programmes, business continuity risks including supply chain disruption and market shock due to external events or factors reducing air travel); accounting policies; key accounting judgements, estimates and controls; credit risks associated with customers; and TotalCare and CorporateCare accounting. • Nuclear business – key business risks (including the future of the UK submarine programme, government relations, new programmes, and product safety); growth in civil nuclear markets; accounting policies and key accounting estimates (which principally relate to accounting for long-term contracts); and controls. • Power Systems – key business risks (including competitor actions, the low oil price, and warranties); new programme developments; accounting policies; key accounting estimates (largely relating to warranty provisions) and controls. • Director of Tax – approach to managing the Group’s tax affairs; key tax risks and how they are managed (with specific consideration of customs duties); effective tax rate; UK tax position; and key tax-related accounting policies and judgements. Financial reporting We place considerable emphasis on making sure that the accounting policies are appropriate and are consistently applied so that the financial statements faithfully represent the results and financial position of the Group and its underlying contractual arrangements. Given the long-term nature of the Group’s businesses, most of the accounting policies subject to significant judgement do not change significantly year-on-year. However, the facts and circumstances on which those judgements are based do vary over time, with a consequential impact on the application of the policies. The key areas of focus in 2015 are set out in the table overleaf. In part, these reflect the current weak trading conditions in Marine. Overall, we are satisfied that the judgements and estimates made are balanced. During the year, we discussed the requirements of IFRS 15 Revenue from Contracts with Customers, which will be applicable for 2018. This new standard will have a significant impact on our accounting policies for revenue recognition in our Civil Aerospace business. The Group is consulting with other companies in the aerospace and defence sector, and we will take account of other interpretations in our implementation of the new requirements. This is discussed further in the accounting policies on page 121. Since the year end, we have reviewed the form and content of the Group’s 2015 Annual Report together with the processes used to prepare and verify it. We have reported to the Board that, taken as a whole, we consider the Annual Report to be fair, balanced and understandable. We further believe the Annual Report provides the necessary information for shareholders to adequately assess the Company’s performance, business model and strategy. The Group is also implementing a new management information system covering both financial and non-financial information. The committee strongly supports this initiative and is reviewing the progress of this project to ensure that it provides improvements in the information used to manage the business. Rolls-Royce Holdings plc Annual Report 2015 93 Directors’ Report Directors’ Report / Corporate governance Directors’ Report Directors’ Report / Committee reports Audit Committee AUDIT COMMITTEE REPORT CONTINUED Key issues Matters considered Outcome Reversal of impairment on contractual aftermarket rights The background to the impairment charges originally made on certain Trent 1000 contractual aftermarket rights and the reasons and supporting evidence as to why it is considered that the circumstances have changed, requiring the reversal of these charges. We are satisfied that this is an appropriate judgement. We paid particular attention to the requirements of accounting standards and to the engineering assessment of the improved outlook for the cost of maintaining these engines. Indications of impairment of the carrying values of intangible assets in Civil Aerospace The assessments of the value-in-use of the principal intangible assets, including the key assumptions and estimates on which they are based. We are satisfied that there were no indications of impairment. The estimates used in accounting for long-term contractual arrangements in Civil Aerospace are appropriate The basis on which the estimates are prepared and, in particular, how the inherent uncertainties are reflected in these estimates. We are satisfied that the process produces balanced estimates, with appropriate consideration of the uncertainties. In 2015, as we had agreed in 2012, the methodologies to reflect risk, current experience and expected long-term performance were reviewed. Refinements to the methodologies as a result of the review, resulted in a one-off profit benefit to the income statement of £189m. The sale of engines to joint ventures The basis for assessing the selling price. Impairment of goodwill in Marine The forecasts for each of the relevant cash generating units, including the key assumptions on which they are based. The business plan, and the underlying assumptions on which it is based. We are satisfied that the price represents the fair value of the engines. We are satisfied with the analysis and that impairments should be recognised where these did not support the carrying value of the goodwill. We are satisfied that, although the headroom has reduced as a result of the current trading environment, there is no indication of impairment. The basis for specific warranty and contractual provisions, including those established in 2014 and 2015 for product quality issues. We are satisfied that the estimates reflect a balanced assessment of the likely outcome. Legal advice received in respect of the SFO enquiries. We are satisfied that the disclosures appropriately reflect the current position. Whether there is any impairment to the carrying value of the goodwill in Rolls-Royce Power Systems AG Warranty and contractual provisions in Marine The disclosures of contingent liabilities, in particular those in respect of the possible outcome of the SFO enquiries, are adequate Risk and control environment Assessment of principal risks Risk management is fundamental and forms an integral part of how we work. All risks are managed through a risk management system (described on page 54) in accordance with policies and guidance established by the Director of Risk and his team and approved by the Board. The new requirements of the Code have provided a catalyst to review and enhance these, to improve Board oversight and to enable continuous monitoring within the businesses. On behalf of the Board, we monitored this system and the enhancements. In addition, as described in last year’s Annual Report, the Board allocated responsibility for reviewing certain principal risks to an appropriate committee. 94 Rolls-Royce Holdings plc Annual Report 2015 This process and the principal risks arising then formed the basis for our assessment of the going concern and viability statements which are discussed later in this report. As described on page 54, the processes are designed to identify and manage, rather than eliminate, the risk of failure to achieve our business objectives. We satisfied ourselves that the processes for identifying and managing the principal risks are appropriate and that all risks and mitigating actions had been subject, during the year, to a detailed review by the Board or an appropriate committee. Based on this and on our other activities including consideration of the work of internal and external audit and presentations from senior management of each business which include risk management, we reported to the Board that a robust assessment of the principal risks facing the Company had been undertaken. Committee reports / Audit Committee We also considered in detail the principal risks that have been allocated to us by the Board. Business continuity – we reviewed management’s contingency plans in the event of a disruptive event, most particularly within the aero gas turbine supply chain, both external and internal. These take account of the likelihood of such an incident, its impact on the business and its likely duration, and the cost and availability of mitigating actions. The Group has an incident management framework in place, including a crisis management team to deal with any significant event. IT vulnerability – recent events make it clear that this is an increasing issue for all companies, and particularly for Rolls-Royce given the nature of the data held. During the year, we visited the Group’s security centre where we met with the senior IT security team. During this visit, the Group’s systems for preventing breaches of the IT system and procedures for monitoring and combatting those arising were demonstrated. We discussed with the team the evolving nature of cyber attacks and how its procedures are evolving in parallel. During the year, a dashboard was developed to monitor attacks and how they are dealt with. Market and financial shock – as part of the decision to issue the US$1.5bn bond in October 2015, the Board considered the exposure of the Group to financial market risks including: foreign currency exchange rates; oil price; liquidity and credit risks; and reduction in air travel or other disruption to customer operations. The Board also reviewed the Group’s management of these risks. As this area was subject to detailed review by the Board, we did not consider it necessary to repeat this. Internal control The Board has overall responsibility to the shareholders for the Group’s system of internal control over its business and risk management processes and the risks identified through the risk management process. The committee has responsibility for reviewing the system’s operation and effectiveness. The Group has a long-standing process for identifying risks and planning mitigating actions and for assessing the effectiveness of internal control. In assessing the Code requirements, enhancements to the existing processes were identified. We approved an enhanced model for representing the system, comprising: We considered that the existing process, together with the enhancements implemented to date, are sufficient to meet the requirements of the Code and the FCA’s Disclosure Rules and Transparency Rules and we concluded that the operation and monitoring of controls, including those relating to the financial reporting process, were effective during the year. Work will continue during 2016 to complete the definition and documentation of the controls in the enhanced model. Judgement is required in evaluating the risks facing the Group in achieving its objectives, in determining the risks that are considered acceptable, in determining the likelihood of those risks materialising, in identifying the Group’s ability to reduce the incidence and impact on the business of risks that do materialise, and in ensuring the costs of operating particular controls are proportionate to the benefit provided. The enhanced control model has been reviewed by the sector audit committees and a summary by this committee. Going forward, this will be included in the presentations we receive from the Group’s businesses and key functions, giving us the opportunity to discuss and challenge the assessments and judgements underlying the internal control systems. The Group is also using this standardisation of the internal control framework as an opportunity to improve the consistency of reporting, in particular from the Group’s smaller operations. We paid particular attention to internal controls over financial reporting and, mindful of the current business challenges the Group is facing, have instigated, and will monitor progress in achieving, a wide-ranging plan to improve controls in this area. The going concern and viability statements We reviewed the processes and assumptions underlying the statements set out on page 57. In particular, we focused on the new viability statement and considered: • the consistency of the analysis of risk impact with that reviewed by the Board as part of its strategy review; • the assessment of the impact of individual risks, both in amount and timing; • the analysis of multiple risk impacts; and • the current financing in place and the availability of future • entity-level controls covering leadership and direction from the financing. As a result, we were satisfied that the viability statement had been prepared on an appropriate basis. top; and • specific control activities, covering detailed process controls, and internal and external assurance activities. This model was then populated and the operation and effectiveness of the controls rated. This commenced in 2015 and prioritised: • entity-level controls; • controls over principal risks as described on pages 55 and 56; • controls over key risks and critical processes for each of the Group’s business; and • core financial controls. Rolls-Royce Holdings plc Annual Report 2015 95 Directors’ Report Directors’ Report / Corporate governance Directors’ Report Directors’ Report / Committee reports Audit Committee AUDIT COMMITTEE REPORT CONTINUED Internal audit External auditor We receive a quarterly dashboard from the Director of Internal Audit identifying key trends and findings of internal audit reports, and the resolution of actions agreed. Twice a year, we review detailed updates of significant findings. In particular, we review the nature and number of issues raised by internal audit and the time to complete the related actions, which during 2015 we considered to be reasonable. 2015 audit During the year, KPMG presented the audit strategy, which identified their assessment of the key audit risks and the proposed scope of audit work. We agreed the approach and scope of audit work to be undertaken. Key risks and the audit approach to these risks are discussed in the Independent Auditor’s report (pages 167 to 174), which also highlights the other significant risks that KPMG drew to our attention. Increasing focus has been put on identifying the root causes of unsatisfactory internal audit reports, both to consider whether there are any systemic areas of concern in the Group’s control environment and to inform the development of future internal audit planning. The committee considered and reviewed the effectiveness of the Group’s internal audit function, including internal audit resources, plans and performance as well as the function’s interaction with management. The outcome of the 2014 review of the audit function provided a number of improvements and changes which have been implemented during 2015. In particular, the recruitment process has been improved to ensure that the function maintains adequate resource to meet its objectives. I meet the Director of Internal Audit privately before each meeting and on an ad-hoc basis throughout the year, and the committee as a whole has a private meeting with him at least once a year. These discussions cover the activities, findings, resolution of control weaknesses, progress against the agreed plan and the resourcing of the department. We were satisfied that the scope, extent and effectiveness of internal audit work are appropriate for the Group and that there is a sound plan for ensuring that this continues to be the case as our business progresses and risks change. We also undertook an assessment of KPMG’s qualifications, expertise and resources, independence and the effectiveness of the external audit process. We reviewed the fees of the external auditor. Our conclusions were that the external audit was carried out effectively, efficiently and with the necessary objectivity and independence. As part of the reporting of the half and full-year results, in July 2015 and February 2016, KPMG reported to the committee on their assessment of the Group’s judgements and estimates in respect of these risks and the adequacy of the reporting. KPMG also report on their assessment of the Group’s control environment. We continue to be supportive of the extended auditor’s report and KPMG’s approach which goes beyond the minimum requirements, providing additional clarity on the key judgements and estimates. I meet with the lead partner prior to each meeting and the whole committee has a private meeting with KPMG at least once a year. In 2015, upon their appointments to the committee, Lee Hsien Yan, Irene Dorner and Alan Davies had briefings with KPMG. Reappointment of KPMG and audit tender process The committee reviews and makes recommendations to the Board with regard to the reappointment of the external auditor. In doing so, we take into account auditor independence and audit partner rotation. KPMG were appointed as auditors in 1990 and we have not tendered the audit since. No contractual obligations restrict our choice of external auditor. 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 will be required to rotate after the 2018 AGM. The committee and the Board have recommended KPMG’s re-appointment at the 2016 AGM. The new EU directive requires us to appoint a different auditor no later than 2020. During 2015, we have considered the plans for meeting these requirements. We believe that it is in the best interests of the Company and its shareholders to allow an appropriate period for the new auditor to build up a detailed knowledge of the business. A tender of the audit will be undertaken during 2016. The new auditor will then be appointed at the 2018 AGM and provide its first auditor’s report in the 2018 Annual Report. 96 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Audit Committee The Committee considers that the Company has, throughout the year ended 31 December 2015, complied with the provisions of the The Statutory Audit Services for Large Companies Market Investigation (Mandatory Use of Competitive Tender Processes and Audit Committee Responsibilities) Order 2014. 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 and summarised below. All proposed services must be pre-approved in accordance with the non-audit services policy which is reviewed and approved annually. Above defined levels, my pre-approval is required. The committee also reviews the non-audit fees charged by KPMG quarterly. Non-audit related fees paid to KPMG during the year were 29% (2014: 39%) of the audit fee. Our annual review of the external auditor takes into account the nature and level of all services provided. Audit Audit-related Tax compliance Other Non-audit 2015 2014 £m 5.9 1.3 0.4 – 1.7 % 22 7 – 29 £m 5.7 1.1 0.7 0.4 2.2 % 19 12 7 39 Based on our review of the services provided by KPMG and discussion with the lead audit partner, we concluded that neither the nature nor the scale of these services gave any concerns regarding the objectivity or independence of KPMG. As part of the EU audit reform, further restrictions will be placed on auditors undertaking non-audit services from 2017. In the UK, these will be implemented by the Financial Reporting Council, which is expected to publish the final requirements in the first half of 2016. We will continue to monitor developments in this area and make amendments as necessary to the policy. We have also put in place additional procedures to monitor engagements with potential future auditors to ensure that, following the tender process, we can discontinue or transition any engagements as required. Looking forward The introduction of the recent changes to the Code has increased the focus of the committee on business risk, which continues to be a high profile topic in boardrooms. During 2015, we have made significant progress in developing further the existing processes for risk management and internal controls. However, we believe that that this is a continuous activity of improvement to the underlying processes, making them as effective and efficient as possible and ensuring that they are fully embedded as part of ‘business-as-usual’ activities. In championing this in 2016 and beyond, we will ensure that the Board, its committees and senior management have a sound basis for understanding the principal risks in the Group, assurance that they are being managed effectively and that the internal controls are appropriate and are operating effectively. We will continue to monitor the key accounting judgements and estimates, focusing on ensuring consistent application across the Group. In particular, we will review the accounting impact of the transition in the Civil Aerospace business from mainly linked to mainly unlinked TotalCare contracts. During 2016, we will also continue to review the development of the plans to implement IFRS 15 in 2018. We will also continue to review the implementation of the improved management information system, ensuring that this will provide a robust basis for the management of the business and will support high quality analysis and will monitor progress on the internal financial control improvement programme. As noted above, we plan to tender the audit in 2016 and this will be a significant activity for both the committee and management. We will ensure that the selection of the new auditor is based on a robust assessment, focusing on the qualities of the proposed audit team and their understanding of our business. As this process develops, our attention will also turn to ensuring that there is a seamless transition from KPMG to the new auditor. Lewis Booth Chairman of the Audit Committee Rolls-Royce Holdings plc Annual Report 2015 97 Directors’ Report Directors’ Report / Committee reports Safety & Ethics Committee SAFETY & ETHICS COMMITTEE REPORT Highlights Successful migration to a single Safety & Ethics Committee Product safety management system effective in responding to incidents in service Key HS&E global improvement programmes delivering results Good progress with the ethics and compliance improvement programme, including introduction of a global local ethics adviser network Aerospace and Defense industry leader in Dow Jones Sustainability Index 2015 Principal responsibilities Under its wide remit, the committee’s responsibilities include: to maintain an understanding of and keep under review the Group’s frameworks for the effective governance of safety and ethics and the Group’s culture in these areas; to oversee and review annually the Group’s key safety and ethics policies, including: the Global Code of Conduct, anti-bribery and corruption and export controls, fraud, product safety, HS&E and sustainability policies, and ensuring appropriate independent scrutiny of policies and practices; to review the Group’s compliance with relevant legislation, regulation and make recommendations in the key policy areas; to oversee training in respect of safety and ethics, including ensuring adequate arrangements exist to enable employees and contractors to raise concerns, in confidence; to review reports on issues raised through the Ethics Line and review the results of any investigations into ethical or compliance breaches or allegations of misconduct; to review reports on risks in relation to products not meeting safety expectations; to review reports on health and safety risk and proposed actions to manage such risks; to review remedial actions and lessons learned in relation to material investigations; to review disciplinary action taken following safety and ethics concerns; and to keep under review the key performance indicators in relation to safety and ethics. The committee regularly reports to the Board and refers any concerns about possible financial improprieties to the Audit Committee. The Director – Engineering & Technology, General Counsel, Director of Risk and other senior safety and risk executives attend committee meetings. During the year the committee reviewed its terms of reference and recommended certain changes to reflect its oversight of the Company’s strengthened commitment to sustainability. The terms of reference for the committee are available in the Board governance document available on the Group’s website. 2015 overview Introduction On 1 January 2015 the Group’s separate Safety and Ethics Committees combined to become one committee. The committee assists the Board in fulfilling its oversight responsibilities in respect of safety and ethics matters, which include: product safety; HS&E (occupational health, process safety, asset integrity, personal security and the environment); sustainability; and ethics (business ethics, anti-bribery and corruption and export controls compliance). It has been allocated responsibility on behalf of the Board for overseeing the Group’s principal risks of product failure and compliance (see pages 54 to 56). In addition to its oversight role for the Board, the committee supports management in its aim to create, promote and maintain an ethical, compliant, safety-conscious, environmentally-aware and socially-responsible culture across the Group as a means of delivering its safety and ethics goals. 98 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Safety & Ethics Committee At a glance Area of focus Matters considered Outcome Product safety Product safety incidents in service and the Group’s response. Satisfactory response to incidents and support to investigations. Review of product safety policy, assurance framework and safety management systems including in Marine and Power Systems. The framework and systems are robust and provide appropriate governance and accountability. Review of product safety learning and development framework. Widely deployed training across the Group, tailored to different HS&E Review of HS&E risk profile and learning from incidents. categories of employees depending on role. Satisfactory process to contain and mitigate against future emergence of risks, including communication of learning points. Review of HS&E governance and accountability framework, learning and development programme and communications. Model remains satisfactory and was strengthened in the non- aerospace businesses during the year. Training is being consolidated. Review of global HS&E improvement programmes. Programmes are delivering improvements. Plans to improve rating in Dow Jones Sustainability Index. Target exceeded and achieved sector Industry Leader. Monitoring of ethics and compliance improvement programme. Significant progress made in implementing the Group’s plans, including Lord Gold’s recommendations. Monitoring deployment of ABC policies and use of advisers. Good progress and significant decrease in advisers. Sustainability Ethics and compliance Principal risks The Board has allocated responsibility to the committee for reviewing the principal risks of product failure and compliance. These topics form a core part of discussions at our meetings, as described in more detail in the remainder of this committee report. Product safety The Group recognises that its products are mission critical to its customers, and the people its customers serve, all over the world. As Rolls-Royce products become increasingly technologically advanced, they are expected to always be reliable and safe whenever they are used, often in harsh operating environments. Our commitment to meet this expectation is essential to the Group’s business, its reputation and its sustainability. As a committee we draw on our collective industry and regulatory experience to oversee the Group’s work in achieving this. Throughout the year, we were kept regularly updated on aviation product-related safety incidents in service and considered the potential impact on the Group and its products. We also oversaw the Group’s response to a marine equipment product issue. Our work in reviewing incidents in service involved: monitoring management’s progress in root cause identification; being briefed on the development and deployment of technical solutions required; testing the Group’s approach in engaging with affected operators; and overseeing plans for the timely mitigation and retirement of any safety risk including through the application of lessons learned back into product design. The committee was satisfied with the Group’s response in swiftly deploying its safety assessment process to mitigate, control and monitor any potential product safety risks as they emerged. The committee considered the Group’s product portfolio in offshore marine applications. We discussed with management the potential safety risk and associated liabilities were the Group in future to be requested to provide dynamic positioning equipment or systems for drill rigs and work-over vessels. The Group does not presently provide any such equipment for these specific applications. However this resulted in management reviewing its processes for ensuring that novel products, and novel applications of existing products, cannot be introduced without being the subject of a rigorous safety assessment and a suitability and performance review. Throughout the year, the committee received detailed briefings in relation to elements of the product safety assurance framework and safety management system outlined on the following page. This included a review of how the Group is managing product safety assurance while major updates to the engineering processes in the Group’s quality system are being implemented. We spent time during 2015 gaining a more detailed understanding of product safety management in the Marine and Power Systems businesses. The committee was assured that progress is being made in deploying many of the rigorous safety methodologies used in aerospace to the Marine business in order to align the Group’s global safety standards. Power Systems operates its own mature product safety assurance system to comparable standards. Further shared learning and closer alignment are planned for the future. To maintain the highest standards of product safety requires that engineering tasks are carried out only by those with a suitable level of competence. During the year, the committee assessed the Group’s product safety learning and development framework as it applies to different categories of employees depending upon their roles. To experience training first-hand, the committee members undertook an employee product safety training module. Rolls-Royce Holdings plc Annual Report 2015 99 Directors’ Report Directors’ Report / Committee reports Safety & Ethics Committee SAFETY & ETHICS COMMITTEE REPORT CONTINUED Safety management system In order to help the organisation to follow these five principles and meet the required standards through operational processes, the Group maintains a product safety management system (SMS). During 2015, it was agreed to develop the SMS manual further to clarify how accountability for product safety, in particular the conforming product element, flows through the organisation; and to define the role of Quality and Safety Assurance Boards in identifying and addressing causes of non-conformance. The Group’s engineering and safety processes must work together closely in order to ensure that we efficiently produce safe designs for our products. Safety assessments are undertaken in support of the design of all Rolls-Royce products and during in-service operation to support the response to arising safety issues. The test applied to all product safety risks is that they are both tolerable and as low as reasonably practicable. Tolerable risks are those that satisfy all relevant targets. The targets are set internally by the Group and externally by customers and regulators. The safety assessment process that has been developed is based upon a standard industry approach as follows: Safety assessment IDENTIFY AND ASSESS THE HAZARDS REVIEW AND MONITOR THE RISKS MITIGATE THE RISKS CONTROL THE REMAINING RISK Product safety policy The Group’s product safety policy sets out the internal standards that we expect to be met across the Group, through the following five governing principles: 1. Leadership commitment and accountability 2. Level of product safety 3. Maintaining and improving product safety 4. Conforming product 5. Safety awareness and competence Our leaders champion product safety and prioritise it so that safety-related tasks receive the right level of attention, time and resource. We make accountability for product safety clear and ensure people understand what they are accountable for. We design our products to achieve a high level of safety consistent with their application, always ensuring that we meet or better the relevant Group, legal, regulatory and industry requirements. We assess what potentially could go wrong and put in place controls to meet the required safety levels, thereby reducing safety risks as far as is reasonably practicable. We are committed to the continuous improvement of product safety and actively engage in setting industry standards and good practice. We continually measure our performance and rigorously investigate and resolve safety-related issues, systematically embedding the learning from these back into our practices and processes. Everyone is encouraged to report any product safety concerns. Robust quality is an essential building block of product safety and by following our processes we can ensure that our products and those of our suppliers conform to specification. Everyone who works in the Group shares responsibility for product safety and we are mindful of the safety implications of our actions. Training is provided to ensure a clear understanding of the product safety policy and processes. There is a collective and personal responsibility accepted by all. The product safety policy is subject to annual review by both the Group product safety review board and the committee. No significant policy weakness or omission was identified during the period of review. 