Rolls-Royce Holdings plc
Annual Report 2017
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Financial Highlights and Contents
01
Pioneering the
power that matters
Rolls-Royce pioneers cutting-edge
technologies that deliver the cleanest,
safest and most competitive solutions
to meet our planet’s vital power needs.
Financial Highlights *†‡
Free cash flow
£273m
2016: £100m
Underlying revenue
£15,090m
2016: £13,783m
Underlying operating profit
£1,175m
2016: £915m
Underlying profit before tax
£1,071m
2016: £813m
Order book
£78,476m
2016: £80,910m
Reported revenue
£16,307m
2016: £14,955m
Reported operating profit
£1,287m
2016: £44m
Reported profit/(loss) before tax
£4,897m
2016: £(4,636)m
Underlying earnings per share
40.5p
2016: 30.1p
Reported earnings per share
229.4p
2016: (220.1)p
Full year payment to shareholders
11.7p
2016: 11.7p
Net debt
£(520)m
2016: £(225)m
* All figures in the narrative of the Strategic Report are underlying unless otherwise stated.
Underlying explanation is in note 2 to the Financial Statements on page 132.
† Unless otherwise stated, all underlying financial data excludes the impact of the acquisition of ITP Aero,
completed on 19 December 2017.
‡ All references to organic change are at constant translational currency, excluding M&A.
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.
Contents
Strategic Report
Group at a Glance
Chairman’s Statement
Chief Executive’s Review
The Trends Shaping our Markets
Our Vision and Strategy
Business Model
Key Performance Indicators
Financial Review
Business Review
Civil Aerospace
Defence Aerospace
Power Systems
Marine
Nuclear
Technology
Sustainability
Environment
People
STEM
Ethics
Additional Financial Review
IFRS 15
2018 Outlook
Principal Risks
Going Concern and Viability Statements
Directors’ Report
Chairman’s Introduction
Board of Directors
Corporate Governance
Committee Reports
Nominations & Governance
Remuneration
Audit
Safety & Ethics
Science & Technology
Responsibility Statements
Other Statutory Information
Financial Statements
Financial Statements Contents
Group Financial Statements
Company Financial Statements
Subsidiaries
Joint Ventures and Associates
Other Information
Independent Auditor’s Report
Sustainability Assurance Statement
Other Financial Information
Other Statutory Information
Shareholder Information
Glossary
02
04
06
10
11
12
14
16
20
20
26
30
34
38
42
44
44
46
48
49
50
55
58
59
63
64
66
69
79
79
83
97
104
110
114
198
115
116
172
175
181
183
195
196
198
202
204
STRATEGIC REPORT
02
Strategic Report
Group at a Glance
Rolls-Royce Holdings plc Annual Report 2017
Group at a Glance
Underlying revenue mix in 2017
Nuclear
5%
Marine
7%
We are one of
the world’s leading
industrial technology
companies, creating
power and propulsion
systems for use on land,
at sea and in the air.
Power
Systems
20%
Civil
Aerospace
53%
Defence
Aerospace
15%
Underlying revenue
£15,090m
Underlying operating profit
£1,175m
Free cash flow
£273m
Gross R&D expenditure
£1.4bn
Patents approved for filing
704
Countries
50
Read more in our
Business Review
on pages 20 to 41
Engineers (year end)
18,245
Employees (year average)
50,000
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Group at a Glance
03
Our five businesses in 2017
Civil
Aerospace
See page 20
Defence
Aerospace
See page 26
Power
Systems
See page 30
Marine
See page 34
Nuclear
See page 38
Civil Aerospace is a major
manufacturer of aero engines
for the large commercial
aircraft, regional jet and
business aviation markets.
The business uses its
engineering expertise,
in-depth knowledge and
capabilities to provide
through-life support
solutions for its customers.
Defence Aerospace is a
market leader in defence
aero engines for military
transport and patrol aircraft
and has strong positions
in other sectors, including
combat, training aircraft
and helicopters.
Power Systems is a leading
provider of high-speed and
medium-speed reciprocating
engines, complete propulsion
systems and distributed
energy solutions. The business
serves the marine, defence,
power generation and
industrial markets.
Marine manufactures and
services propulsion and
handling solutions for the
maritime offshore, merchant
and naval markets, ranging
from standalone products to
complex integrated systems.
Nuclear is the technical
authority for the UK nuclear
steam raising plant that
powers the Royal Navy’s
nuclear submarine fleet;
managing plant design,
safety, manufacture and
service support. Our civil
nuclear operation supplies
safety-critical systems to
about half the world’s
nuclear power plants.
Underlying revenue
£8,023m
Underlying
operating profit
£520m
Underlying revenue
£2,275m
Underlying
operating profit
£374m
Underlying revenue
£2,923m
Underlying
operating profit
£330m
Underlying revenue
£1,077m
Underlying
operating loss
£(25)m
Underlying revenue
£818m
Underlying
operating profit
£38m
Underlying revenue mix
V2500
12%
Business
aviation
14%
Regional
4%
Large
engine
70%
Underlying revenue mix
Other
17%
Combat
30%
Transport
and patrol
53%
Underlying revenue mix
Defence
and other
12%
Industrial
25%
Marine
30%
Power generation
33%
Underlying revenue mix
Naval
31%
Commercial
69%
Underlying revenue mix
Civil
nuclear
23%
Submarines
77%
* From January 2018, Rolls-Royce will be reporting as three new core business units. See page 8 for more information.
STRATEGIC REPORT
04
Strategic Report
Chairman’s Statement
Rolls-Royce Holdings plc Annual Report 2017
Chairman’s Statement
Ian Davis
Chairman
Our focus on improving operational and financial
performance has been demonstrated in this year’s
results. Our new vision and refreshed strategy
lays a firm foundation for creating long-term
shareholder value.
Chairman’s Introduction to Directors’ Report page 64
2017 Overview
After a very challenging few years, I believe
that Rolls-Royce is building real and
sustainable momentum. Progress will not
be smooth, given the nature of the industry
and the number of new products we are in
the process of introducing into the market,
and I do not want to underestimate the
risks. But, the medium-term prospects
look increasingly bright and the long-term
opportunities for us remain significant.
Our near to medium-term priorities are:
to improve operational performance, with
the focus on product reliability for our
customers and on cost competitiveness;
and cash flow generation for our long-term
prosperity. Growth opportunities for us in
our core industries are excellent. We have
to build customer satisfaction and cash flow
and, as a consequence, strengthen investor
confidence, to enable us to capitalise on
these. That is what we are determined to do.
Warren East, our Chief Executive, gives
in his report a full explanation of major
milestones and achievements in 2017. I would
like to highlight a few key developments.
There has been great progress in building
the executive leadership team. We have
refreshed our strategy and long-term vision.
We have refined our capital allocation
process. We have delivered financial
results ahead of budget and expectations
and we have ramped up production in our
Civil Aerospace business. We have initiated
a simplification of the Group into three
businesses and are embarking upon a
fundamental restructuring. This will make
for a simplified and more focused business.
At the same time, we have had to deal with
some significant operational challenges,
most notably with some in-service fleet
issues on two of our Civil Aerospace large
engine programmes. We are acutely aware
of the challenge this has created for some
of our customers. Our absolute priority
is to overcome these. Customer trust and
confidence – the bedrock of any business
– is, and must be, our number one goal.
We are continually looking to inject pace
and simplicity into our business operations,
even as we expand production to meet the
growth in demand for our products. We are
well advanced in the complex process of
overhauling our management information
systems. Our intent is to provide the data
we need, not only to manage the business
effectively, but to provide greater clarity
on outcomes and progress – progress in
real economic, not just accounting, terms.
We are a long-term business with long
investment cycles. We have continued
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Chairman’s Statement
05
our commitment to, and investment in, next
generation technologies and facilities that
will be crucial to competitiveness and value
creation. We have met our key technology
milestones. I would draw attention to the fact
that we have sustained investment in capital
expenditure and R&D notwithstanding
short-term financial pressures.
We are putting increased emphasis on
strategic partnerships and collaborations.
These collaborations range across
electronics, composite materials, gearbox
technology, digital technologies and
services. We are determined to be at the
forefront of the ‘next technology revolution’
built around artificial intelligence, data
analytics, machine learning and digital.
This will be crucial to our future
competitiveness as well as to our ability
to attract and retain exceptional talent.
I would also like to draw attention to the
progress we have made on the management
of environmental impacts and the increased
emphasis we are giving to safety. These are
foundational goals and responsibilities that
I, and the Board, monitor carefully.
Governance and culture
In January 2017, the Group entered into
deferred prosecution agreements with
the UK Serious Fraud Office and other
authorities. This has been a sobering
experience for all concerned. The Board
and executive team remain totally
committed to always acting with integrity
and to ensuring that the appropriate values
and behaviours are embedded throughout
the Group. This is an ongoing and relentless
task and it is an absolute priority for the
Board and management.
Culture, as always, is key. There is much
to cherish and to protect in the Rolls-Royce
culture. But we also have to develop and
adapt. We need to be more transparent
and open, and to engage more externally.
Performance management, cost
competitiveness and operational delivery
against commitments are as fundamental
to our longer-term aspirations and goals
as are product innovation and technology.
As a Board, we are determined to role
model these cultural ambitions. We have,
for example, introduced a Meet the Board
initiative where employees have the
opportunity to meet with and question the
Board at an ‘employee AGM’ style event.
In addition – as part of our focus on a
more open, inclusive culture – I asked
Irene Dorner, one of our Non-Executive
Directors, to take on an employee champion
role on the Board.
An additional cultural priority is to build
a more diverse organisation. This is a
daunting challenge for us, and indeed
for the whole sector. Progress to date has
been disappointing. We have to do more
and this remains high on my agenda and
on my list of frustrations. Rolls-Royce has
an extraordinary brand and we are
exceptionally well-placed to defy the
traditional engineering industry norms. I am
hugely encouraged by the great work that
so many colleagues from Rolls-Royce across
the world do to inspire the next generation
in science, technology, engineering and
maths (STEM) careers. I continue to be
inspired by the work done by our support
networks and employee resource groups
to stimulate and reinforce diversity. I am also
very pleased that the proportion of women
we recruit as apprentices and graduates
increased again in 2017. But there still
remains much to be done to improve
diversity and inclusion and to accelerate,
in particular, the advancement of talented
women and high potential younger
executives into senior management roles.
This is a huge talent opportunity for us.
As part of this focus on diversity in 2017,
I introduced a new Board apprentice
programme designed to give prospective
leaders within the business insights and
experience into the working of the Board.
Investor trust and confidence
I am acutely aware that in recent years our
credibility with investors has been damaged.
We are determined to restore it and we
know that it is results, not words, that will
be the catalyst. This is a long-term business
that needs shareholders with a long-term
perspective. That perspective must be
based on a long-term confidence in the
growth prospects of the industry, in the
value creation potential of the Company
and in the strength of the management team.
Risk assessment is an important part of
the Board’s work. This has been important
input into our viability statement, which we
see as a lot more than a short-term liquidity
assessment. There are significant risks –
most notably product reliability failure,
a disorderly Brexit or an external global
shock that would disrupt travel. We have
contingency plans to address these risks.
We understand the importance of dividends
to many of our shareholders, and also the
importance of rebuilding a strong balance
sheet and credit rating. I do not believe that,
in the long term, these are incompatible
with our growth aspirations. We will
talk more during 2018 about our capital
allocation plans and priorities. For the short
term, our focus is on generating cash to
meet the investment needs of the business
and to strengthen our balance sheet and
credit rating.
Delivering on our financial commitments
is fundamental to investor confidence and
trust. In addition, we are striving to reinforce
this with more open engagement with
investors. In addition to our regular
interactions with investors, we have held
a series of governance events, including
a seminar in the spring of 2017. We plan
to continue this level of engagement.
Improved transparency of financial results
plays an important role in investor
confidence. We are working hard to make
our accounts and, more importantly, our
business economics, more intelligible and
accessible. The implications of IFRS 15 and
IFRS 16 may complicate matters in the short
term and we will work to clarify the impact
of these new accounting regulations. The
accounting regulation changes will, I believe,
be beneficial. It is in everyone’s interest to
better align the recognition of profit and
cash. Profitability, and return on capital in
particular, are crucial strategic measures but
for the short term, cash flow is our dominant
financial metric.
Conclusion
I hope the preceding words have been
helpful in clarifying where we stand.
We are, I believe, building real momentum.
Our short-term focus over the next two to
three years is on meeting customer
commitments and requirements whilst
generating substantial increases in cash flow.
Longer term, our goal is to build and grow
our business so that, in time, we are a
world-leading industrial technology
company focused on pioneering the power
that matters. This is not an industry sector
short of growth options. Our long-term
aim is to capitalise on them, effectively
and responsibly.
I would like to conclude this statement
with a big thanks to all my colleagues in
Rolls-Royce. It has been another demanding
year, but one marked by real progress.
The drive, dedication and ingenuity of
our people (and, indeed, of our former
employees) across the globe is extraordinary
and, I believe, the Company’s single biggest
asset. I continue to be inspired by the
dedication and sheer decency of our
people and their passion for Rolls-Royce.
Ian Davis
Chairman
STRATEGIC REPORT 06
Strategic Report
Chief Executive’s Review
Rolls-Royce Holdings plc Annual Report 2017
Chief Executive’s Review
Warren East
Chief Executive
Rolls-Royce made good progress in 2017, achieving
a number of important operational and technological
milestones, while focusing on managing significant
in-service engine issues in Civil Aerospace. Looking
forward, sustaining this improvement and delivering
increasing cash flow generation will strengthen our
position as one of the world’s leading industrial
technology companies.
Underlying revenue (£m)
£15,090m
2017
2016
15,090
13,783
Underlying operating profit (£m)
£1,175m
2017
2016
Free cash flow (£m)
£273m
2017
2016
100
Review of 2017
1,175
915
273
Overview
Rolls-Royce made good progress in 2017,
achieving a number of important operational
and technological milestones. Results were
ahead of our expectations as we delivered
growth in underlying revenue, underlying
operating profit and free cash flow. This was
achieved while focusing on managing the
well-publicised in-service fleet issues on
the Trent 1000 and Trent 900 engines that
led to increased costs as efforts were made
to minimise the disruptive impact on our
customers and to develop longer-term
solutions. There was better understanding
across the business of the need for cultural
change and tangible progress in our efforts
to increase openness and transparency with
investors. We strengthened the executive
leadership team (ELT) as we continued to
drive cultural change across the Group.
We completed our strategic update and
are ready to move forward in our drive
for pace and simplicity, restructuring from
five to three businesses, with a review
of strategic options for our commercial
marine operation.
Civil Aerospace had some notable successes
in 2017 with record levels of large engine
deliveries, further expanding the installed
fleet and generating service revenue
growth. We made good progress with our
new large engine programmes, achieving
the first flight of three new engine designs
within a 12-month period. Power Systems
delivered a strong performance
in its first year with new leadership,
streamlining the product portfolio and
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Chief Executive’s Review
07
making new inroads into the Chinese market.
Defence Aerospace had another solid
year as we renewed a number of core US
contracts and further developed our service
delivery capability. We delivered operational
improvements in Nuclear, while in Marine we
established leadership in ship intelligence
and autonomous shipping. We also received
regulatory approval for the acquisition of ITP
Aero which was completed on 19 December
2017 – see page 9.
The Group faced several challenges in the
year. These are not unusual given the nature
of the industries in which we operate. In Civil
Aerospace, production milestones were
achieved against a backdrop of capacity
constraints, primarily blade manufacturing
and test bed availability, driven by the
in-service fleet issues on the Trent 1000
and Trent 900. As these emerged during
the year, we increased our estimates of
additional maintenance activity required
to mitigate problems, to develop longer-term
solutions and to support customers through
a proactive engine management programme
to minimise any disruption. In Marine, with
the average Brent crude oil price remaining
below US$55 per barrel for the third
consecutive year, our commercial marine
operation continued to see substantially
reduced activity levels in its historically
important offshore market.
Efficiencies from the 2015 transformation
programme have achieved run-rate cost
savings at the top end of our initial
expectations of £200m by the end of 2017.
However, costs and complexity within
the Group remain too high. The further
simplification announced in January 2018
to move from five to three operating
businesses will enable us to act with greater
pace, to innovate in core technologies
and to better take advantage of future
opportunities in areas such as electrification
and digitalisation. It will help us to undertake
a more fundamental restructuring to
remove duplicated support and
management functions.
Within the Group, we appreciate our talk
of simplification must translate into greater
enablement for our people if we are to
succeed in bringing about lasting change.
These efforts must begin with our leaders
and during the year I brought in additional
talent and experience to the ELT with the
appointment of Stephen Daintith as Chief
Financial Officer, Paul Stein as Chief
Technology Officer and Simon Kirby as
Chief Operating Officer. In early 2018, we
announced Chris Cholerton would be taking
up the post of President – Civil Aerospace,
Tom Bell would be returning to Rolls-Royce
as President – Defence and Harry Holt took
up the post of Group HR Director.
2017 priorities
Strengthen
our focus on
engineering,
operational and
aftermarket
excellence
Sustain
the strong
start to our
transformation
programme
Rebuild
trust and
confidence
in our long-term
growth prospects
Develop
our long-term
vision and
strategy
2017 priorities
At the beginning of the year we set out
four key priorities:
Priority 1: Strengthen our focus
on engineering, operational and
aftermarket excellence
Engineering excellence – our central
engineering function was restructured to
integrate engineering into the businesses
closer to our customers. At the same time,
we have created a new technology team
led by the Chief Technology Officer to
heighten the importance of technology
in driving future growth – see pages
42 and 43. We invested over £1bn in
self-funded R&D in 2017, part of which
supported the installation of digital
engineering tools, producing our first
all-digital engine design.
‘
The Trent XWB-84 achieved
over 1.2 million flying hours
with unprecedented levels
of reliability.’
In Civil Aerospace, while we worked to
minimise the impact of in-service issues,
key milestones were achieved towards
entry into service for the new
Trent 1000 TEN, Trent XWB-97 and
Trent 7000. Testing of our new power
gearbox design, a vital component in our
new UltraFan demonstrator programme,
has proceeded well and the Advance3
demonstrator achieved its first successful
ground test. Electrification will play an
increasingly important role in all areas of
the Group over the coming years and during
the year we established a new electrical unit.
In November 2017, we announced that
we will develop the E-Fan X hybrid electric
aircraft demonstrator in collaboration
with Airbus and Siemens; reflecting the
growing importance of electrification
to the long-term future of the
aerospace industry.
Operational excellence – a new operating
strategy was developed and we invested
a further £764m in capital expenditure
in 2017. Capitalising on the rapidly
advancing digital techniques, our aim is
to create an agile, highly productive and
cost-competitive manufacturing footprint.
Our new plants have already undergone
a digital transformation generating an
unprecedented insight into our value
chain capability. We are also developing
industry-leading capabilities in digital
manufacturing, through innovative
collaboration and partnerships, which will
lead to double-digit benefits in productivity
and efficiency. All our businesses had
significant execution targets and product
delivery milestones to achieve. Civil
Aerospace delivered a 35% increase in
large engine deliveries. In Defence
Aerospace, the modernisation programme
at the Indianapolis facility progressed well
and is on track with its cost saving targets.
In Power Systems, the new leadership
focused the business on simplifying the
product portfolio, achieving around a 20%
year-on-year reduction in product variants.
Aftermarket excellence – service focus is
driven by customer demand for reliability
and availability. This has seen aftermarket
support transition from the sale of spare
products to a partnership with customers
based on predictive maintenance and
proactive management of in-service issues.
In 2017, the Civil Aerospace team worked
hard to minimise customer disruption from
in-service fleet issues with our Trent 1000
and Trent 900 engines and to develop
longer-term solutions. Concurrently, the
Trent XWB-84 achieved over 1.2 million
flying hours with unprecedented levels
of reliability. In Defence Aerospace, we
opened a further two dedicated service
delivery centres (SDCs) to support the
RAF and the Indian Air Force, accelerating
decision-making on engine issues to
maximise availability. Power Systems also
opened customer care centres in key time
zones, replicating the TotalCare service
developed in Civil and Defence Aerospace.
Power Systems’ first availability contract
commenced in 2017 with Hitachi Rail to run
STRATEGIC REPORT 08
Strategic Report
Chief Executive’s Review
Rolls-Royce Holdings plc Annual Report 2017
for over 20 years, covering support for the
UK’s intercity programme. Looking forward,
a focus on lifecycle costs coupled with the
delivery of more digitally enabled engines
and systems should support further growth
in proactive service management offerings
at Power Systems.
Priority 2: Sustain the strong start
to our transformation programme
On-target delivery of transformation
benefits – since November 2015, we have
been pursuing a transformation programme
focused on simplifying the organisation,
streamlining management, reducing
fixed costs and adding greater pace
and accountability to decision-making.
The benefits are on-target, having achieved
run-rate cost savings at the top end of
our initial expectations of £200m by the
end of 2017.
Priority 3: Rebuild trust and
confidence in our long-term
growth prospects
Greater financial transparency through
further clarity on cash drivers and
revenue – as outlined at our half-year 2017
results, our focus is on sustaining stronger
cash generation. A stronger finance team,
led by Stephen Daintith, is bringing greater
financial transparency and clarity both
internally and for our investors. In 2018,
we plan to introduce new KPIs to align
with our refined long-term performance
objectives and reflect our focus on free
cash flow as a fundamental indicator of
performance. See page 17 for more details.
On adopting the new revenue reporting
standard IFRS 15, introduced from 1 January
2018, we have selected accounting policies
that provide clarity and transparency of
our revenue and profit – see page 55.
On page 170 we have taken the opportunity
to proactively present our 2017 financial
results as they would look under the new
reporting standard.
Priority 4: Develop our
long-term vision and strategy
Refreshed vision and strategy for
Rolls-Royce – we completed our strategic
update in the year and in early January
2018 we announced a simplification from
five to three businesses and a review
of strategic options for our commercial
marine operation. This simplification
aligns our business more closely with our
customers and with our strategic vision
to pioneer cutting-edge technologies
that deliver the cleanest, safest and most
competitive solutions to meet our planet’s
vital power needs.
Our ambition is to be the world’s leading
industrial technology company. We will
continue to innovate in our core areas
while looking to champion electrification
to support the move to a low carbon global
economy. Our digital tools and technologies
will allow us to create new insights and
opportunities across our businesses.
The simplification of the Group enables
us to focus our capital allocation
on projects that support our strategy.
Further details on our vision and strategy
can be found on page 11.
Simplification of the business (based on 2017 revenue)
Existing five operating businesses
Civil
Aerospace
£8.0bn
Power
Systems
£2.9bn
Defence
Aerospace
£2.3bn
Nuclear
£0.8bn
Marine
£1.1bn
New core business units *
Civil
Nuclear
£0.2bn
Submarines
£0.6bn
Naval
Marine
£0.3bn
Commercial
Marine
£0.8bn
Civil
Aerospace
£8.0bn
Power
Systems
£3.1bn
Defence
£3.2bn
Operation
subject to
a review of
strategic
options
* Following the acquisition of ITP Aero in December 2017, it will operate and report as a separate business unit.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Chief Executive’s Review
09
2018 priorities and outlook
Our people worked hard in 2017 but more
remains to be done. Our goal is to make
2018 a breakthrough year in terms of
strategic, operational and financial goals.
The simplification of our operating
businesses into three focused units will
enable the Group to operate at greater
pace. We must also address the cost
and complexity of the Group in order to
improve the service we offer customers
and our financial returns. I am confident
that with the right management team now
in place, a simplified business structure
and steps being taken to improve our
processes, we will make further meaningful
progress in meeting our strategic,
operational and financial goals in 2018.
Our largest business, Civil Aerospace,
will continue to focus on increasing engine
deliveries and working with customers
to minimise the impact of in-service engine
issues. Across the Group there will be new
product introductions and continued R&D
investment and capital expenditure to
revitalise current products and innovate
new technologies. We will also look to
report progress on the strategic review
of our commercial marine operation.
This fundamental restructuring, combined
with improving cash flow, will strengthen
our balance sheet and we will communicate
2018 priorities
Customers
mitigate impact to
rectify in-service
issues, ramp up
large engine
production,
grow service
capabilities
Technology
focus through
product
digitalisation,
electrification
and revitalisation
Resilience
through
adaptability with
a spotlight on
safety, diversity &
inclusion, and the
highest ethical
standards
Financial progress
delivering
improving free
cash flow,
strengthening
balance sheet,
more disciplined
capital allocation
the KPIs that underpin a more disciplined
approach to capital allocation. While Group
underlying revenue and profit before
financing will be impacted by the adoption
of IFRS 15, free cash flow is unaffected
by accounting changes and is expected
to increase significantly from 2017 levels.
Longer-term outlook
Our longer-term outlook remains strong
and we believe in the transformative
potential of our technology. The
progressive roll-out of our original
equipment into markets with long-term
underlying growth will increase our
installed base over the next ten years.
This, in turn, will drive significant free cash
flow as we increase penetration of our
service products. The fundamental
restructuring announced in January 2018
shows our willingness to take decisive
action now in order to secure and enhance
the long-term benefit of the cash flows that
will be generated over the years to come.
We must become a more agile and
adaptable organisation.
Our aim is for our people to have a shared
vision while being empowered to act
responsively. This will support us as we
look to develop innovative power expertise,
new digital solutions and advances in
electrification that will enable Rolls-Royce
technology to lead the world into a low
carbon future.
ITP AERO BECOMES A ROLLS-ROYCE COMPANY
In late 2017, Rolls-Royce received approval from the Spanish
Government for the acquisition of the 53.1% stake in ITP Aero
owned by our partner in the business, SENER. Having taken
full ownership of the company, ITP Aero is now a separate
business unit within Rolls-Royce. ITP Aero will retain
organisational autonomy allowing it to continue serving
other original equipment manufacturers (OEM) as customers,
while meeting our governance and compliance standards.
Based in Bilbao, Spain, ITP Aero is an aero-engine component
designer and manufacturer that offers products and services
across the widebody, single-aisle, regional, corporate and
defence aviation markets. It has worked with Rolls-Royce
as a risk and revenue sharing partner on all members of
the Trent engine family, manufacturing low pressure
turbines, and is an important partner on the UltraFan engine
development programme. ITP Aero also provides essential
aerospace products and services to a number of important
customers outside of Rolls-Royce. ITP Aero is a partner in the
main European Defence aviation consortia and is the Spanish
Defence aeronautical engine reference company, supporting
existing and future programmes as well as providing in-service
support to the Spanish fleet.
STRATEGIC REPORT 10
Strategic Report
The Trends Shaping our Markets
Rolls-Royce Holdings plc Annual Report 2017
The Trends Shaping our Markets
As pioneers, we must continuously innovate to provide the best solutions
in the markets we serve. This requires us to anticipate the opportunities
and challenges that our customers will face. In the coming years, we
believe that three key trends will define the world’s future power needs.
Growing demand for cleaner,
safer and more competitive power
Global economic power and rising prosperity will lead to
increased demand for travel, trade and energy. The growing
understanding of the science of climate change is also
shaping demand for power.
To provide superior power for our customers, we will
continuously develop and apply cutting-edge technologies.
Electrification
As we move to a low carbon global economy, our engines will
become part of broader, hybrid systems with lower emissions
and lower environmental impact.
To provide solutions for our customers, we will act as a
systems integrator, combining our traditional mechanical
technology with electrical technology.
Digitalisation
Advances in sensors, communication, data storage,
processing power, machine learning, artificial intelligence,
robotics and additive layer manufacturing are all combining
to create new insights, processes and opportunities.
To provide lifelong performance for our customers, we will use
the huge power of digitalisation to transform our activities.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Our Vision and Strategy
11
Our Vision and Strategy
To respond to these key trends, we have refreshed
our Group vision and strategy.
Our vision
Pioneering the power that matters
Rolls-Royce pioneers cutting-edge technologies that deliver the cleanest,
safest and most competitive solutions to meet our planet’s vital power needs.
Our strategy
Champion electrification
Reinvent
with digital
Transform
our business
Vitalise existing capabilities
Build a balanced portfolio
Champion electrification
We will invest in new power solutions
for our long-term success.
We are building on our strong heritage
in thermo-mechanical engineering
to produce state-of-the-art
electro-mechanical and hybrid power
systems. Today, we already combine
our engines in hybrid systems for trains,
ships and micro-grids.
Reinvent with digital
We will be Digital First in everything we
do to generate new insights, new solutions
and new opportunities.
We are renowned as a pioneer in the use
of digital solutions for our customer care.
We are continuously enhancing the digital
twin of our physical activities and seeking
new data innovations.
Vitalise existing capabilities
We will develop next generation
technologies to sustain and grow
our current competitiveness.
We are investing in our existing
thermo-mechanical products to ensure
that they provide the cleanest, safest
and most competitive solutions for our
customers. For example, the UltraFan
represents a fundamental upgrade of
our gas turbines, incorporating
11 breakthrough technologies.
Transform our business
We will fundamentally change the way
we do business to generate substantial
value for our stakeholders.
We are implementing and improving the
Rolls-Royce operating system. Digitalisation
allows us to create entirely new ways of
engineering, manufacturing and serving
our customers across the Group.
Build a balanced portfolio
We will seek new markets and products that
bring new technologies and capabilities,
and generate scale and synergies.
We are investing to manage the transition
towards electrification and digitalisation.
We mitigate the risk of long-term investment
by increasing our preparedness. For
example, by developing activities where
electrification is relevant today, such as
micro-grids, we will be better placed to
benefit in activities where electrification is
still some years away, such as aero engines.
We are committed to creating
an environment where all our
people are able to be at their best.
For more information see page 46
STRATEGIC REPORT 12
Strategic Report
Business Model
Rolls-Royce Holdings plc Annual Report 2017
Business Model
Our resources
Brand
Our brand enables us to
sustain relationships, secure
business and attract talent.
People and culture
Our success is a result of
the commitment, skills and
ingenuity of our employees
and their determination
to be ‘Trusted to Deliver
Excellence’.
Technology
Our technology enables
us to meet emerging
customer needs.
Engineering capability
Our engineering expertise
enables us to embed
cutting-edge technologies
into outstanding products.
Advanced
manufacturing
capability
Our manufacturing processes
enable us to embed advanced
technologies in our products
quickly and efficiently.
Service capability
Our service orientation
enables our customers to
focus on their core activities.
Rolls-Royce
operating system
Our operating system
enables us to drive best
practice and value across
the Group.
Partners
Our partners enable us to
collaborate in technology,
manufacturing and services.
Financial strength
Our financial strength
enables us to pursue
long-term cutting-edge
technologies and to support
our customers throughout
the entire product lifecycle.
Rolls-Royce is one of the world’s leading industrial
technology companies. We provide power solutions for
our customers which combine three elements: advanced
technologies; system solutions; and system life. These are
delivered as part of a virtuous cycle which begins with the
development of cutting-edge technologies. We optimise
the value of our power solutions throughout their lives.
Cutting-edge
technologies
1
Dynamic
technology
management
5
2
Resilient
business
4
3
Long-term
value creation
Compelling
customer
propositions
Our competitive advantage comes from:
Advanced
technologies
System
solutions
System
life
We apply cutting-edge
technologies to provide
cleaner, safer and more
competitive power. Our
technologies ensure that our
customers have power that
meets their emerging needs.
We package technologies
into systems that provide
complete solutions for our
customers. Our solutions
mean that our customers
have power from a single,
trusted partner.
We care about the
performance of our
solutions throughout
their lives. Our whole-life
capabilities maximise
availability and enable
us to meet changing
customer needs.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Model
13
1 Cutting-edge
technologies
Cutting-edge technology allows
us to meet emerging customer
needs. We instinctively pursue
new technologies that will help
us deliver cleaner, safer and more
competitive solutions.
We identify the key horizon
technologies that will generate
a competitive advantage for
Rolls-Royce in the long term.
Link to risks A B
2 Dynamic technology
management
Our future technological world is
complex with many exciting new
challenges across everything we
do. We respond to this with broader
and deeper collaboration with others,
and with a more dynamic approach
to ensure that our technology brings
the most value to our customers
and our business.
We are inclusive in the pursuit,
co-operative in the application and
aggressive in the commoditisation
of technology.
Link to risks A B
3 Compelling
customer propositions
Our customer relationships are
our greatest strength. We offer our
customers a combination of advanced
technology, in a complete systems
solution, optimised throughout its life.
We create combinations of
technology, systems and aftermarket
performance that make our customers
more competitive.
See below for details of how we do this.
Link to risks B C D E
4 Long-term
value creation
Our activities are complex and global.
We share best practice across the
Group and assess where and how
activities can offer the best value.
We use the Rolls-Royce operating
system to generate greater value.
Link to risks E
5
Resilient business
Our activities have a major impact
on our planet, the global economy
and on communities. To ensure that
we are free to operate and invest for
the long term, we are thoughtful
and careful about the business we
undertake, our financial resources
and our wider impact.
We build balance in our activities,
strength in our balance sheet and
behave sustainably.
Link to risks F G H I J
Value creation for
our stakeholders in 2017
Customers
We develop product
solutions that improve our
customers’ competitiveness.
Gross R&D
expenditure
£1.4bn
Investors
We generate attractive
returns for investors over
the long term.
Total shareholder
return
25.4%
Employees
We create an environment
where each employee is
able to be at their best.
Partners
We create partnerships
based on collaboration
where each partner
benefits from the
relationship.
Communities
We improve the
communities that we
impact locally, nationally
and globally.
Invested in
training and
development
£31.2m
Spent with
external suppliers
£8.7bn
Hours of
employee time
volunteered
93,900
Governing bodies and regulators
We aim to create trusted relationships with
governing bodies and regulators, meeting all legal
and regulatory commitments and requirements.
Our power solutions create revenue from:
Link to principal risks
– original equipment sales
– maintenance, repair and overhaul sales
– secondary or repurposing sales
– additional products and services
Our intimate knowledge of our customers and our products enables us to
optimise the value of our power solutions throughout their lives. We share
this value with our customers by offering power as a service.
A Disruptive technologies and business models
B Competitive position
C Major product programme delivery
D Product safety
E Talent and capability
F Business continuity
G IT vulnerability
H Market and financial shock
I Political risk
J Compliance
Revenue recognition page 125
Principal Risks page 59
STRATEGIC REPORT
14
Strategic Report
Key Performance Indicators
Rolls-Royce Holdings plc Annual Report 2017
Key Performance Indicators
Financial key performance indicators
Description
Why we measure it
How we have performed
Order book
£78.5bn
We measure our order book
as an indicator of future
business volume; however, its
value may not be reflective of
future revenue. 1
The 3% decline principally reflects the
current period where Civil Aerospace
engine deliveries have outpaced new
orders as Civil Aerospace customers
focused on delivering against their backlog.
Power Systems and Nuclear order books
improved, reflecting greater activity.
£bn
2017
2016
2015
2014
2013
Order intake
£17.2bn
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. 2
Order intake was £1.9bn lower than
achieved in 2016 due to Civil Aerospace
customers focusing more on delivery of
airframes than new sales campaigns. All
other business units saw an improvement in
their order books, including in Marine from
what was a low base.
Underlying revenue
£15,090m
Monitoring of revenue provides
a measure of business growth. 3
Self funded R&D
as a proportion of
underlying revenue
6.9%
Capital expenditure
as a proportion of
underlying revenue
5.1%
This measure reflects the need
to generate current returns as
well as to invest for the future. 4
To deliver on its commitments
to customers, the Group invests
significant amounts in its
infrastructure. 5
Underlying
operating profit
£1,175m
This measure reflects the
Group’s underlying economic
performance taking account of
its hedging strategies. 6
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. 7
Free cash flow
£273m
* Excluding Energy
** Including Energy
Underlying revenue rose 6% organically, 8
reflecting increased delivery volumes
in both Civil Aerospace and Defence
Aerospace plus improved end markets
at Power Systems. Service revenue was
7% higher led particularly by growth in
Civil Aerospace.
Disciplined control of spend kept R&D
stable as percentage of sales, with
self-funded R&D increasing to £1.04bn.
This was primarily due to expenditure
within Civil Aerospace, focused on new
engines coming into service, progress on
next generation UltraFan and business jet
development programmes.
Capital expenditure rose as proportion
of revenue, and was £764m in absolute
terms, reflecting investment in modernising
manufacturing processes and facility
expansion within Civil Aerospace,
upgrading of Defence Aerospace’s
Indianapolis site and expansion of our
spare engine fleet to support the growing
installed base of widebody engines.
Organic 8 growth of 22% driven by revenue
improvement, our focus on reducing
fixed costs, higher capitalised R&D and
product mix. This was despite higher costs
incurred from in-service issues with Trent
1000 and Trent 900 fleets. Transformation
programme benefits reached the top end
of the targeted £200m run-rate reduction.
Cash generation was better than expected,
notably in Power Systems, driven by
improved profitability and strong working
capital management which saw a £546m
working capital inflow in the year. These
more than offset higher capex and R&D and
increased costs to resolve Civil Aerospace
in-service engine issues.
£bn
2017
2016
2015
2014 *
2014 **
2013
£m
2017
2016
2015
2014 *
2014 **
2013
%
2017
2016
2015
2014 *
2014 **
2013
%
2017
2016
2015
2014 *
2014 **
2013
£m
2017
2016
2015
2014 *
2014 **
2013
£m
2017
2016
2015
2014 *
2014 **
2013
78.5
80.9
76.4
73.7
71.6
17.2
19.1
18.2
19.0
19.4
26.9
15,090
13,783
13,354
13,864
14,588
15,505
6.9
6.8
6.2
5.9
5.8
4.8
5.1
4.5
3.7
4.7
4.6
4.4
1,175
915
1,492
1,681
1,678
1,831
273
100
179
447
254
781
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Key Performance Indicators
15
Non-financial key performance indicators †
Description
Why we measure it
How we have performed
Customer delivery
91%
Employee engagement
75
To deliver on our commitments
to our customers we measure the
percentage of on-time deliveries
to our customers including new
equipment, spare parts, equipment
repair and overhaul. This is tracked
Group-wide in our scheduling and
order fulfilment system.
This is measured through our
employee opinion survey which
produces a composite sustainable
engagement score. The targets
are based on absolute scores
for six key questions within the
overall survey.
† These non-financial performance indicators are linked to our remuneration structure.
We continued to improve our on-time
delivery in a period where we are
significantly increasing the output
of our Trent engines.
%
2017
2016
We maintained our employee engagement
score of 75 in 2017, which was the same
as in 2016. However we fell short of our
target of 77.
2017
2016
91%
88%
75
75
Notes
1 We measure our order book at our long-term planning exchange rate (LTPR) 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. We only include the first seven years’ revenue from long-term aftermarket contracts.
2 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 from long-term aftermarket contracts, include the
addition of the following year of revenue on long-term aftermarket contracts.
3 Underlying revenue is used as it reflects the impact of our foreign exchange (FX) hedging policy by valuing foreign currency revenue at the actual exchange rates achieved as a result
of settling FX contracts in the year. This provides a clearer measure of the year-on-year performance.
4 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 revenue 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.
5 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%. (Capital expenditure excludes
additions arising from TotalCare Flex arrangements).
6 In particular: (a) revenue and costs denominated in US dollars and euros are presented on the basis of the exchange rates achieved during the year based on our FX hedge book;
(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.
7 We measure free cash flow as the movement in net debt/funds during the year, before movements arising from payments to shareholders, acquisitions and disposals, and FX.
8 Organic change is at constant translational currency, excluding M&A.
STRATEGIC REPORT 16
Strategic Report
Financial Review
Rolls-Royce Holdings plc Annual Report 2017
Financial Review
Stephen Daintith
Chief Financial Officer
Overview 2017
I believe I have joined Rolls-Royce as Chief
Financial Officer at a significant point in
its history. Over the past five years, we have
made substantial investments of almost
£8bn in new products and operations, with
cumulative tangible capital expenditure
of £3.2bn and self-funded R&D investment
of £4.4bn. This has allowed Rolls-Royce
to develop and bring to market a number
of the world’s most powerful aero engines.
Over a period of 12 months, three new
widebody engines achieved first flights.
Our active Civil Aerospace in-service
engine base stands at 12,966, including
4,409 large engines, an increase of 16%
since 2012 and an increase in our large
engine installed base of 7% in 2017 alone.
The growth of the installed base highlighted
above helped drive a 12% increase in
widebody engine flying hours in 2017,
delivering 12% growth in Civil Aerospace
service revenue. Another solid year in our
Defence Aerospace business, together with
a strong performance at Power Systems
and ongoing cost benefits from our
transformation programme, helped us deliver
an improved financial performance in the
year. Underlying operating profit and free
cash flow were both above our expectations.
Overall Group underlying revenue
grew organically 6% to £15.1bn. Original
equipment (OE) revenue of £7.7bn grew
6%, reflecting increased delivery volumes
in Civil Aerospace and Defence Aerospace
plus improved end markets for Power
Systems. Marine OE revenue fell 15%
due to challenging end markets. Nuclear
revenue rose by 4%. Service revenue,
which accounts for 49% of Group revenue,
rose 7% to £7.4bn in 2017, led by growth
in Civil Aerospace.
Underlying operating profit grew 22%
organically to £1,175m (reported operating
profit of £1,287m) in 2017 which was driven
by revenue improvement, our focus on
fixed costs and higher capitalised R&D.
It was delivered despite higher costs
incurred from Civil Aerospace’s in-service
engine issues with the Trent 1000 and
Trent 900 which had a negative £227m
impact on profit in the year (2016: £98m).
Transformation programme benefits have
now reached the top end of our targeted
£200m run-rate reduction in fixed costs.
Cash generation was better than expected
in 2017, notably in Power Systems, with
£273m of Group free cash flow (2016:
£100m), driven by improved profitability
and strong working capital performance
which saw a £546m working capital inflow
in the year. These were more than offset by
higher capex, R&D and the £170m cash
costs incurred on Trent 1000 and Trent 900
in-service issues (2016: £90m). Looking
ahead, I believe we are now poised to
significantly improve our free cash flow as
the business starts to reap the benefits of
its previous investment cycle and growing
installed engine base.
Our primary objective is to generate strong
and growing free cash flow. Several key
levers are central to delivering this:
improving OE economics within Civil
Aerospace; continuing to drive growth
in Power Systems; delivering ongoing
growth in service revenue; and continuing
to reduce our costs. We have considerable
visibility of the service revenue streams
which form a vital part of the resilience and
longevity of our business model. We will also
drive working capital efficiencies throughout
the business, seek to reduce overhead costs
further through our recently announced
restructuring programme, increase utilisation
of our facilities and become more disciplined
in our spending and investment decisions.
With more financial flexibility and a more
disciplined capital allocation approach,
our aim is for Rolls-Royce to regain
A-grade investment status, putting
us in a position to restore shareholder
payments to an appropriate level balanced
against a disciplined investment programme
to capture carefully selected growth
opportunities. We have progressed our
portfolio strategy, with the decision to
review our commercial marine operation.
We will continue to review our portfolio
and, where appropriate, pursue tactical
disposals of non-core assets to further
improve our balance sheet.
I am also determined to provide greater
financial transparency, both internally
and externally. There has been good
progress here in 2017, with further significant
steps to be made going forward. In 2018,
we aim to introduce some new KPIs to align
with our focus on cash flow and improved
discipline on capital allocation. We are
setting ambitious but achievable targets,
reflecting our confidence that the business
can deliver significantly improved financial
performance over the next few years.
2018 outlook
We are confident 2018 will be a year of
good progress. Organic revenue should
grow mid-single digit, with underlying
operating profit of around £400m
excluding ITP Aero (around £450m
including ITP Aero). Free cash flow should
improve to around £450m excluding ITP
Aero, (around £400m including ITP Aero).
We are making solid progress with
longer-term solutions for Trent 1000 and
Trent 900 in-service issues, largely through
re-designing affected parts, and we expect
these to be fully embodied on the Trent
1000 fleet by 2022. On the Trent 900,
an extended life turbine blade is already
being rolled-out with further re-designs
available from 2020. Based on our current
estimates, in 2018 the anticipated annual
cash impact is expected to broadly double
and reach a peak. It is then expected to fall
by around £100m in 2019. The majority of
this work will be undertaken in 2018 and
2019 and is not expected to complete until
2022. All of these costs are included in our
cash flow guidance for 2018 and beyond.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Financial Review
17
Financial priorities
To build a business that can generate long-term, sustainable value for stakeholders, I have
established five financial priorities, focused on better understanding and improving free cash flow.
Action has already started and will continue in 2018 and beyond.
1 Improve cash flow generation
2 Continue cost reduction
Cash is a fundamental indicator of economic performance.
Our primary financial objective is to grow free cash flow.
Key drivers of this will be:
— improved OE economics, principally by reducing the
deficit per engine sold, with the Trent XWB engine a key
indicator of progress; we aim to move the Trent XWB
engine to break-even by 2020;
— growth in service cash inflows through growth in the
installed engine base and flying hours;
— a focus on improved working capital management;
— reducing our cost base; and
— improved operational performance in Defence Aerospace
and Power Systems.
Our transformation programme which began in 2015 continued
to deliver significant benefits in 2017. For 2018 we have
launched a new restructuring plan to further improve
efficiency around overhead costs.
Key drivers going forward will be:
— reducing product lifecycle costs through targeted
re-engineering;
— removal of duplicated support and management functions
as we move from five to three businesses;
— reduction in manufacturing footprint and increasing
plant productivity;
— improving efficiency and reducing cost and headcount
in commercial and administrative (C&A) functions; and
— disciplined R&D investment.
2017 achievements
Trent XWB OE deficit per engine down 37% year-on-year
TotalCare engine flying hours up 12%
Inventory turns improved 4% to 2.9x
2017 achievements
Global production footprint reduced by 3.5%
C&A costs down 80bps as % of sales
R&D stable as % of sales at 6.9% despite new
programme investment
3 Disciplined
capital allocation
A disciplined approach to capital
allocation and sustaining a healthy
balance sheet will play a major part
in driving our long-term growth.
Through improved free cash flow
generation, we aim to maintain a strong
investment grade rating and ultimately
return to A-grade status. Restoring
our shareholder payments to an
appropriate level will be a key element
of our capital allocation framework.
Growing free cash flow will also
help sustain our investment in R&D
programmes across existing core
areas as well as develop new
opportunities, notably in pursuing
our electrification strategy.
4 Provide greater
financial transparency
There will be a continuing focus
to improve the understanding and
explanation of the financial drivers
of our business, both from an
internal and external perspective.
The introduction of IFRS 15 (see
page 55 for more detail) will help
provide greater transparency on the
performance and financial dynamics
of our business, especially around OE.
Looking at and presenting our Civil
Aerospace business on a cash flow
driver basis should also help increase
understanding. Finally, moving more of
our internal and external performance
metrics to be based around free cash
flow will help clarity and focus.
5 Strengthen the
finance function
We are taking steps to strengthen the
finance function, focusing our resources
on improving insight and analysis to
help drive results and change across
Rolls-Royce. With several new
appointments already made, we are
bringing on board different experiences
to support the continued transformation
of Rolls-Royce into the world's leading
industrial technology company.
Four key initiatives have been launched
as part of a change programme within
the Rolls-Royce finance function to
deliver on our financial priorities.
These include the re-engineering of our
finance operating model (our finance
systems and reporting), establishing
value-based modelling (the use of rolling
forecasts) and embedding a strong
cash-focused culture to improve working
capital management. Finally, a Finance
Academy is being established to develop
and grow our finance professionals across
the organisation.
STRATEGIC REPORT
18
Strategic Report
Financial Review
Rolls-Royce Holdings plc Annual Report 2017
Group trading summary
Underlying revenue up 6%
Group revenue rose 6% to £15,090m,
reflecting 6% growth in OE and 7% in
services. Civil Aerospace led the progress,
with revenue up 12% reflecting strong
growth in OE engine delivery volumes
(up 5% in total and up 35% for widebody).
Service revenue in Civil Aerospace rose 12%,
benefiting from the growing installed base
of in-service large engines, which rose 7%
to 4,409. Power Systems revenue grew 3%
driven by growth in commodity-related
markets, construction & agriculture and
power generation business. Marine revenue
was weak, down 9%, reflecting ongoing
weakness in the offshore oil & gas markets.
Nuclear revenue rose 4%.
Gross profit up 1%
Gross profit rose 1% to £2,973m, with
gross margins of 19.7%, down 100bps
in the year. This decline was driven by
both Civil and Defence Aerospace. Civil
Aerospace margins reflected the impact
of higher volumes of unlinked OE engines,
which carry an OE deficit, allied to lower
long-term service agreement (LTSA) margins
and other related costs driven by additional
maintenance costs on Trent 1000 and
Trent 900 engines. Defence Aerospace
gross margins were impacted by lower
spares volumes and lower LTSA contract
margin improvements. Power Systems saw a
strong gross margin improvement of 240bps,
principally reflecting improved product
mix and pricing discipline.
R&D costs down 18%
Gross R&D expenditure grew 1% to £1,392m.
After funding from customers and other
third parties, self-funded R&D rose 7% to
£1,035m. This was primarily driven by
increased investment in Civil Aerospace
with the development of a number of new
engines plus ongoing investment in existing
product improvement, including fuel burn
efficiency enhancements. Capitalisation of
R&D rose from £99m to £342m due to the
stage of development programmes and
included £83m from a policy application
change. Contributions from risk & revenue
sharing partners declined £24m. Overall the
underlying expensed R&D charge fell 18%
to £737m.
C&A costs down 3%
C&A costs were £1,168m, 3% down on the
prior year, reflecting the beneficial effects
of transformation actions to reduce
overhead costs. Looking ahead to 2018
and beyond, we expect to realise additional
benefits from further restructuring of our
support and management functions.
Group trading summary
£m
Order book *
Underlying revenue
Underlying OE revenue
Underlying services revenue
Underlying gross profit
Gross margin %
Commercial and administrative costs
Research and development costs
Joint ventures and associates
Underlying operating profit
Underlying operating margin
Financing costs
Underlying profit before tax
Tax
Underlying profit for the year
Underlying earnings per share (pence)
Free cash flow
Organic
change
-3%
+6%
+6%
+7%
+1%
-100bps
-3%
-18%
-13%
+22%
+100bps
2017
78,476
15,090
7,687
7,403
2,973
19.7%
(1,168)
(737)
107
1,175
7.8%
(104)
1,071
(328)
743
40.46
273
2016
Change
80,910
13,783
7,027
6,756
2,818
20.4%
(1,158)
(862)
117
915
6.6%
(102)
813
(261)
552
30.13
100
-3%
+9%
+9%
+10%
+6%
-70bps
+1%
-15%
-9%
+28%
+120bps
+2%
+32%
+26%
+35%
+34%
n/a
* The 2016 opening order book has been restated by £1.5bn reflecting a methodology change in the exchange rates
used to translate order books – moving from long-term planning rates to period spot rates – for overseas subsidiaries,
and a restatement of Defence Aerospace's order book opening balance by £(441)m.
Exceptional restructuring charges
£104m of exceptional restructuring
charges were taken in 2017 (2016: £129m)
primarily due to restructuring in Power
Systems and Defence Aerospace,
reflecting actions to remove cost and
improve operational efficiency.
Underlying operating profit
up £260m
Underlying operating profit of £1,175m
(2016: £915m) was up 22% reflecting
a number of factors:
— Civil Aerospace profit increased to
£520m, up 34% with positive margin
contribution from higher linked
Trent 700 OE sales, increased service
revenue and higher sales of spare parts.
This was offset by higher costs relating
to the Trent 1000 and Trent 900
in-service engine issues, with £227m
of costs charged for these. Expensed
R&D fell £156m to £412m reflecting
increased capitalisation.
— Defence Aerospace profit of £374m
was down 7% due to lower demand for
engine spares, higher restructuring costs
and a £14m reduction in LTSA contract
margin improvements taken in 2016.
These more than offset the non-repeat
of the TP400 charge of £31m in 2016.
— Power Systems made excellent progress
in 2017, with profit of £330m up 61%,
reflecting 3% revenue growth, a 240bps
expansion in gross margin, due to better
mix and pricing discipline, and benefits
of overhead cost reduction actions
which saw C&A costs fall 7%.
— Despite the 9% decline in Marine
revenue, restructuring drove a material
reduction in overhead costs with C&A
costs 13% lower, helping to reduce
underlying operating losses to £25m
(a £2m improvement versus 2016).
— Nuclear operating profit of £38m
was 18% lower versus 2016, primarily
reflecting a higher R&D charge of
£23m compared with the £6m incurred
in 2016 which had benefited from
a one-off positive of £7m due to the
change in treatment of R&D credits.
Payment to shareholders held flat
For 2017, the final payment to shareholders
is held at 7.1 pence giving a full year
payment of 11.7 pence (2016 full year:
11.7 pence), a cash cost of £216m. Restoring
our shareholder payments to an appropriate
level over time as free cash flow grows will
be a key capital allocation priority.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Financial Review
19
Free cash flow
£273m
£273m
£100m
£179m
£447m
£254m
2017
2016
2015
2014 *
2014 **
2013
* Excluding Energy
** Including Energy
£781m
Underlying profit before tax
Reported profit/(loss) before tax
£1,071m
£4,897m
2017
2016
2015
2014 *
2014 **
2013
£1,071m
£813m
£1,432m
£1,617m
£1,618m
£1,759m
2017
2016
2015
2014
2013
£4,897m
£(4,636)m
£160m
£67m
£1,759m
Reported results
Reported profit before tax was £4.9bn,
a material increase over the 2016 loss
of £4.6bn. This included £798m of gains
resulting from the acquisition of ITP Aero,
a positive FX mark-to-market adjustment
of our hedge book of £2.6bn (£4.4bn
negative in 2016), a charge of £671m for
financial penalties from agreements with
investigating bodies in 2016, a charge
(principally relating to the Vickers Group
Pension Scheme) of £306m for the
restructuring of the UK pension schemes
in 2016 and goodwill/other impairments
of £24m versus £219m in 2016. This also
includes improvements in other operational
performances as highlighted above.
Free cash flow improving
Free cash inflow in the year was better
than expected at £273m (2016: £100m),
excluding the £14m post-acquisition cash
outflow of ITP Aero. The strong cash
flow performance was driven by higher
profitability in Civil Aerospace, Defence
Aerospace and Power Systems and good
working capital performance, again
principally in receivables, across the Group.
This was achieved despite £98m of higher
R&D cash spend in 2017, a £188m increase
in capital expenditure and the reversal of
the £180m working capital management
benefit generated in the first half. Trading
cash flow in Civil Aerospace of £38m was
unchanged year-on-year. This reflected
increased flying hour receipts and higher
spare parts sales, offset by an increased
outflow from higher deliveries of OE
widebody engines and the higher Trent
1000 accelerated maintenance activity.
Total cash costs incurred in the year on
Trent 1000 and Trent 900 in-service issues
were £170m (2016: £90m).
Looking ahead, improved Civil Aerospace
engine OE economics and increased
engine flying hours will drive a further
improvement in free cash flow in 2018
and beyond. More details on the movement
in trading and free cash flow are included
in the funds flow section of the Additional
Financial Review – see page 51.
IFRS 15
As highlighted in 2016, the introduction
of the new revenue reporting standard,
IFRS 15 Revenue from Contracts with
Customers, will change fundamentally
how Rolls-Royce measures its revenue
and profit, Civil Aerospace having by far
the largest impact. There are three
broad implications:
— linked accounting will cease to exist
so all OE sales will be treated on the
same basis;
— OE engine cash deficits will no longer be
capitalised and recorded as contractual
aftermarket rights, they will instead be
recognised on delivery; and
— revenue and profit for aftermarket
services will be recognised on an activity
basis as costs are incurred.
Further information on the 2017 results
under IFRS 15 can be found on page 55.
Net debt
In 2017, the Group’s net debt position rose
from £225m to £520m (excluding ITP Aero)
largely reflecting the £273m free cash
generation offset by shareholder payments
of £214m and £286m covering payments
due in 2017 for the financial penalties
from agreements with investigating bodies.
A further £378m of regulatory fines remain
due to the SFO, with a payment schedule
extending to 2021.
Following the acquisition of ITP Aero,
its operating cash outflow of £14m and
the consolidation of the net funds of
£215m result in Group net debt rising
somewhat less to £305m.
Credit rating
The Group is committed to maintaining
a robust balance sheet with an investment-
grade credit rating. We believe that this
is important for our customers given that
we deliver high-performance products
and support for equipment which will be
in operation for decades. Standard & Poor’s
updated its rating in January 2017 to BBB+
from A-/negative outlook, while Moody’s
lowered its rating in February 2017 from
A3/stable to A3/negative.
Foreign exchange
The Group hedges transactional foreign
exchange exposures to reduce volatility
of revenue and costs. The most significant
exposure is net US dollar income which is
converted into GBP (currently approximately
$5bn per year and forecast to increase
significantly by 2021). The Group has a
hedge book of $38.5bn (at an average rate
of USD:GBP 1.55) covering this exposure.
We expect the achieved £/$ hedge rate
to remain unchanged at around
USD:GBP 1.54 for the coming three years.
Interest
Interest and other financing costs remained
broadly flat year-on-year, up £2m to £104m.
Net interest payable reduced by £10m to
£53m. Other underlying financing costs
increased by £12m to £51m.
Taxation
Underlying taxation was £328m (2016:
£261m), an underlying rate of 30.6%
compared with 32.1% in 2016. The underlying
tax rate remains high due to the continued
non-recognition of deferred tax assets on
losses in Norway and the mix of profits
arising in higher tax rate countries,
predominantly the US and Germany.
STRATEGIC REPORT
20 Strategic Report
Business Review
Rolls-Royce Holdings plc Annual Report 2017
POWERING GLOBAL AVIATION
At the same time as delivering a significant
increase in Civil Aerospace engine production,
Rolls-Royce marked the entry into service of the
Trent 1000 TEN on the Boeing 787 Dreamliner
in November 2017. That milestone followed the
first test flight of the Airbus A330neo, powered
by the new Trent 7000, in October and the first
test flight of the Airbus A350-1000, powered by
the new Trent XWB-97 in late 2016. That means
Rolls-Royce successfully flew three new civil
widebody engines in a period of just 12 months
– an unprecedented achievement in the
aerospace industry. Each programme has
brought together more than 20,000 parts to
create engines that have undergone rigorous
testing at facilities around the world.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Review
21
Civil Aerospace
Key facts
Civil Aerospace is a major manufacturer of
aero engines for the large commercial aircraft,
regional jet and business aviation markets.
The business uses its engineering expertise,
in-depth knowledge and capabilities to
provide through-life support solutions for
its customers.
35
types of commercial
aircraft powered by
Rolls-Royce engines
13,000
engines in service
around the world
24,600
average number of
employees during 2017
Civil Aerospace | Key financial data *
Key highlights
Underlying revenue
Underlying gross profit
Underlying operating profit
Trading cash flow
Order book
2017
£8,023m
£1,192m
£520m
£38m
£70.2bn
Year-on-year
change
Organic
change †
+14%
+1%
+42%
-12%
-3%
+12%
-2%
+34%
-12%
-3%
* See note 2 on page 132 for further segmental detail.
† Organic change is at constant translational currency, excluding M&A.
Underlying revenue mix
Services
52%
OE
48%
Large
engine
70%
Business
aviation
14%
Regional
4%
V2500
12%
Underlying revenue and underlying
operating profit growth of 12% and
34% respectively, driven by 35%
increase in large engine delivery
volumes and a 12% increase in
invoiced flying hours
Underlying service revenue
grew by 12%
Unit cost reductions and pricing
improvements; 37% reduction in
Trent XWB-84 cash deficit; and
overall OE cash deficit stable at
£1.6m, as expected given the
change in production mix
Good progress on new engine
programmes during 2017:
Trent 1000 TEN entering into
service, Trent XWB-97 achieving
certification, and Trent 7000
powering Airbus A330neo first flight
Significant in-service engine issues on
Trent 1000 and Trent 900; principally
due to lower than expected durability
of certain turbine and compressor
rotor blade parts (see page 24);
and focus to mitigate disruption to
customers, current year £227m income
statement charge and £170m impact
to cash flow
Change in R&D policy application:
£83m of the £243m increase in R&D
capitalisation in year
STRATEGIC REPORT
22
Strategic Report
Business Review
Rolls-Royce Holdings plc Annual Report 2017
Overview 2017
2017 marked some notable successes for
Civil Aerospace, with record levels of
widebody engine deliveries, expanding the
installed fleet and generating positive service
revenue growth. The Trent XWB-97 and the
Trent 7000 achieved full flight certification
during the year and the Trent 1000 TEN
entered into service. The Trent XWB-84
saw much improved OE economics and
has achieved over 1.2 million flying hours
in service with unprecedented levels of
reliability. These milestones have been
achieved against a backdrop of capacity
constraints, primarily for blade manufacture
and test beds, which have been exacerbated
by a number of in-service engine issues
relating to the serviceable life of a small
number of parts on the Trent 1000, which
have led to significant customer disruption,
and on the Trent 900. Investments have been
made in facilities and people to minimise
the disruption caused to our customers
and to develop longer-term solutions.
Financial overview
Total underlying revenue
Total underlying revenue rose 12% to
£8,023m, with both OE revenue of £3,818m
(2016: £3,357m) and service revenue of
£4,205m (2016: £3,710m) up 12%. The rise
in OE revenue reflected record levels of
widebody engine deliveries, with growth
in Trent XWB-84 engine sales, to support
the Airbus A350 programme ramp-up,
a significant contributor.
Higher service revenue was driven by both
increased engine flying hours and higher
time and material activity. Overall large
engine flying hours increased by 12% to
12.6 million. This reflects a 22% increase in
flying hours from the in-production Trent
engine fleet partially offset by a decrease
of 12% from the legacy fleet of engines,
the Trent 500 and Trent 800 and RB211s,
which are no longer in production.
For business aviation, while OE sales were
26% lower, reflecting a 32% reduction in
engine sales as airframe production
transitioned to competitor-powered
programmes, there was a 10% increase
in service revenue from continued fleet
growth and consistently high CorporateCare
coverage. Overall, V2500 revenue increased
6% driven by higher maintenance, repair
and overhaul activity. Service revenue
from V2500 increased 13% led by higher
maintenance activity. V2500 OE module
sales continued to reduce but revenue from
flying hours remained stable.
Underlying operating profit
Underlying operating profit increased to
£520m, up 34% (2016: £367m). Increased
gross margin contributions were generated
by higher deliveries of link-accounted
Trent 700 engines, increased flying hours
in growing widebody and business aviation
fleets and increased sales of spare parts.
This was partially offset by the decline in
business jet engine OE sales.
Given the performance of our in-service
fleets continued to evolve, as we do every
year, we have updated our forward estimates
of revenue and costs across our long-term
contracts. While this included some
favourable effects, such as increased
utilisation and reduced servicing costs
across our business aviation fleet, it also
required the inclusion of higher costs for
additional maintenance activity for the
Trent 1000 and Trent 900 fleets and
increased customer support to alleviate
the impact of limited engine availability.
In total, the contract accounting adjustments
created an £18m headwind (2016: £90m
benefit) which included a £148m charge
(2016: £98m charge) for technical cost
(including certain costs relating to the Trent
1000 and Trent 900 in-service issues), a
£113m (2016: £217m) benefit from lifecycle
cost improvements and a £77m benefit from
a customer credit rating change, offset by
other charges of £60m (2016: £64m charge)
ON TIME, EVERY TIME
In June, Rolls-Royce opened its
Airline Aircraft Availability Centre
(the Centre), in Derby, UK, combining
the latest in digital data management
and technology innovation. Using
industry-leading data analytics, the
Centre plans engine operations and
maintenance, driving efficiency in
an industry where one per cent fuel
savings can be worth $250,000 per
aircraft per year. With a Rolls-Royce
powered aircraft taking off or landing
every 16 seconds, the business can use
data from thousands of aircraft across
the world to ensure they are available
for service 24/7. The Centre will also
be a hub for the introduction of new
technologies including real-time
collaboration systems which allow
engineers working around the world
to share live pictures from inside an
engine with the team at the Centre
and receive advice on what action
to take. In addition, ‘remote surgery’
techniques will enable experts at
the Centre to carry out complex
engineering tasks by remote control.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Review
23
THE TRENT XWB – ONE IN A MILLION
In late 2017, the Trent XWB-84 passed an important milestone:
one million flying hours. The engine, which powers the Airbus
A350 XWB and is the most efficient large aero engine flying
in the world today, achieved the milestone while delivering
the best ever widebody entry into service performance, with
despatch reliability reaching 99.94% in October and zero
in-flight disruption. The engine continues to set new standards
of performance and popularity in our industry. Not only is it
the most efficient large aero engine flying in the world today,
it is also the fastest-selling widebody engine ever, with more
than 1,600 already sold or on order.
The engine, assembled in Derby, UK, and Dahlewitz, Germany,
has a front fan that is just under ten feet across, which draws
in up to 1.3 tonnes of air every second at take-off. The high-
pressure turbine blades inside the engine rotate at 12,500rpm,
with their tips reaching 1,200rpm – twice the speed of sound.
At take off, each of the engine’s 68 high-pressure turbine blades
generates around 900 horsepower per blade – similar to a
Formula One racing car – and at full power, air leaves the nozzle
at the back of the engine travelling at almost 1,000mph.
largely relating to operational changes.
Profit was also impacted by the non-repeat
of the £53m release in 2016, following
accounting and legal review, of an accrual
relating to the termination in prior years of
intermediary services. Gross margin from
spare engine sales to joint ventures
contributed £67m (2016: £97m).
Investment in self-funded R&D rose by
£50m largely reflecting increased
investment in the development of a number
of new engine types which we successfully
progressed, plus ongoing investment in
product improvements to our existing
portfolio. In 2017, this focused on further
enhancing in-service durability, with a
notable focus on the longer-term solutions
to the Trent 900 in-service engine issues,
and fuel burn efficiency as we look to deliver
on our customer commitments. This was
more than offset by an increase in R&D
capitalisation which rose to £328m (2016:
£85m), largely reflecting the stage of
capitalisation of a number of development
programmes. It also reflects a change we
have made to better align with European
peers and best practice, to the point at
which we start capitalising development
costs to reflect current engine programmes
reaching technical maturity earlier in the
development cycle than has been the case
historically. This resulted in additional
development costs of £83m being
capitalised. Contributions from risk and
revenue partners decreased to £39m
(2016: £63m). Overall the expensed R&D
charge fell to £412m in 2017 from £568m
in 2016. Higher restructuring provisions
contributed to the 5% increase in C&A costs.