100 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Safety & Ethics Committee Health, safety and the environment (HS&E) During the year, we receive a number of briefings and presentations as part of an annual agreed cycle of HS&E topics. This enables oversight, discussion and year-on-year monitoring of the Group’s progress on key aspects of its HS&E management and assurance. At each meeting, the committee receives HS&E performance reports and a balanced scorecard showing performance trends against the objectives of protecting health, preventing injury and reducing environmental impact. Overall, in 2015, this showed improvement in all areas except personal safety. Areas for improvement were identified. The committee also oversees the ‘learning from incidents’ process that examines root causes of significant and major incidents and defines measures to mitigate against the risk of similar incidents. In July 2015, we were saddened to learn that a contractor working in Italy had died from an electric shock at a customer site. A detailed investigation was conducted and a Group-wide HS&E bulletin was issued to share lessons learned and to stipulate actions needed to prevent any similar incident. The Group also suffered two dust fires during the year at one of its facilities in Hucknall, UK. Whilst these were contained and no-one was injured, again the lessons learned were promptly shared and steps taken to mitigate against any re-occurrence at other Group sites. We conducted an annual review of HS&E governance and concluded that this remained satisfactory, noting that it had been strengthened during the year to include a rolling calendar of executive level reviews. The committee also examined the HS&E Group risk profile which had been adapted during the year, and received assurance on the steps taken to contain known issues and to mitigate against the effects of future emerging risks. In December 2015, we endorsed the adoption of a revised Group HS&E policy. The Group’s HS&E experts gave progress updates to the committee during the year on the key HS&E improvement programmes: • the process safety management programme is driving improvements in the management of high hazard processes, including relating to chemicals; • the electrical safety programme has successfully raised the level of electrical safety management and control across the Group; • waste control standards and tools, innovation, multi-site solutions and the development of exemplar sites are being used to manage and further the Group’s waste action programme; and • development of an improved HS&E management system continued throughout 2015 and is starting to be deployed. The committee was satisfied that these programmes will continue to deliver improvements. We also learned about the Group’s management of the integrity of its infrastructure and assets, in order that HS&E risk can be profiled to reflect age or environmental conditions. This year, as part of its occupational health strategy, the Group has increased the level of focus and resources being applied in promoting health risk management, resilience and wellbeing among the workforce. This has included the launch of toolkits, workshops, videos and blogs from the Chief Medical Officer. The committee reviewed the overall HS&E learning and development programme and discussed how HS&E culture can be promoted and strengthened. The HS&E communications plan and initiatives were discussed, including the regular inclusion of HS&E ‘moments’ at team meetings (including the ELT), promotion of HS&E walks and talks, and the HS&E Week held Group-wide in October 2015. In September 2015, the committee undertook an HS&E walk with members of management at operational facilities in Derby, UK. The committee received a presentation on the Group’s environmental strategy, centred around efficient products, advanced technology for future low emission products, and reducing the environmental impact of business operations. The model for governance of environmental aspects of the Group’s business, product and operational strategies was also reviewed. This includes support provided to the management by an Environmental Advisory Board whose members and supporting project teams are respected authorities in their fields drawn from academia and external organisations. Sustainability The committee oversees and helps guide the Group’s approach to sustainability, as well as monitoring progress towards goals in this area. In 2015, we discussed how sustainability can be used as a driver of value creation. To support this, the Group has been focusing in the year on reducing what it uses, re-using waste material, and recycling end-of-life products. We were delighted that, in September 2015, Rolls-Royce achieved Industry Leader for the Aerospace and Defense sector in the Dow Jones Sustainability Index. This marked a significant (17%) improvement since 2014 reflecting the Group’s progress across sustainability and corporate responsibility disciplines. All scores were well above the industry average for all sections. Of particular note to the committee was that the Group achieved industry best scores for product stewardship, corporate citizenship and philanthropy, as well as the environmental and social dimensions as a whole. You can read more about the Group’s approach to sustainability on pages 48 to 51. Ethics and compliance There is recognition that the Board and the ELT must continue to demonstrate leadership around ethical and behavioural standards. The Board is determined to ensure this is embedded into the culture of the business. The committee plays a vital role in providing dedicated focus and attention on behalf of the Board to this critical area, including reviewing the Group’s 2015 ethics and compliance employee communications plan. Regulatory investigations We previously reported that the SFO had begun a formal investigation. The Group is continuing to co-operate with the authorities in the UK, US and elsewhere. The committee received regular updates on the regulatory investigations. As the investigations are still ongoing we are unable to give any further details or a timescale for when they will conclude. Rolls-Royce Holdings plc Annual Report 2015 101 Directors’ Report Directors’ Report / Committee reports Safety & Ethics Committee Disciplinary proceedings under the Global Code of Conduct (Global Code) If an employee is found to have acted in breach of the Company’s Global Code, the Group takes appropriate action to address that breach. That action may include giving a disciplinary warning, imposing another penalty or, ultimately, terminating employment in the most serious of cases. In 2015, there were 33 employees whose employment ended for reasons relating to breaches of the Global Code. Ethics and compliance improvement programme and Lord Gold’s review Lord Gold was engaged in 2013 to provide independent assessment and guidance to assist the Company in improving its ethics and compliance culture. In December 2014, Lord Gold issued a second interim report and recommendations on the results from his detailed review. The Group has been implementing these recommendations in 2015 through its ethics and compliance improvement programme under the committee’s oversight, and has continued to make good progress. Lord Gold attended three meetings of the committee during the year. We discussed the results of his review and his observations, including insights from focus groups held with a mix of employees in different countries. The size, structure and skills of the risk team were kept under review during the year with regard to required resourcing to deliver and maintain the appropriate level of focus. Anti-bribery and corruption (ABC) policies In 2014, the ABC compliance team completed a thorough and successful review and update of the Group’s policies on ABC, advisers, confidential information, gifts and hospitality and facilitation payments. In 2015, this work expanded to the review and updating of policies on offset, conflicts of interest and lobbying and political donations together with guidance on managing the ABC risks of sponsorship and donations. All of these refreshed policies were fully operational by the end of 2015 and are being rolled out in the Power Systems business in 2016. Completion of this roll-out will mean that unified global ABC policies will be implemented across the entire Group. The committee, throughout the year, turned its focus to ensuring the effective monitoring of the suite of policies and their implementation. During the year, the risk team also launched a due diligence toolkit, which enables managers across the Group to understand and manage ABC risks relating to lower risk third parties such as maintenance repair and overhaul centres, logistics providers and suppliers. Following the introduction of the Group’s new adviser policy, the number of advisers engaged has reduced dramatically for all businesses except Power Systems, which has a large network of distributors and is more reliant on the services of third parties to sell, distribute and support its products. However, the Group is applying its new adviser policies to all Power Systems’ third parties and this review is expected to be completed during 2016. In addition, every new proposal to engage an adviser must go through rigorous review by the Group’s advisers and offset panel, presently comprised of the Director of Risk, Lord Gold, and a partner from an external law firm. Ethics Line and local ethics advisers As part of the committee’s responsibility, the Group’s confidential reporting line, the Ethics Line, was discussed and reviewed. The Group continues to improve awareness of the ‘speak-up’ channels available to employees through training and ongoing engagement. Ethical questions and concerns that are raised by employees and other stakeholders are recorded as contacts in the Ethics Line system. Whilst the total number of Ethics Line contacts decreased in 2015 to 729 (2014: 850 contacts) this was largely driven by a reduction in the number of questions asked, with the number of ethical concerns raised remaining at a similar level to last year at 439 (2014: 434 concerns). The Ethics Line oversight group, which was originally formed in 2014, continued to review cases, analyse the contact trends and provide updates to the committee highlighting any high-risk cases. We share any concerns about possible improprieties in matters of financial reporting with the Audit Committee. During 2015, the committee supported and welcomed the introduction of a global network of local ethics advisers appointed from the existing workforce who are trained in how to respond to ethical issues raised. The presence of these 76 local points of contact is designed to promote ‘speaking-up’ and tackling of ethical issues locally where appropriate to provide staff with an alternative to using other ‘speak-up’ channels including the Ethics Line. Export control During the year, the committee received briefings and a presentation on the export control compliance landscape, the key risks, and the Group’s export control enhancement programme to address those risks. This included discussion of the Group’s processes and systems for classification of parts, and the deployment of extra export control professionals into the business. Training The committee reviewed the proposal for an integrated ethics training and communications campaign to engage the Group’s employees further, and to create the right environment for our employees to ‘speak-up and ask’ and ‘think and act’. This built on the manager-led ethics toolkit discussions undertaken in 2014 whilst bringing a fresh approach for 2015, built around a series of filmed scenarios to prompt manager-led group discussions. Annual ethics training is mandatory for all employees across the Group, and the Board and the ELT undertook this ethics training in the year. Each member of the ELT also had a personal objective to lead an ethics session with their teams during 2015. A series of monthly dilemma-based stories drawn from real cases were also published on the Group’s intranet during 2015, inviting employees to vote on what action they would take. In 2015, a further mandated ABC training programme for employees was rolled out, as well as annual online export control training. Conclusion The committee is pleased with the progress made by the Group during the year promoting the safety and ethics agenda, and in particular in developing and undertaking detailed improvement plans. These plans are making a difference across the Group. The focus of the committee in 2016 is expected to turn to the challenge of ensuring that the improvement programmes transition into a sustainable ‘steady-state’ position that will provide a strong platform for achievement of the Group’s safety, ethics, and wider objectives and targets over the years to come. Sir Frank Chapman Chairman of the Safety & Ethics Committee 102 Rolls-Royce Holdings plc Annual Report 2015 Committee reports / Science & Technology Committee SCIENCE & TECHNOLOGY COMMITTEE REPORT Highlights Broad review of key technologies undertaken Technology acquisition process and relevant benchmarks reviewed Technology selection and funding outcomes for 2015 reviewed Deep reviews of selected key technologies for aerospace and marine Group’s approach to digitisation as a disruptive enabler reviewed in detail Principal responsibilities The remit of the committee is to: to review the strategic direction of the Company’s research, technology and development activities; to provide assurance that significant trends in science, technology, software and data are identified and incorporated into management plans; to assist the Board in its oversight of major R&D investment and provide assurance on the competitiveness and adequacy of any R&D; to oversee the effectiveness of key engineering and technological processes and operations, including delivery of major product development and technology programmes, intellectual property management and interactions with institutions; to provide assurance on the identification and management of key technological risks; to oversee processes for ensuring effective resourcing and development of required technological capability and skills; to conduct visits to R&D facilities; to ensure dialogue with the Group’s engineering and technology leaders and employees; and to review industry and scientific benchmark data and best practices. The Director – Engineering & Technology, and other senior engineering and technology executives, attend the committee meetings. Rolls-Royce Holdings plc Annual Report 2015 103 2015 overview Introduction I am pleased to present the inaugural report of the Science & Technology Committee, which the Board agreed to establish with effect from 1 January 2015. The Group invests more than £1bn each year in R&D to enable us to conceive, design and deliver world-class technology that meets our customers’ current and future requirements. The Board considers that this key area of the business will benefit from the dedicated focus and support of the committee especially in helping with the formulation of strategic direction. It is the aim of the committee to provide high level oversight and assurance of the Group’s scientific and technological strategy, processes and investments. Upon its creation, Warren East (then a Non-executive Director) assumed the chairmanship of the committee. In May 2015, he chaired the first of the two meetings of the committee held during the year (a planning session also having taken place in March 2015). Warren stepped down from the committee when he became Chief Executive in July 2015, and as an interim arrangement Ruth Cairnie chaired the second meeting of the committee in December 2015. I was appointed as the new chairman of the committee in February 2016. The membership of the committee presently comprises four independent Non-executive Directors. Directors’ Report Directors’ Report / Committee reports Science & Technology Committee SCIENCE & TECHNOLOGY COMMITTEE REPORT CONTINUED At a glance Area of focus Matters considered Outcome Overview of technology Deep dives How the Group selects, develops and acquires new technology across all areas of the business; and the outcome of the process during 2015. The technology process was appropriate and supported the development of the business. Detailed technical briefings on certain key technologies for aerospace and marine applications. The committee supported areas of innovation and the commercial application of new technologies. Governance The adequacy of the committee’s terms of reference. No changes were made to the terms of reference. University Technology Centres (UTCs) We have established a global network of UTCs, with the first formal collaborations being signed in 1990. At first, UTCs were established mostly in the UK and more recently they have been founded in the US, Norway, Sweden, Italy, Germany and Korea. Additionally, Rolls-Royce has significant relationships with many other research centres around the world, including Japan, Singapore, China, Germany and the US. Each UTC addresses a key technology; collectively they tackle a wide range of engineering disciplines from combustion and aerodynamics to noise and manufacturing technology. This consistent strategy of developing long-term relationships with selected universities has provided close contact with world-class academic institutions, and given access to a wealth of talent and creativity to help protect our capability into the future. The aim is to satisfy the needs of the business and its customers whilst providing technical input that enhances the research reputation of the university. UTCs are long-term, funded collaborations that ensure continuity of work, offering high-quality technology for the Group and real-world challenges for academic partners. Each is led by a world-class academic and supported by a strong team of research fellows, associates, students, technicians, staff and facilities. While the main focus of the UTC is long-term research, an additional advantage of the relationship is to provide the Group with access to highly capable people to support short-term needs. This can be beneficial to both parties, providing practical experience for the research team and valuable solutions for the Group. Overview and deep dive reviews The first meeting of the committee served as an orientation session at which the members received detailed briefings and presentations from senior engineering and technology executives. This included a review of the Group’s technology acquisition process, and a detailed walkthrough of each of the Group’s identified key technologies in its businesses. The committee learned about how the Group benchmarks its activities in R&D and research & technology providing measures to establish whether the Group is doing enough to capture its intellectual property. In December 2015, a briefing was provided on technologies which could be potential disruptors (both as potential risks and opportunities). A detailed discussion was held with the Group’s Chief Scientific Officer and Chief Information Officer on steps taken in identifying and mitigating the risks and opportunities in emerging digital capabilities, and the Group’s future plans for digital business. This included consideration of how digitisation could be applied to particular technologies reviewed in detail by the committee. The committee reviewed the processes and outcomes of current technology selection and related funding, including a discussion of items that did not get funded and the reasons why. The committee is continuing to review the Group’s current and emerging technologies, as well as the measures that the Group deploys continually to assess the competitive and technological landscape. Maintaining technological advantage through leading-edge R&D, engineering and manufacturing techniques in the development of our products whilst ensuring they remain reliable, safe and compliant with regulatory standards is core to what the Group does. The committee will continue to support and guide management in its strategic decision-making on technology investments, and in assessing scientific and technology risks and opportunities for our business. Sir Kevin Smith Chairman of the Science & Technology Committee 104 Rolls-Royce Holdings plc Annual Report 2015 Responsibility statements RESPONSIBILITY STATEMENTS STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT OF THE ANNUAL REPORT AND THE FINANCIAL STATEMENTS The Directors, as listed on pages 58 to 61, 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. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of affairs of the Group and parent company and of their profit or loss for that period. In preparing each of the Group and parent company financial statements, the Directors are required to: • select suitable accounting policies and then apply them consistently; • make judgements and estimates that are reasonable and prudent; • for the Group financial statements, state whether they have been prepared in accordance with IFRS as adopted by the EU; Under applicable law and regulations, the Directors are also responsible for preparing a Directors’ Report, Directors’ Remuneration Report and Corporate Governance Statement that complies with that law and those regulations. The Directors are responsible for the maintenance and integrity of the corporate and financial information included on the Group’s website. Legislation in the UK governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions. RESPONSIBILITY STATEMENTS UNDER THE DISCLOSURE RULES AND TRANSPARENCY RULES 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 Company and the undertakings included in the consolidation taken as a whole; ii) the Strategic Report on pages 2 to 57 and Directors’ Report on pages 58 to 104 and pages 178 to 181 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 • for the parent company financial statements, state whether iii) the Annual Report, taken as a whole, is fair, balanced and applicable UK Accounting Standards have been followed, subject to any material departures disclosed and explained in the parent company financial statements; and understandable and provides the information necessary for shareholders to assess the Group’s position and performance, business model and strategy. • 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. By order of the Board Pamela Coles Company Secretary 11 February 2016 Rolls-Royce Holdings plc Annual Report 2015 105 Directors’ Report FINANCIAL STATEMENTS 157 157 158 158 158 158 159 159 159 CONSOLIDATED FINANCIAL STATEMENTS COMPANY FINANCIAL STATEMENTS Consolidated income statement 107 Company balance sheet Consolidated statement of comprehensive income Consolidated balance sheet Consolidated cash flow statement Consolidated statement of changes in equity Notes to the Consolidated Financial Statements 1 Accounting policies 2 Segmental analysis 3 Research and development 4 Net financing 5 Taxation 6 Earnings per ordinary share 7 Employee information 8 Auditors’ remuneration 9 Intangible assets 10 Property, plant and equipment 11 Investments 12 Inventories 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 Leases 23 Contingent liabilities 24 Related party transactions 25 Acquisitions and disposals Company statement of changes in equity 108 109 110 Notes to the Company Financial Statements 1 Accounting policies 112 2 Investments – subsidiary undertakings 3 Financial liabilities 4 Share capital 5 Contingent liabilities 6 Other Information 113 113 122 127 127 128 130 131 131 132 134 135 138 138 138 139 139 140 148 149 153 153 154 155 156 156 106 Rolls-Royce Holdings plc Annual Report 2015 Financial Statements CONSOLIDATED INCOME STATEMENT For the year ended 31 December 2015 Continuing operations 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 acquisition/reclassification of joint ventures Profit on disposal of businesses Profit before financing and taxation Financing income Financing costs Net financing Profit before taxation 1 Taxation Profit for the year from continuing operations Discontinued operations Profit for the year from ordinary activities Profit on disposal Profit for the year from discontinued operations Profit for the year Attributable to: Ordinary shareholders Non-controlling interests Profit for the year Earnings per ordinary share attributable to ordinary shareholders: From continuing operations Basic Diluted From continuing and discontinued operations Basic Diluted Payments to ordinary shareholders in respect of the year: Per share Total 1 Underlying profit before taxation 2015 £m 2014 £m 13,725 (10,459) 3,266 10 (1,059) (818) 100 1,499 – 2 1,501 115 (1,456) (1,341) 160 (76) 84 – – – 84 83 1 84 13,736 (10,533) 3,203 10 (1,124) (793) 94 1,390 2 6 1,398 121 (1,452) (1,331) 67 (151) (84) 4 138 142 58 69 (11) 58 Notes 2 3 11 2 4 4 5 2 6 4.51p 4.48p 4.51p 4.48p (3.90)p (3.90)p 3.68p 3.68p 17 16.37p 301 23.10p 435 2 1,432 1,620 Rolls-Royce Holdings plc Annual Report 2015 107 Financial StatementsFinancial Statements CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the year ended 31 December 2015 Profit for the year Other comprehensive income (OCI) Movements in post-retirement schemes Related tax movements Items that will not be reclassified to profit or loss Foreign exchange translation differences on foreign operations Reclassified to income statement on disposal of businesses Share of OCI of joint ventures and associates Related tax movements Items that may be reclassified to profit or loss Total comprehensive income for the year Attributable to: Ordinary shareholders Non-controlling interests Total comprehensive income for the year Notes 19 11 5 2015 £m 84 (722) 257 (465) (129) 1 (19) (2) (149) 2014 £m 58 1,192 (431) 761 (158) (29) (13) (2) (202) (530) 617 (530) – (530) 650 (33) 617 108 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsCONSOLIDATED BALANCE SHEET At 31 December 2015 ASSETS Intangible assets Property, plant and equipment Investments – joint ventures and associates Investments – other Other financial assets Deferred tax assets Post-retirement scheme surpluses Non-current assets Inventories Trade and other receivables Taxation recoverable Other financial assets Short-term investments Cash and cash equivalents Assets held for sale Current assets TOTAL ASSETS LIABILITIES Borrowings Other financial liabilities Trade and other payables Current tax liabilities Provisions for liabilities and charges Current liabilities Borrowings Other financial liabilities Trade and other payables Non-current tax liabilities Deferred tax liabilities Provisions for liabilities and charges Post-retirement scheme deficits Non-current liabilities TOTAL LIABILITIES NET ASSETS EQUITY Called-up share capital Share premium account Capital redemption reserve Cash flow hedging reserve Other reserves Retained earnings Equity attributable to ordinary shareholders Non-controlling interests TOTAL EQUITY Notes 2015 £m 2014 £m 9 10 11 11 17 5 19 12 13 17 14 15 17 16 18 15 17 16 5 18 19 20 4,645 3,490 576 33 83 318 1,063 10,208 2,637 6,244 23 29 2 3,176 5 12,116 22,324 (419) (331) (6,923) (164) (336) (8,173) (2,883) (1,651) (2,317) (1) (839) (304) (1,140) (9,135) (17,308) 4,804 3,446 539 31 107 369 1,740 11,036 2,768 5,509 19 22 7 2,862 1 11,188 22,224 (68) (209) (6,791) (184) (433) (7,685) (2,193) (717) (2,445) (10) (1,228) (374) (1,185) (8,152) (15,837) 5,016 6,387 367 180 161 (100) (51) 4,457 5,014 2 5,016 376 179 159 (81) 78 5,671 6,382 5 6,387 The financial statements on pages 107 to 156 were approved by the Board on 11 February 2016 and signed on its behalf by: WARREN EAST Chief Executive DAVID SMITH Chief Financial Officer Rolls-Royce Holdings plc Annual Report 2015 109 Financial StatementsFinancial Statements CONSOLIDATED CASH FLOW STATEMENT For the year ended 31 December 2015 Reconciliation of cash flows from operating activities Operating profit from continuing operations Operating loss from discontinued operations 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 Return of capital from joint ventures Gain on consolidation of previously non-consolidated subsidiary Amortisation and impairment of intangible assets Depreciation and impairment of property, plant and equipment Impairment of investments (Decrease)/increase in provisions Decrease 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 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 Acquisition of non-controlling interest Disposal of discontinued operations Disposals of other businesses Investments in joint ventures and associates Net cash outflow from investing activities Cash flows from financing activities Repayment of loans Proceeds from increase in loans and finance leases Capital element of finance lease payments Net cash flow from increase/(decrease) in borrowings and finance leases Interest received Interest paid Interest element of finance lease payments Decrease in short-term investments Issue of ordinary shares (net of expenses) Purchase of ordinary shares – share buyback Purchase of ordinary shares – other Dividend paid to non-controlling interest Redemption of C Shares Net cash inflow/(outflow) from financing activities Change in cash and cash equivalents Cash and cash equivalents at 1 January Exchange (losses)/gains on cash and cash equivalents Cash and cash equivalents at 31 December 110 Rolls-Royce Holdings plc Annual Report 2015 Notes 11 11 11 9 10 11 19 21 2015 £m 1,499 – 1,499 8 (100) 63 – – 432 378 2 (151) 63 (836) 242 (305) 213 (259) 5 1,254 (160) 1,094 (6) (408) 4 (487) 8 33 (5) – (121) 2 (15) (995) (54) 1,150 (1) 1,095 5 (58) (2) 5 32 (433) (2) – (421) 221 320 2,862 (6) 3,176 2014 £m 1,390 (1) 1,389 (3) (94) 73 3 (3) 367 375 – 129 166 (878) 214 (30) 170 (322) 21 1,577 (276) 1,301 (11) (477) – (648) 11 65 (3) (1,937) 1,027 24 (17) (1,966) (233) 49 – (184) 18 (63) – 313 1 (69) (2) (76) (406) (468) (1,133) 3,987 8 2,862 Financial StatementsReconciliation of movements in cash and cash equivalents to movements in net funds Change in cash and cash equivalents Cash flow from (increase)/decrease in borrowings and finance leases Cash flow from decrease in short-term investments Change in net funds resulting from cash flows Net funds (excluding cash and cash equivalents) of businesses acquired Exchange gains 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 2015 £m 2014 £m 320 (1,095) (5) (780) – 3 45 (732) 608 (124) 13 (111) (1,133) 184 (313) (1,262) (30) 19 (59) (1,332) 1,940 608 58 666 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 Cash and cash equivalents Short-term investments Other current borrowings 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 2015 £m 739 692 1,431 2,862 7 (67) (2,149) (45) 608 58 666 Funds flow £m (69) 92 297 320 (5) (64) (1,027) (4) (780) Exchange differences £m (8) (1) 3 (6) – – 12 (3) 3 (780) 3 Fair value adjustments £m – – – – – 8 37 – 45 (45) – Reclassifications £m – – – – – (294) 294 – – – At 31 December 2015 £m 662 783 1,731 3,176 2 (417) (2,833) (52) (124) 13 (111) Rolls-Royce Holdings plc Annual Report 2015 111 Financial StatementsFinancial Statements CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2015 At 1 January 2014 Profit for the year Foreign exchange translation differences on foreign operations Reclassified to income statement on disposal of businesses Movement on post-retirement schemes Share of other comprehensive income 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 buyback 4 Ordinary shares cancelled 4 Ordinary shares purchased – other Share-based payments – direct to equity 5 Transactions with NCI – acquisition of NCI shares Dividend paid to NCI Related tax movements Other changes in equity in the year At 1 January 2015 Profit for the year Foreign exchange translation differences on foreign operations Reclassified to income statement on disposal of businesses Movement on post-retirement schemes Share of other comprehensive income 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 buyback 4 Ordinary shares cancelled 4 Ordinary shares purchased – other Share-based payments – direct to equity 5 Transactions with NCI Related tax movements Other changes in equity in the year At 31 December 2015 Attributable to ordinary shareholders Notes Share capital £m 376 – Share premium £m 80 – Capital redemption reserve £m 163 – Cash flow hedging reserve1 £m (68) – Other reserves2 £m 250 – Retained earnings3 £m 4,804 69 Non- controlling interests (NCI) £m 698 (11) Total £m 5,605 69 Total equity £m 6,303 58 – – – – – – 2 – – – (2) – – – – – – 376 – – – – – – – – – – – (9) – – – – (9) 367 – – – – – – 99 – – – – – – – – – 99 179 – – – – – – – 1 – – – – – – – – 1 180 – – – – – – – (414) 408 – 2 – – – – – (4) 159 – – – – – – – – (430) 423 – 9 – – – – 2 161 – – – (13) – (13) – – – – – – – – – – – (81) – – – – (19) – (19) – – – – – – – – – – (100) (141) – (141) (17) (158) (29) – – 1,199 (29) 1,199 – (7) (29) 1,192 – (2) (172) – – – – – – – – – – – 78 – – (433) 835 (100) 2 (408) (69) – (2) 29 584 – (4) 32 5,671 83 (13) (435) 650 1 (412) – (69) – (2) 29 584 – (4) 127 6,382 83 – 2 (33) – – – – – – – (584) (76) – (660) 5 1 (13) (433) 617 1 (412) – (69) – (2) 29 – (76) (4) (533) 6,387 84 (128) – (128) (1) (129) 1 – – (722) 1 (722) – (2) (129) – – – – – – – – – – (51) – 257 (382) – 2 (423) (433) – (2) 30 – (6) (832) 4,457 (19) 255 (530) 1 (428) – (433) – (2) 30 – (6) (838) 5,014 – – – – – – – – – – – – (3) – (3) 2 1 (722) (19) 255 (530) 1 (428) – (433) – (2) 30 (3) (6) (841) 5,016 19 11 5 20 17 17 20 5 19 11 5 17 17 20 5 1 See accounting policies note 1. 2 Other reserves include a merger reserve of £3m (2014: £3m, 2013 £3m) and a translation reserve of £(54)m (2014: £75m, 2013: £247m). 3 At 31 December 2015, 5,894,064 ordinary shares with a net book value of £52m (2014 14,561,097, 2013 11,960,535 ordinary shares with net book values of £129m and £91m respectively) were held for the purpose of share-based payment plans and included in retained earnings. During the year, 10,892,026 ordinary shares with a net book value of £98m (2014 7,770,113 shares with a net book value of £64m) vested in share-based payment plans. During the year the Company acquired 224,993 (2014 169,404) of its ordinary shares via reinvestment of dividends received on its own shares and purchased 2,000,000 (2014 nil) of its ordinary shares through purchases on the London Stock Exchange. During the year, the Company issued no new ordinary shares (2014 10,200,000) to the Group’s share trust for its employees share-based payment plans with a net book value of nil (2014 £100m). 4 Following the completion of the sale of the Energy business to Siemens on 1 December 2014 and further to the announcement on 19 June 2014 of a £1bn share buyback, the Company put in place a programme to enable the purchase of its ordinary shares. The aim of the buyback was to reduce the issued share capital of the Company, helping enhance returns for shareholders. In the period to 31 December 2014, 8,215,000 shares were purchased at an average price of 840p. These shares were cancelled. In the year to 31 December 2015, 46,016,303 shares were purchased at an average price of 937p. 44,016,303 of these shares were cancelled and 2,000,000 were retained for use in share-based payment programmes. On 6 July 2015, the Company announced that the share buyback programme had been curtailed at the to-date total of £500m. 5 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. 112 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Accounting policies THE COMPANY Rolls-Royce Holdings plc (the ‘Company’) is a company domiciled in the United Kingdom. The consolidated financial statements of the Company for the year ended 31 December 2015 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 2015 (Adopted IFRS). The Company has elected to prepare its individual company financial statements under FRS 101 Reduced Disclosure Framework. This year is the first year that the financial statements have been prepared under FRS 101. They are set out on pages 157 to 159 and the accounting policies in respect of Company financial statements are set out on page 158. 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 obligations are valued on the basis required by IAS 19 Employee Benefits – and on a going concern basis as described on page 57. The consolidated financial statements are presented in sterling which is the Company’s functional currency. The preparation of financial statements in conformity with Adopted IFRS requires management to make judgements and estimates 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. Actual results could differ from those estimates. KEY AREAS OF JUDGEMENT Introduction The Group generates a significant portion of its revenues and profit on aftermarket arrangements arising from the installed original equipment (OE) fleet. As a consequence, the Group will often agree contractual prices for OE deliveries that take into account the anticipated aftermarket arrangements. Accounting policies reflect this aspect of the business model, in particular the policies for the recognition of contractual aftermarket rights and the linkage of OE and aftermarket arrangements. When a civil large engine is sold, the economic benefits received usually far exceed the cash receivable under the contract, due to the rights to valuable aftermarket spare parts business. However, because the value of this right cannot be estimated with enough precision, accounting standards require that the revenue recognised in the accounts on sale of the engine is restricted to a total amount that results in a break even position. The amount of the revenue recognised in excess of cash receivable is recognised as an intangible asset, which is called a ‘contractual aftermarket right’ (previously referred to as a ‘recoverable engine cost’; this change has been made to reflect better the nature of the asset). There is only one circumstance where accounting standards require the recognition of more of the value of the aftermarket rights when an engine is sold. This occurs where a long-term aftermarket contract (generally a TotalCare agreement – TCA) and an engine sale contract have been negotiated together. In this circumstance, the part of the aftermarket rights covered by the TCA can be valued much more precisely and is recognised at the time of the engine sale through accounting for the engine sale and TCA as a single contract. Nevertheless, the accounting profit recognised is still less than the economic benefits on the sale as there will be other valuable aftermarket rights (for instance for the period beyond the TCA term or for the sale of parts which are outside the scope of the TCA) which cannot be recognised. The Group enters into arrangements with long-term suppliers to share the risks and rewards of major programmes – risk and revenue sharing arrangements (RRSAs). The accounting policy for these arrangements has been chosen, consistent with Adopted IFRS, to reflect their commercial effect. The key judgements in determining these accounting policies are described below. Contractual aftermarket rights (CARs) On delivery of Civil Aerospace engines, 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. The Directors consider that these rights meet the definition of an intangible asset in IAS 38 Intangible Assets. However, the Directors do not consider that it is possible to determine a reliable fair value for this intangible asset. Accordingly, an intangible asset (CAR) 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 reliably measureable. An equal amount of revenue is recognised at the same point. Where a long-term aftermarket contract is linked to the OE contract (see below), the contractual price of the engine (including amounts allocated from the aftermarket contract) is above its cost of manufacture; consequently no CAR is recognised. Rolls-Royce Holdings plc Annual Report 2015 113 Financial StatementsFinancial Statements 1 Accounting policies continued Measure of performance on long-term aftermarket contracts A large proportion of the Group’s activities relate to long-term aftermarket contracts, in particular TotalCare and similar arrangements in the Aerospace Division. Under these contracts, the Group’s primary obligation is to maintain customers’ equipment in an operational condition and achieves this by undertaking various activities, such as engine monitoring, line maintenance and repair and overhaul, over the period of the contract. In general, the Directors consider that the stage of performance of the contract should be by reference to the obligation to maintain an operational fleet and that this is best measured by the operation of the fleet. Accordingly, stage of performance is measured by reference to flying hours of each fleet under contract. Linkage of original and long-term aftermarket contracts Where the key terms of a long-term aftermarket contract are substantively agreed (eg. in a term sheet) at the same time as an OE contract with the operator, the Directors consider these to be linked for accounting purposes and they are treated as a single contract, as this best reflects the overall commercial effect. Where the OE contract is not with the operator, eg. where it is with an OE manufacturer or a lessor, the contracts are not linked as they were not negotiated on a unified basis. Risk and revenue sharing arrangements 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 (ie. as long as the engine remains in service). The share of development costs borne by the workshare partner and of the revenues it receives reflect the partner’s proportionate cost of providing its production parts compared to the overall manufacturing cost of the engine. The share is based on a jointly agreed forecast at the commencement of the arrangement. 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. In summary, and as described below, the Directors’ view is that the 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 costs incurred by the Group. Having considered the features above, the Directors considered that 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 controls 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. 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, additional 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 the Directors do not believe conflicts with IFRS in this regard). The resulting accounting policy (described on page 117) 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. 114 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements1 Accounting policies continued As described in the 2013 Annual Report, an alternative 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 predetermined 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 size of the difference between the two approaches is monitored and is not currently expected to become material in the foreseeable future. The impact of the different approaches on profit before tax and net assets, which is not considered to be material, is as follows: Adopted policy Difference Alternative policy 2015 2014 Reported profit before tax £m 160 (28)1 132 Underlying profit before tax £m 1,432 (28) 1,404 Net assets £m 5,016 (435) 4,581 Reported profit before tax £m 67 (30)1 37 Underlying profit before tax £m 1,617 (30) 1,587 Net assets £m 6,387 (402) 5,985 1 If the alternative policy were adopted, the difference would be included in profit before financing, which would change from £1,501m as reported to £1,473m (2014: £1,398m to £1,368m) Internally generated development costs IAS 38 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 around half of development costs recognised; for these, the criteria are generally satisfied around the time of the initial engine certification. Customer financing contingent liabilities 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. Forecasts and discount rates The carrying values of a number of items on the balance sheet are dependent on the estimates of future cash flows arising from the Group’s operations, in particular: • The assessment of whether the goodwill and other intangible assets (carrying value at 31 December 2015: £1,502m, 31 December 2014: £1,658m) arising on the consolidation of RRPS is impaired is dependent of the present value of the future cash flows expected to be generated by the business. • The assessment as to whether there are any indications of impairment of development, participation, certification, customer relationships and contractual aftermarket rights recognised as intangible assets (carrying values at 31 December 2015: £2,533m, 31 December 2014: £2,533m) 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 (CARs) for launch customers and typically reduces as programmes become more established. 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. During 2015, the methodologies for making these estimates were reviewed and refined. 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 is based on assumptions determined with independent actuarial advice, resulted in a net deficit of £77m before deferred taxation being recognised on the balance sheet at 31 December 2015 (31 December 2014: net surplus £555m). The size of the net surplus/ 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. Rolls-Royce Holdings plc Annual Report 2015 115 Financial StatementsFinancial Statements 1 Accounting policies continued Provisions As described in the accounting policy on page 120, the Group measures provisions (carrying value at 31 December 2015: £640m, 31 December 2014: £807m) 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, or uncertain, then reasonable estimates may be used to determine the tax charge included in the financial statements. The main area of uncertainty is in relation to cross border transactions, entered into in the normal course of business, as the amount of income or profit taxable in each country involved can be subjective and therefore open to interpretation by the relevant tax authorities. This can result in disputes and possibly litigation. Accruals for tax contingencies require management to make judgements and estimates of exposures in relation to tax audit issues and other areas of uncertainty. Contingent liabilities, including in respect of any tax disputes or litigation, are covered in note 23 (contingent liabilities). All provisions are in current liabilities. Any liability relating to interest or penalties on tax liabilities is included in the tax charge. Deferred tax assets are recognised to the extent it is probable that future taxable profits will be available, against which the deductable temporary difference can be utilised, based on management’s assumptions relating to the amounts and timing of future taxable profits. Further details on the Group’s tax position can be found on page 176. SIGNIFICANT ACCOUNTING POLICIES The Group’s significant accounting policies are set out below. These accounting policies have been applied consistently to all periods presented in these consolidated financial statements and by all Group entities. Basis of consolidation The Group consolidated financial statements include the financial statements of the Company and its subsidiary undertakings together with the Group’s share of the results of joint arrangements and associates made up to 31 December. In line with common practice in Germany, a small number of immaterial subsidiaries of Rolls-Royce Power Systems are not consolidated and are carried at cost in other investments. If such subsidiaries become material, they are consolidated. The difference between the net assets recognised and the investment cost eliminated is recognised in other operating income. A subsidiary is an entity controlled by the Company. Control exists when the Company has power over an entity, exposure to variable returns from its involvement with an entity and the ability to use its power over an entity so as to affect the Company’s returns. A joint arrangement 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. Joint arrangements may be either joint ventures or joint operations. An associate is an entity, being neither a subsidiary nor a joint arrangement, 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. Joint operations are accounted for using proportionate accounting. Any subsidiary undertakings, joint arrangements or associates sold or acquired during the year are included up to, or from, the date of change of control. Transactions with non-controlling interests are recorded directly in equity. Where a put option over shares held by a non-controlling interest has been agreed, 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 arrangements and associates to the extent of the Group’s interest in the entity. 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 113, a sale of OE at a contractual price below its cost of manufacture is considered to give rise to revenue to the extent that an intangible asset (contractual aftermarket right) is recognised at the same time. 116 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements1 Accounting policies continued Sales of services are recognised by reference to the stage of completion based on services performed to date. As described on page 114, 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. As described on page 114, 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 list prices. The 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 balance is a liability, it is recognised in ‘accruals and deferred income’. Provided that the outcome of construction contracts can be assessed with reasonable certainty, the revenues and costs on such contracts are recognised based on stage of completion and the overall contract profitability. Full provision is made for any estimated losses to completion of contracts, having regard to the overall substance of the arrangements. Progress payments received, when greater than recorded revenue, are deducted from the value of work in progress except to the extent that payments on account exceed the value of work in progress on any contract where the excess is included in 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. TotalCare arrangements As described above, these are accounted for on a stage of completion basis, with the stage of completion based on the proportion of flying hours completed compared to the total estimated under the contract. In making the assessment of future revenues, costs and the level of profit recognised the Group takes account of: (i) the forecast utilisation of the engines by the operator; (ii) the forecast costs to maintain the engines in accordance with the contractual requirements – the principal variables being the time between shop visits and the cost of each shop visit; and (iii) the recoverability of any contract asset arising. The Group benchmarks the forecast costs against previous programmes, recognising that the reliability of the forecasts will improve as operational experience of the engine increases. To the extent that actual costs differ from forecast costs or that forecast costs change, the cumulative impact is recognised in the period. An allowance is made against forecast contract revenues given the potential for reduced engine flying hours based on historical forecasting accuracy, the risk of aircraft being parked by the customer and the customer’s creditworthiness (previously assessed against contract assets arising, based on both the customer’s creditworthiness and an assessment of the importance of the particular engine fleet to the customer). Again, changes in this allowance are recognised in the period. Risk and revenue sharing arrangements (RRSAs) As described on page 114, 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. Rolls-Royce Holdings plc Annual Report 2015 117 Financial StatementsFinancial Statements 1 Accounting policies continued 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: • Current tax is the expected tax payable for the year, using tax rates enacted or substantively enacted at the balance sheet date, and any adjustment to tax payable in respect of previous years. • Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and the amounts used for tax 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 tax is also dealt with in equity. Deferred tax liabilities are recognised for taxable temporary differences arising on investments in subsidiaries and joint arrangements, 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. Foreign currency translation Transactions denominated in currencies other than the functional currency of the transacting Group undertaking 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: • short-term investments are generally classified as available for sale; • short-term deposits (principally comprising funds held with banks and other financial institutions), trade receivables and short-term investments not designated as available for sale are classified as loans and receivables; • borrowings, trade payables, financial RRSAs, put options on NCI, and C Shares are classified as other liabilities; and • 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: • 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. • 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. • 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. 118 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements1 Accounting policies continued 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. Changes in the fair values of derivatives designated as fair value hedges and changes in fair value of the related hedged item are recognised directly in the income statement. Changes in the fair values of derivatives that are designated as cash flow hedges and are effective are recognised directly in equity. Any ineffectiveness in the hedging relationships is included in the income statement. The amounts deferred in equity are recognised in the income statement to match the recognition of the hedged item. 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 arrangements 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 115, 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 over its useful economic life, up to a maximum of 15 years from the entry into service of the product. Contractual aftermarket rights As described under key judgements on page 113, the Group may sell OE to customers at a price below its cost, on the basis that it also receives valuable aftermarket rights. Such a sale is considered to give rise to an intangible asset which is recognised, in accordance with IAS 38, at the same time as the revenue at an amount equal to the cash deficit and is 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 as a result of 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. Rolls-Royce Holdings plc Annual Report 2015 119 Financial StatementsFinancial Statements 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 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 25 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 13 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, using a discount rate derived from high-quality corporate bonds denominated in the currency of the plan, 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: • current service costs are spread systematically over the lives of employees; • past service costs are recognised immediately; and • financing costs are recognised in the periods in which they arise. 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. 120 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements 1 Accounting policies continued 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 115, the Directors consider the likelihood of crystallisation in 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 2015 There were no changes to accounting standards that had a material impact on the 2015 financial statements. Revisions to IFRS not applicable in 2015 Standards and interpretations issued by the IASB are only applicable if endorsed by the EU. Once 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. IFRS 15 Revenue from Contracts with Customers (effective for the year ending 31 December 2018, not yet endorsed by the EU) provides a single, principles-based five-step model to be applied to all sales contracts, based on the transfer of control of goods and services to customers. It replaces the separate models for goods, services and construction contracts currently included in IAS 11 Construction Contracts and IAS 18 Revenue. Given the nature of the Group’s long-term contracts, it is likely that the adoption of IFRS 15 will require significant judgement. Based on the provisional assessment, IFRS 15 will have a significant impact on the timing of recognition of revenue on individual long-term contracts, most particularly in the Civil Aerospace business, although this impact is likely to be significantly reduced at a Group level when all long-term contracts (with different start and end dates) are combined. The key areas of judgement are: (i) whether contractual aftermarket rights can continue to be recognised; (ii) whether OE and TotalCare contracts can be linked for accounting purposes; and (iii) how performance should be measured on TotalCare contracts. The Group will continue to assess the impact during 2016 and also consider the interpretations of other aerospace and defence companies . IFRS 16 Leases (effective for the year ending 31 December 2019, not yet endorsed by the EU) will require all leases to be recognised on the balance sheet. Currently, IAS 17 Leases only requires leases categorised as finance leases to be recognised on the balance sheet, with leases categorised as operating leases not recognised. In broad terms, the impact will be to recognise a lease liability and corresponding asset for the operating lease commitments set out in note 22. The Group does not consider that any other standards, amendments or interpretations issued by the IASB, but not yet applicable, will have a significant impact on the financial statements. Rolls-Royce Holdings plc Annual Report 2015 121 Financial StatementsFinancial Statements 2 Segmental analysis The analysis by Division (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: AEROSPACE DIVISION: Civil Defence – development, manufacture, marketing and sales of commercial aero engines and aftermarket services. – development, manufacture, marketing and sales of military aero engines and aftermarket services. LAND & SEA DIVISION: Power Systems – development, manufacture, marketing and sales of reciprocating engines and power systems. Marine Nuclear – development, manufacture, marketing and sales of marine-power propulsion systems and aftermarket services. – development, manufacture, marketing and sales of nuclear systems for civil power generation and naval propulsion systems. The Energy business was sold on 1 December 2014 and is excluded from the 2014 comparative figures. The residual businesses previously included in the Energy sector and costs associated with the wind-down are shown as ‘Other’. 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. Additional disclosure of the two segments is also provided. 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 credits on post-retirement schemes, exceptional restructuring costs, the effect of acquisition accounting and the impairment of goodwill. Underlying profit before taxation – In addition to those adjustments in underlying profit before financing: • includes amounts realised from settled derivative contracts and revaluation of relevant assets and liabilities to exchange rates forecast to be achieved from future settlement of derivative contracts; and • 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. Taxation – the tax effect of the adjustments above are excluded from the underlying tax charge. In addition changes in the amount of recoverable advance corporation tax recognised and the impact of changes in tax rates are also excluded. This analysis also includes a reconciliation of the underlying results to those reported in the consolidated income statement. 122 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements2 Segmental analysis continued Aerospace Land & Sea Civil £m Defence £m Total £m Power Systems £m Marine £m Nuclear £m Other 1 £m Intra- segment £m Inter- segment £m Total reportable segments £m Total £m 773 551 1,324 260 (201) (16) (28) – 15 1,481 7 (783) 705 Year ended 31 December 2015 Underlying revenue from sale of original equipment Underlying revenue from aftermarket services Total underlying revenue Gross profit Commercial and administrative costs Restructuring Research and development costs Share of results of joint ventures and associates Underlying profit before financing and taxation 3,258 3,675 6,933 1,526 (296) (7) (515) 104 812 801 1,234 2,035 579 (124) (8) (73) 19 393 4,059 4,909 8,968 2,105 (420) (15) (588) 123 1,205 1,618 767 2,385 635 (275) (4) (162) – 194 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 11,229 545 (8,709) 3,065 1,437 12,666 557 (10,407) 2,816 12 (1,698) (249) 3,376 8 (1,017) 2,367 668 410 84 58 752 468 108 197 36 111 Year ended 31 December 2014 Underlying revenue from sale of original equipment 2 3,463 Underlying revenue from aftermarket services 2 3,374 6,837 Total underlying revenue 1,675 Gross profit (283) Commercial and administrative costs (82) Restructuring (461) Research and development costs 93 Share of results of joint ventures and associates 942 Underlying profit before financing and taxation 816 1,253 2,069 567 (112) (55) (50) 16 366 4,279 4,627 8,906 2,242 (395) (137) (511) 109 1,308 1,893 827 2,720 742 (296) (7) (183) (3) 253 1,070 639 1,709 425 (254) (4) (29) – 138 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 10,268 507 (7,418) 3,357 1,460 13 (1,743) (270) 11,728 520 (9,161) 3,087 3,581 7 (1,100) 2,488 1,636 5 (1,075) 566 836 381 78 49 914 430 144 221 36 38 251 436 687 111 (53) (2) 14 – 70 300 3 (324) (21) 18 23 230 408 638 119 (61) (1) (7) – 50 333 3 (389) (53) 23 22 76 20 96 64 (4) (2) (1) (5) 52 119 1 (120) – – 11 24 22 46 8 (10) – – – (2) 621 4 (491) 134 8 13 (53) (53) (106) 7 – – – – 7 – – – – – – (78) (77) (155) (13) – – – – (13) (22) – – (22) – – 2,665 1,721 4,386 1,077 (533) (24) (177) (5) 338 5,276 19 (2,244) 3,051 162 342 3,139 1,819 4,958 1,281 (621) (12) (219) (3) 426 6,724 – 6,630 – – 13,354 3,182 – (953) – (39) – (765) – 118 – 1,543 – (850) 17,092 576 (11,801) 5,867 – 850 – – – 914 810 7,418 – – 6,446 – 13,864 3,523 – (1,016) – (149) – (730) – 106 – 1,734 – 6,149 19 (3,055) 3,113 (1,269) 16,608 539 (10,947) 6,200 – 1,269 – 211 294 – – 1,125 724 1 Energy business retained following 2014 disposal. 