Trading cash flow
Trading cash flow in Civil Aerospace of £38m
was unchanged year-on-year. This reflected
increased flying hour receipts from the
growing widebody fleet and higher spare
parts sales, offset by an increased outflow
from higher deliveries of OE widebody
engines and the higher Trent 1000
accelerated maintenance activity. The
average cash deficit on widebody engines
remained flat at £1.6m per engine, reflecting
greater volumes of discounted Trent 700
and some temporary pricing headwind on
Trent 900, offsetting strong improvement
on Trent XWB-84, where the cash deficit
per engine reduced by 37%, underpinning
our confidence of further cost reduction
and economic improvement. Total cash costs
incurred in the year for in-service engine
issues on the Trent 1000 were £119m
(2016: £45m) and £51m (2016: £45m) on
the Trent 900.
The increase in self-funded R&D investment
mentioned above, together with higher
capital expenditure for additional production
capacity and for engines to support the
growing fleet, were offset by good working
capital performance on cash collections from
a number of key customers at the end of the
year. This benefit helped offset the growth
in inventory to support the continuing
widebody engine ramp-up in 2018.
Additional financial information
and IFRS 15 adoption impact
Further details on revenue, profit and
balance sheet for Civil Aerospace results
can be found on pages 53 and 54.
A comparison of the 2017 financial results
under IFRS 15 to those under the current
basis, together with a commentary on the
key differences between the two approaches
can be found on pages 56 and 57.
Order book
Order intake in 2017 was £10.5bn
(2016: £14.1bn including a £2.1bn uplift from
a change in the long-term USD planning
rate) with orders placed for 185 widebody
engines. The closing order book was
£70.2bn (2016: £72.0bn) and includes
orders for over 2,500 widebody engines.
Orders placed during the year included
119 engines for Airbus platforms including
the A350 XWB and A330neo as well as
66 engines for Boeing 787 Dreamliners.
Operational and
strategic review
The business has made significant progress
in the year, despite capacity constraints on
parts and test beds, achieving a record level
of large engine production and deliveries
while also focusing on minimising the impact
on customers from in-service issues on the
Trent 1000 and Trent 900 fleets.
Engineering and R&D
Significant milestones have been achieved
in each of the three new large engine
programmes on their progression towards
entry into service. Two new engines
achieved certification: the Trent 1000 TEN
and the Trent XWB-97. The Trent 1000 TEN
entered service on the Boeing 787-9 in
STRATEGIC REPORT 24
Strategic Report
Business Review
Rolls-Royce Holdings plc Annual Report 2017
November and the Trent XWB-97 powering
the Airbus A350-1000 entered into service
in early 2018. In October, Trent 7000 engines
powered the first test flight of the Airbus
A330neo and the programme remains on
schedule for entry into service in mid-2018.
The business continues to invest in
developing future technologies which will be
key to winning positions on next generation
platforms for both large engines and for
future business jet programmes. Good
progress has been made on new engine
architecture demonstrator programmes
in 2017. The Advance3 demonstrator
successfully completed initial ground test
runs and the UltraFan power gearbox
successfully completed a high power
test run to a record 70,000hp.
In November, the business announced
that it will be developing the E-Fan X hybrid
electric demonstrator in collaboration with
Airbus and Siemens. This development
reflects the growing importance of
electrification to the long-term future
of the industry.
Operational progress
Civil Aerospace has invested in both
its facilities and in building the skilled
workforce necessary to support the
continuing ramp-up in widebody engine
production. These actions enabled the
business to deliver a record 483 widebody
engines in 2017 (2016: 357), up 35%, despite
challenges caused by in-service issues.
In June, a £150m investment in facilities was
announced with the majority going to new
testing facilities for large engines in Derby.
We also opened a new Trent XWB assembly
line in Dahlewitz to complement the existing
one in Derby. Together these two facilities
will enable us to deliver seven Trent XWB
engines a week by mid-2018.
The new fleet support facility in Tyne and
Wear, UK, became operational, allowing the
early closure of an older facility to take place
in 2018. In addition, legacy supply chain
facilities in Ansty and Sunderland, UK, were
exited during 2017.
In-service fleet performance
Our large engine fleet has continued to
grow, with over 4,400 engines in active
service at the end of 2017, up 7% on 2016.
Invoiced flying hours from in-production
Trent engines rose 22% and total invoiced
flying hours from service agreements across
all our widebody, business aviation and
regional jet engines were 16.7 million, an
8% increase on 2016. The Trent 700, which
constitutes 36% of our installed widebody
engine fleet, continued to perform
well in service, achieving a dispatch
reliability of 99.9%.
We celebrated a number of milestones
in the year, including the Trent XWB-84
achieving over 1.2 million flying hours with
unprecedented levels of reliability (99.9%
dispatch reliability).
We have, however, experienced an
increased level of activity managing
in-service issues on two engine programmes
in 2017, the Trent 1000 and Trent 900,
caused by the lower than expected
durability of a small number of parts.
In the first half of the year, we took £59m
of charges related to technical issues with
the in-service fleet, the largest component
of which related to the Trent 1000. Since
then we have continued to progress our
understanding of the technical issues
impacting compressor rotor blades,
intermediate and high-pressure turbine
blades for the Trent 1000 and also
high-pressure turbine blades for the
Trent 900, together with the consequential
operational impact on our customers.
This has been a dynamic situation and
we are managing these issues through
a proactive engine maintenance programme.
This has required increased short-term
support including both on-wing and shop
visit intervention, which has resulted in
disruption for some of our customers.
We have grown our Trent 1000 maintenance,
repair and overhaul capacity since an issue
with the intermediate pressure turbine blade
was first identified, including doubling the
number of lines available in the UK,
developing a dedicated shop in our SAESL
facility in Singapore and using lean methods
to reduce turn-around times. We continue
to make solid progress with longer-term
solutions, largely through the re-design of
affected parts, and we expect these to be
fully embodied in the Trent 1000 fleet by
2022. Reducing disruption to our customers
remains our top priority. The Trent 1000 TEN
engine, the latest variant of the Trent 1000,
includes a variety of improvements that help
deliver greater capability, durability and
efficiency. It is, however, possible that a
population of early Trent 1000 TEN engines
may benefit from proactive maintenance
to embody re-designed parts that weren’t
available at the point of production. On the
Trent 900, an extended life turbine blade
is being rolled out into the current fleet.
Further re-designs are underway and will
be available in 2020.
Total charges of £227m (2016: £98m) were
recognised in the income statement in
relation to accelerated maintenance activity
for the Trent 1000 and Trent 900 in 2017
and £170m (2016: £90m) in our cash flow.
Based on our current estimates, in 2018 the
anticipated annual cash impact in respect
of both the Trent 1000 and the Trent 900
is expected to broadly double from the total
cash cost in 2017 of £170m and reach a peak
in 2018, as maintenance activity intensifies.
It is then expected to fall by around £100m
in 2019. The majority of the work will be
undertaken in 2018 and 2019 although
it is expected to be fully complete by 2022.
All of these costs are included in our cash
flow guidance for 2018 and beyond.
Developing the service offerings
As the engine base matures and flying
hours continue to grow, the business has
broadened its range of long-term service
packages to meet the needs of an
increasingly diverse customer base.
In June, the Airline Aircraft Availability
Centre was opened in Derby. The Centre
uses industry-leading data analytics to
proactively plan engine operations and
maintenance, and complements the existing
global network of customer service centres
working to provide in-depth expertise in
their local markets.
The service network has continued to
evolve with Air France/KLM joining the
CareNetwork for Trent XWB engines.
The global network of Authorised Service
Centres for business aviation aircraft
now totals 74.
We have sought to develop both physical
and digital infrastructure for aftermarket
services through a number of initiatives.
We introduced the CareStore as a customer
gateway to the full range of digitally-enabled
services, supporting more informed
decisions. Online apps were launched for
both commercial and business aviation
customers to provide better insight into
their engines to help optimise performance
and provide real-time service information.
We continued to develop our services for
our lessor customers and in January 2018
we launched LessorCare, a pioneering
new service tailored to their needs, and
successfully signed three customers up
in the first wave. Total service revenue
of £4.2bn in 2017 now represents 52% of
Civil Aerospace revenue and 28% of Group
revenue. Over the next few years we expect
continued aftermarket revenue growth as
we build towards a 50% plus share of the
installed widebody passenger market and
service revenue from Civil Aerospace
become a greater proportion of our
Civil Aerospace and Group revenue.
Civil Aerospace outlook
Outlook for the new business structure
under IFRS 15 is discussed in the 2018
Outlook on page 58.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
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25
CENTRE OF EXCELLENCE FOR POWER
GEARBOX TECHNOLOGY
In November, Rolls-Royce officially opened its state-of-the-art
power gearbox (PGB) test facility in Dahlewitz, Germany.
The facility is part of the new centre of excellence for power
gearbox technology, one of the key enabling technologies for
the UltraFan engine. Development and testing is already well
underway. The facility has already set a new world record for
the running of the world’s most powerful aerospace gearbox
– with the PGB successfully reaching 70,000hp. But it won’t
stop there: our PGB is designed to run at up to 100,000hp.
When running at maximum power, each pair of teeth on the
gearbox transmit more power than the whole starting grid
of a Formula 1 race.
Operating environment
Rolls-Royce key differentiators
Our continued development of advanced world-leading
technology, culture of partnership with customers and innovation
in services are attributes that Civil Aerospace customers really
value and are difficult to imitate. These differentiators will
maintain the business’ position at the forefront of the civil
aerospace industry.
Market dynamics
— The slow-down in new aircraft orders highlighted in 2016
has continued through 2017 across all regions. These market
conditions were to be expected after the high levels of order
placement over the past few years, as airlines absorb the
increased capacity. It does not imply a slow-down in the
growth of air travel, which remains robust.
— Demand growth for air travel in all regions has remained
resilient to recent geopolitical uncertainties, and historically
growth has recovered quickly following major economic
shocks. A broad consensus forecasts that air traffic
(revenue passenger kilometres) will grow by approximately
5% compound annual growth rate over the next 20 years.
— The business jet market is recovering slowly in the US
(the largest market) and there are tentative signs of
growing demand elsewhere.
Opportunities
— The business has a strong and growing market position on
widebody aircraft produced by the world’s two major aircraft
manufacturers: Airbus and Boeing. The current share of the
widebody engine market is at 35% of the installed passenger
fleet and is expected to exceed 50% early in the next decade.
— The increasing size of the installed base delivers significant
service growth opportunities. 90% of the current Rolls-Royce
widebody fleet is covered by TotalCare service agreements.
— The business continues to invest in technologies to enhance
the existing and near-future product portfolio. In parallel,
a number of engine demonstrators with embedded electrical
generators have been successfully run; and work on
innovative hybrid aircraft demonstrator projects is ongoing.
— Boeing sees an opportunity for a new aircraft sized between
the 737 and 787 families, dubbed the ‘New Mid-market
Airplane’. Rolls-Royce is engaged in discussions with Boeing
to explore this potential prospect.
— China’s COMAC and Russia’s UAC announced a joint venture
in May; the China Russia Commercial Aircraft International
Corporation (CRAIC). CRAIC recently unveiled plans to
develop the CR929, a long-haul widebody aircraft. Rolls-Royce
is actively exploring this opportunity.
Business risks
— If a major product failure in service is experienced, then
this could result in loss of life and significant financial and
reputational damage.
— If the technical performance of a product falls significantly
below customer expectation (e.g. Trent 1000 and Trent 900
time on-wing is less than planned) or fails to deliver the
planned business benefits, then this would cause significant
financial and reputational damage.
— If an external event or severe economic downturn significantly
reduces air travel and thereby reduces engine flying hours
and demand for aircraft, then financial performance may
be impacted.
— If aircraft manufacturer customers significantly delay their
production rates or if the business suffers a major disruption
in its supply chain then delivery schedules would be delayed,
damaging financial performance and reputation.
— If the business experiences significant pricing pressure from
increased competitor challenge in key markets, then financial
performance may be impacted.
— If there are significant changes to the regulatory environment
for the airline industry, then the market position of the Civil
Aerospace business may be impacted.
STRATEGIC REPORT 26
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Rolls-Royce Holdings plc Annual Report 2017
SERVICE DELIVERY CENTRES
BRING ROLLS-ROYCE CLOSER
TO DEFENCE CUSTOMERS
The new Defence service delivery centre (SDC)
located at RAF Lossiemouth in Scotland, opened
in 2017, supports EJ200 engines powering the
resident fleet of Typhoon combat aircraft.
Established in partnership with the MoD’s
Defence Infrastructure Organisation, it houses
a team of specialist Rolls-Royce engineers,
together with their RAF and Serco counterparts,
working to deliver tailored support services.
SDCs form part of a suite of innovative support
solutions that Rolls-Royce is implementing across
a global network of over 150 military customers.
During 2017 a further site opened in Bangalore,
India, supporting over 750 engines in service
with the Indian Armed Forces.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Review
27
Defence Aerospace
Key facts
Defence Aerospace is a market leader in
defence aero engines for military transport
and patrol aircraft and has strong positions
in other sectors, including combat, training
aircraft and helicopters.
16,000
engines in service
around the world
Over 150
customers in over
100 countries
6,100
average number of
employees during 2017
Defence | Key financial data *
Key highlights
Underlying revenue
Underlying gross profit
Underlying operating profit
Underlying operating margin
Order book
2017
£2,275m
£575m
£374m
16.4%
£3.4bn
Year-on-year
change
+3%
+2%
-3%
-100bps
-18%
Organic
change †
-1%
-2%
-7%
-100bps
-14%
* See note 2 on page 132 for further segmental detail.
† Organic change is at constant translational currency, excluding M&A.
Underlying revenue mix
Services
58%
Other
17%
Combat
30%
OE
42%
Transport
and patrol
53%
Underlying revenue broadly flat
with modest decline in both spare
parts and LTSA revenue, the latter
due to the retirement of the UK
Ministry of Defence Gnome-powered
Sea King fleet in 2016
Underlying operating profit down
7% through product mix and higher
R&D spend reflecting ongoing future
programme development
Order intake of over $1.4bn secured
in the US, including further funding
for long-term service contracts with
US Department of Defense
Expansion of service offerings
through the opening of new service
delivery centres in Lossiemouth
and Bangalore and extended supply
agreement signed with Aviall,
a Boeing company
Joint venture signed with Turkish
industrial conglomerate Kale Group to
develop an indigenous engine solution
for the TF-X combat programme
STRATEGIC REPORT
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Strategic Report
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Rolls-Royce Holdings plc Annual Report 2017
Overview 2017
The Defence Aerospace business had
another solid year. Original equipment (OE)
production focused on executing under
long-term contracts in transport & patrol
as well as delivering technology to improve
fuel efficiency for legacy fleets. In combat,
as well as increasing production for the
LiftSystem, the joint venture announced
with Kale in Turkey positioned us well to
offer an indigenous engine solution for
the TF-X fighter jet.
A number of core US service contracts
were renewed, covering over 3,000 engines,
and an agreement with Aviall, a Boeing
company, significantly improved the spares
distribution channel for AE defence engines.
There were also additions in the UK and
India to further enhance our SDC network.
The facility modernisation programme in
Indianapolis, US, met all of its 2017 milestones
with targeted cost reductions also on track.
Finally, we continued to make progress
on the development of next generation
technologies across our portfolio to ensure
we can continue to offer our customers
increased performance and capability
for their operations.
Financial overview
Underlying revenue
Underlying revenue of £2,275m was broadly
flat on the prior year on a constant currency
basis. OE revenues increased 4% through
higher transport and patrol volumes,
partially offset by lower combat sales
following the completion of Middle Eastern
delivery contracts in early 2017. Service
revenue was down 4%, reflecting slightly
lower LTSA revenue related to the 2016
retirement of the UK MoD Gnome-powered
Sea King fleet and reduced demand for
spare parts in India in particular. We did,
however, see increased overhaul activity
in the US for the F-35B fleet and for the
Typhoon fleet in Saudi Arabia.
Underlying operating profit
Gross profit of £575m was 2% lower than
prior year reflecting lower LTSA margin
improvements of £68m (2016: £82m), largely
due to lower cost savings compared with
2016 on the Eurofighter Typhoon contract,
and lower spare parts volumes. These were
mostly offset by the non-repeat of £31m of
one-off costs for the TP400 programme.
Overall the R&D charge of £78m (2016: £71m)
was slightly higher and included ongoing
future programme development across
our portfolio focused on the combat and
transport markets. Restructuring costs
included within C&A were £14m higher
due to the non-repeat of the one-off benefit
in 2016 following the closure of the Defence
Aerospace facility at Ansty. As a result of
these changes, underlying operating profit
of £374m was 7% lower than the prior year.
During the year, the Defence Aerospace
order book was restated by £(441)m to
reflect a number of assumption changes
relating to certain historical orders and
long-term contracts including revised
scope and lower expectations of price
escalation and delivery volumes. After
order intake of £1.8bn, the order book
closed at £3.4bn.
Operational and
strategic review
Activity with key customers included major
contract renewals with the US Department of
Defense supporting engine fleets on aircraft
such as the C-130 Hercules, V-22 Osprey and
T-45 Goshawk. Together these cover around
3,000 engines and the orders taken in 2017
for over $1.4bn provide good visibility on a
substantial portion of aftermarket revenues
for the next five years. Internationally the
business signed its first OE export order with
the Japanese Self-Defense Force to power
its new V-22 Osprey fleet and also secured
additional Multi Role Tanker Transport
engine contracts.
Operationally, the Defence Aerospace
business focused on delivering on its
long-term contracts for core transport
programmes. In combat, LiftSystem
production for the F-35B Lightning II
increased, with the current in-service fleet
performing well. The aircraft made its first
international operational deployment
with the US Marine Corps to Japan, and
its first UK-based deployment for the MoD
is planned for 2018. EJ200 production was
lower following completion of the Saudi
Typhoon contract in 2016, although there
is the expectation of incremental orders
from the State of Qatar following the
signing of a contract to purchase 24
aircraft in December.
Technology inserts for the C-130 Hercules
legacy fleet met operational performance
expectations and demonstrated excellent
reliability and fuel efficiency in extended
hurricane operations during major US
storms in 2017. This helped generate good
international interest with a potential first
export order currently being evaluated.
Defence Aerospace continued with its
strategy of moving into adjacent products
to deepen relationships with existing
customers, identifying an additional
platform opportunity for infrared
suppressors installed on the MH-47
helicopter to be fitted onto C-130 gunships.
The business continued with the
modernisation programme of its
manufacturing and technology research
plant in Indianapolis with all key 2017
milestones achieved on time. The plant’s
first turbine production cell came on
stream in March and a second is nearing
completion. The modernisation will help
drive meaningful productivity benefits
and reduce operational overheads by
2020. We also announced further
rationalisation of our operational footprint
with the closure of our repair and overhaul
facility in Oakland, California by 2020.
A joint venture agreement with Turkish
industrial firm Kale Group positions us well
to develop an indigenous combat engine
for Turkey targeting the TF-X fighter jet.
Development work has also continued on
the Anglo-French Future Combat Air System
(FCAS) feasibility programme, together with
investment in future technologies to position
us for new programme opportunities over
the next decade.
Strategic aftermarket initiatives looked
to deepen customer relationships and
distribution capability, including an
enhanced spares supply contract with
Aviall, a Boeing company, covering all
defence variants of the AE engine fleet.
This multi-year contract is expected to
significantly improve availability and
logistics, while broadening international
opportunities. In addition, two further SDCs
were opened in Lossiemouth and Bangalore
as we continue to find ways to enhance
our offering with core customers, helping
with preventative maintenance and
maximising on-wing availability.
Defence Aerospace outlook
Outlook for the new business structure
under IFRS 15 is discussed in the 2018
Outlook on page 58.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Review
29
ROLLS-ROYCE INNOVATES IN THE ENGINE
EQUIPMENT MARKET WITH INFRARED
SUPPRESSORS
Rolls-Royce continues to demonstrate its engineering
excellence and innovation with expansion into adjacent
engine equipment markets in Defence Aerospace. Building
on the success of the introduction of infrared (IR) suppressor
technology on the MH-47 aircraft – protecting the platform
from heat-seeking missiles – and a successful flight test of
an advanced IR suppressor on the V-22, we were awarded
a contract with US Air Force Special Operations Command
to outfit its AC-130W Stinger II gunships with advanced
IR suppressors to reduce the risk of detection during
dangerous operations.
Operating environment
Rolls-Royce key differentiators
Advanced technology and Defence Aerospace’s collaboration
and innovation, in conjunction with partners and customers,
are its unique hallmarks. These differentiators ensure successful
delivery of products and services tailored to customers’
evolving needs.
— There is strong service growth potential via technology
insertion and emerging service opportunities using digital
technology and data analytics to generate new solutions.
— There is strong interest in electrification and the business
is exploring more electric and hybrid electric propulsion
technologies and power generation for high energy systems.
Business risks
— If a major product failure in service is experienced, then
this may result in loss of life and significant financial and
reputational damage.
— If global defence spending experiences a further downturn,
then financial performance would be impacted.
— If we do not continue to invest to improve the performance
and cost of Rolls-Royce products, then market share
may be lost.
— If the business suffers a major disruption in it supply chain,
then delivery schedules would be delayed, damaging financial
performance and reputation.
— If new applications are not secured, then the business may
have to increase investment or accept erosion in capabilities.
Market dynamics
— As threat levels around the globe increase and economies
grow, many customers are considering increasing their
defence budgets, therefore the business expects to see
modest growth across the globe in the coming years.
— Revenue has historically been broadly balanced between
OE sales and aftermarket services.
— In Europe, the political environment has resulted in a tendency
for large defence programmes to be addressed by consortia
of two or more companies. For example, Defence Aerospace
has partnered with ITP Aero, MTU and Safran on the TP400
engine programme for the Airbus A400M.
— Barriers to entry are high, the competitive landscape is not
envisaged to change significantly in the near future.
Opportunities
— Combat propulsion remains the largest market segment, with
opportunities for current products (LiftSystem and EJ200) as
well as new international and next generation programmes
(Turkey TF-X and Anglo French FCAS).
— In transport, Defence Aerospace is vitalising existing capability
with new products (T56 Series 3.5 kit and infrared suppressors)
and is well positioned for next generation opportunities.
STRATEGIC REPORT 30
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Business Review
Rolls-Royce Holdings plc Annual Report 2017
HITACHI RAIL EUROPE HONOURS
POWER SYSTEMS AS BEST SUPPLIER
In recognition of its outstanding support over
the past three years, Hitachi Rail Europe
awarded MTU its 2017 Best Supplier accolade
for delivery performance. Power Systems
has delivered over 200 MTU PowerPacks –
a third of the total ordered by the company
for rolling stock programmes including
GWR’s new intercity express trains in the UK
– on time and at a consistently high quality.
The relationship does not end with the engine
deliveries: MTU has secured a ValueCare
long-term maintenance contract for the
PowerPacks, spanning just over 27 years,
that includes preventive maintenance as
well as repair and major overhaul.
Rolls-Royce Holdings plc Annual Report 2017
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31
Power Systems
Key facts
Power Systems is a leading provider of
high-speed and medium-speed reciprocating
engines, complete propulsion systems and
distributed energy solutions. The business
serves the marine, land defence, power
generation and industrial markets.
>20,000
reciprocating engines
sold per year
>1,200
development, production,
service and dealership
locations
10,100
average number of
employees during 2017
Power Systems | Key financial data *
Key highlights
Underlying revenue
Underlying gross profit
Underlying operating profit
Underlying operating margin
Order book
2017
£2,923m
£842m
£330m
11.3%
£2.2bn
Year-on-year
change
+10%
+20%
+73%
+410bps
+8%
Organic
change †
+3%
+12%
+61%
+410bps
+4%
* See note 2 on page 132 for further segmental detail.
† Organic change is at constant translational currency, excluding M&A.
Underlying revenue mix
Services
33%
Industrial
25%
OE
67%
Defence
and other
12%
Marine
30%
Power generation
33%
New leadership team driving
transformation programme to
streamline product portfolio,
reduce fixed costs and improve
cash conversion
Improved financial performance with
3% growth in underlying revenue
and signs of market recovery
Power generation products enjoyed
good demand from China and for
US data centres
240bp rise in underlying gross
margin to 28.8% and material
improvement in cash flow
Service revenue growth of 6%:
recovery in US spares demand
and growing interest in a
repair/reconditioning solution;
and MTU’s first long-term availability
contract signed with Hitachi Rail
in UK
Launch of customer care centres
and digital solutions reflect focus on
customer service initiatives to provide
service capability for the installed
base of over 100,000 engines
STRATEGIC REPORT
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Rolls-Royce Holdings plc Annual Report 2017
Overview 2017
Power Systems’ core business is the design,
manufacture and servicing of reciprocating
engines including diesel, gas and
hybrid/electrical solutions, propulsion
systems and distributed power generation
plants. It has a significant installed engine
base across a diverse range of end markets.
In 2017, strengthening demand in key end
markets combined with a clear focus on
operational improvements through the
RRPS 2018 transformation programme.
This enabled the business to deliver a
strong performance achieved against
the background of greater operational
efficiencies and a more balanced annual
production cycle. Revenue grew slightly
and helped deliver significant profit and
cash flow growth.
Under new leadership the business was
able to achieve a material reduction in
product variants and greater R&D discipline
while targeting low-emission technologies.
There has also been a move to develop
more comprehensive and connected
power solutions leveraging digitalisation
as an enabler of service penetration and
a growing competitive advantage.
Power Systems also sought to expand
its geographic reach with manufacturing
and assembly partnerships in India and
in the core growth market of China.
Financial overview
Underlying revenue
Underlying revenue of £2,923m increased
by 3%. OE revenue grew 1% while service
revenues increased 6%. Commodity-related
markets, such as mining and oil & gas saw
a strong recovery, as did construction and
agriculture. Power generation products
enjoyed good demand from China and for
US data centres, but was more subdued
elsewhere, as was the yacht market for
much of the year. The service business
broadened its market reach with good
interest in our reconditioning service
offering and from US customers.
Underlying operating profit
Overall, gross margins increased 240bps
to 28.8% reflecting improved product
mix, including from service revenue and
programme applications, operational
gearing and from higher volumes. An
improved balance of production between
the first and second half of the year also
helped to achieve better factory utilisation.
The actions taken as part of the RRPS 2018
programme on direct material costs also
contributed to the improved gross margin.
A more focused approach to R&D drove
a 6% reduction to £177m. C&A costs
reduced 7% to £331m reflecting cost
reduction activities in the year. Overall
underlying operating profit which increased
strongly to £330m (2016: £191m).
Operational and
strategic review
Power Systems’ customers span a range of
end markets providing significant diversity.
The strong performance in 2017 reflected
growing demand in a number of key end
markets as the overall environment
improved. Engine production increased
principally due to demand for the core
Series 4000 products, large engines and
rail Power Packs. The business was also
successful in greater smoothing of the
sales and production cycle over the year,
reducing the proportion of sales and
production activity in the fourth quarter,
which has historically been abnormally high.
There was growing order interest through
the year, particularly from naval and
government customers with a stronger order
book in the second half. The medium-speed
business announced two notable power
station orders from Bangladesh.
Manufacturers active in the construction
and agriculture market increased orders
in advance of new EU emissions regulations
due to come into force at the start of 2019.
The first delivery of the new S4000 marine
natural gas engine which is IMO Tier III
compliant, was made to the Dutch ferry
operator Doeksen. Gas systems sales in
marine and power generation now make up
over 14% of revenue from the S4000 range.
The business entered into new segments
such as excavators with products meeting
the latest emissions standards driven by
orders from market leaders KATO and JCB.
A project agreement was signed with
agricultural machinery manufacturer Claas
for the annual supply of around 5,000
Series 1000-1500 engines.
Power Systems also sought to grow its
share of its engine service opportunity.
This included the Reman product, where
engines are reconditioned and restored
to the latest MTU specification and come
with an as-new warranty package, and
which generated strong interest. Customer
Care Centres were established in key time
zones to greatly enhance technical support
responsiveness to customers’ critical
requirements and applications were
launched to deepen customer service and
dialogue. Over time, the business will look
to develop more comprehensive power
solutions which will offer higher-value and
digitally connected products which will
deepen the customer experience. An initial
step was the business’s first long-term
availability contract signed with Hitachi Rail
for their UK Intercity programme, covering
the period to the early 2040s; and Power
Systems sees significant opportunity to
develop similar long-term service offerings
for other customers.
A reinvigorated leadership team under
the new CEO, Andreas Schell, helped drive
the RRPS 2018 restructuring programme.
This was a key contributor to the strong
performance in 2017, delivering significant
operational improvements as the business
pursued greater efficiencies and focus
across both R&D and production. This
delivered a 20% reduction in product
variants and was combined with actions
to improve material costs, quality control,
inventory levels and a footprint reduction.
Greater digitalisation within the development
programmes helped to reduce the time
to product launch, including the online
monitoring of the ramp-up fleet and greater
collaborative working.
Agreements made in India and China
are intended to broaden the production
capability in lower-cost locations closer
to core end markets. These included the
official registration of a 50/50 joint venture
with Guangxi Yuchai Machinery in China.
The agreement will enable localised
production of the MTU Series 4000
diesel engines under license, which comes
on-stream in early 2018, and is part of the
China growth strategy. An agreement was
also signed with Garden Reach Shipbuilders
& Engineers Ltd for final assembly in India
of Series 4000 naval engines, and we are
looking to secure additional partnerships
for end markets such as power generation.
R&D programmes have focused on
the strategic priorities addressing new
technologies, alternative fuels and
system-based solutions, reflecting the
structural shift away from traditional diesel
engines expected over the next decade.
This included strengthening the gas engine
portfolio, reflecting greater demand from
better infrastructure and availability within
power generation, industrial and marine
segments. This complements the investment
in electrification to expand our hybrid
capabilities and further development
of micro-grid solutions. A co-operation
agreement with G+L innotec GmbH for
electrical-assisted turbo charging
technology is part of a programme to
build a range of advanced electrical
capabilities as a basis for development of
future hybrid and electrical drive solutions.
Power Systems outlook
Outlook for the new business structure
under IFRS 15 is discussed in the 2018
Outlook on page 58.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Review
33
MTU SERIES 4000 ENGINES –
STILL LEADING THE PACK
When it was introduced more than two decades ago, the
Series 4000 engine was ahead of its time. It was the first
fast-running, high performance large diesel engine with
common rail fuel injectors, technology that was only just
debuting in the automotive industry. Today, it still leads the
pack. From ships and locomotives, to mining vehicles and
electricity generators, it is the all-rounder in the MTU engine
range with sales of over 37,000 units. During 2017, the Series
4000 story opened a new chapter with the establishment
of MTU Yuchai Power Co, a joint venture with China’s Guangxi
Yuchai Machinery Company. From spring 2018, it will
manufacture up to 1,500 engines a year for the oil & gas
and power generation industries.
Operating environment
Rolls-Royce key differentiators
Technology leadership and a reputation for market-leading
performance and system approach, new product innovation,
full lifecycle service solutions and high levels of customisation
in collaboration with customers will maintain a strong market
position for Power Systems.
Market dynamics
— Most OE markets started to recover in 2017, with the exception
of the offshore marine markets. There is strong demand in
onshore oil & gas markets.
— Increased utilisation in resource industries, especially oil & gas
and mining, is driving aftermarket service demand after several
years of challenging market conditions.
— There continues to be increasingly stringent government
regulation in most markets with regards to emissions from
diesel engines.
— The industry is increasingly focused on service solutions,
electric and hybrid power solutions and digital capabilities;
this is stimulating investments in acquisitions, partnerships
and in-house digital organisations.
— Power Systems is experiencing increasing competition
in its core power range as existing competitors launch
new engine series and new players emerge with new
technologies, e.g. Tesla.
Opportunities
— Rising energy demand in developing countries in combination
with expansion of renewable energy sources will increase
the demand for flexible generating sets and products beyond
combustion engines (e.g. hybridisation, electrification
and gasification).
— There is continued growth forecast in emerging markets,
e.g. China and India, where domestic partnerships including
local value creation will continue to be important.
— Tightening emission regulations in several regions will
require clean diesel solutions where the business is well
positioned (e.g. S4000 engine).
— Exponentially growing data usage requires rapid
expansion of data centres and infrastructure and therefore
corresponding back-up power solutions, Rolls-Royce
generators are in particular demand due to their reliability.
— Increased utilisation in recovering resource markets due
to wear and tear of existing fleets is leading to emerging
services opportunities.
Business risks
— If we fail to develop more innovative products than our
competitors, then market share would be lost in our core
power ranges and markets.
— If electrical-storage technologies develop faster than
anticipated, then these may substitute Rolls-Royce products
and/or affect margins.
— If other players in the industry consolidate, then they may
generate synergies or capabilities that outpace the ability
of the business to get new products and services to market.
— If new disruptive service models, e.g. 3D printing of spare parts
or new digital service models are offered by competitors, then
we may lose attractiveness and competitive edge.
STRATEGIC REPORT 34
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Business Review
Rolls-Royce Holdings plc Annual Report 2017
A WORLD FIRST SETS SAIL
Copenhagen harbour witnessed a world
first in 2017 with the demonstration of the
first remotely operated commercial vessel.
The combination of technical expertise in
ship intelligence at Rolls-Royce and global
towage operator Svitzer’s operational
knowledge, ensured a successful maiden
voyage for the Svitzer Hermod. The vessel
was fitted with a Rolls-Royce dynamic
positioning system, which provided data to
the Rolls-Royce designed Remote Operating
Centre (ROC) where the captain controlled
the vessel.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
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35
Marine
Key facts
Marine manufactures and services propulsion
and handling solutions for the maritime
offshore, merchant and naval markets,
ranging from standalone products to
complex integrated systems.
30,000
commercial vessels using
Rolls-Royce equipment
70
Naval forces using
Rolls-Royce equipment
4,600
average number of
employees during 2017
Marine | Key financial data *
Underlying revenue
Underlying gross profit
Underlying operating loss
Underlying operating margin
Order book
2017
£1,077m
£225m
£(25)m
-2.3%
£0.8bn
Year-on-year
change
-3%
-5%
-7%
-10bps
-18%
Organic
change †
-9%
-9%
+15%
-10bps
-15%
* See note 2 on page 132 for further segmental detail.
† Organic change is at constant translational currency, excluding M&A.
Underlying revenue mix
Services
47%
Naval
31%
OE
53%
Key highlights
Underlying revenue 9% lower,
reflecting ongoing offshore
market weakness
Underlying operating loss reduced
through strong focus on cost control
and modest cash outflow
Continued investment in Rauma
facility, Finland, to create state-of-
the-art production and test facilities,
together with progress on
autonomous shipping programme
Strategic review of commercial
marine business underway
Commercial
69%
STRATEGIC REPORT
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Strategic Report
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Rolls-Royce Holdings plc Annual Report 2017
The main operational focus across the
Marine business was the continued effort
to reduce fixed costs to help mitigate the
impact of the weaker offshore market.
The restructuring programme announced
in November 2016 achieved its target
of £45-50m of annualised cost savings.
This was helped during the year through
further rationalisation of back office
functions, together with the closure
of the Shanghai assembly facility.
Investment of around £20m in the year
was made in a state-of-the-art production
and test facility in Rauma, Finland, which
will deliver significant capabilities for what
is a growing market opportunity.
The Marine business has also sought
to capitalise on the broader shift from
mechanical to electrical and digital
technologies, both within its existing product
range and also through investment in
opportunities for integrated ship systems
and remote or autonomous vessels. The
launch of a new energy management
solution and the first ever Marine availability-
based contract reflects the growing potential
in this area. Third-party funding was secured
to support R&D for land-based control
centres and a fleet management centre
was established for remote optimisation
of ship operations. Rolls-Royce successfully
demonstrated this new technology by
partnering with global towage operator,
Svitzer, including the first trial of a remotely
operated commercial vessel that took place
in Copenhagen harbour.
Marine outlook
Outlook for the new business structure
under IFRS 15 is discussed in the 2018
Outlook on page 58.
Overview 2017
With the average Brent crude oil price
remaining below US$55/barrel for the third
consecutive year, our commercial marine
business continued to see substantially
reduced activity levels in its historically
important offshore market, but saw
opportunities within the merchant sector.
The naval business had a successful year
with new projects from existing core clients
such as the UK and US navies and from
new geographies.
As a result of the weak market environment,
the business focused on executing its
restructuring programmes, reducing
its fixed cost base, including significant
headcount reduction, and closing non-core
facilities. At the same time it is repositioning
itself with product development such as
permanent magnet thrusters, investing in
future technologies as the industry moves
to greater electrification and exploring the
growing potential for remote vessel
operations and autonomous shipping.
It was announced after the year end that
our commercial marine operations would
be subject to a strategic review in 2018,
including the potential for sale, while the
naval operations would be integrated into
an enlarged Defence business unit.
Financial overview
Underlying revenues
Underlying revenue was down 9% at
£1,077m, reflecting declining OE activity,
with weakness in both offshore and
cargo-related merchant markets. Service
revenue was stable, though off a low base in
2016, and there was a notable improvement
in naval revenue, particularly in the second
half. The 15% decline in OE revenue resulted
in service revenue rising to 47% of the total
(2016: 43%). By segment, commercial marine
was down 14% to £805m (2016: £875m) and
naval was up 10% to £272m (2016: £239m).
Underlying operating loss
Despite the 9% decline in underlying
revenue there was a £2m reduction in
the underlying operating loss for the
year to £25m (2016: £27m), helped by the
greater proportion of higher margin service
revenue and reflecting the positive impact
of cost-cutting programmes. R&D spend
was broadly flat at £46m, with the focus
on developing ship intelligence capabilities
as well as on new product development.
C&A costs of £204m were 13% lower,
demonstrating the progress made in
reducing both headcount and fixed costs,
together with a significant reduction in
inventory which helped mitigate the scale
of cash outflows.
Operational and
strategic review
Lower activity within commercial marine
reflected the weak market environment as
deep water exploration activities remained
at depressed levels. While OE activity
continued to decline, the business was
encouraged by the signing of the first
offshore service contract since 2015 and
a long-term service agreement reached for
azimuth thrusters. There was also activity
across the merchant sector including
Norwegian ferry operator contracts for
new gas engines and thrusters along with
further auto-crossing system product sales.
Within the naval business a landmark
contract was signed to supply the US
coastguard’s largest shipbuilding
programme, initially covering up to 11
vessels with a range of propulsion and
related technologies. In addition, the MT30
gas turbine continued to demonstrate its
attractiveness as a naval engine choice
with its selection by the Republic of
Korea for three Daegu type frigates.
Work continued with a number of
customers who had previously selected
the MT30 including factory acceptance
testing with the Italian Navy’s landing
helicopter dock vessel and in the UK
both on the Royal Navy’s Type 26 frigate
programme and the two new aircraft
carriers. HMS Queen Elizabeth completed
successful sea trials and preparation for
the first run of the HMS Prince of Wales
power plants is scheduled for 2018.
The team also announced a concept
autonomous defence vessel capable
of a range of single role naval missions,
drawing on the expertise across power
and propulsion and autonomous tools.
Rolls-Royce Holdings plc Annual Report 2017
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HMS QUEEN ELIZABETH TAKES TO THE SEAS
HMS Queen Elizabeth, the largest warship ever built for
the UK’s Royal Navy, left Rosyth dockyard in Scotland to
begin sea trials in June 2017. This was a major landmark for
Marine’s naval business, having been involved in the project
since its launch over a decade ago. The new class of aircraft
carrier – weighing in at 70,000 tonnes – features a range
of Rolls-Royce equipment including twin MT30 marine gas
turbines, propellers and steering gear, stabilisers, reception
points and electrical distribution. The MT30 continues to
attract customers and is proving to be the gas turbine of
choice for modern naval combatants with over 40 engines
delivered to customers worldwide.
Operating environment
Rolls-Royce key differentiators
Marine is a leading provider of mission-critical solutions for
the commercial and naval maritime markets, a position built
on unique domain knowledge, continuous leadership in maritime
innovation and digital solutions that allow close partnership with
our customers globally across a broad range of ship types.
Market dynamics
— Marine operates in three key markets: merchant, offshore
and naval. Growth within these markets is fundamentally
driven by GDP, trade, oil price and defence spending.
— Naval budgets and naval shipbuilding are growing across
target countries. The US market is stable and remains the
largest market, although Asian markets are growing strongly.
— The offshore market broadly continues to be challenging
linked to significant oversupply in several vessel segments
and financial constraints within the customer base.
— Opportunities continue to be exploited in stable markets
including naval, passenger, and tugs where we have also
seen growth in interest in autonomous solutions.
— Key competitors continue to seek internal cost savings,
whilst developing electrical and digital offerings.
Opportunities
— Historically cyclical marine markets are expected to recover
across the range of merchant and offshore segments,
but with a new focus on efficiency and cost.
— Continued trend towards hybrid/full-electric propulsion
and integrated electric systems with increased adoption
of energy storage solutions.
— Increasing interest from vessel owners in remote and
autonomous solutions, which Rolls-Royce is pioneering,
to improve performance, reduce cost and increase safety.
— Increasing evidence of suppliers partnering with vessel
operators to deliver digital solutions to create greater
availability and reduce operational risks.
Business risks
— If offshore exploration and production expenditure remains
low, then there will be sustained pressure and further delay
in market recovery for both new build and aftermarket.
— If competitors react to a depressed market by pricing
aggressively on new equipment to protect future aftermarket
revenue, then Marine could experience further pressure
on near-term margins.
— If continuing market downturn leaves key customers, suppliers
and competitors exposed to strain, then there could be further
consolidation impacting the competitive landscape.
— If market shifts in technology (e.g. electrification and
digitalisation) proceed at a faster rate than expected, then the
business may not be positioned to take full advantage of this
potential growth.
STRATEGIC REPORT 38 Strategic Report
Business Review
Rolls-Royce Holdings plc Annual Report 2017
AUDACIOUS TAKES TO THE SEA
April saw the fourth of seven Rolls-Royce
powered Astute submarines lowered into the
water for the first time in Barrow-in-Furness,
Cumbria, UK. Audacious is undergoing the
next phase of its test and commissioning
programme ahead of sea trials in 2018. For
over 50 years, Rolls-Royce has been the sole
technical authority for the UK nuclear steam
raising plant that powers the Royal Navy’s
submarines and is home to the largest
population of experienced nuclear design
engineers in the UK. To support the current
fleet, as well as develop and manufacture the
new generation PWR3 reactor plant for the
new Dreadnought class submarines,
Rolls-Royce is investing in new manufacturing
facilities, people and infrastructure at
Derby, UK.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Business Review
39
Nuclear
Key facts
Nuclear is the technical authority for the
UK nuclear steam raising plant that powers
the Royal Navy’s nuclear submarine fleet;
managing plant design, safety, manufacture
and service support. Our civil nuclear
operation supplies safety-critical systems to
about half the world’s nuclear power plants.
>50
years’ experience
developing nuclear
technologies
200
reactors in 20 countries
where Rolls-Royce
nuclear technology
is installed
4,400
the average number
of employees in 2017
Nuclear | Key financial data *
Key highlights
Underlying revenue
Underlying gross profit
Underlying operating profit
Underlying operating margin
Order book
2017
£818m
£133m
£38m
4.6%
£2.0bn
Year-on-year
change
+5%
+10%
-16%
-120bps
+8%
Organic
change †
+4%
+7%
-18%
-120bps
+7%
* See note 2 on page 132 for further segmental detail.
† Organic change is at constant translational currency, excluding M&A.
Underlying revenue mix
Services
53%
Civil nuclear
23%
Underlying revenue up 4% on
greater submarine activity, but
lower underlying operating profit
as R&D spend on small modular
reactors increased
Submarines achieves strong
improvements in operational delivery;
further investment in facilities
Civil nuclear delivered key milestones
as part of the long-term, retrofit
contracts in France and Finland
OE
47%
Submarines
77%
STRATEGIC REPORT
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Strategic Report
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Rolls-Royce Holdings plc Annual Report 2017
Overview 2017
Nuclear plays a key role in the UK’s
submarine programme, acting as the
technical authority, sole supplier and
provider of through-life support for all
submarine nuclear propulsion systems
(representing over 75% of sales). This year,
work principally focused on the Astute
and Dreadnought classes, with significant
progress made in operational and
delivery performance as part of a
multi-year improvement programme
and increased investment in the Derby
manufacturing facilities.
The civil nuclear business achieved key
milestones on large retrofit contracts for
safety-critical control systems in Finland
and France. Service contracts were signed
with nuclear utility customers across
Europe, Canada and China while additional
investment was made into the small modular
reactor (SMR) programme where the UK
Government announced a viability study
covering a number of technologies.
Financial overview
Underlying revenue
Underlying revenue rose by 4% driven
mainly by increased production activity
in support of the Dreadnought class build
programme, together with greater activity
in civil nuclear new build contracts and
field services. Submarine revenue grew
3% to £633m, while civil nuclear revenue
grew 9% to £185m. There was a strong
second half performance, reflecting
phasing within the submarine programmes.
Underlying operating profit
Gross margin was broadly flat, reflecting
a combination of increased activity offset
by additional costs incurred to ensure
higher levels of delivery performance for
the key submarine programmes. The R&D
charge was £17m higher than 2016 as the
SMR programme moved to concept design
activity and did not benefit from the one-off
change in treatment of R&D credits
(2016: £7m credit). As a result, underlying
operating profit was £38m, £7m lower than
the previous year.
Operational and
strategic review
The Nuclear business focused on improving
cost-control, sustainable quality and on-time
delivery for the key submarine programmes.
As part of an overall regeneration of the
submarine business capability, a significant
number of new manufacturing technologies
and systems were introduced. These have
helped to drive significant improvements
in delivery of reactor plant components
into the Astute programme.
Investment was made into new
manufacturing facilities, people and
infrastructure at Derby. This includes
a planned expansion of the primary
component operations factory, principally
in support of the new Dreadnought
programme, where production work is
increasing in support of the build
programme. The expanded facilities will
help develop and manufacture the new
generation PWR3 reactor plant as well
as support the current submarine fleet.
In addition, the contract to deliver the
nuclear propulsion system for HMS
Agamemnon, the sixth of the new Astute
class submarines was signed during the year.
Steady progress was also made towards
the establishment of a delivery alliance
for the Dreadnought class which should
provide greater programme and cost control
benefits to help meet the affordability
challenges for our MoD customer.
The civil nuclear business saw good growth
during the year and is well positioned
on new build projects. In the UK, activity
was centred on Hinkley Point C, with a
number of projects underway including
the successful completion of the early
contractor involvement (ECI) phase for the
design of heat exchangers. We also signed
the main contract to complete detailed
design work and begin manufacturing and
equipment delivery. There was progress
on the supply and delivery of both waste
treatments systems and ultimate diesel
generators under similar ECI arrangements.
Internationally, the civil nuclear business
achieved key milestones on schedule, as
part of its long-term contracts to retrofit
and upgrade safety-critical control systems
at Loviisa, Finland and for EDF’s fleet of
nuclear reactors in France. The business
renewed a contract with EDF to provide
long-term support and secured a contract
for the partial modernisation of safety-
critical control systems on all 34 units of
its 900MW French fleet.
At Fennovoima’s new build plant at
Hanhikivi, Finland, due for completion
in 2024, the business was selected as
preferred bidder to supply instrumentation
and controls. The business strengthened
its position in China with new commercial
agreements signed with CTEC (CGN) and
secured orders for the current new build
programme at Tianwan 5 and 6. In Canada,
the contract with Bruce Power to help
improve through-life operational efficiency
will utilise cutting-edge digital analytical
tools developed from innovations in the
business and based on capability within
Civil Aerospace.
Rolls-Royce welcomed the UK Government’s
decision to set up an expert finance panel to
assess the viability of technology options
including short-term deployable SMRs
and will participate in this review in 2018.
The announcement in November of a
technical feasibility study with state-owned
Jordan Atomic Energy Commission (JAEC)
for the construction of a Rolls-Royce
SMR highlights the international potential,
including growing interest from major
markets in the Commonwealth and
Middle East.
Nuclear outlook
Outlook for the new business structure
under IFRS 15 is discussed in the 2018
Outlook on page 58.
Rolls-Royce Holdings plc Annual Report 2017
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ROLLS-ROYCE PARTNERS TO DELIVER SMRs
In 2017, Rolls-Royce announced it had teamed up with leading
UK industrial engineering organisations with a track record
of delivery – including Arup, Laing O’Rourke and Nuvia –
to champion the potential of SMRs to meet the UK’s energy
needs. Together the partners in this consortium believe that
SMRs represent a unique opportunity for the UK to become
a global leader in innovative nuclear technologies, creating
up to 40,000 highly skilled jobs, opening up valuable export
markets and producing energy for as low as £60/MWh –
competitive against wind and solar.
Operating environment
Rolls-Royce key differentiators
Over a 50-year period, Rolls-Royce has developed unique, leading
technology capabilities in the defence nuclear market, and is the
only company to provide the nuclear propulsion for the UK
submarines programme. In the civil nuclear market, Nuclear
deploys its offerings globally in partnership with customers across
the nuclear lifecycle.
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.
— The competitive landscape has been changing in the last
12 months with some OE manufacturers facing significant
financial difficulty along with programme delays and predicted
overspends; aspirations for SMRs places the business in direct
competition with large reactor vendors.
— Internationally, the Chinese and Russian reactor vendors are
leading the export market, in part due to their ability to
provide full or partial funding to the operating nation.
— Rolls-Royce is the sole custodian of a unique strategic national
capability providing nuclear propulsion for UK submarines –
Nuclear is therefore restricted from any other defence market.
— The UK submarine market expands and contracts in line
with the MoD’s acquisition programme. The business operates
in a partnership model with Babcock and BAE Systems.
Opportunities
— For large civil nuclear reactor new build in the UK, Nuclear
is well positioned with opportunities for engineering and
supply chain offerings.
— SMRs provide a complementary alternative to large
nuclear power installations for the global market.
— Capturing a higher share of the nuclear services market
through extension of services to a larger geographic reach.
— Exploiting digital technology to optimise reactor plant
operation and maintenance, thereby maximising the
business’ ability to access commercial incentives.
— Strengthening the position Nuclear has in the rapidly
growing importance of the Chinese and Russian domestic
and export markets.
Business risks
— If we experience a major product failure in service, then
this could result in loss of life and significant damage to
our reputation.
— If the pool of suitably qualified and experienced personnel
is insufficient to support all elements of future programmes,
then we may not have the ability to deliver to customer
requirements.
— If public sentiment turns against further reliance on nuclear
power, then there will be less support for the development
of new and existing capabilities and markets would be
greatly reduced.
— If political tensions prevent trade or co-operation with
state-owned potential partner organisations, then access
to anticipated nuclear opportunities in the UK and overseas
may not be available.
— If the products which we offer are not affordable to customers
or are not delivering the required effect, then demand for
the products on offer may be greatly reduced.
— If there is a continued lack of clarity regarding governments’
long-term energy strategies, then continued investment in
technology such as SMRs may be questioned.
STRATEGIC REPORT 42
Strategic Report
Technology
Rolls-Royce Holdings plc Annual Report 2017
Technology
At Rolls-Royce, sustaining significant R&D
expenditure is fundamental to our strategy
and long-term growth potential.
Rolls-Royce is a technology rich company,
delivering world-class products and
services for its customers. Technology
leadership is integral to maximising our
competitive advantage and driving the
Group’s long-term success. The decision
to split the technology and engineering
functions in 2017 has allowed the newly
formed technology team, led by the Chief
Technology Officer, to enhance the pace
and agility with which we harness the speed
of change in our markets. The engineering
team is responsible for design rigour,
product safety and ensuring our skills
match business needs. It is headed up by a
newly appointed group chief engineer. The
Science & Technology Committee provides
oversight to all our technology investments.
Creating value from new
technologies and innovation
The Group needs to balance short, medium
and long-term technology needs against
market opportunities. During 2017, actions
have been taken to:
— establish a single technology
organisation with responsibility for
current and future technologies;
— maintain momentum on delivery
of core technologies to ensure the
competitiveness of our products
and services;
— drive technology in digital design and
manufacture to unlock the productivity
benefits of these technologies;
— ensure future skills align with our
technology strategy and further develop
the Rolls-Royce Fellowship programme;
— ensure continuous improvement of the
environmental impact of our products
and services; and
— ensure continued focus on products
and technology that will enable transition
to a low carbon global economy.
Our innovation strategy helps our people
contribute great winning ideas and our
online innovation portal continues to be
successful. The portal connects employees
across the globe and has more than
24,000 users.
We are proud of our university partnership
network which feeds Rolls-Royce with
world-class applied research to underpin
the technology in our products. We have
31 University Technology Centres (UTCs)
and seven Advanced Manufacturing
Research Centres (AMRCs) which not only
provide research that is directly applied
in our business, but also gives us access
to a rich talent pool.
Technologies for today
and tomorrow
The increasingly demanding requirements
of civil aviation are driving game-changing
innovation in our aerospace gas turbines.
The new UltraFan architecture will provide a
step change in efficiency and environmental
performance for ‘middle of the market’ up
to large widebody aircraft. We are also
using our latest technology to meet new
performance and customer requirements
for our military and business jet engines.
Rolls-Royce gas turbines are underpinned
by a range of ever-advancing core
technologies and physical models.
Research to improve our understanding
of the fundamental physics of gas turbines is
central to this and is increasingly supported
by high-performance computing to
model behaviour.
Key facts
2017 Gross R&D expenditure (£m)
Number of engineers (as at 31 Dec 2017)
704
Patents approved for filing
18,245 *
Number of engineers
across the Group
£1.4bn
Gross R&D expenditure
UK
government
273
US government 43
EU funding 16
German
government 14
Other 6
Singapore
government 5
Rolls-Royce
1,035
Other
2,315
Electrical
1,883
Services
1,276
Manufacturing
3,890
Design
8,881
* The number of engineers across the Group has increased from 16,526 in 2016 to 18,245 in 2017 as at 31 December. We have brought agency engineering contractors who support non-core
tasks in new product introduction programmes into our direct headcount following a reinterpretation of export control regulations. For further headcount detail see page 46.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Technology
43
Advances in manufacturing technologies
are also helping to improve our operational
efficiency across the Group through the use
of 3D printing technologies including
additive layer manufacturing (ALM); virtual
design and manufacturing; and robotics.
Advanced materials remain vital to improving
weight and performance.
We believe that nuclear technology will
play a pivotal role in meeting future energy
demands. Our innovative small modular
reactor (SMR) design is an economic
solution for low carbon power. We are
working in cross-industry collaboration,
using our extensive experience in the
nuclear industry, combined with learning
from the broader Group in digital and
robotics technologies, to develop this
solution (see case study on page 41).
Ship intelligence is an important theme in
our Marine business, developing market-
shifting system solutions, and improving
safety and efficiency in the industry (see
case study on page 34).
Our refreshed strategy places much
greater emphasis on digitalisation and
electrification as our business gradually
moves from being a thermo-mechanical
to a electro-mechanical company.
Electrification is already core to our Marine
business where permanent magnet electric
thrusters, hybrid ships and battery powered
ferries are indicative of this change. In
Power Systems, micro-grids are being
used for peak load balancing or off-grid
power generation, and hybrid technology
is also revolutionising the performance
of regional trains.
We are now designing, for the first time,
electrical propulsion systems for aviation
with civil and defence experimental aircraft
which can exploit the flexibility in aircraft
design brought about by the electrification
of aviation. Our recent announcement on
the development of a full-scale hybrid
electric demonstrator, jointly with Airbus
and Siemens, cements our position
as a pioneer of this next generation
of aviation propulsion.
Digital technology impacts everything
we do. Using data analytics and artificial
intelligence across design, manufacture
and services, we are driving production
in our business, efficiency for customers
and generating new innovations.
We are at a point of exciting change.
Technology is driving core products to
ever higher levels of performance while
electrification and digitalisation are
opening market-shifting new opportunities.
TECHNOLOGY IN ACTION TODAY – ADVANCE3 AND ULTRAFAN
Advance3 is the first major new civil aero-engine architecture for Rolls-Royce
in decades and sets new benchmarks in efficiency, environmental
performance and precision engineering. The new architecture and advanced
technologies within Advance3 are required to meet the pace of change within
the industry and remain on track to meet ACARE’s FlightPath 2050 goals.
Innovations include lean-burn combustion and new manufacturing and
material technologies, including 3D printing and ceramic matrix composites.
Advance3 is central to the UltraFan demonstrator programme, which will add
power gearbox, composite fan and high-speed turbine technology elements.
Advance3 will be 20% more fuel efficient than the original Trent 700 engine.
When combined with UltraFan from 2025, that efficiency saving will extend
to 25%.
FLEXIBLE POWER – MICRO-GRIDS
Rolls-Royce reciprocating engines are increasingly being integrated with
multiple power generation assets and storage into micro-grids, able to
dynamically manage the supply of power and react to fluctuations in
demand. The rapid start-up, fast increase in output and quick shutdown
characteristics of MTU engines make them an ideal component of next
generation micro-grids. Applications include power provision for large
industrial sites and very remote or rural areas. Micro-grids are increasingly
being seen as the perfect solution for the problem of providing reliable
and optimal power.
STRATEGIC REPORT 44
Strategic Report
Sustainability – Environment
Rolls-Royce Holdings plc Annual Report 2017
Environment
As a leading industrial technology company, our activities
have a profound effect on society and the environment.
We have an irrefutable role in addressing the risks and
opportunities associated with climate change.
Our approach
We have a long-standing commitment to reducing the environmental impact of our products, services and manufacturing
activities. This commitment is embedded within our governance framework, including our operating system and production
system, and therefore is not a standalone environmental policy. During the year we strengthened our approach to governance
and risk management in this area by introducing an executive-level environment & sustainability committee. Our environmental
strategy focuses on three core areas:
1
2
3
Further reducing the
environmental impact of our
products and services
Developing new technologies
and capabilities for low emission
products and services
Continually reducing the
impact of our business
operations and facilities
1. Products and services
In 2017, over two-thirds of R&D investment
at Rolls-Royce went into improving the
environmental performance of our products.
Together with our supply chain and research
partnerships, we have delivered products
that are industry-leading in terms of fuel
efficiency, emissions and noise.
Our service capabilities contribute
to reducing environmental impact by
maintaining our products to the highest
standards. Increasingly we are able to repair
individual engine components, reducing
the manufacture of new parts and
minimising customer disruption.
We are also frequently retro-fitting
improvements throughout the life of our
engines. Our global network of service
provider partners is crucial to this.
TRENT XWB
Our Trent XWB engine is the sixth generation of the Trent engine family
and is now the most efficient large aero-engine flying today. It delivers
15% better fuel efficiency than the original Trent engine.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Sustainability – Environment
45
2. New technologies
and capabilities
The transition to a low carbon global
economy is dependent on the development
of new technologies and capabilities.
We are building on our strong engineering
heritage to produce state-of-the-art
electro-mechanical and hybrid power
systems, combined with digital solutions.
This means building on our existing
thermo-mechanical products to deliver
step changes in emissions performance.
In partnership with our global network
of University Technology Centres and
Advanced Manufacturing Research
Centres, Rolls-Royce is able to apply
innovations across the product portfolio.
For more information
see Technology, pages 42 and 43
3. Business operations
and facilities
We continue to invest in new facilities
and manufacturing technologies which
will reduce the environmental impacts
of our operations even as we increase
engine production. We continually monitor
performance across our global footprint
to set policy, procedures and targets.
PROJECT SUNSHINE
Over 16,700 photovoltaic panels have been installed on the roof and car port
of our Seletar campus in Singapore. This became fully operational in June
2017, and currently provides 7% of the site’s electricity needs, helping save
over 31,000 tonnes of CO2 across its lifetime. This is one of a series of low
carbon energy projects completed during 2017 including; a ground-source
heating installation at our Bristol, UK site; a further solar installation at our
Aiken, US facilities; and a combined heat and power (CHP) facility at our
Friedrichshafen campus, Germany.
Absolute GHG
emissions (ktCO2e)
415 ktCO2e
2025
TARGET
247
2017
2016
2015
2014
BASELINE
Energy use
(MWh/£m)
Total solid and
liquid waste (t/£m)
81 MWh/£m
3.57 t/£m
2020
TARGET
415
424
455
494
2017
2016
2015
2014
BASELINE
81
81
95
112
116
2025
TARGET
2017
2016
2015
2014
BASELINE
3.33
3.57
4.48
4.31
4.43
Waste to landfill
(000 tonnes)
3.8 tonnes
2020
TARGET
0
2017
2016
2015
2014
3.8
4.8
BASELINE
7.2
6.7
Target: Reduce GHG emissions
by 50% by 2025 1,2
Target: Reduce energy
use by 30% by 2020 1
Target: Reduce solid and
liquid waste by 25% by 2025 1,3
Target: Achieve zero waste
to landfill by 2020 1
During 2017, we completed several
renewable solar installations and
low carbon energy schemes as
part of our longer-term strategy
to reduce the environmental impact
of our operations.
We have continued to invest in
energy efficiency improvements,
including lighting, heating and
compressed air systems upgrades,
investing a further £8m in 2017.
As a result, we have met our energy
reduction target three years early.
We have made good progress
with reducing the amount of waste
we generate, despite increasing
engine production. During 2017,
we launched a renewed waste
programme, focused on key waste
streams including machining coolant
and process chemicals.
We are progressing well with
our target of zero non-hazardous
waste to landfill. Over 40 of our
manufacturing and office sites have
now achieved zero waste to landfill.
1 External assurance over the STEM, energy, GHG, and TRI rate data provided by Bureau Veritas. See page 195 for their sustainability assurance statement.
2 Statutory greenhouse gas (GHG) emissions data details on page 200.
3 Waste data for 2016 and 2017 has been calculated in accordance with our basis of reporting, as set out at www.rolls-royce.com/sustainability. There remains a degree of uncertainty
in the accuracy and completeness of waste-related data. We will continue to review historical and source data and if a material impact is identified will seek to restate these reported
figures in 2018. As a result of these continued issues with data completeness we have extended our total solid and liquid waste reduction target from 2020 to 2025. The baseline year
of 2014 remains unchanged. See pages 107 and 108 for more detail.
STRATEGIC REPORT 46
Strategic Report
Sustainability – People
People
Rolls-Royce Holdings plc Annual Report 2017
We are committed to creating an environment where all our people
are able to be at their best. We are determined to ensure we have
the right values and competencies for the business today, and the
right capabilities and behaviours for the future.
Care
Create a working environment where each of us is able to be at our best.
Growing capabilities
Key capabilities needed to secure emerging opportunities:
Growing behaviours
Key behaviours needed to secure emerging opportunities:
— systems integration
— electrical engineering
— data sciences
— pursue collaboration
— seek simplicity
— embrace agility
— be bold
Core competencies
Key competencies needed to safeguard our current
competitiveness:
— engineering pre-eminence
— programme management
— business acumen
Core values
Key values needed to safeguard our current competitiveness:
— ‘Trusted to Deliver Excellence’
— act with integrity
— operate safely
Our 2017 headcount
Health and safety
Our global employee distribution continued
to evolve as we increased production in
our Civil Aerospace business and faced
continued external pressure on our Marine
business. Our total employee turnover rate
for 2017 was 9.3%.
Headcount by business unit 1
Civil Aerospace
Defence
Aerospace
Power Systems
Marine
Nuclear
Other businesses
and corporate
Total
2017
24,600
2016
23,800
6,100
10,100
4,600
4,400
6,000
10,300
5,300
4,300
200
50,000
200
49,900
Headcount by location 1
UK
US
Canada
Germany
Nordic countries
Rest of world
Total
2017
22,500
6,200
1,000
10,600
3,000
6,700
50,000
2016
22,300
6,300
1,000
10,700
3,400
6,200
49,900
It is with deep regret we report two
fatalities, in separate incidents, during the
year. One work-related incident resulted
in a fatal accident at a customer’s site.
The other incident was road-traffic related
and occurred while commuting to work –
a reportable incident in Germany where
it occurred.
These tragic incidents reinforce the
importance of health and safety across all
that we do and led us to strengthen the
governance that underpins our HSE policy.
We conduct thorough investigations into
actual and potential high-consequence
incidents and apply lessons learnt across
our global operations through risk-based
improvement programmes.
Employee wellbeing is a core element
of our approach to managing health
and safety and to enabling our people
to be at their best. We are investing in
creating workplaces where employees
are encouraged to make healthier choices.
Our LiveWell accreditation scheme
recognises sites that have taken steps
to create environments that support
employee wellbeing. To date, 60% of
our manufacturing and office facilities
have achieved a LiveWell award.
For more information on our health
and safety performance see the
Safety & Ethics Committee Report,
pages 104 to 109.
Employee engagement
Our total reportable injury (TRI) rate for
2017 was 0.55 per 100 employees 2. This
represents a 14% improvement since 2014.
In 2017, we initiated focused improvement
plans on areas of the Group with the
greatest safety challenges. In 2018, we will
launch a Group-wide programme focusing
on sites considered to have higher HSE risk
profiles, to provide a detailed understanding
of potential HSE risk and required controls.
During 2017, we shifted our focus from
performance management to performance
enablement, encouraging our managers
to adopt regular, less formal conversations,
feedback and coaching with their teams.
Employee performance ratings are now
made up of delivery against objectives
and performance against our values
and behaviours, including those set out
in our Global Code of Conduct.
1 Headcount data is calculated in terms of average full-time employees.
2 External assurance over the STEM, energy, GHG, and TRI rate data provided by Bureau Veritas. See page 195 for their
sustainability assurance statement.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Sustainability – People
47
During 2017, we invested £31.2m in employee
learning and development, delivering over
a million hours of employee training in
subjects ranging from HSE, quality, product
safety, export control and ethics.
We provide a variety of channels to
communicate with and listen to employees
and their representatives and encourage
participation and engagement throughout
the organisation.
Our annual employee opinion survey helps
measure the success of these engagement
activities. More than 30,000 employees
took part in the survey this year which gave
a snap-shot of progress against our key
engagement drivers. We maintained our
employee engagement score of 75 in 2017,
the same as in 2016. The survey highlighted
strengths in company values, ethical
behaviours, and employee accountability,
as well as fairness and inclusiveness. Areas
for improvement identified included prompt
decision making and establishing priorities.
For more on the Board’s employee
engagement activities see page 73.
Diversity and inclusion
We believe that having a culture of inclusion
is the foundation for driving diversity. During
2017, we made significant progress, however
diversity continues to be a challenge for
Rolls-Royce and the engineering sector
as a whole.
We have launched a new diversity and
inclusion strategy and reviewed our
global diversity and inclusion and
anti-discrimination policies to ensure all
employees, regardless of gender, race,
SUPPORTING OUR LGBT COLLEAGUES
We are committed to building an inclusive culture and diverse workforce. PRISM is
our UK employee resource group (ERG) for lesbian, gay, bisexual and trans (LGBT+)
people. The PRISM vision is to connect, encourage and develop diverse people to
drive innovation, attract and promote talent and to support global growth. We have
14 ERGs globally with a variety of focuses and more planned.
religion or physical ability are treated
with respect and are empowered to work
without fear of bullying or harassment.
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, expertise and potential.
We are recruiting from groups
under-represented in the engineering
sector, particularly women, those from
disadvantaged backgrounds and minority
ethnic groups.
We believe it is important to increase
the number of women at all levels, as well
as attracting more women and people
from diverse backgrounds into science,
technology, engineering and maths (STEM)
careers. Our work with organisations such
as Women in Science and Engineering
seeks to boost our visibility amongst
potential female employees, and we
support initiatives such as the Institution
of Engineering and Technology’s
‘#9percentisnotenough’ campaign.
We published our gender pay
report for the UK in November
2017. Further details can be
found on page 94.
Our diversity and inclusion targets
Employees by gender *
During 2017, we launched a new diversity
and inclusion strategy with global targets
to increase female participation at all levels
of our organisation by 2020. Our employee
population is currently 15% female.
Our global targets are supported
by local targets in key regions where
there are specific diversity challenges
associated with ethnicity, nationality
and age.
2017
2016
2015
2014
41,600
7,400 (15.1%)
42,400
7,400 (14.8%)
42,800
7,700 (15.2%)
46,100
8,000 (14.8%)
30% female
High potential population
30% female
Graduate population
17% female
All employee population
We have also introduced a global
target around inclusiveness, measured
by a subset of our employee opinion
survey. We have agreed to improve
our performance year-on-year for
questions related to fairness and
inclusiveness.
For Board members by gender
see Nominations & Governance
Committee Report, page 82.
■ Male ■ Female ■ Undeclared
(2016: 100, 2017: 100)
Senior managers by gender
2017
2016
2015
2014
■ Male ■ Female
114
18 (13.6%)
125
16 (11.4%)
177
14 (7.3%)
168
12 (6.7%)
* In 2016 we reclassified certain joint ventures as joint operations. As a result, 900 employees are listed in our overall headcount, however we do not currently collect diversity
information for these joint operations, therefore they are omitted from this data.
STRATEGIC REPORT
48
Strategic Report
Sustainability – STEM
STEM
A strong pipeline
of diverse talent and
experience is critical
to the future success
of our business. We are
committed to inspiring
the next generation into
science, technology,
engineering and maths
(STEM) careers.
We recognise the need to engage young
people in STEM at an early age, enabling
them to make informed education and
early career choices. Our education
outreach and community investment
programmes particularly focus on activities
that demonstrate the lifelong opportunities
that careers in STEM can offer. We are
actively targeting groups under-represented
in STEM sectors to attract more people
from diverse backgrounds.
Globally we aim to reach six million
people through our STEM activities and
programmes by 2020. 1,400 Rolls-Royce
employees volunteer their time as STEM
ambassadors, helping us to reach 3.8
million 1 people since 2014. This includes
one million people in 2017, 48% of whom
were actively engaged in our programmes.
We continue to attract high numbers of
applicants to our graduate and apprentice
development programmes. These provide
a pipeline of talent into engineering and
other functions.
During 2017, we recruited 313 graduates
and 339 apprentices worldwide. 74%
of these graduates joined engineering
development programmes.
The proportion of women recruited as
apprentices in our 2017 intake increased to
21%, and the proportion of female graduates
increased to 22%.
We have agreed a global target to increase
our female graduate population to 30%
by 2020 as part of our diversity and
inclusion strategy.
Rolls-Royce Holdings plc Annual Report 2017
MUSKAAN PROJECT, INDIA
The Rolls-Royce Muskaan project aims to increase young peoples’ interest
in STEM subjects by demonstrating how fun science and maths can be.
Muskaan, which means ‘smile’ in Hindi, is designed to supplement the
school’s regular curriculum through guided interactive learning and
classroom kits dedicated to STEM topics. The project reached more than
2,100 school children across India in 2017.
SUPPORTING OUR COMMUNITIES
We are committed to having a positive impact
in the global and local communities where
we operate. We focus our engagement
activities on four key areas:
— education and skills, primarily STEM;
— arts, culture and heritage;
— environment; and
— social investment.
Our activities vary from national programmes,
such as the Rolls-Royce Science Prize, to local
activities with schools and community partners
close to our operations. We encourage our
people to volunteer their time as part of
our employee engagement and development
programmes.
We believe there is greater impact in lasting
engagement than one-off cash contributions,
but do make charitable donations aligned
to our strategy. During 2017, this included
one-off donations to the Women in Tech
Foundation and the Campaign for Science
& Engineering.
In total, we invested £7.7m in supporting
communities in 2017. This includes £4.3m
in cash contributions and 93,900 hours
in employee time.
Reach 6 million
people by 2020
1,400 STEM
ambassadors
£7.7m invested
in supporting
communities
1 External assurance over the STEM, energy, GHG, and TRI rate data provided by Bureau Veritas. See page 195 for their sustainability assurance statement.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Sustainability – Ethics
49
Ethics
Who we are and how
we behave matters
to our people and our
stakeholders. We have
made fundamental
changes in recent years
to place ethics and
compliance at the heart
of everything we do.
We have a Global Code of Conduct
(the Global Code) that applies to all
employees of Rolls-Royce, its subsidiaries
and controlled joint ventures, wherever
they are located. Breaches of the Global
Code are not acceptable and will result
in the Company taking action. This may
include disciplinary action up to and
including dismissal. In 2017, there were
65 employees (2016: 38 employees) whose
employment ended for reasons related
to breaches of the Global Code.
The Global Code sets out principles that
underpin our values and the way we do
business. It also provides guidance on how
to apply these in everything we do. 100%
of managers completed a certification
exercise during the year, confirming their
commitment to the Global Code. We
encourage all employees and stakeholders
to raise ethical questions or concerns,
without fear of retaliation. For employees,
we provide four main channels for them to
speak up, including a 24hr Ethics Line and
network of 84 local ethics advisers around
the world.
Anti-bribery and corruption
The Global Code includes clear statements
regarding our zero-tolerance approach
to bribery and corruption.
This year we revised our anti-bribery and
corruption related policies, standards and
guidance and brought them together into
one comprehensive Global Anti-Bribery
and Corruption Manual. This provides
a framework for our anti-bribery and
corruption programme and clearly sets
out the responsibilities that apply to all
employees, including requirements to
conduct due diligence on customers,
suppliers and other business partners.
Our anti-bribery due diligence includes
screenings, interviews and obtaining
in-depth due diligence reports from
ALL-EMPLOYEE ETHICS TRAINING
Our ethics training programme is designed to bring our Global Code of Conduct
to life. This year’s all-employee training focused on having conversations about
its application and its relevance to individual roles. 98% of employees completed
this activity.
specialist providers, depending on the level
of risk that a particular third party presents.
In addition to our all-employee ethics
training, we have introduced training
workshops for senior managers and any
other roles that are likely to be exposed
to situations where there is a risk of
attempted bribery and corruption.
Human rights
We remain committed to protecting
and preserving the human rights of our
employees, those working in our global
supply chain, and those who may be
impacted by our business operations.
Our commitment to human rights, including
our position on forced labour, involuntary
labour, child labour, and human trafficking,
is outlined in the Global Code, as well as our
Global Supplier Code of Conduct and Global
Human Rights policy. We have taken an
integrated approach to minimising the risk
of slavery and human trafficking taking
place in our supply chain or any part of
our business. Adherence and due diligence
associated with these policies is embedded
within our operating system and processes
across our global functions, including
human resources, ethics and procurement.
More information on our approach can
be found in our anti-slavey and human
trafficking statement, available at
www.rolls-royce.com.
Ethics in our supply chain
We spent over £8.7bn in our external supply
chain in 2017. Our suppliers and partners
are vital to our success, so we are committed
to working collaboratively with them to
maintain the highest ethical standards.
At the end of 2017, all our suppliers had
agreed to adhere to our Global Supplier
Code of Conduct, or a mutually agreed
alternative. This sets out the minimum
behaviours and practices we expect our
suppliers to demonstrate based on our
own Global Code and related policies,
including our Global Human Rights
policy and Global Anti-Bribery and
Corruption Manual.
This year, we have introduced further
monitoring and assessments prioritised
by the potential level of risk the supplier
may present. To date, 67% of prioritised
suppliers have completed a self-assessment
questionnaire which aims to understand
how suppliers are adhering to the principles
set out in the Global Supplier Code of
Conduct within their own operations.
We are now working with these suppliers
to collaboratively agree plans to address any
gaps that may have been identified as part
of our supplier management frameworks.
For more information see
Safety & Ethics Committee Report,
pages 104 to 109.
STRATEGIC REPORT 50
Strategic Report
Additional Financial Review
Rolls-Royce Holdings plc Annual Report 2017
Additional Financial Review
In this section we provide additional detail and commentary on
key financial areas – Group reported results, funds flow and
balance sheet and additional Civil Aerospace detail.
Group – reported results
Reconciliation between underlying and reported results
Year to 31 December
£m
Underlying
Revenue recognised at exchange
rate on date of transaction 1
Mark-to-market adjustments
on derivatives 8
Related foreign exchange adjustments 1
Movements on other financial
instruments
Effects of acquisition accounting 2
Impairments 3
Exceptional restructuring 4
Acquisitions and disposals 5
Financial penalties 6
Post-retirement schemes 7
Other
Reported
Revenue
Profit before financing
Financing
Profit/(loss) before tax
2017
15,090
2016
13,783
1,217
1,172
–
–
–
–
–
–
–
–
–
–
16,307
–
–
–
–
–
–
–
–
–
–
14,955
2017
1,175
–
24
345
–
(129)
(24)
(104)
798
–
–
–
2,085
2016
915
–
–
570
–
(115)
(219)
(129)
(3)
(671)
(306)
(1)
41
2017
(104)
2016
(102)
2017
1,071
–
–
–
2,648
257
11
–
–
–
–
–
1
(1)
2,812
(4,420)
(151)
(8)
–
–
–
–
–
3
1
(4,677)
2,672
602
11
(129)
(24)
(104)
798
–
1
(1)
4,897
2016
813
–
(4,420)
419
(8)
(115)
(219)
(129)
(3)
(671)
(303)
–
(4,636)
The changes in 2017 resulting from
underlying trading are described on page 18.
Consistent with past practice and IFRS,
we provide both reported and underlying
figures. As the Group does not hedge
account in accordance with IAS 39 Financial
Instruments, we believe underlying figures
are more representative of the trading
performance by excluding the impact
of year-end mark-to-market adjustments.
In particular, the USD:GBP hedge book has
had a significant impact on the reported
results in 2017 as the USD:GBP rate has risen
from 1.23 to 1.35 and the EUR:GBP has fallen
from 1.17 to 1.13. The adjustments between
the underlying income statement and the
reported income statement are set out
in note 2 to the Consolidated Financial
Statements. This basis of presentation has
been applied consistently.
The most significant items included in
the reported income statement, but not
in underlying are summarised below.
Profit before financing
1. The impact of measuring revenue
and costs at spot rates rather than
rates achieved on hedging transactions
increased revenue by £1,217m
(2016: £1,172m) and increased profit
before financing by £345m
(2016: increased £570m).
2. The effects of acquisition accounting
£129m (2016: £115m) principally relate
to the amortisation of intangible assets
arising on the acquisition of Power
Systems in 2013.
7. In 2016, the UK pension schemes were
restructured resulting in costs of £306m,
principally a settlement charge on the
transfer of the Vickers Group Pension
Scheme to an insurance company.
3. The impairment of goodwill, investments,
PPE and inventory of £24m (2016: £219m).
In 2017, this includes £12m as a result of
consolidating a previously unconsolidated
subsidiary and £12m relating to the Marine
business. The impairments in 2016 largely
related to the Marine business as a result
of the weakness in the oil & gas market.
4. Exceptional restructuring costs of £104m
(2016: £129m). These are costs associated
with the substantial closure or exit of
a site, facility or activity related to the
significant transformation project that
the business is currently undertaking.
A number of the projects within the
transformation programme are spread
over several years.
5. The acquisition of ITP Aero resulted in
a gain of £553m from the revaluation
of the previous joint venture investment
and recognition of a bargain purchase
of £245m.
6. In 2016, £671m of penalties from
agreements with investigating bodies
were recognised.
Financing and taxation
8. The mark-to-market gain on the Group’s
hedge book of £2,648m (2016: loss of
£4,420m). These reflect: the large hedge
book held by the Group (circa USD
$38.5bn); and the strengthening of
sterling, particularly against the US
dollar offset by the weakening of
sterling against the euro, as noted above.
At each year end, our foreign exchange
hedge book is included in the balance
sheet at fair value (mark-to-market) and
the movement in the year included in
reported financing costs.
Appropriate tax rates are applied to these
additional items included in the reported
results, leading to an additional tax charge
of £361m (2016: credit £865m), largely as
a result of the mark-to-market adjustments
£(463)m and £792m in 2017 and 2016
respectively. In addition, £163m of advance
corporation tax credits has been recognised
as a result of changes to UK tax laws in 2017.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Additional Financial Review
51
Group – funds flow
Summary funds flow statement 1
£m
Opening net (debt)
Closing net (debt)/funds
Change in net (debt)/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 pensions in excess of underlying
PBT charge
Taxation paid
Free cash flow
Shareholder payments
Net funds acquired/acquisitions
Payment of financial penalties
Other
Foreign exchange
Change in net funds
Excluding the
impact of
ITP Aero
(225)
(520)
(295)
2017
ITP Aero
–
215
215
1,071
741
546
(1,732)
(164)
462
(9)
(180)
273
(214)
(17)
(286)
8
(59)
(295)
–
–
(14)
–
–
(14)
–
–
(14)
–
229
–
–
–
215
Change
excluding
ITP Aero
–
–
–
+258
+21
+601
-531
-211
+138
+58
-23
+173
+87
+136
-286
+8
-299
2016
(111)
(225)
(114)
813
720
(55)
(1,201)
47
324
(67)
(157)
100
(301)
(153)
–
–
240
(114)
Total
(225)
(305)
(80)
1,071
741
532
(1,732)
(164)
448
(9)
(180)
259
(214)
212
(286)
8
(59)
(80)
1 The derivation of the summary funds flow statement above from the reported cash flow statement is included on page 168.
Movement in working capital
The main drivers of the £546m cash inflow
from a fall in working capital were increased
receipts from airframers in advance of
discounts payable to the operator (£460m)
in Civil Aerospace together with an
increase in payables (£120m) but partly
offset by increased inventory (£330m),
all linked with the ramp-up of our newer
programmes. Other significant contributors
to the working capital reduction were
improved receivables and deposits (£90m)
in Power Systems and the Aviall distribution
agreement in Defence Aerospace (£120m)
and associated reduced inventory.
Pensions
Cash contributions reduced by £22m to
£249m, split evenly between the UK and
overseas. The UK contributions are net
of a refund of £5m from a wound-up
scheme. The UK pension cost increased
by £21m in 2017, largely due to changes
in discount rates which determine the
accounting charge.
Shareholder payments
The change in shareholder payments
reflects the difference between the 2015
and 2016 payments, which are paid in the
following year.
Expenditure on property, plant
and equipment and intangibles
The major increases are due to: investment
in Civil Aerospace operations and
manufacturing assembly and test facilities
as well as increases to the aero-engine fleet
to support the growing installed fleet; and
increased capitalisation of development
costs in the Civil Aerospace business,
reflecting the stage of the new programmes.
Acquisitions and disposals
The consideration for ITP Aero is payable
in eight quarterly instalments from January
2018, no payments were made in 2017.
The deferred consideration can be settled
in cash or Rolls-Royce Holdings plc shares,
at the discretion of Rolls-Royce with a 3%
premium to be applied if the consideration
is in shares. The net funds of ITP Aero on
acquisition were £229m. From the date
of acquisition to 31 December 2017, the
Free cash flow
£273m
2017
2016
2015
2014 *
2014 **
2013
£273m
£100m
£179m
£447m
£254m
* Excluding Energy
** Including Energy
£781m
net funds outflow in ITP Aero was £14m;
excluding the impact of ITP Aero, free cash
flow would have been £273m.
In addition, the consolidation of MTU Brazil
for the first time resulted in the recognition
of net debt of £17m.
Payment of financial penalties
Following the agreements reached with
investigating authorities in January 2017,
£286m of penalties were paid in the UK, US
and Brazil. Further UK payments of £378m
(plus interest) will be made in 2019-2021.
STRATEGIC REPORT
52
Strategic Report
Additional Financial Review
Rolls-Royce Holdings plc Annual Report 2017
Group – balance sheet
Summary balance sheet
At 31 December
£m
Intangible assets
Property, plant and equipment
Joint ventures and associates
Net working capital 1
Net funds 2
Provisions
Net post-retirement scheme surpluses/
(deficits)
Net financial assets and liabilities 2
Other net assets and liabilities 3
Net assets
Other items
US$ hedge book (US$bn)
TotalCare assets
TotalCare liabilities
Net TotalCare assets
Excluding the
impact of
ITP Aero
5,646
4,356
892
(1,874)
(520)
(815)
738
(2,449)
(602)
5,372
Impact of
ITP Aero
1,417
268
(204)
(444)
215
(68)
−
(148)
(238)
798
2017
7,063
4,624
688
(2,318)
(305)
(883)
738
(2,597)
(840)
6,170
38.5
3,536
(1,033)
2,503
2016
5,080
4,114
844
(1,553)
(225)
(759)
(29)
(5,751)
143
1,864
37.8
3,348
(907)
2,441
1 Net working capital includes inventories, trade and other receivables, trade and other payables and current tax assets
and liabilities.
2 Net funds includes £277m (2016: £358m) of the fair value of financial instruments which are held to hedge the fair value
of borrowings.
3 Other includes other investments and deferred tax assets and liabilities.
The acquisition of ITP Aero has had a
significant impact on the shape of our
balance sheet which is described below.
Other key changes are as follows:
Intangible assets
Intangible assets (page 142) increased by
£566m. Additions of £973m (including
£160m of certification and participation
fees, £342m of development costs,
£286m of contractual aftermarket rights
and software of £135m) were offset by
amortisation of £430m.
The carrying values of the intangible
assets are assessed for impairment against
the present value of forecast cash flows
generated by the intangible asset.
The principal risks remain: reductions in
assumed market share; programme timings;
increases in unit cost assumptions; and
adverse movements in discount rates.
Investments in joint ventures
and associates
Investments in joint ventures and associates
increased by £48m. The main movements
were: additions of £48m, including £28m of
investment in joint ventures that finance some
of the Civil Aerospace spare engine pool; the
Group’s share of retained profit of £52m;
offset by £44m of exchange differences.
Net funds
Movements in net funds are shown on
page 51.
Net working capital
Net working capital reduced by £321m. As
well as the cash impact of £546m described
above, the movement reflects the payment
of penalties of £286m. The remaining
movements are primarily driven by
movements in foreign exchange rates.
Property, plant and equipment
Property, plant and equipment (page 144)
increased by £242m. Additions of £764m
were offset by depreciation of £444m.
Additions included an increase to the size
of the Civil Aerospace engine pool (£136m)
driven by fleet support for new
programmes, investment in industrial
footprint consolidation (£109m) and in
manufacturing assembly and test (£68m).
Provisions
Provisions largely relate to warranties and
guarantees provided to secure the sale
of OE and services. The increase of £56m
includes a provision for tax interest and
penalties that was previously included in
current tax liabilities but reclassified due
to guidance issued by the International
Financial Reporting Interpretations
Committee (IFRIC).
Net post-retirement
scheme surpluses
Net post-retirement scheme surpluses
(page 159) have increased by £767m.
In the UK (increase in surplus of £772m),
changes in actuarial estimates reduced the
value of the obligations £515m, principally
due to: (i) inclusion of the latest mortality
tables; and (ii) the reflection of actual
experience as part of the 2017 funding
valuation. In addition, there were returns
(in excess of those assumed) on the scheme
assets of £265m.
The position overseas has remained broadly
stable, with in the impact of reduced
discount rates in Germany and the US being
offset by other actuarial gains in the US.
Net financial assets and liabilities
Net financial assets and liabilities principally
relate to the fair value of foreign exchange,
commodity and interest rate contracts,
set out in detail on page 150. All contracts
continue to be held for hedging purposes.
The fair value of foreign exchange
derivatives is a net financial liability of
£2.3bn, a reduction of £3.2bn in the year,
mainly a result of the strengthening of
sterling against the US dollar.
US$ hedge book
The US$ hedge book increased by 2% to
US$38.5bn. This represents around six years
of net exposure and has an average book
rate of £1 to US$1.55.
Net TotalCare assets
Net TotalCare assets relate to long-term
service agreement (LTSA) contracts in the
Civil Aerospace business, including the
flagship services product TotalCare. These
assets represent the timing difference
between the recognition of income and
costs in the income statement and cash
receipts and payments.
Impact of the acquisition
of ITP Aero
The acquired net assets of ITP Aero are
shown on page 167. The most significant
intangible assets acquired relate to
customer relationships, to technology,
patents and licences and to in-process
development. In addition, working capital
includes an accrual of £648m for the
deferred consideration to be paid in 2018
and 2019. The deferred consideration can
be settled in cash or Rolls-Royce Holdings
plc shares, at the discretion of Rolls-Royce
with a 3% premium to be applied if the
consideration is in shares.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Additional Financial Review
53
2017
3,818
1,895
1,103
598
222
4,205
2,626
527
343
709
2016
3,357
1,604
742
757
254
3,710
2,289
452
342
627
Change
+14%
+18%
+49%
-21%
-13%
+13%
+15%
+17%
–
+13%
Organic
change
+12%
+18%
+49%
-26%
-13%
+12%
+15%
+10%
-5%
+13%
Service revenue from our regional jet
engines declined 5%, reflecting further
retirements and reduced utilisation of
our fleets by North American operators
in particular.
On the V2500 programme, which powers
aircraft including the Airbus A320,
revenue from OE modules declined 13% as
production slowed down further as Airbus
transitions to the A320neo, powered by
a competitor engine provider. However,
V2500 service revenues of £709m increased
by 13% driven by an increased number
of overhauls with increased workscope.
The contractual payment from International
Aero Engines based on flying hours was
broadly stable, with a reduction in flying
hours flowing from retirements of some
older aircraft being mitigated by
price escalation.
Civil Aerospace – additional financial information
Civil Aerospace underlying revenue analysis
£m
Original equipment
Large engine: linked and other
Large engine: unlinked installed
Business aviation
V2500
Services
Large engine
Business aviation
Regional
V2500
Revenue
Overall, underlying revenue for Civil
Aerospace rose 12% to £8.0bn, with OE
revenue of £3.8bn (2016: £3.4bn) up 12% and
services revenue of £4.2bn (2016: £3.7bn)
also up 12%. The rise in OE revenue reflected
record levels of widebody engine deliveries,
with growth in Trent XWB-84 engine sales,
to support the Airbus A350 XWB programme
ramp-up, a significant contributor.
OE revenue from large engine: linked and
other was up 18% reflecting increased
volumes of Trent 700 engines following a
relatively low year in 2016 in which a higher
proportion of A330s built were powered by
competitor engines, combined with higher
deliveries of Trent 900 engines for A380s
for Emirates. Sales of spare engines to joint
ventures, included in large engine: linked
and other, generated revenue of £362m
(2016: £288m).
OE revenue from large engine: unlinked
installed increased 49%, driven by
improved pricing and higher volumes
of Trent XWB-84 engines.
The 15% growth in large engine service
revenue reflected a 22% increase in invoiced
TotalCare flying hours from the growing
in-production engine fleet which more than
offset the 12% flying hour reduction from
mature engine types as older aircraft retired
or where customers selected alternative
service offerings on transitions. Higher
volumes of spare part sales for RB211-535
and Trent 700 engines for time and material
overhauls and for TotalCare engines, where
not covered by the flying hour payments,
also contributed to the revenue increase.
Revenue from business aviation OE engine
sales declined for a second year, with a fall
in unit volumes of 32%, mostly BR710’s,
reflecting continued weakness at the higher
end of the market coupled with the effect
of the transition to newer non Rolls-Royce
powered platforms. Volumes of the newer
BR725 engine, which powers the Gulfstream
G650 and G650ER, remained broadly stable.
Overall, although business aviation OE
revenues declined 26%, service revenue
increased by 10% reflecting continued fleet
expansion, increased CorporateCare
penetration and price escalation.
Underlying revenue mix
2017 – original equipment
Underlying revenue mix
2017 – service
V2500
6%
Business
aviation
16%
V2500
17%
Regional
8%
Business
aviation
13%
Large
engine
78%
Large
engine
62%
STRATEGIC REPORT
54
Strategic Report
Additional Financial Review
Rolls-Royce Holdings plc Annual Report 2017
Contract accounting adjustments
The in-year net charge from long-term
contract accounting adjustments included
within the gross margin totalled £18m
(2016: £90m total benefit, including a £35m
benefit from a change to our long-term
USD:GBP planning rate).
The benefit from lifecycle cost improvements
in 2017 of £113m (2016: benefit of £217m)
included a £70m benefit across the portfolio
of business aviation contracts following
re-assessments of shop visit frequency and
costs. Given that the performance of our
in-service fleet has evolved over the year,
we have increased our estimates for future
costs associated with part life limitations,
particularly in relation to compressor
rotor blades within the Trent 1000 and
high-pressure turbine blades within the
Trent 900. The resulting contract accounting
adjustments associated with these shortfalls
in part life, combined with additional
customer disruption support costs across
these two engine programmes, represents
£114m (2016: £55m) of the total £148m impact
(2016: £98m).
The overall benefit in 2017 from other
operational changes was £17m (2016: £64m
charge). This comprised a £60m charge
driven by changes in the utilisation pattern
of several customers’ Trent 700, Trent 800
and RB211 fleets, offset by a £77m benefit
taken in the first half arising from a change
to a customer credit rating risk assessment.
Contract accounting adjustments
£m
Lifecycle cost improvements
Change in estimated long-term USD to GBP planning rate
Technical costs
Operational changes
Total contract accounting adjustments
2017
113
–
(148)
17
(18)
2016
217
35
(98)
(64)
90
TotalCare net assets
TotalCare net assets increased in 2017 by
£62m (2016: £230m) to £2.5bn. This reflected
an increase in the overall cash deficit
combined with higher linked profit driven
by increased volumes of new linked
engines of £612m (2016: £432m), notably
the Trent 700.
This increase was offset by adverse contract
accounting adjustments taken in the year of
£18m (2016: £90m benefit), foreign exchange
of £(97)m (2016: £77m) and cash inflows and
net other items of £(435)m (2016: £(369)m).
Contractual aftermarket
rights (CARs)
The CARs balance increased by £230m
(2016: increase of £169m) to £803m
reflecting higher sales of unlinked Trent
XWB engines partly offset by price increases
and engine unit cost improvements.
TotalCare net assets
£m
Cash deficit reversal and profit from new linked engines
Contract accounting adjustments
Foreign exchange
Cash inflows and net other items
Total change in TotalCare net assets
2017
612
(18)
(97)
(435)
62
2016
432
90
77
(369)
230
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
IFRS 15
55
IFRS 15
Group – impact of adopting IFRS 15
Group underlying results
2017
£m
Revenue
Civil Aerospace
Defence Aerospace
Power Systems
Marine
Nuclear
Other
Total revenue
Operating profit
Civil Aerospace
Defence Aerospace
Power Systems
Marine
Nuclear
Other
Total operating profit
IFRS 15 overview
IFRS 15 Revenue from Contracts with
Customers (effective from 1 January 2018)
replaces the separate models for goods,
services and construction contracts
currently included in IAS 11 Construction
Contracts and IAS 18 Revenue. The Group
will present its 2018 results, including 2017
comparatives, on an IFRS 15 basis.
IFRS 15 impact
The impact of IFRS 15 on the 2017 underlying
results is shown in the tables on this page
with further information provided in notes 1
and 27 to the Consolidated Financial
Statements. The cumulative impact on net
assets as at 31 December 2017 is £(5.2)bn.
As processes and procedures are further
embedded during 2018, it is possible that
some changes to the impact may result. The
adoption of IFRS 15 has had a significant
impact on the measurement and the timing
of recognition of revenue, most particularly
in the Civil Aerospace business. It has no
impact on the timing or measurement of
the reported cash flows.
The key impacts of adopting IFRS 15 on
our Civil Aerospace business are:
— generally, our contracts with airframers
for OE and with operators for aftermarket
services will not be linked;
— revenue for OE will be recorded at the
net amount of consideration receivable
with any profit or loss on sale, after
recognition of the costs of producing
the OE, recorded on delivery; and
— revenue on LTSAs will be recognised
as services are performed rather than
as the equipment is used as is frequently
the case under the current accounting
policy. The stage of completion will be
measured using the actual costs incurred
to date compared to the estimated costs
to complete the performance obligation.
As we are generally paid on a monthly
basis as engine flying hours occur, whilst
overhaul and repair activities happen
periodically over the term of the LTSA,
the recognition of revenue and profit
will generally be deferred compared
to the current accounting policy and
to cash receipts.
Current
accounting
8,023
2,275
2,923
1,077
818
(26)
15,090
520
374
330
(25)
38
(62)
1,175
IFRS 15
6,613
2,282
2,919
1,075
818
(25)
13,682
(330)
370
331
(26)
38
(62)
321
In addition, the overall net impact on
operating profit of the adoption of IFRS 15
within the Defence Aerospace business was
£4m. This comprised a £34m LTSA margin
impact which is broadly expected to recur
in the short term, but was offset by a £30m
favourable timing benefit from a spares
distribution contract, which is not expected
to repeat in 2018.
STRATEGIC REPORT 56
Strategic Report
IFRS 15
Rolls-Royce Holdings plc Annual Report 2017
Civil Aerospace – impact of adopting IFRS 15
Civil Aerospace underlying income statement summary
2017
£m
Underlying revenue
Underlying OE revenue
Underlying services revenue
Underlying gross profit
Gross margin
R&D costs
Underlying operating profit/(loss)
Underlying operating margin %
Current
accounting
8,023
3,818
4,205
1,192
14.9%
(412)
520
6.5%
IFRS 15
6,613
2,905
3,708
381
5.8%
(451)
(330)
(5.0)%
Difference
(1,410)
(913)
(497)
(811)
(39)
(850)
The following tables provide more detail
on the impact of adopting IFRS 15 in Civil
Aerospace. We have provided additional
information about this business here as
it is most significantly impacted by IFRS 15.
A more detailed analysis of the impact of
adopting IFRS 15 on the other segments
are set out in note 27 to the Consolidated
Financial Statements.
The adoption of IFRS 15 reduces Civil
Aerospace underlying revenue and
underlying operating profit by £1,410m
and £850m respectively.
Underlying OE revenue reduces by
£913m, primarily from de-linking the OE
and service contracts and no longer
capitalising cash deficits. In addition,
participation fees paid to airframers are
treated as a reduction to revenue where
previously presented as a cost.
Underlying service revenue reduces by
£497m. This reduction is driven by: a timing
change to revenue recognition on TotalCare
and CorporateCare long-term contracts
where stage of completion has been
amended from a flying hours basis to a cost
incurred or ‘input’ basis; the de-linking of OE
and services contracts; and classification of
operator guarantee payments as a reduction
to revenue under IFRS 15 where classified as
costs under current accounting.
Underlying revenue by market
segmentation under IFRS 15
The most significant changes to Civil
Aerospace revenue from the adoption
of IFRS 15 relate to large engine OE and
long-term service contract revenue for
both large and business aviation engines.
Large engine service revenue is £299m
lower under IFRS 15. Under current
accounting service revenue is recognised
on an engine flying hour basis, i.e. as
the engines are being used by the airline
operators. The move to recognising
revenue on an activity basis (i.e. when
Civil Aerospace performs the repairs,
maintenance and overhauls) changes
the point at which revenue is recognised.
This change will typically delay the point
at which revenue is recognised under
IFRS 15 when compared with the treatment
under current accounting and as a result
lowers service revenues due to the
relatively young age of the fleet with many
engines yet to reach their first overhaul.
The nature of the change is the same
for CorporateCare service packages in
business aviation. For business jet engines
the timing impact may be more pronounced
than for large engines as business jet
engines are often on wing for many years
before requiring an initial overhaul.
Civil Aerospace underlying revenue analysis
2017
£m
Original equipment
Large engine
Business aviation
V2500
Services
Large engine
Business aviation
Regional
V2500
Current
accounting
3,818
2,998
598
222
4,205
2,626
527
343
709
IFRS 15
Difference
2,905
2,104
582
219
3,708
2,327
396
277
708
(913)
(894)
(16)
(3)
(497)
(299)
(131)
(66)
(1)
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
IFRS 15
57
Contract accounting adjustments
under IFRS 15
Under current accounting, the stage of
completion of long-term service contracts is
assessed based on flying hours. As set out
on page 55, this means that the percentage
of completion will usually be lower under
IFRS 15 than under current accounting.
For linked OE and service contracts, the
stage of completion takes into account
both OE and flying hour revenue. The
consequence of this linkage with the
services contract means that the difference
between the completion percentage
under IFRS 15 and current accounting will
be greater. This is because the linked OE
revenue is no longer included in assessing
the stage of completion. This change in
the way the percentage of completion is
calculated will impact the level of contract
accounting benefit recognised under
current accounting in respect of beneficial
lifecycle cost margin adjustments by £(96)m
from £113m under current accounting
to £17m under IFRS 15.
On the other hand, the contract margin
adjustment associated with technical costs
will be £50m lower under IFRS 15.
The benefit from other operational changes
totalled £17m in 2017 under current
accounting. This included a £77m benefit
arising from a change to a customer credit
rating risk assessment on a linked contract
where under IFRS 15, with no linkage, there
is no benefit in the year.
Contract accounting adjustments under IFRS 15
2017
£m
Lifecycle cost improvements
Technical costs
Operational changes
Total contract accounting adjustments
Current
accounting
113
(148)
17
(18)
IFRS 15
17
(98)
(68)
(149)
Difference
(96)
50
(85)
(131)
Balance sheet adjustments
under IFRS 15
The impact of adopting IFRS 15 on the
Civil Aerospace balance sheet is
summarised below.
£(5.1)bn of the £(5.2)bn impact to the Group’s
opening reserves from the adoption of IFRS
15 is driven by Civil Aerospace.
The transition to IFRS 15 requires
de-recognition of the contractual aftermarket
rights recorded as intangible assets under
current accounting. As this cost will now
be recorded at the point of sale of OE the
amortisation previously recorded will cease
benefiting the gross profit reported on
underlying services revenue.
Under IFRS 15 we regard participation
fees as payments to customers that are
offset against future revenue from those
customers. Therefore, they are recognised
as contract assets rather than as intangible
assets under current accounting.
In assessing the accounting for the
participation fee payments we make to
our OE customers, we have also assessed
the accounting for up-front payments
we sometimes receive from the Group’s
suppliers under RRSAs to allow them to
participate in an engine programme.
We have concluded that, consistent
with changes to how we will account for
participation fees noted above, these
receipts should be deferred and recognised
against cost of sales over the period of
supply. This will also require judgement
as to the number of units over which the
receipts will be allocated.
The most significant change is to the
net contract balance. Other than the
reclassification of participation fees and
the transition from revenue recognition on
an engine flying hours to a cost input basis,
the adjustment also represents £(3.2)bn of
reversal of profit from contract linkage.
The majority of service contracts are on
monthly payment terms based on engine
flying hours. As a result, in many cases we
will receive cash in advance of incurring
costs to support the contract including for
overhauls. Under IFRS 15 we will recognise
the revenue as costs are incurred, changing
the net contract debtor under current
GAAP to a net deferred revenue creditor
under IFRS 15.
Balance sheet adjustments under IFRS 15
2017
£bn
Contractual aftermarket rights
Participation fees - intangible
Participation fees - contract asset
Net contract debtor/(creditor)
Other
Risk and revenue sharing agreements (RRSAs)
Civil Aerospace net assets (pre-tax)
Tax
Civil Aerospace reserves impact (post-tax)
Current
accounting
0.8
0.4
–
2.5
(0.6)
(0.3)
2.8
IFRS 15
–
–
0.4
(2.7)
(0.3)
(0.8)
(3.4)
Difference
(0.8)
(0.4)
0.4
(5.2)
0.3
(0.5)
(6.2)
1.1
(5.1)
STRATEGIC REPORT 58
Strategic Report
2018 Outlook
Rolls-Royce Holdings plc Annual Report 2017
2018 Outlook
New core business units (from January 2018)
Civil
Nuclear
Submarines
Civil
Aerospace
Power
Systems
Defence
Naval
Marine
Civil Aerospace
Power Systems
Defence
Underlying revenue
Underlying revenue
Underlying revenue
2017 IFRS 15: £6,613m
2018 outlook: High single-digit growth
2017 IFRS 15: £3,106m
2018 outlook: High single-digit growth
2017 IFRS 15: £3,184m
2018 outlook: Stable
Underlying operating profit
Underlying operating profit
Underlying operating profit
2017 IFRS 15: £(330)m
2018 outlook: Losses reduce by
up to a third
— Revenue growth from higher OE
delivery volumes and services activity
— Higher services activity driving profit
growth. Around £50m increased
R&D capitalisation
— Increased cash flow from continued
flying hour growth and further working
capital improvements
— But higher deliveries of cash deficit
OE engines albeit at lower unit losses
— Higher Trent 1000 and Trent 900
in-service costs
2017 IFRS 15: £319m
2018 outlook: Margins stable
2017 IFRS 15: £451m
2018 outlook: Margins around 250bps lower
— Continued recovery of naval, oil & gas,
and construction & agriculture end
markets
— Product mix towards lower margin
mining and construction & agricultural
products
— Higher R&D spend on alternative
fuel solutions
— Headwinds from timing changes on
export activity and in contract mix,
higher investment to support new
product development
— Expected non-repeat of £30m
favourable timing benefit from the
Aviall spares distribution contract
Group *
ITP Aero
Underlying revenue
Free cash flow (excluding. ITP Aero)
Underlying revenue
2017 IFRS 15: £13,682m
2018 outlook: Mid single-digit growth
2017: £273m
2018 outlook: £450m +/- £100m
2017 IFRS 15: €827m
2018 outlook: Double-digit growth
Underlying operating profit
2017 IFRS 15: £321m
2018 outlook: £400m +/− £100m
2018 outlook
Underlying operating profit
2017 IFRS 15: €75m
2018 outlook: Modest decline
We are confident 2018 will be a year of good progress. Organic revenue should grow
mid-single digit, with underlying operating profit of around £400m excluding ITP Aero
(around £450m including ITP Aero). Free cash flow should improve to around £450m
excluding ITP Aero, (around £400m including ITP Aero). We are making solid progress
with longer-term solutions for Trent 1000 and Trent 900 in-service issues, largely through
re-designing affected parts, and we expect these to be fully embodied on the Trent 1000
fleet by 2022. On the Trent 900, an extended life turbine blade is already being rolled-out
with further re-designs available from 2020. Based on our current estimates, in 2018 the
anticipated annual cash impact is expected to broadly double and reach a peak. It is then
expected to fall by around £100m in 2019. The majority of this work will be undertaken in
2018 and 2019 and is not expected to complete until 2022. All of these costs are included
in our cash flow guidance for 2018 and beyond.
— Double-digit revenue growth driven
by strong increase in delivery volumes
on civil programmes
— Margin contraction driven by mix
change. Lower volumes of higher
margin defence engines with strong
growth in less profitable civil engines
— Cash outflow (€70m-80m) as a result
of investments and contributions to
third party programmes. Cash flow
expected to move closer to breakeven
in 2019
* Group figures are after inclusion of commercial marine and other eliminations (2017: revenue £779m and loss (£119m)).
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Principal Risks
59
Principal Risks
Risk management
The Board is responsible for the Group’s
risk management system (RMS) and internal
control systems.
Our RMS 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.
— focusing on analysing root causes of risks
or incidents and developing standard
approaches for managing common risks;
— improving our risk appetite framework;
— conducting progressively more
challenging crisis management team
exercises based on our principal risks;
— strengthening our risk assurance
capability to improve alignment of risk,
control and assurance activities; and
Major product programme delivery
Since last year, the level of risk for the major
product programme delivery principal risk
has increased. This is due to in-service issues
that we have experienced with our Trent
1000 and Trent 900 engines (see page 24)
and the resources required to mitigate the
impact of these issues on our customers.
The change in risk level also reflects the
importance that successful delivery of major
programmes has in generating cash to fund
our refreshed strategy.
We continue to build risk management
into the way we work to help us to make
better decisions. It is implemented through
a mandated Group-wide risk management
policy, including our process, software tools
and governance structures. Our risk policy
is supported by training and a team of
experts. Businesses and functions are
accountable for identifying and managing
risks in line with this policy.
— rolling out our risk visualisation tool into
the businesses and functions to bring risk
discussions to life and help management
to focus on the most important risks.
In 2018, we will look to build on these
improvements and continue to integrate
risk management into the culture change
and transformation programmes and key
decision-making activities.
Business continuity plans are in place
to mitigate continuity risks and there
has continued to be regular testing of
the adequacy of these plans through
exercises at every level of our incident
management framework.
Joint ventures constitute a large part of
the Group’s activities. Responsibility for risk
and internal controls 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.
Improving our RMS
We have continued to enhance our RMS
in 2017, including:
— updating our risk policy and actively
communicating it to our employees;
— embedding risk assessment as part of key
decision-making activities e.g. allocating
capital investment;
Principal risks
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 ELT and the
Board during their risk reviews.
The Board, assisted by the ELT, has carried
out a robust assessment of the principal risks
facing the Group, including undertaking a
deep dive into each risk. Deep dives allow
the Board to assess the effectiveness of
management and mitigation of the risk,
including consideration of the effectiveness
of material internal controls. These reviews
are supported by the ELT risk committee
conducting in-depth reviews of related
bottom-up key risks and the actions and
controls in place to manage them.
Changes in principal risks
These ongoing reviews of risks and
understanding of potential root causes
has resulted in changes to the following
principal risks compared to last year.
Product safety
As the Group continues to transform,
the product failure principal risk has been
re-defined and focuses specifically on
the product safety aspects to ensure that
ownership of this risk is clearly aligned
to the changes in our engineering and
technology functions – see page 42.
Political risk
Our Brexit steering group has continued
to assess potential impacts of leaving the
EU, including uncertainties related to our
principal risks. We have briefed the UK
Government and other governments on
our Brexit-related issues and have made
representations through our trade
association memberships.
While we wait for political certainty from
the Brexit negotiations and details of the
final Brexit deal, we have assessed potential
additional operational impacts to understand
what action Rolls-Royce might need to take
before Brexit occurs in 2019.
We could be impacted through a number
of routes. For example: our regulatory
relationship with the EU (European
Aviation Safety Agency; REACH chemical
certification programme); our operational
relationship (customs union and movement
of people); our tax and treasury strategy;
our EU R&T funding relationship and other
interfaces. We are managing these risks
through our operational assessment and
applying our business continuity risk
management process to Brexit.
Management of principal risks
Our risk framework ensures that risks are identified, managed and communicated throughout 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)
STRATEGIC REPORT 60
Strategic Report
Principal Risks
Rolls-Royce Holdings plc Annual Report 2017
Other changes
We are aware of the impact our products and operations have on the planet and the impact climate change may have on our business
either directly or indirectly. To help readers understand where we see the biggest risks and in line with the Financial Stability Board (FSB)
Taskforce on Climate-related Financial Disclosures (TCFD) we have updated our description of two principal risks: i) disruptive
technologies and business models and ii) business continuity.
Risk management enables our strategy
1 Customer focus
to rectify in-service
issues, ramp up
large engine
production
2 Technology focus
through product
revitalisation,
electrification
and digitalisation
Priorities for 2018 on page 9
3 Resilience through
adaptability with
a spotlight on
safety, diversity
& inclusion, and the
highest ethical
standards
4 Financial progress
delivering improving
free cash flow,
strengthening
balance sheet,
more disciplined
capital allocation
Change in risk level
Increased
Decreased
Static
Principal risk or uncertainty
and potential impact
How we manage it
Key controls
Change in
risk level
2018
priorities
Disruptive technologies
and business models
Disruptive technologies, new
entrants with alternative business
models or disruptions to key
markets or customers could
reduce our ability to sustainably
win future business, achieve
operating results and realise
future growth opportunities.
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 few. Our main
competitors have access to
significant government funding
programmes as well as the ability
to invest heavily in technology
and industrial capability.
Major product
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.
— Horizon and emerging technology scanning and
— Strategic
understanding our competitors, including patent searches.
planning process
— Investing in innovation and new technologies.
— Focusing on enhancing our skills and capabilities to maintain
— Investment
review committee
our technology leadership.
— Forming strategic partnerships and conducting joint research
programmes.
— Establishing our digital business.
This principal risk is subject to review by the Science
& Technology Committee.
— Digital
governance
board
— Research &
technology
board
— Digital business
development
board
— Accessing and developing key technologies and service
offerings which differentiate us competitively – see page 42.
— Focusing on being responsive to our customers and improving
the quality, delivery and reliability of our products and services.
— Financial
performance
review
— Strategic
— Partnering with others effectively.
— Driving down cost and improving margins.
— Protecting credit lines.
— Investing in innovation, manufacturing and production,
and continuing governance of technology programmes
– see page 111.
— Maintaining a healthy 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.
planning process
— Investment
review committee
— Science &
Technology
Committee
— Research &
technology
board
— Major programmes are subject to Board approval.
— 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 programmes lifecycle – see page 71.
— Investing in facilities and people to minimise the level of
disruption to our customers from Trent 1000 and Trent 900
in-service issues and developing longer-term solutions
to these issues.
— 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.
— Rolls-Royce
management
system
— Operational
performance
review
— Project
assurance
— Gated business
and technical
reviews
— Quality
compliance audit
— Major quality
investigations
board
This principal risk is subject to review by the Board.
2
3
4
1
4
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Principal Risks
61
Principal risk or uncertainty
and potential impact
How we manage it
Key controls
Change in
risk level
2018
priorities
Product safety
The lives of people that our
customers serve depend on
the safety of our products
wherever and whenever they
operate them. Any failure to
meet this expectation, or if
our product causes significant
environmental impact, would
adversely affect our reputation
and long term sustainability. 1
Talent and capability
Inability to attract and retain
the critical capabilities and
skills needed in sufficient
numbers to effectively organise,
deploy and incentivise our
people to deliver our strategies,
business plans and projects.
Business continuity
Breakdown of external supply
chain or internal facilities that
could be caused by destruction
of key facilities, natural disaster
(including those caused by
climate change), regional
conflict, financial insolvency
of a critical supplier or scarcity
of materials which would
reduce the ability to meet
customer commitments, win
future business or achieve
operational results.
— Ensuring a culture that puts safety first.
— Applying our engineering design and validation process
from initial design, through production and into service.
— Company
product safety
assurance board
— Reviewing the scope and effectiveness of the Group’s product
— Quality
safety policies to ensure that they operate to the highest
industry standards.
— 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 pages 104 to 107.
— Improving our supply chain quality.
This principal risk is subject to review by the Safety
& Ethics Committee.
compliance audit
— Engineering
technical audit
— Crisis
management
team
— Environment and
sustainability
committee
— Attracting, rewarding and retaining the right people with the
right skills globally in a planned and targeted way, including
regular benchmarking of remuneration – see pages 46 and 47.
— Developing and enhancing organisational, leadership, technical
— Remuneration
Committee
— ELT
— Senior
and functional capability to deliver global programmes.
— Continuing a strong focus on individual development and
succession planning.
leadership team
— HR executive
team
— 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.
— 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 page 47.
This principal risk is subject to review by the Nominations
& Governance Committee.
— Continuing our investment in adequate capacity and modern
— Crisis
equipment and facilities.
— Identifying and assessing points of weakness in our internal and
external supply chain, our IT systems and the skills
of our people.
— Selecting stronger suppliers, developing dual sources
or dual capability.
— Ensuring our suppliers are aware of the 2018 REACH deadline
and conducting research on alternative materials.
— Crisis management exercises and testing site-level incident
management and business recovery plans.
— Providing improved response to supply chain disruption
through customer excellence centres.
This principal risk is subject to review by the Audit Committee.
IT vulnerability
Breach of cyber security causing
controlled or critical data to
be lost, made inaccessible,
corrupted or accessed by
unauthorised users.
— 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 page 101.
— Running security and network operations centres.
— Actively sharing cyber security information through industry,
government and security forums.
This principal risk is subject to review by the Audit Committee.
1 Redefined from product failure – see page 59.
management
team
— Major incidents
board
— Quality board
and process
councils
— Operations and
IT executive
— Supplier audit
— Environment &
sustainability
committee
— Operations and
IT executive
— IT security
management
— Crisis
management
team
3
4
1
2
3
4
1
4
1
2
4
STRATEGIC REPORT
62
Strategic Report
Principal Risks
Rolls-Royce Holdings plc Annual Report 2017
Principal risk or uncertainty
and potential impact
How we manage it
Key controls
Change in
risk level
2018
priorities
4
1
2
3
4
3
4
Market and financial shock
The Group is exposed to a
number of market risks, some of
which are of a macro-economic
nature (e.g. foreign currency, oil
price, rates) and some of which
are more specific to the Group
(e.g. 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.
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.
Examples include: explicit trade
protectionism, differing tax or
regulatory regimes, potential
for conflict or broader
political issues.
Compliance
Non-compliance by the Group
with legislation, the terms
of the deferred prosecution
agreements or other regulatory
requirements in the heavily
regulated environment
in which it operates (e.g. export
controls; use of controlled
chemicals and substances; and
anti-bribery and corruption
legislation) compromising the
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
(including export credit
financing), each of which could
have a material adverse effect.
— Maintaining a strong balance sheet, through managing cash
— Financial
balances and debt levels – see page 19.
— 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 page 11.
— 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).
— Review debt financing and hedging in light of volatility in
external financial markets caused by external events, such as
Brexit or other geopolitical changes.
This principal risk is subject to review by the Audit Committee.
performance
review
— Financial risk
committee
— Operational
performance
review
— Group finance,
treasury and tax
teams
— 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.
— Government
relations and
Group tax teams
— Diversifying global operations to avoid excessive concentration
— Strategic
of risks in particular areas.
planning process
— The Group’s businesses and its strategic marketing network
— Supplier audit
proactively monitoring local situations.
— Maintaining a balanced business portfolio with high barriers
to entry and a diverse customer base – see page 58.
— Proactively influencing regulation where it affects us.
— Steering committee to co-ordinate activities across the
Group and minimise the impact of Brexit – see page 59.
This principal risk is subject to review by the Board.
— 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 page 49.
— Corporate
governance
framework
— Compliance
and export
control teams
— Group Secretariat
— Legal team
— 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.
— Engaging with external regulatory authorities.
— Implementing a comprehensive REACH compliance programme.
This includes ensuring that we and our supply chain are covered
by REACH authorisations for a number of chemicals needed
for our products, establishing appropriate data systems and
processes and working with our suppliers, customers and
trade associations.
This principal risk is subject to review by the Safety
& Ethics Committee.
Rolls-Royce Holdings plc Annual Report 2017
Strategic Report
Going Concern and Viability Statements
63
Going Concern and Viability Statements
Introduction
Viability
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 (e.g. 12 month) period
where debt markets were effectively
closed to the Group;
— that in the event of one or more risks
occurring, which has 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; and
— 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.
Signed on behalf of the Board
Warren East
Chief Executive
06 March 2018
The viability assessment considers solvency
and liquidity over a longer period than
the going concern assessment. Consistent
with previous years, we have assessed our
viability over a five-year period. 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 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;
worsening or new in-service issues on new
Civil Aerospace programmes (the base cash
flow forecasts include the estimated future
costs resulting from Trent 900 and Trent
1000 in-service issues described on page
24); or, the impact of a political risk such
as Brexit on the Group (see page 59
for further information on the process
we are taking to manage the risks
related to Brexit).
The scenarios assume an appropriate
management response to the specific event,
but not broader mitigating actions which
could be undertaken, which have been
considered separately. The cash flow impacts
of these scenarios were overlaid on the
five-year 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.
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.
Rolls-Royce operates an annual planning
process. Our plans and risks to their
achievement are reviewed by the Board and
once approved 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
59 and 60. As also described there, the
risk management process, and 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 197, the Group meets
its funding requirements through a mixture
of shareholders’ funds, bank borrowings,
bonds and notes. At 31 December 2017, the
Group had borrowing facilities of £5.4bn and
total liquidity of £5.1bn, including cash and
cash equivalents of £3.0bn and undrawn
facilities of £2.1bn. £82m of the facilities
mature in 2018.
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 FRC in
September 2014).
STRATEGIC REPORT 64
Directors’ Report
Chairman’s Introduction
Rolls-Royce Holdings plc Annual Report 2017
Chairman’s Introduction to Directors’ Report
Ian Davis
Chairman
Introduction
Employee engagement
As I consider our approach to governance
at Rolls-Royce, and reflect on the activities
of the Board during 2017, I am pleased with
the progress we are making. We have been
undertaking some interesting and, at times,
experimental initiatives designed to ensure
the Board maintains an awareness and
appreciation of the perspectives of our key
stakeholder groups as we help to shape
the Group’s direction and strategy.
The Board and I were deeply saddened by
the death of two colleagues in separate
work-related incidents during the year.
These tragic events reinforce the importance
of health and safety across all that we do.
We were also extremely sad to learn of the
death of Dame Helen Alexander, a former
Non-Executive Director of the Company
and close colleague. Helen will be greatly
missed by many, and she leaves behind a
legacy and contribution to the advancement
of corporate governance, notably in her
work on the promotion of gender diversity.
In light of the operational challenges
faced by the Civil Aerospace business,
the Board remained regularly informed on
the management of these issues including:
conflicting demands on resource; the
handling of impacted customers’ interests;
and the management of the resultant
programme risks. As well as briefings from
the Chief Executive, the Board also heard
from the President – Civil Aerospace and
members of his team throughout the year
with updates on the latest developments.
Employees and the Board were deeply
disappointed by the business conduct that
led to the announcement in January 2017
that the Group had entered into deferred
prosecution agreements (DPAs) with the UK
Serious Fraud Office and other authorities.
We have continued to strengthen and
embed ethics and compliance procedures
across the Group. Our continuing ethics
training and Code of Conduct clarify
the responsibilities which apply to all
Rolls-Royce employees. The Board remains
committed to this programme as we believe
that the right behaviours and culture will
deliver enhanced long-term performance.
We encourage an honest, open and direct
dialogue with our employees and their
representatives. This led us to introduce
two new initiatives to strengthen our
employee engagement programme.
The Meet the Board event in May was
tremendously engaging and positively
received. We also selected Irene Dorner
as our Board employee champion. Irene
has taken the lead in strengthening links
between the Board and our employees,
who are key stakeholders in the Group’s
future success. You can read more about
these initiatives on page 73 and in Irene’s
introduction opposite.
For more information on employee
engagement see People on page 46.
Sustainability
Investment in our people and communities
remains a key priority for the Board. During
2017, we maintained active graduate and
apprenticeship development programmes
and are proactively working to increase
the number of women at all levels within
Rolls-Royce. We are engaging with
communities on an international basis
through our research partnerships and
STEM (science, technology, engineering
and mathematics) programmes. As one of
the world’s leading industrial technology
companies, we recognise we have an
important role in addressing the risks
and opportunities associated with climate
change through our engineering expertise
and operational strategy. See pages 44
and 45 for further information and pages
104 to 109 for the Safety & Ethics
Committee Report.
Board apprentice programme
I am particularly proud that in 2017
we launched a new Board apprentice
programme that provides coaching and
board experience to a diverse group of
emerging leaders selected from the Group’s
talent pool, each assigned to a Board or
executive committee. This direct involvement
in nurturing leadership talent is proving
to be very rewarding for all participants,
as well as serving to support diversity
and our succession pipeline. See more
on page 81.
Board developments
We welcomed two new Directors during
2017, as mentioned in the Nominations
& Governance Committee Report on
page 81. Beverly Goulet was appointed
to the Board in July 2017 and joined the
Nominations & Governance and Audit
Committees. Beverly has 24 years’
experience in the US airline industry and
will enhance our customer perspective
on the Board. To ensure strong executive
leadership was in place at an important
juncture for the Group as we refreshed
our vision and strategy, Stephen Daintith
joined the Board as Chief Financial Officer
in April 2017 as previously announced.
In February 2018 it was announced that
Nick Luff had been appointed to join the
Board as a Non-Executive Director with
effect from the conclusion of the AGM in
May 2018, subject to shareholder approval.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Chairman’s Introduction
65
Looking forward
The Board remains strongly committed to
continuous improvement in governance.
We actively reviewed and responded to
the FRC’s consultation to the UK Corporate
Governance Code.
Areas we intend to focus on in 2018 include
Brexit, health and safety, cyber security
and sustainability. We will be monitoring
developments in best practice and I look
forward to continuing a progressive and
innovative approach to governance in the
year ahead.
Ian Davis
Chairman
During the year we renewed the terms of
appointment for Ruth Cairnie, Lewis Booth
and Sir Frank Chapman each for a further
three-year term. In February 2018, we also
agreed to extend Brad Singer’s initial
two-year appointment for a further three
years. All Directors will stand for re-election
at the AGM in May 2018. The Company and
Brad Singer are party to a relationship
agreement with ValueAct (a summary of
which can be found at www.rolls-royce.com).
The agreement will expire on 3 May 2018
but will be replaced with a new agreement
covering treatment of confidential
information and conflicts of interest only.
The Board has a diverse membership with
varied and balanced experience and skills
that are highly relevant to the Group’s
needs and challenges. We recognise that
the Directors need to remain mindful
of their duties to consider the interests
of key stakeholders. We received training
from the Company Secretary on our
duties under the Companies Act 2006,
of particular importance for those Board
members who do not hold directorships at
other UK companies, and a useful refresher
for the other Directors. The Board also
resolved in December to adopt our Board
diversity policy which sets a target of a
minimum of one third of women on the
Board. See page 82 to read more.
More detail on the changes to the Board
is set out in the Nominations & Governance
Committee Report on page 81.
Stakeholder engagement
We set out to actively capture our
stakeholders’ views in a number of ways this
year. As well as our employee engagement
activities, we invited some of our Civil
Aerospace customers to present to the
Board and provide their views on what it is
like to work with Rolls-Royce. The direct and
open feedback was appreciated and helped
our understanding of what is working well
and which areas need more focus.
We benefit from having Brad Singer on
the Board. He is able to provide an investor
perspective drawing on his experience
as chief operating officer of ValueAct, the
Group’s largest shareholder. To remain alert
to the views of our wider shareholder base,
in March 2017 we held the second of our
governance events for fund managers and
governance analysts. We also undertook
an open and meaningful shareholder
consultation exercise on our remuneration
policy, approved with a majority of over
95% at the AGM in May 2017.
You can read about our stakeholder
engagement activities on page 73.
who have attended a session and have
been motivated to take action on an issue
which has particularly engaged them.
Future plans will include visiting our
overseas sites. Recognising that the
engagement in 2017 was primarily
UK-focused, we will find ways to reach
a wider audience and to bring their views
in an organised manner to the Board and
the heart of the organisation.
2017 was a foundational year on which we
can build and learn how to do this better.
I have no doubt that this initiative will evolve
and offer opportunities for change for
individuals and Rolls-Royce.
Irene Dorner
Non-Executive Director
meetings and piggy-backed on other events.
I hosted an online discussion with employees
that was particularly rewarding because it
allowed for a free flow of conversation
across many sites on many subjects.
What has marked all of these events has
been the openness of our people and their
willingness to raise issues. Often there
is simply a real curiosity to understand
what the Board does, but equally we have
had open discussions about: connecting
the Rolls-Royce vision more closely to
our employees; diversity and inclusion;
working methods; career development;
the effectiveness of the employee
opinion survey; the role of employee
representatives; transformation; and
culture and communications.
I have been ably assisted by the formation
of an employee stakeholder engagement
group where we can discuss what we have
learnt and plan our next moves.
I have reported back to the Board and
continue to have open dialogues with
various employees around Rolls-Royce
IRENE DORNER,
EMPLOYEE CHAMPION
Experiments are almost always by their very
nature exciting and kicking off the employee
champion activities has been no exception.
I think it is important to get around the
Group and see as many different cohorts
of people in order to get a broad range
of views. This presents challenges in itself
and we have experimented with a variety
of events, some more formal than others.
I have attended dedicated sessions in
theatre style, gatecrashed already existing
DIRECTORS’ REPORT 66
Directors’ Report
Board of Directors
Rolls-Royce Holdings plc Annual Report 2017
Board of Directors
Ian Davis
Chairman of the Board and Chairman,
Nominations & Governance Committee
NG
Warren East CBE
Chief Executive Officer
Stephen Daintith
Chief Financial Officer
Appointed to the Board in March 2013
and as Chairman in May 2013. Tenure: 5 years
Appointed to the Board in January 2014
and as Chief Executive in July 2015. Tenure: 4 years
Appointed in April 2017. Tenure: less than 1 year
Career, skills and experience
Ian was a partner at McKinsey for 31 years and
served as chairman and worldwide managing
director. He brings significant financial and
strategic experience and has worked with and
advised global organisations and companies,
enabling him to draw on knowledge of diverse
issues and outcomes to assist the Board.
Other principal roles
— BP p.l.c., senior independent director
— Johnson & Johnson Inc., director
— McKinsey & Company, senior partner emeritus
Career, skills and experience
Warren is an engineer and joined ARM Holdings
plc in 1994 where he served as CEO from 2001 until
2013. He has a deep understanding of technology
and has proven strategic and leadership skills in
a global business. He is a fellow of the Institute of
Engineering and Technology; the Royal Academy
of Engineering; the Royal Society; and of the Royal
Aeronautical Society. He was awarded a CBE in
2014 for services to the technology industry.
Career, skills and experience
Stephen trained and qualified as a member of the
ICAEW with PwC and has considerable financial
expertise. His previous roles include CFO of Daily
Mail and General Trust plc from January 2011 to
April 2017. He worked in New York as the CFO
and COO of Dow Jones and in London as the
CFO of News International, both part of News
Corporation. He also previously held several
executive positions at British American Tobacco.
Other principal roles
— Dyson James Group Limited, director
Other principal roles
— 3i Group plc, non-executive director
Note: Tenures are stated as at 6 March 2018.
Board skills and experience
Board members by gender
Balance of the Board
7
6
5
4
4
Number of Directors with:
■ Chairman/CEO/CFO experience
■ Related industry/operational
■ Financial
■ Engineering/technology
■ Safety/regulatory/risk
■ Remuneration/HR
Key
NG Nominations & Governance Committee
A Audit Committee
R Remuneration Committee
SE Safety & Ethics Committee
ST Science & Technology Committee
10
Female
4
Executive
Directors
2
Male
8
Non-Executive
Directors
10
Non-Executive Directors’ tenure
Board members by nationality *
6–9 years
2
3–6 years
4
German
1
Singaporean
1
American
2
0–3
years
4
British
8
Full Director’s biographies can be
found at: www.rolls-royce.com
* According to the Company’s Articles of
Association, at least 50% of its Directors
must be British citizens.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Board of Directors
67
Lewis Booth CBE
Independent Non-Executive Director
Chairman, Audit Committee
Ruth Cairnie
Independent Non-Executive Director
Chairman, Remuneration Committee
Sir Frank Chapman
Independent Non-Executive Director
Chairman, Safety & Ethics Committee
NG A
R
NG
R
ST
NG
R
SE
Appointed in May 2011. Tenure: 6 years
Appointed in September 2014. Tenure: 3 years
Appointed in November 2011. Tenure: 6 years
Career, skills and experience
Lewis has considerable financial expertise
and experience and brings an international
perspective from his 42-year career in the motor
industry. After gaining a bachelor of engineering
degree with honours in mechanical engineering,
Lewis began his career with British Leyland.
He spent 34 years at Ford Motor Company
including as executive vice president and CFO.
He was awarded a CBE in 2012 for services to the
UK automotive and manufacturing industries.
Career, skills and experience
A physicist by background, Ruth has strong
strategic and commercial experience gained at
Royal Dutch Shell Plc where she held a number
of senior international roles, including executive
vice president strategy and planning. Ruth has
significant remuneration committee experience
having chaired the remuneration committee at
Keller Group plc from April 2012 to May 2017 and
has been a member of the remuneration committee
at Associated British Foods plc since 2014.
Other principal roles
— Mondelez International Inc., director
— Gentherm Inc., director
Other principal roles
— Associated British Foods plc,
non-executive director
— ContourGlobal plc, non-executive director
— POWERful Women, industry chair
Career, skills and experience
Sir Frank has significant industrial and safety
experience, having worked in the oil & gas
industry for 38 years including appointments
within Royal Dutch Shell plc and BP p.l.c.
He has a life-long passion for engineering
and innovation and a deep understanding of
technology. He was chief executive of BG Group
plc for 12 years and chairman of Golar LNG Ltd.
Sir Frank is a fellow of the Royal Academy of
Engineering, the Institute of Mechanical Engineers
and the Energy Institute. He was knighted in 2011
for services to the oil & gas industry.
Other principal roles
— Myeloma UK, vice chairman
Irene Dorner
Independent Non-Executive Director
Beverly Goulet
Independent Non-Executive Director
Lee Hsien Yang
Independent Non-Executive Director
NG
A
SE
NG
A
NG
A SE
Appointed in July 2015. Tenure: 2 years
Appointed in July 2017. Tenure: less than 1 year
Appointed in January 2014. Tenure: 4 years
Career, skills and experience
Irene was CEO and president of HSBC, US
until December 2014. Her background in risk
management played a key role in strengthening
the financial institution’s risk processes and she
brings this insight as part of her role on our Audit
Committee. During a 30-year career at HSBC,
she held a number of international roles including
leading HSBC in Malaysia. Irene was a consultant
at PwC, is an honorary fellow of St Anne’s College,
Oxford and a passionate advocate of diversity
and inclusion.