2 The basis for the allocation of Civil Aerospace revenues on linked TotalCare contracts between OE and aftermarket has been reviewed and amendments made to reflect better the commercial substance of the combined contracts. Historically, the allocation has resulted in OE revenue and aftermarket revenue reflecting the contractual terms rather than the commercial substance of the contracts. The 2014 figures have been restated on the same basis; the impact was an increase in OE revenue of £198m and an equal decrease in aftermarket revenue. Rolls-Royce Holdings plc Annual Report 2015 123 Financial StatementsFinancial Statements 2 Segmental analysis continued RECONCILIATION TO REPORTED RESULTS Year ended 31 December 2015 Revenue from sale of original equipment Revenue from aftermarket services Total revenue Gross profit Other operating income Commercial and administrative costs Restructuring Research and development costs 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 from continuing operations Profit for the year from discontinued operations Profit for the year Attributable to: Ordinary shareholders Non-controlling interests Year ended 31 December 2014 Revenue from sale of original equipment Revenue from aftermarket services Total revenue Gross profit Other operating income Commercial and administrative costs Restructuring Research and development costs 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 from continuing operations Profit for the year from discontinued operations Profit for the year Attributable to: Ordinary shareholders Non-controlling interests 1 Central corporate costs. CASH FLOWS FROM DISCONTINUED OPERATIONS Revenue Profit before taxation Tax on ordinary activities Profit for the year from ordinary activities Profit on disposal of discontinued operations Tax on profit on disposal of discontinued operations Profit for the year from discontinued operations Net cash outflow from operating activities Net cash outflow from investing activities Net change in cash and cash equivalents 124 Rolls-Royce Holdings plc Annual Report 2015 Total reportable segments £m Underlying central items £m Total underlying £m Underlying adjustments £m Discontinued business £m 6,724 6,630 13,354 3,182 – (953) (39) (765) 118 – 1,543 7,418 6,446 13,864 3,523 – (1,016) (149) (730) 106 – – 1,734 – (51)1 – – – – (51) (60) (111) (351) – (53)1 – – – – – (53) (61) (114) (388) 6,724 6,630 13,354 3,182 – (1,004) (39) (765) 118 – 1,492 (60) 1,432 (351) 1,081 – 1,081 1,080 1 7,418 6,446 13,864 3,523 – (1,069) (149) (730) 106 – – 1,681 (61) 1,620 (388) 1,232 – 1,232 1,226 6 215 156 371 84 10 (55) 39 (53) (18) 2 9 (1,281) (1,272) 275 (997) – (997) (997) – (1) (127) (128) (320) 10 (55) 149 (63) (12) 2 6 (283) (1,270) (1,553) 237 (1,316) – (1,316) (1,299) (17) 142 142 142 – Group £m 6,939 6,786 13,725 3,266 10 (1,059) – (818) 100 2 1,501 (1,341) 160 (76) 84 – 84 83 1 7,417 6,319 13,736 3,203 10 (1,124) – (793) 94 2 6 1,398 (1,331) 67 (151) (84) 142 58 69 (11) 2014 £m 713 1 3 4 136 2 142 (127) (35) (162) NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements2 Segmental analysis continued UNDERLYING ADJUSTMENTS Underlying performance previously reported Energy disposed in 2014 Underlying performance Revenue recognised at exchange rate on date of transaction Realised losses/(gains) on settled derivative contracts 1 Net unrealised fair value changes to derivative contracts 2 Effect of currency on contract accounting Revaluation of trading assets and liabilities Put option on NCI and financial RRSAs – foreign exchange differences and other unrealised changes in value Effect of acquisition accounting 3 Impairment of goodwill Net post-retirement scheme financing Gain on reclassification of joint ventures to subsidiaries Disposal of businesses Restructuring 4 Other Related tax effect 5 Total underlying adjustments Reported per consolidated income statement 2015 2014 Revenue £m Profit before financing £m Net financing £m Taxation £m Revenue £m Profit before financing £m Net financing £m Taxation £m 13,354 1,492 371 – – – – – – – – – – – – – 371 – 287 (9) (9) (13) – (124) (75) – – 2 (49) (1) – 9 (60) – (35) (1,306) – 20 8 – – 32 – – – – – (1,281) 14,588 (724) 13,864 (128) – – – – – – – – – – – – – (128) (351) – – – – – – – – – – – – – 275 275 1,678 3 1,681 – (91) (15) 13 (11) – (142) – – 2 6 (39) (6) – (283) (61) – (61) – (5) (1,141) – (8) (87) – – (29) – – – – – (1,270) (387) (1) (388) – – – – – – – – – – – – – 237 237 13,725 1,501 (1,341) (76) 13,736 1,398 (1,331) (151) 1 2 3 4 Realised losses/(gains) on settled derivative contracts include adjustments to reflect the losses/(gains) in the same period as the related trading cash flows. Unrealised fair value changes to derivative contracts included in profit before financing: (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. The adjustment eliminates charges recognised as a result of recognising assets in acquired businesses at fair value. Restructuring is excluded from underlying performance when it concerns the closure of a significant business or site. 5 2015 includes an £18m credit relating to changes in UK tax rates. 2014 included a charge of £64m for the derecognition of advance corporation tax. The reconciliation of underlying earnings per ordinary share is shown in note 6. RECONCILIATION TO THE BALANCE SHEET 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 2015 £m 17,092 576 3,178 74 341 1,063 22,324 (11,801) (3,302) (61) (1,004) (1,140) (17,308) 5,016 2014 £m 16,608 539 2,869 80 388 1,740 22,224 (10,947) (2,261) (22) (1,422) (1,185) (15,837) 6,387 Rolls-Royce Holdings plc Annual Report 2015 125 Financial StatementsFinancial Statements 2 Segmental analysis continued GEOGRAPHICAL SEGMENTS The Group’s revenue by destination from continuing operations is as follows: United Kingdom Germany Switzerland Norway France Italy Spain Russia Rest of Europe Europe United States of America Canada North America South America Saudi Arabia Rest of Middle East Middle East China South Korea Singapore Malaysia Japan India Rest of Asia Asia Africa Australasia Other 2015 £m 1,780 642 782 280 249 222 200 59 786 5,000 3,591 475 4,066 425 365 445 810 1,236 278 549 78 136 99 546 2,922 144 278 80 13,725 2014 £m 1,599 734 670 322 292 201 113 86 575 4,592 3,751 472 4,223 407 327 418 745 1,290 485 396 280 272 161 493 3,377 115 207 70 13,736 No single customer represented 10% 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-employment benefit surpluses, by the geographical area in which the assets are located, are as follows: 2015 £m 4,072 835 598 2,339 900 8,744 2014 £m 3,864 827 724 2,493 912 8,820 United Kingdom United States of America Nordic countries Germany Other 126 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements3 Research and development 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 Discontinued operations Net underlying cost recognised in the income statement previously reported 4 Net financing 2015 £m (831) 51 (136) (916) 83 (28) 43 (818) 53 (765) 2014 £m (818) 83 (125) (860) 51 (38) 54 (793) 63 (730) (25) (755) Financing income Interest receivable Fair value gains on foreign currency contracts 1 Put option on NCI and financial RRSAs – foreign exchange differences and other unrealised changes in value Finance income on post-retirement scheme surpluses Net foreign exchange gains 3 Financing costs Interest payable Fair value losses on foreign currency contracts 1 Put option on NCI and financial RRSAs – financing Put option on NCI and financial RRSAs – foreign exchange differences and other unrealised changes in value Fair value losses on commodity derivatives 1 Finance cost 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 Net loss on fair value items through profit or loss 2015 2014 Per consolidated income statement £m Underlying financing 2 £m Per consolidated income statement £m Notes Underlying financing 2 £m 17 17 19 17 17 17 17 19 12 – 21 65 17 115 (71) (1,217) (8) (13) (89) (33) – (25) (1,456) (1,341) (59) 32 (1,314) (1,341) (1,306) 12 – – – 32 44 (71) – (8) – – – – (25) (104) (60) (59) – (1) (60) – 17 2 89 13 – 121 (63) (1,127) (7) (174) (15) (42) (13) (11) (1,452) (1,331) (46) (29) (1,256) (1,331) (1,140) 17 – – – – 17 (63) – (5) – – – – (10) (78) (61) (46) – (15) (61) – 2 See note 2 3 The underlying financing income includes £34m from gains on settlement of foreign exchange contracts following the receipt in the UK of dividends from overseas subsidiaries. Rolls-Royce Holdings plc Annual Report 2015 127 Financial StatementsFinancial Statements 5 Taxation Current tax Current tax charge for the year Less double tax relief Adjustments in respect of prior years Deferred tax Deferred tax credit for the year Adjustments in respect of prior years Derecognition of advance corporation tax Deferred tax credit resulting from reduction in tax rates Recognised in the income statement OTHER TAX CREDITS/(CHARGES) Current tax: Share-based payments – direct to equity Deferred tax: Movement in post-retirement schemes Share-based payments – direct to equity Net investment hedge TAX RECONCILIATION ON CONTINUING OPERATIONS Profit before taxation Less share of results of joint ventures and associates (note 11) Profit before taxation excluding joint ventures and associates UK 2015 £m 9 – 9 6 15 (37) 10 – (18) (45) (30) 2014 £m 8 – 8 1 9 (72) (14) 64 – (22) (13) Overseas Total 2015 £m 157 – 157 (23) 134 (23) (5) – – (28) 2014 £m 240 – 240 12 252 (77) (11) – – (88) 106 164 2015 £m 166 – 166 (17) 149 (60) 5 – (18) (73) 76 2014 £m 248 – 248 13 261 (149) (25) 64 – (110) 151 OCI Equity Items that will not be reclassified Items that may be reclassified 2015 £m 2014 £m 2015 £m 2014 £m 2015 £m 2014 £m 257 (431) 257 (431) (2) (2) (2) (2) – (6) (6) 2015 £m 160 (100) 60 12 – 63 13 – 5 (7) 20 (12) – (18) 76 351 (275) 76 3 (7) (4) 2014 £m 67 (94) (27) (6) (6) 71 – 17 22 (3) 4 (12) 64 – 151 388 (237) 151 Nominal tax charge at UK corporation tax rate 20.25% (2014: 21.5%) UK R&D credit Rate differences 1 Impairment of goodwill Change in value of put option on NCI 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 Derecognition of advance corporation tax Reduction in closing deferred taxes resulting from decrease in tax rates Underlying items (note 2) Non-underlying items 1 Rate differences mainly relate to tax on profits in countries, such as the US and Germany, which have higher tax rates than the UK. 128 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements5 Taxation continued TAX ON DISCONTINUED OPERATIONS Tax credit on ordinary activities of the discontinued operations Tax credit on profit on disposal of discontinued operations DEFERRED TAXATION ASSETS AND LIABILITIES At 1 January Amount credited to income statement Amount credited/(charged) to other comprehensive income Amount charged to equity Acquisition of businesses Exchange differences At 31 December Deferred tax assets Deferred tax liabilities The analysis of the deferred tax position is as follows: Intangible assets Property, plant and equipment Other temporary differences Amounts recoverable on contracts Pensions and other post-retirement scheme benefits Foreign exchange and commodity financial assets and liabilities Losses 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 R&D expenditure credit Advance corporation tax Included in: Taxation Discontinued operations At 1 January 2014 £m (511) (210) 80 (380) 153 (92) 323 7 64 (566) 2015 £m – – – 2015 £m (859) 73 255 (6) – 16 (521) 318 (839) (521) 2014 £m (3) (2) (5) 2014 £m (566) 120 (433) (7) (3) 30 (859) 369 (1,228) (859) Recognised in income statement £m 52 7 (69) (13) (30) 171 (49) 4 – Recognised in OCI £m – – (2) – 257 – – – – Recognised in equity £m – – (7) – – – 1 – – Exchange differences £m 11 (2) 2 – 7 – (2) – – At 31 December 2015 £m (392) (190) 21 (539) (90) 306 343 20 – 73 255 (6) 16 (521) Recognised in OCI £m – – (2) – (431) Recognised in equity £m – – (10) – – Disposals of businesses £m – (6) (1) – – Exchange movements £m 15 1 7 – 8 At 31 December 2014 £m (455) (195) 97 (526) (324) – – – – (433) – 3 – – (7) – 4 – – (3) 1 (2) – 30 135 393 16 – (859) At 1 January 2015 £m (455) (195) 97 (526) (324) 135 393 16 – (859) Recognised in income statement £m 41 20 23 (146) (54) 226 65 9 (64) 120 110 10 Rolls-Royce Holdings plc Annual Report 2015 129 Financial StatementsFinancial Statements 5 Taxation continued UNRECOGNISED DEFERRED TAX ASSETS 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 1 1 Advance corporation tax, tax losses and other deductible temporary differences are not expected to expire under current legislation. 2015 £m 182 36 218 2014 £m 182 35 217 DEFERRED TAXATION ASSETS AND LIABILITIES The Summer Budget 2015 announced that the UK corporation tax rate will reduce to 19% from 1 April 2017 and 18% from 1 April 2020; these reductions were substantively enacted on 26 October 2015. As the reductions were 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 2015, £18m has been credited to the income statement and £3m 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 £347m (2014: £512m). 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. Profit attributable to ordinary shareholders (£m): Continuing operations Discontinued operations Weighted average number of ordinary shares (millions) EPS (pence): Continuing operations Discontinued operations 2015 Potentially dilutive share options Diluted Basic 2014 Potentially dilutive share options 83 – 83 1,851 4.48 – 4.48 (73) 142 69 1,874 (3.90) 7.58 3.68 12 (0.03) – (0.03) 18 – – – Basic 83 – 83 1,839 4.51 – 4.51 1 As profit from continuing operations is negative, the effect of potentially dilutive ordinary shares is anti-dilutive. 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 Profit on disposal of discontinued operations Related NCI effects EPS/Profit attributable to ordinary shareholders Diluted underlying EPS 2015 2014 Pence 58.73 (69.17) 14.95 – – 4.51 58.35 £m 1,080 (1,272) 275 – – 83 Pence 65.42 (82.88) 12.65 7.58 0.91 3.68 64.80 Diluted1 (73) 142 69 1,892 (3.90) 7.58 3.68 £m 1,226 (1,553) 237 142 17 69 130 Rolls-Royce Holdings plc Annual Report 2015 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDFinancial Statements7 Employee information Average number of employees United Kingdom United States of America Canada Germany Nordics Rest of world Civil Defence Aerospace Power Systems Marine Nuclear Other (2014: included discontinued operations) Land & Sea 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: Audit related assurance services 2 Taxation compliance services All other services Fees payable in respect of the Group's pension schemes: Audit 2015 Number 2014 Number 23,200 6,400 1,100 10,700 3,800 5,300 50,500 23,200 6,400 29,600 10,600 6,000 4,100 200 20,900 50,500 24,500 7,900 1,500 10,500 4,000 5,700 54,100 23,900 7,000 30,900 10,700 6,400 4,100 2,000 23,200 54,100 £m £m 2,442 334 5 299 3,080 2,646 362 21 328 3,357 2015 £m 0.3 5.6 5.9 1.3 0.4 – 7.6 0.2 2014 £m 0.2 5.5 5.7 1.1 0.7 0.4 7.9 0.2 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 This includes £0.3m (2014: £0.3m) for the review of the half-year report. Rolls-Royce Holdings plc Annual Report 2015 131 Financial StatementsFinancial Statements 9 Intangible assets Cost: At 1 January 2014 Reclassifications 1 Exchange differences Additions Acquisitions of businesses Disposals of businesses At 1 January 2015 Exchange differences Additions Acquisitions of businesses Disposals At 31 December 2015 Accumulated amortisation: At 1 January 2014 Reclassifications 1 Exchange differences Charge for the year 2 Impairment Disposal of business At 1 January 2015 Exchange differences Charge for the year 2 Impairment Reversal of impairment Disposals At 31 December 2015 Net book value: At 31 December 2015 At 31 December 2014 At 1 January 2014 Certification costs and participation fees £m Goodwill £m Development expenditure £m Contractual aftermarket rights £m Customer relationships £m Software £m Other £m Total £m 1,861 (8) (112) – 1 (67) 1,675 (87) – 1 – 1,589 23 (8) – – 1 – 16 (5) – 75 – – 86 1,503 1,659 1,838 928 – (8) 159 – – 1,079 (7) 73 – – 1,145 265 – – 46 – – 311 (1) 63 – – – 373 772 768 663 1,646 4 (43) 100 – – 1,707 (32) 55 – – 1,730 444 4 (9) 125 – – 564 (10) 137 – – – 691 1,039 1,143 1,202 580 – – 93 – (35) 638 – 161 – – 799 352 – – 37 – – 389 – 55 – (50) – 394 405 249 228 475 11 (17) – – – 469 (14) – 1 – 456 69 (11) (4) 42 – – 96 (3) 46 – – – 139 317 373 406 453 19 (1) 83 – (11) 543 – 79 – (6) 616 198 5 – 63 – (7) 259 – 68 – – (2) 325 291 284 255 532 (28) (28) 42 – – 518 (16) 40 1 – 543 137 6 (6) 53 – – 190 (3) 38 – – – 225 318 328 395 6,475 (2) (209) 477 1 (113) 6,629 (156) 408 3 (6) 6,878 1,488 (4) (19) 366 1 (7) 1,825 (22) 407 75 (50) (2) 2,233 4,645 4,804 4,987 1 In 2013, following the acquisition of RRPS, the Group revised the classification of intangible assets. During 2014, a number of minor inconsistencies in these classifications were identified and amended. The net movement of £2m relates to software previously included in property, plant and equipment. 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 2015 £m 202 491 25 739 46 1,503 2014 £m 215 552 77 760 55 1,659 132 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED9 Intangible assets continued Goodwill has been tested for impairment during 2015 on the following basis: • The carrying values of goodwill 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. Given the long-term and established nature of many of the Group’s products (product lives are often measured in decades), these forecasts generally cover 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%) that reflect the products, industries and countries in which the relevant CGU or group of CGUs operate. • The key assumptions for the impairment tests are the discount rate and, in the cash flow projections, the programme assumptions, the growth rates and the impact of foreign exchange rates on the relationship between selling prices and costs. Impairment tests are performed using prevailing exchange rates. • The pre-tax cash flow projections have been discounted at rates based on the Group’s weighted average cost of capital, adjusted for specific risk where appropriate. The discount rate used, before taking account of specific risks, is 13% (2014: 13%). As a result of the continuing poor market conditions in the Marine offshore business caused by the low crude oil price and the consequential reduced order intake in the period, the Group has recognised an impairment loss of £69m (included in the total impairment charge of £75m) to the carrying value of goodwill of cash generating units in this market. This is included in cost of sales in the income statement, but excluded from the underlying results. The impairment loss primarily relates to the cash generating units Scandinavian Electric Holding AS (acquired in 2008) and ODIM ASA (acquired in 2010), which are both business operations included in Marine. The impairment loss is based on a value in use calculation using cash flows forecast over a ten-year period and a pre-tax discount rate of 13% which indicated a recoverable amount of £74m compared with a pre-impairment carrying value of £143m. The principal value in use assumptions for goodwill balances considered to be individually significant are: • 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 from recent management forecasts for a five-year period have been included. Cash flows beyond five years are assumed to grow at 2% (2014 2%). Reasonably possible change in the key assumptions would cause the value in use of the goodwill to fall below its carrying value, which include a reduction in the level of cash generation of 9%, or an increase in the assumed discount rate of 2%. • 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% (2014: 2.5%). 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 69% to cause an impairment of this balance. • 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% (2014: 2.5%). 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 54% to cause an impairment of this balance. OTHER INTANGIBLE ASSETS Certification costs and participation fees, development costs and contractual aftermarket rights have been reviewed for impairment in accordance with the requirements of IAS 36 Impairment of Assets. Where an impairment test was considered necessary, it has been performed on the following basis: • The carrying values have been assessed by reference to value in use. These have been estimated using cash flows from the most recent forecasts prepared by management, which are consistent with past experience and external sources of information on market conditions over the lives of the respective programmes. • The key assumptions underlying cash flow projections are assumed market share, programme timings, unit cost assumptions, discount rates, and foreign exchange rates. • The pre-tax cash flow projections have been discounted at 11% (2014: 11%), based on the Group’s weighted average cost of capital, reduced where relevant to take account of the lower risk associated with contracted aftermarket flows. 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. During the year, following analysis of the first major overhauls of the Trent 1000 engines, the recoverable amount of certain contractual aftermarket rights have been reassessed. This analysis demonstrated that the aftermarket cash flows from the engines were better than originally assumed, arising from both operational and contractual performance improvements. As a result of this analysis, the value in use (based on a pre-tax discount rate of 9%) has increased to around £140m, exceeding the unimpaired carrying value of £72m. Accordingly, cumulative impairments prior to 2015 of £50m have been reversed. This reversal is included in the Civil Aerospace business cost of sales. Rolls-Royce Holdings plc Annual Report 2015 133 Financial StatementsFinancial Statements 10 Property, plant and equipment Cost: At 1 January 2014 Exchange differences Additions Acquisitions of businesses Disposals of businesses Reclassifications Disposals/write-offs At 1 January 2015 Exchange differences Additions Acquisitions of businesses Disposals of businesses Reclassifications Transferred to assets held for sale Disposals/write-offs At 31 December 2015 Accumulated depreciation: At 1 January 2014 Exchange differences Charge for the year 1 Impairment Reclassifications Disposals/write-offs At 1 January 2015 Exchange differences Charge for the year 1 Impairment Disposals of businesses Transferred to assets held for sale Disposals/write-offs At 31 December 2015 Net book value: At 31 December 2015 At 31 December 2014 At 1 January 2014 Land and buildings £m Plant and equipment £m Aircraft and engines £m In course of construction £m 1,297 (23) 24 – (88) 134 (10) 1,334 (20) 18 – – 81 (8) (30) 1,375 386 (8) 49 – (29) (7) 391 (7) 48 3 – (5) (14) 416 959 943 911 3,490 (42) 160 – (94) 137 (51) 3,600 (39) 117 1 (1) 335 (23) (96) 3,894 1,949 (26) 294 – (62) (46) 2,109 (24) 299 2 (1) (20) (81) 2,284 1,610 1,491 1,541 324 (1) 57 38 (77) 32 (52) 321 (2) 19 – – 7 (2) (4) 339 84 – 31 – (9) (3) 103 (1) 26 – – (1) (2) 125 214 218 240 700 2 427 – (28) (305) (1) 795 (3) 340 – – (423) – (1) 708 – – – 1 – – 1 – – – – – – 1 707 794 700 Total £m 5,811 (64) 668 38 (287) (2) (114) 6,050 (64) 494 1 (1) – (33) (131) 6,316 2,419 (34) 374 1 (100) (56) 2,604 (32) 373 5 (1) (26) (97) 2,826 3,490 3,446 3,392 1 Depreciation charged during the year is presented in the income statement or included in the cost of inventory as appropriate. 134 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED10 Property, plant and equipment continued Property, plant and equipment includes: Net book value of finance leased assets: Land and buildings Plant and equipment Aircraft and engines Assets held for use in operating leases: Cost Depreciation Net book value Capital expenditure commitments Cost of fully depreciated assets 2015 £m 5 7 40 321 (87) 234 167 853 2014 £m 6 9 43 267 (64) 203 194 792 The Group’s share of equity accounted entities’ capital commitments is £75m (2014: £82m). 11 Investments COMPOSITION OF THE GROUP The entities contributing to the Group’s financial results are listed on pages 160 to 166. NON-CONTROLLING INTERESTS In 2015 the Group did not have any material non-wholly owned subsidiaries. On 7 March 2014, Daimler AG announced its intention to exercise its put option on its 50% of Rolls-Royce Power Systems Holding GmbH (RRPSH). Formal notice of this intention was served on 24 March 2014. From this date, the Group had an effective economic interest in RRPSH of 100% and NCI of £584m was transferred to retained earnings. The Group acquired the shares on 26 August 2014, giving it a 100% interest in RRPSH. Summarised financial information for RRPSH is as follows: Current assets Non-current assets Current liabilities Non-current liabilities Equity attributable to Rolls-Royce shareholders Non-controlling interests 1 Immediately prior to the exercise of the put option Revenue Loss for the period Attributable to ordinary shareholders Non-controlling interests Total comprehensive income for the period Attributable to ordinary shareholders Non-controlling interests Dividends paid to non-controlling interests Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Net cash outflow At 24 March 20141 £m 1,529 2,511 (974) (1,118) 1,364 584 Period to 24 March 2014 £m 551 (25) (12) (12) (69) (35) (35) (76) 33 (17) (158) (142) Rolls-Royce Holdings plc Annual Report 2015 135 Financial StatementsFinancial Statements 11 Investments continued EQUITY ACCOUNTED AND OTHER INVESTMENTS At 1 January 2014 Reclassification 1 Exchange differences Additions Taxation paid by the Group Transfer to subsidiary Share of retained profit Disposals Return of capital Consolidation of previously non-consolidated subsidiary Share of OCI – may be reclassified to profit or loss At 1 January 2015 Exchange differences Additions Taxation paid by the Group Share of retained profit/(loss) Impairment Share of OCI – may be reclassified to profit or loss At 31 December 2015 Equity accounted Other Joint ventures £m 599 (25) 7 15 3 (1) 23 (70) (3) – (13) 535 7 12 (3) 42 – (19) 574 Associates £m 2 – – 2 – – – – – – – 4 – 3 – (5) – – 2 Total £m 601 (25) 7 17 3 (1) 23 (70) (3) – (13) 539 7 15 (3) 37 – (19) 576 Unlisted £m 27 – (2) 11 – – – – – (5) – 31 (2) 6 – – (2) – 33 1 The reclassification relates to an adjustment in 2013 relating to transactions between the Group and a joint venture which was included in creditors. It was transferred to investments in joint ventures in 2014. RECONCILIATION TO THE INCOME STATEMENT AND CASH FLOW STATEMENT Share of profit after tax Share of dividends paid Share of retained profit Continuing operations Discontinued operations Total 2015 £m 100 (63) 37 2014 £m 94 (71) 23 2015 £m – – – 2014 £m 2 (2) – 2015 £m 100 (63) 37 2014 £m 96 (73) 23 The following joint ventures are considered to be individually material to the Group: Alpha Partners Leasing Limited (APL) Hong Kong Aero Engine Services Limited (HAESL) Singapore Aero Engine Services Pte Limited (SAESL) Industria de Turbo Propulsores SA (ITP) Principal location UK Hong Kong Singapore Spain Activity Aero engine leasing Aero engine repair and overhaul Aero engine repair and overhaul Aero engine component manufacture and maintenance Ownership interest 50.0% 45.0% 39.0% 46.9% 136 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED11 Investments continued Summarised financial information of the Group’s individually material joint ventures is as follows: APL HAESL SAESL ITP Revenue Profit from continuing operations Post-tax profit from discontinued operations Profit for the year Other comprehensive operations Total comprehensive income for the year Dividends received during the year Profit for the year included the following: Depreciation and amortisation Interest income Interest expense Income tax expense Current assets Non-current assets Current liabilities Non-current liabilities Net assets Included in the above: Cash and cash equivalents Current financial liabilities 1 Non-current financial liabilities 1 1 Excluding trade and other payables. 2015 £m 130 65 – 65 – 65 (29) (59) – (17) (7) 129 1,349 (70) (1,123) 285 20 (19) (969) 2014 £m 105 39 – 39 – 39 (13) (47) – (15) (11) 72 1,171 (62) (959) 222 11 (13) (815) 2015 £m 652 27 – 27 – 27 (23) (8) – (1) (5) 223 85 (116) (38) 154 4 – (30) 2014 £m 652 34 – 34 – 34 (30) (8) – (1) (7) 159 86 (61) (37) 147 8 – (29) 2015 £m 626 46 – 46 – 46 (35) (5) – – – 218 125 (75) (136) 132 10 – (136) 2014 £m 815 60 – 60 – 60 (56) (5) – (1) – 207 102 (88) (106) 115 11 – (106) 2015 £m 520 40 – 40 – 40 (19) (37) 10 (16) 7 576 554 (416) (431) 283 225 (25) (273) 2014 £m 529 24 – 24 – 24 (19) (37) 19 (12) 4 603 525 (415) (418) 295 256 (10) (282) Reconciliation to the carrying amount recognised in the consolidated financial statements Ownership interest Group share of net assets above 50.0% 143 50.0% 111 45.0% 69 45.0% 66 39.0% 51 39.0% 45 46.9% 133 46.9% 138 The summarised aggregated results of the Group’s share of all equity accounted investments is as follows: Assets: Non-current assets Current assets Liabilities: 2 Current liabilities Non-current liabilities 2 Liabilities include borrowings of: Post-tax profit from continuing operations Post-tax profit from discontinued operations Profit for the year Other comprehensive income Total comprehensive income for the year Joint ventures Associates 2015 £m 2014 £m 2015 £m 2014 £m Total 2015 £m 1,998 843 (541) (1,726) 574 (1,473) 105 – 105 (19) 86 1,911 715 (519) (1,572) 535 (1,376) 94 2 96 (13) 83 – 2 – – 2 – (5) – (5) – (5) 2 4 (1) (1) 4 – – – – – – 1,998 845 (541) (1,726) 576 (1,473) 100 – 100 – 100 2014 £m 1,913 719 (520) (1,573) 539 (1,376) 94 2 96 (13) 83 Rolls-Royce Holdings plc Annual Report 2015 137 Financial StatementsFinancial 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 1 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 1 Amounts recoverable on contracts include £2,994m (2014: £2,492m) of TotalCare assets 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 110 ) 2015 £m 509 882 23 1,173 50 2,637 221 64 14 2015 £m 1,612 3,179 252 1,006 195 6,244 2,061 843 3,340 6,244 57 2,768 1 131 68 3,025 2015 £m 662 783 1,731 3,176 – 3,176 2014 £m 553 984 22 1,149 60 2,768 265 62 1 2014 £m 1,531 2,684 309 785 200 5,509 1,981 671 2,857 5,509 40 2,444 – 61 55 2,600 2014 £m 739 692 1,431 2,862 – 2,862 Cash held as collateral against third party obligations (note 18) 35 42 Cash and cash equivalents at 31 December 2015 include £21m (2014: £30m) 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. 