Other principal roles
— AXA SA, director
— Control Risks Group Holdings Limited,
chairman
— Virgin Money Holdings (UK) PLC, chair elect
and non-executive director
Career, skills and experience
Beverly, a US national, started her career as
a securities and M&A lawyer and has spent a
considerable amount of her career in the airline
industry. From 1993 until June 2017, Beverly was
a key member of the executive team of American
Airlines where she served in a number of
senior roles. Beverly brings valuable operational
experience with significant knowledge of
corporate finance and treasury matters.
Other principal roles
— Xenia Hotels & Resorts, director
— Dallas Women’s Foundation, board member
— Rolls-Royce North America Holdings, Inc.,
board member
Career, skills and experience
A Singaporean, Hsien Yang was formerly a member
of our international advisory board and combines
a strong background in engineering with extensive
international business experience. He was chief
executive of Singapore Telecommunications
Limited for 12 years and served as chairman and
non-executive director of Fraser and Neave Limited.
He has significant industrial and financial skills.
Other principal roles
— Civil Aviation Authority of Singapore, chairman
— General Atlantic LLC and associated funds,
special adviser
— The Islamic Bank of Asia Private
Limited, chairman
DIRECTORS’ REPORT 68
Directors’ Report
Board of Directors
Rolls-Royce Holdings plc Annual Report 2017
Bradley Singer
Non-Independent Non-Executive Director
Sir Kevin Smith CBE
Senior Independent Non-Executive Director
Chairman, Science & Technology Committee
Jasmin Staiblin
Independent Non-Executive Director
ST
NG
R
ST
NG
ST
Appointed in March 2016. Tenure: 2 years
Appointed in November 2015. Tenure: 2 years
Appointed in May 2012. Tenure: 5 years
Career, skills and experience
Bradley, a US national, has an outstanding
record as a business leader. He brings experience
of public companies during periods of change,
growth and significant financial outperformance,
particularly in the US. He has been senior
executive vice president and CFO of Discovery
Communications, Inc. and CFO and treasurer
of American Tower Corp. Before these
appointments, he worked as an investment
banker at Goldman Sachs. He provides an investor
perspective drawing on his experience as COO
of ValueAct.
Other principal roles
— ValueAct Capital, partner and chief
operating officer
— The Posse Foundation, director
— McIntire School Foundation, University
of Virginia, trustee
Career, skills and experience
Sir Kevin has extensive industrial leadership
experience and a deep knowledge of global
engineering and manufacturing businesses, as well
as the aerospace industry. He was CEO of GKN plc
for nine years. Before joining GKN, he spent nearly
20 years with BAE Systems in a number of senior
executive positions. He has an honorary fellowship
doctorate from Cranfield University and is an
honorary fellow of the University of Central
Lancashire. He was awarded a CBE in 1997 and
knighted in 2006 for services to industry.
Other principal roles
— Unitas Capital, senior adviser
— L.E.K. Consulting, European advisory
board member
— University of Central Lancaster, industry
steering group member
Career, skills and experience
A German national, Jasmin combines a strong
background in advanced engineering and
deep technology knowledge with extensive
international business experience, having lived
and worked in Switzerland, Sweden and Australia.
She has been the CEO of Alpiq Holding AG since
2013. She held a number of senior positions in the
ABB Group becoming CEO of ABB Switzerland
from 2006 until 2012.
Other principal roles
— Alpiq Holding AG, chief executive officer
— Georg Fischer AG, board member
Board committee membership
Pamela Coles
Company Secretary
Appointed in October 2014.
Career, skills and experience
Pamela is an expert in corporate governance
and company law. She has been a fellow of ICSA:
The Governance Institute, since 1997. 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 and head of legal at RAC plc.
Other principal roles
— E-ACT, non-executive director
R
SE
ST
NG
C
A
C
C
C
C
Ian Davis
Lewis Booth
Ruth Cairnie
Sir Frank Chapman
Irene Dorner
Beverly Goulet
Lee Hsien Yang
Bradley Singer
Sir Kevin Smith
Jasmin Staiblin
Key
NG Nominations & Governance Committee
A Audit Committee
R Remuneration Committee
SE Safety & Ethics Committee
ST Science & Technology Committee
C Denotes chairman of committee
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Corporate Governance
69
Corporate Governance
The Board
The role of the Board
Key matters reserved to the Board
The Board is ultimately responsible to shareholders for
the direction, management, performance and long-term
success of the Company. It sets the Group’s strategy and
objectives and oversees and monitors internal controls,
risk management, principal risks, governance and viability
of the Company. In doing so, the Directors comply with
their duties under section 172 Companies Act 2006.
The Board has established certain principal committees
to assist it in fulfilling its oversight responsibilities, providing
dedicated focus on particular areas, as set out below.
Each committee chairman reports to the Board on the
committee’s activities after each committee meeting.
In addition to the Board’s principal committees, it has
established a sub-committee of Directors who each
hold an appropriate level of UK national security clearance
for the purpose of receiving and considering, on behalf
of the Board, any UK classified information relating to
the Group’s programmes and activities. Beverly Goulet,
a US national and independent Non-Executive Director, also
sits on the board of Rolls-Royce North America Holdings,
Inc. to create a link between the Board and the Group’s
North American governance structure.
The Board committees
The Group’s long-term objectives, strategy and
risk appetite
The Group’s organisation and capability
Shareholder engagement and general meetings
Overall corporate governance arrangements including
Board and committee composition, committee terms
of reference, 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
Annual budgets and financial expenditure and
commitments above levels set by the Board
Remuneration policy and remuneration of Directors
and senior executives
Nominations &
Governance Committee
Audit
Committee
Remuneration
Committee
Safety & Ethics
Committee
Science & Technology
Committee
Board & committee composition
Financial reporting
Remuneration policy
Product safety
Technology strategy
Board nominations
Succession planning
Corporate governance
Oversight of principal risk –
talent & capability
Internal controls &
risk management
Internal audit
External auditor
Oversight of principal risks –
IT vulnerability, business continuity,
market & financial shock
Incentive design and setting
of targets
Executive remuneration review
HSE
Sustainability
Cross-sector technology
Technology capabilities and skills
Ethics & compliance
Technology trends and risks
Oversight of principal risks –
compliance, product safety
Oversight of principal risk –
disruptive technologies
& business models
Executive leadership team (ELT)
Matters that are not reserved to shareholders, the Board or one of the Board committees are the responsibility of the Chief Executive
who has established and maintains a schedule of delegations of authority to members of the ELT and other management.
The ELT is an executive-level forum of the Group’s most senior leaders, chaired by the Chief Executive. It comes together to communicate,
review and agree on issues and actions of Group-wide significance. 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 in the performance of his duties. See rolls-royce.com for details of the ELT members.
DIRECTORS’ REPORT
70
Directors’ Report
Corporate Governance
Rolls-Royce Holdings plc Annual Report 2017
Board and committee meetings held in 2017
ST
SE
R
A
NG
B
R
B
R
NG
B
SE
B
ST
R
A
NG
B
ST
B
ST
SE
SE
A
NG
B
R
NG
B
SE
B
ST
ST
SE
R
A
NG
B
R
A
NG
B
January
February
March
April
May
June
July
August
September
October
November
December
Key
B Board
R Remuneration Committee
R SE ST Denotes unscheduled meeting
NG Nominations & Governance Committee
SE Safety & Ethics Committee
A Audit Committee
ST Science & Technology Committee
Unscheduled meetings
The unscheduled meetings of the Remuneration Committee in
January and March were to discuss 2017 bonus plan targets.
Two additional Science & Technology Committee calls were held,
the first in June for the Committee to debrief on the site visits that
took place in May, and the second in August to help shape the
technology strategy presentation for the Board strategy meeting.
The unscheduled meeting of the Safety & Ethics Committee
in July was to receive an update on the latest discussions and
developments with certain regulators following the DPAs.
Non-attendance
Some Board members were unable to participate in certain Board
and Committee meetings due to these being held on short notice
or for medical reasons, as noted in the table below. If any Directors
are unable to attend a meeting they communicate their opinions
and comments on the matters to be considered via the Chairman
of the Board or the relevant committee chairman.
Board and committee members and attendance at meetings in 2017
Ian Davis
Warren East
Stephen Daintith (appointed 7 April 2017)
Lewis Booth 1
Ruth Cairnie
Sir Frank Chapman 2
Irene Dorner
Beverly Goulet (appointed 3 July 2017)
Lee Hsien Yang 3
Brad Singer
Sir Kevin Smith 4
Jasmin Staiblin 5
Former Directors
David Smith (stepped down on 24 February 2017)
Colin Smith (stepped down on 4 May 2017)
John McAdam (stepped down on 4 May 2017)
Board
(11 meetings)
11/11
11/11
8/8
11/11
11/11
10/11
11/11
5/5
10/11
11/11
10/11
11/11
2/2
5/5
5/5
Nominations &
Governance
(7 meetings)
7/7
Audit
(5 meetings)
Remuneration
(7 meetings)
Safety &
Ethics
(6 meetings)
Science &
Technology
(6 meetings)
7/7
7/7
6/7
7/7
4/4
7/7
6/7
7/7
3/3
5/5
5/5
3/3
5/5
5/5
7/7
6/7
6/7
5/6
6/6
6/6
1/1
6/6
6/6
6/6
5/6
4/4
2/2
1 Lewis Booth was appointed to the Remuneration Committee and stepped down from the Science & Technology Committee in April 2017.
2 Sir Frank Chapman was unable to attend the Safety & Ethics Committee in April due to unforeseen circumstances and the May meetings of the Board and committees due to
medical reasons.
3 Lee Hsien Yang was unable to attend the June Board meeting due to unforeseen urgent personal matters.
4 Sir Kevin Smith was unable to attend the November meetings of the Board and committees due to medical reasons.
5 Jasmin Staiblin was unable to attend the unscheduled meeting of the Science & Technology Committee in August due to prior commitments and this being arranged on short notice.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Corporate Governance
71
Board’s focus during the year
Area of focus
Matters considered
Outcome
Strategy
and risk
Review and refresh the Group’s vision
and strategy
The Board approved the refreshed vision and strategy for the
Group, rolled out internally and externally from early 2018.
The Board held an all-day meeting with the ELT focused on
the Group’s overarching strategy, including discussions on all
areas of the business and people capability. The Board provided
reflections on the day at the subsequent Board meeting.
Feedback and content of discussions were shared with the
ELT and businesses.
Review of principal risks, including
‘deep dives’ on:
— political risk;
— competitive position; and
— major product programme delivery
The ongoing review of risks resulted in changes to principal risks in
the year. The product failure risk was redefined as product safety.
The description of the disruptive technologies and business models
and business continuity principal risks were updated to reflect the
TCFD recommendations (see page 60).
The Board confirmed that the management of risks remained
effective. Lord Powell, after obtaining input from other members
of the international advisory board (IAB) ¹, presented on political
risk in March 2017, including: the implications of Brexit; potential
military conflicts; and current geo-political factors for the Group.
The Board considered the Group's competitive position as part
of its strategy sessions in September, and separately reviewed
the competitive positions of Power Systems and Marine.
The Board reviewed the risks to delivery of Civil Aerospace
widebody engine programmes periodically throughout the year
with a detailed review of Trent 900 and Trent XWB business plan
performance in December, leading into a detailed review of Trent
1000 business plan in 2018.
Ongoing cooperation with regulators
following deferred prosecution
agreements (DPAs)
The Board kept oversight of compliance with the DPAs.
Lord Gold provided an update on his continuing areas
of focus to the Board in March 2017.
Succession
and leadership
Diversity and inclusion
There is a continuing focus to increase diversity throughout the
Group. The Board diversity policy was presented in November
and approved in December 2017. The Board confirmed its support
for the Group’s updated diversity and inclusion policies and the
introduction of Group targets to increase the percentage of
roles held by women and other under-represented groups across
the Group.
During 2017, a number of significant projects were completed
and key milestones reached. See page 47 for more details.
Effectiveness of the Board, Chairman
and Chief Executive
An external evaluation was undertaken and it concluded that the
Board operated effectively in 2017.
Financial
performance
Review of financial KPIs
Group tax policy review
Aquisition of ITP Aero
The Chairman and Chief Executive received constructive
feedback on their respective performance.
The Board obtained monthly financial performance reports
and discussed the reports with the Chief Financial Officer at each
Board meeting.
The Board noted that new UK tax rules would require the
Group to publish its tax strategy on the website during 2017.
The Board approved and endorsed the approach.
Progress updates received. A sub-committee of the Board was
set up to make decisions on the settlement of consideration
for ITP Aero.
New accounting standards (IFRS 15)
reporting/impact
Updates provided throughout the year, giving the Board
oversight on progress, introduction and the impact of IFRS 15.
1 It was agreed in the year to disband the IAB but some former members, including Lord Powell, have been retained by the Company as advisers on geo-political issues.
DIRECTORS’ REPORT 72
Directors’ Report
Corporate Governance
Rolls-Royce Holdings plc Annual Report 2017
Area of focus
Matters considered
Outcome
Operational
performance/
challenges
Operational performance updates
Civil Aerospace programme challenges,
including new product introduction
Stakeholder
engagement
and governance
Safety incidents
Investor engagement
Stakeholder engagement
Government’s green paper on corporate
governance reform and FRC’s proposed
revisions to the UK Corporate
Governance Code
Matters reserved to the Board and
delegated authorities
UK Modern Slavery Act revisions
UK gender pay gap reporting
Year-to-date status across key operational performance measures
and key priorities presented throughout the year. The operational
KPIs for each business were also discussed.
There were some operational challenges during the year as
described in the Civil Aerospace review on pages 20 to 25. The
Board remained regularly informed on the management of these
issues, including steps to minimise customer disruption, and
received briefings from the Chief Executive and President – Civil
Aerospace on the latest developments and status of programmes.
The Board were briefed on the two employee fatalities during
the year (more detail can be found on pages 46 and 107)
and on plans to increase the focus on HSE across the Group.
Increased transparency in investor briefings. The governance
event in March 2017 was successful with good engagement from
fund managers and governance analysts.
The Board received training from the Company Secretary on
s.172 of the Companies Act 2006 which included a discussion
around the Group’s key stakeholders and a review of how the
Board currently discharges this duty.
The Board held the first successful Meet the Board event for
employees in May 2017.
Updates were given by Irene Dorner on her employee champion
role and meetings/events she had attended.
The Board were kept up-to-date on the proposed changes to
the governance landscape. An assessment of the Company’s
position and status against each recommendation was presented
in November and the Company’s response to the FRC on the
proposed changes was outlined in February 2018.
The Board confirmed these remained appropriate.
The anti-slavery and human trafficking statement was
presented and approved by the Board early in 2017, and again
in February 2018.
Kept up-to-date on the Company’s plan to report the required
gender pay gap data for UK legal entities published on our
website and on the UK Government website.
The Board’s areas of focus in 2018 are expected to include:
The Group’s vision, values and culture
Continuing to monitor compliance with the terms of the DPAs
Execution of strategic priorities
The implications of Brexit on the Group’s activities
Overview of the restructuring of the businesses, support and
management functions
Strategic review of commercial marine operations
Monitoring management of Trent 1000 and Trent 900 in-service
issues towards resolution
Civil Aerospace programme delivery ramp-up
Continued monitoring of financial and operational performance
Strong focus on safety and regular reviews of safety activities
Principal risk reviews
Cyber security updates
Stakeholder engagement programme
Updates on the developments and changes to the corporate
governance landscape and the UK Corporate Governance Code
Sustainability
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Corporate Governance
73
Stakeholder engagement
Stakeholder engagement remains vital to building a sustainable
business. This year, the Company took a significant step towards
increasing stakeholder engagement with our two key employee
engagement initiatives. The Board wanted to continue an honest
and direct dialogue with our employees following the DPAs.
The creation of the role of employee champion and our first
Meet the Board event, detailed below, helped to strengthen the
link between employees and the Board and ensure employee views
can be taken into account as part of the Board’s decision-making.
As part of training provided by the Company Secretary, the
Board discussed the Company’s key stakeholders, reviewed how
we currently discharge the duty to promote the success of the
Company and discussed what more could be done to help foster
stakeholder relationships. The Board will continue to focus on
stakeholder engagement more widely over the next year, with
a focus on starting to build a comprehensive stakeholder
engagement programme.
Employees
MEET THE BOARD EVENT
Employee champion
In early 2017, one of our Non-Executive Directors Irene Dorner
became our first Board champion for employee engagement,
our employee champion, taking the lead in looking at how the
Company could strengthen the links between the Board and
employees and bring those insights back to the boardroom.
In April 2017, she was introduced to all employees by a Group-wide
communication and personally introduced at our Meet the Board
event in May.
Irene has attended many events so far, including a European Works
Council meeting in London, hosted a diversity and inclusion event
in Bristol, met graduates and apprentices at Barnoldswick and
Derby, and has participated in a live online interactive session
with employees.
At the end of 2017, a communication video from Irene was made
available to all employees updating them on her role and insights
so far. We will continue communications in 2018 to ensure
employees are aware of the activities Irene is taking part in.
As part of her role, Irene updated the Nominations & Governance
Committee and the Board on her views and insights and she will
continue to do so regularly. This was always an experimental year,
however, the new initiative has proved to be of great interest to
all involved and we intend to continue this interaction.
You can read more about Irene’s view on her new role in her
introduction on page 65.
In May 2017, following our AGM in Derby, we held our first
Meet the Board event for employees. Our entire UK workforce,
as well as visiting employees from overseas, were invited to apply
for one of the 350 places available and participants were
selected on a ballot. All Group employees were invited to submit
questions in advance of the event. The meeting was recorded
so it could be watched after the event had taken place by those
employees unable to attend in person.
The meeting started with a welcome from the Chairman. Irene
Dorner then spoke about her role as employee champion and
Warren East provided a brief business update on 2016. The
main focus of the meeting was a question and answer session.
The quality of questions was excellent and generated a lively
debate that covered a broad range of topics including
diversity, behaviour, our strategy, future focus for the Group
and each Board member’s top priority. After the meeting, the
Board joined attendees in the main reception area and this
was another great opportunity for interaction.
The objective was for employees to gain a better understanding
of the Board’s role and to start a conversation that will lead to
a stronger, more open and collaborative culture. The event was
a huge success and based on some helpful feedback, we have
already identified changes that will make future meetings
even better.
One employee, interviewed immediately after the meeting
said, “It was really helpful to have the apparent barriers broken
down that can sometimes exist between the Board and the
people that work in the organisation. I particularly enjoyed
the openness, honesty and transparency”.
In March 2018, we plan to hold a similar event in Friedrichshafen,
Germany, and in May after the AGM in Derby, UK.
DIRECTORS’ REPORT 74
Directors’ Report
Corporate Governance
Rolls-Royce Holdings plc Annual Report 2017
Shareholders
The Board continues to value the importance of building strong
investor relations, delivered through an active shareholder
communication programme. Since 2016, we have significantly
enhanced disclosure and transparency through improved
reporting, allied to proactive engagement and publications
such as our periodic Investor Update newsletter. This was one
of the Group’s strategic priorities as set out on page 7.
In 2017, our engagement programme has focused on addressing
key elements of the investment case, and identifying both risks
and opportunities to the business. In particular, we have set out
our focus on helping investors better understand the key drivers
of cash across the businesses, together with the implementation
of IFRS 15, which will see a material change in the way the business
reports its financial results.
During the year, an extensive investor engagement programme
has been undertaken involving formal events, site visits, smaller
group and one-to-one investor meetings. Many of these provide
the chance for institutional investors and equity analysts to meet
senior executive management and ask more detailed questions
that can improve individual knowledge or clarify areas of
misunderstanding. We regularly monitor the Group’s shareholder
base and ensure management’s time is allocated appropriately
with regard to current and potential shareholder interests.
As well as attending numerous investor conferences and roadshows
in the UK, Europe and the US, we were also active at trade-related
events such as the Paris Airshow and the defence trade show DSEI,
allowing investors to hear from key business managers. In total,
over 400 one-to-one and group meetings took place in 2017, led by
the Chief Executive, Chief Financial Officer, the director of investor
relations or members of the investor relations team and supported
by other management.
On governance-related matters there was a very significant
consultation programme in advance of the remuneration policy
vote at the AGM in May. In addition, another well-attended
governance event was held in May, hosted by the Chairman.
Fund managers and governance analysts heard from the Chief
Executive on his strategic agenda and from the Board committee
chairmen and had the opportunity to engage directly with them
in small groups. The lead audit partner from KPMG also attended
this event and answered questions. Topics covered at the event
included board composition, skillset and 2017 priorities, financial
reporting, IFRS 15 and risk management, and the context and
design of the new remuneration policy. Materials from this event
are available at www.rolls-royce.com.
The Chairman, Senior Independent Director and other members
of the Board make themselves available to meet with institutional
investors when requested. In 2018, the Chairman and Senior
Independent Director have already attended governance meetings
with some of our largest institutional shareholders in London
and Edinburgh.
We also published quarterly Investor Update newsletters
throughout the year, which include commentary on the investor
relations calendar, key news flow and a Q&A section which
addresses investor issues that have been raised in recent
discussions. Feedback on this newsletter has been very positive.
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.
The AGM will be held on Thursday 3 May 2018 at Pride Park Stadium,
Pride Park, Derby, DE24 8XL. The notice of meeting (notice) for
the 2018 AGM will set out in full the resolutions for consideration
by shareholders, together with explanatory notes and further
information on the Directors standing for election and re-election.
The Company intends to send the notice and any relevant papers
to shareholders at least 20 working days before the meeting.
Notable events in 2017
CEO/CFO
meetings
>150
Investor
conferences
and other events
18
Investor
Update
newsletters
4
Total
investor
meetings
>400
More information on investor events, presentations, updates
and the notice can be found at: www.rolls-royce.com
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Corporate Governance
75
Board induction and development
The Chairman and Company Secretary arrange a comprehensive
tailored induction programme for newly-appointed Non-Executive
Directors, which includes dedicated time with Group executives and
scheduled trips to business operations. The programme is tailored
based on experience and background and the requirements of
the role. All Directors visit the Group’s main operating sites as part
of their induction and are encouraged to make at least one visit
to other sites each year throughout their tenure. In 2017, Board
members visited locations including: Barnoldswick, Bristol and
Derby, UK; Friedrichshafen, Germany; and Reston, US. We regard
these site visits as an important part of continuing education as well
as an essential part of the induction process. They help Directors
understand the Group’s activities through direct experience of
seeing processes in operation and by having discussions with
a range of employees.
Beverly Goulet was appointed to the Board in July 2017 and
joined the Nominations & Governance and Audit Committees.
Since her appointment she has undertaken a thorough induction
and met with members of the ELT. She was also briefed by the
Company Secretary on UK listed company requirements, the UK
Corporate Governance Code and other key governance areas.
Beverly has attended a number of site visits, including Bristol,
UK and Reston, US.
It is important that the Directors continue to develop and refresh
their understanding of the Group’s activities. To facilitate this,
the Board met local management and external stakeholders at
its meetings in Derby and Bristol, UK and they are encouraged
to visit the Group’s facilities around the world.
It is also important that the Directors regularly refresh and
update their skills and knowledge and receive relevant training
when necessary. Members of the Board also attend relevant
seminars, conferences and training events to keep up-to-date
on developments in key areas.
Board induction programme for Beverly Goulet
Timing
People to meet
Key topics covered
Within first month
Chairman
Chief Executive
Chief Financial Officer
Company Secretary
Within first
three months
ELT members
Within first
nine months
Committee chairmen
Senior management, including director of
investor relations, director of internal audit
and director of corporate affairs
Auditors
Overview of the Board
Business model
Current strategic priorities
Opportunities/risks
Current issues
Finance, treasury and tax overviews
Budget
Accounting issues
UK Corporate Governance Code
UK listed company requirements
Directors’ duties
Board administration and meeting dates
Overview of each business
— Markets and competition
— Operational and financial performance
— KPIs
— Current issues
Overview of committees
Plan of work for the year
Current issues
Overview of specific business/functional areas
Audit report and findings
Controls
Accounting issues
DIRECTORS’ REPORT 76
Directors’ Report
Corporate Governance
Rolls-Royce Holdings plc Annual Report 2017
Board effectiveness
Board evaluation
This year Independent Audit Limited (IAL) was invited back to
undertake another externally-facilitated effectiveness review,
following on from its yearly reviews since 2014. IAL has not
provided any other services to the Company during the year.
The evaluation was consciously ‘light touch’ compared to previous
reviews and it was undertaken through a questionnaire-based
survey. This was complemented by confidential one-to-one
discussions between IAL and several members of the Board
and management to help bring focus to the questions. The review
covered four specific areas which had been identified as requiring
further development during last year’s review and the scope was
agreed with the Company Secretary after consultation with the
Chairman. The four specific areas of focus were: Board dynamics;
focus; information; and culture.
A review of the effectiveness of Board committees was undertaken
separately at the end of the year internally with the use of an
effectiveness questionnaire. A thorough review of the committees
will form part of next year’s evaluation. To provide a renewed
perspective, next year’s evaluation will be undertaken by a new
external provider and this will take place in the second half of 2018.
Good progress had been made since the last effectiveness review
and the Board feels that it is working more effectively. The Board
discussed the findings of the report in December.
At a private meeting of the Non-Executive Directors, Sir Kevin
Smith, Senior Independent Director, led a review of the Chairman’s
performance without the Chairman present.
Progress on four key areas
Stages of the Board effectiveness process
Briefing and
areas of focus
identified
1
Priorities and
action plan
agreed
5
2
Survey and
one-to-one
discussions
with Board
members
4
3
Board discussion
with Independent
Audit Limited
Results collated
and evaluated
The Nominations & Governance Committee also met without
any management present to discuss the performance of the
Chief Executive. The meetings concluded that both the Chairman
and the Chief Executive continued to be effective and constructive
feedback was shared with each of them.
Areas of focus
IAL’s findings in 2017
Focus for 2018
Board
dynamics
Focus
Information
Culture
The dynamics of the Board have improved, with
good all-round commitment from Board members,
a good mix of styles, a constructive approach and
wide participation in meetings. Cross-membership
and active collaboration has meant liaison across
committees is working well.
Considerable progress has been made in setting a
clear strategic direction and getting the right senior
executives in place. The changes resulted in better
discussions on the most relevant topics. There was
a better balance of time during meetings, with more
time spent on key discussion items.
There has been some progress in improving the
information provided to the Board. However more
work is needed to ensure papers focus on the relevant
data and avoid excessive and unnecessary detail.
The Board is confident with its approach to oversight
of culture and takes a robust approach to assessing
ethical standards: issues are well understood and
are tracked.
Maintaining an open tone between the
Non-Executive Directors and management
to encourage constructive discussions on
the challenges ahead.
Responsibility: Chairman
Continue to oversee the execution of the Group’s
strategic priorities and how management are
addressing the near-term operational challenges.
Ensure agendas continue to allow enough time
for the Board to focus on the most relevant topics
and allow the appropriate amount of time for
high-quality discussion.
Responsibility: Chairman/Company Secretary
Improving information will continue to be a
priority. In particular, management will focus on
providing all the relevant information to allow
informed debate without over-burdening the
Board with excessive operational detail.
Responsibility: Chief Executive/
Chief Financial Officer/Company Secretary
The Board will remain focused on culture in
2018 and will be kept well-informed on progress
with the latest restructuring plans, including
monitoring of management’s approach to
embedding behaviours.
Responsibility: Chairman/Chief Executive
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Corporate Governance
77
Compliance with the UK Corporate Governance Code 2016 (the Code)
The Company is subject to the principles and provisions of
the Code, a copy of which is available in full at www.frc.org.uk.
For the year ended 31 December 2017, the Board considers
that it has complied in full with the provisions of the Code.
Below is a statement of compliance that explains how the
Company has applied the principles and complied with the
provisions in the Code.
A – LEADERSHIP
A1 The role of the Board
The Board is ultimately responsible for the management, direction
and performance of the Company and its businesses. It sets the
Group’s strategy and objectives and oversees and monitors internal
controls, risk management, principal risks, governance and viability
of the Company.
The Board Governance document (available at www.rolls-royce.com)
includes a clear schedule of matters reserved for the Board’s
approval, which is reviewed at least annually.
A2 Clear division of responsibilities
The roles of the Chairman and Chief Executive are clearly defined
and the Board supports the separation of the two roles. The key
responsibilities are clearly documented in our Board Governance
document. The Chairman is responsible for the leadership and
effectiveness of the Board. The Chief Executive is responsible
for the running of the Company’s business.
A3 Role of the Chairman
The Chairman ensures effective running of the Board and its
committees in accordance with the highest standards of corporate
governance. He sets the agenda for Board meetings making sure
consideration is given to the main challenges and opportunities
facing the Company and facilitates open and constructive dialogue
during meetings.
A4 Role of the Non-Executive Directors
Non-Executive Directors are independent of management
and bring a diverse set of skills and experience to meetings.
The Non-Executive Directors support the Chairman and
provide objective and constructive challenge to management.
Their views are actively sought when developing proposals
on strategy, including during discussions in meetings, in
post-meeting conversations, or as part of the annual Board
and ELT strategy day. All of the Board committees consist
exclusively of Non-Executive Directors.
The Senior Independent Director provides a sounding board
for the Chairman and serves as an intermediary for the Chief
Executive, other Directors, and shareholders when required.
At the end of most scheduled Board meetings, the Chairman holds
meetings with the Non-Executive Directors without the Executive
Directors or management present.
B – EFFECTIVENESS
B1 The composition of the Board
The Board believes it operates effectively with the appropriate
balance of independent Non-Executive and Executive Directors
who have the right mix of skills, experience and knowledge
of the Company. The Nominations & Govenance Committee is
responsible for regularly reviewing the composition of the Board.
Details of the Board, their biographies and committee membership
are set out on pages 66 to 68.
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 82. The review
in November 2017 concluded that all the Non-Executive Directors,
with the exception of Brad Singer, remained independent in
character and judgement.
Brad Singer is a partner and the chief operating officer of
ValueAct Capital, a major shareholder, and therefore was not
considered independent under the provisions set out in the
Code. A relationship agreement between the Company, ValueAct
and Brad Singer, was in place throughout 2017 to manage any
conflicts of interest that arise from his connection to ValueAct.
The Code does not consider the test of independence to be
appropriate to the chairman of the company. However, Ian Davis
did meet the Code’s independence criteria upon his appointment
as a Non-Executive Director in March 2013 and as Chairman in
May 2013.
B2 Appointments to the Board
Appointments of new Directors are led by the Nominations
& Governance Committee, which are recommended to the Board.
Details of the appointment process, and changes made during
the year, are set out in the Nominations & Governance Committee
report on pages 79 to 82.
MWM Consulting provided external search consultancy services
in relation to the appointments of Beverly Goulet and Nick Luff.
They had no other connection to the Company during the year.
B3 Time commitment
Non-Executive Directors are advised of the time commitment
expected from them on appointment. External appointments,
which may affect existing time commitments for the Board’s
business, must be agreed with the Chairman. Full details of these
are set out at www.rolls-royce.com.
B4 Induction, training and development
All new Directors receive a full induction programme when they
are appointed to the Board, more details of which are on page 75.
The Board received additional training throughout the year on
key topics, as appropriate.
B5 Information and support
The Company Secretary makes sure that appropriate and timely
information is provided to the Board and its committees and
is responsible for advising and supporting the Chairman and
Board on all governance matters. All Directors have access to
the Company Secretary and may take independent professional
advice at the Company’s expense in conducting their duties.
DIRECTORS’ REPORT 78
Directors’ Report
Corporate Governance
Rolls-Royce Holdings plc Annual Report 2017
B6 Evaluation
The Board evaluation for 2017 was externally facilitated and more
details can be found on page 76. The Chairman also met each
Director individually to discuss their contribution, performance
over the year and any development needs. Following the meetings,
the Chairman confirmed that each Director was committed to their
role and they were effective.
At a private meeting of the Non-Executive Directors, Sir Kevin
Smith, Senior Independent Director, led a review of the Chairman’s
performance without the Chairman present. The Nominations
& Governance Committee also met without management present
to discuss the performance of the Chief Executive. The meetings
concluded that both the Chairman and the Chief Executive
continued to be effective and constructive feedback was shared
with them.
B7 Election/re-election
All Directors are subject to election or re-election at the AGM.
Following recommendations from the Nominations & Governance
Committee the Board considers that all Directors continue to be
effective, committed to their roles and have sufficient time available
to perform their duties. In accordance with the Code, Beverly
Goulet and Nick Luff will seek election and all other Directors
will seek re-election at the 2018 AGM.
C – ACCOUNTABLITY
C1 Financial and business reporting
The requirement for the Annual Report, taken as a whole, to be fair,
balanced and understandable is taken into consideration in the
drafting and reviewing process. See page 99 for the process to
review the form and content. The Strategic Report, set out on pages
1 to 63, provides information about the Group’s business model,
performance, strategy and principal risks.
C2 Risk management and internal control
The Board has carried out a robust assessment of the principal
risks facing the Company including those that would threaten
its business model, future performance, solvency or liquidity.
See pages 59 to 62 for more details on the Group’s principal risks
and a description of changes during the year.
In developing the internal governance framework (see page 82)
the Group looked at how the risk management and internal
control systems work together. You can read more about the
risk management system on page 59 and details of the internal
control system on page 101. 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 up to the
date of this report. The Board confirms that the Group continues
to be compliant with the Code, Financial Conduct Authority’s
Disclosure Guidance and Transparency Rules (DTR) in this regard.
The activities of the Audit Committee, which assists the Board with
its responsibilities in relation to risk and assurance, are set out on
pages 97 to 103.
C3 Audit Committee and auditors
The Audit Committee Report on pages 97 to 103 sets out details of
how the Committee has discharged its duties and its areas of focus
during the year.
In accordance with the Code and DTR 7.1 the Board is satisfied
that Lewis Booth, Beverly Goulet and Irene Dorner, all members
of the Audit Committee, have recent and relevant financial
experience, and when considered as a whole, the Committee has
competence relevant to the sector in which the Company operates
to ensure the right balance of skills, experience, professional
qualifications and knowledge.
D – REMUNERATION
D1 The level and components of remuneration
The Directors’ remuneration report is set out on pages 83 to 96
which outlines the areas of focus during the year and a summary
of the remuneration policy, as approved by shareholders at the
2017 AGM.
The Remuneration Committee sets levels of remuneration which
are designed to promote the long-term success of the Group,
aligning this with the Group’s strategy and business objectives
and ensuring it reflects our stakeholders’ interests. It is responsible
for recommending to the Board the remuneration policy for
Executive Directors, other members of the ELT and for the
Chairman, and for implementing the policy.
In November 2017 we decided to publish our data on gender pay
earlier than required. More information is available on page 94
and at www.rolls-royce.com.
D2 Procedure
For more information on the work of the Remuneration Committee
and Directors’ remuneration see the report on pages 83 to 96.
Ruth Cairnie, the chairman of the Remuneration Committee,
meets with institutional shareholders regularly, as appropriate.
E – RELATIONS WITH SHAREHOLDERS
E1 Dialogue with shareholders
The Board considers that effective channels of communication with
the Company’s institutional investors and individual shareholders
are very important. You can read more about engagement with
shareholders on page 74.
E2 Constructive use of General Meetings
The AGM provides a key opportunity for the Board to meet and
communicate with shareholders. Shareholders can ask questions
of the Board on matters put to the meeting, including the Annual
Report and the running of the Company generally. Company
representatives and the Company’s Registrar are also available
for any questions shareholders might have.
Terms of reference of the Board committees
and shareholder information are available at
www.rolls-royce.com
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Nominations & Governance Committee Report
79
Nominations & Governance
Committee Report
Principal responsibilities
Board and committee composition
Review the structure, size and composition of the Board and its
committees regularly, to ensure that they remain appropriate,
and to make any recommendations of any changes to the Board.
Evaluate and consider any Director’s conflicts of interest.
Board nominations
Recommendation of new appointments to the Board.
Oversee the induction plans, training and site visits for
the Directors.
Succession planning
Consider succession plans for Directors and senior executives.
Diversity and inclusion reviews and implementation of policy.
Evaluation of Chairman, Chief Executive
and Non-Executive Directors
Conduct an annual evaluation of the Chairman.
Conduct an annual evaluation of the Chief Executive.
Review the independence of the Non-Executive Directors.
Corporate governance
Review the Group’s global governance framework.
Keep up-to-date with the changing governance landscape and
report on the Group’s corporate governance practices to ensure
they remain appropriate for a group the size and complexity
of Rolls-Royce, taking account of best practice principles.
Principal risk – talent and capability
Oversight of one of the Company’s principal risks.
Areas of focus for 2018
— Diversity and inclusion
— Talent, capability and succession
— Employee engagement
— Culture and behaviour
Ian Davis
Chairman of the
Nominations
& Governance
Committee
Key highlights
The appointment of Beverly Goulet as a Non-Executive
Director was considered and recommended to the Board
Diversity and inclusion (including a new Board policy)
Talent, capability and succession
Monitoring of UK corporate governance proposals
Introduction
The Committee leads the process for nominations to the Board,
making recommendations to the Board as appropriate. It gives full
consideration to the composition of the Board and succession
planning for Directors and senior executives. The Committee also
keeps the Group’s corporate governance arrangements under
review and ensures they are consistent with best practice standards.
Operation of the Committee
The Committee consists wholly of independent Non-Executive
Directors and the Chief Executive attends the meetings.
Brad Singer, although not independent, attends meetings when
it is considered appropriate. Our biographies are on pages 66
to 68. The Committee’s responsibilities are outlined in its terms
of reference, available at www.rolls-royce.com, which we review
annually and refer to the Board for approval.
Committee members
Member
Ian Davis
Lewis Booth
Ruth Cairnie
Sir Frank Chapman
Irene Dorner
Beverly Goulet
Lee Hsien Yang
Sir Kevin Smith
Jasmin Staiblin
See page 70 for reasons of non-attendance.
Attended Eligible to attend
7
7
7
7
7
4
7
7
7
7
7
7
6
7
4
7
6
7
DIRECTORS’ REPORT 80
Directors’ Report
Nominations & Governance Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Nominations & Governance Committee focus during 2017
Area of focus
Matters considered
Outcome
Board and
committee
composition
Board
nominations
A review of the composition of the Board and
committee membership
Re-appointment of three Non-Executive Directors
The appointment of Beverly Goulet as Non-Executive
Director and oversight of Beverly’s induction plan
A review of site visits undertaken by Board members
Succession
planning
Progress on succession planning
Two updates on diversity and inclusion
Evaluation of
Chairman,
Chief Executive
and Non-Executive
Directors
Corporate
governance
Annual review of the effectiveness of the Chairman and
the Chief Executive, led by the Senior Independent
Director and the Chairman respectively
Annual review of whether the Non-Executive Directors
remained independent, taking into account the
independence criteria set out in the Code
A review of our global governance framework
Periodic governance updates from the Company
Secretary
Oversight
of principal risk –
talent and capability
The principal risk is considered when discussing
talent and capability
When reviewing Non-Executive Director
appointments the Committee considers the current
skills, experience and tenure of the Directors and
assesses future needs against the longer-term strategy
of the Group. The Committee recommended to the
Board that Lewis Booth, chair of the Audit Committee,
join the Remuneration Committee to strengthen the
link between the Remuneration and Audit Committees.
The Committee satisfied itself that the Directors
considered for re-appointment continued to be
committed and effective.
Members of the Committee were involved in the
interview process for the new Non-Executive Director
and the Committee recommended Beverly Goulet’s
appointment to the Board. You can read more about
the appointment process on page 81.
There has been a continued focus on succession
planning this year, with a number of changes to the ELT.
The discussions focused on the executive pipeline.
The Committee approved the Board diversity policy
in December 2017. It was agreed to maintain focus on
diversity and inclusion in 2018.
The Chairman and Chief Executive continue to be
effective. Feedback was shared directly with them.
The review concluded that all Non-Executive
Directors, with the exception of Brad Singer,
remained independent.
A refreshed governance framework was published
internally in June 2017.
The Committee has been kept informed about the
changes to the governance landscape and the various
proposals on UK corporate governance.
It was agreed that continuing focus was required,
particularly on the high-potential and emerging
talent pools. The Board apprentice programme was
introduced as a pilot initiative.
Board and committee composition
The Committee regularly reviews the balance and composition
of the Board, its committees and the executive team, as well as
Non-Executive Director independence, skills and tenure.
When reviewing the Non-Executive Directors appointments
the Committee considers the current skills and experience of the
Board and assesses future needs against longer-term succession
planning in light of the Group’s strategy.
The Committee also takes into account the need to make sure
there is appropriate diversity on the Board. During the year, the
Committee considered the external reviews on diversity, namely
the Parker Review and the Hampton-Alexander Review, published
in November 2016. Further details on our approach to diversity are
set out on pages 81 to 82. The Committee is satisfied with the
current composition of the Board committees and believes that
undue reliance is not placed on particular individuals. The Board
committee membership is set out on page 68. This will be regularly
reviewed and refreshed by the Board.
Board inductions, training and development
The Company Secretary is responsible for ensuring that new
Directors have a thorough and appropriate induction. Each newly
appointed Director has a structured induction programme and
receives a comprehensive data pack providing detailed information
on the Group. You can read more about inductions and continuing
development on page 75.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Nominations & Governance Committee Report
81
Board nominations
In April 2017, Stephen Daintith was appointed to the Board as
Chief Financial Officer. In July 2017, the Committee recommended to
the Board the approval of Beverly Goulet as Non-Executive Director.
During the year, we considered and recommended to the Board
the terms of appointment for Ruth Cairnie for a second three-year
term and Lewis Booth and Sir Frank Chapman both for a third
three-year term subject to annual shareholder re-election. For each
re-appointment we consider the effectiveness and commitment of
the Director and undertake a more thorough review of those
Directors who are being re-appointed for their third three-year term.
The Committee was satisfied with the Directors’ continued
commitment and effectiveness.
Beverly was identified as a candidate for the Board through our
external search for a director with experience in the airline or
aerospace sectors, with a particular focus on the US. Prior to her
appointment, Beverly met with seven members of the Board and
we collected references from chairmen of companies where she had
previously worked. The Committee agreed that Beverly had strong
functional expertise in finance, strategy and legal matters as well
as a wealth of knowledge of the airline industry.
In February 2018, it was announced that Nick Luff, currently
chief financial officer of RELX Group, would be appointed as
Non-Executive Director with effect from close of the AGM in May
2018, subject to shareholder approval. Nick will join the Audit
Committee and Nominations & Governance Committee. Nick was
identified as a candidate that would bring significant expertise in
finance and accounting to the Board. Prior to his appointment,
Nick met with eight members of the Board including the Chairman,
Chief Executive and Chief Financial Officer.
For Beverly’s and Nick’s appointments, the Committee appointed
MWM Consulting. Prior to the new appointments, the Chairman
agreed a Non-Executive Director profile and the Committee
provided input into a shortlist of candidates for the roles. You can
read their full biographies at www.rolls-royce.com.
Succession planning
The Committee is committed to regularly reviewing succession
planning and it plays a vital role in promoting effective board
succession, making sure that this is aligned to the Group’s strategy.
A principal risk to the business is the inability to attract, retain
and incentivise talented individuals to deliver our strategy; the
Committee is responsible for reviewing talent, capability and
succession at the most senior levels of the business. There has
been a continued focus on succession planning in the year and
we have taken significant steps to strengthen our management
and ELT.
In September, the Chief Executive and Group Human Resources
Director led discussions on succession planning with the Board
and the Committee. The review focused on the executive pipeline
from which the future leaders of the Company were likely to
emerge, both at ELT level and other key management areas.
Strong successors have been identified for most ELT roles and
future considerations have been taken into account in identifying
successors both immediately below ELT level and those that would
be ready to take up an ELT position in one or two moves. A diverse
pipeline of ‘ready later’ emerging talent has been identified, and
a plan would be put in place to accelerate their path to succession
where possible. It was also identified that there was a need for more
rigour, challenge and calibration around talent and succession and
we would review progress again in 2018.
As we reported last year, 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.
Throughout the year, Directors took opportunities to meet with
senior management throughout the Company, including in Bristol
where they met the Defence Aerospace leadership team and at
the senior leadership conference where they met key managers.
At the beginning of 2018, we were also pleased to announce the
appointments of Chris Cholerton, former President – Defence
Aerospace, as the new President – Civil Aerospace, and Tom Bell,
a former employee, as the new President – Defence. These
appointments come at a crucial time for our business as the
Company seeks to make 2018 a breakthrough year.
Board apprentice programme
In 2017, we created a new Board apprentice programme. This is a
nine-month programme that will provide leadership development
experience to demonstrate our commitment to the participants’
career progression and development as leaders in the organisation.
The opportunity provides the participants with exposure to the
Board and personal career development through observing and
learning from boardroom experience.
The first high-potential candidates to participate in a trial of the
programme brought diversity of thought, gender, nationality and
ethnicity. The key elements of the programme include: early career
conversations with the Group Human Resources Director or
members of the senior leadership team; an orientation meeting
providing an overview from Directors of what it means to be on
a board; an opportunity to network with other candidates on the
programme; attendance at Board/committee meetings; and
networking with our ELT.
Diversity and inclusion
Diversity and inclusion continues to be an area of focus for the
Committee. As mentioned on page 47, during 2017 we launched
a new strategy with global targets to increase female participation
at all levels of our organisation by 2020. The Committee was
updated on progress against these and activities to drive diversity
and inclusion across the Company including: establishing a Global
Diversity and Inclusion Council; a number of senior female
appointments; launching an online series of digital communications
on diversity and inclusion focusing on key issues such as flexible
working and mental health; launching the Board apprentice
programme; and trialling female-only assessment centres for
STEM roles.
Rolls-Royce is also a founding patron of the FTSE-100
Cross-Company Mentoring Programme which aims to widen the
pool of eligible female board candidates. At the date of this report
the percentage of women currently on our Board is 33% (2016:
23%). The Committee will instruct search consultants to identify,
as a priority, female candidates who meet the skills and experience
brief. As with all previous appointments, we will consider candidates
from the widest possible pool and will only engage search firms
that have signed up to the Voluntary Code of Conduct for
Executive Search firms.
DIRECTORS’ REPORT 82
Directors’ Report
Nominations & Governance Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Board diversity policy
Objective
Progress
All Board appointments will be made in the context of the skills
and experience that are needed for the Board to be effective.
The Committee regularly reviews the composition of the Board.
Maintain a balance so that, as a minimum, one third of the
Directors are women.
The chart below highlights that the percentage of women
on the Board is 33%, which is higher than last year.
Support and monitor Group activities to increase the
percentage of senior management roles held by women
and other under-represented groups.
Monitor, challenge and support internally set targets for diversity
and inclusion at all levels across the organisation.
In the year, the Board approved the Board diversity policy which
adopts a target that one third of Board members should be female.
It is recognised that there will be periods of change on the Board
and that this number may be smaller for periods of time while the
Board is refreshed. It is our longer-term intention, however, to at
least maintain this balance.
Our policy will continue to promote an inclusive and diverse
culture and will reaffirm our aspiration to meet and exceed the
recommended voluntary target of 33% of Board positions being
held by women in 2020. The objectives in the policy remain
relevant targets against which to measure our progress. We will
continue to progress our Board diversity policy. During the year
we are committed to set and publish a target for ELT and senior
leadership gender balance. You can find the full policy at
www.rolls-royce.com.
Board members by gender
8 (67%)
4 (33%)
10
10
3
4
2017
2016
2015
■ ■ Male 8 (67%)
■ ■ Female 4 (33%)
Governance
We strive to take an innovative approach in all that we do and that
includes our approach to governance. In 2017, we have carried
out a number of initiatives such as our Meet the Board event,
the Board apprentice programme and the appointment of Irene
Dorner as our Non-Executive Director employee champion and we
continue to look to be ‘best in class’ and to ensure our governance
is appropriate for the Group and all our stakeholders.
The Group’s governance framework continues to be effective.
Following its launch in 2016, an updated version was issued in June
2017, containing a new section on strategy, planning and in-year
appraisal. We continue to work on developing and maturing the
framework, with the current focus on building on the considerable
work done to date on our Group policies, to bring further
improvements and ensure the Group policies are understood and
embedded across the organisation. The outcome of this work will
provide a condensed and more succinct set of Group policies.
In September, we established a new executive level group
governance committee, chaired by the General Counsel. This new
The Committee focused on strengthening the pipeline of
executive talent in the Company. Group activities include the
external hiring of diverse senior managers and internal promotion
activity and continued emphasis on diverse pipeline, graduate
and apprentice recruitment. You can find out more on page 47.
This is ongoing and will be kept under review. The charts on
page 66 provide a clearer picture of our Board diversity and
our diversity & inclusion targets are on page 47.
committee will help to keep the governance framework and the
development of the Group policies under review. It will oversee the
effectiveness of the framework across the organisation and ensure
that the Group’s corporate governance and corporate compliance
arrangements, practices and procedures (below Board level) are
consistent with appropriate best practice principles and standards
for a group of the size and complexity of Rolls-Royce.
The Nominations & Governance Committee is provided with regular
updates on key developments to corporate governance. This year,
the Committee has been kept informed about the changes to the
governance landscape and the proposals from the government’s
green paper on UK corporate governance and the FRC’s
consultation on the UK Corporate Governance Code.
Conflicts of interest and independence
The Board continues to monitor and note potential conflicts of
interest that each Director may have and recommends to the Board
whether these should be authorised and whether any conditions
should be attached to any authorisation. The Directors are regularly
reminded of their continuing obligations in relation to conflicts, and
are required annually to review and confirm their external interests,
which helps to determine whether each of them continue to be
considered independent.
Brad Singer, as a representative of a significant shareholder, is not
considered to be independent. As noted on page 77, the conflict
of interest was managed throughout the year by a relationship
agreement between the Company, ValueAct and Brad Singer.
During the year, following an annual review, no additional conflicts
of interest were identified which required approval by the Board.
The Committee advised the Board that it considered that each of the
remaining Non-Executive Directors continued to be independent.
Looking forward
I am pleased to report we have made good progress against our
priorities for 2017 in relation to succession planning. However, we still
have work to do in this area and in relation to diversity and inclusion.
During the course of 2018, the Committee will continue to keep
under review any future UK corporate governance reforms as they
are finalised and also review progress of our initiatives including
the Board apprentice and employee engagement programmes.
Ian Davis
Chairman of the Nominations & Governance Committee
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Remuneration Committee Report
83
Remuneration Committee Report
Ruth Cairnie
Chairman of the
Remuneration
Committee
Key highlights
Implementation of the new Directors’ remuneration policy
Strong bonus performance for 2017
Stephen Daintith’s appointment to the Board
Employee engagement on executive remuneration
Introduction
I am pleased to present my second report as Chairman of the
Remuneration Committee, outlining the areas of focus for
the Committee during the year.
New remuneration policy
In 2017, we revised our remuneration policy to strengthen the
connection to our strategy. The changes addressed the themes
of transformation, competitiveness, alignment with shareholders
and simplicity and included:
— simplifying the design of both short and long-term incentives;
— increasing the maximum level of long-term incentive plan (LTIP)
award;
— reducing the vesting level for threshold performance in the
LTIP and adding a two-year holding period.
In developing the new policy we engaged extensively with our
major shareholders to understand their perspectives and address
any concerns, and we secured strong support for the policy at the
2017 AGM (96%).
Based on the first year of implementation, the new policy is working
well for us. The additional potential for performance-based awards
has supported our talent agenda, enabling us to bring experience
from other sectors into senior positions; an example is the
appointment of Stephen Daintith as Chief Financial Officer. The
structure of the performance-based incentives is much simpler and
we have been able to communicate progress towards our targets
more clearly to employees. The alignment of shareholder interests
and our remuneration targets is evident: to pay out, our incentives
require the continued ramp-up of new engine delivery, increase in
flying hours, improvements in operational performance, strong cash
management and a shift in our culture towards pace and simplicity.
I am pleased that the clarity of our measures and strong link to
strategy enables the Committee to have robust, data-driven debate
about both targets and outcomes.
2017 outturns
The 2015 performance share plan (PSP) awards will not vest as
the performance conditions were not met over the three-year
performance period to 31 December 2017. This reflects the reset in
performance expectations, notably EPS, during this performance
period as the business entered a major period of transition. This
is the third consecutive year that PSP has not vested, an outcome
which aligns with our shareholders’ experience over this period.
When setting targets for the 2017 annual bonus, the Committee
took a diligent approach, recognising that many of the headwinds
encountered in 2016 (for example the cash drain associated with
delivery of increasing numbers of new engines) would continue
to impact the businesses, but that substantial progress was
needed on the path to a transformed business with stronger
financial performance.
The reported financial performance in 2017 saw both underlying
profit and free cash flow exceeding expectations. This resulted
from the growth in our installed engines delivering significantly
higher service revenue, a solid performance in Defence Aerospace
and strong performance by Power Systems, together with the
benefits of the transformation programme being felt. The higher
profitability and better working capital management led to the
growth in cash flow.
In determining the outcomes for bonus the Committee has
rigorously examined the quality of both profit and cash flow
outturns to ensure that awards reflect operational improvements
and delivery of the transformation programme. Adjustments were
made to remove the greater than budgeted benefit of the R&D
capitalisation policy. After this adjustment both profit and cash
outcomes remained above target levels.
For our non-financial incentive measures, our delivery metric was
just above target level, with strong performances in some businesses
offsetting challenges in Civil Aerospace. Employee engagement
remained at the same level as in 2016 which limited the outturn
of this metric to base level. The overall bonus outturn across both
financial and non-financial metrics was 72% of maximum reflecting
a strong performance in a year with many challenges.
The Committee also considered the bonus in the round, to decide
whether this outperformance seemed appropriate, taking into
account external factors, progress on the strategic journey and
shareholder experience. Overall we felt that management had
responded vigorously to the challenges posed by in-service issues
as well as continued market challenges, for example in Marine,
and had made good strategic progress. Taking everything into
account we decided not to make any further adjustments.
I am also pleased that we are able to pay bonuses to employees
throughout the organisation for a second consecutive year.
Board changes
Stephen Daintith joined the Board in April 2017. Awards that he
would otherwise have forfeited from his previous employer were
bought out, retaining performance conditions where relevant and
matching or exceeding previous time horizons.
We also announced the departure of both Colin Smith and David
Smith from the Board in 2017. In both cases outstanding PSP awards
were pro-rated and will vest at the normal time against achievement
of the relevant performance conditions. The 2015 PSP awards
have lapsed as the targets were not met. Neither Colin nor David
participated in any incentive plans in 2017. David Smith’s contractual
payments were mitigated due to his external appointment to QinetiQ.
DIRECTORS’ REPORT 84
Directors’ Report
Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
2018 salary review and incentives
The Committee has reviewed the salary levels of the Executive
Directors and has concluded that no increases will be made
for 2018.
The only change we have made to the implementation of our policy
is to increase the weighting of the cash metric in the annual bonus
from 37.5% to 50%, reflecting that cash is the key performance
metric across our business.
Other attendees
In addition to the members of the Committee, the Chairman,
Chief Executive, 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
discussion of his or her own remuneration package. The Committee
is supported by the Company Secretary, the Group HR Director
and Global Performance, Reward & Pensions Director.
Gender pay
In line with the new UK regulations, we published our gender pay
gap in November 2017. It showed a median pay gap of 8.1% (mean
8.3%) across all Rolls-Royce employees in the UK. While our UK
gender pay gap is better than the UK national average, as with many
engineering organisations we have a relatively low number of women
in our business and they are not as well represented in higher level
roles as men. We are working to improve the representation of
diverse talent at all levels in the organisation with the adoption
of the Board Diversity policy and with plans in place that are set
out on pages 47, 81 and 82.
Engagement with employees
I am keen that the Committee keeps in touch with what our
employees are thinking about executive remuneration. Combined
with insights from shareholders, this helps ensure the Committee has
a rounded view to inform the decisions that we make. At the end of
2017, I started to engage in employee focus groups to get feedback
on this topic and I will continue to meet with employees in 2018.
These meetings are closely aligned with the work of fellow director
Irene Dorner in her role as employee champion.
In addition we have chosen to publish our CEO pay ratio versus
UK employees in this year’s report on page 93. We believe it is
helpful to be as transparent as possible about executive pay.
Operation of the Committee
All members of the Committee are independent Non-Executive
Directors. Lewis Booth joined the Committee in April 2017.
Our biographies are on pages 67 and 68.
The Committee’s responsibilities are outlined in its terms of reference
which can be found at www.rolls-royce.com, and which we review
annually and refer to the Board for approval.
In addition to its five scheduled meetings, the Committee held
unscheduled meetings in January and March to discuss 2017 bonus
plan targets.
Committee members
Member
Ruth Cairnie (chairman)
Lewis Booth
Sir Frank Chapman
Sir Kevin Smith
See page 70 for reasons of non-attendance.
Attended Eligible to attend
7
5
7
7
7
5
6
6
Advisers
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 £126,750 (2016: £159,175). Deloitte also advised the Company
on tax, corporate compliance, employee global mobility, assurance,
pensions and corporate finance and Deloitte MCS Limited provided
consulting services. The Committee is exclusively responsible for
reviewing, selecting and appointing its advisers.
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 and is satisfied that the advice it has
received has been objective and independent.
Principal responsibilities
Set and monitor the strategy and policy for the remuneration
of Executive Directors, Chairman and members of the executive
leadership team (ELT).
Determine the design, conditions and coverage of annual
incentives and LTIPs for senior executives and approve total
and individual payments under the plans.
Determine targets for any performance-related pay plans.
Determine the issue and terms of all-employee share plans.
Oversee any major changes in remuneration.
Areas of focus for 2018
The Committee is operating well with the members bringing a
wealth of diverse experience. In 2018 in addition to our regular
activities we will:
— Continue our focus on incentive measures and targets to ensure
they remain aligned with strategy and performance
— Consider the forthcoming governance reforms and their impact
on the Committee’s remit and process
— Continue to develop our approach to engaging with employees
— With the HR function, consider how the wider reward strategy
can play an even stronger role in supporting new behaviours
and culture through the forthcoming business restructuring
Ruth Cairnie
Chairman of the Remuneration Committee
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Remuneration Committee Report
85
Remuneration Committee focus during 2017
Area of focus
Matters considered
Outcome
Remuneration
policy
Gain shareholder approval for a new
policy to:
— better align executive reward to the
transformation agenda;
— improve competitiveness of the total reward
package to attract and retain talent;
— align executive reward with the interests
of shareholders; and
— introduce simplified plans that can be
cascaded down the organisation
The overall reward structure was reviewed with a continued
focus on pay for performance. The designs of both annual bonus
and LTIPs were simplified to additive models. Performance
metrics focus on the measures that will drive the business
strategy and align with shareholder interests.
The maximum level of LTIP award was increased to 250% for
the Chief Executive and 225% for other Executive Directors.
At the same time the amount vesting at threshold was reduced
from 30% to 20% and an additional two-year holding period
was introduced. The new policy was approved by 96% of
shareholders at the 2017 AGM.
Base salaries
Review of base salaries in accordance with
the remuneration policy and the broader
employee context
Increase to Warren East’s salary of 2% with effect from
September 2017. There will be no increases for Warren East
and Stephen Daintith for 2018.
Annual bonus
2017 bonus – review of performance against
the 2017 bonus targets
2018 bonus – Review of measures and targets
to ensure continued alignment to strategy
Warren East received a bonus of 122% of salary (68% of
maximum). Stephen Daintith received a bonus of 83% of salary,
equivalent to 113% of salary (75% of maximum) on a full-year
basis. 40% of the awards were deferred into shares.
The Committee agreed that for the 2018 bonus plan the same
measures would apply as in 2017 but with more focus on free
cash flow as the key performance metric. The weighting
will be as follows:
— Profit – 25%
— Cash – 50%
— Customer delivery – 12.5%
— Employee engagement – 12.5%
Awards will be based 80% on Group performance and 20%
on individual performance. The maximum opportunities remain
at 180% of salary for the Chief Executive and 150% for other
Executive Directors.
Long-term
incentive plan
2015 PSP – review of achievement of
performance measures
The 2015 awards will not vest due to performance conditions
not being satisfied.
2018 LTIP – setting targets that ensure
significant stretch
For 2018 grants, targets will continue to be based on CPS (60%),
EPS (20%) and TSR (20%). The EPS targets for threshold, on target
and maximum vesting are now based on IFRS 15 accounting.
Executive Director
changes
Stephen Daintith joined the Board on
7 April 2017
Buy-out awards were made to Stephen Daintith to compensate
him for awards he forfeited on joining Rolls-Royce.
The maximum opportunities remain at 250% for the Chief
Executive and 225% for other Executive Directors.
David Smith left Rolls-Royce on
28 February 2017
Colin Smith left Rolls-Royce on 31 May 2017
Payments were made to David Smith and Colin Smith in
accordance with their contractual entitlements on leaving.
The Committee mitigated the payments made to David Smith
in relation to his appointment at QinetiQ.
Neither David Smith or Colin Smith received a bonus for 2017.
Existing long-term incentive awards will be pro-rated based
on service and subject to achievement of plan performance
conditions at the normal vesting dates.
DIRECTORS’ REPORT 86
Directors’ Report
Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Summary of our remuneration policy
Fixed pay
Base salary
Bene�ts
Pension
Variable pay
Annual bonus
Long-term incentive plan
80% Group
performance
+
20% individual
performance
75%
Financial
• Pro�t
• Cash
25%
Non-�nancial
• Customer delivery
• Employee engagement
60%
CPS
20%
EPS
20%
TSR
40% deferral for 2 years
2-year holding period
Malus and clawback
Shareholding requirements
There are four key themes that underpin the policy:
Simplification
Stewardship
Talent
Supporting transformation
These themes continue to align to our organisational strategy and our reward programmes support them through a combination of salary,
benefits, annual bonus and long-term incentives, underpinned by stretching performance measures and appropriate award levels. The full
policy is in the 2016 Annual Report, available at www.rolls-royce.com.
Remuneration policy – worked examples for 2018
Chief Executive £000
Chief Financial Of�cer £000
Minimum
On-target cash
On-target total
Maximum
£1,194
£2,043
£3,222
£5,250
Minimum
On-target cash
On-target total
Maximum
£850
£1,360
£2,125
£3,400
■ Fixed remuneration (including salary, bene�ts and pension)
■ Annual bonus
■ Long-term incentive plan – this does not include share price growth
Minimum – fixed remuneration (salary, pension, benefits), no bonus award or LTIP vesting.
On-target cash – fixed remuneration, 50% of maximum bonus award, no LTIP vesting.
On-target total – fixed remuneration, 50% of maximum bonus award, 50% of LTIP vesting.
Maximum – fixed remuneration, 100% of maximum bonus award, 100% of LTIP vesting.
Shareholder voting
Results of resolutions 2 and 3 – proposed at the AGM on 4 May 2017
Approval of the Directors’ remuneration policy (resolution 2)
Approval of the Directors’ remuneration report (resolution 3)
1 Withheld votes are not counted towards the total percentage of votes cast.
Number
of votes
1,357,109,903
1,390,482,627
For
%
95.79
98.78
Number
of votes
59,613,198
17,243,067
Against
%
4.21
1.22
Withheld 1
Number
of votes
2,505,008
11,527,537
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Remuneration Committee Report
87
Executive Directors’ remuneration
The following pages 87 to 90 show how we have applied our remuneration policy during 2017 and disclose all elements of remuneration
received by our Executive Directors. Details of remuneration received by our Non-Executive Directors during 2017 can be found on pages
95 and 96.
Executive Directors’ single figure of remuneration (audited)
Fixed pay
Variable pay
Salary (a)
£000
Benefits (b)
£000
Pension (c)
£000
Bonus (d)
£000
Long-term
incentives (e)
£000
Other (f)
£000
Total remuneration
£000
2017
2016
2017
2016
2017
2016
2017
2016
2017
2016
2017
2016
2017
2016
Executive Directors
Warren East
Stephen Daintith 1
Former Executive Directors
Colin Smith 2
David Smith 3
Total
931
499
925
–
17
15
17
–
233
110
231
–
1,150
565
916
–
–
1,259
229
90
1,749
550
540
2,015
63
9
104
156
51
224
73
29
445
176
173
580
–
–
1,715
413
405
1,734
–
–
1,259
–
–
–
–
–
–
–
–
– 2,448
2,331 2,089
–
418
124
542
–
–
–
783
252
1,295
1,169
5,814 4,553
1 Stephen Daintith took up his role at Rolls-Royce on 7 April 2017. The LTIP awards which vested in 2017 represent part of his buy-out awards – see page 90.
2 Colin Smith left Rolls-Royce on 31 May 2017. He received a payment totalling £469k in respect of the remainder of his contractual notice period of which £418k was paid in 2017.
3 David Smith left Rolls-Royce on 28 February 2017.
a) Salary
The Company provides competitive salaries suitable to attract and retain individuals of the right calibre to develop and execute the
business strategy. The Committee reviewed Warren East and Stephen Daintith’s salary in early 2018 and agreed there would be no
increases for 2018.
Executive Director
Warren East
Stephen Daintith (appointed 7 April 2017)
Base salary as at
1 March 2018
Base salary as at
1 September 2017
Base salary as at
1 March 2016
£943,500
£680,000
£943,500
£680,000
£925,000
–
b) Executive Directors’ benefits (audited)
Benefits are provided to ensure that remuneration packages remain sufficiently competitive to attract and retain individuals of the
right calibre to develop and execute the business strategy and to enable them to devote themselves fully to their roles. The taxable value
of all benefits paid to Executive Directors during 2017 is shown below.
Executive Directors
Warren East
Stephen Daintith 1
Former Executive Directors
Colin Smith 2
David Smith 3
Total
Car or car
allowance inc.
fuel allowance
£000
2017
15
13
13
4
45
2016
15
–
30
28
73
Financial
planning
£000
Medical
insurance
£000
Travel and
subsistence
£000
Accommodation
costs
£000
2017
–
–
2016
–
–
2017
2
1
2016
2
–
2017
–
1
5
–
5
6
–
6
–
–
3
2
2
6
3
3
7
2016
–
–
7
6
13
2017
–
–
42
2
44
2016
–
–
111
15
126
2017
17
15
63
9
104
Total
£000
2016
17
–
156
51
224
1 Stephen Daintith took up his role at Rolls-Royce on 7 April 2017.
2 Colin Smith left Rolls-Royce on 31 May 2017.
3 David Smith left Rolls-Royce on 28 February 2017.
DIRECTORS’ REPORT 88
Directors’ Report
Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
c) Pension entitlements (audited)
The Company provides competitive pension arrangements suitable to attract and retain individuals of the right calibre to develop and
execute the business strategy. Executive Directors are offered membership of a defined contribution pension plan. A cash allowance may
be payable in lieu of pension contributions, reduced to allow for additional National Insurance incurred. Warren East receives a cash
allowance of 25% and Stephen Daintith receives a cash allowance of 22% of salary in lieu of pension accrual. The Group’s UK pension
schemes are funded, registered schemes and were approved under the regime applying until 6 April 2006. They include both defined
contribution and defined benefit pension schemes and there is now only one defined benefit pension plan, the ‘Rolls-Royce UK Pension
Fund’. None of the current Directors is a member of this plan. Colin Smith, who left the Group on 31 May 2017, started to receive his
pension on 1 December 2016.
d) Annual bonus outturn (audited)
The Company’s annual bonus scheme is designed to incentivise the execution of the business strategy, delivery of financial targets and
the achievement of personal objectives. Executive Directors receive any annual bonus awarded in March following the performance
period. 60% of the bonus is paid in cash with the remaining 40% awarded in deferred shares. Deferred shares are held in trust for two
years before being released, subject to the recipient still being employed by the Group and include the right to receive an amount equal
in value to the C shares issued during the deferral period. The annual maximum for the Chief Executive is 180% of salary and 150% for
the other Executive Director(s):
— 80% of the award is based on Group performance
— 20% of the award is based on individual performance
The Committee retains overriding discretion on the outturns of the annual bonus.
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 Group’s Global Code
of Conduct; or individual gross misconduct. Clawback will apply from the date of deferral until three years after the release of shares.
2017 annual bonus outturn
The Committee reviewed the 2017 outturn against the performance measures; 80% of annual bonus is based on Group performance
and 20% is based on individual performance. The Group performance measures are shown below:
Weighting
Base (25%)
Target (50%)
Maximum (100%)
2017 performance 1
% of maximum
Profit
37.5%
£813m
£953m
£1,096m
£1,062m
88%
Cash
37.5%
(£207m)
£93m
£393m
£255m
77%
Customer
delivery
12.5%
80%
90%
100%
91%
56%
Employee
engagement
12.5%
75
77
79
75
25%
Total
100%
72%
1 For the purposes of assessing performance the Committee adjusted the underlying profit and free cash flow to reflect unbudgeted foreign exchange movements and the greater than
budgeted benefit from the R&D capitalisation policy.
Definitions used for performance measures:
Profit – underlying profit before tax that is reported by the Group for 2017, adjusted for unbudgeted acquisitions and disposals.
Cash – free cash flow which is cash flow before acquisitions and disposals, shareholder payments, foreign exchange and
share buybacks.
Customer delivery – % on-time to purchase order, measured for new equipment, spare parts or equipment repair and overhaul.
Employee engagement – measured through our long-standing global employee opinion survey. 59% of our people participated
in our survey in 2017 and our sustainable engagement score was 75.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Remuneration Committee Report
89
Individual performance
Executive Directors have 20% of their bonus based on achievement of their personal objectives. Personal performance objectives are set
at the beginning of the year and are aligned with the Group’s internal strategic priorities.
For Executive Directors these have included:
— Sustain the transformation programme
— Build a strong and effective ELT
— Review the Group vision and strategy and portfolio
— Develop the medium term plan to achieve strategic goals and a focus on safety, cash and people
— Embed a simpler organisation with accountable, engaged and empowered people
— Improve management information systems to provide visibility on business economics and costs
— Develop clear plans and objectives on diversity
The Committee assesses performance against the objectives. The overall assessed percentage is based on the Committee’s judgement
and may include other factors and achievements in the year.
The following provides an overview of key achievements during the year for each Executive Director:
Warren East
Delivered savings from the 2015 transformation programme
at the top end of expectations
Reshaped the ELT and improved its effectiveness
Delivered strong strategic progress including the successful
launch of three new engines – Trent 1000 TEN, Trent 7000
and Trent XWB-97
Developed the new Group vision and strategy with enhanced focus
on underlying technology for the future (electrical and digital).
Re-organised the engineering & technology function to move more
engineering closer to our customers
Undertook a strategic review of the Group resulting in the
planned restructure into three operating businesses
2017 annual bonus outturn (paid in March 2018)
Stephen Daintith
Delivered a step change in the performance of the finance function,
strengthening leadership and transformation capability
Significantly improved financial planning and analysis to provide
better understanding of Group performance and its drivers
Led medium term planning process across the Group to deliver
a significant increase in free cash flow by 2020, increased focus
on cost reduction and simplification of processes
Successfully prepared for the introduction and implications
of IFRS 15 both internally and externally
Significantly improved market communications with greater clarity
over key cash flow drivers
Warren East
Stephen Daintith 1
Group
performance
(% of salary)
104%
64%
Individual
Performance
(% of salary)
18%
19%
Total bonus
(% of salary)
122%
83%
Total bonus
(% of maximum)
68%
55%
1 The bonus received by Stephen Daintith was reduced pro-rata to reflect his joining date of 7 April 2017. The full year equivalent would have been 113% of salary and 75% of maximum.
e) Long-term incentives (audited)
Awards are made to Executive Directors under the LTIP to reward the execution and development of the business strategy over a
multi-year period.
LTIP awards made in May 2017
The performance targets for awards made in May 2017 are shown below. Performance will be measured over three years to 31 December 2019.
Threshold (20% vesting)
Mid (50% vesting)
Maximum (100% vesting)
Warren East
Stephen Daintith
CPS (60%)
60p
80p
110p
Number
of shares
281,954
186,547
EPS (20%)
115p
135p
160p
Relative TSR (20%)
Median
Between median and upper quartile
Upper quartile
% of salary
250
225
Face value
of award
£000
2,312
1,530
Performance
period end date
31 December 2020
31 December 2020
DIRECTORS’ REPORT 90
Directors’ Report
Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
PSP awards vesting in March 2018
The following sets out details in respect of the March 2015 PSP award (made under the 2014 remuneration policy) for which the final year
of performance was the 2017 financial year. Subject to performance conditions, the vesting date of these awards is March 2018, three years
after the awards were made.
EPS growth (hurdle)
Aggregate CPS
Relative TSR
Targets for 2015-2017 period
Awards will vest if EPS growth exceeds the OECD
index of consumer prices. Awards will lapse if the
hurdle is not met.
Aggregate CPS over three-year period of less than
60p – zero vesting.
Aggregate CPS over three-year period of
100p – 100% vesting.
Relative TSR versus FTSE 100 constituents less than
median – 1.0 x multiplier.
Relative TSR versus FTSE 100 constituents equal
to median – 1.25 x multiplier.
Relative TSR versus FTSE 100 constituents equal
to upper quartile – 1.5 x mulitplier.
Performance against targets
EPS growth of -39.4% over the three-year period
underperformed the hurdle which was 4.1%.
Aggregate CPS performance over three-year period
of 26p.
Relative TSR over the three-year period was
below median.
Outturn
None of the 2015 awards will vest in March 2018.
There are also outstanding awards, made under the Rolls-Royce Performance Share Plan (PSP), which were agreed prior to the approval
of the LTIP at the AGM in 2017. These include awards made to Stephen Daintith to compensate for unvested incentives awarded to him at
Daily Mail & General Trust plc (DMGT) which were forfeited as a result of him joining Rolls-Royce. The awards shown below are of equivalent
value to the DMGT awards forfeited and reflect performance conditions and match or exceed the time horizons. Awards vesting in 2019
will be assessed against the 2016 PSP performance conditions.
PSP awards made to Stephen Daintith in May 2017
Number
of shares
Face value of
award £000
Vesting conditions
Vesting date
Outturn %
118,103
14,792
70,027
79,726
891
112
528
602
Determined by the extent to which DMGT awards vest
Continued employment and good level of
31 October 2017
personal performance 31 December 2017
Determined by the Company’s performance between
1 January 2016 and 31 December 2018
Determined by the Company’s performance between
1 January 2016 and 31 December 2018
1 March 2019
31 October 2019
100
100
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 Group’s Global Code of
Conduct; or individual gross misconduct. These provisions will apply from the date of the award until three years from the date of vesting.
All awards under the 2017 LTIP are subject to a further two-year holding period after the three-year performance period. The holding
period will normally continue to apply post-employment.
f) Other (audited)
Payments for loss of office
David Smith left the Group on 28 February 2017 and Colin Smith on 31 May 2017. Neither received a bonus award for 2017.
David Smith served six months of his 12 months’ notice and received a payment in lieu of notice in relation to the remaining six months
of his notice period, paid in monthly instalments. The Committee reduced these payments to account for his remuneration with QinetiQ
resulting in total payments of £124k (which included unpaid holiday entitlement).
Colin Smith, having served four months of his 12 months’ notice, received total payments of £469k in lieu of notice payable to him in eight
instalments. Seven of these instalments, totalling £418k, were paid to him in 2017. The final instalment, which related to the last month of his
notice period, was paid in January 2018. Outplacement support has also been provided.
Both will retain pro-rated PSP awards, granted prior to leaving, subject to the Company meeting the performance targets for those awards
and subject to and in accordance with the rules of the plan. Shares will only be released on the normal vesting dates.
Payments to past directors
Colin Smith stepped down from the Board on 4 May 2017 and left the Group on 31 May 2017. A short-term agreement was put in place
to represent the Company in an ambassadorial capacity for a maximum of 15 days to the end of 2017 and 35 days to the end of 2018.
The 15 days that Colin carried out this role in 2017 will be paid in 2018.
Rolls-Royce Holdings plc Annual Report 2017
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Remuneration Committee Report
91
Implementation of remuneration policy in 2018
Base salary
Benefits
Pensions
Annual bonus
There will be no change to base salary for 2018; base salaries remain as:
— Warren East – £943,500
— Stephen Daintith – £680,000
There will be no change to our approach to benefits in 2018, which includes car or car allowance, financial
planning assistance, insurances and other benefits.
There will be no change to our approach to pensions in 2018. Pension arrangements will be:
— Warren East: cash allowance of 25% of salary
— Stephen Daintith: cash allowance of 22% of salary
For 2018, bonuses will continue to be awarded using a simple additive approach:
— 80% of the award will be based on Group performance
— 20% of the award will be based on individual performance
For 2018, the Group measures will be unchanged, however there will be an increased weighting to free cash
flow to emphasise this as the key performance metric for 2018:
Profit (25%) – Free cash flow (50%) – Customer delivery (12.5%) – Employee engagement (12.5%)
Maximum opportunities will remain unchanged:
— Chief Executive – 180% of salary
— Other Executive Directors – 150% of salary
LTIP awards
For awards to be granted in 2018 performance measures will be weighted:
— 60% on CPS
— 20% on EPS
— 20% on relative TSR (versus FTSE 100 and Global S&P Index, to recognise that Rolls-Royce is a global
company).
Performance will be measured over three years to 31 December 2020. Performance targets will be:
Threshold (20% vesting)
Mid (50% vesting)
Maximum (100% vesting)
CPS
95p
126p
158p
EPS
IFRS 15 basis 1
73p
86p
103p
Relative TSR
Median
Between median and upper quartile
Upper quartile
1 EPS is now based on IFRS 15 accounting which is a different basis from prior years’ targets.
Performance below threshold will result in that element lapsing in full.
The above targets are not an indication of forecast numbers for the three-year period.
Methodologies
CPS – 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. The
Committee will review CPS performance to ensure that it is a fair reflection of achievements over the period.
EPS – calculated as cumulative absolute underlying EPS over the three-year performance period on an
IFRS 15 basis.
Relative TSR – measured 50% against the constituents of the FTSE 100 and 50% against the constituents
of the S&P Global Industrials index.
Award sizes for maximum performance
— Chief Executive: 250% of salary
— Other Executive Directors: 225% of salary
Threshold vesting at 20% equates to 50% of salary for the Chief Executive and 45% of salary for other
Executive Directors. LTIP awards will be subject to an additional shareholding period of two years following
the three-year performance period.
DIRECTORS’ REPORT 92
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Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Other information
Executive Directors’ share interests (audited)
The Directors and their connected persons hold the following interests in the ordinary shares of the Company:
Ordinary shares
Warren East
Stephen Daintith
31 December 2017
25,733
70,433
Conditional shares
not subject to
performance
conditions
(Deferred share bonus)
Conditional
Options over
shares subject to
shares subject to
performance
savings contract
conditions (PSP)
(Sharesave)
6 March 2018 31 December 2017 31 December 2017 31 December 2017 31 December 2017
1,264
925
Conditional
shares subject to
performance
conditions (LTIP)
290,845
149,753
281,954
186,547
25,868
70,433
47,398
–
Executive Directors’ interests in vested and unvested shares – changes in 2017 (audited)
Warren East
PSP 2015
PSP 2016
Total
LTIP 2017 1
Deferred share bonus
Sharesave (options) 2
Stephen Daintith
PSP 2017 (buy-out award) 3
PSP 2017 (buy-out award) 3
PSP 2017 (buy-out award) 3
PSP 2017 (buy-out award) 3
Total
LTIP 2017 1
Sharesave (options) 2
31 December
2016
126,643
164,202
290,845
–
–
1,264
31 December
2016
–
–
–
–
–
–
–
Granted
during the
year
–
–
–
281,954
47,398
–
Granted
during the
year
118,103
14,792
70,027
79,726
282,648
186,547
925
Vested
awards
–
–
–
–
–
–
Vested
awards
118,103
14,792
–
–
132,895
–
–
Lapsed
awards
–
–
–
–
–
–
31 December
2017
126,643
164,202
290,845
281,954
47,398
1,264
Lapsed
awards
–
–
–
–
–
–
–
31 December
2017
–
–
70,027
79,726
149,753
186,547
925
Market price
at date of
award (p)
730.00
676.00
–
Date
of grant
01/09/15
01/03/16
–
Date
of vesting
01/09/18
01/03/19
–
820.17 05/05/17 04/05/20
01/03/19
772.83
01/02/21
616.80
01/03/17
12/10/15
Market price
at date of
award (p)
754.70
754.70
754.70
754.70
–
Date
of grant
01/03/17
01/03/17
01/03/17
01/03/17
–
Date
of vesting
31/10/17
31/12/17
01/03/19
31/10/19
–
820.17 05/05/17 04/05/20
01/02/21
758.40
13/10/17
Market price
at vesting (p)
–
–
–
–
–
–
Market price
at vesting (p)
961.00
840.80
–
–
–
–
–
1 The LTIP grant price is the average of the closing mid-market price calculated over 2, 3 and 4 May 2017.
2 For Sharesave, the price shown is the exercise price which was 85% of the market price at the date of the award.
3 The grant price for PSP awards made to Stephen Daintith was the average closing mid-market price calculated over one month, up to 22/09/16 (the date that his appointment
to Rolls-Royce was announced). The exercise of the PSP award vesting on 31/12/17 took place on 02/01/18. More information on these awards is on page 90.
Shareholding requirement
Executive Directors are required to work towards holding beneficially-owned shares equivalent in value to a percentage of their salary
by retaining at least one half of after-tax shares released from the PSP/LTIP until this requirement is met. For the Chief Executive this
requirement is 250% of salary and for other Executive Directors this requirement is 200% of salary. The current shareholdings, as a
percentage of the requirement, for Warren East and Stephen Daintith are 26% and 42% respectively.*
* The percentage of the requirement was calculated by reference to the May 2017 LTIP grant price and salary as at date of grant. Unvested PSP awards, LTIP awards and Sharesave
options are not included in this calculation.
Former Executive Directors’ share interests
At the time of leaving Rolls-Royce, former Executive Directors and their connected persons held the following interests in the ordinary
shares of the Company:
Colin Smith – 224,370 ordinary shares (as at 31 May 2017)
David Smith – 42,367 ordinary shares (as at 28 February 2017)
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Remuneration Committee Report
93
Former Executive Directors’ interests in vested and unvested shares – changes in 2017
Colin Smith
PSP 2014
PSP 2015 1
PSP 2016
Total
Sharesave (options) 2
David Smith
PSP 2014
PSP 2015 1
PSP 2016
Total
Sharesave (options) 2
31 December
2016
Granted
during the
year
Vested
awards
Lapsed
awards
31 December
2017
Market price
at date of
award (p)
Date
of grant
Date
of vesting
Market price
at vesting (p)
53,336
58,263
81,361
192,960
758
31 December
2016
18,287
57,204
79,882
155,373
758
–
–
–
–
–
–
–
–
–
–
(53,336)
–
–
(53,336)
758
0
58,263
81,361
139,624
–
984.33
07/05/14
944.00 02/03/15
01/03/16
676.00
–
–
12/10/15
616.80
03/03/17
02/03/18
01/03/19
–
–
–
–
–
–
–
Granted
during the
year
–
–
–
–
–
Vested
awards
–
–
–
–
–
Lapsed
awards
(18,287)
–
–
(18,287)
758
31 December
2017
0
57,204
79,882
137,086
–
Market price
at date of
Date
award (p)
of grant
984.33 03/03/14
944.00 02/03/15
01/03/16
676.00
–
–
12/10/15
616.80
Date
of vesting
03/03/17
02/03/18
01/03/19
–
–
Market price
at vesting (p)
–
–
–
–
–
1 The 2015 PSP award lapsed on 2/3/2018.
2 For Sharesave, the price shown is the exercise price which was 85% of the market price at the date of the award.
Pay across the organisation
This section of the report enables our remuneration arrangements to be seen in context by providing:
— a comparison of the year-on-year percentage change in our Chief Executive’s remuneration with the change in average remuneration
across the UK;
— a year-on-year comparison of the total amount spent on employment costs across the Group and shareholder payments;
— a nine-year history of our Chief Executive’s remuneration;
— our TSR performance over the same period; and
— an indication of the ratio between our Chief Executive’s remuneration and the remuneration of employees.
Percentage change in Chief Executive remuneration
The following table compares the percentage change in the Chief Executive’s salary, bonus and benefits (excluding LTIP) to the average
percentage change in salary, bonus and benefits for all UK employees from 2016 to 2017.
Change in remuneration
Chief Executive
UK employees average 1
Salary
2%
2.3%
Benefits
0%
5%
Annual bonus
25.6%
2.1%
1 UK employees were chosen as a comparator group in order to avoid the impact of exchange rate movements over the year. UK employees excluding apprentices, graduates and
interns, make up 45% of the total employee population.
Chief Executive pay ratio
The Committee is mindful of the relationship between the remuneration of the Chief Executive and the wider employee population.
All employees participate in a bonus plan. We also encourage all employees to join our Sharesave plan, launched every two years.
For our recent launch around 50% of our employees globally joined the plan, sharing in 14 million shares/stock appreciation rights.
Included below is the ratio of the remuneration of the Chief Executive to other UK employees in the Group during 2017. The ratio will
be higher when Group performance triggers incentive pay-outs. The ratio could vary significantly depending on the extent that the
Group’s performance triggers the payment of short and long-term incentives.
CEO pay ratio (total remuneration)
41:1
CEO pay ratio (pay only)
21:1
DIRECTORS’ REPORT 94
Directors’ Report
Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Relative spend on pay
The following chart sets out the percentage change in payments to shareholders and overall expenditure on pay across the Group.
Payment to shareholders (£m) *
(Consolidated Cash Flow Statement)
Group employment costs (£m)
(Note 7 – Consolidated Financial Statements)
2017
2017
2016
2016
215
215
-29%
-29%
301
301
2017
2017
2016
2016
* Value of C Shares issued during the year.
** Includes £306m costs of restructuring the UK defined benefit pension schemes.
-0.6%
-0.6%
3,801
3,801
3,822 **
3,822 **
Chief Executive pay
Year
2017
2016
2015
2015
2014
2013
2012
2011
2011
2010
Chief Executive 1
Warren East
Warren East
Warren East
John Rishton
John Rishton
John Rishton 2
John Rishton 2
John Rishton
Sir John Rose 3
Sir John Rose
Single figure
of total
remuneration
£000
2,331
2,089
543
754
2,596
6,228
4,577
3,677
3,832
3,914
Annual bonus
as a % of
maximum
68
55
0
0
0
55
85
63
–
100
LTIP
as a % of
maximum
–
–
–
–
45
100
–
–
75
100
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 as Chief Executive 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.
3 The remuneration for Sir John Rose does not include any pension accrual or contribution as he received his pension from 1 February 2008.
TSR performance
The Company’s TSR performance over the previous nine 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 nine years, relative to the FTSE 100 index.
500
400
300
200
100
d
n
u
o
P
£
Rolls-Royce
FTSE 100
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Year
Gender pay reporting
The Company is committed to creating a diverse and inclusive place to work where our people can be themselves and be at their best.
We published our gender pay gap in November 2017, which showed:
■ Median gender pay gap across all Rolls-Royce UK employees
■ Mean gender pay gap across all Rolls-Royce UK employees
8.1%
8.3%
Overall, women currently represent 15% of Rolls-Royce UK employees. Women are less well-represented than this figure in the higher pay
quartiles due to proportionally more men being in senior level roles. Increasing the number of women in our business and moving towards
a more balanced distribution of men and women across all levels is very important. We are making progress on this in many ways, such as
increasing the proportion of women in our apprentice and graduate intakes. More details are available on page 47 and at www.rolls-royce.com.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Remuneration Committee Report
95
Contractual arrangements
The Executive Directors have service agreements that set out the contract between each Executive Director and the Company.
Executive Directors’ service contracts
Warren East
Stephen Daintith
Date of contract
21 April 2015
21 September 2016
Notice period from Company
12 months
12 months
Notice period from individual
6 months
12 months
Payments received for serving on external boards
Executive Directors retain payments received from serving on the boards of external companies, the details of which are given below:
Warren East
Stephen Daintith
Non-Executive Directors’ remuneration
Single figure of remuneration (audited)
Directorships held
Dyson James Group Limited
3i Group plc
Payments received and retained
£000
80
75
Chairman and Non-Executive Directors
Ian Davis
Lewis Booth 1
Ruth Cairnie
Sir Frank Chapman
Irene Dorner
Beverly Goulet 2
Lee Hsien Yang
Brad Singer
Sir Kevin Smith
Jasmin Staiblin
Former Non-Executive Directors
Dame Helen Alexander
Alan Davies
John McAdam 3
Total
Fees
(£000)
Benefits
(£000)
Total
(£000)
2017
425
95
90
90
70
35
70
70
105
70
–
–
24
1,144
2016
425
100
83
90
70
–
70
58
98
70
31
62
70
1,227
2017
2
69
4
4
–
11
3
20
5
7
–
–
–
125
2016
2
14
2
2
–
–
3
–
2
4
–
1
–
30
2017
427
164
94
94
70
46
73
90
110
77
–
–
24
1,269
2016
427
114
85
92
70
–
73
58
100
74
31
63
70
1,257
1 The tax treatment of travel expenses incurred by Lewis Booth, while travelling to and from the UK, changed in May 2016 (five years after his date of appointment and in accordance
with HMRC rules). This change is reflected in the value of benefits reported.
2 Beverly Goulet joined the Board on 3 July 2017.
3 John McAdam stepped down from the Board on 4 May 2017 after completing nine years.
Non-Executive Directors’ fees
The Chairman’s fee is reviewed by the Board as a whole on the recommendation of the Committee. The review of the other Non-Executive
Directors’ base fees is reserved to the Executive Directors, who consider recommendations from the Chairman. No individual may be
involved in setting his or her own fee. The Chairman and the Non-Executive Directors are not eligible to participate in any of the Group’s
share schemes, incentive arrangements or pension schemes. A facility is in place which enables Non-Executive Directors (who reside in a
permitted dealing territory) 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. Ruth Cairnie, Sir Frank Chapman, Ian Davis, Lee Hsien Yang and Sir Kevin Smith use this facility.
DIRECTORS’ REPORT 96
Directors’ Report
Remuneration Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Non-Executive Directors’ fees
Chairman
Other Non-Executive Directors base fee
Chairman of the Audit Committee
Chairman of the Remuneration Committee
Chairman of the Safety & Ethics Committee
Chairman of the Science & Technology Committee
Senior Independent Director
2018
£000
425
70
25
20
20
20
15
2017
£000
425
70
25
20
20
20
15
2016
£000
425
70
25
20
20
20
15
Non-Executive Directors’ benefits (audited)
The benefits for Non-Executive Directors relate predominantly to travel, hotel and subsistence incurred in attending meetings.
For Non-Executive Directors based outside the UK the Company may also pay towards tax advice and the cost of making tax filings.
Non-Executive Directors’ share interests (audited)
The Non-Executive Directors and their connected persons hold the following interests in the ordinary shares of the Company:
Chairman and Non-Executive Directors
Ian Davis
Lewis Booth
Ruth Cairnie
Sir Frank Chapman
Irene Dorner
Beverly Goulet
Lee Hsien Yang
Brad Singer
Sir Kevin Smith
Jasmin Staiblin
Former Non-Executive Director
John McAdam (balance at date of stepping down from the Board)
31 December 2017
57,436
60,000
14,097
27,798
10,244
4,250
5,482
–
24,701
–
4 May 2017
3,362
6 March 2018
58,141
60,000
14,626
28,733
10,297
4,272
5,742
–
25,451
–
n/a
Non-Executive Directors’ letters of appointment
Our Non-Executive Directors serve a maximum of three, three-year terms (nine years in total).
Chairman and Non-Executive Directors
Ian Davis
Lewis Booth
Ruth Cairnie
Sir Frank Chapman
Irene Dorner
Beverly Goulet
Lee Hsien Yang
Brad Singer
Sir Kevin Smith
Jasmin Staiblin
Original appointment date
1 March 2013
25 May 2011
1 September 2014
10 November 2011
27 July 2015
3 July 2017
1 January 2014
2 March 2016
1 November 2015
21 May 2012
Current letter of
appointment end date
28 February 2019
24 May 2020
31 August 2020
9 November 2020
26 July 2018
2 July 2020
31 December 2019
3 May 2018
31 October 2018
20 May 2018
Statutory requirements
The Committee’s composition, responsibilities and operation comply with the principles of good governance, as set out in the UK
Corporate Governance Code with the Listing Rules (of the Financial Conduct Authority) and with the Companies Act 2006. The Directors’
remuneration report has been prepared on the basis prescribed in the Large and Medium-sized Companies and Groups (Accounts and
Reports) (Amendment) Regulations 2013.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Audit Committee Report
97
Audit Committee Report
Lewis Booth
Chairman of the
Audit Committee
Key highlights
Focus on business and functional risks
Preparations complete for the implementation of IFRS 15
Revenue from Contracts with Customers
Continued strengthening of the control environment
PwC confirmed its independence ahead of appointment in
2018 and transition progressing
Introduction
I am pleased to present the 2017 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.
The Group has complex long-term accounting and every year
we spend much of our time reviewing the accounting policies and
accounting judgements implicit in our financial results. For 2017,
this work has been compounded by preparing for the change in
revenue recognition under IFRS 15, which has a major impact on
the presentation of the accounts; management has been pro-active
in analysing the effect of this new standard and providing input to
the market on its impact, and we are satisfied that the interpretation,
judgements, and estimates for IFRS 15 are appropriate. In addition,
we reviewed the plans to implement IFRS 9 Financial Instruments
from 2018.
As a result of the audit tender completed in 2016, we have been
preparing for the appointment of PricewaterhouseCoopers LLP
(PwC) as the Company's new auditor in 2018. This has required a
significant effort to reassign work from PwC to ensure that they are
independent, and I am delighted that they achieved this in October.
The management team has introduced effective controls to ensure
that PwC (and KPMG until the completion of their audit
responsibilities) maintain their independence.
2017 has also seen the finance team strengthened at the senior level.
Significant progress has been made in financial analysis and
reporting and in the supporting management information systems.
This has provided additional support for the Committee's work.
For 2018, work will continue to strengthen the control environment
(including recommendations arising from the DPAs), review of all key
accounting judgements, as well as reviewing the progress on IFRS 16
Leases which takes effect from 2019.
Operation of the Committee
All members of the Committee are independent Non-Executive
Directors. Beverly Goulet joined the Committee on 3 July 2017.
For the purposes of the Code and DTR 7.1, Beverly Goulet, Irene
Dorner and I have recent and relevant financial experience.
Our biographies are on page 67.
The Committee’s responsibilities are outlined in its terms of
reference, which can be found at www.rolls-royce.com, which we
review annually and refer to the Board for approval. During 2017,
we made an amendment to cover the revised Provision C.3.1
of the Code that requires the Committee, as a whole, to have
competence relevant to the sector in which the Company operates,
which the Nominations & Governance Committee confirmed is
already the case.
Committee members
Member
Lewis Booth (chairman)
Irene Dorner
Beverly Goulet
Lee Hsien Yang
Attended Eligible to attend
5
5
3
5
5
5
3
5
Principal responsibilities
Financial reporting
Financial announcements, focusing on:
— accounting policies, judgements and estimates;
— inclusion of appropriate disclosures;
— compliance with relevant regulations; and
— whether the Annual Report is fair, balanced and understandable.
Risk and control environment
Scope and effectiveness of the risk management system.
Monitoring of financial fraud risks.
Systems of internal control.
Principal risks
Business continuity, market and financial shock,
and IT vulnerability.
Internal audit
Scope, resources, results and effectiveness.
External auditor
Relationship with, and effectiveness of, the external auditor.
Recommendations to the Board for the external auditor’s
appointment and fees.
DIRECTORS’ REPORT 98
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Audit Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Audit Committee focus during 2017
Area of focus
Matters considered
Outcome
Financial
reporting
The appropriateness and disclosure of accounting
policies, key judgements and key estimates with
a focus on:
The accounting policies, judgements and estimates
are appropriate and balanced.
Agreed the judgements and estimates to adopt IFRS 9.
— the methodology for capitalisation and amortisation
of development costs;
— carrying value of goodwill in Marine;
— treatment, estimation and disclosure of costs in Civil
Aerospace for the remediation of in-service issues
on the Trent 1000 and Trent 900 programmes;
— restructuring costs; and
— acquisition of ITP Aero.
The implementation projects for IFRS 9, IFRS 15 and
IFRS 16. In particular, the preparation of the restated
information on an IFRS 15 basis which is included in
notes 1 and 27 to the Consolidated Financial Statements.
The form and content of the Annual Report.
Continued improvements to the enterprise risk
management and internal controls systems, including
a focus on core financial controls, and risks at
remote locations.
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 going
concern and viability statements.
Risk and control
environment
Principal risks
Management’s assessment of the risk of a
business continuity event.
The procedures for preventing, monitoring and
combatting breaches of the security of the Group’s
IT systems.
The Group’s policies, procedures and controls for
identifying, managing and mitigating a market shock.
The effectiveness of the internal audit function, its
key findings and trends arising, and the resolution
of these matters.
Internal audit
External audit
The approach and scope of external audit and the
effectiveness and independence of the external auditor.
The extent of non-audit services provided by KPMG.
The transition to PwC as auditor in 2018.
IFRS 15 interpretations, judgements and estimates
made are appropriate.
Agreed the approach being taken to implement
IFRS 16 (see page 132).
The Annual Report, taken as a whole, is fair,
balanced and understandable.
The internal control system meets the requirements of
the Code. It will continue to be enhanced during 2018,
including extending the documentation of internal
controls to include compliance controls relating to
the DPAs.
Reported to the Board that an appropriate process
is in place to make the viability statement.
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, cyber security and market
shock risks.
The scope and extent of internal audit are appropriate
and the function remains effective.
Assessed KPMG as effective and independent.
No concerns over the nature and amount of the
non-audit services provided by KPMG.
Recommended that PwC be appointed as the
Group’s auditors at the 2018 AGM.
Monitored the procedures to ensure that PwC
became independent of the Group in October 2017
and approved enhanced policies to maintain this.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Audit Committee Report
99
Sector audit committees
Financial reporting
To strengthen the ownership of accounting policies and controls,
and to support our work, each of the Group’s businesses and
principal functions has its own sector audit committee. These
committees are chaired by the director of internal audit, comprise
business functional leaders and senior finance personnel and are
attended by KPMG. They meet twice a year and:
— review the application of accounting policies, judgements
and estimates;
— review risk management, internal control 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.
The director of internal audit reported to this Committee on
key matters arising and also provided updates on the work and
effectiveness of the sector audit committees during the year.
In 2017, the sector audit committees continued to focus on the
improvement projects for internal control and risk management
process, in particular the embedding of these in our normal
operational processes.
Members of the Committee attended at least one sector audit
committee each, and we are satisfied that this process is now
owned by the business and is helping to improve our risk
management and the control environment.
Business and function presentations
In addition to a regular review of the sector audit committee process
and any key issues identified, we have a regular schedule of
presentations from each of the Group’s businesses and its key
functions. During 2017, we received presentations from the following:
— Civil Aerospace – key business risks (focusing on new programme
introductions, ramp-up in production and in-service product
issues); supply chain resilience; internal control environment
(including financial analysis, the implementation of IFRS 15 in 2018
and planning and forecasting capability to reflect the business
growth); and accounting policies, judgements and estimates.
— Power Systems – key accounting estimates (including warranty
provisions and the impact of the transformation programme);
key business risks (including regulatory compliance,
competitive position, and transformation programmes); and
the control environment.
— Nuclear – key accounting estimates (which principally relate
to accounting for long-term contracts and are affected by the
changing contractual arrangements with the UK MoD); key
business risks (including government relations, programme
delivery, IT security, and safety of nuclear facilities and products);
future of civil nuclear markets; and the control environment.
— Group tax director – the main drivers of the Group’s tax position
and key tax risks and how they are managed (with specific
consideration of tax disputes); key tax law developments and
new requirements (in particular the new UK corporate offence
of ‘failure to prevent the facilitation of tax evasion’); key sources
of estimation uncertainty (in particular the recognition of deferred
tax assets); and key tax-related disclosures.
During the year, we considered proposals for revisions to the
methodologies applied to determine when development costs
should be capitalised and how they should be amortised. These
are described in more detail on pages 124 and 128. The Committee
agreed that the experience on the significant number of new
programmes in the Civil Aerospace business and changes in the
way in which technical risk is being managed on these programmes
indicated that the criteria for the capitalisation of development costs
were generally met at an earlier stage than has previously been
assessed, and that costs eligible for capitalisation continue to be
incurred after the first engines have entered service. We were
satisfied that appropriate governance procedures and controls are
in place to manage this revised methodology. The impact of this
change in 2017 is the capitalisation of an additional £83m of costs.
We also agreed that an amortisation methodology that reflects
the number of engines in service better reflects the pattern of
consumption of the intangible asset.
A summary of the principal matters we considered in respect of
the 2017 Consolidated Financial Statements is set out in the table
on page 100. Where relevant (in particular, in regard to the carrying
value of programme assets and estimates on long-term contractual
arrangements) we took account of the potential impact of the
in-service issues on the Civil Aerospace Trent 1000 and Trent 900
programmes. These are described on page 24.
We continued to monitor the implementation of new standards.
Our conclusions on IFRS 15 are shown in the table on page 100.
IFRS 9 is applicable from 2018. The impact on the Group is not
significant and is described on page 130. IFRS 16 is applicable
from 2019. In broad terms this requires a balance sheet liability
to be reported for all leases. We considered progress of the project
and analysis of the Group’s lease portfolio.
Since the year end, we have reviewed the form and content of
the Company’s 2017 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 position and performance, business model and strategy.
In making this assessment, we considered:
— the process for preparing the Annual Report, including a steering
committee, the core team, and instructions to contributors;
— written representations from management in respect of the
business reviews, sustainability, principal risks and Financial
Statements;
— the completion of a regulatory compliance checklist;
— all reviews performed (including the Board, the ELT and KPMG)
and ensured that all feedback was appropriately reflected; and
— the presentation and discussion in the Strategic Report of:
(i) the underlying as well as reported results; (ii) the in-service
issues on the Trent 1000 and Trent 900 programmes; and (iii)
trends, in particular, the impact of individually significant items.
DIRECTORS’ REPORT 100
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Audit Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Areas of focus for the 2017 Financial Statements
Key issue
Matters considered
Outcome
Accounting for
development costs
Methodology for capitalisation and amortisation
of development costs – see pages 124 and 128
Impairment of the carrying
values of programme
assets in Civil Aerospace
Assessments of the values of the principal
programme assets, including key assumptions
and estimates – see page 143
Determining the
appropriateness of the
judgements and estimates
used in accounting for
long-term contractual
arrangements
Classification of
restructuring costs
The sale of engines
to joint ventures
Continuing appropriateness of the judgements
We considered carefully the estimates used in the
accounting regarding the cost of the in-service
engine issues on the Trent 1000 and Trent 900
programmes and the resulting performance
improvements
The criteria for excluding certain costs from
the underlying results and whether the costs
meet this criteria – see page 135
Indications of impairment
of goodwill in Marine
The forecasts and the key assumptions on
which they are based – see page 143
We are satisfied that the revised methodology for
capitalisation and amortisation of development costs
appropriately reflects changes in the ways in which risk
is managed in the programmes and the consumption
of the programme asset.
We are satisfied that no write-down of programme
assets is required.
We are satisfied that the judgements continue to be
appropriate and that the process produces balanced
estimates, with appropriate consideration of the
uncertainties. No significant changes to the basis
of preparation were made in 2017.
We are satisfied that the agreed criteria have been
consistently applied.
value of the engines.
We are satisfied that no impairment is required but, as
the headroom remains low, we will continue to monitor
this. We were also satisfied that no adjustments were
required in 2017 as result of the reorganisation of
Marine announced in January 2018.
Basis for assessing the selling price – see page 166 We are satisfied that the price represents the fair
Deferred tax assets
(DTAs) and advance
corporation tax
Acquisition of ITP Aero
Implementation of IFRS 9
Implementation of IFRS 15
Basis for recognition of DTAs arising from tax
losses and advance corporation tax in the UK
and non-recognition of DTAs in Norway
Based on the Group’s forecasts and taking account
of the current uncertainties in the oil & gas market,
we are satisfied that the treatment is appropriate.
The acquisition accounting focusing on the
remeasurement of the existing joint venture
investment and the allocation of the purchase
price to the assets acquired, giving rise to the
recognition of a gain – see page 167
The assessment of judgements and estimates
necessary to implement IFRS 9 in 2018 –
see page 130
The progress of the project to implement IFRS 15
in 2018 and the preparation of the disclosures
of the impact of the change for 2017 (see pages
55 to 57, 131 to 132 and 170 to 171)
We are satisfied that the provisional judgements
and estimates made were appropriate and that,
in accordance with IFRS 3 Business Combinations,
these will be finalised in 2018.
We are satisfied that the judgements and estimates
are appropriate.
We are satisfied that the judgements and estimates
made are appropriate and consistent with the new
requirements; that the disclosures of the impact are
appropriate; and that the Group has systems and
processes in place to report on the new basis in 2018.
Rolls-Royce Holdings plc Annual Report 2017
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101
Risk and control environment
Assessment of principal risks
Risk management is a fundamental and integral part of how we
work. All risks are managed through a risk management system
(RMS – described on page 59) in accordance with policies and
guidance approved by the Board.
Judgement is required in:
— evaluating the risks facing the Group in achieving its objectives;
— determining the risks that are considered acceptable;
— determining the likelihood of those risks materialising;
— identifying the Group’s ability to reduce the incidence and
impact on the business of risks that do materialise; and
— ensuring the costs of operating particular controls are
proportionate to the benefit provided.
During 2017, on behalf of the Board, we monitored the RMS,
including continued developments and improvements. These are
described in more detail on page 59. We also specifically
considered how risks at remote sites are identified and managed.
This process and the principal risks arising (see pages 59 to 62)
then formed the basis for our assessment of the going concern and
viability statements which are discussed on page 63. 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 Board 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.
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 system comprises:
— entity-level controls covering leadership and direction from
the top; and
— specific control activities, covering detailed process controls,
and internal and external assurance activities.
We routinely review controls over the Group’s principal risks and
the key risks and critical processes in each of the Group’s businesses.
Both the sector audit committees and this Committee also consider
KPMG’s observations on the Group’s control environment.
During 2017, the Group completed the documentation of core
financial controls in line with the plans established in 2015, and
commenced a formal programme to continually assess and test
the effective operation of those controls across the Group. In
addition, it is extending the documentation of internal controls
to include compliance controls relating to the DPAs. In 2017, the
testing and assessment of core financial controls identified that
further improvements are required to fully embed and mature these
controls. Therefore new policies and formalised compensating
internal controls specifically in respect of financial reporting
were introduced.
We have conducted a review of the effectiveness of the Group’s
risk management and internal controls systems, including those
relating to the financial reporting process, in accordance with
the Code. These systems have been in place throughout 2017.
We consider that they meet the requirements of the Code and
the DTR.
Going concern and viability statements
We reviewed the processes and assumptions underlying the
statements set out on page 63. In particular, we considered:
— the Group’s forecast funding position over the next five years;
— an analysis of impacts of severe but plausible risk scenarios,
ensuring that these were consistent with the risks reviewed
by the Board as part of its strategy review;
— the impact of multiple risks occurring simultaneously;
— additional mitigating actions that the Group could take in
extreme circumstances; and
— the current borrowing facilities in place and the availability
of future facilities.
As a result, we were satisfied that the going concern and viability
statements have been prepared on an appropriate basis.
Principal risks
We considered in detail the principal risks that have been allocated
to us by the Board, see pages 61 and 62. From our discussions
we are satisfied that all of the principal risks that we oversee
have received significant management attention during the year.
We reviewed:
Business continuity
In February, the director of civil aerospace operations updated
us on how business continuity risks present in the external supply
chain were being mitigated and governed.
In November, the Group's chief information officer updated us on
the programme of work to identify and mitigate potential IT single
points of failure.
In December, the director of civil aerospace operations presented
information on supply chain resilience and potential single points
of failure in our internal supply chain.
We also spent time reviewing progress made with improvements
agreed last year to mitigate specific business continuity risks and
to address internal audit recommendations.
IT vulnerability
In May, the director, security, risk & compliance updated the
Committee on the potential key risks related to cyber security, how
the threat landscape is changing and how lessons are being learnt.
We also reviewed the cyber security strategy, designed to improve
the visibility of threats, enforcement of cyber security policies and
learning from intelligence gained about the main cyber risk actors
as well as our ‘defence in depth’ approach.
In November, we received an update from the Group's chief
information officer on the progress that was being made to
mitigate the cyber security threats that we discussed in May.
We also received ad hoc updates during cyber attacks such
as WannaCry.
DIRECTORS’ REPORT 102
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Audit Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Market and financial shock
In July, we reviewed potential key risks, including liquidity and
credit rating risks and how they are managed by the Group's
financial risk committee.
We also considered the impact of other risks, notably changing
accounting standards and Brexit.
We are 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. I was pleased to see that the continued
improvement in the function was recognised by the Institute of
Internal Audit when awarding it the Private Sector Outstanding
Team of the Year.
Our risk management system
In February, we reviewed the programme to enhance the risk
management system and in July and December reviewed progress
that had been made. In December, we also received an update
from the head of enterprise risk management on the development
of the risk appetite framework to use risk metrics to inform decision
making. The framework includes upper and lower limits and triggers
to provide early warning if the limit of the Group’s capacity to
withstand principal risks was being approached.
Internal audit
The director of internal audit provides the Committee with:
— quarterly: a dashboard identifying the key trends and findings
from internal audit reports, and the resolution of actions agreed;
— biannually: a detailed update of significant findings and his
perspectives on the internal control environment, management
responses to underlying root causes and systemic issues;
— the results of audits on advisor processes (including payments)
and conflicts of interest, as part of the Group's response to the
DPAs;
— an annual report on compliance with expenses policies for
the directors and ELT members; and
— a work plan for the following year.
I meet the director of internal audit privately before each meeting
and on an ad-hoc basis throughout the year, as do other members
of the Committee. As a whole, we have 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. Specific topics discussed in
2017 included: process and control design; compliance to process;
data security and integrity; project management; and accountability.
The nature and number of issues raised by internal audit and the
time to complete the related actions remains a key focus. We pay
particular attention to the small number of overdue actions and
were pleased to observe a continued reduction in the time to
complete actions.
The plan is developed to focus on the key risks facing the business.
We monitor changes during the course of the year.
We considered and reviewed the effectiveness of the Group’s
internal audit function, including resources, plans and performance
as well as the function’s interaction with management. The outcome
of the 2017 review was positive and identified opportunities for
continued improvement which are being implemented.
External audit
2017 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 and we also assessed KPMG’s qualifications,
expertise and resources, independence and the effectiveness
of the external audit process.
Key risks and the audit approach to these risks are discussed in
the Independent Auditor’s Report (pages 183 to 194), which
also highlights the other significant risks that KPMG drew to our
attention. We continue to support the extended auditor’s report and
KPMG’s approach which goes beyond the minimum requirements,
providing additional clarity on the key judgements and estimates.
As part of the reporting of the half-year and full-year results, in
July 2017 and February 2018, KPMG reported to the Committee
on its assessment of the Group’s judgements and estimates in
respect of these risks and the adequacy of the reporting. KPMG
also reported on its assessment of the Group’s control environment.
It is important that for areas of judgement that are finely balanced,
KPMG provide additional insight to assist in making the most
appropriate judgement. In our meetings and discussions with
KPMG and management, it is clear that this role is being
performed well.
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.
Non-audit services provided by KPMG
In order to safeguard the auditor’s independence and objectivity,
and in accordance with the FRC’s Ethical Standard, 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. Accordingly,
our policies for the engagement of the auditor to undertake
non-audit services broadly limit these to audit-related services
such as reporting to lenders and grant providers.
Fees paid to KPMG are set out on page 141 and summarised on page
103. All proposed services must be pre-approved in accordance with
the policy which is reviewed and approved annually. Above defined
levels, my pre-approval is required. During 2017, we have further
strengthened the process and controls in this area. We also review
quarterly the non-audit fees charged by KPMG.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Audit Committee Report
103
Non-audit related fees paid to KPMG during the year were 24%
(2016: 17%) of the audit fee. Our annual review of the external auditor
takes into account the nature and level of all services provided.
Looking forward
As well as our regular review of accounting policies, our focus
will include:
Audit
Non-audit
Audit-related 1
Tax compliance
Other
2017
2016
£m
7.6
0.7
0.1
1.0
1.8
% of
audit fee
10
1
13
24
£m
6.8
0.6
0.5
0.1
1.2
1 Includes £0.3m for the review of the half-year report.
% of
audit fee
— the audit transition activities;
— the implementation of IFRS 16, including the supporting
processes and controls;
— embedding and maturing the finance processes and core
financial controls with continued training and education;
— completion of the documentation of compliance controls
relating to the DPAs;
— strengthening the information technology controls over key
finance systems; and
9
7
1
17
— the continuing development of the management information
systems and improvements to the underlying systems and tools.
In addition to the continuing oversight by the Safety & Ethics
Committee of the ethics and compliance programme (see page 109),
we will continue to monitor the Group’s actions relating to risk
management, internal controls and other matters relevant to
the Committee that arise out of Lord Gold’s recommendations,
and from the agreements with prosecuting authorities.
Lewis Booth
Chairman of the Audit Committee
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.
Auditor transition and appointment of PwC
The Committee reviews and makes recommendations to the Board
with regard to the appointment of the external auditor.
Following the audit tender process in 2016, we recommended to
the Board that PwC be appointed as auditor for the financial year
commencing 1 January 2018. No contractual obligations restricted
our choice of external auditor.
During 2017, we have monitored the activities of the audit transition
team, which was established to ensure that the transition is as
seamless as possible. A key part of the activities was to ensure
that, on appointment, PwC meets the independence requirements
and that we have procedures to ensure that this is maintained (and
that of KPMG until the completion of their audit responsibilities).
This involved moving existing PwC engagements, most significantly
global tax compliance, to alternative providers. PwC became
independent in October 2017. As well as this, during 2017, PwC
has attended the Committee meetings and sector audit committee
meetings, made familiarisation visits to our major sites and held
a global planning workshop. Following the confirmation of
independence, PwC has reviewed KPMG’s audit files for 2016
and our key accounting policies and judgements, including
those relating to IFRS 15. We are also working on a detailed plan
for each of the subsidiary companies around the world.
KPMG has been the Company's auditor since 1990. On behalf
of the Company, I express my thanks to them for their contribution
over this period.
Ian Chambers, as the PwC lead audit partner, will be required to
rotate after five years and other key audit partners will be required
to rotate every seven years. We will monitor compliance with these
requirements. The Committee and the Board will recommend PwC’s
appointment at the 2018 AGM.
Compliance
During 2017, the Company complied with The Statutory Audit
Services for Large Companies Market Investigation (Mandatory
Use of Competitive Tender Processes and Audit Committee
Responsibilities) Order 2014.
DIRECTORS’ REPORT 104
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Rolls-Royce Holdings plc Annual Report 2017
Safety & Ethics Committee Report
Sir Frank Chapman
Chairman of the
Safety & Ethics
Committee
Committee members
Member
Sir Frank Chapman (chairman)
Irene Dorner
Lee Hsien Yang
See page 70 for reasons of non-attendance.
Principal responsibilities
Product safety
Attended Eligible to attend
6
6
6
5
6
6
Key highlights
Supporting executive leadership with renewed focus on HSE
Review of product safety in Defence Aerospace
Maintaining product safety, occupational safety and asset
integrity focus during organisational change
Maintain an understanding of, and keep under review, the
Group’s framework for the effective governance of product
safety, including risk management, policies, training, capability
and elements of the product safety management system.
Monitor product safety performance, the response to product
in-service issues and lessons learned.
Monitoring of compliance with obligations under the deferred
prosecution agreements (DPAs)
HSE
Maintaining oversight of the implementation of Lord Gold’s
recommendations on ethics and compliance
Further embedding compliance culture in the businesses
Review of the Group’s refreshed approach to sustainability
Oversee HSE governance, review performance, incidents
and monitor improvement projects.
Guide and support management in the promotion of a culture
of leadership in HSE.
Introduction
This year the importance of the Committee’s role in assisting the
Board, and guiding and overseeing management, has been evident.
As part of organisational transformation, there has been significant
executive leadership emphasis on driving greater ambition in all
aspects of safety and ethics. Employee, customer and public
expectations in these areas continue to increase. I and the other
Committee members welcome the opportunity to support the
leadership as it strives for continuous performance improvement.
The Committee has carefully monitored compliance with the DPAs.
We have reviewed the handling of product in-service issues, the
investigations and conclusions from occupational health and safety
and asset integrity incidents, and have acted as a sounding board for
plans to improve the Group’s vigour and approach to sustainability.
Operation of the Committee
All members of the Committee are independent Non-Executive
Directors. Our biographies are on page 67. The Committee’s
responsibilities are outlined in its terms of reference, available
at www.rolls-royce.com, which we review annually and refer to
the Board for approval.
In addition to the usual scheduled meetings during the year, the
Committee added extra calls in April and October so that we could
maintain more regular oversight over the Group’s compliance with
its obligations under the DPAs, the implementation of Lord Gold’s
recommendations on ethics and compliance, and the embedding
of compliance culture within the businesses. We held an
unscheduled meeting to receive an update on the latest discussions
with regulators following the DPAs. The Committee also conducted
an on-site product safety review of Defence Aerospace operations.
Sustainability
Oversee the Group’s approach to sustainability, including how
environmental/climate impacts from its operations are managed,
and monitor performance towards sustainability targets.
Ethics & compliance
Review the Group’s compliance with relevant legislation.
Keep the Global Code of Conduct (Global Code) and
anti-bribery and corruption policies under review.
Review reports on issues raised through the Ethics Line and
other channels and review the results of any investigations into
ethical or compliance breaches or allegations of misconduct.
Principal risks: compliance and product safety
Maintain oversight of these principal risks. The product failure
principal risk was redefined as product safety during the year
(see page 59).
Areas of focus for 2018
— Oversight of the Group’s activities to meet its continuing
obligations under the DPAs and to implement Lord Gold’s
recommendations
— Oversight of the deployment of the revised Global Code
of Conduct
— Supporting leadership with the development of structured
improvement plans to support the Group’s increasing
safety ambition
Rolls-Royce Holdings plc Annual Report 2017
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105
Safety & Ethics Committee focus during 2017
Area of focus
Matters considered
Outcome
Product
Safety
Maintaining safety during organisational change
Product safety policy and processes, training, safety
assurance case and competence in manufacturing
Product safety performance and issues in service
Product safety management systems
Product safety in Defence Aerospace
HSE
Monitoring investigations into two employee fatalities
and the Company’s response
Detailed reviews of serious injury and high potential
incidents including asset integrity matters
Events, key findings, shared learning and actions
HSE ambition, strategy and plans for continuous
HSE improvement
HSE performance including incidents, injuries, waste,
energy use and GHG emissions metrics
HSE programmes – LiveWell, asset care, waste action
Sustainability
Review of sustainability strategy, governance, in-year
and planned activity
Publication of annual anti-slavery and human
trafficking statement under UK Modern Slavery Act
2015 amendments
Review of plans to meet external sustainability
reporting requirements in light of increased
regulations and stakeholder expectations
Ethics &
compliance
Updates on dialogue with regulators and agencies and
impact on customers and partners post-DPAs
Compliance with continuing obligations under the DPAs
and implementation of Lord Gold’s recommendations
Plans to refresh Global Code of Conduct and policies
Resourcing of ethics and compliance team, and
effectiveness of compliance officers
Embedding of ethics and compliance culture and
behaviours. Review of number and nature of Ethics
Line contacts
Management of intermediaries including termination,
settlements, screening, appointments and payments
Progress with Data Privacy Binding Corporate
Rules application
Oversight of
principal risks
Principal risks of compliance and product
safety reviewed
The Committee was satisfied that product safety
governance remained robust following changes to
organisational accountability.
Safety performance remained at expected acceptable
levels, with safety aspects of in-service issues handled
competently and appropriately.
The product safety management system in Defence
Aerospace is effective and well-operated.
Support to the employees’ families and colleagues has
been made available. Several investigations are being
undertaken but are not yet concluded.
Strengthening of HSE leadership, strategies, plans
and communications as part of a structured approach
to achieve continuous improvement.
Programmes are at varying maturity levels but there
are signs of progress. Energy consumption target has
been met three years early. Waste reduction target
time horizons have been restated to realistic levels
following review.
A revised approach aligned to the Group’s new vision
was agreed. A new ELT-level committee has been
formed to oversee environment and sustainability
matters, including policy, approach and key
performance indicators.
The Group’s anti-slavery and human trafficking
statement was reviewed and approved.
Reviewed the transparency and credibility of existing
external reporting and agreed an approach to
participation in key sustainability assessments.
The Committee was kept appraised of continuing
cooperation. Customers and partners were
appropriately engaged.
Reviewed detailed plans for, and progress on,
compliance. Reviewed the first annual report to US
Department of Justice.
A new Global Code is to be issued in 2018.
The ethics and compliance team is effective and has
been strengthened in some areas.
There is anecdotal evidence from business leaders
that cultural change is being embedded in the
businesses. Continued oversight is required.
The intermediary processes are effective to manage
the risks.
The Committee supported the approach on data
privacy. The decision of the Information Commissioner
on Binding Corporate Rules is awaited.
These principal risks are reviewed and discussed at
every meeting of the Committee, and both are being
managed effectively.
DIRECTORS’ REPORT 106
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Safety & Ethics Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Product safety
Rolls-Royce aims to go beyond compliance with regulatory product
safety standards, setting a goal of continuous product safety
improvement, in common with other industry participants. This is
regarded as fundamental to the Group’s licence to operate and to
the sustainability of our business. Product safety encompasses the
design, manufacture, assembly, installation, in-service operation,
maintenance and repair of products, across all of our businesses,
and regions where we operate. It is critical that product safety
processes develop continuously to underpin the science and
technological innovation that enables product designs to evolve
and extend operational boundaries.
In 2017, we continued with our rolling review programme of key
product safety topics across the Rolls-Royce businesses, as well
as considering special topics and in-service issues as they arose.
Throughout the year, we retained a focus on how safety risk was
being managed through the period of transformation for the
Group. This included overseeing changes to the product safety
governance model and policy to reflect new organisational
accountabilities aligned to changes in senior operations and
engineering roles. We also emphasised the importance of ensuring
safety processes continued on a positive trajectory against a
backdrop of organisational change and pursuit of operational
and cost efficiencies. Emphasis continued on the evolution of
our product safety competence across the workforce, with new
employees being appropriately trained on processes from the outset.
We monitor improvements that are proposed to the Group’s product
safety management system (SMS). We reviewed the work of the
product safety process council, part of the role of which is to ensure
that the product safety processes are clearly understood and
effective. The council gathers information from a broad range of
sources including KPIs, audits, user surveys and feedback, and safety
governance forums. Together these ensure that there is regular,
diverse activity to monitor the state of our safety processes.
These indicators showed the product safety processes to be
effective, efficient and fit-for-purpose, and also continued to
highlight opportunities for improvement in some areas. This led to
work in 2017 on: continued communication to increase awareness;
further safety case guidance and user support; document
simplification and updates; development of a product safety
assurance case; reporting tool simplifications; corporate audit of
targeted safety processes; and updates to the senior managers’
product safety awareness training.
We reviewed progress on the use of a safety case to articulate
why a product is acceptably safe to operate, supported by
evidence (see example safety case below). The preparation of
a product safety case was introduced to the Group’s processes
based on best practice from the Rolls-Royce Nuclear business.
We saw how the introduction of a safety case served to increase
further the focus on safety in a structured and consistent manner
across the businesses. We also noted the lessons being learned
and captured for future projects on how to structure safety cases.
The Committee received briefings at each of its meetings during
the year on issues that had arisen with products in service. These
included updates on investigations of root cause, assessment of
implications, and oversight of the Group’s response. The Committee
was satisfied that processes and plans were appropriate and effective
in identifying, managing and retiring safety risk. We were kept
updated on the programme to address the issues previously
identified on the Trent 1000 fleet and were satisfied with the
approach taken from a safety perspective.
In February, we reviewed the overall metrics for product safety
in 2016. We noted that neither the number nor rate of safety events
for 2016 indicated any significant concern with either the safety
performance of the Group’s products or with performance
in managing safety issues.
In December, we reviewed the processes for ensuring competence
in manufacturing, as an element of the SMS.
We were briefed on the activity during the year to refresh the
product safety training for employees, which we noted would
be more targeted to particular roles.
We also reviewed the product safety principal risk and supported
the proposal to the Board to redefine this as product safety
(you can read more about this on page 59).
Example safety case
Claim
Argument
The product is acceptably safe to operate
All hazards
have been
identified
All hazard
causes
have been
eliminated or
adequately
mitigated
The risks
are tolerable
Risks have
been
reduced to
levels that
are ALARP *
The
certification
requirements
have been
satisfied
All Group
safety
policies have
been
satisfied
The
appropriate
safety
controls are
in place
* ALARP: as low as reasonably practicable.
Evidence
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
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107
HSE
The Committee maintained focus on HSE developments during
a particularly challenging year in this area.
We regret to report that there were two employee fatalities in
October. The first was the death of an electrical engineer employed
in the civil nuclear business, while working at a customer site
in central France. The matter remains under investigation.
The second was an employee of Power Systems who died from
injuries sustained in a road traffic accident while on the way to a
customer’s site in Germany. No other vehicles were involved. These
two tragic incidents have remained under the Committee’s review
and are a stark reminder of the critical importance of managing HSE
effectively across all activities. The leadership’s heightened HSE
performance ambition aims to eliminate all recordable incidents.
We were given detailed briefings on HSE matters throughout the
year. In July and December, we reviewed the Group’s HSE key
activities, performance metrics, insights and learning, noting that
the total reportable injury (TRI) rate was behind the year-on-year
target trajectory. Again, this added stimulus to the leadership’s
determination to achieve higher HSE performance levels. Asset
integrity, infrastructure maintenance and control of contractors
were common factors across a number of these incidents and will
be targeted for improvement as part of the structured HSE
improvement plans.
TRI rate (per 100 employees) *
1
0.8
0.6
0.4
0.2
0
2014
2015
2016
2017
2020
target
* External assurance over STEM, energy, GHG and TRI rate data provided by
Bureau Veritas. See page 195 for the sustainability assurance statement.
We were briefed on the Group’s asset care strategy for Group
property assets and manufacturing assets, noting that the
property maintenance capital programme had been revised
and re-prioritised based on asset criticality, condition, reliability
data and lifecycle cost. We were encouraged that quarterly asset
reports for certain sites outside the Americas had been introduced
to provide an overview to local stakeholders of maintenance
provided, costs, safety critical maintenance requirements,
equipment reliability analysis, training needs and improvements
delivered. We also welcomed the introduction of a new leading
indicator to track planned maintenance schedule adherence for
high-consequence safety critical equipment.
Slips, trips and falls remained the highest single cause of reportable
injury and we reviewed the range of activities undertaken to
mitigate this risk, including housekeeping, toolkits to help leaders
engage and reinforce safety awareness, and a dynamic risk
assessment application for use by employees working at customer
locations to assess the safety risk level of their work environment.
DEFENCE AEROSPACE PRODUCT SAFETY
WORKSHOP
In order to provide effective oversight of product safety risk,
the Committee remains conversant with product safety
processes and the Group’s SMS. In September 2017, we focused
our attention on product safety in Defence Aerospace with a
visit to the Group’s facilities in Bristol, UK.
We were briefed by the product safety leadership team on
Defence Aerospace markets, products and operating
environments. We learned about the governance of product
safety through a robust product safety review board structure.
We also discussed the product safety processes within Defence
Aerospace joint ventures and how these interact with the
Group’s own processes under a defined management plan.
We examined specific cases, how these were being handled,
findings, corrective measures taken and the relationship
management maintained with third parties involved. We were
given a detailed briefing on the ‘red top’ and safety alert report
processes, and reviewed current metrics.
We also gained an understanding of the military certification
regulatory regimes and how these differ from the equivalent
civil aerospace processes. This covered how engine
documentation on legacy platforms is registered to maintain
product knowledge and enable continuing support under the
business’ historic engines policy.
We visited the Defence Aerospace operations centre and
saw how incidents in service are handled. We then moved
on to air safety investigations with a visit to the investigations
workshops. We observed how the forensic teams work as
leaders in this field using advanced equipment and techniques
such as electron beam microscopy and 3D scanning.
We visited the maintenance, repair and overhaul facility, where
we were able to gauge a strong and supportive product safety
culture on the shop floor. We also viewed the new test bed
for the TP400 engine that will allow for significantly enhanced
test capability. The day finished with further discussions over
dinner with key members of the Defence Aerospace team.
Overall, the workshop provided a good level of confidence
to the Committee that the SMS, as operated in Defence
Aerospace, was effective, robust and competently operated.
DIRECTORS’ REPORT 108
Directors’ Report
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Rolls-Royce Holdings plc Annual Report 2017
HSE maturity model
HIGH
RELIABILITY
HSE is how we do
business and part
of the Rolls-Royce
strategy and DNA:
— HSE culture and
performance best
in class
PROACTIVE
We actively seek out
HSE issues and
opportunities and
work to resolve them
together:
— Integrated HSE
management system
— Personal and visible
HSE leadership
at all levels
— SMART HSE
objectives
— Robust HSE risk
management
— Continuous
improvement
CALCULATIVE
We have systems to
manage HSE:
— HSE management
system
— Active leadership
— Right capability
— Risk management
process
— Use of leading
and lagging
indicators
— Externally certified
REACTIVE
HSE is only important
when we have an
incident:
— HSE policy and
some control
procedures are
in place
PATHOLOGICAL
HSE is not important:
— Minimal compliance
We reviewed a proposal to revise the Group’s target, set at the end
of 2014, to reduce the amount of waste produced from the Group’s
operations by 25% by 2020, normalised on turnover. Due to
historical data discrepancies and inaccuracies we agreed a
proposal in June 2017 to retain the 25% reduction target but to
extend the time period to achieve this from 2020 to 2025.
In July, we received a briefing on the Group’s aspiration to achieve
significantly higher levels of HSE performance and move Rolls-Royce
to a leading position in HSE across all businesses. We noted the
benchmarking that had been undertaken with a number of large
companies and supported the Group’s adoption of the HSE maturity
model shown above, and the refocused strategy of themes and
enablers to achieve high reliability.
The ELT members conducted a focused session in November
on safety culture, challenging themselves on what more could
be done to promote vigilance and awareness to keep employees
safe. We were briefed on this in December and were encouraged
to see commitment to demonstrating strong and sustained safety
leadership. Work continues on developing structured improvement
plans and defining common leadership themes and communications
plans. The Committee will be keeping the Group’s progress on this
under close review during 2018 and beyond.
Sustainability
Some organisational changes in the first half of the year provided an
opportunity for a fresh look at the Group’s approach to sustainability.
We were briefed in July on some changes to the HSE and
sustainability team structure to enable more strategic and aligned
thinking across broader sustainability themes. In December, the
team returned to present an update on a refreshed sustainability
strategy. We discussed and endorsed a move away from having
a separate, standalone, sustainability strategy with its own vision
and principles, in favour of building on the strong alignment to
the Group’s refreshed vision, its strategic focus areas and business
model. This approach allows the sustainability team to support
the businesses and functions in embedding consideration of
sustainability issues into core business strategies, policies, risk
assessments, decision-making tools and programmes, and in
doing so to identify and exploit opportunities.
The Committee has previously cautioned against the introduction
of too many new safety and ethics initiatives, with attendant risks
of confusion and dilution of key messages. A fresh look has been
taken across these initiatives and many have been rationalised as
part of a simpler approach.
We were briefed during the year on the Group’s response to the
new EU Non-Financial Reporting Regulations, UK gender pay gap
reporting, and consideration of the recommendations of the FSB
Taskforce on Climate-related Financial Disclosures (TCFD), as well
as the publication in early 2018 of the Group’s annual update on
progress against the UK Modern Slavery Act revisions.
Our overall score in the annual Dow Jones Sustainability Index
(DJSI) declined slightly in 2017 versus 2016. Analysis showed this was
largely as a result of the introduction of new question sets, significant
changes to other sections, and receiving a lower score in the codes
of conduct and export control sections as a result of the regulatory
investigations leading to the DPAs in January. We were pleased
to remain within the top 10% overall and to remain listed in both
the DJSI World index (as one of only four aerospace and defence
companies out of 36 invited to participate) and DJSI Europe index.
Particularly encouraging was that we achieved the maximum
possible score for environmental reporting and the industry-leading
scores for human rights and stakeholder engagement. This
contributed to the Company qualifying for inclusion in RobecoSAM’s
2018 Sustainability Yearbook and receiving a Bronze Class distinction
for excellent sustainability performance.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Safety & Ethics Committee Report
109
A new executive-level environment and sustainability committee,
co-chaired by the Chief Operating Officer and Chief Technology
Officer, was formed during the year to provide executive level
oversight of the Group’s response to sustainability issues including
policy, approach and related KPIs.