138 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED15 Borrowings Unsecured Overdrafts Bank loans 7 3⁄8% Notes 2016 £200m 6.55% Notes 2015 US$83m 1 6.75% Notes 2019 £500m 2 2.375% Notes 2020 US$500m 1 2.125% Notes 2021 €750m 1 3.625% Notes 2025 US$1,000m 1 3.375% Notes 2026 £375m 2 Secured Obligations under finance leases 3 Current Non-current Total 2015 £m – 217 200 – – – – – – 2 419 2014 £m – 12 – 55 – – – – – 1 68 2015 £m – 330 – – 536 333 576 668 390 2014 £m – 392 200 – 547 – 615 – 395 2015 £m – 547 200 – 536 333 576 668 390 2014 £m – 404 200 55 547 – 615 – 395 50 2,883 44 2,193 52 3,302 45 2,261 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 Non-current Total 2015 £m 1,491 1,397 197 90 1,784 1,964 6,923 2014 £m 1,291 1,348 235 109 1,756 2,052 6,791 2015 £m 516 23 2 1 361 1,414 2,317 2014 £m 860 13 4 1 320 1,247 2,445 2015 £m 2,007 1,420 199 91 2,145 3,378 9,240 2014 £m 2,151 1,361 239 110 2,076 3,299 9,236 161 158 35 99 196 257 Included within trade and other payables are government grants of £64m (2014: £80m). During the year, £21m (2014: £24m) of government grants were released to the income statement. Included in accruals and deferred income are deferred receipts from RRSA workshare partners of £228m (2014: £244m) and £783m (2014: £687m) of TotalCare liabilities. 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 2015 £m 3,101 817 5,322 9,240 2014 £m 3,049 831 5,356 9,236 Rolls-Royce Holdings plc Annual Report 2015 139 Financial StatementsFinancial Statements 17 Financial instruments CARRYING VALUES AND FAIR VALUES OF FINANCIAL INSTRUMENTS 2015 Unlisted non-current asset investments Trade receivables and similar items Other non-derivative financial assets Derivative financial assets 1 Short-term investments Cash and cash equivalents Borrowings Derivative financial liabilities 1 Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities 2014 Unlisted non-current asset investments Trade receivables and similar items Other non-derivative financial assets Derivative financial assets 1 Short-term investments Cash and cash equivalents Borrowings Derivative financial liabilities 1 Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities Assets Liabilities Total 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 B B B A B B C B B D C E B B B – – – 112 – – – – – – – – 112 – – – 129 – – – – – – – – 129 33 2,061 843 – 2 1,731 – – – – – – 4,670 31 1,981 671 – 7 1,431 – – – – – – 4,121 – – – – – 783 – – – – – – 783 – – – – – 692 – – – – – – 692 Fair value through profit or loss £m – – – – – – – (1,843) – – – – (1,843) – – – – – – – (759) – – – – (759) Cash £m – – – – – 662 – – – – – – 662 – – – – – 739 – – – – – – 739 Other £m – – – – – – (3,302) – (110) (29) (3,101) (817) (7,359) – – – – – – (2,261) – (145) (22) (3,049) (831) (6,308) £m 33 2,061 843 112 2 3,176 (3,302) (1,843) (110) (29) (3,101) (817) (2,975) 31 1,981 671 129 7 2,862 (2,261) (759) (145) (22) (3,049) (831) (1,386) 1 In the event of counterparty default relating to derivative financial assets and liabilities, offsetting would apply and financial assets and liabilities held with the same counterparty would net off. If this occurred with every counterparty, total financial assets would be nil and liabilities £1,731m. Fair values equate to book values for both 2015 and 2014, with the following exceptions: Borrowings Financial RRSAs 2015 2014 Book value £m Fair value £m Book value £m Fair value £m (3,302) (110) (3,312) (110) (2,261) (145) (2,362) (152) 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. E 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 Fair Value Measurement defines a three level valuation hierarchy: Level 1 – quoted prices for similar instruments Level 2 – directly observable market inputs other than Level 1 inputs Level 3 – inputs not based on observable market data 140 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED17 Financial instruments continued CARRYING VALUES OF OTHER FINANCIAL ASSETS AND LIABILITIES 2015 Non-current assets Current assets Assets Current liabilities Non-current liabilities Liabilities 2014 Non-current assets Current assets Assets Current liabilities Non-current liabilities Liabilities Foreign exchange contracts £m 3 29 32 (244) (1,428) (1,672) (1,640) 28 22 50 (144) (545) (689) (639) Commodity contracts £m Interest rate contracts £m Total derivatives £m Financial RRSAs £m C Shares £m Total £m – – – (39) (65) (104) (104) – – – (21) (22) (43) (43) 80 – 80 – (67) (67) 13 79 – 79 – (27) (27) 52 83 29 112 (283) (1,560) (1,843) (1,731) 107 22 129 (165) (594) (759) (630) – – – (19) (91) (110) (110) – – – (22) (123) (145) (145) – – – (29) – (29) (29) – – – (22) – (22) (22) 83 29 112 (331) (1,651) (1,982) (1,870) 107 22 129 (209) (717) (926) (797) 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 and forward rate agreements 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 Currency options at inception 1 Movements in fair value hedges 2 Movements in other derivative contracts 3 Contracts settled 4 At 31 December Foreign exchange instruments Commodity instruments Interest rate instruments Total 2015 £m (639) (20) 1 (1,217) 235 (1,640) 2014 £m 498 – 3 (1,125) (15) (639) 2015 £m (43) – – (89) 28 (104) 2014 £m (39) – – (15) 11 (43) 2015 £m 52 – (36) – (3) 13 2014 £m (6) – 58 – – 52 2015 £m (630) (20) (35) (1,306) 260 (1,731) 2014 £m 453 – 61 (1,140) (4) (630) 1 The Group has written currency options to sell USD and buy GBP as part of a commercial agreement. The fair value of this option on inception is treated as a discount to the customer 2 Gain on related hedged items £35m (2014: £61m loss) 3 Included in financing 4 Includes £8m contracts settled in fair value hedges (2014: £nil). Contracts settled in 2014 included a loss of £76m in relation to contracts put in place to hedge the settlement of the put option on RRPS EXERCISE PRICE OF PUT OPTION ON NON-CONTROLLING INTERESTS AND FINANCIAL RISK AND REVENUE SHARING ARRANGEMENTS 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. The Group had agreed a put option with Daimler AG, such that Daimler could sell its interest in Rolls-Royce Power Systems Holding GmbH to the Group. Daimler AG exercised this option on 24 March 2014 and the Group acquired Daimler’s 50% share of RRPSH on 26 August 2014. Prior to this, the fair value of the exercise value of this option was included as a financial liability. Rolls-Royce Holdings plc Annual Report 2015 141 Financial StatementsFinancial Statements 17 Financial instruments continued Movements in the carrying values were as follows: At 1 January Exchange adjustments included in OCI Financing charge 1 Excluded from underlying profit: Financing charge 1 Changes in put option exercise price 1 Exchange adjustments 1 Cash paid to partners Settlement of put option At 31 December 1 Included in financing. Financial RRSAs Put option on non-controlling interests 2015 £m (145) – (8) – – 8 35 – (110) 2014 £m (167) 3 (5) – – (8) 32 – (145) 2014 £m (1,858) – – (2) (166) 89 – 1,937 – 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. 142 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED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 2015 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 2014 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 – 22,418 2,437 – 268 25,123 46 20,889 1,512 2 240 22,689 – 5,736 – 4,266 – 11,637 – – – – 500 – 90 5,826 72 4,338 83 12,220 46 5,431 53 2 79 5,611 – 4,793 – 10,665 – – 500 – 62 4,855 71 11,236 – 779 1,937 – 23 2,739 – – 959 – 28 987 – 32 74 6 – 112 6 44 74 5 – 129 – (1,672) (61) (6) (104) (1,843) – (689) (22) (5) (43) (759) 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 2015 Currencies sold forward: Sterling US dollar Euro Other At 31 December 2014 Currencies sold forward: Sterling US dollar Euro Other – 18,869 2 131 – 16,659 150 167 383 – 76 12 429 – 61 9 – 1,552 – 143 – 2,014 – 114 Other derivative financial instruments are denominated in the following currencies: Sterling US dollar Euro 221 902 125 2 199 938 185 10 2015 £m 875 1,279 550 604 21,323 203 288 628 19,611 396 300 2014 £m 877 292 584 Rolls-Royce Holdings plc Annual Report 2015 143 Financial StatementsFinancial Statements 17 Financial instruments continued Non-derivative financial instruments are denominated in the following currencies: At 31 December 2015 Unlisted non-current investments Trade receivables and similar items Other non-derivative financial assets Short-term investments Cash and cash equivalents Assets Borrowings Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities Liabilities At 31 December 2014 Unlisted non-current investments Trade receivables and similar items Other non-derivative financial assets Short-term investments Cash and cash equivalents Assets Borrowings Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities Liabilities Sterling £m US dollar £m Euro £m Other £m Total £m – 131 280 – 1,554 1,965 (1,369) – (29) (1,536) (242) (3,176) (1,211) – 232 400 – 513 1,145 (1,341) – (22) (1,489) (248) (3,100) (1,955) 1 1,228 350 – 959 2,538 (1,162) (75) – (859) (303) (2,399) 139 – 1,180 53 – 1,404 2,637 (101) (97) – (887) (333) (1,418) 1,219 31 613 102 – 446 1,192 (768) (35) – (523) (139) (1,465) (273) 30 479 101 – 619 1,229 (819) (48) – (545) (161) (1,573) (344) 1 89 111 2 217 420 (3) – – (183) (133) (319) 101 1 90 117 7 326 541 – – – (128) (89) (217) 324 33 2,061 843 2 3,176 6,115 (3,302) (110) (29) (3,101) (817) (7,359) (1,244) 31 1,981 671 7 2,862 5,552 (2,261) (145) (22) (3,049) (831) (6,308) (756) 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: Sterling £m US dollar £m Euro £m Other £m Total £m – (12) 4 – – (2) 2 5 – 1 – 3 28 – 5 19 1 – – 1 2 (1) – 6 27 8 – (1) 35 8 11 1 28 (3) 4 3 65 5 18 31 Functional currency of Group operations At 31 December 2015 Sterling US dollar Euro Other At 31 December 2014 Sterling US dollar Euro Other 144 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED17 Financial instruments continued AGEING BEYOND CONTRACTUAL DUE DATE OF FINANCIAL ASSETS At 31 December 2015 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 2014 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 2015 Borrowings Derivative financial liabilities Financial RRSAs C Shares Trade payables and similar items Other non-derivative financial liabilities At 31 December 2014 Borrowings Derivative financial liabilities 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 – 184 5 – – – 189 – 206 4 – – – 210 – 98 1 – – – 99 – 104 – – – – 104 – 34 2 – – – 36 – 14 – – – – 14 Within terms £m 33 1,745 835 112 2 3,176 5,903 31 1,657 667 129 7 2,862 5,353 Total £m 33 2,061 843 112 2 3,176 6,227 31 1,981 671 129 7 2,862 5,681 Gross values Between one and two years £m Between two and five years £m After five years £m Discounting £m Carrying value £m (161) (329) (20) – (38) (43) (591) (385) (115) (19) – (32) (95) (646) (1,317) (1,026) (76) – (4) (74) (2,497) (214) (324) (72) – (2) (20) (632) (1,897) (314) (10) – – (60) (2,281) (1,880) (181) (52) – (3) (66) (2,182) 603 112 12 – – – 727 366 35 15 – – – 416 (3,302) (1,843) (110) (29) (3,101) (817) (9,202) (2,261) (759) (145) (22) (3,049) (831) (7,067) Within one year £m (530) (286) (16) (29) (3,059) (640) (4,560) (148) (174) (17) (22) (3,012) (650) (4,023) Rolls-Royce Holdings plc Annual Report 2015 145 Financial StatementsFinancial 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. At 31 December 2015 Short-term investments 1 Cash and cash equivalents 2 Unsecured bank loans Other borrowings £200m floating rate loan £43m floating rate loan €125m fixed rate loan €75m fixed rate loan €50m fixed rate loan Unsecured bond issues 7 3⁄8% Notes 2016 £200m 6.75% Notes 2019 £500m Effect of interest rate swaps 2.375% Notes 2020 $500m Effect of interest rate swaps 2.125% Notes 2021 €750m Effect of interest rate swaps 3.625% Notes 2025 $1,000m Effect of interest rate swaps 3.375% Notes 2026 £375m Effect of interest rate swaps Other secured Obligations under finance leases At 31 December 2014 Short-term investments 1 Cash and cash equivalents 2 Unsecured bank loans Other borrowings Interest rate swaps £200m floating rate loan €125m fixed rate loan €75m fixed rate loan €50m fixed rate loan Unsecured bond issues 7 3⁄8% 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 Effective interest rate % GBP LIBOR + 1.26 GBP LIBOR + 0.402 2.6000% 2.0600% 2.3500% 7.3750% 6.7500% GBP LIBOR + 2.9824 2.3750% GBP LIBOR + 0.8410 2.1250% GBP LIBOR + 0.7005 3.6250% GBP LIBOR + 1.4658 3.3750% GBP LIBOR + 0.8930 4.1089% Effective interest rate % 5.8156% 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 + 0.8930 4.1089% Period in which interest rate reprices 6 months or less £m 2 3,176 6-12 months £m – – (1) (200) (43) – – – – – (536) – (333) – (576) – (668) – (390) – – – – – – – – – – – – – – – – – Period in which interest rate reprices 6 months or less £m 5 2,862 6-12 months £m 2 – (1) 2 (200) – – – – – (55) – (547) – (615) – (395) (1) – (2) – – – – – (55) 55 – – – – – – (1) Total £m 2 3,176 (129) (200) (43) (92) (55) (28) (200) (536) – (333) – (576) – (668) – (390) – (52) (124) Total £m 7 2,862 (12) – (200) (97) (59) (36) (200) (55) – (547) – (615) – (395) – (45) 608 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 146 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED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 £1,780m (2014: £1,277m) of undrawn committed borrowing facilities available for at least the next 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 2015 £m (1,574) 1,288 (130) 111 18 (15) (13) 13 2014 £m (1,336) 1,093 (147) 123 15 (12) (15) 15 At 31 December 2015 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 142. 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% of LIBOR on the 0.1p nominal value of each share, paid on a twice-yearly basis, and have limited voting rights. The Company has the option to compulsorily redeem the C Shares, at any time, if the aggregate number of C Shares in issue is less than 10% of the aggregate number of C Shares issued, or on the acquisition or capital restructuring of the Company. Movements in issued and fully paid C Shares during the year were as follows: At 1 January Issued Redeemed At 31 December 2015 2014 Millions 22,005 429,536 (422,581) 28,960 Nominal value £m 22 430 (423) 29 Millions 16,286 413,669 (407,950) 22,005 Nominal value £m 16 414 (408) 22 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 2015 2014 Pence per share 9.27 7.10 16.37 £m 170 131 301 Pence per share 9.00 14.10 23.10 £m 170 265 435 Rolls-Royce Holdings plc Annual Report 2015 147 Financial StatementsFinancial 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 (14) (1) – – – (2) (17) Disposal of businesses £m (1) – – – – – (1) Unused amounts reversed £m (28) (1) (30) (27) (5) (9) (100) Charged to income statement £m 106 10 106 11 15 2 250 At 1 January 2015 £m 426 41 122 47 65 106 807 433 374 Utilised £m (108) (13) (132) (11) (8) (27) (299) At 31 December 2015 £m 381 36 66 20 67 70 640 336 304 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. These include commitments of US$3.1bn to provide borrowing facilities to enable customers to purchase aircraft (of which approximately US$322m could be called during 2016). These facilities may only be used if the customer is unable to obtain financing elsewhere and are priced at a premium to the market rate. Consequently the Directors do not consider that there is a significant exposure arising from the provision of these facilities. 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 Financial review on page 46. 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 2015 £m 3 12 5 20 2014 £m 32 11 4 47 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 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: 2015 2014 £m 269 (136) (79) 54 78 35 $m 399 (201) (118) 80 115 52 £m 388 (245) (84) 59 90 42 $m 605 (382) (132) 91 140 66 2 Although sensitivity calculations are complex, the reduction of relevant security by 20% illustrates the sensitivity to changes in this assumption. 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. 148 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED19 Post-retirement benefits The Group operates a number of defined benefit and defined contribution schemes: • 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 • 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 2015. 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 investment policies to mitigate some of these risks. This involves investing a significant proportion of the schemes’ assets in Liability Driven Investment 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. In the UK, surpluses are recognised on schemes where, on ultimate wind-up when there are longer any remaining members, any surplus will be returned to the Group. AMOUNTS RECOGNISED IN THE INCOME STATEMENT Defined benefit schemes: Current service cost and administrative expenses Past-service and curtailment (credit)/cost Defined contribution schemes Operating cost Net financing in respect of defined benefit schemes Total income statement charge The operating cost is charged as follows: Cost of sales Commercial and administrative costs Research and development Operating cost – continuing operations Discontinued operations Total operating cost UK schemes £m 2015 Overseas schemes £m 169 (16) 153 33 186 (65) 121 52 8 60 85 145 33 178 UK schemes £m 2014 Overseas schemes £m 156 (18) 138 32 170 (11) 159 45 (13) 32 97 129 40 169 Total £m 221 (8) 213 118 331 (32) 299 Defined benefit Defined contribution Total 2015 £m 147 32 34 213 – 213 2014 £m 117 21 27 165 5 170 2015 £m 80 21 17 118 – 118 2014 £m 84 23 17 124 5 129 2015 £m 227 53 51 331 – 331 Total £m 201 (31) 170 129 299 29 328 2014 £m 201 44 44 289 10 299 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 £32m (2014: £35m) 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 cost on scheme deficits UK schemes £m 375 (440) – (65) (65) – 2015 Overseas schemes £m 57 (24) – 33 – 33 Total £m 432 (464) – (32) (65) 33 UK schemes £m 390 (427) 26 (11) (13) 2 2014 Overseas schemes £m 64 (24) – 40 – 40 Total £m 454 (451) 26 29 (13) 42 Rolls-Royce Holdings plc Annual Report 2015 149 Financial StatementsFinancial 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 Included in other comprehensive income UK schemes £m (185) (70) 56 (593) – – (792) 2015 Overseas schemes £m 8 70 8 (16) – – 70 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 Net asset/(liability) recognised in the balance sheet Post-retirement scheme surpluses Post-retirement scheme deficits 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 UK schemes £m (10,914) 11,957 1,043 – 1,043 1,059 (16) 2015 Overseas schemes £m (650) 597 (53) (1,067) (1,120) 4 (1,124) Assets £m 152 – 429 – 16 597 2015 Obligations £m (188) (553) (513) (426) (37) (1,717) UK schemes £m 23 (1,099) (343) 2,258 513 47 1,399 UK schemes £m (10,606) 12,341 1,735 – 1,735 1,735 – 2014 Overseas schemes £m (17) (228) (17) 55 – – (207) 2014 Overseas schemes £m (664) 593 (71) (1,109) (1,180) 5 (1,185) Assets £m 160 – 414 – 19 593 2014 Obligations £m (208) (592) (508) (423) (42) (1,773) Total £m (177) – 64 (609) – – (722) Total £m (11,564) 12,554 990 (1,067) (77) 1,063 (1,140) Net £m (36) (553) (84) (426) (21) (1,120) Total £m 6 (1,327) (360) 2,313 513 47 1,192 Total £m (11,270) 12,934 1,664 (1,109) 555 1,740 (1,185) Net £m (48) (592) (94) (423) (23) (1,180) DEFINED BENEFIT SCHEMES Assumptions Significant actuarial assumptions for UK schemes (weighted average, weighted by the size of the obligation) used at the balance sheet date were as follows: Discount rate Inflation assumption (RPI) 1 Rate of increase in salaries Male life expectancy from age 65: current pensioner future pensioner currently aged 45 1 This is the assumption for the Retail Price Index. The Consumer Price Index is assumed to be 1.1% lower 2015 3.6% 3.2% 4.0% 22.8 years 24.8 years 2014 3.6% 3.2% 4.2% 22.5 years 24.1 years 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. 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 2015 core projections and long-term improvements of 1.5%. Where appropriate, these are adjusted to take account of the relevant scheme’s actual experience. 150 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 19 Post-retirement benefits continued 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: Discount rate Inflation assumption Long-term healthcare cost trend rate Male life expectancy from age 65: current pensioner future pensioner currently aged 45 Changes in present value of defined benefit obligations At 1 January Exchange differences Current service cost Past service cost Finance cost Contributions by employees Benefits paid out Disposal 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 (years) 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 Settlements/curtailment At 31 December Total return on scheme assets 2015 3.6% 2.2% 5.0% 21.1 years 23.3 years 2014 3.3% 2.2% 5.0% 21.1 years 23.3 years UK schemes £m (10,606) – (164) 16 (375) (3) 417 – (199) – – (10,914) (10,914) – (4,273) (1,946) (4,695) 18 UK schemes £m 12,341 – (5) 440 (593) 188 3 (417) – 11,957 (153) 2015 Overseas schemes £m (1,773) 17 (50) (5) (58) (4) 75 – 84 – (3) (1,717) (650) (1,067) (921) (130) (666) 16 2015 Overseas schemes £m 593 (2) (2) 24 (16) 71 4 (75) – 597 8 Total £m (12,379) 17 (214) 11 (433) (7) 492 – (115) – (3) (12,631) (11,564) (1,067) (5,194) (2,076) (5,361) 17 Total £m 12,934 (2) (7) 464 (609) 259 7 (492) – 12,554 (145) UK schemes £m (9,046) – (151) 18 (390) (4) 376 10 (1,419) – – (10,606) (10,606) – (4,170) (2,009) (4,427) 17 UK schemes £m 9,776 – (5) 427 2,258 257 4 (376) – 12,341 2,685 2014 Overseas schemes £m (1,493) (7) (44) 16 (63) (5) 71 16 (266) 6 (4) (1,773) (664) (1,109) (974) (97) (702) 16 2014 Overseas schemes £m 504 18 (1) 24 55 65 5 (71) (6) 593 79 Total £m (10,539) (7) (195) 34 (453) (9) 447 26 (1,685) 6 (4) (12,379) (11,270) (1,109) (5,144) (2,106) (5,129) 17 Total £m 10,280 18 (6) 451 2,313 322 9 (447) (6) 12,934 2,764 Rolls-Royce Holdings plc Annual Report 2015 151 Financial StatementsFinancial 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 Fair value of scheme assets UK schemes £m 7,283 (5) 1,977 1,868 (477) 118 10,764 (142) 810 232 110 24 68 91 11,957 2015 Overseas schemes £m 297 (1) 239 – – 21 556 – 1 – 3 – 21 16 597 UK schemes £m 7,282 (2,622) 2,053 4,218 (360) 193 10,764 10 787 216 105 15 166 278 12,341 2014 Overseas schemes £m 167 2 237 – – 127 533 – 3 – 4 – 32 21 593 Total £m 7,580 (6) 2,216 1,868 (477) 139 11,320 (142) 811 232 113 24 89 107 12,554 Total £m 7,449 (2,620) 2,290 4,218 (360) 320 11,297 10 790 216 109 15 198 299 12,934 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 has agreed an average life expectancy of pensioners with a counterparty. If pensioners live longer than expected the counterparty will make payments to the Fund 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. The longevity swap is valued at fair value in accordance with IFRS 13 (Level 3). 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 funding liability At 1 January Movements in unrecognised surplus through OCI 1 Movements in minimum funding liability through OCI 2 Related finance costs At 31 December UK schemes £m – – – – – 2015 Overseas schemes £m – – – – – Total £m – – – – – UK schemes £m (534) 513 47 (26) – 2014 Overseas schemes £m – – – – – Total £m (534) 513 47 (26) – 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. During 2014, the rules of one scheme were amended, which removed the restriction on recognising the surplus. 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. FUTURE CONTRIBUTIONS The Group expects to contribute approximately £260m to its defined benefit schemes in 2016. 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 152 Rolls-Royce Holdings plc Annual Report 2015 Obligations at 31 December 2015 £m (7,871) (1,913) (702) Valuation date 31 March 2015 5 April 2013 31 March 2013 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED19 Post-retirement benefits continued Sensitivities The calculations of the defined benefit obligations are sensitive to the assumptions set out above. The following table summarises how the estimated impact of a change in a significant assumption would affect the UK defined benefit obligation at 31 December 2015, 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 and 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% 1 Real increase in salaries of 0.25% One year increase in life expectancy Obligation Plan assets (LDI portfolio) Obligation Plan assets (LDI portfolio) Obligations Obligations £m (524) 569 (249) 231 (86) (308) 1 The difference between the sensitivities on obligations and plan assets 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% for discount rates and 89% for inflation. 20 Share capital Issued and fully paid At 1 January 2014 Proceeds from shares issued for share option schemes Purchase and cancellation of ordinary shares At 31 December 2014 Purchase and cancellation of ordinary shares At 31 December 2015 Non-equity Equity Special Share of £1 Nominal value £m Ordinary shares of 20p each Millions Nominal value £m 1 1 1 – – – 1,880 10 (8) 1,882 (44) 1,838 376 2 (2) 376 (9) 367 The rights attaching to each class of share are set out on page 178. 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 credit 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 Directors’ Remuneration Report on pages 77 to 89. 2015 £m 6 (1) 5 – 2014 £m 26 (5) 21 13 Rolls-Royce Holdings plc Annual Report 2015 153 Financial StatementsFinancial Statements 21 Share-based payments continued MOVEMENTS IN THE GROUP’S SHARE-BASED PAYMENT PLANS DURING THE YEAR Outstanding at 1 January 2014 Granted Additional entitlements arising from TSR performance Additional shares accrued from reinvestment of C Shares Forfeited Exercised Outstanding at 1 January 2015 Granted Additional entitlements arising from TSR performance Forfeited Exercised Outstanding 31 December 2015 Exercisable at 31 December 2015 Exercisable at 31 December 2014 ShareSave PSP APRA Weighted average exercise price Pence 660 – – – 775 487 660 617 – 908 445 677 – – Number Millions 26.0 – – – (1.0) (0.5) 24.5 13.0 – (4.6) (9.7) 23.2 – – Number Millions 12.0 2.9 0.5 – (1.2) (4.4) 9.8 3.0 0.5 (2.9) (1.7) 8.7 – – Number Millions 3.1 1.1 – 0.1 (0.2) (1.7) 2.4 – – (0.1) (1.4) 0.9 – – As share options are exercised throughout the year, the weighted average share price during the year of 820p (2014: 1013p) is representative of the weighted average share price at the date of exercise. The closing price at 31 December 2015 was 575p (2014: 870p). FAIR VALUES OF SHARE-BASED PAYMENT PLANS The weighted average fair value per share of equity-settled share-based payment plans granted during the year, estimated at the date of grant, are as follows: PSP – 25% TSR uplift PSP – 50% TSR uplift ShareSave – 3 year grant ShareSave – 5 year grant APRA 2015 1,015p 1,036p 192p 219p n/a 2014 1,105p 1,227p n/a n/a 984p 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 (or equivalent). 22 Leases OPERATING LEASES Leases as lessee Rentals paid – hire of plant and machinery – hire of other assets Non-cancellable operating lease rentals are payable as follows: Within one year Between one and five years After five years 154 Rolls-Royce Holdings plc Annual Report 2015 2015 £m 122 124 190 488 496 1,174 2014 £m 123 75 182 542 438 1,162 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUED 22 Leases continued Leases as lessor Rentals received – credited within revenue from aftermarket services Non-cancellable operating lease rentals are receivable as follows: Within one year Between one and five years After five years 2015 £m 3 12 12 8 32 2014 £m 15 16 30 13 59 The Group acts as lessee and lessor for both land and buildings and gas turbine engines, and acts as lessee for some plant and equipment. • Sublease payments of £1m (2014: £1m) and sublease receipts of £3m (2014: £12m) were recognised in the income statement in the year. • Purchase options exist on aero engines, land and buildings and plant and equipment with the period to the purchase option date varying between one to eight years. • Renewal options exist on aero engines, land and buildings and plant and equipment with the period to the renewal option varying between one to 52 years at terms to be negotiated upon renewal. • Escalation clauses exist on some leases and are linked to LIBOR. • The total future minimum sublease payments expected to be made is £3m (2014: £6m) and sublease receipts expected to be received are £24m (2014: £31m). FINANCE LEASES Finance lease liabilities are payable as follows: Within one year Between one and five years After five years Payments £m 5 18 46 69 2015 Interest £m 2 8 7 17 Principal £m 3 10 39 52 Payments £m 3 13 47 63 2014 Interest £m 2 7 9 18 Principal £m 1 6 38 45 23 Contingent liabilities Contingent liabilities in respect of customer financing commitments are described in note 18. On 6 December 2012, the Company announced that it had passed information to the Serious Fraud Office (SFO), following a request from the SFO for information about allegations of malpractice in overseas markets. On 23 December 2013, the Company announced that it had been informed by the SFO that it had commenced a formal investigation. Since the initial announcement, the Company has continued its investigations and is engaging with the SFO and other authorities in the UK, the USA and elsewhere in relation to the matters of concern. The consequence of these disclosures will be decided by the regulatory authorities. It is 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 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 £11m (2014: £11m). Rolls-Royce Holdings plc Annual Report 2015 155 Financial StatementsFinancial Statements 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 2015 £m 1,896 (2,266) (88) 9 63 16 2 2014 £m 2,138 (2,544) (81) 9 73 2 2 Included in sales of goods and services to joint ventures and associates are sales of spare engines amounting to £189m (2014: £138m). Profit recognised in the year on such sales amounted to £71m (2014: £54m), including profit on current year sales and recognition of profit deferred on sales in previous years. 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 pages 58 to 61. Remuneration for key management personnel is shown below: Salaries and short-term benefits Post-retirement schemes Share-based payments 2015 £m 8 – – 8 2014 £m 9 1 4 14 More detailed information regarding the Directors’ remuneration, shareholdings, pension entitlements, share options and other long-term incentive plans is shown in the Directors’ Remuneration Report on pages 77 to 89. The charge for share-based payments above is based on when the award is charged to the income statement in accordance with IFRS 2 Share-Based Payments, rather than when the shares vest, which is the basis used in the Directors’ Remuneration Report. 