Overall, the Committee is supportive of the increased focus
and governance on sustainability topics and with the continued
strengthening of the Group’s reporting. This includes the Group’s
updated website at www.rolls-royce.com/sustainability, which has
its contents structured around the core topic areas of environment,
people, ethics, customers and suppliers, and performance.
You can read more about the Group’s sustainability activities
on pages 44 to 49.
Ethics and compliance
Following the DPAs, much of the Committee’s focus in the year has
been on overseeing the Group’s work plans to meet its continuing
obligations to the regulators, and monitoring progress in
implementing the recommendations put forward by Lord Gold in
his reports. Lord Gold himself attended most Committee meetings
during the year and updated the Committee on how he has been
overseeing and supporting this work, as well as reporting on his
particular areas of focus and activities. This included a review of
processes for the granting of commercial concessions to customers,
and attending employee focus groups and other internal events to
understand views from the workforce on ‘speaking up’ and on the
Group’s culture in the area of ethics and compliance.
The Committee has also taken a keen interest in hearing from the
leaders of some of the businesses as to how ethics and compliance
are being embedded into the Group’s culture in practice. We
scheduled two additional Committee meetings, which took place
in April and October, to provide more time for status updates and
discussion of these topics.
We discussed the need for the business leadership to continue
to drive the right behaviours, as well as having the right processes,
so that individuals are accountable for their own actions and feel
able to speak up. To help us understand how this was progressing,
we received separate updates from the president and the chief
compliance officer of the Civil Aerospace business, and from the
chief financial officer and general counsel & head of integrity
at Power Systems. It was noted that the businesses operated
globally across territories that had different levels of maturity
and sophistication regarding ethics and compliance, and this
could present challenging situations for employees such as field
service engineers who work in remote locations. A programme of
compliance verification visits to selected sites had been introduced
to check the effectiveness of training and levels of awareness, so
that any gaps could be promptly addressed. We heard about specific
examples of areas for improvement being identified and addressed
either through additional training or improved communications,
processes or controls. Overall we were assured that the leadership
teams, supported by the central ethics and compliance function,
were setting the ‘tone from the top’, by expressing clearly and
regularly the high standards expected and encouraging
employees to speak up.
At each of our meetings during the year, we received an update
from the General Counsel on the Group’s continuing dialogue and
cooperation with regulators and government agencies. We also
received reports and briefings from the chief compliance counsel
on ethics and compliance matters generally.
In the 2016 Annual Report, we reported on the significant reduction
in the number of advisers used by the Group over recent years, and
the stringent vetting process for any new engagements. We kept
the level and nature of adviser engagements under review in 2017,
and were notified of any claims received during the year from any
advisers who had been terminated in the past. We noted the careful
approach taken with regard to termination of certain Power Systems’
advisers to ensure that customers were not exposed to gaps in
capability for safety-critical work.
We kept the resourcing and capabilities of the compliance team
under review, both centrally and within the businesses. We were
satisfied that the responsibilities of the director of risk, who left the
business during the year, had been assumed either by the general
counsel or the chief compliance counsel through an orderly
transition process. We recognised the need for the compliance
team to remain appropriately balanced between roles in the central
team and within the businesses. We were therefore supportive
of the recruitment of the new director of ethics and compliance
at Power Systems, and the proposed addition of a number of new
roles. We also recommended that likely resourcing requirements
for the compliance function in the longer term be considered.
Another area of interest for the Committee, and for Lord Gold,
during the year was the coordination of training, disciplinary
processes and the employee communications strategy to help
drive the desired culture. We received briefings from the Group
HR Director and members of her team, with input from the chief
compliance counsel, on activity in this area. The Committee
recognised the need to balance the drive to embed accountability
for behaviour with considerations of employees’ legal rights to
privacy, but encouraged the team to explore ways to show the
workforce real examples of consequences for breach of the Global
Code or group policies, or for failure to complete mandatory training.
We examined proposals to refresh the Global Code in 2018. The
current Global Code was first introduced in 2013 and we agreed that
a comprehensive review was therefore timely. The new Global Code
will also be supported by new training modules designed to bring
it to life in a simple, understandable and relevant way, focusing on
behaviours. We look forward to seeing progress on this in 2018.
We were also pleased to see this approach to providing a simplified
and more concise document being applied in the consolidation
of several group policies into one simple manual for employees.
Looking forward
Overall, this has been a year of challenge in all of the areas overseen
by the Committee, that has required us to be constructively critical
and supportive of management’s ambitions and plans.
In 2018, we will continue our focus on ensuring the Group
progresses its ambitions for an improved HSE performance,
continues to evolve product safety processes and meets its
regulatory obligations under the DPAs. More generally, we will
continue to provide support to management on the embedding of
a productive culture encompassing all aspects of safety and ethics.
Sir Frank Chapman
Chairman of the Safety & Ethics Committee
DIRECTORS’ REPORT 110
Directors’ Report
Science & Technology Committee Report
Rolls-Royce Holdings plc Annual Report 2017
Science & Technology Committee Report
Sir Kevin Smith
Chairman of the
Science & Technology
Committee
Key highlights
Technology strategy, investment and programmes review
Electrical systems strategy
Additive layer manufacturing (ALM) strategy
Competitiveness of civil aero engines and
reciprocating engines
Emerging and disruptive technologies
Principal responsibilities
Technology strategy
Review the strategic direction of the Group’s research,
technology and development activities.
Ensure investment is allocated appropriately.
Keep under review the key technology programmes.
Assist the Board in its oversight of major R&D investment
and provide assurance on its competitiveness and the adequacy
of R&D investment.
Cross-sector technology
Oversee the effectiveness of key engineering and technology
processes and operations, including delivery of major product
development and technology programmes.
Technology capabilities and skills
Oversee processes for ensuring effective resourcing and
development of required technological capability and skills.
Virtual tour of Advance3 build shop and UltraFan power
gearbox test facility
Visits to Trent XWB final assembly, a large engine test
bed and the National Composites Centre
Conduct visits to R&D facilities.
Technology trends and risks
Introduction
The Group invests more than £1 billion each year in R&D to conceive,
design and deliver world-class technology that meets our customers’
current and future needs. In a fast-changing world, the Committee
provides dedicated focus, directional input and oversight of the
Group’s scientific and technological strategy, processes and
related investments.
Provide assurance on the identification and management
of key technological risks.
Review and consider any other topics or risks appropriate
to the overall remit of the Committee as delegated by the Board.
Principal risk – disruptive technologies and business models
Oversee one of the Group’s principal risks. This risk was added
in 2016 to reflect the increasing importance of transformative
technologies and new ways of doing business.
Operation of the Committee
Areas of focus for 2018
All members of the Committee are Non-Executive Directors.
Lewis Booth stepped down from the Committee in April 2017 when
he joined the Remuneration Committee. Our biographies are on
pages 67 to 68. The Committee’s responsibilities are outlined in
its terms of reference, available at www.rolls-royce.com, which we
review annually and refer to the Board for approval.
The Committee held four meetings face to face and two via
teleconference during the year.
Committee members
Member
Sir Kevin Smith (chairman)
Lewis Booth
Ruth Cairnie
Brad Singer
Jasmin Staiblin
See page 70 for reasons of non-attendance.
Attended Eligible to attend
6
1
6
6
6
6
1
6
6
5
— Oversight of the Group’s technology programme
— A review of technology partnering strategy
— Update on key programmes including Advance3, UltraFan
and small modular reactors
— Technology for services
— Advanced manufacturing technology and industry digitisation
— A review of electrical and digital skills and capability
development
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Science & Technology Committee Report
111
Science & Technology Committee focus during 2017
Area of focus
Matters considered
Outcome
Technology
strategy
The Group’s technology strategy
Investment allocation
Confirmed that the strategic objectives and associated
investment funding allocations were appropriate.
Review of key technology programmes
Review of competitiveness of civil aero engines
Review of competitiveness of reciprocating engines
Supported the strengthening of the approach to
electrical systems.
Endorsed the creation of the Chief Technology
Officer’s organisation.
Cross-sector
technology
The Group’s electrical systems strategy and
advanced manufacturing strategy
The reviews of competitiveness shaped inputs and
recommendations for the Board strategy discussions
in September and helped confirm the appropriateness
of our technology plans.
Endorsed the initial programme of electrical systems
technology demonstrators and the creation of a
dedicated management structure at Group level.
Had early sight of the Group’s updated advanced
manufacturing strategy, provided comments and
identified areas of follow-up.
Technology
capabilities
and skills
A new focus on electrical systems requires additional
resources, new capabilities and skills and a different
way of thinking
Requested a more detailed electrical system skills
and capability development plan which would be
reviewed in 2018.
Visits to Trent XWB final assembly/test bed and
the National Composites Centre
Live virtual tours of Advance3 and UltraFan power
gearbox rig
Visits were insightful, provided physical evidence of
progress on key technology programmes and provided
an invaluable opportunity to meet the teams.
Technology trends
and risks
Disruptive potential from various sources including
digital technologies, novel materials and manufacturing
Opportunities and threats in electrical systems
We are satisfied that the Group has robust processes
in place to identify disruptive threats and opportunities
and develop appropriate actions.
Oversight of
principal risk
The principal risk of disruptive technologies and
business models was reviewed twice during the year
We are confident that we are receiving enough
detail around this principal risk and on the ways the
risk is being kept under review by the Group.
DIRECTORS’ REPORT 112
Directors’ Report
Science & Technology Committee Report
Rolls-Royce Holdings plc Annual Report 2017
2017 overview
The Committee’s main focus for 2017 was on our technology
strategy and on aligning this to the Group’s strategic reviews,
the allocation of technology funding and our competitiveness
in key technology and product areas. At the beginning of the year,
we reviewed the programme of work to deliver in 2017 and the
investment funding allocation and received an update on the
progress made on technology plans for each business.
Of note was a significant increase in spend in our aerospace
businesses as activity on our technology demonstrator programmes
ramps up. Although there were resource constraints, the overall
programme was considered reasonable.
We gave our support to management in seeking to take a new
approach to strategic planning for technology. In the past,
investment has been allocated principally by matching resource
bids from the businesses to our product strategies. At the beginning
of the year, it had been decided by management that a stronger
Group-driven approach should be developed to allocate investment
across different types of technology programmes which provided
synergy and opportunity across the Group. This will achieve a better
balance of product-specific technologies with broader sector
opportunity. Each Committee member gave time to management
individually and provided input to help shape the approach and
align it to the Group’s strategy.
We received a briefing on the Group’s activities in additive layer
manufacturing (ALM), its development, supply chain and reasons
for its importance.
ADVANCE3
We noted that the use of ALM globally has been rising at a
35% compound annual growth rate. The Group is exploring
a number of partnership and supply chain strategies to accelerate
its development. The Group’s technology focus in ALM is on
specialised materials, such as high temperature alloys and parts
with high value and high manufacturing complexity. The Committee
benefited significantly from a visit to the ALM research facility
in 2016 and will keep the delivery of the Group’s strategy for
ALM under review.
Throughout the year, the Committee discussed technology
competitiveness and carried out a specific review on the Civil
Aerospace business and the market for large engines. We looked
at: the business’ product and technology strategies and product
evolution path; the relative position on key technologies versus
competitors; the fundamental capability drivers and enabling
technologies; and an analysis of our R&D/R&T spend compared to
competitors. A similar session was held with the Power Systems team
to discuss competitiveness of our reciprocating engine technology.
We also reviewed the Group’s emerging electrical systems strategy.
There is a growing demand for electrical capability across all our
platforms hence this is an important area of focus to ensure the
Group positions itself competitively for the future. We heard about
potential future applications of hybrid electrical configurations
for aircraft in the aerospace businesses and how electrical systems
technology was rapidly increasing in the markets addressed by
our Marine and Power Systems businesses.
In May, we viewed a live virtual tour of the Advance3 where we
were shown some of the expert work on how the demonstrator
engine was being assembled and the high degree of
instrumentation required in preparation for the initial engine test.
The Advance3 reflects a new engine core architecture (the
high pressure system and the intermediate pressure system
differ from the Trent engine family) and includes new
technology such as a radically revised fuel system.
The Committee was updated on each of the businesses’ electrical
systems demonstrator programmes which vary significantly in
complexity and pace. This highlighted implications in terms of skills,
the requirement for a resourcing strategy, as well as a shift in
thinking for senior leadership.
Rolls-Royce has a solid platform of electrical activities on which
to build, covering rail (hybrid trains), power generation (including
micro-grids), marine (hybrid and full electric ships) and applications
in aerospace. We also noted the strong opportunity for
cross-company synergies in electrical systems.
In May, as part of the review of competitiveness of civil aero engines,
we visited our site in Derby, UK, where we received a tour of the
Trent XWB final assembly and test facility, the large aero engine
development test facility and test preparation area.
Rolls-Royce Holdings plc Annual Report 2017
Directors’ Report
Science & Technology Committee Report
113
We also received a virtual tour of the UltraFan power gearbox rig
via videolink from Dahlewitz, Germany. This facility is the largest
of its kind in the world and is critical to supporting changes to
engine architecture and component technologies to form the core
of the next generation of more efficient Rolls-Royce aero engines.
The rig simulates real in-service pitch and roll conditions by tilting
the gearbox to place it under different torque and load, which
enables analysis of oil flows for heat management. The rig is now
fully functional and provides the Group with a very powerful
capability for the future.
In September, the Board visited our site in Bristol, UK and also
had the opportunity to visit the National Composites Centre (NCC).
The NCC was established by the University of Bristol, in collaboration
with sponsors including Rolls-Royce, and its key objective is to
enable UK design and manufacturing enterprises to deliver winning
solutions in the application of composites. The visit provided
valuable background to our understanding of the technology
development route for the UltraFan composite fan system.
In December 2016, the Committee was allocated responsibility
for overseeing management of the Group’s new principal risk of
disruptive technologies and business models. This was brought
to the Committee twice for discussion in 2017. We were updated
on the key processes the Company has developed to keep the risk
under review, including five advisory boards with external subject
matter experts that report to and support the ELT.
Looking forward
In my view, the Science & Technology Committee is the most
exciting and uplifting of the Board committees and I feel privileged
to chair it. Our subject matter is the life blood of the Group vested
in some extremely talented people. I am grateful to all of them for
the support they have given during the year.
I have been pleased with our progress this year as the Group has
carried out a detailed review of its technology strategy.
In 2018, we will continue to focus on supporting management and
the Board in further deploying this strategy with a particular focus
on technology skills and capability development and building
partnerships to accelerate progress.
Sir Kevin Smith
Chairman of the Science & Technology Committee
Deborah Harris, STEM Ambassador and Rolls-Royce
engineering graduate, hosted the 2017 Science Prize
award event at the London Science Museum
ROLLS-ROYCE SCIENCE PRIZE
The science prize initiative was launched in 2004 as part
of the Group’s continuing commitment to science education.
It is designed to foster, recognise and reward outstanding
work in science and maths teaching. It promotes innovative
and sustainable strategies for teaching and contributes to
continuous professional development by providing science
and maths teachers with the support they need to implement
big ideas. Since the launch of the programme, over 20,000
applications have been received and £1.5 million has been
given out in prize money to over 600 schools across the UK.
DIRECTORS’ REPORT 114
Directors’ Report
Responsibility Statements
Rolls-Royce Holdings plc Annual Report 2017
Responsibility Statements
Statement of Directors’ responsibilities in respect
of the Annual Report and the Financial Statements
The Directors, as detailed on pages 66 to 68, 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, including
FRS 101 Reduced Disclosure Framework, 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, relevant,
reliable and prudent;
— for the Group Financial Statements, state whether they have
been prepared in accordance with IFRS as adopted by the EU;
— for the parent company Financial Statements, state whether
applicable UK Accounting Standards have been followed, subject
to any material departures disclosed and explained in the parent
company Financial Statements;
— assess the Group and parent Company’s ability to continue
as a going concern, disclosing, as applicable, matters related
to going concern; and
— use the going concern basis of accounting unless they either
intend to liquidate the Group or the parent Company or to cease
operations, or have no realistic alternative but to do so.
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 are responsible for such internal control as they
determine is necessary to enable the preparation of Financial
Statements that are free from material misstatement, whether due
to fraud or error and have general responsibility for taking such
steps as are reasonably open to them to safeguard the assets of
the Group and to prevent and detect fraud and other irregularities.
Under applicable law and regulations, the Directors are also
responsible for preparing a Strategic Report, 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
Guidance 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 that:
— each of the Group and parent company Financial Statements,
prepared in accordance with IFRS as adopted by the EU 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;
— the Strategic Report on pages 1 to 63 and Directors’ Report
on pages 64 to 114 and pages 198 to 201 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
— the Annual Report, taken as a whole, is fair, balanced and
understandable and provides the information necessary for
shareholders to assess the Group’s position and performance,
business model and strategy.
By order of the Board
Pamela Coles
Company Secretary
6 March 2018
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
115
Financial Statements
Consolidated Financial Statements
Company Financial Statements
Company Balance Sheet
Company Statement
of Changes in Equity
Investments – subsidiary undertakings
Notes to the Company
Financial Statements
1 Accounting policies
2
3 Financial liabilities
4 Share capital
5 Contingent liabilities
6 Other information
Subsidiaries
Joint Ventures and Associates
172
172
173
173
173
174
174
174
175
181
Consolidated Income Statement
Consolidated Statement
of Comprehensive Income
Consolidated Balance Sheet
Consolidated Cash Flow Statement
Consolidated Statement
of Changes in Equity
Research and development
Notes to the Consolidated
Financial Statements
1 Accounting policies
2 Segmental analysis
3
4 Net financing
5 Taxation
6 Earnings per ordinary share
7 Employee information
8 Auditors’ remuneration
Intangible assets
9
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
26 Derivation of summary funds
flow statement
27 Impact of IFRS 15
116
117
118
119
121
122
132
137
137
138
140
141
141
142
144
145
147
147
148
148
148
149
158
159
163
164
165
166
166
167
168
170
FINANCIAL STATEMENTS
116
Financial Statements
Consolidated Income Statement
Rolls-Royce Holdings plc Annual Report 2017
Consolidated Income Statement
For the year ended 31 December 2017
Revenue
Cost of sales
Gross profit
Commercial and administrative costs 1
Research and development costs
Share of results of joint ventures and associates
Operating profit *
Gains arising on the acquisition of ITP Aero
Loss on disposal of business
Profit before financing and taxation
Financing income
Financing costs
Net financing
Profit/(loss) before taxation
Taxation
Profit/(loss) for the year
Attributable to:
Ordinary shareholders
Non-controlling interests
Profit/(loss) for the year
Earnings per ordinary share attributable to ordinary shareholders:
Basic
Diluted
Payments to ordinary shareholders in respect of the year:
Per share
Total
* Underlying operating profit
Notes
2
3
11
25
2
4
4
5
6
17
2
2017
£m
16,307
(13,134)
3,173
(1,222)
(795)
131
1,287
798
–
2,085
2,973
(161)
2,812
4,897
(689)
4,208
2016
£m
14,955
(11,907)
3,048
(2,203)
(918)
117
44
–
(3)
41
96
(4,773)
(4,677)
(4,636)
604
(4,032)
4,207
1
4,208
(4,032)
–
(4,032)
229.40p
228.64p
(220.08)p
(220.08)p
11.7p
216
1,175
11.7p
215
915
1
In 2016, ‘commercial and administrative costs’ include £671m for financial penalties from agreements with investigating bodies (see note 23) and £306m for the restructuring of the UK
pension schemes (see note 19).
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Consolidated Statement of Comprehensive Income
117
Consolidated Statement
of Comprehensive Income
For the year ended 31 December 2017
Profit/(loss) for the year
Other comprehensive income (OCI)
Movements in post-retirement schemes
Share of OCI of joint ventures and associates
Related tax movements
Items that will not be reclassified to profit or loss
Foreign exchange translation differences on foreign operations
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
2017
£m
4,208
2016
£m
(4,032)
19
11
5
11
5
735
(1)
(307)
427
(142)
(5)
1
(146)
495
(2)
(179)
314
861
(7)
4
858
4,489
(2,860)
4,488
1
4,489
(2,860)
–
(2,860)
FINANCIAL STATEMENTS 118
Financial Statements
Consolidated Balance Sheet
Rolls-Royce Holdings plc Annual Report 2017
Consolidated Balance Sheet
At 31 December 2017
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
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
2017
£m
2016
£m
9
10
11
11
17
5
19
12
13
17
14
15
17
16
18
15
17
16
5
18
19
20
7,063
4,624
688
26
610
271
2,125
15,407
3,660
7,919
17
36
3
2,953
7
14,595
30,002
(82)
(581)
(9,527)
(209)
(526)
(10,925)
(3,406)
(2,435)
(4,178)
(1,144)
(357)
(1,387)
(12,907)
(23,832)
5,080
4,114
844
38
382
876
1,346
12,680
3,086
6,956
32
5
3
2,771
5
12,858
25,538
(172)
(651)
(7,957)
(211)
(543)
(9,534)
(3,185)
(5,129)
(3,459)
(776)
(216)
(1,375)
(14,140)
(23,674)
6,170
1,864
368
195
162
(112)
673
4,881
6,167
3
6,170
367
181
162
(107)
814
445
1,862
2
1,864
The Consolidated Financial Statements on pages 116 to 171 were approved by the Board on 6 March 2018 and signed on its behalf by:
Warren East
Chief Executive
Stephen Daintith
Chief Financial Officer
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Consolidated Cash Flow Statement
119
Consolidated Cash Flow Statement
For the year ended 31 December 2017
Operating profit
Loss on disposal of property, plant and equipment
Share of results of joint ventures and associates
Dividends received from joint ventures and associates
Amortisation and impairment of intangible assets
Depreciation and impairment of property, plant and equipment
Impairment of investments
Increase in provisions
Increase in inventories
(Increase)/decrease in trade and other receivables
(Decrease)/increase in amounts payable for financial penalties from agreements with investigating bodies
Other 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 business
Consolidation of previously unconsolidated subsidiary
Disposals of other businesses
Increase in share in joint ventures
Other investments in joint ventures and associates
Cash and cash equivalents of joint ventures reclassified as joint operations
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
Increase in short-term investments
Issue of ordinary shares (net of expenses)
Purchase of ordinary shares – other
Redemption of C Shares
Net cash 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
Notes
11
9
10
11
19
19
21
11
9
9
25
11
11
2017
£m
1,287
11
(131)
79
430
450
14
58
(235)
(462)
(286)
1,411
(661)
240
(249)
34
1,990
(180)
1,810
(4)
(973)
7
(773)
14
4
263
1
–
–
(48)
–
(1,509)
(160)
366
(6)
200
14
(64)
(3)
–
21
(24)
(214)
(70)
231
2,771
(69)
2,933
2016
£m
44
5
(117)
74
628
426
–
44
(161)
54
671
234
(608)
510
(271)
35
1,568
(157)
1,411
–
(631)
8
(585)
15
8
(6)
–
7
(154)
(30)
5
(1,363)
(434)
93
(4)
(345)
14
(84)
(2)
(1)
1
(21)
(301)
(739)
(691)
3,176
286
2,771
FINANCIAL STATEMENTS 120
Financial Statements
Consolidated Cash Flow Statement
Rolls-Royce Holdings plc Annual Report 2017
Consolidated Cash Flow Statement continued
For the year ended 31 December 2017
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 increase in short-term investments
Change in net funds resulting from cash flows
Net funds (excluding cash and cash equivalents) on acquisition of ITP Aero
Net funds (excluding cash and cash equivalents) of previously unconsolidated subsidiary
Net funds (excluding cash and cash equivalents) of joint ventures reclassified as joint operations
Exchange (losses)/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
The movement in net funds (defined by the Group as including the items shown below) is as follows:
2017
£m
231
(200)
–
31
(34)
(18)
–
(59)
131
51
(583)
(532)
227
(305)
2016
£m
(691)
345
1
(345)
–
–
(9)
240
(345)
(459)
(124)
(583)
358
(225)
At
1 January
2017
£m
872
552
1,347
–
2,771
3
(169)
(3,121)
(67)
(3,357)
Funds
flow
£m
(5)
44
212
(20)
231
–
159
(280)
(79)
(200)
Net funds on
acquisition of
business
£m
–
–
–
–
–
–
(6)
(28)
–
(34)
Net funds on
consolidation of
previously
unconsolidated
subsidiary
£m
–
–
–
–
–
–
(18)
–
–
(18)
Exchange
differences
£m
(29)
(7)
(33)
–
(69)
–
3
(2)
9
10
Fair value
adjustments
£m
–
–
–
–
–
–
–
131
–
131
Reclassifications
£m
–
–
–
–
–
–
(8)
8
–
–
At
31 December
2017
£m
838
589
1,526
(20)
2,933
3
(39)
(3,292)
(137)
(3,468)
(583)
31
(34)
(18)
(59)
358
(225)
31
(34)
(18)
(59)
131
(131)
–
–
–
(532)
227
(305)
Cash at bank and in hand
Money-market funds
Short-term deposits
Overdrafts
Cash and cash equivalents
Short-term investments
Other current borrowings
Non-current borrowings
Finance leases
Financial liabilities
Net funds excluding fair
value swaps
Fair value of swaps hedging
fixed rate borrowings
Net funds
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Consolidated Statement of Changes in Equity
121
Consolidated Statement of Changes in Equity
For the year ended 31 December 2017
At 1 January 2016
Loss for the year
Foreign exchange translation differences
on foreign operations
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 4
Redemption of C Shares
Ordinary shares purchased
Share-based payments – direct to equity 5
Related tax movements
Other changes in equity in the year
At 1 January 2017
Profit for the year
Foreign exchange translation differences
on foreign operations
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 4
Redemption of C Shares
Ordinary shares purchased
Share-based payments – direct to equity 5
Related tax movements
Other changes in equity in the year
At 31 December 2017
Attributable to ordinary shareholders
Notes
Share
capital
£m
367
–
Share
premium
£m
180
–
Capital
redemption
reserve
£m
161
–
Cash flow
hedging
reserve 1
£m
(100)
–
Other
reserves 2
Retained
earnings 3
£m
(51)
–
£m
4,457
(4,032)
Total
£m
5,014
(4,032)
Non-
controlling
interests
(NCI)
£m
2
–
19
11
5
17
17
5
19
11
5
17
17
5
–
–
–
–
–
–
–
–
–
–
–
–
367
–
–
–
–
–
–
1
–
–
–
–
–
1
368
–
–
–
–
–
1
–
–
–
–
–
1
181
–
–
–
–
–
–
14
–
–
–
–
–
14
195
–
–
–
–
–
–
(301)
302
–
–
–
1
162
–
–
–
–
–
–
–
(215)
215
–
–
–
–
162
–
–
(7)
–
(7)
–
–
–
–
–
–
–
(107)
–
–
–
(5)
–
(5)
–
–
–
–
–
–
–
(112)
861
–
–
4
865
–
–
–
–
–
–
–
814
–
(142)
–
–
1
(141)
–
–
–
–
–
–
–
673
–
495
861
495
(2)
(179)
(3,718)
–
1
(302)
(21)
30
(2)
(294)
445
4,207
(9)
(175)
(2,860)
1
(300)
–
(21)
30
(2)
(292)
1,862
4,207
–
735
(142)
735
(1)
(307)
4,634
(14)
1
(215)
(24)
51
3
(198)
4,881
(6)
(306)
4,488
1
(214)
–
(24)
51
3
(183)
6,167
–
–
–
–
–
–
–
–
–
–
–
–
2
1
–
–
–
–
1
–
–
–
–
–
–
–
3
Total
equity
£m
5,016
(4,032)
861
495
(9)
(175)
(2,860)
1
(300)
–
(21)
30
(2)
(292)
1,864
4,208
(142)
735
(6)
(306)
4,489
1
(214)
–
(24)
51
3
(183)
6,170
1 See accounting policies note 1.
2 Other reserves include a merger reserve of £3m (2016: £3m, 2015: £3m) and a translation reserve of £670m (2016: £811m, 2015: £(54)m).
3 At 31 December 2017, 6,466,153 ordinary shares with a net book value of £52m (2016: 6,854,216, 2015: 5,894,064 ordinary shares with net book values of £56m and £52m respectively)
were held for the purpose of share-based payment plans and included in retained earnings. During the year, 4,992,304 ordinary shares with a net book value of £42m (2016: 1,955,390
shares with a net book value of £17m) vested in share-based payment plans. During the year, the Company acquired 92,537 (2016: 165,542) of its ordinary shares via reinvestment of
dividends received on its own shares and purchased 2,711,349 (2016: 2,750,000) of its ordinary shares through purchases on the London Stock Exchange. During the year, the
Company issued 1,740,355 new ordinary shares (2016: nil) to the Group’s share trust for its employee share-based payment plans with a net book value of £14m (2016: nil).
4 In Rolls-Royce Holdings plc’s own Financial Statements, C Shares are issued from the merger reserve. As this reserve is eliminated on consolidation, in the Consolidated Financial
Statements, the C Shares are shown as being issued from the capital redemption reserve.
5 Share-based payments – direct to equity is the share based payment charge for the year less the actual cost of vesting and cash received on share based schemes vesting.
FINANCIAL STATEMENTS 122
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
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 2017 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 2017 (Adopted IFRS).
The Company has elected to prepare its individual Company Financial Statements under FRS 101 Reduced Disclosure Framework.
They are set out on pages 172 to 174 and the accounting policies in respect of Company Financial Statements are set out on page 173.
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 63.
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 revenue 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 revenue 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 actual 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 (CAR).
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
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 measurable. An equal amount of revenue is recognised at the same point. Where a
long-term aftermarket contract is linked to the OE contract (see page 123), the contractual price of the engine (including amounts
allocated from the aftermarket contract) is above its cost of manufacture; consequently no CAR is recognised.
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 Civil Aerospace. Under these contracts, the Group’s primary obligation is to maintain customers’ equipment in an operational condition
and it achieves this by undertaking various activities, such as engine monitoring, line maintenance and repair and overhaul, over the
Rolls-Royce Holdings plc Annual Report 2017
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123
1 Accounting policies continued
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. Consistent with the above, the Directors also consider that, in
general, all costs incurred to meet the primary obligation should be included in the accounting for these contracts, even if these costs had
not been originally anticipated. This includes the additional costs being incurred to address the Trent 1000 and Trent 900 in-service
issues. (In contrast, provision is made when additional costs on non long-term contract arrangements are identified.)
Linkage of OE and long-term aftermarket contracts
Where the key terms of a long-term aftermarket contract are substantively agreed (e.g. 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 (e.g. where it is with an OE manufacturer or a lessor)
the contracts are not linked as they were not negotiated on a unified basis.
Sales of spare engines to joint ventures
Whether the sales price reflects fair value when the Group sells spare engines to a joint venture company.
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 revenue as a ‘life of type’ supplier (i.e. as long as
the engine remains in service). The share of development costs borne by the workshare partner and of the revenue 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 consider 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.
The resulting accounting policy (described on page 126) 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 revenue (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.
FINANCIAL STATEMENTS 124
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
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 1
2017
2016
Reported
profit before tax
£m
4,897
23
4,920
Underlying profit
before tax
£m
1,071
23
1,094
Net assets
£m
6,170
(423)
5,747
Reported
profit before tax
£m
(4,636)
(2)
(4,638)
Underlying profit
before tax
£m
813
(2)
811
Net assets
£m
1,864
(442)
1,422
1
If the alternative policy were adopted, the difference would be included in operating profit, which would change from £1,287m as reported to £1,310m (2016: £44m to £42m).
As part of our assessment of accounting policies under IFRS 15 (see page 131), we have concluded that the way we account for the entry
fees received from RRSAs should be aligned with how we account for participation fees we pay to airframers (which will change on
adoption of IFRS 15). This will result in an accounting policy similar to the alternative view set out above.
Internally-generated development costs
IAS 38 requires that internally generated development costs should only be capitalised if strict criteria are met, in particular relating to
technical feasibility and generation of future economic benefits. The Group incurs significant research and development expenditure
in respect of various development programmes, most notably in Civil Aerospace. Determining when capitalisation should commence and
cease is a critical judgement as is the determination of when subsequent expenditure on the programme assets should be capitalised.
Within the Group there is an established Product Introduction and Lifecycle Management process (‘PILM’) process in place. This is
a gated process which assesses both the technical feasibility and commercial viability of programmes. A multi-functional team is involved
in the assessment ensuring the technical and operational aspects of the programme have been assessed together with the financial
assessment. Until the programme has obtained sign off on the criteria set out under ‘Research and development costs’ on page 128,
all expenditure is expensed as incurred.
Subsequent expenditure which enhances the performance of the engine and the economic benefits to the Group is capitalised. This
expenditure is referred to as enhanced performance and is governed by the PILM process referred to above. Expenditure on sustaining
engineering is expensed as incurred.
Following a review of progress on Civil Aerospace programmes during 2017, the point at which the relevant criteria are met has been
moved one gate earlier than in the past. This has resulted in an additional £83m of development costs being capitalised than otherwise
would have been.
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 (carrying value at 31 December 2017: £1,545m, 31 December 2016: £1,537m), arising on the
consolidation of acquired businesses, is impaired is dependent on the present value of the future cash flows expected to be generated
by the business. Sensitivities to impairment risk on Marine goodwill are shown in note 9.
– 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 2017: £4,687m,
31 December 2016: £2,846m) 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 revenue 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 (including the in-service fleet issues) and the costs to be incurred; lifecycle cost improvements over the
Rolls-Royce Holdings plc Annual Report 2017
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125
1 Accounting policies continued
term of the contracts and escalation of revenue and costs. The estimates take account of the inherent uncertainties and the risk of
non-recovery of any resulting contract balances. In addition, many of the revenues and costs are denominated in currencies other than
that of the relevant Group undertaking.
These are translated at an estimated long-term exchange rate, based on historical trends. In 2016, the US dollar long-term exchange
rate was reduced by five cents, resulting in a one-off benefit to profit before tax of £35m.
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 surplus of £738m before
deferred taxation being recognised on the balance sheet at 31 December 2017 (31 December 2016: net deficit £29m). 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 and sensitivities are included in note 19.
Provisions
As described in the accounting policy on page 129, the Group measures provisions (carrying value at 31 December 2017: £883m,
31 December 2016: £759m) 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.
Tax provisions require management to make judgements and estimates of exposures in relation to tax audit issues and other areas of
uncertainty. Contingent liabilities in respect of any tax disputes or litigation, are covered in note 23. All provisions are in current liabilities.
Deferred tax assets are recognised to the extent it is probable that future taxable profits will be available, against which the deductible
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 196.
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. As set out in note 25, ITP Aero was acquired on 19 December 2017. It has been assumed that ITP Aero did not have any
significant trading activity between the acquisition date and 31 December 2017.
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 undertaking, joint arrangement or associate 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.
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.
FINANCIAL STATEMENTS 126
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
1 Accounting policies continued
Revenue recognition
Revenue comprises sales to outside customers after discounts, excluding value added taxes.
Sales of products (both OE 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 122, 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.
Sales of services are recognised by reference to the stage of completion based on services performed to date. As described on page 122,
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 123, 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 revenue 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 revenue, 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 revenue 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. Again, changes in this allowance are recognised
in the period.
Risk and revenue sharing arrangements
As described on page 123, 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 revenue. 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 revenue for their production components are charged to cost of sales
as programme revenue 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.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
127
1 Accounting policies continued
Government grants
Government grants are recognised in the income statement so as to match them with the related expenses that they are intended to
compensate. Where grants are received in advance of the related expenses, they are included in the balance sheet as deferred income.
Non-monetary grants are recognised at fair value.
Interest
Interest receivable/payable is credited/charged to the income statement using the effective interest method. Where borrowing costs are
attributable to the acquisition, construction or production of a qualifying asset, such costs are capitalised as part of the specific asset.
Taxation
The tax charge/credit on the profit or loss for the year comprises current and deferred tax:
– 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, and C Shares are classified as other liabilities.
– Derivatives, comprising foreign exchange, interest rate and commodity contracts 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.
FINANCIAL STATEMENTS 128
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
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. 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 on a straight-line basis, up to
a maximum of 15 years from the entry into service of the product.
Research and development
In accordance with IAS 38, 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 (which predominantly
relates to Civil Aerospace engine programmes) is capitalised as an internally generated intangible asset (programme asset) only if it meets
strict criteria, relating in particular to technical feasibility and generation of future economic benefits.
More specifically, development costs are capitalised from the point at which the following conditions have been met:
– the technical feasibility of completing the programme and the intention and ability (availability of technical, financial and other
resources) to complete the programme asset and use or sell it;
– the probability that future economic benefits will flow from the programme asset; and
– the ability to measure reliably the expenditure attributable to the programme asset during its development.
Capitalisation continues until the point at which the programme asset meets its originally contracted technical specification (defined
internally as the point at which the asset is capable of operating in the manner intended by management).
Subsequent expenditure is capitalised where it enhances the functionality of the programme asset and demonstrably generates an
enhanced economic benefit to the Group. All other subsequent expenditure on programme assets is expensed as incurred.
Development expenditure capitalised is amortised on a straight-line basis up to a maximum of 15 years from the entry into service of the
programme asset. In accordance with IAS 38, we assess the basis on which we amortise programme assets annually. At the end of 2017,
we confirmed that we will commence amortisation of programme assets on a 15 year straight-line basis pro rata over the estimated number
of units produced. We will apply this approach prospectively from 1 January 2018.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
129
1 Accounting policies continued
Contractual aftermarket rights
As described under key judgements on page 122, 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.
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 on a straight-line basis 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:
– Land and buildings, as advised by the Group’s professional advisers:
– freehold buildings – five to 45 years (average 26 years);
– leasehold buildings – lower of adviser’s estimates or period of lease; and
– no depreciation is provided on freehold land.
– Plant and equipment – five to 25 years (average 12 years).
– Aircraft and engines – five to 20 years (average 13 years).
Where the Group obtains effective control of customers’ installed engines as a result of a TotalCare Flex arrangement, the fair value
of these engines is recognised as an addition (shown separately in note 10). The corresponding liability is recognised either as deferred
revenue or a financial liability depending on the precise nature of the arrangement.
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 is 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. 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.
FINANCIAL STATEMENTS 130
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
1 Accounting policies continued
Post-retirement benefits
Pensions and similar benefits (principally healthcare) are accounted for under IAS 19.
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 and settlements 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.
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.
Customer 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 158, 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 2017
There were no changes to accounting standards that had a material impact on the 2017 Consolidated Financial Statements.
Revisions to IFRS not applicable in 2017
Standards and interpretations issued by the IASB are only applicable if endorsed by the EU.
IFRS 9 Financial Instruments
IFRS 9 (effective for the year beginning 1 January 2018) relates to the accounting for financial instruments and covers: classification and
measurement; impairment; and hedge accounting. Except for hedge accounting, retrospective application is required with any adjustment
being made to reserves on 1 January 2018. The Group is not required to restate 2017 comparative information and is analysing the impact
of adoption on its Financial Statements. This is not expected to be material.
– The Group can sell its trade receivables from certain customers before their due date. The trade receivables of these customers that
are not sold will be classified and disclosed as fair value through other comprehensive income from 2018. This will not have a significant
impact on the income statement.
– The Group will adopt the simplified approach to provide for losses on receivables and contract assets resulting from transactions within
the scope of IFRS 15. The Group has performed a preliminary assessment of the adoption of the standard on the basis of average default
risk of customers and will continue to analyse the impact during 2018. We do not anticipate that this will have a significant impact on the
income statement.
– The Group has determined that all existing effective hedging relationship will continue to qualify for hedge accounting under IFRS 9.
We will continue not to hedge account for forecast foreign exchange transactions. This will not have an impact on the Financial Statements.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
131
1 Accounting policies continued
IFRS 15 Revenue from Contracts with Customers
IFRS 15 provides a single, principles based five-step model to be applied to all sales contracts. It is based on the transfer of control of
goods and services to customers and replaces the separate models for goods, services and construction contracts currently included
in IAS 11 Construction Contracts and IAS 18 Revenue. There are three broad implications:
– linked accounting will cease to exist so all OE sales will be treated on the same basis;
– OE engine cash deficits will no longer be capitalised and recorded as contractual aftermarket rights, they will instead be recognised on
delivery; and
– revenue and profits for aftermarket services will be recognised on an activity basis as costs are incurred.
The Group will adopt IFRS 15 on 1 January 2018 using the ‘full’ retrospective approach. The Group has undertaken significant analysis
on the impact of IFRS 15 and the most significant accounting judgements, estimates and policies are set out below. Work will continue
during 2018 to review and refine policies and procedures required to implement IFRS 15. As a result it is possible that there may be some
changes to the impact reported.
Key areas of judgement:
Determining the timing of satisfaction of performance obligations:
– Where the performance obligation is the supply of goods (principally OE and spare parts) which is satisfied at the point in time that
those goods are transferred to the customer, the Group will recognise revenue at that point in time.
– The Group generates a significant proportion of its revenue and profit from aftermarket arrangements arising from the use of the
installed OE. These aftermarket contracts, such as TotalCare and CorporateCare agreements in Civil Aerospace, cover a range of
services and generally have contractual terms covering more than one year. Under these contracts, the Group’s primary obligation
is to maintain customers’ equipment in an operational condition and this is achieved by undertaking various activities, such as repair,
overhaul and engine monitoring over the period of the contract. Revenue on these contracts is recognised over the period of the
contract and the measure of performance is a matter of judgement. In general, the Directors consider that the stage of performance of
the contract is best measured by using the actual costs incurred to date compared to the estimated costs to complete the performance
obligations.
– The assessment of stage of completion is generally measured for each contract. However, in certain cases, such as for CorporateCare
agreements where there are many contracts covering aftermarket services, each for a small number of engines, the Group will apply
the practical expedient offered by IFRS 15 to account for a portfolio of contracts together as it expects that the effects on the Financial
Statements would not differ materially from applying the standard to the individual contracts in the portfolio.
The Group has paid participation fees to airframe manufacturers, its customers for OE on certain programmes. Amounts paid are initially
treated as contract assets and subsequently charged as a reduction to the OE revenue when it is transferred to the customer. The number
of units over which the asset will be charged is a matter of judgement as the orders will grow over the course of the programme.
In assessing the accounting for the participation fee payments we make to our OE customers, we have also assessed the accounting for
up-front payments we sometimes receive from the Group’s suppliers under RRSAs to allow them to participate in an engine programme.
We have concluded that, consistent with changes to how we will account for participation fees noted above, these receipts should be
deferred and recognised against cost of sales over the period of supply. This will also require judgement as to the number of units over
which the receipts will be allocated.
The Group has elected to use the practical expedient to expense as incurred any incremental costs of obtaining or fulfilling a contract
if the amortisation period of an asset created would have been one year or less.
Key sources of estimation uncertainty:
Assessment of long-term contractual arrangements.
– The estimated revenue and costs under such agreements are inherently imprecise and significant estimates are required to take into
account uncertainties relating to: (i) the forecast utilisation of the engines by the operator and related pricing; (ii) the frequency of
engine overhauls where the principal variables are the operating parameters of the engine and operational lives of components; and (iii)
the forecast costs to maintain the engines in accordance with the contractual requirements where the cost of each overhaul is
dependent on the required work-scope and the cost of parts and labour at the time.
– An allowance is made against the risk of non-recovery of resulting contract balances from reduced utilisation e.g. engine flying hours,
based on historical forecasting experience, the risk of aircraft being parked by the customer and the customer’s creditworthiness.
– A significant amount of revenue and cost is denominated in currencies other than that of the relevant Group undertaking. These are
translated at estimated long-term exchange rates.
Significant accounting policies:
Revenue recognition comprises sales to outside customers after discounts and amounts payable to customers and excludes value added
taxes. The Group has elected to use the practical expedient not to adjust revenue for the effect of financing components where the
expectation is that the period between the transfer of goods and services to customers and the receipt of payment is less than a year.
Sales of services are recognised by reference to the progress towards complete satisfaction of the performance obligation provided the
outcome of contracts can be assessed with reasonable certainty. Full provision is made for any estimated losses to completion of contracts,
having regard to the overall substance of the arrangements.
FINANCIAL STATEMENTS 132
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
1 Accounting policies continued
TotalCare and similar long-term aftermarket service arrangements are accounted for on a stage of completion basis. A contract liability
will be created where payment is received ahead of the costs incurred to meet performance obligations. In making the assessment of
future revenue, costs and the level of profit recognised, the Group takes account of the inherent uncertainties and the risk of non-
recovery of any resulting contract balances. To the extent that actual revenue and costs differ from forecast or that forecasts change, the
cumulative impact is recognised in the period. When accounting for a portfolio of long-term service arrangements, such as CorporateCare
agreements, the Group uses estimates and assumptions that reflect the size and composition of the portfolio. The new standard has no
impact on the timing of the reported cash flows.
The comparative 2017 results to be included in the 2018 Financial Statements will be restated. Certain tables from note 2, have been prepared
on the IFRS 15 basis set out above and are shown in note 27. Overall, the adoption of IFRS 15 is expected to result in a reduction in 2017
underlying revenue and operating profit of £1,408m and £854m respectively and a reduction of net assets of £5.2bn at 31 December 2017.
IFRS 16 Leases
IFRS 16 (effective for the year beginning 1 January 2019) 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.
The Group is progressing well in its analysis of how IFRS 16 should be implemented and is developing the data-set, systems and processes
that will be required. The most significant leases, by value, relate to property and aircraft engines. The Group expects to apply the
standard retrospectively with the cumulative effect of initial application recognised on 1 January 2019. Under this approach the Group will
not restate comparative periods.
In broad terms the impact of the standard will be to:
– recognise an additional lease liability equivalent to the present value of the lease commitments at the date of transition. Further work
is required to validate the contracts which will represent leases under IFRS 16, including ongoing consideration of some supply chain
contracts. The Group is also considering whether there are any re-assessments of lease term required, and the discount rate to be
applied. Under the expected transition option, payments will be discounted using incremental borrowing rates at 1 January 2019. The
Group holds some leases in non-functional currencies where the value of the lease liability will be dependent on spot exchange rates
on transition; and
– recognise a right-of-use asset measured either: as if the standard had applied since commencement of the lease; or at an amount equal
to the lease liability on transition.
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.
2 Segmental analysis
The analysis by business segment is presented in accordance with IFRS 8 Operating Segments, on the basis of those segments whose
operating results are regularly reviewed by the Board (the Chief Operating Decision Maker as defined by IFRS 8), as follows:
Civil Aerospace
Defence Aerospace – development, manufacture, marketing and sales of military aero engines and aftermarket services.
Power Systems
Marine
Nuclear
– development, manufacture, marketing and sales of reciprocating engines and power systems.
– 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
– development, manufacture, marketing and sales of commercial aero engines and aftermarket services.
propulsion systems.
The operating results are reviewed by the Board and are prepared on an underlying basis, which the Board considers reflects better the
economic substance of the Group’s trading during the year and provides financial measures that, together with the results prepared in
accordance with Adopted IFRS, allow better analysis of the factors affecting the year’s results compared to the prior year. This approach
has been applied consistently. The principles adopted to determine underlying results are:
Underlying revenue and cost of sales
Where revenue and costs are denominated in a currency other than the functional currency of the Group undertaking and the Group
hedges the net exposure, these reflect the achieved exchange rates arising on derivative contracts settled to cover the net exposure. This
reflects the economic hedging that the Group undertakes. These achieved exchange rates are applied to all relevant revenue and costs,
including those for which there is a natural offsetting position, rather than translating the offsetting transactions at spot rates. The
underlying profits would be the same under both approaches, but the Board considers that the approach taken provides a better
indication of trends over time.
Underlying profit before financing
In addition to the impact of exchange rates on revenue and costs above, adjustments have been made to exclude one-off past service
costs or credits on post-retirement schemes, exceptional restructuring costs (associated with the substantial closure or exit of a site, facility
or line of business or other major transformation activities), the effect of acquisition accounting (including in 2017, the gains arising on the
acquisition of ITP Aero) – so that all segments are measured on a consistent basis, the effect of business disposals, the impairment of
goodwill and similar items, and in 2016 financial penalties from agreements with investigating bodies.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
133
2 Segmental analysis continued
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 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.
The tables below and overleaf set out the results of the reportable segments on the basis described above and a reconciliation of these
underlying results to those reported in the consolidated income statement.
Year ended 31 December 2017
Underlying revenue from sale of original equipment
Underlying revenue from aftermarket services
Total underlying revenue at 2016 exchange rates
Translation to 2017 exchange rates
Total underlying revenue at 2017 exchange rates
Gross profit
Commercial and administrative costs
Research and development costs
Share of results of joint ventures and associates
Underlying operating profit/(loss) at 2016 exchange rates
Translation to 2017 exchange rates
Underlying operating profit/(loss) at 2017 exchange rates
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
Year ended 31 December 2016
Underlying revenue from sale of original equipment
Underlying revenue from aftermarket services
Total underlying revenue
Gross profit
Commercial and administrative costs
Research and development costs
Share of results of joint ventures and associates
Underlying operating profit/(loss)
Segment assets
Investments in joint ventures and associates
Segment liabilities
Net (liabilities)/assets
Investment in intangible assets, property, plant and equipment
and joint ventures and associates
Depreciation, amortisation and impairment
Civil 1
Aerospace
£m
Defence
Aerospace
£m
Power
Systems
£m
Marine
£m
Nuclear
£m
Inter-
segment
£m
Total
reportable
segments
£m
3,775
4,158
7,933
90
8,023
1,157
(370)
(403)
109
493
27
520
15,335
670
(13,160)
2,845
928
1,264
2,192
83
2,275
555
(126)
(77)
7
359
15
374
1,741
1
(1,837)
(95)
1,828
897
2,725
198
2,923
786
(310)
(166)
(3)
307
23
330
3,772
15
(1,256)
2,531
1,455
525
120
60
118
231
3,357
3,710
7,067
1,185
(353)
(568)
103
367
13,030
826
(14,510)
(654)
890
1,319
2,209
564
(124)
(71)
15
384
1,755
4
(1,996)
(237)
1,810
845
2,655
702
(335)
(177)
1
191
3,828
9
(1,151)
2,686
1,215
491
112
67
123
207
534
483
1,017
60
1,077
214
(193)
(44)
–
(23)
(2)
(25)
1,270
1
(761)
510
56
38
631
483
1,114
236
(222)
(41)
–
(27)
1,518
2
(903)
617
37
239
377
430
807
11
818
130
(71)
(22)
–
37
1
38
395
1
(426)
(30)
40
24
354
423
777
121
(70)
(6)
–
45
351
1
(435)
(83)
19
39
(27)
(37)
(64)
(6)
(70)
–
–
–
–
–
–
–
7,415
7,195
14,610
436
15,046
2,842
(1,070)
(712)
113
1,173
64
1,237
(1,360)
–
1,360
–
21,153
688
(16,080)
5,761
–
–
1,789
878
(36)
(40)
(76)
–
–
–
–
–
7,006
6,740
13,746
2,808
(1,104)
(863)
119
960
(1,223)
–
1,223
–
19,259
842
(17,772)
2,329
–
–
1,506
1,043
1
Included within the results for Civil Aerospace in 2017 is a charge of £227m (2016: £98m) related to in-service engine issues for the Trent 1000 and Trent 900.
FINANCIAL STATEMENTS 134
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
2 Segmental analysis continued
Reconciliation to reported results
Year ended 31 December 2017
Revenue from sale of original equipment
Revenue from aftermarket services
Total revenue at 2016 exchange rates
Translation to 2017 exchange rates
Total revenue at 2017 exchange rates
Gross profit
Commercial and administrative costs
Research and development costs
Share of results of joint ventures and associates
Operating profit/(loss) at 2016 exchange rates
Translation to 2017 exchange rates
Operating profit/(loss) at 2017 exchange rates
Gains arising on the acquisition of ITP Aero
Profit/(loss) before financing and taxation
Net financing
Profit/(loss) before taxation
Taxation
Profit for the year
Attributable to:
Ordinary shareholders
Non-controlling interests
Year ended 31 December 2016
Revenue from sale of original equipment
Revenue from aftermarket services
Total revenue
Gross profit
Commercial and administrative costs
Research and development costs
Share of results of joint ventures and associates
Operating profit/(loss)
Loss on disposal of businesses
Profit/(loss) before financing and taxation
Net financing
Profit/(loss) before taxation
Taxation
Profit/(loss) for the year
Attributable to:
Ordinary shareholders
Non-controlling interests
Total reportable
segments
£m
Other businesses 1
and corporate
£m
Total
underlying
£m
Underlying
adjustments and
foreign exchange
£m
Group at actual
exchange rates
£m
7,415
7,195
14,610
436
15,046
2,842
(1,070)
(712)
113
1,173
64
1,237
–
1,237
7,006
6,740
13,746
2,808
(1,104)
(863)
119
960
–
960
21
20
41
3
44
4
(54)
1
(11)
(60)
(2)
(62)
–
(62)
(104)
(166)
(328)
21
16
37
10
(54)
1
(2)
(45)
–
(45)
(102)
(147)
(261)
7,436
7,215
14,651
439
15,090
2,846
(1,124)
(711)
102
1,113
62
1,175
–
1,175
(104)
1,071
(328)
743
742
1
7,027
6,756
13,783
2,818
(1,158)
(862)
117
915
–
915
(102)
813
(261)
552
552
–
654
1,002
1,656
(439)
1,217
327
(98)
(84)
29
174
(62)
112
798
910
2,916
3,826
(361)
3,465
3,465
–
561
611
1,172
230
(1,045)
(56)
–
(871)
(3)
(874)
(4,575)
(5,449)
865
(4,584)
(4,584)
–
8,090
8,217
16,307
–
16,307
3,173
(1,222)
(795)
131
1,287
–
1,287
798
2,085
2,812
4,897
(689)
4,208
4,207
1
7,588
7,367
14,955
3,048
(2,203)
(918)
117
44
(3)
41
(4,677)
(4,636)
604
(4,032)
(4,032)
–
1
Other businesses comprise former Energy businesses not included in the disposal to Siemens in 2014.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
135
2 Segmental analysis continued
Underlying adjustments
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
Financial RRSAs – foreign exchange differences and
changes in forecast payments
Effect of acquisition accounting 3
Impairment of goodwill
Impairment of assets
Pension restructuring 4
Net post-retirement scheme financing
Disposal of businesses
Exceptional restructuring
Financial penalties from agreements with
investigating bodies
Gains arising on the acquisition of ITP Aero
Consolidation of previously non-consolidated subsidiary
Other
Recognition of advance corporation tax
Reduction in corporate tax rates 5
Total underlying adjustments
Reported per consolidated income statement
2017
Profit
before
financing
£m
1,175
Net
financing
£m
(104)
Revenue
£m
15,090
2016
Profit
before
financing
£m
915
Net
financing
£m
(102)
Taxation
£m
(261)
Taxation
£m
(328)
Revenue
£m
13,783
1,217
–
–
–
–
–
–
–
–
–
–
–
–
–
475
24
(124)
(6)
–
(129)
–
(12)
–
–
–
(104)
–
173
2,648
–
84
–
(111)
(463)
21
(12)
1,172
–
–
–
–
11
–
–
–
–
1
–
–
(3)
35
–
–
–
(1)
–
31
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,217
16,307
–
798
(12)
–
–
–
910
2,085
–
–
–
(1)
–
–
2,916
2,812
–
–
–
4
163
(25)
(361)
(689)
–
–
–
–
–
–
1,172
14,955
–
426
–
77
67
–
(115)
(219)
–
(306)
–
(3)
(129)
(671)
–
–
(1)
–
–
(874)
41
–
162
(4,420)
–
(313)
(8)
–
–
–
–
3
–
–
–
–
–
1
–
–
(4,575)
(4,677)
–
(107)
792
(14)
56
(1)
35
–
–
107
(2)
–
34
–
–
–
(5)
–
(30)
865
604
Realised losses/(gains) on settled derivative contracts include adjustments to reflect the losses/(gains) in the same year as the related trading cash flows.
1
2 Unrealised fair value changes to derivative contracts included in profit before financing: (i) include those of equity accounted joint ventures; and (ii) exclude those for which the
related trading contracts have been cancelled when the fair value changes are recognised immediately in underlying profit.
3 The adjustment eliminates charges recognised as a result of recognising assets in acquired businesses at fair value.
4 In the UK, tax is provided on pension surpluses at a rate of 35%, which is the relevant rate if the surpluses were to be returned to the Group.
5 The 2017 reduction in corporate tax rates relates to the reduction in the Federal tax rate in the US. The 2016 comparative relates to the reduction in the UK corporate tax rate.
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
Other businesses and corporate 1
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
Other businesses and corporate 1
Borrowings
Income tax liabilities
Post-retirement scheme deficits
Total liabilities
Net assets
1
Includes ITP Aero.
2017
£m
21,153
688
2,565
2,956
227
288
2,125
30,002
(16,080)
(1,524)
(3,488)
(1,353)
(1,387)
(23,832)
6,170
2016
£m
19,259
844
49
2,774
358
908
1,346
25,538
(17,772)
(183)
(3,357)
(987)
(1,375)
(23,674)
1,864
FINANCIAL STATEMENTS 136
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
2 Segmental analysis continued
Geographical segments
The Group’s revenue by destination is as follows:
United Kingdom
Germany
Switzerland
France
Spain
Norway
Italy
Russia
Rest of Europe
Europe
United States
Canada
North America
South America
Saudi Arabia
Rest of Middle East
Middle East
China
Singapore
Japan
South Korea
Malaysia
India
Rest of Asia
Asia
Africa
Australasia
Other
2017
£m
1,881
973
733
388
329
218
301
63
736
5,622
4,419
324
4,743
173
356
885
1,241
1,952
565
294
248
126
110
629
3,924
281
230
93
16,307
2016
£m
1,821
850
745
294
289
279
232
75
700
5,285
4,176
341
4,517
314
486
570
1,056
1,417
518
333
251
117
99
508
3,243
290
188
62
14,955
No single customer represented 10% or more of the Group’s revenue.
The carrying amounts of the Group’s non-current assets including investments but excluding other financial instruments, deferred tax
assets and post-employment benefit surpluses, by the geographical area in which the assets are located, are as follows:
United Kingdom
Germany
United States
Nordic countries
Other
2017
£m
5,367
2,872
1,258
502
2,402
12,401
2016
£m
4,643
2,714
1,046
512
1,161
10,076
On 17 January 2018, the Group announced a simplification from five to three businesses and a review of strategic options for our
commercial marine operation. Until certain elements of the simplification are sufficiently advanced (including the strategic review of
commercial marine), it is not possible to determine reliably the full financial impact.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
137
3 Research and development
Expenditure in the year
Capitalised as intangible assets
Amortisation of capitalised costs
Impairment 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
Translation to 2016 exchange rates
Net underlying cost at 2016 exchange rates
4 Net financing
2017
£m
(1,035)
342
(150)
–
(843)
64
(44)
28
(795)
58
(737)
26
(711)
2016
£m
(937)
99
(147)
(2)
(987)
73
(40)
36
(918)
56
(862)
–
(862)
2017
2016
Per
consolidated
income
statement
£m
Per
consolidated
income
statement
£m
Underlying
financing 2
£m
Notes
Underlying
financing 2
£m
Financing income
Interest receivable
Net fair value gains on foreign currency contracts 1
Financial RRSAs – foreign exchange differences and changes
in forecast payments
Net fair value gains on commodity contracts 1
Financing on post-retirement scheme surpluses
Net foreign exchange gains
Financing costs
Interest payable
Net fair value losses on foreign currency contracts 1
Financial RRSAs – foreign exchange differences and changes
in forecast payments
Financial charge relating to financial RRSAs
Financing on post-retirement scheme deficits
Net foreign exchange losses
Other financing charges
Net financing
Analysed as:
Net interest payable
Net fair value gains/(losses) on derivative contracts
Net post-retirement scheme financing
Net other financing
Net financing
17
17
19
17
17
17
19
11
2,611
17
37
39
258
2,973
(67)
–
(6)
(5)
(38)
–
(45)
(161)
2,812
(56)
2,648
1
219
2,812
11
–
–
–
–
–
11
(64)
–
–
(5)
–
–
(46)
(115)
(104)
(53)
–
–
(51)
(104)
14
1
23
16
42
–
96
(77)
(4,437)
(31)
(6)
(39)
(145)
(38)
(4,773)
(4,677)
(63)
(4,420)
3
(197)
(4,677)
1 Net gain/(loss) on fair value items through profit or loss
2,648
–
(4,420)
2 See note 2.
14
–
–
–
–
–
14
(77)
–
–
(6)
–
–
(33)
(116)
(102)
(63)
–
–
(39)
(102)
–
FINANCIAL STATEMENTS
138
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
5 Taxation
Current tax
Current tax charge for the year
Adjustments in respect of prior years
Deferred tax
Deferred tax charge/(credit) for the year
Adjustments in respect of prior years
Recognition of advance corporation tax
Deferred tax charge resulting from reduction
in tax rates
UK
2017
£m
33
–
33
543
(2)
(163)
–
378
2016
£m
12
(8)
4
(804)
(5)
–
30
(779)
Recognised in the income statement
411
(775)
278
Overseas
Total
2017
£m
244
(10)
234
6
13
–
25
44
2016
£m
187
4
191
(44)
24
–
–
(20)
171
2017
£m
277
(10)
267
549
11
(163)
25
422
2016
£m
199
(4)
195
(848)
19
–
30
(799)
689
(604)
Other tax (charges)/credits
Deferred tax:
Movement in post-retirement schemes
Share-based payments – direct to equity
Net investment hedge
Tax reconciliation
OCI
Equity
Items that will not
be reclassified
Items that may
be reclassified
2017
£m
2016
£m
2017
£m
2016
£m
2017
£m
2016
£m
(307)
(179)
(307)
(179)
1
1
4
4
Profit/(loss) before taxation
Less share of results of joint ventures and associates (note 11)
Profit/(loss) before taxation excluding joint ventures and associates
Nominal tax charge/(credit) at UK corporation tax rate 19.25% (2016: 20%)
UK tax rate differential 1
Overseas rate differences 2
Impairment of goodwill
Financial penalties from agreements with investigating bodies
Gains arising on the acquisition of ITP Aero
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
Recognition of advance corporation tax
Reduction in closing deferred taxes resulting from decrease in tax rates
Underlying items (note 2)
Non-underlying items
The UK tax rate differential arises on the difference between the appropriate deferred tax rate and the UK statutory tax rate.
1
2 Overseas rate differences mainly relate to tax on profits in countries, such as the US and Germany, which have higher tax rates than the UK.
3
3
(2)
(2)
2017
£m
4,897
(131)
4,766
2016
£m
(4,636)
(117)
(4,753)
917
(68)
103
–
–
(154)
4
–
24
1
(163)
25
689
328
361
689
(951)
41
25
44
153
–
11
(2)
30
15
–
30
(604)
261
(865)
(604)
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
139
5 Taxation continued
Deferred taxation assets and liabilities
At 1 January
Amount (charged)/credited to income statement
Amount charged to other comprehensive income
Amount credited/(charged) to equity
On acquisition of business
Exchange differences
At 31 December
Deferred tax assets
Deferred tax liabilities
The analysis of the deferred tax position is as follows:
2017
£m
100
(422)
(306)
3
(238)
(10)
(873)
271
(1,144)
(873)
2016
£m
(521)
799
(175)
(2)
–
(1)
100
876
(776)
100
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 credit
Advance corporation tax
At
1 January
2017
£m
Recognised
in income
statement
£m
Recognised
in OCI
£m
Recognised in
equity
£m
On acquisition
of business
£m
Exchange
differences
£m
At
31 December
2017
£m
(389)
(191)
28
(512)
(131)
926
339
30
–
100
20
93
(62)
20
(69)
(545)
(50)
8
163
(422)
–
–
1
–
(307)
–
–
–
–
(306)
–
–
3
–
–
–
–
–
–
3
(277)
(29)
(97)
–
–
–
5
160
–
(238)
(46)
(18)
25
–
25
–
4
–
–
(10)
(692)
(145)
(102)
(492)
(482)
381
298
198
163
(873)
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 credit
Unrecognised deferred tax assets
At
1 January
2016
£m
(392)
(190)
21
(539)
(90)
Recognised
in income
statement
£m
11
14
15
27
103
Recognised
in OCI
£m
–
–
4
–
(179)
Recognised
in equity
£m
–
–
–
–
–
Exchange
differences
£m
(8)
(15)
(12)
–
35
At
31 December
2016
£m
(389)
(191)
28
(512)
(131)
306
343
20
(521)
620
(1)
10
799
–
–
–
(175)
–
(2)
–
(2)
–
(1)
–
(1)
2017
£m
19
180
199
926
339
30
100
2016
£m
182
71
253
Advance corporation tax
Losses and other unrecognised deferred tax assets 1
Deferred tax not recognised on unused tax losses and other items on the basis that future economic
benefit is uncertain
1 The losses and other unrecognised deferred tax assets include £77m on acquisition of ITP Aero.
FINANCIAL STATEMENTS 140
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
5 Taxation continued
Deferred taxation assets and liabilities
Deferred tax assets include £285m (2016: £326m) relating to tax losses in the UK and £163m (2016: nil) relating to advance corporation tax.
In both cases, a recoverability assessment has been undertaken, taking account of deferred tax liabilities against which the reversal of the
deferred tax asset can be offset and using latest UK forecasts to assess the level of future taxable profits. The assessment takes into
account new tax laws that are effective from 1 April 2017 (restricting the offset of tax losses), and the fact that neither asset time expires.
The forecasts show the UK business, which is mainly Civil Aerospace and Defence Aerospace, continues to generate sufficient future
taxable profits to support the continued recognition of the deferred tax asset relating to tax losses even though the new tax laws extend
the period over which the losses are expected to be used. This is aligned to the business outlook, in particular Civil Aerospace with its
growth in original equipment revenue from large engines and engine unit cost improvements.
Prior to the new tax laws, advance corporation tax would not be utilised until after all the UK tax losses had been used. One of the
consequences of the change in tax laws is that UK tax payments will be accelerated. Advance corporation tax can be offset against such
payments. This is reflected in the forecasts that show it now being used over a similar period to the losses. As a result the advance
corporation tax has been recognised as a deferred tax asset in 2017. The resulting credit to the income statement has been excluded from
underlying profit.
The US Tax Cuts and Jobs Act was enacted on 22 December 2017. This reduces the Federal tax rate in the US from 35% to 21% with effect
from 1 January 2018. As the reduction has been enacted prior to the year end, the closing deferred tax assets and liabilities of US
companies within the Group 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 2017, £25m has
been charged to the income statement and £45m has been charged to OCI.
The Budget 2016 announced that the UK tax rate will reduce to 19% with effect from 1 April 2017 and 17% with effect from 1 April 2020.
The rate reduction to 17% was substantively enacted on 6 September 2016. The deferred tax assets and liabilities of UK companies within
the Group have therefore been calculated at 17%.
The temporary differences associated with investments in subsidiaries, joint ventures and associates, for which a deferred tax liability
has not been recognised, aggregate to £188m (2016: £276m). 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/(loss) attributable to ordinary shareholders (£m)
Weighted average number of ordinary shares (millions)
EPS (pence)
1 As there is a loss, the effect of potentially dilutive ordinary shares is anti-dilutive.
2017
Potentially
dilutive
share options
6
(0.76)
Basic
4,207
1,834
229.40
Diluted
4,207
1,840
228.64
Basic
(4,032)
1,832
(220.08)
2016
Potentially
dilutive
share options 1
–
–
Diluted
(4,032)
1,832
(220.08)
The reconciliation between underlying EPS and basic EPS is as follows:
Underlying EPS/Underlying operating profit attributable to ordinary shareholders
Total underlying adjustments to profit before tax (note 2)
Related tax effects
EPS/Profit/(loss) attributable to ordinary shareholders
Diluted underlying EPS
2017
2016
Pence
40.46
208.62
(19.68)
229.40
40.33
£m
742
3,826
(361)
4,207
Pence
30.13
(297.43)
47.22
(220.08)
30.08
£m
552
(5,449)
865
(4,032)
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
141
7 Employee information
Average number of employees
United Kingdom
Germany
United States
Nordics
Canada
Rest of world
Civil Aerospace
Defence Aerospace
Power Systems
Marine
Nuclear
Other businesses and corporate 1
Group employment costs 2
Wages, salaries and benefits
Social security costs
Share-based payments (note 21)
Pensions and other post-retirement scheme benefits (note 19)
2017
2016
22,500
10,600
6,200
3,000
1,000
6,700
50,000
24,600
6,100
10,100
4,600
4,400
200
50,000
22,300
10,700
6,300
3,400
1,000
6,200
49,900
23,800
6,000
10,300
5,300
4,300
200
49,900
£m
£m
2,982
413
34
372
3,801
2,788
376
35
623
3,822
1 Other businesses and corporate includes the Energy businesses not sold to Siemens in 2014 and corporate employees who do not provide a shared service to the segments.
Where corporate functions provide such a service, employees have been allocated to the segments on an appropriate basis.
2 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 2
Total fees payable for audit services
Fees payable to the Company’s auditors and its associates for other services:
Audit related assurance services 3
Taxation compliance services
All other services
Fees payable in respect of the Group’s pension schemes:
Audit
2017
£m
0.3
7.3
7.6
0.7
0.1
1.0
9.4
0.2
2016
£m
0.3
6.5
6.8
0.6
0.5
0.1
8.0
0.3
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 Audit fees for overseas entities are reported at the average exchange rate for the year.
3 This includes £0.3m (2016: £0.3m) for the review of the half-year report.
FINANCIAL STATEMENTS 142
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
9 Intangible assets
Cost
At 1 January 2016
Exchange differences
Additions
Acquisition of business
Disposals
At 1 January 2017
Exchange differences
Reclassifications
Additions
Acquisition of business
Disposals
At 31 December 2017
Accumulated amortisation
At 1 January 2016
Exchange differences
Charge for the year 1
Impairment
At 1 January 2017
Exchange differences
Charge for the year 1
Disposals
At 31 December 2017
Net book value
At 31 December 2017
At 31 December 2016
At 1 January 2016
Certification
costs and
participation
fees
£m
Goodwill
£m
Development
expenditure
£m
Contractual
aftermarket
rights
£m
Customer
relationships
£m
Software
£m
Other
£m
Total
£m
1,589
284
–
1
–
1,874
(5)
–
–
–
–
1,869
86
32
–
219
337
(13)
–
–
324
1,545
1,537
1,503
1,145
26
154
–
–
1,325
8
–
160
128
–
1,621
373
3
64
–
440
1
63
–
504
1,117
885
772
1,730
116
100
–
(2)
1,944
16
(9)
342
202
–
2,495
691
48
147
2
888
8
149
–
1,045
1,450
1,056
1,039
799
–
208
–
–
1,007
–
–
286
70
–
1,363
394
–
39
–
433
–
57
–
490
873
574
405
456
84
–
–
–
540
(3)
–
–
966
–
1,503
139
28
42
–
209
(4)
51
–
256
1,247
331
317
616
16
116
–
(6)
742
(3)
–
135
7
(13)
868
325
8
81
–
414
(1)
81
(6)
488
380
328
291
543
66
53
1
–
663
8
9
50
44
–
774
225
35
33
1
294
–
29
–
323
451
369
318
6,878
592
631
2
(8)
8,095
21
–
973
1,417
(13)
10,493
2,233
154
406
222
3,015
(9)
430
(6)
3,430
7,063
5,080
4,645
1 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 Power Systems AG
Marine – arising from the acquisitions of Vinters Limited, Scandinavian Electric Holding AS
and ODIM ASA
Rolls-Royce Deutschland Ltd & Co KG
Other
Primary reporting
segment
Power Systems
Marine
Civil Aerospace
Various
2017
£m
868
410
244
23
1,545
2016
£m
871
401
236
29
1,537
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
143
9 Intangible assets continued
Goodwill has been tested for impairment during 2017 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. These forecasts cover the next five years. Growth rates for the period not covered by the forecasts are based
on a range of growth rates 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 principal value in use assumptions for goodwill balances considered to be individually significant are:
Marine
– Trading assumptions (e.g. volume of equipment deliveries, capture of aftermarket and cost escalation) are based on current and known
future programmes, estimates of customers’ fleet requirements and long-term economic forecasts, in particular the cyclical recovery of
the commercial marine market.
– Cash flows beyond the five-year forecasts are assumed to grow at 2.5% (2016: 2.5%).
– Pre-tax discount rate 13% (2016: 13%).
The estimate of value in use is approximately £50m higher than the carrying value and deterioration of key assumptions could result in an
impairment. For example, the value in use would reduce by approximately £50m if alternative trading assumptions resulted in forecast cash
flows reducing by 10%, by approximately £60m if the discount rate increased by 1% and by approximately £100m if the market recovery
were delayed by one year compared to that assumed.
On 17 January 2018, the Group announced a strategic review of commercial marine. Until the review is sufficiently advanced, it is not
possible to determine reliably the full financial impact.
Rolls-Royce Power Systems AG
– Trading assumptions (e.g. volume of equipment deliveries, pricing achieved and cost escalation) are based on current and known future
programmes, estimates of capture of market share and long-term economic forecasts.
– Cash flows beyond the five-year forecasts are assumed to grow at 1.8% (2016: 2%).
– Pre-tax discount rate 11.7% (2016 11.7%).
The Directors do not consider that any reasonably possible changes in the key assumptions would cause the value in use of the goodwill
to fall below its carrying value.
Rolls-Royce Deutschland Ltd & Co KG
– Trading assumptions (e.g. volume of engine deliveries, flying hours of installed fleet and cost escalation) are based on current and
known future programmes, estimates of customers’ fleet requirements and long-term economic forecasts.
– Cash flows beyond the five-year forecasts are assumed to grow at 2.5% (2016: 2.5%).
– Pre-tax discount rate 13% (2016: 13%).
The Directors do not consider that any reasonably possible changes in the key assumptions would cause the value in use of the goodwill
to fall below its carrying value.
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 9–13% (2016: 9-13%), based on the Group’s weighted average cost of
capital, adjusted for the estimated programme risk, for example taking account of whether or not the forecast cash flows arise from
contracted business.
No impairment is required on this basis. However, a combination of adverse changes in assumptions (e.g. market size and share, unit costs
and programme delays) and other variables (e.g. discount rate and foreign exchange rates), could result in impairment in future years.
In making this assessment, the Directors noted that the adoption of IFRS 15 on 1 January 2018 would result in the derecognition of contractual
aftermarket rights of £873m, which will itself significantly reduce the risk of impairment on other intangible assets.
FINANCIAL STATEMENTS 144
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
10 Property, plant and equipment
Cost
At 1 January 2016
Exchange differences
Reclassification of joint ventures to joint operations
Additions – purchased
Additions – arising from TotalCare Flex contracts (non-cash)
Disposals of businesses
Reclassifications
Disposals/write-offs
At 1 January 2017
Exchange differences
Additions – purchased
Additions – arising from TotalCare Flex contracts (non-cash)
Acquisition of business
Consolidation of previously non-consolidated subsidiary
Reclassifications
Transfer to assets held for sale
Disposals/write-offs
Adjustment 2
At 31 December 2017
Accumulated depreciation
At 1 January 2016
Exchange differences
Reclassification of joint ventures to joint operations
Charge for the year 1
Impairment
Disposals of businesses
Reclassifications
Disposals/write-offs
At 1 January 2017
Exchange differences
Charge for the year 1
Impairment
Reclassifications
Transfer to assets held for sale
Disposals/write-offs
Adjustment 2
At 31 December 2017
Net book value
At 31 December 2017
At 31 December 2016
At 1 January 2016
Land and
buildings
£m
Plant and
equipment
£m
Aircraft
and engines
£m
In course of
construction
£m
1,375
141
7
25
–
(1)
131
(11)
1,667
(18)
36
–
74
9
92
(5)
(13)
–
1,842
416
44
1
63
1
–
–
(10)
515
(9)
58
3
(7)
(3)
(3)
–
554
1,288
1,152
959
3,894
352
87
124
–
(3)
230
(85)
4,599
(61)
155
–
155
1
308
(11)
(111)
–
5,035
2,284
182
52
333
–
(2)
(9)
(75)
2,765
(32)
351
3
7
(10)
(100)
–
2,984
2,051
1,834
1,610
339
12
–
51
75
–
63
(49)
491
(5)
127
1
28
–
29
–
(4)
20
687
125
4
–
28
–
–
9
(40)
126
(1)
35
–
–
–
(1)
14
173
514
365
214
708
55
–
426
–
–
(424)
–
765
(11)
446
–
11
–
(429)
–
(9)
–
773
1
–
–
–
1
–
–
–
2
–
–
–
–
–
–
–
2
771
763
707
Total
£m
6,316
560
94
626
75
(4)
–
(145)
7,522
(95)
764
1
268
10
–
(16)
(137)
20
8,337
2,826
230
53
424
2
(2)
–
(125)
3,408
(42)
444
6
–
(13)
(104)
14
3,713
4,624
4,114
3,490
Depreciation charged during the year is included in the income statement or included in the cost of inventory as appropriate.
1
2 The adjustment relates to industrial engines sold with the Energy business in 2014.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
145
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
The Group’s share of equity accounted entities’ capital commitments is £20m (2016: £17m).
11 Investments
Composition of the Group
The entities contributing to the Group’s financial results are listed on pages 175 to 182.
Non-controlling interests
The Group does not have any material non-wholly owned subsidiaries.
Equity accounted and other investments
At 1 January 2016
Exchange differences
Increase in share in joint ventures
Other additions
Reclassification of joint ventures to joint operations
Share of retained profit/(loss)
Share of OCI – will not be reclassified to profit or loss
Share of OCI – may be reclassified to profit or loss
At 1 January 2017
Exchange differences
Additions
Transfer from joint venture to subsidiary
Impairment 1
Consolidation of previously non-consolidated subsidiary
Share of retained profit/(loss)
Share of OCI – will not be reclassified to profit or loss
Share of OCI – may be reclassified to profit or loss
At 31 December 2017
Equity accounted
Joint ventures
£m
574
109
154
20
(57)
44
(2)
(7)
835
(46)
47
(204)
–
–
62
(1)
(5)
688
Associates
£m
2
(2)
–
10
–
(1)
–
–
9
2
1
–
(2)
–
(10)
–
–
–
1 The unlisted investment impairment of £12m relates to the consolidation of a previously non-consolidated subsidiary.
2017
£m
5
7
82
552
(140)
412
257
1,355
Total
£m
576
107
154
30
(57)
43
(2)
(7)
844
(44)
48
(204)
(2)
–
52
(1)
(5)
688
2016
£m
5
6
42
413
(108)
305
252
1,059
Other
Unlisted
£m
33
5
–
–
–
–
–
–
38
2
4
–
(12)
(6)
–
–
–
26
FINANCIAL STATEMENTS 146
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
11 Investments continued
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 Aero)
Spain
Principal location Activity
UK
Hong Kong
Singapore
Aero engine leasing
Aero engine repair and overhaul
Aero engine repair and overhaul
Aero engine component manufacture and
maintenance
Ownership interest
50.0%
50.0%
50.0%
46.9% 1
1 On 19 December 2017 the Group acquired the remaining share of ITP Aero to take the total shareholding to 100%.
Summarised financial information of the Group’s individually material joint ventures is as follows:
APL
HAESL
SAESL
ITP Aero
Revenue
Profit for the year
Total comprehensive income
for the year
Dividends paid during the
year
Profit for the year included
the following:
Depreciation and
amortisation
Interest income
Interest expense
Income tax (charge)/credit
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.
2017
£m
188
60
60
(25)
(94)
–
(34)
(10)
185
2,116
(531)
(1,299)
471
23
(503)
(1,101)
2016
£m
151
58
58
(27)
(82)
–
(24)
(5)
176
1,888
(348)
(1,296)
420
21
(292)
(1,111)
2017
£m
954
48
48
(44)
(11)
–
(1)
(9)
268
114
(116)
(91)
175
9
–
(83)
2016
£m
799
233
233
(237)
(10)
–
(1)
(8)
248
105
(88)
(79)
186
12
(7)
(71)
2017
£m
933
40
40
(47)
(12)
–
(2)
–
362
148
(202)
(138)
170
32
–
2016
£m
763
33
33
(24)
(12)
–
(2)
–
307
167
(146)
(143)
185
7
–
(137)
(143)
Reconciliation to the carrying amount recognised in the Consolidated Financial Statements
Ownership interest
Group share of net assets
above
Goodwill
Adjustments for
intercompany trading
Included in the consolidated
balance sheet
50.0%
50.0%
50.0%
50.0%
50.0%
50.0%
236
–
–
236
210
–
–
210
88
34
–
122
93
38
–
131
85
92
–
177
93
100
–
193
2017
£m
689
46
46
–
(51)
11
(15)
–
–
–
–
–
–
–
–
–
n/a
n/a
n/a
n/a
n/a
2016
£m
615
50
50
(19)
(45)
11
(16)
7
731
701
(497)
(485)
450
274
(12)
(331)
46.9%
211
–
(43)
168
On 11 July 2016, the Group announced that it would purchase the outstanding 53.1% shareholding in ITP Aero owned by SENER Grupo
de Ingeniería SA (SENER). This followed a decision by SENER to exercise its put option. On 19 December 2017, the Group completed
the purchase of ITP Aero to take its shareholding to 100% at a valuation of €718m. Under the agreement, consideration will be settled over
a two-year period in eight quarterly instalments of equal value. The updated agreement allows flexibility to settle the consideration either
in cash, in the form of Rolls-Royce shares or any mixture of the two. A decision as to whether each payment will be settled in cash, shares
or cash and shares will be determined by Rolls-Royce during the payment period.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
147
11 Investments continued
The summarised aggregated results of the Group’s share of all equity accounted investments is as follows:
Individually material joint
ventures (previous page)
Other joint ventures
Associates
2017
£m
1,316
407
(425)
(764)
534
(912)
98
–
98
2016
£m
1,503
710
(524)
(987)
702
(970)
84
–
84
2017
£m
835
424
(394)
(711)
154
(710)
43
(5)
38
2016
£m
921
383
(266)
(905)
133
(761)
34
(7)
27
2017
£m
2016
£m
–
–
–
–
–
–
(10)
–
(10)
8
1
–
–
9
–
(1)
–
(1)
Total
2017
£m
2,151
831
(819)
(1,475)
688
(1,622)
131
(5)
126
Assets:
Non-current assets
Current assets
Liabilities: 1
Current liabilities
Non-current liabilities
1 Liabilities include borrowings of
Profit/(loss) for the year
Other comprehensive income
Total comprehensive income for the year
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 £3,536m (2016: £3,348m) of TotalCare assets.
2016
£m
2,432
1,094
(790)
(1,892)
844
(1,731)
117
(7)
110
2016
£m
529
1,199
18
1,312
28
3,086
271
74
8
2016
£m
1,945
3,514
297
1,003
197
6,956
2,470
811
3,675
6,956
81
3,020
–
109
69
3,279
2017
£m
558
1,452
9
1,605
36
3,660
244
85
4
2017
£m
2,492
3,936
180
1,120
191
7,919
3,045
782
4,092
7,919
82
3,328
1
41
49
3,501
FINANCIAL STATEMENTS 148
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
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 119)
Cash held as collateral against third party obligations (note 18)
2017
£m
838
589
1,526
2,953
(20)
2,933
22
2016
£m
872
552
1,347
2,771
–
2,771
38
Cash and cash equivalents at 31 December 2017 include £23m (2016: £34m) that is not available for general use by the Group. This balance
relates to cash held in non-wholly owned subsidiaries and joint arrangements.
Balances are presented on a net basis when the Group has both a legal right of offset and the intention to either settle on a net basis or
realise the asset and settle the liability simultaneously. A gross overdraft balance of £20m is disclosed at 31 December 2017.
15 Borrowings
Unsecured
Overdrafts
Bank loans
6.75% Notes 2019 £500m 1
2.375% Notes 2020 US$500m 2
2.125% Notes 2021 €750m 2
3.625% Notes 2025 US$1,000m 2
3.375% Notes 2026 £375m 1
Secured
Obligations under finance leases 3
Current
2017
£m
20
39
–
–
–
–
–
23
82
2016
£m
–
169
–
–
–
–
–
3
172
Non-current
Total
2017
£m
–
572
519
362
701
726
412
2016
£m
–
271
534
403
682
814
417
2017
£m
20
611
519
362
701
726
412
2016
£m
–
440
534
403
682
814
417
114
3,406
64
3,185
137
3,488
67
3,357
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.
1
2 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.
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
2017
£m
1,237
2,458
46
125
3,144
2,517
9,527
2016
£m
1,246
1,981
268
93
2,243
2,126
7,957
2017
£m
1,046
10
4
–
1,124
1,994
4,178
2016
£m
1,024
–
3
–
784
1,648
3,459
2017
£m
2,283
2,468
50
125
4,268
4,511
13,705
2016
£m
2,270
1,981
271
93
3,027
3,774
11,416
78
140
25
17
103
157
Included within trade and other payables are government grants of £102m (2016: £75m). During the year, £7m (2016: £11m) of government
grants were released to the income statement.
Included in accruals and deferred income are deferred receipts from RRSA workshare partners of £178m (2016: £233m) and £1,033m
(2016: £907m) of TotalCare liabilities. Other payables include £378m (2016: £671m) for financial penalties from agreements with investigating
bodies and £648m (2016: nil) for deferred consideration in relation to the acquisition of ITP Aero (see note 25).
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
149
16 Trade and other payables continued
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
17 Financial instruments
Carrying values and fair values of financial instruments
2017
£m
2016
£m
4,602
2,150
6,953
13,705
3,889
1,660
5,867
11,416
Assets
Liabilities
Total
Basis for
determining
fair value
Fair value
through
profit or loss
£m
Notes
Loans and
receivables
£m
Available
for sale
£m
Fair value
through
profit or loss
£m
Cash
£m
Other
£m
£m
2017
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
TotalCare Flex
C Shares
Trade payables and similar items
Other non-derivative financial liabilities
2016
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
TotalCare Flex
C Shares
Trade payables and similar items
Other non-derivative financial liabilities
11
13
13
14
15
16
16
11
13
13
14
15
16
16
A
B
B
C
B
B
D
C
E
E
B
B
B
A
B
B
C
B
B
D
C
E
E
B
B
B
–
–
–
646
–
–
–
–
–
–
–
–
–
646
–
–
–
387
–
–
–
–
–
–
–
–
–
387
26
3,045
782
–
3
1,526
–
–
–
–
–
–
–
5,382
38
2,470
811
–
3
1,347
–
–
–
–
–
–
–
4,669
–
–
–
–
–
589
–
–
–
–
–
–
–
589
–
–
–
–
–
552
–
–
–
–
–
–
–
552
–
–
–
–
–
838
–
–
–
–
–
–
–
838
–
–
–
–
–
872
–
–
–
–
–
–
–
872
–
–
–
–
–
–
–
(2,730)
–
–
–
–
–
(2,730)
–
–
–
–
–
–
–
(5,636)
–
–
–
–
–
(5,636)
–
–
–
–
–
–
(3,488)
–
(244)
(14)
(28)
(4,602)
(2,150)
(10,526)
–
–
–
–
–
–
(3,357)
–
(101)
(15)
(28)
(3,889)
(1,660)
(9,050)
26
3,045
782
646
3
2,953
(3,488)
(2,730)
(244)
(14)
(28)
(4,602)
(2,150)
(5,801)
38
2,470
811
387
3
2,771
(3,357)
(5,636)
(101)
(15)
(28)
(3,889)
(1,660)
(8,206)
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 £31m and liabilities £2,115m.
FINANCIAL STATEMENTS 150
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
17 Financial instruments continued
Fair values equate to book values for both 2017 and 2016, with the following exceptions:
Borrowings
Financial RRSAs
2017
2016
Book value
£m
(3,488)
(244)
Fair value
£m
(3,557)
(247)
Book value
£m
(3,357)
(101)
Fair value
£m
(3,413)
(109)
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. The fair
value of borrowings is estimated by discounting contractual future cash flows. (Level 2 as defined by IFRS 13).
E The fair values of RRSAs and TotalCare Flex liabilities are estimated by discounting expected future cash flows. The contractual cash flows are based on future trading
activity, which is estimated based on latest forecasts (Level 3 as defined by IFRS 13).
IFRS 13 defines a three-level valuation hierarchy:
Level 1 – quoted prices for similar instruments
Level 2 – directly observable market inputs other than Level 1 inputs
Level 3 – inputs not based on observable market data
Carrying values of other financial assets and liabilities
2017
Non-current assets
Current assets
Assets
Current liabilities
Non-current liabilities
Liabilities
2016
Non-current assets
Current assets
Assets
Current liabilities
Non-current liabilities
Liabilities
Foreign
exchange
contracts
£m
362
27
389
(493)
(2,208)
(2,701)
(2,312)
13
4
17
(566)
(5,002)
(5,568)
(5,551)
Commodity
contracts
£m
Interest rate
contracts 1
£m
Total
derivatives
£m
Financial
RRSAs
£m
TotalCare
Flex
£m
C Shares
£m
Total
£m
16
9
25
(10)
(14)
(24)
1
5
1
6
(24)
(38)
(62)
(56)
232
–
232
–
(5)
(5)
227
364
–
364
–
(6)
(6)
358
610
36
646
(503)
(2,227)
(2,730)
(2,084)
382
5
387
(590)
(5,046)
(5,636)
(5,249)
–
–
–
(50)
(194)
(244)
(244)
–
–
–
(33)
(68)
(101)
(101)
–
–
–
–
(14)
(14)
(14)
–
–
–
–
(15)
(15)
(15)
–
–
–
(28)
–
(28)
(28)
–
–
–
(28)
–
(28)
(28)
610
36
646
(581)
(2,435)
(3,016)
(2,370)
382
5
387
(651)
(5,129)
(5,780)
(5,393)
1 Includes the foreign exchange impact of cross-currency interest rate swaps.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
151
17 Financial instruments continued
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
Acquisition of business
Movements in fair value
hedges 2
Movements in other
derivative contracts 3
Contracts settled
At 31 December
Foreign exchange instruments
Commodity instruments
Interest rate instruments
Total
2017
£m
(5,551)
2016
£m
(1,640)
–
7
–
(33)
–
–
2,611
621
(2,312)
(4,436)
558
(5,551)
2017
£m
(56)
–
2
–
37
18
1
2016
£m
(104)
–
–
–
16
32
(56)
2017
£m
358
–
–
(131)
–
–
227
2016
£m
13
–
–
345
–
–
358
2017
£m
(5,249)
–
9
(131)
2016
£m
(1,731)
(33)
–
345
2,648
639
(2,084)
(4,420)
590
(5,249)
The Group wrote currency options to sell USD and buy GBP as part of a commercial agreement. The fair values of these options on inception was treated as a discount to the customer.
1
2 Loss on related hedged items £131m (2016: £345m loss).
3 Included in financing.
Financial risk and revenue sharing arrangements and other financial liabilities
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.
Movements in the carrying values were as follows:
At 1 January
Exchange adjustments included in OCI
Acquisition of business
Additions
Financing charge 1
Excluded from underlying profit:
Changes in forecast payments 1
Exchange adjustments 1
Cash paid to partners
Other
At 31 December
1 Included in financing.
Financial RRSAs
TotalCare Flex
2017
£m
(101)
(14)
(157)
–
(5)
1
10
22
–
(244)
2016
£m
(110)
5
–
–
(6)
5
(13)
18
–
(101)
2017
£m
(15)
–
–
–
–
1
–
(14)
2016
£m
–
–
–
(14)
(1)
(3)
3
(15)
FINANCIAL STATEMENTS
152
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
17 Financial instruments continued
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 generally 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.
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 funds 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 generally not designated as hedging instruments.
Other price risk – The Group’s cash equivalent balances represent investments in money-market instruments, with a term of up to three
months. The Group does not consider that these are subject to significant price risk.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
153
17 Financial instruments continued
Derivative financial instruments
The nominal amounts, analysed by year of contractual maturity, and fair values of derivative financial instruments are as follows:
At 31 December 2017
Foreign exchange contracts:
Cash-flow hedges
Non-hedge accounted
Interest rate contracts:
Fair value hedges
Cash-flow hedges
Non-hedge accounted
Commodity contracts:
Cash-flow hedges
Non-hedge accounted
At 31 December 2016
Foreign exchange contracts:
Non-hedge accounted
Interest rate contracts:
Fair value hedges
Non-hedge accounted
Commodity contracts:
Non-hedge accounted
Contractual 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
214
97
81
36
–
29,130
4,505
3,674
13,051
7,900
2,650
19
–
41
241
32,295
–
4
–
8
85
4,699
500
4
–
7
68
4,334
1,035
11
–
19
81
14,233
1,115
–
–
7
7
9,029
7
382
227
–
5
5
20
646
–
(2,701)
–
–
(5)
(3)
(21)
(2,730)
29,021
3,403
5,056
12,484
8,078
17
(5,568)
2,735
–
–
–
–
–
300
32,056
83
3,486
80
5,136
1,548
–
122
14,154
1,187
–
15
9,280
358
6
6
387
–
(6)
(62)
(5,636)
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 2017
Currencies sold forward:
Sterling
US dollar
Euro
Other
At 31 December 2016
Currencies sold forward:
Sterling
US dollar
Euro
Other
–
25,177
136
27
–
25,089
35
13
–
–
177
29
–
–
146
101
127
2,272
–
89
246
1,882
–
112
Other derivative financial instruments are denominated in the following currencies:
Sterling
US dollar
Euro
241
802
251
16
274
903
196
24
2017
£m
875
1,383
693
368
28,251
564
161
520
27,874
377
250
2016
£m
875
1,515
645
FINANCIAL STATEMENTS 154
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
17 Financial instruments continued
Non-derivative financial instruments are denominated in the following currencies:
At 31 December 2017
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
TotalCare Flex
C Shares
Trade payables and similar items
Other non-derivative financial liabilities
Liabilities
At 31 December 2016
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
TotalCare Flex
C Shares
Trade payables and similar items
Other non-derivative financial liabilities
Liabilities
Sterling
£m
US dollar
£m
Euro
£m
Other
£m
Total
£m
–
171
227
–
827
1,225
(1,462)
–
–
(28)
(1,668)
(702)
(3,860)
(2,635)
–
160
284
–
1,134
1,578
(1,194)
9
–
(28)
(1,730)
(889)
(3,832)
(2,254)
5
2,012
284
–
1,055
3,356
(1,225)
(60)
(14)
–
(1,652)
(536)
(3,487)
(131)
1
1,567
271
–
831
2,670
(1,374)
(78)
(15)
–
(1,437)
(588)
(3,492)
(822)
20
760
129
–
807
1,716
(767)
(184)
–
–
(1,149)
(845)
(2,945)
(1,229)
36
653
123
–
507
1,319
(783)
(32)
–
–
(573)
(138)
(1,526)
(207)
1
102
142
3
264
512
(34)
–
–
–
(133)
(67)
(234)
278
1
90
133
3
299
526
(6)
–
–
–
(149)
(45)
(200)
326
26
3,045
782
3
2,953
6,809
(3,488)
(244)
(14)
(28)
(4,602)
(2,150)
(10,526)
(3,717)
38
2,470
811
3
2,771
6,093
(3,357)
(101)
(15)
(28)
(3,889)
(1,660)
(9,050)
(2,957)
Currency exposures
The Group’s actual currency exposures after taking account of derivative foreign currency contracts, which may not be designated as
hedging instruments for accounting purposes are as follows:
Functional currency of Group operations
At 31 December 2017
Sterling 1
US dollar
Euro
Other
At 31 December 2016
Sterling
US dollar
Euro
Other
Sterling
£m
US dollar
£m
–
(10)
3
–
–
(22)
(2)
3
3
–
212
4
(1)
–
(1)
9
Euro
£m
(642)
(5)
–
18
3
(2)
–
18
Other
£m
11
8
7
(3)
–
19
1
2
Total
£m
(628)
(7)
222
19
2
(5)
(2)
32
1
The euro exposure primarily relates to deferred consideration payable on the acquisition of ITP Aero. Movements in this balance in relation to foreign exchange (recognised through
the consolidated income statement) are partially matched by the related foreign exchange movement in the subsidiary’s net assets, recognised through the consolidated statement of
other comprehensive income.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
155
17 Financial instruments continued
Ageing beyond contractual due date of financial assets
At 31 December 2017
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 2016
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 2017
Borrowings
Derivative financial liabilities 1
Financial RRSAs
TotalCare Flex
C Shares
Trade payables and similar items
Other non-derivative financial liabilities
Derivative financial liabilities comprise:
Cash inflows on foreign exchange contracts
Cash outflows on foreign exchange contracts
Other net cash flows
Total
At 31 December 2016
Borrowings
Derivative financial liabilities 1
Financial RRSAs
TotalCare Flex
C Shares
Trade payables and similar items
Other non-derivative financial liabilities
Derivative financial liabilities comprise:
Cash inflows on foreign exchange contracts
Cash outflows on foreign exchange contracts
Other net cash flows
Total
Within
one year
£m
(186)
(514)
(40)
–
(28)
(4,545)
(1,262)
(6,575)
3,443
(3,947)
(10)
(514)
(276)
(605)
(24)
–
(28)
(3,860)
(1,080)
(5,873)
3,079
(3,660)
(24)
(605)
Up to
three
months
overdue
£m
Between
three
months and
one year
overdue
£m
More than
one year
overdue
£m
–
199
–
–
–
–
199
–
218
13
–
–
–
231
–
70
1
–
–
–
71
–
85
–
–
–
–
85
–
53
–
–
–
–
53
–
34
2
–
–
–
36
Within
terms
£m
26
2,723
781
646
3
2,953
7,132
38
2,133
796
387
3
2,771
6,128
Total
£m
26
3,045
782
646
3
2,953
7,455
38
2,470
811
387
3
2,771
6,480
Gross values
Between
one and
two years
£m
Between
two and
five years
£m
After
five years
£m
Discounting
£m
Carrying
value
£m
472
578
22
3
–
–
–
1,075
(3,488)
(2,730)
(244)
(14)
(28)
(4,602)
(2,150)
(13,256)
498
887
17
3
–
–
–
1,405
(3,357)
(5,636)
(101)
(15)
(28)
(3,889)
(1,660)
(14,686)
(831)
(561)
(50)
–
–
(40)
(436)
(1,918)
3,310
(3,862)
(9)
(561)
(114)
(1,298)
(26)
–
–
(15)
(68)
(1,521)
5,013
(6,295)
(16)
(1,298)
(1,345)
(1,448)
(96)
(17)
–
(17)
(331)
(3,254)
8,310
(9,748)
(10)
(1,448)
(2,007)
(3,196)
(66)
(18)
–
–
(438)
(5,725)
12,409
(15,582)
(23)
(3,196)
(1,598)
(785)
(80)
–
–
–
(121)
(2,584)
4,321
(5,106)
–
(785)
(1,458)
(1,424)
(2)
–
–
(14)
(74)
(2,972)
7,342
(8,763)
(3)
(1,424)
1 The Group regularly renegotiates the contractual maturities of its foreign exchange contracts. In general, the effect of such negotiations is the settlement of derivative financial
liabilities somewhat earlier than the contractual maturity date.
FINANCIAL STATEMENTS 156
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
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 2017
Short-term investments 1
Cash and cash equivalents 2
Unsecured bank loans
Other borrowings
£200m floating rate loan
£43m floating rate loan
£280m floating rate loan
€50m fixed rate loan
€20m floating rate loan
€30m floating rate loan 3
Unsecured bond issues
6.75% Notes 2019 £500m
Effect of interest rate swaps
2.375% Notes 2020 US$500m
Effect of interest rate swaps
2.125% Notes 2021 €750m
Effect of interest rate swaps
3.625% Notes 2025 US$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 2016
Short-term investments 1
Cash and cash equivalents 2
Unsecured bank loans
Other borrowings
£200m floating rate loan
£43m floating rate loan
€75m fixed rate loan
€50m fixed rate loan
Unsecured bond issues
6.75% Notes 2019 £500m
Effect of interest rate swaps
2.375% Notes 2020 US$500m
Effect of interest rate swaps
2.125% Notes 2021 €750m
Effect of interest rate swaps
3.625% Notes 2025 US$1,000m
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
GBP LIBOR + 0.805
2.3500%
EUR LIBOR+ 1.9310
EUR LIBOR + 2.001
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
4.1442%
Effective interest rate
%
GBP LIBOR + 1.26
GBP LIBOR + 0.402
2.0600%
2.3500%
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
4.5488%
Period in which interest
rate reprices
Total
£m
3
2,953
6 months or less
£m
1
2,953
6-12 months
£m
2
–
(54)
(200)
(43)
(280)
(20)
(15)
(19)
(519)
–
(362)
–
(701)
–
(726)
–
(412)
–
(137)
(532)
(20)
(200)
(43)
(280)
–
(15)
(19)
–
(519)
–
(362)
–
(701)
–
(726)
–
(412)
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
Period in which interest
rate reprices
Total
£m
3
2,771
6 months or less
£m
1
2,771
6-12 months
£m
2
–
(107)
(200)
(43)
(64)
(26)
(534)
–
(403)
–
(682)
–
(814)
–
(417)
–
(67)
(583)
–
(200)
(43)
–
–
–
(534)
–
(403)
–
(682)
–
(814)
–
(417)
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
–
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.
3 Interest rate swap in place to hedge floating rate loan.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
157
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 £2,106m (2016: £2,280m) of undrawn committed borrowing facilities of which £2,000m is 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
2017
£m
(2,323)
1,856
(126)
99
(14)
11
(22)
22
2016
£m
(2,552)
2,089
(158)
133
26
(21)
(19)
19
At 31 December 2017, 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 152.
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
2017
2016
Millions
28,125
215,235
(214,931)
28,429
Nominal
value
£m
28
215
(215)
28
Millions
28,960
300,993
(301,828)
28,125
Nominal
value
£m
29
301
(302)
28
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
2017
2016
Pence
per share
4.60
7.10
11.70
£m
85
131
216
Pence
per share
4.60
7.10
11.70
£m
85
130
215
FINANCIAL STATEMENTS 158
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
18 Provisions for liabilities and charges
Warranties and guarantees 1
Contract loss
Restructuring
Customer financing
Insurance
Tax related interest and
penalties
Employer liability claims 1
Other
Current liabilities
Non-current liabilities
At
1 January
2017
£m
474
54
44
19
68
–
–
100
759
543
216
Exchange
differences
£m
–
(1)
1
–
–
Acquisition of
business
£m
5
63
–
–
–
Re-
classification 1
£m
(61)
–
–
–
–
Unused
amounts
reversed
£m
(18)
(3)
(7)
(3)
–
Charged to
income
statement
£m
140
14
28
5
27
–
–
(2)
(2)
–
–
–
68
56
61
–
56
–
–
(26)
(57)
–
–
114
328
Utilised
£m
(111)
(21)
(30)
–
(32)
–
–
(75)
(269)
At
31 December
2017
£m
429
106
36
21
63
56
61
111
883
526
357
1
The reclassification of provisions includes: (i) £61m relating to employer healthcare liability claims as a result of an historic insolvency of the previous provider; and (ii) a provision for
tax related interest and penalties of £56m that was previously included in current tax liabilities which has been reclassified following guidance issued by the International Financial
Reporting Interpretations Committee (IFRIC) in September 2017. Prior year figures have not been restated.
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$3.3bn (2016: US$3.2bn) (on a discounted basis) to provide borrowing facilities to enable customers to purchase aircraft (of which
approximately US$390m (on a discounted basis) could be called during 2018). 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. 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
2017
£m
2016
£m
11
5
5
21
2
12
5
19
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:
2017
2016
£m
145
(41)
(51)
53
64
22
$m
196
(55)
(69)
72
86
29
£m
238
(103)
(74)
61
86
38
$m
293
(126)
(91)
76
106
47
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.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
159
19 Post-retirement benefits
The Group operates a number of defined benefit and defined contribution schemes:
– The UK defined benefit scheme is funded, with the assets held in a separate trustee-administered fund. Employees are entitled
to retirement benefits based on either their final or career-average salaries and length of service.
– Overseas defined benefit schemes are a mixture of funded and unfunded plans 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 2017.
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 and Canadian 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 scheme has invested in a longevity swap, which is
designed to offset longevity risks in respect of approximately two thirds of current pensioners.
Following the buy-out of the liabilities of the Vickers Group Pension Scheme in 2016, the scheme returned its remaining surplus
of £5m (net of tax) to the Group in the year. This scheme is expected to be formally wound up in early 2018.
Amounts recognised in the income statement
Defined benefit schemes:
Current service cost and administrative expenses 1
Past-service (credit)/cost
Settlements 1
Defined contribution schemes
Operating cost
Net financing (credit)/charge in respect of defined
benefit schemes
Total income statement charge
UK
schemes
£m
2017
Overseas
schemes
£m
190
(8)
–
182
33
215
(38)
177
58
–
–
58
100
158
37
195
UK
schemes
£m
2016
Overseas
schemes
£m
169
(22)
302
449
29
478
(41)
437
50
1
10
61
87
148
38
186
Total
£m
248
(8)
–
240
133
373
(1)
372
Total
£m
219
(21)
312
510
116
626
(3)
623
1
In 2016, £306m of costs were excluded from the underlying results, these comprised: £301m settlement cost on the buy-out of the Vickers Group Pension Scheme; £3m of
administrative expenses on the restructuring all the UK defined benefit plans; and £2m settlement cost in relation to winding-up lump sums on small pensions as a consequence
of the restructuring.
The operating cost is charged as follows:
Cost of sales
Commercial and administrative costs
Research and development
Defined benefit
Defined contribution
Total
2017
£m
169
38
33
240
2016
£m
133
343
34
510
2017
£m
92
23
18
133
2016
£m
72
27
17
116
2017
£m
261
61
51
373
2016
£m
205
370
51
626
FINANCIAL STATEMENTS 160
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
19 Post-retirement benefits continued
Net financing comprises:
Financing on scheme obligations
Financing on scheme assets
Net financing (income)/charge in respect of defined
benefit schemes
Financing income on scheme surpluses
Financing cost on scheme deficits
UK
schemes
£m
317
(355)
(38)
(38)
–
2017
Overseas
schemes
£m
65
(28)
37
(1)
38
Total
£m
382
(383)
(1)
(39)
38
UK
schemes
£m
385
(426)
(41)
(41)
–
Amounts recognised in OCI in respect of defined benefit schemes
UK
schemes
£m
2017
Overseas
schemes
£m
Total
£m
UK
schemes
£m
2016
Overseas
schemes
£m
65
(27)
38
(1)
39
2016
Overseas
schemes
£m
Total
£m
450
(453)
(3)
(42)
39
Total
£m
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
208
96
173
265
742
15
(88)
9
57
(7)
223
566
12
578
8
(2,360)
(90)
(2,450)
182
322
735
(16)
2,326
516
52
5
(21)
36
2,331
495
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 1/(liability) recognised in the balance sheet
Post-retirement scheme surpluses
Post-retirement scheme deficits
UK
schemes
£m
(11,499)
13,607
2,108
–
2,108
2,108
–
2017
Overseas
schemes
£m
(774)
750
(24)
(1,346)
(1,370)
17
(1,387)
Total
£m
(12,273)
14,357
2,084
(1,346)
738
2,125
(1,387)
UK
schemes
£m
(12,014)
13,350
1,336
–
1,336
1,336
–
2016
Overseas
schemes
£m
(798)
747
(51)
(1,314)
(1,365)
10
(1,375)
Total
£m
(12,812)
14,097
1,285
(1,314)
(29)
1,346
(1,375)
1
The surplus in the UK scheme is recognised as, on ultimate wind-up when there are no longer any remaining beneficiaries, any surplus would be returned to the Group, which has the
power to prevent the surplus being used for other purposes in advance of this event.
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
2017
Obligations
£m
(243)
(789)
(602)
(460)
(26)
(2,120)
Assets
£m
197
–
553
–
–
750
Net
£m
(46)
(789)
(49)
(460)
(26)
(1,370)
2016
Obligations
£m
(243)
(717)
(631)
(497)
(24)
(2,112)
Assets
£m
194
–
553
–
–
747
Net
£m
(49)
(717)
(78)
(497)
(24)
(1,365)
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
161
19 Post-retirement benefits continued
Defined benefit schemes’ assumptions
Significant actuarial assumptions for the UK schemes used at the balance sheet date were as follows:
Discount rate
Inflation assumption (RPI) 1
Rate of increase in salaries
Life expectancy from age 65: current male pensioner
future male pensioner currently aged 45
current female pensioner
future female 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.
2017
2.55%
3.40%
3.65%
22.2 years
23.5 years
23.5 years
25.3 years
2016
2.70%
3.50%
4.25%
22.7 years
24.3 years
24.1 years
26.4 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 SAPS 2 “All” actuarial tables, with future
improvements in line with the CMI 2016 core projections and long-term improvements of 1.25%. Where appropriate, these are adjusted
to take account of the relevant scheme’s actual experience.
Other assumptions have been set on advice from the relevant actuary, having regard to the latest trends in scheme experience and the
assumptions used in the most recent funding valuation. The rate of increase of pensions in payment is based on the rules of the relevant
scheme, combined with the inflation assumption where the increase is capped.
Assumptions for overseas schemes are less significant and are based on advice from local actuaries. The principal assumptions are:
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
2017
2.9%
2.1%
4.8%
20.2 years
22.1 years
2016
3.3%
2.1%
4.8%
21.0 years
22.5 years
At 1 January
Exchange differences
Current service cost
Past service cost
Finance cost
Contributions by employees
Benefits paid out
Actuarial gains/(losses)
Settlement
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)
UK
schemes
£m
(12,014)
–
(183)
8
(317)
(3)
533
477
–
–
(11,499)
(11,499)
–
(4,625)
(2,243)
(4,631)
20
2017
Overseas
schemes
£m
(2,112)
81
(56)
–
(65)
(7)
87
(64)
(3)
19
(2,120)
(774)
(1,346)
(1,124)
(164)
(832)
16
UK
schemes
£m
(10,914)
–
(160)
22
(385)
(3)
430
(1,810)
806
–
(12,014)
(12,014)
–
(5,279)
(2,146)
(4,589)
20
2016
Overseas
schemes
£m
(1,717)
(339)
(48)
(1)
(64)
(2)
79
(27)
10
(3)
(2,112)
(798)
(1,314)
Total
£m
(12,631)
(339)
(208)
21
(449)
(5)
509
(1,837)
816
(3)
(14,126)
(12,812)
(1,314)
(1,120)
(154)
(838)
16
(6,399)
(2,300)
(5,427)
19
Total
£m
(14,126)
81
(239)
8
(382)
(10)
620
413
(3)
19
(13,619)
(12,273)
(1,346)
(5,749)
(2,407)
(5,463)
19
FINANCIAL STATEMENTS
162
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
19 Post-retirement benefits continued
Changes in fair value of scheme assets
At 1 January
Exchange differences
Administrative expenses
Financing
Return on plan assets excluding financing
Contributions by employer 1
Contributions by employees
Benefits paid out
Settlements/curtailment
At 31 December
Total return on scheme assets
UK
schemes
£m
13,350
–
(7)
355
265
174
3
(533)
–
13,607
620
2017
Overseas
schemes
£m
747
(56)
(2)
28
57
75
7
(87)
(19)
750
85
UK
schemes
£m
11,957
–
(9)
426
2,326
185
3
(430)
(1,108)
13,350
2,752
2016
Overseas
schemes
£m
597
131
(2)
27
5
86
2
(79)
(20)
747
32
Total
£m
14,097
(56)
(9)
383
322
249
10
(620)
(19)
14,357
705
Total
£m
12,554
131
(11)
453
2,331
271
5
(509)
(1,128)
14,097
2,784
1
Pension contributions to UK pension arrangements are generally paid via a salary sacrifice scheme under which employees agree to a reduction in gross contractual pay in return for
the Group making additional pension contributions on their behalf. As a result, there is a decrease in wages and salaries and a corresponding increase in pension costs of £30m (2016:
£31m) in the year.
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 1
Liability driven investment (LDI) portfolios 2
Longevity swap 3
Listed equities
Unlisted equities
Synthetic equities 4
Sovereign debt
Corporate debt instruments
Cash
Other
UK
schemes
£m
9,135
–
3,223
2,266
(480)
(1,761)
12,383
(187)
1,141
162
–
–
100
8
–
13,607
2017
Overseas
schemes
£m
308
2
337
–
–
20
667
–
76
–
2
4
–
2
(1)
750
UK
schemes
£m
7,574
–
3,061
2,063
(420)
(51)
12,227
(175)
969
214
–
–
–
25
90
13,350
2016
Overseas
schemes
£m
335
3
297
–
–
15
650
–
82
–
3
4
–
9
(1)
747
Total
£m
9,443
2
3,560
2,266
(480)
(1,741)
13,050
(187)
1,217
162
2
4
100
10
(1)
14,357
Total
£m
7,909
3
3,358
2,063
(420)
(36)
12,877
(175)
1,051
214
3
4
–
34
89
14,097
1
Cash and similar instruments include repurchase agreements on UK Government bonds amounting to £(2,285)m (2016: £(321)m). The latest maturity date for these short-term
borrowings is 7 March 2019.
2 A portfolio of gilt and swap contracts, backed by investment grade credit instruments and LIBOR generating assets, that is designed to hedge the majority of the interest rate and
inflation risks associated with the schemes’ obligations.
3 Under the longevity swap, the Rolls-Royce UK 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).
4 A portfolio of swap contracts designed to provide investment returns in line with global equity markets. The notional value of the portfolio was $84m (2016 $125m).
The investment strategy for the UK scheme is controlled by the Trustee in consultation with the Group. The scheme assets do not directly
include any of the Group’s own financial instruments, nor any property occupied by, or other assets used by, the Group. At 31 December
2017, there was an indirect holding of £1m of the Group’s financial instruments.
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
(e.g. 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.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
163
19 Post-retirement benefits continued
Future contributions
The Group expects to contribute approximately £230m to its defined benefit schemes in respect of 2018 (UK: £145m, Overseas: £85m).
In the UK, the funding is based on a statutory triennial funding valuation process. This includes a negotiation between the Group and
the Trustee on actuarial assumptions used to value obligations (Technical Provisions) which may differ from those used for accounting set
out above. The assumptions used to value Technical Provisions must be prudent rather than a best estimate of the liability. Most notably,
the Technical Provision discount rate is currently based upon UK Government yields plus 0.5% rather than being based on yields of AA
corporate bonds. Following the triennial valuation process, a Schedule of Contributions (SoC) must be agreed which sets out the required
contribution for current service cost and any contributions from the employer to eliminate a deficit. The most recent valuation, as at
31 March 2017, agreed by the Trustee in December 2017, showed that the UK scheme was estimated to be 112% funded on the Technical
Provisions basis. Employer contributions (inclusive of employee contributions paid by a salary sacrifice arrangement) will subsequently be
paid at a rate of 27% in 2018/19 and 28.5% in 2020 (2017: 31.6%). The SoC includes an arrangement for a potential increase in contributions
during 2021 to 2023 (capped at £48.3m a year) if the Technical Provisions funding position is below 107% at 31 March 2020. As at
31 December 2017 the Technical Provisions funding position was estimated to be 114%.
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 surplus at 31 December 2017, 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 hedge the risks from interest rates and inflation measured on a proxy
solvency basis. For the UK scheme, the interest rate and inflation hedging is currently based on UK Government bond yields without any
adjustment for any credit spread. The longevity risk of approximately two thirds of UK pensioner liabilities is also hedged. 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
2017
£m
(590)
675
(310)
291
(105)
(545)
2016
£m
(625)
630
(320)
272
(115)
(415)
1 The differences between the sensitivities on obligations and plan assets arise largely due to differences in the methods used to value the obligations for accounting purposes and the
adopted proxy solvency basis.
20 Share capital
Issued and fully paid
At 1 January 2016 and 1 January 2017
Shares issued to share trust
At 31 December 2017
Non-equity
Equity
Special
Share
of £1
Nominal
value
£m
Ordinary
shares
of 20p each
Millions
Nominal
value
£m
1
–
1
–
–
–
1,838
2
1,840
367
1
368
The rights attaching to each class of share are set out on page 198.
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.
FINANCIAL STATEMENTS 164
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
21 Share-based payments
Effect of share-based payment transactions on the Group’s results and financial position
Total expense recognised for equity-settled share-based payments transactions
Total expense recognised for cash-settled share-based payments transactions
Share-based payments recognised in the consolidated income statement
Liability for cash-settled share-based payment transactions
2017
£m
31
3
34
3
2016
£m
34
1
35
1
A description of the share-based payment plans is included in the Directors’ remuneration report on pages 87 to 90.
Movements in the Group’s share-based payment plans during the year
Sharesave
PSP/LTIP
APRA
Outstanding at 1 January 2016
Granted
Forfeited
Exercised
Outstanding at 1 January 2017
Granted
Forfeited
Exercised
Outstanding 31 December 2017
Exercisable at 31 December 2017
Exercisable at 31 December 2016
Weighted
average
exercise price
Pence
677
–
752
538
672
758
886
527
714
–
–
Number
Millions
23.2
–
(1.7)
(0.1)
21.4
14.0
(3.3)
(4.6)
27.5
–
–
Number
Millions
8.7
7.3
(3.4)
(1.0)
11.6
5.8
(3.4)
(1.0)
13.0
–
–
Number
Millions
0.9
–
–
(0.9)
–
0.2
–
–
0.2
–
–
The weighted average share price at the date share options were exercised was 756p (2016: 711p). The closing price at 31 December 2017
was 847p (2016: 668p).
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 (CEO)
PSP – 30% TSR uplift (Board)
PSP – 50% TSR uplift (ELT)
LTIP
PSP (CFO)
LTIP (ELT and Board)
Sharesave – three-year grant
Sharesave – five-year grant
APRA
2017
n/a
n/a
n/a
739p
882p
714p
244p
260p
773p
2016
714p
731p
795p
613p
n/a
n/a
n/a
n/a
n/a
PSP/LTIP
The fair value of shares awarded are 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).
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
165
22 Leases
Operating leases
Leases as lessee
Non-cancellable operating lease rentals are payable as follows:
Within one year
Between one and five years
After five years
2017
£m
281
849
741
1,871
2016 1
£m
240
706
582
1,528
1
Non-cancellable operating lease rentals payable at 31 December 2016 were previously disclosed as £1,217m with changes made to correct the exchange rate applied to foreign
currency leases and to include leases erroneously omitted, which have been identified during the IFRS 16 transition programme.
– Operating lease rental obligations at 31 December 2017 primarily relate to either aero engines (£1,143m) that are used to support
customer’s aircraft fleets or to land and buildings (£630m) used for production, administration or training purposes.
– Both classes of asset contain some contracts where payments are linked to an index such as LIBOR.
– Operating leases for aero engines typically contain no specific contractual right to renewal. Certain building operating leases have
renewal options with an assessment of the appropriate lease term having being made at inception of each lease.
– Renewal dates for the most significant property leases fall between 2022 and 2025.
During the year £277m was recognised as an expense in the income statement in respect of operating leases (2016: £224m).
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
2017
£m
53
14
46
32
92
2016
£m
35
11
35
27
73
The Group acts as a lessor for both land and buildings and aero engines.
– Sublease payments of nil (2016: £1m) and sublease receipts of £36m (2016: £35m) were recognised in the income statement in the year.
– The total future minimum sublease payments expected to be made are £1m (2016: £2m) and sublease receipts expected to be received
are £51m (2016: £49m).
Finance leases
Finance lease liabilities are payable as follows:
Within one year
Between one and five years
After five years
Payments
£m
28
94
42
164
2017
Interest
£m
5
18
4
27
Principal
£m
23
76
38
137
Payments
£m
6
29
54
89
2016
Interest
£m
3
11
8
22
Principal
£m
3
18
46
67
FINANCIAL STATEMENTS 166
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
23 Contingent liabilities
Contingent liabilities in respect of customer financing commitments are described in note 18.
In January 2017, after full cooperation, the Company concluded deferred prosecution agreements with the SFO and the US Department
of Justice and a leniency agreement with the MPF, the Brazilian federal prosecutors. Prosecutions of individuals may follow and other
investigations or enforcement action may be taken by other authorities. In addition, we could still be affected by actions from customers
and customers’ financiers. The Directors are not currently aware of any matters that are likely to lead to a financial loss, but cannot
anticipate all the possible actions that may be taken or their potential consequences.
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 nil (2016: £12m).
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
2017
£m
2,469
(2,224)
(127)
5
79
–
2
2016
£m
2,022
(1,881)
(101)
5
74
22
2
Included in sales of goods and services to joint ventures and associates are sales of spare engines amounting to £418m (2016: £356m).
Profit recognised in the year on such sales amounted to £75m (2016: £119m), including profit on current year sales and recognition of profit
deferred on sales in previous years. On an underlying basis (at actual achieved rates on settled derivative transactions), the amounts were
£67m (2016: £97m).
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 (pages 66 to 68) and the members of the ELT (described on page 69).
Remuneration for key management personnel is shown below:
Salaries and short-term benefits
Post-retirement schemes
Share-based payments
2017
£m
16
−
7
23
2016
£m
13
–
1
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 87 to 90. 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.
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
167
25 Acquisitions
Acquisitions
On 19 December 2017, the Group completed the acquisition of the 53.1% of the shares of Industria de Turbo Propulsores SA (ITP Aero)
owned by SENER Grupo de Ingenieria SA (SENER) which it did not already own.
The consideration of €718m is payable in eight quarterly instalments, commencing on 15 January 2018. At the Group’s election, each
instalment may be settled in either cash or Rolls-Royce Holdings plc shares. If the consideration is in shares, a 3% premium is applied.
Interest is accrued on the outstanding balance based on LIBOR + 1.5%.
The fair value of the previous joint venture investment in ITP Aero of £204m was re-measured using a discounted cash flow methodology
using judgement in estimating future cash flows, assessing the discount rate and establishing a non-controlling interest discount. This gave
rise to a gain of £553m.
Given the proximity of the acquisition to the year end, and as permitted by IFRS 3 Business Combinations, the fair value of acquired
identifiable assets and liabilities have been presented on a provisional basis. Fair values were determined on the basis of an initial
assessment performed by an independent professional expert prior to the acquisition date. Measurement techniques and estimation
of future cash flows have been used to assess the value of the intangible assets at the date of acquisition. The total fair value of acquired
identifiable assets and liabilities is £1,650m of which a significant value was allocated to intangible assets. The valuation indicated a
bargain purchase of £245m, which has been recognised in the income statement.
The acquisition of the controlling interest in ITP Aero on 19 December 2017 did not have a significant impact on the Group’s underlying
results for the year.
Recognised amounts of identifiable assets acquired and liabilities assumed
Intangible assets
Property, plant and equipment
Deferred tax assets
Inventory
Trade and other receivables
Taxation recoverable
Cash and cash equivalents
Trade and other payables
Borrowings
Other financial assets and liabilities
Deferred tax liability
Provisions
Total identifiable assets and liabilities
Total consideration
Bargain purchase gain arising
Consideration satisfied by:
Deferred consideration to be paid in cash or shares
Existing shareholding
Net cash outflow arising on acquisition:
Cash consideration
Less: cash and cash equivalents acquired
Cash inflow per cash flow statement
Identifiable intangible assets comprise:
Technology, patents and licences
Customer relationships
Trademark
In-process development
Other
£m
1,417
268
148
316
497
2
263
(625)
(34)
(148)
(386)
(68)
1,650
(1,405)
245
648
757
1,405
–
(263)
(263)
245
833
44
91
204
1,417
FINANCIAL STATEMENTS 168
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
26 Derivation of summary funds flow statement
* Underlying profit before tax (PBT) – page 169
Depreciation and impairment of property, plant and
equipment
Amortisation of intangible assets
Impairment of goodwill
Impairment of property, plant and equipment
Acquisition accounting
* Depreciation and amortisation
Increase in inventories
Non-underlying impairment
Decrease in trade and other receivables/payables
Realised losses on settled foreign exchange derivatives
in financing
Revaluation of trading assets
* Movement on net working capital
Additions of intangible assets
Purchases of property, plant and equipment
Government grants received
* Expenditure on PP&E and intangible assets
Realised losses on hedging instruments
Net unrealised fair value to changes to derivatives
Foreign exchange on contract accounting
Exceptional restructuring
Other
Underlying financing
Loss on disposal of property, plant and equipment
Joint ventures
Increase in provisions
Cash flows on other financial assets and liabilities
included in underlying operating profit
Share-based payments
Additions of unlisted investments
Disposal of intangible assets
Disposal of property, plant and equipment
Investments in joint ventures and associates
Net interest
Net funds of JVs reclassified to joint operations
Issue of ordinary shares
Purchase of ordinary shares for share schemes
* Other
* Trading cash flow
Net defined benefit plans – underlying operating charge
2017
£m
£m
1,071
2016
£m
£m
813
Source
450
430
–
(6)
(129)
(235)
(6)
946
(173)
(6)
(973)
(773)
14
475
24
(124)
(104)
(3)
104
11
(52)
58
(488)
34
(4)
7
4
(48)
(53)
–
21
(24)
745
426
628
(219)
–
(115)
(161)
–
288
(162)
67
720
Cash flow statement (CFS)
CFS
Reversal of adjustment in underlying PBT
Reversal of adjustment in underlying PBT
Reversal of adjustment in underlying PBT
CFS
Reversal of underlying impairment (included in
£12m impairment of assets)
CFS
Reported to underlying adjustment (note 2)
Reversal of adjustment in underlying PBT
526
32
(631)
(585)
15
(1,732)
(1,201)
426
–
77
(129)
(1)
102
5
(43)
44
(446)
35
–
8
8
(30)
(72)
(4)
1
(21)
CFS
CFS
CFS
Reversal of adjustment in underlying PBT
Reversal of adjustment in underlying PBT
Reversal of adjustment in underlying PBT
Reversal of adjustment in underlying PBT
Reversal of adjustment in underlying PBT
Reversal of charge in underlying PBT
CFS
Joint ventures dividends less share of results –
CFS
CFS
Reported to underlying adjustment (note 2)
CFS
CFS
CFS
CFS
CFS
Interest received and paid – CFS
Net cash and borrowings reclassified – CFS
CFS
CFS
(162)
448
(40)
324
240
204
CFS
(271)
(249)
Cash funding of defined benefit plans
* Contributions to defined benefit schemes
in excess of underlying PBT charge
* Tax
* Free cash flow
* Shareholder payments
* Payments of penalties to investigating authorities
* Acquisition of ITP Aero
* Other acquisitions and disposals
Other
* Foreign exchange
* Change in net funds
This table shows the derivation of the summary funds flow statement (lines marked *) on page 51 from the cash flow statement on page 119.
(9)
(180)
259
(214)
(286)
229
(17)
8
(59)
(80)
(67)
(157)
100
(301)
–
–
(153)
–
240
(114)
Redemption of C Shares – CFS
CFS
CFS
CFS
CFS
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
169
26 Derivation of summary funds flow statement continued
Free cash flow is a measure of financial performance of the business’s cash flow to see what is available for distribution among those
stakeholders funding the business (including debt holders and shareholders). Free cash flow is calculated as trading cash flow less
recurring tax and post-employment benefit expenses excluding capital expenditures, payments made to shareholders, amounts spent
(or received) on business acquisitions and foreign exchange changes on net funds. The Board considers that free cash flow reflects
cash generated from the Group’s underlying trading.
Reported operating profit
Realised losses on hedging instruments
Net unrealised fair value to changes to derivatives
Foreign exchange on contract accounting
Revaluation of trading assets and liabilities
Effect of acquisition accounting
UK pension restructuring
Impairments
Exceptional restructuring
Accrual for deferred prosecution agreement penalties
Other
Adjustments to reported operating profit
Underlying profit before financing
Underlying financing
Underlying profit before tax
2017
£m
£m
1,287
2016
£m
£m
44
(475)
(24)
124
6
129
–
24
104
–
–
(426)
–
(77)
(67)
115
306
219
129
671
1
(112)
1,175
(104)
1,071
871
915
(102)
813
Source
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Reported to underlying adjustment (note 2)
Underlying income statement (note 2)
The table below shows a reconciliation of free cash flow to the change in cash and cash equivalents presented in the Consolidated Cash
Flow Statement.
Change in cash and cash equivalents
Returns to shareholders
Net cash flow from changes in borrowings and finance leases
Increase/decrease in short-term investments
Acquisition of business
Consolidation of previously unconsolidated subsidiary
Increase in share in joint ventures
Debt of joint ventures reclassified as joint operations
Disposal of other businesses
Changes in group structure
Payment of deferred prosecution agreement penalties
Other
Free cash flow
Exclude cash outflow of ITP Aero
Free cash flow excluding ITP Aero
2017
£m
(263)
(1)
–
–
–
£m
231
214
(200)
–
(264)
286
(8)
259
14
273
2016
£m
6
–
154
(9)
(7)
£m
(691)
301
345
1
144
−
−
100
–
100
FINANCIAL STATEMENTS
170
Financial Statements
Notes to the Consolidated Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
27 Impact of IFRS 15
The segmental analysis shown in note 2 would have been as follows if prepared under the IFRS 15 policies set out in note 1:
Civil
Aerospace
£m
Defence
Aerospace
£m
Power
Systems
£m
Marine
£m
Nuclear
£m
Inter-
segment
£m
Total
reportable
segments
£m
Year ended 31 December 2017
Underlying revenue from sale of original equipment
Underlying revenue from aftermarket services
Total underlying revenue at 2016 exchange rates
Translation to 2017 exchange rates
Total underlying revenue at 2017 exchange rates
Gross profit
Commercial and administrative costs
Research and development costs
Share of results of joint ventures and associates
Underlying operating profit/(loss) at 2016 exchange
rates
Translation to 2017 exchange rates
Underlying operating profit/(loss) at 2017 exchange
rates
2017 accounting policies
2,862
3,671
6,533
80
6,613
350
(370)
(442)
109
(353)
23
911
1,287
2,198
84
2,282
551
(126)
(77)
7
355
15
1,825
896
2,721
198
2,919
786
(310)
(165)
(3)
308
23
(330)
370
331
539
476
1,015
60
1,075
213
(193)
(44)
–
(24)
(2)
(26)
Total underlying revenue
Underlying operating profit
8,023
520
2,275
374
2,923
330
1,077
(25)
377
430
807
11
818
131
(71)
(23)
–
37
1
38
818
38
(27)
(37)
(64)
(5)
(69)
–
–
–
–
–
–
–
6,487
6,723
13,210
428
13,638
2,031
(1,070)
(751)
113
323
60
383
(70)
–
15,046
1,237
Reconciliation to reported results
Year ended 31 December 2017
Revenue from sale of original equipment
Revenue from aftermarket services
Total revenue at 2016 exchange rates
Translation to 2017 exchange rates
Total revenue at 2017 exchange rates
Gross profit
Commercial and administrative costs
Research and development costs
Share of results of joint ventures and associates
Operating profit/(loss) at 2016 exchange rates
Translation to 2017 exchange rates
Operating profit/(loss) at 2017 exchange rates
Gains arising on the acquisition of ITP Aero
Profit/(loss) before financing and taxation
Net financing
Profit/(loss) before taxation
Taxation
Profit for the year
Total
reportable
segments
£m
Other
businesses
and corporate
£m
Total
underlying
£m
Underlying
adjustments
and foreign
exchange
£m
Group at actual
exchange
rates
£m
Group at actual
exchange
rates - 2017
accounting
policies
£m
6,487
6,723
13,210
428
13,638
2,031
(1,070)
(751)
113
323
60
383
–
383
22
20
42
2
44
4
(54)
–
(10)
(60)
(2)
(62)
–
(62)
(112)
(174)
(166)
6,509
6,743
13,252
430
13,682
2,035
(1,124)
(751)
103
263
58
321
–
321
(112)
209
(166)
43
771
775
1,546
(430)
1,116
244
(98)
(83)
29
92
(58)
34
798
832
2,966
3,798
(381)
3,417
7,280
7,518
14,798
–
14,798
2,279
(1,222)
(834)
132
355
–
355
798
1,153
2,854
4,007
(547)
3,460
8,090
8,217
16,307
–
16,307
3,173
(1,222)
(795)
131
1,287
–
1,287
798
2,085
2,812
4,897
(689)
4,208
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Notes to the Consolidated Financial Statements
171
27 Impact of IFRS 15 continued
Underlying adjustments
Underlying performance
Revenue recognised at exchange rate on date of transaction
Realised (gains)/losses on settled derivative contracts
Net unrealised fair value changes to derivative contracts
Effect of currency on contract accounting
Revaluation of trading assets and liabilities
Financial RRSAs – foreign exchange differences and
changes in forecast payments
Effect of acquisition accounting
Impairment of assets
Net post-retirement scheme financing
Exceptional restructuring
Gains arising on the acquisition of ITP Aero
Consolidation of previously non-consolidated subsidiary
Other
Recognition of advance corporation tax
Reduction in corporate tax rates
Total underlying adjustments
Reported per consolidated income statement
2017
Profit before
financing
£m
321
–
453
24
(180)
(6)
–
(129)
(12)
–
(104)
798
(12)
–
–
–
832
1,153
Revenue
£m
13,682
1,116
–
–
–
–
–
–
–
–
–
–
–
–
–
–
1,116
14,798
Net
financing
£m
(112)
–
195
2,648
–
113
11
–
–
1
–
–
–
(2)
–
–
2,966
2,854
Taxation
£m
(166)
–
(111)
(463)
21
(12)
(3)
35
–
(1)
31
–
–
9
163
(50)
(381)
(547)
As processes and procedures are further embedded during 2018, it is possible that some changes to the information above may result.