25 Acquisitions and disposals ACQUISITIONS On 27 March 2015, the Group acquired 100% of R.O.V. Technologies Inc. for US$8m. The acquisition gave rise to goodwill of £1m and other intangible assets of £2m. DISPOSALS On 27 November 2015, the Group completed the sale of its Michell Bearings business (comprising a business based in the UK, and a 51% shareholding in Michell Bearings (India) Pvt Ltd, a subsidiary company based in Bangalore) for net consideration of £2m. 156 Rolls-Royce Holdings plc Annual Report 2015 Financial StatementsNOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONTINUEDCOMPANY BALANCE SHEET At 31 December 2015 Assets Non-current assets Investments – subsidiary undertakings Current assets Trade and other receivables TOTAL ASSETS Liabilities Current liabilities Other financial liabilities Trade and other payables TOTAL LIABILITIES NET ASSETS Equity Called-up share capital Share premium account Merger reserve Capital redemption reserve Other reserve Retained earnings TOTAL EQUITY Notes 2015 £m 2014 £m 2 12,016 12,015 – 12,016 57 12,072 3 4 (29) (842) (871) (22) – (22) 11,145 12,050 367 180 7,359 1,699 126 1,414 11,145 376 179 7,789 1,267 124 2,315 12,050 The financial statements on pages 157 to 159 were approved by the Board on 11 February 2016 and signed on its behalf by: WARREN EAST Chief Executive DAVID SMITH Chief Financial Officer Company’s registered number: 7524813 COMPANY STATEMENT OF CHANGES IN EQUITY For the year ended 31 December 2015 At 1 January 2015 Profit for the year Shares issued to share trust Cancellation of ordinary shares Purchase of ordinary shares Issue of C Shares Redemption of C Shares Share-based payments – direct to equity At 31 December 2015 Attributable to ordinary shareholders Share capital £m 376 – – (9) – – – – 367 Share premium £m 179 – 1 – – – – – 180 Merger reserve £m 7,789 – – – – (430) – – 7,359 Capital redemption reserve £m 1,267 – – 9 – – 423 – 1,699 Other reserve1 £m 124 – – – – – – 2 126 Retained earnings £m 2,315 – – – (414) – (423) (64) 1,414 Total equity £m 12,050 – 1 – (414) (430) – (62) 11,145 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 Rolls-Royce Holdings plc Annual Report 2015 157 Financial StatementsFinancial Statements NOTES TO THE COMPANY FINANCIAL STATEMENTS 1 Accounting policies BASIS OF ACCOUNTING These financial statements have been prepared in accordance with Financial Reporting Standard 101 Reduced Disclosure Framework (‘FRS 101’) on the historical cost basis. These are the Company’s first financial statements prepared in accordance with FRS 101. In preparing these financial statements, the Company applies the recognition, measurement and disclosure requirements of International Financial Reporting Standards as adopted by the EU (‘Adopted IFRS’), but makes amendments where necessary in order to comply with the Companies Act 2006. In the transition to FRS 101, the Company has applied IFRS 1, whilst ensuring that its assets and liabilities are measured in compliance with FRS 101. In these financial statements the Company has applied the exemptions available under FRS 101 in respect of the following disclosures: • a cash flow statement and related notes; and • the requirements of IAS 24 Related Party Transactions and has, therefore, not disclosed transactions between the Company and its wholly owned subsidiaries. FRS 101 has had no impact on the figures presented in these financial statements. As permitted by Section 408 of the Companies Act 2006, a separate income statement 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. INVESTMENTS IN SUBSIDIARY UNDERTAKINGS Investments in subsidiary undertakings are reported at cost less any amounts written off. SHARE-BASED PAYMENTS As described in the Directors’ Remuneration Report on pages 77 to 89, 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 IFRS 2 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 IAS 32 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 2015 Additions Cost of share-based payments in respect of employees of subsidiary undertakings less receipts from subsidiaries in respect of those payments At 31 December 2015 3 Financial liabilities C SHARES Movements during the year of issued and fully paid C Shares were as follows: At 1 January 2015 Shares issued Shares redeemed At 31 December 2015 The rights attaching to C Shares are set out on page 178. 158 Rolls-Royce Holdings plc Annual Report 2015 £m 12,015 – 1 12,016 C Shares of 0.1p Millions 22,005 429,536 (422,581) 28,960 Nominal value £m 22 430 (423) 29 Financial Statements4 Share capital Issued and fully paid At 1 January 2015 Cancellation of ordinary shares At 31 December 2015 Non-equity Equity Special Share of £1 Preference shares of £1 each Nominal value £m 1 1 – – – – Ordinary shares of 20p each Millions 1,882 (44) 1,838 Nominal value £m 376 (9) 367 The rights attaching to each class of share are set out on page 178. In accordance with IAS 32, 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 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 2015, these guarantees amounted to £1,937m (2014: £959m). 6 Other information EMOLUMENTS OF DIRECTORS The remuneration of the Directors of the Company is shown in the Directors’ Remuneration Report on pages 77 to 89. EMPLOYEES The Company had no employees in 2015. SHARE-BASED PAYMENTS Shares in the Company have been granted to employees of the Group as part of share-based payment plans, and are charged in the employing company. Rolls-Royce Holdings plc Annual Report 2015 159 Financial StatementsFinancial Statements SUBSIDIARIES Company name A.F.C Wultex Limited* A.P.E. – Allen Gears Limited* Allen Power Engineering Limited* Amalgamated Power Engineering Limited* Bergen Engines AS Bergen Engines Bangladesh Private Limited Bergen Engines BV Bergen Engines Denmark A/S Bergen Engines India Private Limited Bergen Engines Limited Bergen Engines Property Co AS Bergen Engines S.L. Bergen Engines S.r.l Bristol Energy Limited* Bristol Siddeley Engines Limited* Brooks Inspection Solutions Limited Brown Brothers & Company Limited* C.A. Parsons & Company Limited* Composite Technology and Applications Limited Crossley-Premier Engines (Sales) Limited* Croydon Energy Limited* Data Systems & Solutions, LLC Deeside Titanium Limited* Derby Cogeneration Limited* Derby Specialist Fabrications Limited* Europea Microfusioni Aerospaziali S.p.A. Exeter Power Limited* Fluid Mechanics LLC Gate Leasing Limited Hartshill Ventures Limited Heartlands Power Limited* Heaton Power Limited* John Hastie of Greenock (Holdings) Limited* John Thompson Cochran Limited* John Thompson Limited* Kalvet Engineering (Proprietary) Limited* Kamewa AB* Kamewa Do Brazil Equipmentos Maritimos Limitada* Kamewa Holding AB* Kamewa UK Limited* Karl Maybach-Hilfe GmbH L’Orange Unterstützungkasse GmbH L’Orange Fuel Injection (Ningbo) Co, Ltd L’Orange Fuel Injection Trading (Suzhou) Co, Ltd L’Orange GmbH M.L. Limited Mansfield Holdings Limited* MTU America Inc MTU Anlagenvermietung GmbH MTU Asia PTE. Limited MTU Benelux B.V. MTU China Company Limited MTU Do Brazil Limitada 100 * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT 160 Rolls-Royce Holdings plc Annual Report 2015 Address Derby1 Derby1 Derby1 Derby1 125 Hordvikneset, 5108 Hordvik, Bergen, 1201, Norway Plot n.58E, Kemal Ataturk Avenue, Dhaka, 1213, Bangladesh % held 90 100 100 100 100 100 100 Werfdijk 2, 3195HV Pernis, Rotterdam, Netherlands 23 Værftsvej, 9000 Aalborg, Denmark 100 52-b Okhla Industrial Estate, Phase 3, New Delhi 110-020, India 100 Derby1 100 125 Hordvikneset, 5108 Hordvik, Bergen, 1201, Norway 100 Calle Dinamarca, 43120 Constanti, Tarragona, Spain 100 13 Via Castel Morrone, 16161, Genoa, Italy 100 Derby1 100 Derby1 100 Derby1 100 Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Scotland, KY11 9JT 100 Derby1 100 Derby1 100 Derby1 100 Derby1 100 5959 Shallowford Road, Chattanooga, TN 37421, USA 100 Derby1 82.5 Derby1 100 Derby1 100 Zona Industriale AS1, 83040 Morra De Sanctis, Avellino, Italy 100 Derby1 100 39525 MacKenzie Drive, Novi, Michigan 48377, USA 100 London2 100 Derby1 100 Derby1 100 Derby1 100 Derby1 100 Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Scotland KY11 9JT 100 Derby1 100 Corner Marcony Rd and 3rd St, Western Cape, 7441, South Africa 100 Box 1010, S-68129, Kristinehamn, Sweden 100 401 Rua Visconde de Piraja 433, Rio de Janeiro, Brazil 100 Box 1010, S-68129, Kristinehamn, Sweden 100 Derby1 100 1 Maybachplatz, 88045 Friedrichshafen, Germany 100 Harteckweg 9, 72293 Glatten, Germany 100 #3 South Qihang Rd 55, Yinzhou Economic Development Zone Ningbo City, 315145, China 100 #399 Suhong Middle Rd, Suzhou Industrial Park, Suzhou 215000, China 100 30 Porschestrabe, 70435 Stuttgart, Germany 100 Derby1 100 Derby1 100 39625 McKenzie Drive, Novi, MI 48377, USA 100 1 Maybachplatz, 88045 Friedrichshafen, Germany 100 100 #05-01, Robinson Rd 112, 068902, Singapore 100 Merwedestraat 86, 3313 CS, Dordrecht, Netherlands 100 1801–1803, 18/F Ascendas Plaza, No.333 Tian Yao Qiao Road Xuhai District, Shanghai, 200030, China Via Anhanguera, KM 29203, 05276-000 Sao Paulo SP Brazil Other informationCompany name % held Address MTU Engineering (Suzhou) Company Limited MTU France SAS MTU Friedrichshafen GmbH MTU Hong Kong Limited MTU Iberica Propulsion Y Energia S.L. MTU India Private Limited MTU Israel Limited MTU Italia S.r.l MTU Japan Co Limited MTU Korea Limited MTU Middle East FZE MTU Motor Turbin Sanayi Ve Ticaret. A.S MTU Onsite Energy Corporation MTU Onsite Energy GmbH MTU Onsite Energy Systems GmbH MTU Polska SP. ZOO MTU Reman Technologies GmbH MTU RUS LLC MTU South Africa (Pty) Limited MTU UK Limited Navis Consult d.o.o NEI Allen Limited* NEI Combustion Engineering Limited* NEI International Combustion Limited* NEI Limited* NEI Mining Equipment Limited* NEI Nuclear Systems Limited* NEI Overseas Holdings Limited NEI Parsons Limited* NEI Peebles Limited* NEI Power Projects Limited* NEI Services Limited* Nightingale Insurance Limited Optimized Systems and Solutions (US) LLC Optimized Systems and Solutions Limited* Oxygenaire Limited* PKMJ Technical Services, Inc. Powerfield Limited* Powerfield Specialist Engines Limited* Prokura Diesel Services (pty) Limited PT Rolls-Royce PT MTU Indonesia Quay Leasing Limited R. Brooks Associates, Inc. Rallyswift Limited* Reyrolle Belmos Limited* Rolls E.L Turbofans Limited* Rolls-Royce (Ireland)* Rolls-Royce (Thailand) Limited Rolls-Royce (Xi’an) Mechanical Manufacturing Co. Limited Rolls-Royce AB * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT 100 100 100 100 100 100 100 100 100 100 100 100 100 9 Long Yun Rd, Suzhou Industrial Park, Suzhou 215024 Jiang Su, China 281 Chaussée Jules César, 95250 Beauchamp, France 1 Maybachplatz, 88045 Friedrichshafen, Germany 1-3 Wing Yip St, Kwai Chung, New Territories, Hong Kong 26-28 Calle Copernico, 28823 Coslada, Madrid, Spain 159/1 Tathawade, Pune Mumbai Highway, Pune 411033, India 4 Ha"Alon Str, Kfar Neter, 4059300, Israel Via Aurelia Nord, 328, 19021 Arcola (SP), Italy 2-15-19 Takanawa-Meiko, Minato-ku, Tokyo, 108-0074, Japan 20F Kores First Bank Building, 100 Gongpyung-dong, Jongno-gu Seoul, 100-702, Republic of Korea Showroom No. S3B5SR06 , Jebel Ali Free Zone, P.O. Box 61141 Dubai, United Arab Emirates 113. Ada 3.Parsel No.11, Çorlu, Tekirdag, 34555,Turkey 100 Power Drive, Mankato, MIN 56001, USA 8 Rotthofer Straße, 94099 Ruhstorf a.d. Rott, Germany 8 Rotthofer Straße, 94099 Ruhstorf a.d. Rott, Germany Ul. Slaska, Nr 9. Raum, Stargard Szczecinski, 73-110, Potsdam Stargard Szczecinski, Poland 8 Friedrich-List-Strabe, 39122 Magdeburg, Germany Shabolovka Street 2, 119049, Moscow, Russian Federation Corner Marcony Rd and 3rd St, Western Cape, 7441 South Africa Unit 29 The Birches Industrial Estate, East Grinstead, England RH19 1XZ Ul. Bartola Kasica 5/4, HR-51000, Rijeka, Croatia Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 100 100 100 100 100 100 100 100 100 100 75 100 100 100 100 100 100 100 100 100 100 100 100 Maison Trinity, Trinity Square, St. Peter Port, GY1 4AT, Guernsey 100 100 100 100 100 100 100 100 Mid Plaza 2, Lantai 16 Jl. Jenderal Sudirman 10-11, JakartaPusat, 10220, Indonesia 100 100 100 100 100 100 100 Secure Building Blok B, Jl. Raya Protokol Halim, Perdanakusuma Jakarta, 13610, Indonesia London2 6546 Pound Road, Williamson, NY14589, USA Derby1 Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Scotland KY11 9JT Derby1 1st Floor, IFSC House, International Financial Services Centre, Customs House Quay, Dublin, Irish Republic 900, 11th Fl, Tonson Tower, Ploenchit Rd, Bangkok, Thailand E-1, No. 5 Lan Tian Road, Xian Yanliang National Aviation Hi-Tech Industrial Base, China Box 1010, S-68129, Kristinehamn, Sweden Suite 500, 54 Monument Circle, Indianapolis, IN46204, USA Derby1 Derby1 465 Malcolm Dr., Moon Township, PA15108, USA Derby1 Derby1 Corner Marcony Rd and 3rd St, Western Cape, 7441 South Africa Rolls-Royce Holdings plc Annual Report 2015 161 Other informationOther information SUBSIDIARIES CONTINUED Company name % held Rolls-Royce Aero Engine Services Limited* Rolls-Royce Aircraft Management Limited Rolls-Royce Australia Limited Rolls-Royce Australia Services PTY Limited Rolls-Royce Brazil Limitada Rolls-Royce Canada Limited Rolls-Royce Capital Limited Rolls-Royce Civil Nuclear Canada Limited Rolls-Royce Civil Nuclear SAS Rolls-Royce Commercial (Beijing) Co., Limited Rolls-Royce Commercial Aero Engines Limited* Rolls-Royce Control Systems Holdings Co Rolls-Royce Controls and Data Services (NZ) Limited Rolls-Royce Controls and Data Services (UK) Limited Rolls-Royce Controls and Data Services Inc. Rolls-Royce Controls and Data Services Limited Rolls-Royce Corporation Rolls-Royce Côte d’Ivoire Sarl Rolls-Royce Credit Corporation Rolls-Royce Crosspointe LLC Rolls-Royce de Venezuela SA Rolls-Royce Defense Holdings Inc. Rolls-Royce Defense Products and Solutions Inc. Rolls-Royce Defense Services Inc. Rolls-Royce Deutschland Ltd & Co KG Rolls-Royce Directorate Limited* Rolls-Royce Energy Angola Limitada Rolls-Royce Energy Systems Inc. Rolls-Royce Engine Control Systems Pension Trustees Ltd Rolls-Royce Engine Controls Holdings Limited Rolls-Royce Engine Services – Oakland Inc. Rolls-Royce Engine Services Holdings Co Rolls-Royce Engine Services Limitada Inc.* Rolls-Royce Erste Beteiligungs GmbH Rolls-Royce Finance Company Limited* Rolls-Royce Finance Holdings Co Rolls-Royce Fuel Cell Systems Limited Rolls-Royce General Partner Limited Rolls-Royce Group plc Rolls-Royce High Temperature Composites Inc. Rolls-Royce Holdings Canada Inc. Rolls-Royce India Limited Rolls-Royce India Private Limited Rolls-Royce Industrial & Marine Gas Turbines* Rolls-Royce Industrial & Marine Power Limited* Rolls-Royce Industrial Power (India) Limited Rolls-Royce Industrial Power (Overseas Projects) Limited Rolls-Royce Industrial Power Engineering (Overseas Projects) Limited Rolls-Royce Industrial Power Investments Limited* Rolls-Royce Industrial Power Systems Limited* Rolls-Royce Industries Limited* * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT 162 Rolls-Royce Holdings plc Annual Report 2015 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 Address Derby1 London2 Suite 102, 2-4 Lyonpark Rd, Macquarie Park, NSW- 2113, Australia Suite 102, 2-4 Lyonpark Rd, Macquarie Park, NSW- 2113, Australia Rua Dr Cincinato Braga 47, Planalto, Sao Bernando do Campo/SP 09890-900, Brazil 9500 Cote De Liesse Rd, Lachine QC H8T 1A2, Canada Derby1 597 The Queensway, Peterborough ON K9J7J6, Canada 23 Chemin du Vieux Chene, 38240, Meylan, France 2109 China Life Building, 16 Chao Yang Men Wai Street, Beijing 100020, China Derby1 Suite 200, 1875 Explorer Street, Reston, VA20190, USA L7 Bayleys Building, 36 Brandon St, Wellington, 6011 New Zealand Derby1 Suite 200, 1875 Explorer Street, Reston, VA20190, USA Derby1 2001 S Tibbs Avenue, Indianapolis, IN46206, USA 7 Boulevard Latrille, 25 BP 945, Abidjan, Côte d'Ivoire Suite 200, 1875 Explorer Street, Reston, VA20190, USA Suite A, 3811 Corporate Rd. Petersburg, VA 23805-0848, USA Avenida 3E, entre Calles 78 y 79, Torre Empresarial Claret Piso 10, Oficina 10-3, Sector Valle Frio, Maracaibo, Venezuela 2001 S Tibbs Avenue, Indianapolis, IN46206, USA 2001 S Tibbs Avenue, Indianapolis, IN46206, USA 2001 S Tibbs Avenue, Indianapolis, IN46206, USA 11 Eschenweg, 15827 Blankenfelde-Mahlow, Germany Derby1 Rua Rei Katyavala, Entrada B, Piso 8, Luanda, Angola Suite 200, 1875 Explorer Street, Reston, VA20190, USA Derby1 Derby1 7200 Earhart Road, Oakland, CA 64621-4504, USA Suite 200, 1875 Explorer Street, Reston, VA20190, USA Bldg 06 Berthaphil Compound, Jose Abad Santos Avenue, Clark Special Eco Zone, Pampanga, Philippines 11 Eschenweg, 15827 Blankenfelde-Mahlow, Germany Derby1 Suite 200, 1875 Explorer Street, Reston, VA20190, USA Derby1 Derby1 London2 18411 Gothard Street #8, Huntington Beach, CA92648, USA 9500 Cote De Liesse Rd, Lachine QC H8T 1A2, Canada Derby1 Birla Tower West 25, Barakhamba Rd, New Delhi, 110001, India Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Other informationCompany name Rolls-Royce International Limited Rolls-Royce International LLC Rolls-Royce International S.R.O. Rolls-Royce Investment Co Rolls-Royce Italia SRL Rolls-Royce Japan Co. Limited Rolls-Royce JSF Holdings Inc. Rolls-Royce Leasing Limited Rolls-Royce Malaysia SDN BHD Rolls-Royce Marine A/S Rolls-Royce Marine AS Rolls-Royce Marine Asia Limited Rolls-Royce Marine Australia Pty Limited Rolls-Royce Marine Benelux BV Rolls-Royce Marine Chile SA Rolls-Royce Marine Deutschland GmbH Rolls-Royce Marine Electrical Systems Limited Rolls-Royce Marine Espana S.A. Rolls-Royce Marine France Sarl Rolls-Royce Marine Hellas S.A. Rolls-Royce Marine Hong Kong Limited Rolls-Royce Marine India Private Limited Rolls-Royce New Zealand Limited Rolls-Royce Nigeria Limited Rolls-Royce North America (USA) Holdings Co. Rolls-Royce North America Holdings Inc. Rolls-Royce North America Inc. Rolls-Royce North America Ventures Inc. Rolls-Royce North American Technologies Inc. Rolls-Royce Nuclear Field Services France SAS Rolls-Royce Oman LLC Rolls-Royce Operations (India) Private Limited Rolls-Royce Overseas Holdings Limited Rolls-Royce Overseas Investments Limited Rolls-Royce Overseas Projects Limited Rolls-Royce Oy Ab Rolls-Royce Placements Limited Rolls-Royce plc Rolls-Royce Poland Sp z.o.o Rolls-Royce Power Development Limited Rolls-Royce Power Engineering plc Rolls-Royce Power Systems AG * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT Rolls-Royce Marine Korea Limited Rolls-Royce Marine Manufacturing (Shanghai) Rolls-Royce Marine North America Inc. Rolls-Royce Marine Power Operations Limited Rolls-Royce Mechanical Test Operations Centre GmbH Rolls-Royce Mexico Administration S de RL de CV, Rolls-Royce Mexico S de RL de CV Rolls-Royce Military Aero Engines Limited* Rolls-Royce Namibia (Proprietary) Limited 100 100 100 100 100 100 100 100 % held 100 100 100 100 100 100 100 100 100 Address Derby1 10 B. Sadovaya St, 123001, Moscow, Russia Pobřežní 620/3, 186 00, Karlin - Prague 8, Czech Republic Suite 200, 1875 Explorer Street, Reston, VA20190, USA Via Castel Morrone 13,16161, Genova, Italy 31 Fl, Kasumigaseki bldg, 3-2-5 Kasumigaseki, Chiyoda-Ku, Tokyo 100-6031, Japan 2001 S Tibbs Avenue, Indianapolis, IN46206, USA Derby1 Suite 13.03, 13th Fl, Menara Tan & Tan, 207 Jalan Tun Razak 50400 Kuala Lumpur, Malaysia Vaerftsvej 23 , 2300, Aalborg, Denmark 100 Sjogata 80, 6065 Ulsteinvik, Norway 100 1-3 Wing Yip St, Kwai Chung, New Territories, Hong Kong 100 100 Unit 2/8 Wallace Way, Fremantle WA 6160, Australia 100 Werfdijk 2, 3195HV Pernis, Rotterdam, Netherlands 100 100 100 100 100 100 100 100 Alcantara 200, Office 1303, Las Condes, Santiago, Chile Fahrstieg 9, 21107, Hamburg, Germany Derby1 Poligono Industrial de Constanti, 43120 Constanti, Tarragona, Spain 4 Place Des Etats Unis, Imm Monaco Silic 261, Rungis, France 25 Atki Poseidonos & Makrigianni corner, Athens 18344, Greece 1-3 Wing Yip St, Kwai Chung, New Territories, Hong Kong PLOT D-505, TTC Industrial Area, MIDC, Sharaya Hyundai Lane Turbhe, Navi Mumbai, Maharashtra, 400710, India 197 Noksansaneopbung-ro , Gangseogu, Busan, Republic of Korea 1 Xuanzhong Rd, Xuanqiao Town, Pudong New Area, Shanghai 201399, China Suite 200, 1875 Explorer Street, Reston, VA20190, USA Derby1 Kiefernstrasse 1,15827 Blankenfelde-Mahlow, Dahlewitz, Germany Adolfo Ruiz Cortinez 3642-403, Costa de Oro, Veracruz 94299 6, Mexico Derby1 Ausspann Plaza, Dr Agostinho Neto Rd, Private Bag 12012, Asspannplatz, Windhoek, Namibia L7 Bayleys Building, 36 Brandon St, Wellington, 6011, New Zealand 22A Gerrard Street, Ikoyi, Lagos, Nigeria Suite 200, 1875 Explorer Street, Reston, VA20190, USA Suite 200, 1875 Explorer Street, Reston, VA20190, USA Suite 200, 1875 Explorer Street, Reston, VA20190, USA Suite 200, 1875 Explorer Street, Reston, VA20190, USA 2059 S Tibbs Avenue, Indianapolis, IN46241, USA ZA Notre-Dame, 84430, Mondragon, France PO Box 686, Ruwi, 112, Oman 100 100 100 100 100 100 100 100 100 100 Whitefield Rd, EPIP Zone, Mahadevapura Bangalore 560066, India 100 100 100 100 100 100 99.5 100 100 100 Derby1 Derby1 Derby1 PO Box 220, Suojantie 5, 26101, Rauma, Finland Derby1 London2 GNIEW 83-140, ul. Kopernika 1, Poland Derby1 Derby1 1 Maybachplatz, 88045, Friedrichshafen, Germany Rolls-Royce Holdings plc Annual Report 2015 163 Other informationOther information SUBSIDIARIES CONTINUED Company name % held Address Rolls-Royce Saudi Arabia Limited Rolls-Royce Secretariat Ltd* Rolls-Royce Singapore Pte. Ltd Rolls-Royce Technical Support Sarl Rolls-Royce Total Care Services Limited Rolls-Royce Transmission and Distribution Limited* Rolls-Royce Turkey Power Solutions Industry and Trade Limited Rolls-Royce Vietnam Limited Rolls-Royce Zweite Beteiligungs GmbH Ross Ceramics Limited R.O.V Technologies, Inc. R-R Industrial Controls Limited* Scandinavian Electric Gdansk Sp. z.o.o. Scandinavian Electric Systems do Brazil Limitada Spare IPG (AGL) Limited, Spare IPG (CEL) Limited, Spare IPG 3 Limited, Spare IPG 4 Limited, Spare IPG 11 Limited, Spare IPG 15 Limited, Spare IPG 20 Limited, Spare IPG 22 Limited, Spare IPG 24 Limited, Spare IPG 27 Limited, Spare IPG 28 Limited, Spare IPG 30 Limited, Spare IPG 32 Limited* Spare IPG 18 Ltd* Stone Vickers Limited* Superstructure Capital Limited The Bushing Company Limited* Timec 1487 Limited* Trigno Energy S.r.l. Ulstein Holding AS Ulstein Maritime Limited Ulstein Trading Ltd AS* Vessel Lifts Inc* Vickers Pension Trustees Limited* Vickers Pressings Limited* Viking Power Limited* Vinters Defence Systems Limited* Vinters Engineering Limited Vinters International Limited Vinters Limited Vinters-Armstrongs (Engineers) Limited* Vinters-Armstrongs Limited* Wultex Machine Company Limited* * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT 100 100 100 100 100 100 100 100 100 100 100 100 PO Box 88545, Riyadh, 11672, Saudi Arabia Derby1 1 Seletar Aerospace Crescent, 797565 Singapore Centreda 1, av Didier Daurat, 31700 Blagnac, Toulouse, France Derby1 Derby1 Ekemen Han No:1 Kat:6 Kabataş Beyoğlu , Istanbul, Turkey Dong Xuyen Industrial Zone, Rach Dua Ward, Vung Tau City Ba Ria – Vung Tau Province, Vietnam 11 Eschenweg, 15827 Blankenfelde-Mahlow, Germany Derby1 49 Bennett Drive, Guilford, Vermont, USA Derby1 67 M. Reja 3, Gdansk, 80-404, Poland 66 100 Rua Sao Jose 90, salas 1406-07, Rio de Janeiro, RJ, Brazil Derby1 90 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 Derby1 Derby1 Derby1 Derby1 Derby1 Zona Industrial, San Salvo, 66050, Italy Sjøgata 80, 6065 Ulsteinvik, Norway 96 North Bend St, Coquitlam, BC V3K 6H1, Canada Sjøgata 80, 6065, Ulsteinvik, Norway Suite 102, 9130 S Dadeland Blvd, Miami, FL33156, USA Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 Derby1 164 Rolls-Royce Holdings plc Annual Report 2015 Other informationJOINT VENTURES AND ASSOCIATES Company name Aero Gearbox International SAS Aerospace Transmission Technologies GmbH Airtanker 1 Limited* Airtanker Finance Limited Airtanker Holdings Limited Airtanker Limited Airtanker Services Limited Alpha Leasing Limited, Alpha Leasing (No.4) Limited, Alpha Leasing (No.9) Limited, Alpha Leasing (No.10) Limited, Alpha Leasing (No.11) Limited, Rolls-Royce & Partners Finance Limited 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 Alpha Partners Leasing Limited Anecom Aerotest GmbH Clarke Chapman Portia Port Services Limited Egypt Aero Management Services EPI Europrop International GmbH EPI Europrop International Madrid S.L. Eurojet Turbo GmbH GE Rolls-Royce Fighter Engine Team LLC Genistics Holdings Limited Genistics Limited Glacier LP Class Address of shares 18 Boulevard Louis Seguin, 92700 Colombes, France Ordinary Ordinary Adelheidstrasse 40, D-88046, Friedrichshafen, Germany One London Wall, London, England EC2Y 5EB One London Wall, London, England EC2Y 5EB One London Wall, London, England EC2Y 5EB One London Wall, London, England EC2Y 5EB Airtanker Hub, RAF Brize Norton, Carterton, Oxfordshire, England OX18 3LX London2 Ordinary Ordinary Ordinary Ordinary Ordinary Ordinary Suite 200, 1875 Explorer Street, Reston, VA20190, USA Partnerships (no equity held) A Ordinary London2 124/126 Freiheitsstrasse, Wildau, D-15745, Germany Ordinary Maritime centre, Port of Liverpool, Liverpool L21 1LA A Ordinary EgyptAir Engine Workshop, Cairo International Airport, Cairo, Egypt Dachauer Strasse 655, 80995 Munich, Germany Edificio Berlin – First Floor, Parque Empresarial San Fernando, Avenida Castilla 2, 28830 San Fernando De Henares, Madrid, Spain Lilienthalstrasse 2b, 85399 Hallbergmoos, Germany Ordinary 2001 S Tibbs Avenue, Indianapolis, IN46206, USA Ordinary Ordinary Ordinary Derby1 Derby1 Suite 300, Bank Tower, 66 Wellington Street West, Toronto, ON M5K 1E6, Canada Partnership (no equity held) Ordinary A Ordinary Ordinary Global Aerospace Centre for Icing and Environmental Research Inc. 1000 Marie-Victorin Boulevard, Montreal, Ordinary Hong Kong Aero Engine Services Limited Hovden Klubbhaus AS Industria De Turbo Propulsores SA International Aerospace Manufacturing Private Ltd International Engine Component Overhaul Pte Ltd LG Fuel Cell Systems Inc. Light Helicopter Turbine Engine Company (unincorporated partnership) Metlase Limited Ordinary Ordinary Ordinary QC J4G 1A1, Canada 33/F, 2 Pacific Place, 88 Queensway, Hong Kong Stalhaugen 5, Ulsteinvik, 6065 Norway Suite 300, Parque Technologico, 48170 Zamudio, Vizcaya, Spain 3 Kempapure Village, Bangalore, 560037, India No.3 Loyang Way 2, 507102, Singapore 6065 Strip Ave, Canton, OH44720-9207, USA Suite 119, 9238 Madison Boulevard, Madison, AL35758, USA Unipart House, Garsington Road, Cowley, Oxford, England OX4 2PG Am Soldnermoos 17, 85399 Hallbergmoos, Germany Ordinary Am Soldnermoos 17, 85399 Hallbergmoos, Germany Ordinary Ordinary 1 Gerhard-Höltje-Str, D-99310, Arnstadt, Germany Ordinary 1 Gerhard-Höltje-Str, D-99310, Arnstadt, Germany Ordinary Ordinary Ordinary Common Stock Partnership (no equity held) Ordinary B MTU Turbomeca Rolls-Royce GmbH MTU Turbomeca Rolls-Royce ITP GmbH N3 Engine Overhaul Services GmbH & Co KG N3 Engine Overhaul Services Verwaltungsgesellschaft Mbh Northern Engineering Industries Africa Limited (in liquidation)* 2nd floor, Ristone Office Park, 15 Sherborne Rd, Offshore Simulator Centre AS * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT Parktown 2193, South Africa 4 Larsgardsvegen, 6009, Alesund, Norway Ordinary % of class held 50 50 Group interest held % 50 50 20 20 20 20 22 100 – 100 24.9 100 50 20 20 20 20 22 50 50 50 24.9 50 50 28 Effective 35.5 28 Effective 35.5 33 – Effective 39 40 100 100 50 50 45 69 46.9 50 50 32 – 100 33.3 25 50 50 24.4 25 50 50 50 50 45 69 46.9 50 50 32 50 20 33.3 Effective 26 50 50 24.4 25 Rolls-Royce Holdings plc Annual Report 2015 165 Other informationOther information Group interest held % 50 50 50 50 50 50 50 50 50 49 25 Effective 39 50 50 49.5 50 40 20 50 49 49 – 100 100 100 100 100 100 100 49 25 30 50 50 – 100 100 37.5 40 20 50 49 100 Class of shares Ordinary % of class held 100 JOINT VENTURES AND ASSOCIATES CONTINUED Company name Address London2 Omega Leasing Limited, Omega Leasing (No.4) Limited, Omega Leasing (No.9) Limited, Omega Leasing (No.10) Limited, Omega Leasing (No.11) Limited Omega Leasing (US) LLC, Omega Leasing (US) (No 2) LLC, Omega Leasing (US) (No 4) LLC, Omega Leasing (US) (No 5) LLC, Omega Leasing (US) (No.6) LLC, Omega Leasing (US) (No.7) LLC, Omega Leasing (US) (No.8) LLC Rolls Laval Heat Exchangers Limited Rolls-Royce Engine Leasing (Labuan) Limited, Rolls-Royce Engine Leasing (Labuan) (No.2) Limited Rolls-Royce Snecma Limited RRPF Engine Leasing Limited, RRPF Engine Leasing (No.2) Limited RRPF Engine Leasing (US) LLC, RRPF Engine Leasing (US) (No.2) LLC Suite 200, 1875 Explorer Street, Reston, VA20190, Derby1 Unit Level 13(A), Main Office Tower, Financial Park Labuan Jalan Merdeka, 87000, Malaysia Derby1 London2 Suite 200, 1875 Explorer Street, Reston, VA20190, USA Partnerships (no equity held) Ordinary A Ordinary Ordinary B Ordinary Ordinary Ordinary Ordinary USA 28-00, 1 Marina Boulevard, Singapore 018989 Puerto In Buitrago, 804 Casilla de Correo, CP 2900, Buenos Aires, Argentina 97 Daqing West Rd, Datong, Shanxi Province, China Ordinary Ordinary 8 Jubilee Drive, Loughborough, England LE11 5XS Ordinary 11 Calshot Rd, 509932, Singapore Ordinary A Tefen Ind Zone, PO Box 16, 24959, Carmiel, Israel Ordinary B Partnership (no equity held) Ordinary B Ordinary B Shares A Ordinary Ordinary 1209 Orange St, Wilmington, DE19801, USA Derby1 Derby1 Derby1 Booths Park, Chelford Rd, Knutsford, England WA16 8QZ Saunesvn. 10, Ulsteinvik, NO-6067, Norway Xujiawan, Beijiao, PO Box 13, Xian 710021, Shaanxi China XEPZ 12th Fengcheng Rd, Xian 710018, Shaanxi China Ordinary Ordinary Ordinary RRPF Engine Leasing (Singapore) Pte. Limited Servicios de Operation y Mantenimiento S.A. Shanxi North MTU Diesel Co. Limited Sign Assured Limited Singapore Aero Engine Services Private Limited Techjet Aerofoils Limited Texas Aero Engine Services LLC TRT Limited Turbine Surface Technologies Limited Turbo-Union Limited UK Nuclear Restoration Limited Viking Reisebyra AS Xian XR Aero Components Co., Limited Xian XR Turbine Machining Components Co., Ltd * Dormant entity 1 Moor Lane, Derby, Derbyshire, England DE24 8BJ 2 62 Buckingham Gate, London, England SW1E 6AT 166 Rolls-Royce Holdings plc Annual Report 2015 Other information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 2015 set out on pages 107 to 166. In our opinion: • • • • the financial statements give a true and fair view of the state of the Group’s and of the parent company’s affairs as at 31 December 2015 and of the Group’s profit for the year then ended; the Group financial statements have been properly prepared in accordance with International Financial Reporting Standards as adopted by the European Union (Adopted IFRS); the parent company financial statements have been properly prepared in accordance with UK Accounting Standards, including FRS 101 Reduced Disclosure Framework; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. Dynamic Audit planning tool F O B E J K L C H G A P I D M N Q R Likelihood of material misstatement s t n e m e t a t s l a i c n a n i f n o t c a p m i l a i t n e t o P Independent Auditor’s report 2 OUR ASSESSMENT OF RISKS OF MATERIAL MISSTATEMENT When planning our audit, we made an assessment of the relative significance of the key risks of material misstatement to the Group financial statements initially without taking account of the effectiveness of controls implemented by the Group. This initial assessment is shown below in the output from our Dynamic Audit planning tool. As there has been no significant change in the Group’s operations or in our assessment of materiality these key risks are the same as in the prior year, though there have been some changes in the significance to our audit of some of the risks. Of the 18 key risks identified, we describe below (i) the eight risks of material misstatement that had the greatest effect on our audit (those in dark blue on the risk map – the descriptions of risks include an explanation for the changes in significance of these risks from last year), (ii) our key audit procedures to address those risks and (iii) our findings from those procedures in order that the Company’s members as a body may better understand the process by which we arrived at our audit opinion. Our findings are the result of procedures undertaken in the context of and solely for the purpose of our statutory audit opinion on the financial statements as a whole and consequently are incidental to that opinion, and we do not express discrete opinions on separate elements of the financial statements. A B C D E The pressure on and incentives for management to meet revised revenue and profit guidance The basis of accounting for revenue and profit in the Civil Aerospace business The measurement of revenue and profit in the Civil Aerospace business Recoverability of intangible assets in the Civil Aerospace business Liabilities arising from sales financing arrangements F Bribery and corruption G The presentation of ‘underlying profit’ H I Disclosure of the effect on the trend in profit of items which are uneven in frequency or amount Measurement of revenue and profit on long term contracts outside the Civil Aerospace business (see page 115) J K L M N O P Q Determination of development costs to be capitalised (See page 115) The basis of accounting for contractual aftermarket rights (see page 113) Determination of the amortisation period of development costs and CARs (see page 119) The basis of accounting for Risk and Revenue Sharing Arrangement (see page 114) Estimating provisions for warranties and guarantees (see page 116) Valuation of derivatives and hedge accounting (see page 118 and 119) Measurement of post retirement benefits (see page 115) Accounting for uncertain tax positions and deferred tax assets (see page 116) R Valuation of goodwill (see page 115) A The pressure on and incentives for management to meet revised revenue and profit guidance Refer to pages 22 to 41 (Business review) and pages 93 to 94 (Audit Committee report – Financial reporting) The risk – The Group has published a number of revisions to its revenue and profit guidance during the last two years with a generally decreasing trend in profit and revenue and there have been significant associated decreases in the Group’s share price. Clear instructions were given to the Executive Leadership Team and the senior finance executives on more than one occasion not to take any account of the pressure to meet forecasts in preparing the financial results and to manage and be alert to how this pressure might affect personnel across the wider Group. Nevertheless, the continuing heightened Rolls-Royce Holdings plc Annual Report 2015 167 Other information Other information / Independent Auditor’s report INDEPENDENT AUDITOR’S REPORT CONTINUED pressure on and incentives for management to meet the latest guidance increases the inherent risk of manipulation of the Group financial statements. The financial results are sensitive to significant estimates and judgements, particularly in respect of revenues and costs associated with long-term contracts, and there is a broad range of acceptable outcomes of these that could lead to different levels of profit and revenue being reported in the financial statements. Relatively small changes in the basis of those judgements and estimates could result in the Group meeting, exceeding or falling short of guidance. • when considering the risk relating to The presentation of underlying profit ( G refer to page 171) and the risk relating to Disclosure of the effect on the trend in profit of items which are uneven in frequency or amount ( H refer to page 172), we sought to identify items that affected profit (and/or the trend in profit) unevenly in frequency or amount (especially those where management had a greater degree of discretion over the timing or scale of transactions entered into) at a much lower level than we would otherwise have done and to assess the balance and transparency of disclosure of these items. The significance of the risk has increased marginally due to revisions to guidance issued during the year, continuing deterioration in the short-term business outlook and the incidence of individually significant items affecting profit. Our response – We have: (i) extended our enquiries designed to assess whether judgements and estimates exhibited unconscious bias or whether management had taken systematic actions to manipulate the reported results; (ii) compared the results to forecasts and challenged variances at a much lower level than we would otherwise have done based on our understanding of factors affecting business performance with corroboration using external data where possible; and (iii) applied an increased level of scepticism throughout the audit by increasing the involvement of the senior audit team personnel, with particular focus on audit procedures designed to assess whether revenues and costs have been recognised in the correct accounting period, whether central adjustments were appropriate and whether the segmental analysis has been properly prepared. In particular: • • • when considering the risk relating to The measurement of revenue and profit in the Civil Aerospace business ( C refer to page 169), we challenged the basis for changes in the estimated revenues and costs in long-term contracts, with a heightened awareness of the possibility of unconscious or systematic bias, particularly regarding the refinement in the basis of measurement of the risk contingency for forecasts of future revenue to be earned under long-term contracts which resulted in recognition of profit of £189m; when considering the risk relating to Recoverability of intangible assets in the Civil Aerospace business ( D refer to page 170), we challenged with a heightened awareness of the possibility of unconscious or systematic bias the basis for changes in the estimated maintenance costs which led to the reversal of the impairment on certain Trent 1000 launch engine Contractual aftermarket rights (“CARs”) assets and a related provision which resulted in recognition of profit of £65m and avoidance of impairments of £22m that otherwise would have been recorded; when considering the risk relating to The basis of accounting for revenue and profit in the Civil Aerospace business ( B refer below), we challenged the basis on which management had accounted for a sale of engines and a long-term service agreement as a single arrangement which resulted in recognition of profit of £44m despite there being a significant period of time between concluding these agreements; and Our findings – Our testing did not identify any indication of manipulation of results (2014 audit finding: one instance which was corrected by management). We found the degree of caution/ optimism adopted in estimates to be slightly less cautious than in the previous year, but balanced overall. We found that there was ample unbiased disclosure of items affecting the trend in profit. B The basis of accounting for revenue and profit in the Civil Aerospace business Refer to page 113 and 114 (Key areas of judgement – Introduction, Contractual aftermarket rights, Linkage of original and long-term aftermarket contracts), pages 116 and 117 (Significant accounting policies – Revenue recognition) and pages 93 and 94 (Audit Committee report – Financial reporting) 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 this drives the accounting basis to be applied. 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 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. The significance of the risk has increased marginally during the year due to the identification of one instance where the Group had to apply significant judgement in concluding that it was appropriate to account for the sale of engines and the long-term service agreement as a single arrangement. Our response – We re-evaluated the appropriateness of the accounting bases the Group applies in the Civil Aerospace business by reference to accounting standards and re-examining historical long-term aftermarket contracts. We considered whether the disclosure included in the financial statements enables shareholders to understand how the accounting policies represent the commercial substance of the Group’s contracts with its customers. 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. Our findings – We found that the Group has developed a framework for selecting the accounting bases which is consistent with a balanced interpretation of accounting standards (2014 audit finding: balanced) and has applied this consistently. We found that the disclosure was ample. 168 Rolls-Royce Holdings plc Annual Report 2015 Independent Auditor’s report For the agreements entered into during this year, it was generally clear which accounting basis should apply. We identified one instance where the Group had to apply significant judgement in concluding that it was appropriate to account for the sale of engines and the long-term service agreement as a single arrangement, resulting in the recognition of incremental profit of £44m. In this case there was a longer than usual period between conclusion of the engine sale contract and conclusion of the long-term service agreement. We found sufficient evidence that the key commercial terms included in the long-term service agreement had been established at the time the engine sale contract had been concluded and that the intention of both parties had always been to enter into a long-term service agreement on those terms. Consequently, we found the judgements made in the application of the Group’s accounting bases to these particular contracts to be balanced. 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 these 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 systematic or unconscious management bias in the context of the heightened pressure on and incentives for management to meet the latest guidance discussed above. 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 within programmes. C The measurement of revenue and profit in the Civil Aerospace business Refer to page 114 (Key areas of judgement – Measurement of performance on long-term aftermarket contracts), pages 116 and 117 (Significant accounting policies – Revenue recognition and TotalCare arrangements) and pages 93 and 94 (Audit Committee report – Financial reporting) 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 estimating future engine flying hours, time on wing and other operating parameters, the pattern of future maintenance activity and the costs to be incurred. The 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. In 2012, the Group made changes to the way it takes account of risk in making these estimates and agreed with the Audit Committee that it would carry out a comprehensive review of how well the revised basis reflected actual experience after three years. In 2015, the Group has refined the basis of taking account of risk in its estimates of future revenue resulting in an increase in estimated future revenue of approximately 2% which had a one-off profit benefit of £189m. This refinement in basis together with changes in customer flying patterns on some of the older engine programmes resulted in the significance of the risk increasing marginally in the year. In particular with regard to the refined approach to revenue forecasting risk, we assessed the extent to which the new basis better incorporates business risks affecting the Group’s customers based on recently emerging trends being experienced by the Group and our own experience. In terms of future cost estimates, we undertook detailed 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 valuation specialist 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. Our findings – Control weaknesses identified in earlier periods have been partially remediated. The scope and depth of our detailed testing and analysis was expanded to take account of the remaining weaknesses. We found no evidence that the refinement to the basis for incorporating revenue risk was motivated by the positive impact it has had on profit in the current year. Overall, our assessment is that the refined basis for incorporating revenue risk is an improvement and the assumptions and resulting estimates (including appropriate contingencies) resulted in balanced (2014 audit finding: mildly cautious) profit recognition. We found the disclosure of the impact of the refined basis for incorporating revenue risk to be ample. Rolls-Royce Holdings plc Annual Report 2015 169 Other information Other information / Independent Auditor’s report INDEPENDENT AUDITOR’S REPORT CONTINUED D Recoverability of intangible assets (certification costs and participation fees, development expenditure and contractual aftermarket rights) in the Civil Aerospace business Refer to page 115 (Key sources of estimation uncertainty – Forecasts and discount rates), pages 119 and 120 (Significant accounting policies – Certification costs and participation fees, Research and development, Contractual aftermarket rights and Impairment of non-current assets), pages 132 and 133 (Note 9 to the financial statements – Intangible assets) and pages 93 and 94 (Audit Committee report – Financial reporting) 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. In 2015, the Group reduced its estimate of the future maintenance costs on certain Trent 1000 launch engines which in previous periods had been at a level requiring the impairment of the related CARs assets and the recording of a related provision. This resulted in the reversal of previously recognised impairments and the related provision with a profit of £65m being recognised (2014: impairment charge of £19m) and the capitalisation of £22m that would otherwise have been impaired. The significance of the risk has decreased somewhat during the year due to better information on the performance of the Trent 1000 engine following the first shop visits and confirmation of the Emirates order for Trent 900 engines (the Trent 900 programme assets had been identified as being at higher risk of impairment in the prior year). Our response – We tested the controls designed and applied by the Group to provide assurance that the assumptions used in preparing the impairment calculations 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). 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 tested the mathematical accuracy of the impairment calculations. We considered whether the disclosures in note 9 to the financial statements describe the inherent degree of subjectivity in the estimates and the potential impact on future periods of revisions to these estimates. In particular, with regard to the reversal of impairments on certain Trent 1000 launch engine CARs and a related provision, we challenged the key assumptions underlying the forecast future cash flows to be derived from the engines including: the period and mode of operation of the engines, the time and materials maintenance revenue (which the Group has guaranteed will not exceed a specified maximum amount) and the cost of required maintenance activity. Our assessment was that the amount of profit to be recognised depended critically on the Group engineering department’s judgement as to the impact on estimated future maintenance costs of the wear and tear on the engines based on their first few years of operation (evidenced by the first strip down and detailed off-wing investigations of engines in the second half of 2015). Given the specialist knowledge necessary to make these judgements appropriately, we assessed the capabilities and objectivity of the employees making the judgement and the members of management reviewing and approving the judgements. Finally to supplement this and to ensure that the matter had received appropriate attention from the Board, we sought and received written representations from the Directors that, based on their enquiries, they consider that the engineering judgement is appropriate and that, based on that consideration, the recognition of the profit of £65m is appropriate. Our findings – Our testing did not identify weaknesses in the design and operation of controls that would have required us to expand the nature or scope of our planned detailed test work. We found that the assumptions and resulting estimates were balanced (2014 audit finding: balanced) and that the disclosures were proportionate (2014 audit finding: proportionate). We found no errors in calculations (2014 audit finding: none). With regard to the reversal of impairments on certain Trent 1000 launch engine CARs and a related provision, we found no evidence that this was motivated by the positive impact it has had on profit in the current year. We found that the change in estimate from the prior periods was based on improved information becoming available in 2015 as the engine programme moved out of its earliest stages which has reduced estimation uncertainty, that there was no indication of bias and that the estimate of forecast future cash flows to be derived from the engines was balanced and supported the accounting treatments adopted by the Group. We found the disclosure of the impact to be ample. E Liabilities arising from sales financing arrangements Refer to page 115 (Key areas of judgement – Customer financing contingent liabilities), page 121 (Significant accounting policies – Sales financing support), page 148 (Note 18 to the financial statements – Provisions for liabilities and charges) and pages 93 and 94 (Audit Committee report – Financial reporting) 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 a guarantee with respect to the value of an aircraft at a future date, a commitment to buy used aircraft or a guarantee of a customer’s future payments under an aircraft financing arrangement. The Group also provides standby finance lines to certain customers that can be accessed if they fail to arrange alternative financing at the time they take delivery of engines. 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. The significance of the risk has not changed during the year. 170 Rolls-Royce Holdings plc Annual Report 2015 Independent Auditor’s report 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 whether the related disclosure in note 18 to the financial statements appropriately explains 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. Our findings – We found that the level of exposure from asset value support had reduced during the year and that the assumptions and estimates were balanced (2014 audit finding: balanced) and that the disclosures were proportionate (2014 audit finding: proportionate). F Bribery and corruption Refer to page 155 (Note 23 to the financial statements – Contingent liabilities) and pages 93 and 94 (Audit Committee report – Financial reporting) 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. In December 2013, the Group announced that it had been informed by the Serious Fraud Office in the UK that it had commenced a formal investigation into bribery and corruption in overseas markets. The Group is cooperating with the Serious Fraud Office and other agencies, including 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. The significance of the risk has not changed during the year. 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 and met with the Group’s legal advisers to cross check the results of those enquiries with third parties 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 investigations, with the Audit Committee and the Board as well as the Group’s legal advisers and assessed related documentation. We assessed whether the disclosure in note 23 to the financial statements of the Group’s exposure to the financial effects of potential or suspected breaches of law or regulation complies with accounting standards and in particular whether it is the case that the investigations remain at too early a stage to assess the consequences (if any), including in particular the size of any possible fines. Our findings – We found that disclosure to be proportionate (2014 audit finding: proportionate). Presentation and explanation of results Refer to pages 22 to 41 (Business review), pages 42 to 47 (Financial review), pages 122 to 126 (Note 2 to the financial statements – Segmental analysis) and pages 93 and 94 (Audit Committee report – Financial reporting) The presentation of ‘underlying profit’ G 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 124 and 125. A significant recurring adjustment between the Adopted IFRS income statement and the ‘underlying’ income statement relates to the foreign exchange rates 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. 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. In addition, adjustments are made to exclude one-off past-service costs on post-retirement schemes, restructuring activities that significantly change the shape of the Group’s operations and the effect of acquisition accounting (including any subsequent impairments of goodwill or other intangible assets) and a number of other items. Alternative performance measures can provide shareholders with appropriate additional information if properly used and presented. In such cases, measures such as these can assist shareholders in gaining a more detailed and hence better understanding of a company’s financial performance and strategy. However, when improperly used and presented, these kinds of measures Rolls-Royce Holdings plc Annual Report 2015 171 Other information Other information / Independent Auditor’s report INDEPENDENT AUDITOR’S REPORT CONTINUED might prevent the Annual Report being fair, balanced and understandable by hiding the real financial position and results or by making the profitability of the reporting entity seem more attractive. Our findings – We identified a number of significant items that had affected profit for the year or the prior year that required appropriate disclosure in the Annual Report to enable shareholders to assess the Group’s performance. The key items are: The significance of the risk has not changed during the year. Our response – We assessed the appropriateness of the basis for the adjustments between the Adopted IFRS income statement and the ‘underlying’ income statement and the consistency of application of this basis and we recalculated the adjustments with a particular focus on the impact of the foreign exchange rates used to translate foreign currency amounts in the ‘underlying’ income statement. We assessed whether or not the selection of forward foreign exchange contracts settled in the year 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. Our findings – We found no concerns regarding the basis of the ‘underlying’ financial information or its calculation and no indication of management bias in the settlement of forward foreign exchange contracts. We consider that there is proportionate 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 (2014 audit finding: proportionate). We found the overall presentation of the ‘underlying’ financial information to be balanced (2014 audit finding: balanced). H Disclosure of the effect on the trend in profit of items which are uneven in frequency or amount The risk – The Group’s profits are significantly impacted by items such as cumulative adjustments to profit recognised on long-term contracts, impairments (and reversals of impairments) of goodwill, CARs and other intangible assets, sale and leasebacks of spare engines to joint ventures, research and development charges, reorganisation costs and foreign exchange translation which can be uneven in frequency and/or amount. If significant either to the profit for the year or to the trend in profit, appropriate disclosure of the effect of these items is necessary in the Annual Report and financial statements to provide the information necessary to enable shareholders to assess the Group’s performance. The significance of the risk has not changed during the year. Our response – We undertook detailed analysis of business performance at Group and sector level that sought to identify items that affect profit (and the trend in profit) which are uneven in frequency or amount at a much lower level than we would otherwise have done and to assess the transparency of disclosure of these items. We focused on the enhanced financial disclosures included in note 2 to the financial statements and the Business and Financial reviews. 1)  2) 3) 4) 5) the £1,315m unrealised fair value losses (2014: £1,156m) on derivative contracts; the £189m profit (2014: nil) arising from refinement in the basis of measurement of the risk contingency for forecasts of future revenue to be earned under long-term contracts; the £140m profit (2014: £60m profit) arising from the impact of improvements in lifecycle costs on long-term contracts; the £107m loss (2014: £90m profit) arising from other estimate changes on long-term contracts; the £65m profit (2014: £19m charge) (and capitalisation of £22m that otherwise would have been impaired) arising from the reversal of the impairment on certain Trent 1000 launch engine CARs and the related provision; 6) the £818m (2014: £793m) of research and development charges; 7) 8) the £88m, net of a release of prior year provisions of £30m, (2014: £188m) of restructuring charges; the £71m (2014: £54m) profit arising from sales of spare engines to joint ventures; 9) the £75m (2014: £1m) impairments of goodwill; 10) the £142m profit for the year from discontinued operations in 2014; and 11) the £64m tax charge arising from derecognition of advance corporation tax in 2014. We found that the Group had improved the disclosure of its results and the transparency of its commentary on profit trends and that ample disclosure of these items had been provided in the Annual Report and financial statements taken as a whole (2014 audit finding: proportionate). In reaching our audit opinion on the financial statements we took into account the findings that we describe above and those for other, lower risk areas including those included in the output from our Dynamic Audit planning tool set out above. Overall the findings from across the whole audit are that the financial statements have been prepared on the basis of appropriate accounting policies, reflect balanced estimates compared to the mildly cautious estimates made last year resulting in slightly favourable current year profit recognition, and provide proportionate disclosure. Having assessed these findings and evaluated uncorrected misstatements in the context of materiality and considered the qualitative aspects of the financial statements as a whole, we have not modified our opinion on the financial statements. 172 Rolls-Royce Holdings plc Annual Report 2015 3 OUR APPLICATION OF MATERIALITY AND AN OVERVIEW OF THE SCOPE OF OUR AUDIT Our measure of materiality for the Group financial statements as a whole has reduced in line with the reduction in the Group’s profit. This was set at £66m (2014: £70m) and was, as last year, determined with reference to a benchmark of Group profit before taxation, normalised to exclude the volatility in reported profit due to gains and losses on revaluation of foreign currency and other derivative financial instruments which could otherwise result in an inappropriate materiality level being determined. This materiality measure represents 4.5% (2014: 4.6%) of this benchmark and 41.3% (2014: 34.3%) of total reported profit before tax. We carry out audit procedures to assess the accuracy of the gains and losses on these derivative financial instruments (which this year amounted to a £1.3bn (2014: £1.1bn) loss) as part of our audit of the Group’s treasury operations. We report to the Audit Committee: (i) all material corrected identified misstatements; (ii) uncorrected identified misstatements exceeding £3m (2014: £4m) for income statement items; and (iii) other identified misstatements that warrant reporting on qualitative grounds. We subjected 31 (2014: 33) of the Group’s reporting components to audits for group reporting purposes and 11 (2014: 14) to specified risk-focused audit procedures. The latter were not individually financially significant enough to require an audit for group reporting purposes, but did present specific individual risks that needed to be addressed. This work also provided further audit coverage. For the remaining components, the Group audit team performed analysis at an aggregated group level to re-examine our assessment that there were no significant risks of material misstatement within these components. The reduction in reporting components subject to audit primarily resulted from the disposal of the Energy business in late 2014. The Group operates shared service centres for the bulk processing of financial transactions in Derby (UK) and Indianapolis (US), the outputs of which are included in the financial information of the reporting components they service and therefore they are not separate reporting components. Each of the service centres is subject to specified risk-focused audit procedures, predominantly the testing of transaction processing and review controls. Additional audit procedures are performed at certain reporting components to address the audit risks not covered by the work performed over the shared service centres. Independent Auditor’s report SUMMARY AUDIT SCOPE Revenue Underlying profit before tax 92% (2014: 91%) 6% (2014: 9%) 2% (2014: 0%) Audits for group reporting purposes Specified risk-focused audit procedures Group-level procedures only 94% (2014: 90%) 5% (2014: 7%) 1% (2014: 3%) Total assets 91% (2014: 83%) 7% (2014: 12%) 2% (2014: 5%) The Group audit team instructed component auditors, and the auditors of the shared service centres, as to the significant areas to be covered, including the relevant risks detailed above, and the information to be reported back. The Group audit team approved the component materialities, which ranged from £0.2m to £52m (2014: £0.3m to £60m), having regard to the mix of size and risk profile of the Group across the components. The work on 21 of the 42 (2014: 29 of 47) components was performed by component auditors and the rest by the Group audit team. The Group audit team visited 31 (2014: 25) component locations in the UK, the US, Germany, China and Scandinavia, the purpose of which included an assessment of the audit risk and strategy. Telephone conference meetings were also held with these component auditors and with those of the higher risk components that were not physically visited. At these visits and meetings, the findings reported to the Group audit team were discussed in more detail, and any further work required by the Group audit team was then performed by the component auditor. Rolls-Royce Holdings plc Annual Report 2015 173 Other information Other information / Independent Auditor’s report INDEPENDENT AUDITOR’S REPORT CONTINUED Under the Companies Act 2006 we are required to report to you if, in our opinion: • • • • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or the parent company financial statements and the part of the Directors’ Remuneration Report to be audited are not in agreement with the accounting records and returns; or certain disclosures of directors’ remuneration specified by law are not made; or we have not received all the information and explanations we require for our audit. Under the Listing Rules we are required to review: • • the directors’ statements, set out on page 57, in relation to going concern and longer term viability; and the part of the corporate governance report on page 67 relating to the Company’s compliance with the eleven provisions of the 2014 UK Corporate Governance Code 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 page 105, 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 financial statements 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/auditscopeukco2014b, 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 LLP, Statutory Auditor Chartered Accountants 15 Canada Square London E14 5GL 11 February 2016 4 OUR OPINION ON OTHER MATTERS PRESCRIBED BY THE COMPANIES ACT 2006 IS UNMODIFIED In our opinion: • • the part of the directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006; and the information given in the strategic report and directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements. Based solely on the work required to be undertaken in the course of the audit of the financial statements and from reading the strategic report and the directors’ report: • we have not identified material misstatements in those reports; and • in our opinion, those reports have been prepared in accordance with the Companies Act 2006. 5 WE HAVE NOTHING TO REPORT ON THE DISCLOSURES OF PRINCIPAL RISKS Based on the knowledge we acquired during our audit, we have nothing material to add or draw attention to in relation to: • • the directors’ viability statement on page 57, concerning the principal risks, their management, and, based on that, the Directors’ assessment and expectations of the Group’s continuing in operation over the five years to 31 December 2020; or the disclosures on page 57 and in note 1 of the financial statements concerning the use of the going concern basis of accounting. 6 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: • 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 • the Audit Committee report does not appropriately address matters communicated by us to the Audit Committee. 174 Rolls-Royce Holdings plc Annual Report 2015 Sustainability assurance OPINION Based on the assurance work we carried out and the evidence we were presented with, as per the scope of work above, nothing came to our attention to suggest that factual information, performance metrics and data contained within the Annual Report 2015, as far as the verified sustainability performance indicators are concerned, are not: • • demonstrative of Rolls-Royce Holdings plc’s understanding of the material issues that are important to its key stakeholder groups; a fair summary of Rolls-Royce Holdings plc’s sustainability-related activities and performance; and • free from significant error or omission. STATEMENT OF INDEPENDENCE, IMPARTIALITY AND COMPETENCE Rolls-Royce Holdings plc was responsible for the content of the Annual Report 2015 and Bureau Veritas was responsible for the assurance of the selected sustainability performance indicators, as per scope of works mentioned above. Bureau Veritas is an independent professional services company that specialises in quality, environmental, health, safety and social accountability with over 185 years history. Its assurance team has extensive experience in conducting assurance over environmental, social, ethical and health and safety information, systems and processes. The assurance team for this work does not have any involvement in any other Bureau Veritas projects with Rolls-Royce. Bureau Veritas has implemented a Code of Ethics across the business to ensure that its staff maintains high ethical standards in their day-to- day business activities. Flavio Gomes Sustainability Services Manager Bureau Veritas Certification UK Ltd London 1 February 2016 SUSTAINABILITY ASSURANCE Bureau Veritas Independent Assurance Statement INDEPENDENT LIMITED ASSURANCE STATEMENT Bureau Veritas Certification UK Ltd (Bureau Veritas) has been engaged by Rolls-Royce Holdings plc to provide limited external assurance of selected sustainability performance indicators for the year ended 31 December 2015, for inclusion in its Annual Report and Accounts 2015. The aim of this activity is to provide assurance over the accuracy and reliability of the reported information. SCOPE AND METHODOLOGY The reporting boundary for Rolls-Royce Holdings plc sustainability performance indicators covers all of its global business operations. The reporting period is from the 1 January 2015 to the 31 December 2015. The scope of the assurance work includes quantitative performance data only. The following sustainability performance indicators were verified: • Energy use; • Greenhouse gas (GHG) emissions; • Safety – total reportable injuries (TRI). We did not verify any other information that may be presented in Rolls-Royce Holdings plc Annual Report 2015. A limited level of assurance was undertaken taking into account the requirements of the International Standard on Assurance Engagements 3000 – Assurance Engagements other than Audits or Reviews of Historical Financial Information (ISAE 3000) and, concerning GHG emissions, the requirements of the International Standard on Assurance Engagements 3410 – Assurance Engagements on Greenhouse Gas Statements (ISAE 3410), incorporated to Bureau Veritas internal protocol for the assurance of sustainability reports. The assurance process included interviews with content owners, documentary reviews, checking of the calculation of datasets and the application of appropriate conversion factors, and the sampling of data for a number of Rolls-Royce Holdings plc’s operations. The integrity and accuracy of site data was tested by sampling data back to source in cases but mostly through the checking of aggregated data managed centrally. LIMITATIONS AND EXCLUSIONS This statement should not be relied upon to detect all errors, omissions or misstatements. The following exclusion applies: • Emissions of HFCs were not accounted for in the determination of the organisation’s overall GHG emissions, therefore, the verification of those emissions was excluded from this assurance exercise. Rolls-Royce Holdings plc Annual Report 2015 175 Other information Other information 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 2015 1.48 1.53 1.36 1.38 2014 1.56 1.65 1.28 1.24 Change -5% -7% +6% +11% 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; v) where appropriate and possible, the Group enters into consultation with tax authorities to help shape proposed legislation and future tax policy; and vi) the Group seeks to price transactions between Rolls-Royce 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 Around 95% of the Group’s underlying profit before tax (excluding joint ventures and associates) is generated in the UK, the US, 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 income tax is paid is not the same as the consolidated profit before tax reported on page 107. The main reasons for this are: i) the consolidated income statement is prepared under adopted IFRS whereas tax is paid on the profits of each Group company, which are determined by local accounting rules; 176 Rolls-Royce Holdings plc Annual Report 2015 ii) 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 iii) specific tax rules including exemptions or incentives as determined by the tax laws in each country. The Group’s total corporation tax payments in 2015 were £160m. 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 and associates would be 26.6% (the underlying tax rate including joint ventures and associates can be found on page 45). This is due to deferred tax accounting, details of which can be found in note 5 to the Consolidated Financial Statements. The impact of (iii) will often be permanent depending on the relevant tax law. Further information on the tax position of the Group can be found as follows: • Audit Committee report (page 93) – The Director of Tax gave a presentation to the Audit Committee during the year which covered various matters including tax risks and how they are managed; • Note 1 to the Consolidated Financial Statements (page 116 and 118) – Details of key areas of uncertainty and accounting policies for tax; • Note 5 to the Consolidated Financial Statements (page 128 to 130) – Details of the tax balances in the Consolidated Financial Statements together with a tax reconciliation on continuing operations. This explains the main drivers of the tax rate. At this stage we expect these items to continue to influence the underlying tax rate. The reported tax rate is more difficult to forecast due to the volatility of significant items in reported profits, in particular the net unrealised fair value changes to derivative contracts. 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, including the launch of major programmes, 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. 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. 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 A3 A Outlook Grade Stable Investment Negative Investment The Group subscribes to both Moody’s Investors Service and Standard & Poor’s for independent long-term credit ratings. At the date of this report, 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 The Consolidated Financial Statements have been prepared in accordance with International Financial Reporting Standards (IFRS), as adopted by the EU. No new accounting standards had a material impact in 2015. The impact of changes to IFRS which have not been adopted in 2015 is included within the accounting policies in note 1. Share price During the year, the share price decreased by 34% from 870p to 575p, compared to a 12% decrease in the FTSE aerospace and defence sector and 5% decrease in the FTSE 100. The Company’s share price ranged from 1054p in April 2015 to 514p in November 2015. 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. Capital structure £m Total equity Cash flow hedges Group capital Net funds 2015 5,016 100 5,116 (111) 2014 6,387 81 6,468 666 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. On 6 October 2015 the Group issued US$500m 2.375% Notes due 2020 and US$1,000m 3.625% Notes due 2025. During the year the Group renegotiated the £1,000m committed bank borrowing facility, increasing the amount to £1,500m and extending the maturity to 2020. This facility was undrawn at the period end. A €300m committed borrowing facility was cancelled during the period. At the year end, the Group retained aggregate liquidity of £5.0bn, including cash and cash equivalents of £3.2bn and undrawn borrowing facilities of £1.8bn. £419m of the facilities mature in 2016. Rolls-Royce Holdings plc Annual Report 2015 177 Other informationOther information Other information OTHER STATUTORY INFORMATION Share capital C Shares On 31 December 2015, 1,838,677,392 ordinary shares of 20p each, 28,959,754,116 C Shares of 0.1p each and one Special Share of £1 were in issue. The ordinary shares are listed on the London Stock Exchange. Payment to shareholders The Company issues non-cumulative redeemable preference shares (C Shares) as an alternative to paying a cash dividend. Shareholders can choose to: • redeem all C Shares for cash; • redeem all C Shares for cash and reinvest the proceeds in the C Share Reinvestment Plan (CRIP); or • keep the C Shares. The CRIP is operated by Computershare Investor Services PLC (the Registrar). The Registrar will purchase ordinary shares in the market for shareholders electing to reinvest their C Share proceeds. Shareholders wishing to participate in the CRIP or redeem their C Shares must ensure that their instructions are lodged with the Registrar no later than 5pm BST on 1 June 2016 (CREST holders must submit their election in CREST before 3pm BST on 1 June 2016). Redemption will take place on 4 July 2016. At the AGM, the Directors will recommend an issue of 71 C Shares with a total nominal value of 7.1p for each ordinary share. The C Shares will be issued on 1 July 2016 to shareholders on the register on 29 April 2016 and the final day of trading with entitlement to C Shares is 27 April 2016. Together with the interim issue on 4 January 2016 of 92.7 C Shares for each ordinary share with a total nominal value of 9.27p, this is the equivalent of a total annual payment to ordinary shareholders of 16.37p for each ordinary share. Further information for shareholders is on pages 182 and 183. Share class rights The full share class rights are set out in the Company’s Articles of Association (Articles), which are available on the Group’s website at rolls-royce.com, and are summarised below. Ordinary shares Each member has one vote for each ordinary share held. Holders of ordinary shares are entitled to: receive the Company’s Annual Report; attend and speak at general meetings of the Company; appoint one or more proxies or, if they are corporations, corporate representatives; and exercise voting rights. 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 have limited voting rights and attract a dividend of 75% 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 10% of the aggregate number of all C Shares issued, or on the acquisition or capital restructuring of the Company. On a return of capital on a winding-up, the holders of C Shares shall be entitled, in priority to any payment to the holders of ordinary shares, to the repayment of the nominal capital paid-up or credited as paid-up on the C Shares held by them, together with a sum equal to the outstanding preferential dividend which will have been accrued but not been paid until the date of return of capital. The holders of C Shares are only entitled to attend, speak and vote at a general meeting 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). These rights are set out in the Articles. Subject to the provisions of the Companies Act 2006, the Treasury Solicitor may redeem the Special Share at par at any time. The Special Share confers no rights to dividends but in the event of a winding-up it shall be repaid at its nominal value in priority to any other shares. Certain Articles (in particular those relating to the foreign shareholding limit, disposals and the nationality of the Company’s Directors) that relate to the rights attached to the Special Share may only be altered with the consent of the Special Shareholder. The Special Shareholder is not entitled to vote at any general meeting or any other meeting of any class of shareholders. 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 (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 provide that the Company should be and remain under UK control. As such, an individual foreign shareholding limit is set at 15% 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. 178 Rolls-Royce Holdings plc Annual Report 2015 Shareholder agreements and consent requirements Voting rights for employee share plan shares 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 the consent of the Special Shareholder. 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 Change of control At the AGM in 2015, authority was given to the Directors to allot new ordinary shares up to a nominal value of £124,333,948 equivalent to one-third of the issued share capital of the Company. In addition, a special resolution was passed to effect a disapplication of pre-emption rights for a maximum of 5% of the issued share capital of the Company. These authorities are valid until the AGM in 2016, and the directors propose to renew these authorities at that AGM. It is proposed to seek a further authority, at the AGM in 2016 to allot up to two thirds of the total issued share capital, but only in the case of a rights issue. 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 in 2016. The directors propose to renew the authority to allot new C Shares at the AGM in 2016. Authority to purchase own shares At the AGM in 2015, the Company was authorised by shareholders to purchase up to 186,500,921 of its own ordinary shares representing 10% of its issued ordinary share capital. On 6 July 2015 the Company issued revised guidance for 2015 and announced that it would be cancelling its share buyback programme, having completed £500m of the planned £1bn programme during the first half of the year. The authority for the Company to purchase its own shares expires at the conclusion of the AGM in 2016 or 18 months from 8 May 2015 whichever is the earlier. A resolution to renew it will be proposed at the 2016 meeting. Voting rights DEADLINES FOR EXERCISING VOTING RIGHTS Electronic and paper proxy appointments, and voting instructions, must be received by the Company’s Registrar not less than 48 hours before a general meeting. CONTRACTS AND JOINT VENTURE AGREEMENTS There are a number of contracts and joint venture agreements which would allow the counterparties to terminate or alter those arrangements in the event of a change of control of the Company. These arrangements are commercially confidential and their disclosure could be seriously prejudicial to the Company. BORROWINGS AND OTHER FINANCIAL INSTRUMENTS The Group has a number of borrowing facilities provided by various banks. These facilities generally include provisions which may require any outstanding borrowings to be repaid or the alteration or termination of the facility upon the occurrence of a change of control of the Company. At 31 December 2015 these facilities were less than 22% drawn (2014: 24%). The Group has entered into a series of financial instruments to hedge its currency, interest rate and commodity exposures. These contracts provide for termination or alteration in the event that a change of control of the Company materially weakens the creditworthiness of the Group. EMPLOYEE SHARE PLANS In the event of a change of control of the Company, the effect on the employee share plans would be as follows: • • • • PSP – awards would vest pro rata to service in the performance period, subject to Remuneration Committee judgement of Group performance; APRA deferred shares – the shares would be released from trust immediately; ShareSave – options would become exercisable immediately. The new company might offer an equivalent option in exchange for cancellation of the existing option; and 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. Rolls-Royce Holdings plc Annual Report 2015 179 Other informationOther information Other information OTHER STATUTORY INFORMATION CONTINUED Major shareholdings Greenhouse gas emissions At 11 February 2016 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 Rules and Transparency Rules. In 2015, our total greenhouse gas (GHG) emissions from our facilities and processes, including product test and development, was 602 kilotonnes carbon dioxide equivalent (ktCO2e). This represents a decrease of 12% compared with 683 ktCO2e in 2014. Company Date notified ValueAct Capital Master Fund, L.P. 18 November 2015 2 February 2016 Blackrock, Inc. % of issued ordinary sharecapital 10.01 5.00 All figures exclude fugitive emissions of hydrofluorocarbons (HFCs) associated with air conditioning equipment. We are putting in place a system to be able to extract this data from records kept under the F-Gas regulations. We do not anticipate a material impact on our reported GHG emissions. Directors The names of the Directors who held office during the year are set out on page 65. 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: • employee involvement • the future development, performance and position of the Group • the financial position of the Group • R&D activities • the principal risks and uncertainties page(s) 49 2 to 57 42 to 47 18 54 to 57 Political donations The Group’s policy is not to make political donations and therefore did not donate any money to any political party during the year. However, it is possible that certain activities undertaken by the Group may unintentionally fall within the broad scope of the provisions contained in the Companies Act 2006 (the Act). The resolution to be proposed at the AGM is to ensure that the Group does not commit any technical breach of the Act. During the year, expenses incurred by Rolls-Royce North America Inc. in providing administrative support for the Rolls-Royce North America Political Action Committee (RRNAPAC) was US$45,021 (2014: US$52,690). PACs are a common feature of the US political system and are governed by the Federal Election Campaign Act. The PAC is independent of the Group and independent of any political party. The PAC funds are contributed voluntarily by employees and the Company cannot affect how they are applied, although under US Law, the business expenses are paid by the Company. Such contributions do not require authorisation by shareholders under the Companies Act 2006 and therefore do not count towards the limits for political donations and expenditure for which shareholder approval will be sought at this year’s AGM to renew the authority given at the 2015 AGM. 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 Intensity ratio (total emissions normalised by revenue) for facilities, processes, product test and development, and power generation to grid (ktCO2e/£m) 2011 2012 2013 2014* 2015 218 219 241 301 242 327 313 313 382 360 545 532 554 683 602 153 155 132 12 14 15 719 852 749 0.048 0.062 0.055 * 2014 data has been restated to reflect the inclusion of greenhouse gas emissions data from Power Systems. Figures for prior years (2011 to 2013) do not include data from Power Systems and therefore are not directly comparable We engaged Bureau Veritas to undertake a limited assurance engagement, reporting to Rolls-Royce Holdings plc, using the assurance standards ISAE 3000 and ISAE 3410 over the energy, GHG and TRI data that has been highlighted with page 51 and in the table above. The full statement is included on page 175 and as set out on With the exceptions noted above, we have reported on all of the emission sources required under the Companies Act 2006 (Strategic Report and Directors Reports) Regulations 2013. These sources fall within our Consolidated Financial Statements. We do not have responsibility for any emission sources that are not included in our Consolidated Financial Statement. We have used the GHG Protocol Corporate Accounting and Reporting Standard (revised edition) as of 31 December 2014, data gathered to fulfil our requirements under the Carbon Reduction Commitment (CRC) Energy Efficiency scheme and emission factors from the UK Government’s GHG Conversion Factors for Company Reporting 2015. Further details on our methodology for reporting and the criteria used can be found within our Basis of Reporting, available to download from our website at rolls-royce.com/sustainability. 180 Rolls-Royce Holdings plc Annual Report 2015 Branches Management report Rolls-Royce is a global company and our activities and interests are operated through subsidiaries, branches of subsidiaries, joint ventures and associates which are subject to the laws and regulations of many different jurisdictions. Our subsidiaries, joint ventures and associates are listed on pages 160 to 166. Post balance sheet events There have been no events affecting the Group since 31 December 2015 which need to be reflected in the 2015 Consolidated Financial Statements. Financial instruments Details of the Group’s financial instruments are set out in note 17 to the Financial Statements. Related party transactions Related party transactions are set out in note 24 to the Consolidated Financial Statements. Information required by UK Listing Rule (LR) 9.8.4 There are no disclosures to be made under LR 9.8.4. The Strategic Report and the Directors’ Report together are the management report for the purposes of Rule 4.1.8R of the Financial Conduct Authority’s (FCA’s) Disclosure Rules and Transparency Rules. 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 audit 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. Rolls-Royce Holdings plc Annual Report 2015 181 Other informationOther information Other information SHAREHOLDER INFORMATION Financial calendar 2016-2017 5 MAY 11.00AM AGM East Midlands Conference Centre, Nottingham 1 JULY Payment of cash dividend on C Shares 1 JULY Allotment of C Shares 4 JULY Payment of C Share redemption monies 11 JULY Purchase of ordinary shares for CRIP participants (at the latest) 28 JULY Announcement of half-year results 11 NOVEMBER Record date for cash dividend on C Shares 4 JANUARY Payment of cash dividend on C Shares 4 JANUARY Allotment of C Shares 6 JANUARY Payment of C Share redemption monies 13 JANUARY Purchase of ordinary shares for CRIP participants (at the latest) APR 2016 MAY 2016 JUN 2016 JUL 2016 AUG 2016 SEP 2016 OCT 2016 NOV 2016 DEC 2016 JAN 2017 FEB 2017 MAR 2017 28 APRIL Ex-entitlement to C Shares 29 APRIL Record date for entitlement to C Shares 1 JUNE 5.00PM Deadline for receipt by Registrar of C Share instructions (3pm for CREST holders) 3 JUNE Record date for cash dividend on C Shares 20 OCTOBER Ex-entitlement to C Shares 21 OCTOBER Record date for entitlement to C Shares 1 DECEMBER 5.00PM Deadline for receipt by Registrar of C Share instructions (3pm for CREST holders) 31 DECEMBER Financial year end FEBRUARY Announcement of full year results MARCH Annual Report published Managing your shareholding Share dealing 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 beginning with the letter ‘C’ 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)370 703 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 0.1p 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 strongly 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 and means that cleared payments will be credited to your bank account on the payment date. The Registrar offers existing shareholders an internet dealing service at www-uk.computershare.com/investor/sharedealing.asp and a telephone dealing service (+44 (0)370 703 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% of the transaction value subject to a minimum fee of £30. The fee for telephone dealing is 1% of the transaction plus £35. Stamp duty of 0.5% is payable on all purchases. Other share dealing facilities are available but you should always use a firm regulated by the FCA (see fca.org.uk/register). Your share certificate Your share certificate is an important document. If you sell or transfer your shares you must make sure 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 may be liable for any costs incurred by the broker. Share certificates issued in the name of Rolls-Royce plc or Rolls-Royce Group plc are invalid and should be destroyed. If you are unable to find your share certificate please inform the Registrar immediately. American Depositary Receipts (ADR) ADR holders should contact the depositary, JP Morgan, by calling +1 (800) 990 1135 (toll free within the US) or emailing adr@jpmorgan.com. 182 Rolls-Royce Holdings plc Annual Report 2015 WARNING TO SHAREHOLDERS – INVESTMENT SCAMS Visit Rolls-Royce online We are aware that some of our shareholders have received unsolicited telephone calls or correspondence, offering to buy or sell their shares at very favourable terms. The callers can be very persuasive and extremely persistent and often have professional websites and telephone numbers to support their activities. These callers will sometimes imply a connection to Rolls-Royce and provide incorrect or misleading information. This type of call should be treated as an investment scam – the safest thing to do is hang up. You should always check that any firm contacting you about potential investment opportunities is properly authorised by the FCA. If you deal with an unauthorised firm you won’t be eligible for compensation under the Financial Services Compensation Scheme. You can find out more about protecting yourself from investment scams by visiting the FCA’s website fca.org.uk/consumers, or by calling the FCA’s consumer helpline on 0800 111 6768 (overseas callers dial +44 20 7066 1000). If you have already paid money to share fraudsters contact Action Fraud immediately on 0300 123 2040, whose website is at actionfraud.police.uk Remember: if it sounds too good to be true it probably is. DIVIDENDS PAID ON C SHARES HELD C Share calculation period 1 July 2015 – 31 December 2015 1 January 2015 – 30 June 2015 PREVIOUS C SHARE ISSUES Visit rolls-royce.com to find out more about the latest financial results, the share price, payments to shareholders, the financial calendar and shareholder services. Available as a free download from the app store 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 app which provides the latest media and financial information. C Share dividend rate (%) 0.276 0.257 Record date for C Share dividend 13 November 2015 29 May 2015 Payment date 4 January 2016 1 July 2015 No. of C Shares issued per ordinary share 92.7 141 Record date for entitlement to C Shares 23 October 2015 24 April 2015 Latest date for receipt of payment instruction forms by Registrar 1 December 2015 1 June 2015 Issue date 4 January 2016 1 July 2015 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 (%) 559.75 883.19 9.27 14.1 98.37 98.43 1.63 1.57 Date of redemption of C Shares 6 January 2016 3 July 2015 CRIP purchase date 12 January 2016 7 July 2015 CRIP purchase price (p) 557.9420 792.8752 For information on earlier C Share issues, please refer to the Group’s website rolls-royce.com. ANALYSIS OF ORDINARY SHAREHOLDERS AT 31 DECEMBER 2015 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 189,421 8,255 197,676 62,852 98,014 34,992 1,246 405 167 197,676 % of total shareholders 95.82 4.18 100.00 31.80 49.58 17.70 0.63 0.21 0.08 100.00 Number of shares 97,169,761 1,741,507,631 1,838,677,392 5,942,067 26,777,158 56,893,428 33,698,261 137,315,629 1,578,050,849 1,838,677,392 % of total shares 5.28 94.72 100.00 0.32 1.46 3.09 1.83 7.47 85.83 100.00 Rolls-Royce Holdings plc Annual Report 2015 183 Other informationOther information Other information GLOSSARY anti-bribery and corruption American Depositary Receipts Annual General Meeting Approved Maintenance Centre Annual Performance Related Award plan Articles of Association of Rolls-Royce Holdings plc non-cumulative redeemable preference shares commercial and administrative Compound Annual Growth Rate contractual aftermarket rights chief executive officer chief financial officer cash-generating unit carbon dioxide Rolls-Royce Holdings plc cash flow per share C Share Reinvestment Plan Executive Leadership Team earnings per share European Union euro Financial Conduct Authority Future Combat Air System Financial Reporting Council foreign exchange Great British pound or pound sterling greenhouse gas ABC ADR AGM AMC APRA Articles C Shares C&A CAGR CARs CEO CFO CGU CO2 Company CPS CRIP ELT EPS EU EUR FCA FCAS FRC FX GBP GHG Global Code Global Code of Conduct Group HMRC HS&E I&C IAB IAS Rolls-Royce Holdings plc and its subsidiaries HM Revenue & Customs health, safety and environment instrumentation and control International Advisory Board International Accounting Standards IASB IFRIC IFRS KPIs ktCO2e LIBOR LTSA LNG MRO NCI NOx OCI OE OECD PBT PSP R&D R&T REACH Registrar RRPS RRSAs SFO SIP SOx STEM TCA the Code TRI TSR USD/US$ UTCs International Accounting Standards Board International Financial Reporting Interpretations Committee International Financial Reporting Standards key performance indicators kilotonnes carbon dioxide equivalent London Inter-Bank Offered Rate long-term service agreement liquefied natural gas Maintenance, repair and overhaul non-controlling interest nitrogen oxides other comprehensive income original equipment Organisation for Economic Cooperation and Development profit before tax Performance Share Plan research and development research and technology Registration, Evaluation Authorisation and restriction of CHemicals Computershare Investor Services PLC Rolls-Royce Power Systems AG risk and revenue sharing arrangements Serious Fraud Office Share Incentive Plan sulphur oxides science, technology, engineering and mathematics TotalCare agreement UK Corporate Governance Code total reportable injuries total shareholder return United States dollar University Technology Centres 184 Rolls-Royce Holdings plc Annual Report 2015 Designed and produced by 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 2016 Rolls-Royce Holdings plc Registered office: 62 Buckingham Gate London SW1E 6AT T +44 (0)20 7222 9020 www.rolls-royce.com Company number 7524813 

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