FINANCIAL STATEMENTS 172
Financial statements
Company Balance Sheet
Company Statement of Changes in Equity
Rolls-Royce Holdings plc Annual Report 2017
Company Balance Sheet
At 31 December 2017
Assets
Non-current assets
Investments – subsidiary undertakings
Current assets
Trade and other receivables
Cash and cash equivalents
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
2017
£m
2016
£m
2
12,076
12,046
371
2
373
–
–
–
12,449
12,046
(28)
(1,794)
(1,822)
(28)
(1,204)
(1,232)
10,627
10,814
368
195
6,843
2,216
186
819
10,627
367
181
7,058
2,001
156
1,051
10,814
3
4
The Financial Statements on pages 172 to 174 were approved by the Board on 6 March 2018 and signed on its behalf by:
Warren East
Chief Executive
Stephen Daintith
Chief Financial Officer
Company’s registered number: 7524813
Company Statement of Changes in Equity
For the year ended 31 December 2017
At 1 January 2017
Profit for the year
Shares issued to share trust
Issue of C Shares
Redemption of C Shares
Share-based payments – direct to equity
At 31 December 2017
Attributable to ordinary shareholders
Share
capital
£m
367
–
1
–
–
–
368
Share
premium
£m
181
–
14
–
–
–
195
Merger
reserve
£m
7,058
–
–
(215)
–
–
6,843
Capital
redemption
reserve
£m
2,001
–
–
–
215
–
2,216
Other
reserve 1
£m
156
–
–
–
–
30
186
Retained
earnings
£m
1,051
–
–
–
(215)
(17)
819
Total
equity
£m
10,814
–
15
(215)
–
13
10,627
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 2017
Financial statements
Notes to the Company Financial Statements
173
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.
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 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.
– Comparative period reconciliations for share capital.
– The effects of new, but not yet effective accounting standards.
– The requirements of IAS 24 Related Party Transactions and has, therefore, not disclosed transactions between the Company and
its wholly-owned subsidiaries.
The accounting policies set out below have, unless otherwise stated, been applied consistently to all periods presented in these
Financial Statements.
There were no changes to accounting standards that had a material impact on the 2017 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 89 to 90, 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 2017
Cost of share-based payments in respect of employees of subsidiary undertakings
less receipts from subsidiaries in respect of those payments
At 31 December 2017
The subsidiary and joint venture undertakings are listed on pages 175 to 182.
3 Financial liabilities
C Shares
Movements during the year of issued and fully paid C Shares were as follows:
At 1 January 2017
Shares issued
Shares redeemed
At 31 December 2017
The rights attaching to C Shares are set out on page 198.
£m
12,046
30
12,076
C Shares
of 0.1p
millions
28,125
215,235
(214,931)
28,429
Nominal
value
£m
28
215
(215)
28
FINANCIAL STATEMENTS 174
Financial statements
Notes to the Company Financial Statements
Rolls-Royce Holdings plc Annual Report 2017
4 Share capital
Issued and fully paid
At 1 January 2017
Shares issued to share trust
At 31 December 2017
Non-equity
Equity
Special
Share
of £1
Preference
shares of
£1 each
Nominal
value
£m
1
–
1
–
–
–
–
–
–
Ordinary
shares of
20p each
Millions
1,838
2
1,840
Nominal
value
£m
367
1
368
The rights attaching to each class of share are set out on page 198.
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 2017, these guarantees amounted to £2,930m (2016: £2,735m).
6 Other information
Emoluments of directors
The remuneration of the Directors of the Company is shown in the Directors’ remuneration report on pages 87 to 90.
Employees
The Company had no employees in 2017.
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 2017
Financial Statements
Subsidiaries
175
Subsidiaries
As at 31 December 2017, the companies listed below and on the following pages are indirectly held by Rolls-Royce Holdings plc except
Rolls-Royce Group plc which is 100% directly owned by Rolls-Royce Holdings plc. The financial year end of each company is 31 December
unless otherwise indicated.
Company name
A.F.C. Wultex Limited *
A.P.E. - Allen Gears Limited *
Aeromaritime America, Inc.
Aeromaritime Mediterranean Limited
Allen Power Engineering Limited *
Amalgamated Power Engineering Limited *
Address
Derby 1
Derby 1
M&H Agent Services, Inc., 1850 North Central Avenue, Suite 2100,
Phoenix, Arizona 85004, United States
7 Industrial Estate, Hal Far, Birzebbuga, BBG 3000, Malta
Derby 1
Derby 1
AMTEC Corporation
AMTEC On Wing Support, LLC
Corpdirect Agents, Inc., 160 Greentree Drive, Suite 101, Dover,
Delaware 19904, United States
8081 NW 31st Street, Miami, Florida 33152, United States
Bergen Engines AS
Bergen Engines Bangladesh Private Limited Green Granduer, 6th Floor, Plot no.58 E, Kamal Ataturk Avenue
Hordvikneset 125, N-5108, Hordvik, Bergen 1201, Norway
Bergen Engines BV
Bergen Engines Denmark A/S
Bergen Engines India Private Limited 3
Bergen Engines Limited
Bergen Engines PropertyCo AS
Bergen Engines S.L.
Bergen Engines S.r.l.
Bristol Siddeley Engines Limited *
Brown Brothers & Company Limited *
C.A. Parsons & Company Limited *
Celsius Amtec Corporation
Celsius SPV I, Inc.
Celsius SPV II, Inc.
Composite Technology and
Applications Limited
Data Systems & Solutions, LLC
Banani, C/A Dhaka, 1213, Bangladesh
Werfdijk 2, 3195HV Pernis, Rotterdam, Netherlands
Værftsvej 23, DK-9000 Ålborg, Denmark
52-b, 2nd Floor, Okhla Industrial Estate, Phase III,
New Delhi 110020, India
Derby 1
Hordvikneset 125, N-5108, Hordvik, Bergen 1201, Norway
Calle Dinamarca s/n (esquina Calle Alemania), Poligono
Industrial de Constanti, 43120 Constanti, Tarragona, Spain
Via Castel Morrone 13, 16161, Genoa, Italy
Derby 1
Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline,
Fife, KY11 9JT, Scotland
Derby 1
Corpdirect Agents, Inc., 1200 South Pine Island Road, Miami,
Florida 33324, United States
The Corporation Trust Company, Corporation Trust Center, 1209
Orange Street, Wilmington, Delaware 19801, United States
The Corporation Trust Company, Corporation Trust Center, 1209
Orange Street, Wilmington, Delaware 19801, United States
Derby 1
Wilmington 2
Deeside Titanium Limited *
Derby Cogeneration Limited *
Derby Specialist Fabrications Limited *
Europea Microfusioni Aerospaziali S.p.A.
Fluid Mechanics LLC
Derby 1
Derby 1
Derby 1
Zona Industriale AS1, 83040 Morra de Sanctis, Avellino, Italy
Wilmington 2
Heartlands Power Limited *
Heaton Power Limited *
Industria de Tuberías Aeronáuticas
México S.A. de C.V.
Industria de Tuberías Aeronáuticas S.A.U.
Industria de Turbo Propulsores S.A.
ITP Engines UK Limited
ITP Externals India Private Ltd
ITP Externals S.L.U.
Derby 1
Derby 1
Acceso IV, No.6B, Zona Industrial Benito Juárez, Querétaro,
76120, Mexico
Pabellón Industrial, Torrelarrgoiti, Parcela 5H, Naves 7 a 10,
Zamudio, Spain
Parque Technológico Edificio 300, 48170 Zamudio, Vizcaya, Spain Ordinary
Ordinary
The Whittle Estate, Cambridge Road, Whetstone, Leicester,
LE8 6LH, England
Plot 60/A, IDA Gandhi Nagar, Hyderabad, 500037, India
Pabellón Industrial, Polígono Ugaldeguren I, PIIIA,
Pab 1-2 Zamudio, Spain
Ordinary
Ordinary
Ordinary
* Dormant entity.
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
Class
of shares
Ordinary
Ordinary
Common
Ordinary
Ordinary
Deferred
Ordinary
Common
Partnership
(no equity)
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Social
Participation
Social Capital
Ordinary
Ordinary
Ordinary
Common
Common
Common
Ordinary
Partnership
(no equity)
Ordinary
Ordinary
Ordinary
Ordinary
Partnership
(no equity)
Ordinary
Ordinary
Class A
% of
class
held
90
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
82.5
100
100
100
100
100
100
100
100
100
100
100
100
FINANCIAL STATEMENTS 176
Financial Statements
Subsidiaries
Rolls-Royce Holdings plc Annual Report 2017
Capital Stock
100
6% Cumulative
Preference
Ordinary
Ordinary
Ordinary
Quotas
Ordinary
Capital Stock
Capital Stock
Capital Stock
Capital Stock
Capital Stock
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Company name
ITP Ingeniería y Fabricación S.A. de C.V.
ITP México S.A. de C.V.
ITP México Fabricación S.A. de C.V.
ITP Next Generation Turbines S.L.U.
John Thompson Cochran Limited *
Address
Acceso IV, No.6D, Zona Industrial Benito Juárez, Querétaro,
76120, Mexico
Acceso IV, No.6, Zona Industrial Benito Juárez, Querétaro,
76120, Mexico
Acceso IV, No.6, Zona Industrial Benito Juárez, Querétaro,
76120, Mexico
Parque Technológico Edificio 300, 48170 Zamudio, Vizcaya, Spain Ordinary
Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Fife,
KY11 9JT, Scotland
Class
of shares
Class A
Class B
Class A
Class B
Class A
John Thompson Limited *
Kamewa AB *
Kamewa do Brazil Equipmentos
Maritimos Limitada
Kamewa Holding AB *
Karl Maybach-Hilfe GmbH
L'Orange Fuel Injection (Ningbo) Co, Limited #3 Hall, No.55 South Qihang Road, Yinzhou Economic
Derby 1
Box 1010, S-68129, Kristinehamn, Sweden
401 Rua Visconde de Pitaja 433, Rio de Janeiro, Brazil
Box 1010, S-68129, Kristinehamn, Sweden
Maybachplatz 1, 88045, Friedrichshafen, Germany
L'Orange Fuel Injection Trading
(Suzhou) Co. Limited
L'Orange GmbH
L'Orange Unterstützungskasse GmbH
MTU Africa (Proprietary) Limited
MTU America Inc.
MTU Asia PTE Limited
MTU Benelux B.V.
MTU China Company Limited
Development Zone, Ningbo City, 315145, China
Suite 306, 23-B Times Square, Huachi Street, SIP Suzhou 215021,
China
Porschestrasse 8, 70435, Stuttgart, Germany
Rudolph-L'Orange-Strasse 1, 72293 Glatten, Germany
Corner Marconi Road and 3rd Street, Montague Gardens,
Western Cape, 7441, South Africa
Wilmington 2
10 Tukang Innovation Drive, Singapore 618302
Merwedestraat 86, 3313 CS, Dordrecht, Netherlands
Room 1801-1803 18/F Ascendas Plaza, No.333 Tian Qiao Road, Xuhai
Distrcit, Shanghai, 200030, China
Via Anhanguera, KM 29203, 05276-000 Sao Paulo - SP, Brazil
MTU do Brasil Limitada
MTU Engineering (Suzhou) Company Limited 9 Long Yun Road, Suzhou Industrial Park, Suzhou 215024,
MTU France S.A.S.
MTU Friedrichshafen GmbH
MTU Hong Kong Limited
MTU Ibérica Propulsión y Energia S.L.
MTU India Private Limited 3
MTU Israel Limited
MTU Italia S.r.l.
MTU Japan Co. Limited
MTU Korea Limited
MTU Middle East FZE
MTU Motor Türbin Sanayi ve Ticaret. A.Ş.
MTU Onsite Energy GmbH
MTU Onsite Energy Systems GmbH
MTU Polska Sp. z o.o.
MTU Reman Technologies GmbH
MTU Rus Limited Liability Company
Capital Stock
Ordinary
Ordinary
Ordinary
Ordinary
Jiang Su, China
8/10 rue Rosa Luxembourg-Parc des Bellevues, Immeuble Colorado
95610 Erangy-sur-Oise, France
Maybachplatz 1, 88045, Friedrichshafen, Germany
Room 1006, 10/F, Hang Seng Tsimshatsui Building, 18 Carnarvon
Road, Tsimshatsui, Kowloon, Hong Kong
Calle Copérnico 26-28, 28823 Coslada, Madrid, Spain
HM Geneva House, Unit No.303, 3rd Floor, No.14
Cunningham Road, Bangalore, KA 560052, India
4 Ha’Alon Street, South Building, Third Floor,
4059300 Kfar Neter, Israel
Via Aurelia Nord, 328, 19021 Arcola (SP), Italy
Resorttrust Building 4-14-3, Nishitenma Kita-ku, Osaka, Japan
23rd Floor, Olive Tower, 41 Sejongdaero 9 gil, Junggu,
100-737 Seoul, Republic of Korea
S3B5SR06, Jebel Ali Free Zone, P.O. Box 61141, Dubai,
United Arab Emirates
Hatira Sokak, No. 5, Ömerli Mahellesi, 34555 Arnavutköy,
Istanbul, Turkey
Dasinger Strasse 11, 86165, Augsburg, Germany
Rotthofer Strasse 8, 94099 Ruhstorf a.d. Rott, Germany
Ul. Śląska, Nr 9. Raum, Ort: Stargard Szczeciński, Plz: 73-110, Poland Ordinary
Friedrich-List-Strasse 8, 39122 Magdeburg, Germany
Shabolovka Street 2, 119049, Moscow, Russian Federation
Ordinary
Ordinary
Ordinary
Capital Stock
Capital Stock
Capital Stock
Ordinary
Capital Stock
Ordinary
Ordinary
* Dormant entity.
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
% of
class
held
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
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Subsidiaries
177
Company name
MTU South Africa (Proprietary) Limited
MTU UK Limited
Navis Consult d.o.o.
NEI International Combustion 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
PKMJ Technical Services, Inc.
Power Jets
(Research and Development) Limited *
Powerfield Limited *
Precision Casting Bilbao S.A.U.
Prokura Diesel Services (Proprietary) Limited * Corner Marconi Road and 3rd Street, Montague Gardens,
Address
Corner Marconi Road and 3rd Street, Montague Gardens,
Western Cape, 7441, South Africa
Derby 1
Ul. Bartola Kašića 5/4, HR-51000, Rijeka, Croatia
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Maison Trinity, Trinity Square, St. Peter Port, GY1 4AT, Guernsey
Wilmington 2
The Whittle Estate, Cambridge Road, Whetstone, Leicester,
LE8 6LH, England
Derby 1
Calle El Barracón 1, Baracaldo, Spain
Class
of shares
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
PT MTU Indonesia
PT Rolls-Royce
Rallyswift Limited *
Reyrolle Belmos Limited *
Rolls-Royce (Ireland) Unlimited Company *
Rolls-Royce (Thailand) Limited
Rolls-Royce AB
Rolls-Royce Aero Engine Services Limited *
Rolls-Royce Asia Limited
Rolls-Royce Australia Pty Limited
Rolls-Royce Australia Services Pty Limited
Rolls-Royce Brasil Limitada
Rolls-Royce Canada Limited
Rolls-Royce Civil Nuclear Canada Limited
Ordinary
Ordinary
Ordinary
Ordinary
Western Cape, 7441, South Africa
Secure Building Blok B, Jl. Raya Protokol Halim,
Perdanakusuma, Jakarta, 13610, Indonesia
Mid Plaza 2 , Lantai 16 Jl. Jenderal Sudirman 10-11, Jakarta,
Pusat, 10220, Indonesia
Derby 1
Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline,
Fife, KY11 9JT, Scotland
Ulster International Finance, 1st Floor IFSC House, IFSC,
Dublin 1, Ireland
900, 11th Floor Tonson Tower, Ploenchit Road, Lumpini,
Pathumwan, Bangkok, Thailand
Box 1010, S-68129, Kristinehamn, Sweden
Derby 1
G/F, No 1-3 Wing Yip Street, Kwai Chung, New Territories,
Hong Kong
Suite 102, 2-4 Lyonpark Road, Macquarie Park, NSW 2113, Australia Ordinary
Suite 102, 2-4 Lyonpark Road, Macquarie Park, NSW 2113, Australia Ordinary
Rua drive Cincinato Braga No. 47, Planalto District, São Bernando
do Campo, 09890-900, Brazil
9500 Côte de Liesse, Lachine, Québec H8T 1A2, Canada
597 The Queensway, Peterborough Ontario K9J 7J6, Canada
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Quotas
Rolls-Royce Civil Nuclear S.A.S.
Rolls-Royce Commercial (Beijing) Co., Limited 305-306 Indigo Building 1, 20 Jiuxianqiao Road, Beijing,
23 chemin du Vieux Chêne, 38240, Meylan, France
100016, China
Derby 1
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. Wilmington 2
Rolls-Royce Controls and Data Services
Limited
Derby 1
Wilmington 2
Level 7 Bayleys Building, 36 Brandon Street, Wellington, 6011,
New Zealand
Derby 1
* Dormant entity.
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
Common Stock
Class A
Preferred
Common Shares
Ordinary
Registered
Capital
Ordinary
Common Stock
Ordinary
Ordinary
Common Stock
Ordinary
% of
class
held
100
100
75
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
FINANCIAL STATEMENTS 178
Financial Statements
Subsidiaries
Rolls-Royce Holdings plc Annual Report 2017
Company name
Rolls-Royce Corporation
Rolls-Royce Côte d'Ivoire Sarl
Rolls-Royce Crosspointe LLC
Rolls-Royce de Venezuela S.A. *
Rolls-Royce Defense Products
and Solutions, Inc.
Rolls-Royce Defense Services, Inc.
Rolls-Royce Deutschland Ltd & Co KG
Rolls-Royce Energy Angola, Limitada *
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 *3
Rolls-Royce India Private Limited 3
Rolls-Royce Energy Systems Inc.
Rolls-Royce Engine Controls Holdings Limited Derby 1
Rolls-Royce Engine Services Holdings Co.
Rolls-Royce Engine Services Limitada Inc. *
Address
Wilmington 2
7 Boulevard Latrille, Abidjan-Cocody, 25 BP 945, Abidjan 25,
Côte d'Ivoire
Wilmington 2
Avenida 3E, entre Calles 78 y 79, Torre Empresarial Claret, Piso 10,
Oficina 10-3, Sector Valle Frio Maracaibo, Estado Zulia, Venezuela
Wilmington 2
Wilmington 2
Eschenweg 11, 15827 Blankenfelde-Mahlow, Germany
Rua Rei Katyavala, Edificio Rei Katyavala, Entrada B, Piso 8,
Luanda, Angola
Wilmington 2
Wilmington 2
Bldg. 06 Berthaphil Compound, Jose Abad Santos Avenue,
Clark Special Economic Zone, Clark, Pampanga, Philippines
Eschenweg 11, 15827 Blankenfelde-Mahlow, Germany
Derby 1
Wilmington 2
Derby 1
Derby 1
62 Buckingham Gate, London, SW1E 6AT, England
Corporation Service Company, 2710 Gateway Oaks Drive,
Suite 150N, Sacramento, California 95833, United States
9500 Côte de Liesse, Lachine, Québec H8T 1A2, Canada
Derby 1
Birla Tower West, 2nd Floor 25, Barakhamba Road, New Delhi,
110001, India
Derby 1
Rolls-Royce Industrial & Marine
Power Limited *
Rolls-Royce Industrial Power (India) Limited *3 Derby 1
Derby 1
Rolls-Royce Industrial Power (Overseas
Projects) Limited *
Rolls-Royce Industrial Power Engineering
(Overseas Projects) Limited
Rolls-Royce Industrial Power
Investments Limited *
Derby 1
Derby 1
Rolls-Royce Industries Limited *
Rolls-Royce International Limited
Rolls-Royce International LLC
Rolls-Royce International s.r.o.
Rolls-Royce Italia S.r.l.
Rolls-Royce Japan Co., Limited
Rolls-Royce JSF Holdings Inc.
Rolls-Royce Korea Limited
Derby 1
Derby 1
Office 41 N, Lit 32-34 Nevsky Prospect, St. Petersburg,
191186, Russia
Pobřežní 620/3, Postal code 186 00, Karlin - Prague 8,
Czech Republic
Via Castel Morrone 13, 16161, Genoa, Italy
31st Floor, Kasumigaseki Building, 3-2-5 Kasumigaseki,
Chiyoda-Ku, Tokyo, 100-6031, Japan
Wilmington 2
197 Noksan SanEop Buk-Ro (Songjeong-dong), Gangseo-gu,
Busan 46753, Republic of Korea
* Dormant entity.
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
Class
of shares
Common Stock
Ordinary
Partnership
(no equity)
Registered
Shares
Common Stock
Common Stock
Ordinary
Quota
Common Stock
Ordinary
Common Stock
Capital Stock
Capital Stock
Deferred
Ordinary
Common Stock
Ordinary
Ordinary
Ordinary
Ordinary
Common C
Ordinary
Equity
Ordinary
Ordinary
Ordinary
Ordinary
2.8% cumulative
redeemable
preference
4.9% cumulative
preference
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Common Stock
Ordinary
% of
class
held
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
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Subsidiaries
179
Company name
Rolls-Royce Leasing Limited
Rolls-Royce Malaysia Sdn. Bhd.
Rolls-Royce Marine A/S
Rolls-Royce Marine AS
Rolls-Royce Marine Benelux BV
Rolls-Royce Marine Chile S.A.
Rolls-Royce Marine Deutschland GmbH
Rolls-Royce Marine Electrical
Systems Limited *
Rolls-Royce Marine España 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 3
Rolls-Royce Marine Manufacturing
(Shanghai) Limited
Rolls-Royce Marine North America, Inc.
Rolls-Royce Marine Power Operations Limited Derby 1
Rolls-Royce Mexico Administration S. de R.L.
de C.V.
Rolls-Royce Mexico S. de R.L. de C.V.
Rolls-Royce Military Aero Engines Limited *3 Derby 1
Derby 1
Rolls-Royce Money Purchase Pension Plan
Limited *4
Rolls-Royce Namibia (Proprietary) Limited
Rolls-Royce New Zealand Limited
Rolls-Royce Nigeria Limited *
Address
Derby 1
Suite 13.03, 13th Floor, Menara Tan & Tan, 207 Jalan Tun Razak,
50400 Kuala Lumpur, Malaysia
Ostre Havnepromenade 34, 9000, Aalborg, Denmark
Borgundvegen 340, Ålesund, 6009, Norway
Werfdijk 2, 3195 HV Pernis, Rotterdam, Netherlands
Alcantra 200, Office 1303, Las Condes, Santiago, Chile
Fährstieg 9, 21107, Hamburg, Germany
Derby 1
Calle Dinamarca s/n (esquina Calle Alemania), Poligono
Industrial de Constanti, 43120 Constanti, Tarragona, Spain
122 avenue Charles de Gaulle, 92200 Neuilly-sur-Seine, France
25 Atki Poseidonos str. & Makrigianni str., Moschato, Athens,
GR-18344, Greece
G/F, No 1-3 Wing Yip Street, Kwai Chung, New Territories,
Hong Kong
Birla Tower West, 2nd Floor, 25 Barakhamba Road, New Delhi,
110001, India
No.1 Xuanzhong Road, Xuanqiao Town, Pudong New Area,
Shanghai, 201399, China
Wilmington 2
Boulevard Adolfo Ruiz Cortinez 3642-403, Fracc Costa de Oro,
Verzcruz CP 94299 6, Mexico
Boulevard Adolfo Ruiz Cortinez 3642-403, Fracc Costa de Oro,
Verzcruz CP 94299 6, Mexico
2nd Floor, Unit 4, LA Chambers, Ausspann Plaza, Dr Agostinho
Neto Road, Ausspannplatz, Windhoek, Namibia
Level 7 Bayleys Building, 36 Brandon Street, Wellington,
6011, New Zealand
Civic Towers, Plot GA1, Ozumba Mbadiwe Avenue,
Victoria Island, Lagos, Nigeria
Rolls-Royce North America (USA) Holdings Co.Wilmington 2
Wilmington 2
Rolls-Royce North America Holdings, Inc.
Wilmington 2
Rolls-Royce North America, Inc.
Wilmington 2
Rolls-Royce North America Ventures, Inc.
Wilmington 2
Rolls-Royce North American Technologies,
Inc.
Rolls-Royce Nuclear Field Services
France S.A.S.
Rolls-Royce Nuclear Field Services, Inc.
Rolls-Royce Oman LLC
ZA Notre-Dame, 84430, Mondragon, France
Corporation Service Company, 80 State Street, Albany, New York
12207, United States
Bait Al Reem, Business Office #131, Building No 81, Way No 3409,
Block No 234, Al Thaqafa Street, Al Khuwair, PO Box 20,
Postal Code 103, Oman
Class
of shares
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Common Stock
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Common Stock
Common Stock
Common Stock
Common Stock
Common Stock
Ordinary
% of
class
held
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
Common Stock
100
Cash shares
100
Rolls-Royce Operations (India) Private Limited Birla Tower West, 2nd Floor, 25 Barakhamba Road, New Delhi,
Ordinary
Rolls-Royce Overseas Holdings Limited
Rolls-Royce Overseas Investments Limited
Rolls-Royce Oy Ab
Rolls-Royce Placements Limited
110001, India
Derby 1
Derby 1
P.O. Box 220, Suojantie 5, 26101, Rauma, Finland
Derby 1
Ordinary
Ordinary
A shares
Ordinary
100
100
100
100
100
* Dormant entity.
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
4 Reporting year end is 28 February.
FINANCIAL STATEMENTS 180
Financial Statements
Subsidiaries
Rolls-Royce Holdings plc Annual Report 2017
Company name
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
Rolls-Royce Saudi Arabia Limited
Rolls-Royce Singapore Pte. Limited
Rolls-Royce Technical Support Sarl
Rolls-Royce Total Care Services Limited
Rolls-Royce Turkey Power Solutions Industry
and Trade Limited
Rolls-Royce UK Pension Fund
Trustees Limited *
Rolls-Royce Vietnam Limited
Rolls-Royce Zweite Beteiligungs GmbH
Ross Ceramics Limited
Scandinavian Electric Gdansk Sp. z.o.o.
Scandinavian Electric Systems do Brazil
Limitada *
Sharing in Growth UK Limited **
Spare IPG 15 Limited *
Spare IPG 18 Limited *
Spare IPG 20 Limited *
Spare IPG 21 Limited *
Spare IPG 24 Limited *
Spare IPG 27 Limited *
Address
62 Buckingham Gate, London, SW1E 6AT, England
Gniew 83-140, ul. Kopernika 1, Poland
Derby 1
Derby 1
Maybachplatz 1, 88045, Friedrichshafen, Germany
PO Box 88545, Riyadh, 11672, Saudi Arabia
1 Marina Boulevard, #28-00 One Marina Boulevard, 018989,
Singapore
Centreda I, Avenue Didier Daurat, 31700 Blagnac,
Toulouse, France
Derby 1
Meclis-i Mebusan Cad No 1, Ekemen Han, 34427 Kabataş,
Istanbul, Turkey
Derby 1
Class
of shares
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Cash shares
Ordinary
Ordinary
Ordinary
Cash shares
Ordinary
Dông Xuyên Industrial Zone, Rach Dùa Ward, Vüng Tàu City,
Bà Ria-Vüng Tàu Province, Vietnam
Eschenweg 11, 15827 Blankenfelde-Mahlow, Germany
Derby 1
ul. Reja No.3, 80-404, Gdansk, Poland
Rua Sao Jose 90, salas 1406 e 1407, Centro, Rio De Janeiro, Brazil Quotas
Capital Stock
Ordinary
Ordinary
Capital Stock
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Fife,
KY11 9JT, Scotland
Spare IPG 32 Limited *
Derby 1
Spare IPG 4 Limited *
The Bushing Company Limited *
Timec 1487 Limited *
Trigno Energy S.R.L.
Turborreactores S.A. de C.V.
Ulstein Holding AS
Ulstein Maritime Limited *
Vessel Lifter, Inc. *
Vickers Pension Trustees Limited *3
Vinters Defence Systems Limited *
Vinters Engineering Limited
Vinters International Limited
Vinters Limited
Vinters-Armstrongs (Engineers) Limited *
Vinters-Armstrongs Limited *
Wultex Machine Company Limited *
Derby 1
Derby 1
Derby 1
Zona Industriale, San Salvo, 66050, Italy
Acceso IV, No.6, Zona Industrial Benito Juárez, Querétaro,
76120, Mexico
Sjøgata 80, 6065 Ulsteinvik, Norway
96 North Bend Street, Coquitlam, British Columbia V3K 6H1,
Canada
Corporation Service Company, 1201 Hays Street, Tallahassee,
Florida 32301, United States
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
Derby 1
* Dormant entity.
** The entity is not included in the consolidation as Rolls-Royce plc does not have a beneficial interest in the net assets of the entity.
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
% of
class
held
100
99.9
100
100
100
100
100
100
100
100
100
100
100
100
67
66
100
100
90
100
100
100
100
100
100
100
100
100
100
100
100
100
100
100
Limited by
guarantee
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
7% Cumulative
Preference
Ordinary
7.25%
Cumulative
Preference
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Class A
Class B
Ordinary
Common
Common Stock
100
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary
Ordinary B
Ordinary
100
100
100
100
100
100
100
100
Rolls-Royce Holdings plc Annual Report 2017
Financial Statements
Joint Ventures and Associates
181
Joint Ventures and Associates
Address
18 Boulevard Louis Sequin, 92700 Colombes, France
Adelheidstrasse 40, D-88046, Friedrichshafen, Germany Capital Stock
Class
of shares
Ordinary
% of
class held
50
50
Group
interest
held %
50
50
Company name
Aero Gearbox International SAS **
Aerospace Transmission Technologies
GmbH **
Airtanker Holdings Limited
Airtanker Services Limited
Alpha Leasing (US) (No.2) LLC
Airtanker Hub, RAF Brize Norton, Carterton, Oxfordshire,
OX18 3LX, England
Airtanker Hub, RAF Brize Norton, Carterton, Oxfordshire,
OX18 3LX, England
Wilmington 2
Ordinary
Ordinary
Partnership
(no equity held)
Partnership
(no equity held)
Partnership
(no equity held)
Partnership
(no equity held)
Partnership
(no equity held)
Partnership
(no equity held)
Partnership
(no equity held)
Ordinary A
Capital Stock
Limited by
guarantee
Ordinary A
Partnership
(no equity held)
Alpha Leasing (US) (No.4) LLC
Wilmington 2
Alpha Leasing (US) (No.5) LLC
Wilmington 2
Alpha Leasing (US) (No.6) LLC
Wilmington 2
Alpha Leasing (US) (No.7) LLC
Wilmington 2
Alpha Leasing (US) (No.8) LLC
Wilmington 2
Alpha Leasing (US) LLC
Wilmington 2
Alpha Partners Leasing Limited
Anecom Aerotest GmbH
CFMS Limited
62 Buckingham Gate, London, SW1E 6AT, England
122 Freiheitstrasse, Wildau, D-15745, Germany
43 Queen Street, Bristol, BS1 4QP, England
Clarke Chapman Portia Port Services
Limited
Consorcio Español para el
Desarrollo Industrial del Helicóptero
de Ataque Tigre, A.I.E.
Consorcio Español para el
Desarrollo Industrial del Programa
Eurofighter, A.I.E.
Egypt Aero Management Services
EPI Europrop International GmbH
EPIX Power Systems, LLC
Eurojet Turbo GmbH
GE Rolls-Royce Fighter Engine
Team LLC
Genistics Holdings Limited
Global Aerospace Centre for Icing
and Environmental Research Inc.
Hong Kong Aero Engine
Services Limited
Hovden Klubbhus AS
International Aerospace
Manufacturing Private Limited **3
LG Fuel Cell Systems Inc.
Light Helicopter Turbine
Engine Company
(unincorporated partnership)
MEST Co., Limited
Maritime Centre, Port of Liverpool, Liverpool, L21 1LA,
England
Avda. de Aragón 404, 28022 Madrid, Spain
Paseo de John Lennon, s/n, edificio T22, 2ª planta,
Getafe, Madrid, Spain
Partnership
(no equity held)
EgyptAir Engine Workshop, Cairo International Airport,
Cairo, Egypt
Dachauer Strasse 655, 80995, Munich, Germany
The Corporation Trust Company, 1209 Orange Street,
Wilmington, Delaware 19801, United States
Lilienthalstrasse 2b, 85399 Halbergmoos, Germany
The Corporation Trust Company, 1209 Orange Street,
Wilmington, Delaware 19801, United States
Derby 1
1000 Marie-Victorin Boulevard, Longueuil Québec
J4G 1A1, Canada
33rd Floor, One Pacific Place, 88 Queensway,
Hong Kong
Stålhaugen 5, Ulsteinvik, 6065, Norway
Survey No. 3 Kempapura Village, Varthur Hobli,
Bangalore, KA 560037, India
Wilmington 2
Suite 119, 9238 Madison Boulevard, Madison, Alabama
35758, United States
Ordinary
Capital Stock
Partnership
(no equity held)
Capital Stock
Partnership
(no equity held)
Ordinary A
Ordinary
Ordinary
Ordinary
Ordinary
Common Stock
Partnership
(no equity held)
* Dormant company.
** These entities are accounted for as joint operations (see note 1 accounting policies).
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
20
22
–
–
–
–
–
–
–
100
24.9
–
100
–
–
50
44
–
46
–
100
50
50
69
50
27
–
20
22
50
50
50
50
50
50
50
50
24.9
50
50
50
50
50
44
50
46
50
50
50
50
69
50
27
50
97 Bukjeonggongdan 2-gil, Yangsan-si,
Gyeongsangnam-do, 50571, Republic of Korea
Normal
46.8
46.8
FINANCIAL STATEMENTS 182
Financial Statements
Joint Ventures and Associates
Rolls-Royce Holdings plc Annual Report 2017
Company name
Metlase Limited
Address
Unipart House, Garsington Road, Cowley, Oxford,
OX4 2PG, England
Am Söldnermoos 17, 85399 Hallbergmoos, Germany
Am Söldnermoos 17, 85399 Hallbergmoos, Germany
MTU Turbomeca Rolls-Royce GmbH
MTU Turbomeca Rolls-Royce
ITP GmbH
MTU Yuchai Power Company Limited No 7 Danan Road, Yuzhou, Yulin, Guangxi, China,
537005, China
Gerhard-Höltje-Strasse 1, D-99310, Arnstadt, Germany
Gerhard-Höltje-Strasse 1, D-99310, Arnstadt, Germany
N3 Engine Overhaul Services
GmbH & Co KG
N3 Engine Overhaul Services
Verwaltungsgesellschaft Mbh
Offshore Simulator Centre AS
Rolls Laval Heat Exchangers Limited * Derby 1
Rolls-Royce & Partners Finance (US)
(No 2) LLC
Rolls-Royce & Partners Finance (US)
LLC
SAFYRR Propulsion Limited
Shanxi North MTU Diesel Co. Limited No.97 Daqing West Road, Datong City, Shanxi Province,
Borgundvegen 340, 6009, Ålesund, Norway
Wilmington 2
Wilmington 2
Derby 1
Singapore Aero Engine Services
Private Limited
Texas Aero Engine Services LLC
Techjet Aerofoils Limited **
China
11 Calshot Road, 509932, Singapore
The Corporation Trust Company, 1209, Orange Street,
Wilmington, Delaware 19801, United States
Tefen Industrial Zone, PO Box 16, 24959, Israel
TRT Limited
Turbine Surface Technologies
Limited **
Turbo-Union Limited
Derby 1
Derby 1
Derby 1
UK Nuclear Restoration Limited *
Viking Reisebyra AS
Xian XR Aero Components Co.,
Limited **
Booths Park, Chelford Road, Knutsford, Cheshire,
WA16 8QZ, England
Stålhaugen 10, 6065 Ulsteinvik, Norway
Xujiawan, Beijiao, Po Box 13, Xian 710021, Shaanxi,
China
* Dormant company.
** These entities are accounted for as joint operations (see note 1 accounting policies).
1 Moor Lane, Derby, DE24 8BJ, England.
2 Corporation Service Company, 251 Little Falls Drive, Wilmington, Delaware 19808, United States.
3 Reporting year end is 31 March.
Class
of shares
Ordinary B
% of
class held
100
Capital Stock
Capital Stock
33.3
50
Group
interest
held %
20
33.3
50
Capital Stock
Capital Stock
Capital Stock
Ordinary
Ordinary
Partnership
(no equity held)
Partnership
(no equity held)
B Shares
Ordinary
Ordinary
Partnership
(no equity held)
Ordinary A
Ordinary B
Ordinary B
Ordinary B
A Shares
Ordinary
Ordinary
Ordinary
Ordinary
50
50
50
25
100
–
–
100
49
50
–
50
50
100
100
37.5
40
20
50
49
50
50
50
25
50
50
50
50
49
50
50
50
49.9
50
40
20
50
49
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Independent Auditor’s Report
183
Independent Auditor’s Report
to the members of Rolls-Royce Holdings plc
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. Of the 20 key risks identified, we consider nine
(those in dark blue on the risk map) to be key audit matters.
There have been a number of changes since last year:
– During the year, the Group acquired the 53.1% of Industria
De Turbo Propulsores SA (ITP Aero) that it did not already own
and the risks relating to the remeasurement of the interest
already owned to fair value, the risks relating to the identification
and measurement at fair value of the acquired intangible assets
and the consequent recognition of a “bargain purchase gain”
are key risks (and a key audit matter) this year.
– The Group will adopt IFRS 15 Revenue from contracts with
customers with effect from 2018 and is disclosing the impact
in these financial statements for the first time. The risks that the
Group has not developed policies in line with the new standard,
that not all material areas of potential change have been
identified and that the policies have not been applied
appropriately are key risks (and a key audit matter) this year.
– The Group entered into deferred prosecution and leniency
agreements in connection with alleged bribery and corruption
in overseas territories in January 2017. If the Group were found
to have failed to fulfil its responsibilities under the deferred
prosecution agreements it would risk prosecution and this
would require disclosure in the financial statements. The key
risk identified last year relating to bribery and corruption has
been subsumed into a broader key risk (which is also a key audit
matter) relating to the omission of such disclosure. In addition,
the key risk identified last year relating to the disclosure of the
consequences of the investigations is no longer considered
to be a key risk.
– Over recent years, the Group has reduced the level of asset
value support provided to customers (though it continues to
provide standby credit lines to customers) and we assessed the
risk of material misstatement to have reduced to such an extent
that this key risk is no longer a key audit matter.
Apart from this, the key risks are the same as in the previous year.
Finally, following changes to auditing standards, we have included
a key audit matter relating to the recoverability of the parent
Company’s investment in its subsidiaries.
1 Our opinion is unmodified
We have audited the financial statements of Rolls-Royce Holdings plc
(“the parent Company”) for the year ended 31 December 2017 which
comprise the Consolidated Income Statement, the Consolidated
Statement of Comprehensive Income, the Consolidated Balance
Sheet, the Consolidated Cash Flow Statement, the Consolidated
Statement of Changes in Equity, and the related notes, including
the accounting policies in Note 1, and the Company Balance Sheet,
Company Statement of Changes in Equity, and the related notes,
including the accounting policies in Note 1.
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 2017 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;
– 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.
Basis for opinion
We conducted our audit in accordance with International Standards
on Auditing (UK) (“ISAs (UK)”) and applicable law. Our responsibilities
are described below. We believe that the audit evidence we have
obtained is a sufficient and appropriate basis for our opinion. Our
audit opinion is consistent with our report to the Audit Committee.
We were appointed as auditor by the directors for the year ending
31 December 1990. The period of total uninterrupted engagement
is for the 28 financial years ended 31 December 2017. This is my
fifth year as Senior Statutory Auditor. We have fulfilled our ethical
responsibilities under, and we remain independent of the Group
in accordance with, UK ethical requirements including the FRC
Ethical Standard as applied to listed public interest entities. No
non-audit services prohibited by that standard were provided.
2 Key audit matters: our assessment of risks
of material misstatement
Key audit matters are those matters that, in our professional
judgement, were of most significance in the audit of the financial
statements and include the most significant assessed risks of
material misstatement (whether or not due to fraud) identified by us,
including those which had the greatest effect on: the overall audit
strategy; the allocation of resources in the audit; and directing
the efforts of the audit team. We summarise below the key audit
matters in arriving at our audit opinion above, together with our key
audit procedures to address those matters and 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. These matters were addressed, and our findings are based
on procedures undertaken, in the context of, and solely for the
purpose of, our audit of the financial statements as a whole, and in
forming our opinion thereon, and consequently are incidental to that
opinion, and we do not provide a separate opinion on these matters.
OTHER INFORMATION 184
Other Information
Independent Auditor’s Report
Rolls-Royce Holdings plc Annual Report 2017
Dynamic Audit planning tool
(Relative significance of audit risks before taking account of controls)
A The pressure on and incentives
for management to meet revenue,
profit and cash targets
s
t
n
e
m
e
t
a
t
s
i
l
a
c
n
a
n
�
n
o
t
c
a
p
m
i
E
B
A
Q
J
L
R
H
K
l
a
i
t
n
e
t
o
P
M
N
O
C
G
D
I
F
S
P
T
Likelihood of material misstatement
B The basis of accounting for
revenue and profit in the
Civil Aerospace business
C The measurement of
revenue and profit in the
Civil Aerospace business
D Recoverability of intangible assets
in the Civil Aerospace business
E Consequences of deferred
prosecution and leniency
agreements in connection with
alleged bribery and corruption
in overseas markets
F The presentation of
‘underlying profit’
G Disclosure of the effect on the
trend in profit of items which are
uneven in frequency or amount
H Gains resulting from the
acquisition of a controlling
interest in Industria De Turbo
Propulsores SA
I Disclosure of the impact of
adopting IFRS 15
J Liabilities arising from sales
financing arrangements
(see page 130)
K Measurement of revenue and
profit on long-term contracts
outside the Civil Aerospace
business (see pages 124 and 125)
L Determination of development
costs to be capitalised
(see page 124)
M The basis of accounting for
contractual aftermarket rights
(see page 122)
N Determination of the amortisation
period of development costs
and contractual aftermarket
rights (see pages 128 and 129)
O The basis of accounting for
Risk and Revenue Sharing
Arrangements (see pages 123
and 124)
P Estimating provisions for
warranties and guarantees
(see page 125)
Q Valuation of derivatives and
hedge accounting (see pages 127
and 128)
R Measurements of post-retirement
benefits (see page 125)
S Accounting for uncertain tax
positions and deferred tax assets
(see page 125)
T Valuation of goodwill (see page 124)
A The pressure on and incentives for management to meet
revenue, profit and cash targets
Refer to pages 21 to 41 (Business review) and pages 99 and 100
(Audit Committee report – Financial reporting)
The risk (Subjective estimates) – The continuing pressure on and
incentives for management to meet targets 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 forecasts,
guidance or targets. The Group’s incentive schemes include targets
related to profit and to cash generation.
The significance of this risk increased somewhat during the year
as (1) the Group has been impacted by the increasing cost and
challenge of managing significant in-service engine issues on the
Trent 1000 and Trent 900 programmes and so there could be
motivation to overstate financial performance to downplay the
impact of these on the Group and (2) there have been significant
changes in the Executive Leadership Team in the last year and so
there could be motivation to establish credibility.
Our response – Our procedures included:
– Personnel interviews: We have made specific enquiries designed
to assess whether judgements and estimates exhibited
unconscious bias or whether management had taken systematic
actions to manipulate the reported results and whether sector
management received instruction from Group to make changes
in estimates that failed to consider appropriately all relevant
information in determining the estimate;
– Test of details: Compared the results to forecasts, guidance and
targets, 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;
– Our sector experience: 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 pages 185 and 186), 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 with particular emphasis on the treatment
of the additional costs estimated to have to be incurred as a
consequence of the in-service engine issues on the Trent 1000
and Trent 900 programmes;
– when considering the risk relating to Recoverability of
intangible assets in the Civil Aerospace business ( D refer
to pages 186 and 187), we challenged, with a heightened
awareness of the possibility of unconscious or systematic bias,
the basis of cost estimates in particular those relating to the
development of the Trent 900 modifications required to give
improvements to time on wing and fuel burn; and
– Assessing transparency: When considering the risk relating
to The presentation of underlying profit ( F refer to pages 188
and 189) and the risk relating to Disclosure of the effect on the
trend in profit of items which are uneven in frequency or amount
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Independent Auditor’s Report
185
( G refer to pages 189 and 190), 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.
Our findings – Our testing did not identify any indication of
manipulation of results (2016 audit finding: none). We found the
degree of caution/optimism adopted in estimates to be balanced
overall (2016 audit finding: balanced). 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 pages 122 and 123 (Key areas of judgement – Introduction,
Contractual aftermarket rights, Linkage of OE and long-term
aftermarket contracts), page 126 (Significant accounting policies
– Revenue recognition) and pages 99 and 100 (Audit Committee
report – Financial reporting)
The risk (Accounting treatment) – 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 increased during the year as more
engines were delivered this year.
Our response – Our procedures included:
– Accounting analysis: We evaluated the appropriateness of the
accounting bases the Group applies in the Civil Aerospace
business by reference to accounting standards focusing on
the substance of the transactions.
– Assessing transparency: 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.
– Testing application: 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 and has
applied this consistently (2016 audit finding: balanced). We found
that the disclosure was ample (2016 audit finding: ample). For the
agreements entered into during this year, it was clear which
accounting basis should apply.
C The measurement of revenue and profit in the Civil Aerospace
business
Refer to pages 122 and 123 (Key areas of judgement –
Measurement of performance on long-term aftermarket contracts),
page 126 (Significant accounting policies – Revenue recognition
and TotalCare arrangements) and pages 99 and 100
(Audit Committee report – Financial reporting)
The risk (Subjective estimates) – The amount of revenue and profit
recognised in a year on the sale of engines and on 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 typically span 15-25 years and the
profitability of these arrangements typically assumes substantial
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. In addition unanticipated technical
issues can emerge without prior indication and add many hundreds
of millions of pounds to future cost estimates.
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 and the range of
acceptable of judgements are such that the cumulative profit to date
on the programs could vary by some hundreds of millions of pounds.
The Group has experienced significant in-service engine issues
on both the Trent 1000 and Trent 900 programmes. Assessing the
estimated cost of managing these issues, assessing which costs relate
to long-term aftermarket contracts and which are development
costs and assessing the extent to which the proposed engineering
solutions will improve engine performance are all significant
judgements which have a significant effect on profit recognition.
As a consequence of these in-service engine issues, the significance
of the risk has increased significantly during the year.
Our response – Our procedures included:
– Controls: 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.
– Historical comparisons and our sector knowledge: We
challenged the appropriateness of these estimates for each
programme and assessed whether or not the estimates indicated
any evidence of systematic or unconscious management bias in
the context of the heightened pressure on and incentives for
management to meet forecasts, guidance and targets discussed
above. Our challenge was based on our assessment of the
historical accuracy of the Group’s estimates in previous periods
in relation to both cost and revenue forecasts, identification and
analysis of changes in assumptions from prior periods and an
assessment of the consistency of assumptions within programmes
as well as with our sector experience.
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Our analysis of forecast revenues considered each significant
airframe that is powered by the Group’s engines. We developed
expectations of changes which were based on discussions
with commercial and operational management and 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.
Our analysis of forecast costs considered costs on both a
programme-by-programme basis and on a cross-programme basis.
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 the impact of known technical issues on cost forecasts. We
compared future cost assumptions to those adopted in the prior
year and sought explanations for these movements from financial
and operational management, corroborating to appropriate
engineering cost data. We focused on the estimates of costs
expected to be incurred to respond to the in-service engine
issues on the Trent 1000 and Trent 900 programmes.
We considered the nature of the causes of the in-service
engine issues on the Trent 1000 and Trent 900 programmes
and challenged management on its assessment of the extent to
which the proposed engineering solutions will improve engine
performance and the extent to which this assessment has been
reflected in the estimated cumulative profit on aftermarket
contracts on the affected fleets. As this assessment is dependent
on deep engineering expertise of management personnel, we
requested and received specific representations from the Board
of Directors that it was likely that the proposed engineering
solutions should improve engine performance to at least the
levels included in these accounting estimates.
– Test of details: We considered a combination of external and
internal information to determine expectations for contract
revenue and cost assumptions for each programme and
identified contracts that were outliers. We sought explanations
for these outliers and corroborated these explanations by
reference to appropriate commercial information and, where
necessary, the underlying contracts.
For all new contracts in the period we assessed whether key
contractual terms, such as the contract length, the number of
engines expected to be delivered and the flying hour rates, were
correctly reflected in the contract accounting models. We also
reviewed the contracts for unusual terms that might indicate a
cost profile different to the baseline cost assumptions for the fleet.
We also checked the mathematical accuracy of analysis of the
in-year margin impact of changes in cost and revenue estimates
on a contract by contract basis. For a sample of contracts
we obtained explanations for the changes in assumptions,
corroborating those explanations by reference to appropriate
commercial and operational data, and assessed whether any
changes identified had been reflected across other fleets
where relevant.
We considered the completeness of cost estimates for emerging
technical issues by reviewing a combination of external
information, such as air worthiness directives, and internal
information such as registers of in-flight events and
disruption indices.
We challenged the assessment of the recoverability of contract
assets by considering external customer credit ratings and
searching for any other indicators of stress amongst the
customer base. We also considered whether there were any
indicators of heightened risk over forecast revenue assumptions
by considering the recent hours flown by customers, with a
particular focus on older fleets.
– Personnel interviews: We interviewed a wide range of financial
and operational personnel to identify any factors that should be
taken into account in our analysis. In all cases we corroborated
management’s explanations, including changes in assumptions,
and evaluated these relative to our own analysis. We assessed
whether there were any indicators of bias in the explanations
provided to us by management.
Our findings – We focused our controls testing on controls that we
assessed as likely to provide effective audit evidence, largely those
relating to revenue estimates. We also considered the operation of
other controls in order to provide relevant comment to management
and the Audit Committee. We found that the remediation of control
weaknesses identified in earlier periods had been consolidated. The
scope and depth of our detailed testing and analysis was expanded
to take account of the remaining control weaknesses.
We found that the in-service issues on the Trent 1000 and Trent
900 programmes largely related to a shorter than expected life
of turbine blades. We therefore consider that the short-term costs
of monitoring the condition of these blades and replacing them
earlier than anticipated where necessary and the costs of fitting
replacement parts with longer lives (and the cost of related
disruption claims) were properly assessed as being contract costs
and that the cost of designing replacement parts with longer lives
(and associated improvements) were properly assessed as being
development costs that should be charged to the income statement
as incurred.
We found that the estimates included in the accounting for
long-term aftermarket contracts on the Trent 1000 and Trent 900
fleets affected by the in-service engine issues were balanced and
that the current level of understanding and the nature of some of
these issues are such that the estimated level of improvement in
engine performance and the estimated costs could change
significantly in the future as this understanding matures.
Our testing did not identify any indicators of management bias in
the estimation of future contract costs or revenues and verified that
refinements to estimates made during the period were justifiable
and within a range of reasonably expected outcomes. Overall, our
assessment is that the assumptions and resulting estimates resulted
in balanced (2016 audit finding: balanced) profit recognition.
D Recoverability of intangible assets (certification costs and
participation fees, development expenditure and contractual
aftermarket rights) in the Civil Aerospace business
Refer to page 124 (Key sources of estimation uncertainty –
Forecasts and discount rates), pages 128 and 129 (Significant
accounting policies – Certification costs and participation fees,
Research and development, Contractual aftermarket rights and
Impairment of non-current assets), pages 142 to 143 (Note 9 to
the financial statements – Intangible assets) and pages 99 and 100
(Audit Committee report – Financial reporting)
The risk (Forecast-based valuation) – 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.
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The significance of the risk has increased during the year due to
the substantial increase in the estimated cost of managing in-service
engine issues and developing longer-lived turbine blades (and
associated improvements) for the Trent 900 programme, which is
the programme where the intangible assets are most susceptible
to impairment.
Our response – Our procedures focused on the Trent 900
programme intangible assets and included:
– Controls: 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.
– Historical comparisons and our sector knowledge: We
challenged the appropriateness of the key assumptions in the
impairment tests (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 public data where this
was available. This assessment was also informed by discussions
with an aircraft valuation specialist engaged by the Group.
We assessed whether the valuation specialist was objective
and suitably qualified.
We also assessed whether the significant increase in the estimated
cost of managing the in-service engine issues on the Trent 900
programme indicated that management’s estimates made for the
2016 impairment test for that programme were optimistic and
whether that should impact on our assessment of estimates made
this year.
We considered the nature and causes of the in-service engine
issues on the Trent 900 programme and challenged management
on its assessment of the cost of addressing these issues and
on the extent to which the proposed engineering solutions
will improve engine performance and the extent to which this
assessment has been reflected in the estimated future cash flows
of the affected fleets. As these assessments are dependent on
deep engineering expertise of management personnel, we
requested and received specific representations from the Board
of Directors that it was likely that the proposed engineering
solutions should improve engine performance to at least the
levels included in these accounting estimates.
– Test of details: For in-service engines we compared the
assumptions in the impairment model to those that we had
verified to be appropriate in the contract accounting models
through the procedures discussed above. We compared
assumptions in the business plans to those adopted in prior
periods and for all changes we obtained explanations,
corroborating those explanations by reference to appropriate
commercial and operational data.
– Sensitivity analysis: We performed sensitivity analysis to assess
the impact of possible different assumptions related to revenue
and cost estimates including (1) increases or decreases to the
forecast period of aftermarket revenue on current in-service
engines, (2) decreases to the forecast future engine sales and (3)
increases or decreases to the forecast costs or delays in
delivering the solutions to the in-service technical issues
referred to above including any increased pay-outs under
associated guarantees to a cornerstone customer.
– Personnel interviews: We interviewed a wide range of financial
and operational personnel to identify any factors that should be
taken into account in our analysis. In all cases we corroborated
management’s explanations, including changes in assumptions,
and evaluated these relative to our own analysis. We assessed
whether there were any indicators of bias in the explanations
provided to us by management.
– Assessing transparency: 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.
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 no errors in calculations (2016 audit finding: none).
With regard to the Trent 900 programme assets, we found (1)
that the cost estimates made for the 2016 impairment test were
appropriate in hindsight, based on the emergence of the issues
late in 2016 and the data available at that time; (2) that there is no
evidence that estimates made for the 2017 impairment test were
biased; and (3) that overall the assumptions and resulting estimates
on the Trent 900 programme were mildly optimistic and that other
acceptable estimates could have led to the recognition of an
impairment (2016 audit finding: balanced). We found that the
disclosures relating to the carrying value of programme intangible
assets were proportionate in the context of a significant portion of
these assets being derecognised on adoption of IFRS 15 Revenue
from Contracts with Customers (2016 audit finding: proportionate).
E Consequences of deferred prosecution and leniency
agreements in connection with alleged bribery and
corruption in overseas markets
Refer to pages 109 (Safety & Ethics Committee report –
Ethics and compliance)
The risk (Omitted disclosure) – In January 2017, the Group entered
into deferred prosecution agreements with the UK Serious Fraud
Office (SFO) and the US Department of Justice (DoJ) and a leniency
agreement with the Brazilian Federal Prosecution Service (MPF)
(the “Agreements”) related to allegations against the Group for
making fraudulent payments to commercial intermediaries in
overseas territories. Under the Agreements, prosecution was
suspended provided that the Group fulfils certain requirements,
including the payment of a financial penalty. If the Group were found
to have failed to fulfil its responsibilities under the Agreements it
would risk prosecution and this would require disclosure in the
financial statements.
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We have read the Agreements and consider that the most relevant
circumstance that could result in the risk of prosecution would
be identification of further instances of bribery and corruption
(whether or not reported to the authorities). The Group operates
in an industry where some procurement processes are highly
susceptible to the risk of corruption. 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. In addition the Group operates in
a number of territories where the use of commercial intermediaries
is either required by the government or is common practice.
We therefore designed an approach to provide reasonable
assurance that we would identify bribery and corruption involving
commercial intermediaries that would require disclosure in the
financial statements. However, as described below reasonable
assurance is a high level of assurance. It does not guarantee that
an audit conducted in accordance with ISAs (UK) will always detect
a material misstatement when one exists. As with any audit, there
remains a higher risk of non-detection of irregularities (such as
bribery and corruption), as these may involve collusion, forgery,
intentional omissions, misrepresentations, or the override of
internal controls.
Whilst this inherent limitation is the same as that in other audits,
it should be of greater significance to the addressee of this
audit report.
This is a risk arising for the first time this year.
Our response – Our procedures included:
– Heightened scepticism and use of our anti-bribery and
corruption expertise: Throughout the audit we 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.
In particular, we communicated the risks over bribery and
corruption to our team, which included individuals with
experience relevant to considering bribery and corruption risks
in the context of an audit, and we requested our component
teams to report on any possible indications of irregularities in
this area.
– Control design: We evaluated the tone set by the Board of
Directors and the Executive Leadership Team and the Group’s
approach to managing the risk of bribery and corruption.
We evaluated and tested the Group’s policies, procedures
and controls over selection, appointment and renewal of
intermediaries, contracting with intermediaries, ongoing
management of contracts with intermediaries and payments made
to intermediaries. We observed Sector Audit Committee meetings
at which lists of payments were reviewed for completeness.
We evaluated internal audits covering payments to intermediaries
and we compared the results of the internal audits to the results of
our testing of payments described below. We also made enquiries
of the Group’s central compliance function and reviewed their
reporting to the Safety & Ethics Committee and to the Sector
Audit Committees in connection with the identification of and
response to suspected breaches of policy.
– Test of details: We sought to identify payments made to
commercial intermediaries during the year using data analysis
techniques. This included (1) searching for transaction details
which included specific terms or names of organisations that
in our experience could be associated with potential payments
to commercial intermediaries, or the names of commercial
intermediaries that had been rejected through the Group’s
selection process or had been identified during the
investigations by the DoJ, SFO and MPF and (2) extracting details
of transactions that had been recorded in accounts that were
intended to record payments to commercial intermediaries.
For a sample of these transactions, we then tested whether the
identified transactions had been subject to the Group’s controls
over approval of payments made to commercial intermediaries
including whether the organisations to which payments were
made had been subject to the Group’s controls over the
appointment and renewal of commercial intermediaries.
– Enquiry of lawyers: Having enquired of management, including
the Head of Ethics and Compliance and the Group General
Counsel, the Audit Committee and the Board of Directors 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 and also to enquire whether they were
aware of any matters relating to the Group’s compliance with
the Agreements.
– Compliance report scrutiny: We reviewed the compliance
reports required to be made to the DoJ and the SFO under
the Agreements and to other authorities and vouched the status
of matters documented in these reports to further support where
objectively verifiable.
Our findings – We did not identify any breaches of the requirements
of the Agreements, payments of bribes or other corrupt behaviour
that would result in omitted disclosure in the financial statements.
Presentation and explanation of results
Refer to pages 21 to 41 (Business review), pages 16 to 19 and 50
to 54 (Financial review), pages 132 to 136 (Note 2 to the financial
statements – Segmental analysis) and pages 99 and 100
(Audit Committee report – Financial reporting)
F The presentation of ‘underlying profit’
The risk (Presentation appropriateness) – 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 134 and 135.
A significant recurring adjustment between the Adopted IFRS
financial information and the ‘underlying’ financial information
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 a proportion of
forecast transactions denominated in foreign currencies (with the
aim of having transactions denominated in foreign currencies in
the current period fully hedged) but does not apply hedge
accounting in its Adopted IFRS financial information for these
transactions. The ‘underlying’ financial information translates
transactions denominated in foreign currencies 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.
Management bias in the selection of the settled forward foreign
exchange contracts could distort the performance of the Group.
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In addition, adjustments are made to exclude one-off past-service
costs on post-retirement schemes, the cost of restructuring
programmes that involve the substantial closure or exit from a site,
facility or line of business or other major transformation activities,
the effect of acquisition accounting (including any subsequent
impairments of goodwill or other intangible assets), gains or losses
on the sale of businesses and a number of other items.
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.
Alternative performance measures (such as the ‘underlying’
financial information) 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/or presented, these kinds of measures might prevent the
Annual Report being fair, balanced and understandable by hiding
the real financial position and results or by distorting the apparent
profitability of the Group.
The significance of this risk has decreased this year following
the inclusion of somewhat improved disclosure of the nature
and amounts of the adjustments between Adopted IFRS and
underlying measures in the 2016 and 2017 Annual Reports.
Our response – Our procedures included:
– Assessing principles: We assessed the appropriateness of the
basis for the adjustments between the Adopted IFRS income
statement and the ‘underlying’ income statement.
– Assessing application: We assessed 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.
– Assessing transparency: 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 (2016 audit finding:
proportionate (and somewhat improved)). We found the overall
presentation of the ‘underlying’ financial information to be
balanced (2016 audit finding: balanced).
G Disclosure of the effect on the trend in profit of items which
are uneven in frequency or amount
The risk (Presentation appropriateness) – 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,
The significance of this risk has decreased this year as the Group
now has a well-established practice of providing ample disclosure
of these items.
Our response – Our procedures included:
– Assessing balance and assessing transparency: We undertook
detailed analysis of business performance at Group and segment
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 challenged the
prominence and adequacy of the disclosures throughout the
Annual Report and in the results announcement relating to the
significant in-service engine issues on the Trent 1000 and Trent
900 programmes, in particular the adequacy of the disclosure
indicating the estimated future cost of these issues in the context
of only a proportion of the cash impact being incurred to date
and of contract accounting resulting in only a proportion of the
estimated ultimate cost having been recorded in the income
statement to date.
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:
(1) the £2,648m unrealised fair value gains (2016: £4,420m losses)
on derivative contracts;
(2) the £227m loss (2016: £98m loss) relating to in-service engine
issues on the Trent 1000 and Trent 900 programmes;
(3) the £113m gain (2016: £217m gain) arising from the impact
of improvements in lifecycle costs on long-term contracts;
(4) the £148m loss (2016: £98m loss) on long-term contracts arising
from technical issues on Civil Aerospace engines including
£114m (2016: £55m) relating to the in-service engine issues
on the Trent 1000 and Trent 900 programmes which is also
included in (2) above;
(5) the £77m gain (2016: nil) resulting from an improvement
in a customer credit rating;
(6) the £60m loss (2016: £29m loss) arising from other estimate
changes on long-term contracts;
(7) the £795m (2016: £918m) of research and development charges,
which excludes £83m of costs capitalised in 2017 as certain
programmes reached capitalisation point under revised
application of the Group’s accounting policy;
(8) the £104m, net of a release of prior year provisions of £3m,
(2016: £129m, net of a £5m release) of exceptional
restructuring charges;
(9) the £75m (2016: £119m) profit arising from sales of spare engines
to joint ventures;
(10) the £798m of gains resulting from the acquisition of a
controlling interest in ITP Aero;
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(11) the £163m (2016: nil) of advance corporation tax recognised
on change of tax legislation;
(12) the £219m impairment of goodwill recognised in 2016;
(13) the £30m loss arising on Civil Aerospace new engine
programmes in 2016;
(14) the £671m financial penalties recognised in 2016 from
agreements with investigating authorities in connection
with alleged historic bribery and corruption involving
intermediaries in overseas territories;
(15) the £53m release of accruals in 2016 relating to the termination
in prior years of intermediaries services;
(16) the £306m loss recognised in 2016 from the restructuring of
the UK pension schemes.
We found that ample disclosure of these items had been provided
in the Annual Report and financial statements taken as a whole
(2016 audit finding: ample).
H Gains resulting from the acquisition of a controlling interest
in Industria De Turbo Propulsores SA (ITP Aero)
Refer to pages 99 and 100 (Audit Committee report – Financial
reporting), page 128 (Note 1 to the financial statements –
Accounting policies) and page 167 (Note 25 to the financial
statements – Acquisitions and disposals)
The risk (Subjective valuation) – On 19 December 2017, the Group
purchased the outstanding 53.1% of Industria de Turbo Propulsores
SA (ITP Aero) that it did not already own. As explained on page 167,
given the proximity of the acquisition to the end of the year, the fair
values of the assets and liabilities acquired have been assessed on
a provisional basis.
Estimating the fair value of the intangible assets of ITP Aero at the
date of acquisition involved the use of complex valuation techniques
and the estimation of future cash flows over a considerable period
of time.
The Group’s existing 46.9% shareholding has been remeasured
to estimated fair value at the acquisition date and a £553m gain
has been recognised in the income statement. As the consideration
payable for the remaining interest was established through
a contractual mechanism included in the option agreement
under which the remaining interest was “put” to the Group, it is
not considered to be indicative of a fair value of the existing
shareholding. The Group has calculated the fair value of the existing
shareholding using a discounted cash flow methodology that
involves the use of significant judgement in estimating future cash
flows over a considerable period of time, assessing the appropriate
discount rate to use and establishing a suitable non-controlling
interest discount to deduct from the enterprise value.
Our response – Our procedures, which were carried out in the
context of the fair values of the acquired intangible assets only
being able to be estimated on a provisional basis, included:
– Assessing the valuer’s credentials: Management engaged a
third party expert to assist in identifying ITP Aero’s intangible
assets and in determining their fair values at the acquisition date.
We evaluated the expert’s competence and independence
and whether it had been appropriately instructed and had
been provided with complete, accurate data on which to base
its valuations.
– Assessing the due diligence provider’s credentials: Management
engaged a third party expert to assist in estimating the future
cash flows of ITP Aero to be used in valuing the intangible assets
acquired and the existing shareholding in ITP Aero. The third party
expert was provided with base data by the management of ITP
Aero and subjected this to challenge and derived adjustments
to the base cash flows provided by management for use in
the valuations. We evaluated the expert’s competence and
independence and whether it had been appropriately instructed.
– Our corporate finance expertise and our sector knowledge:
We evaluated the basis upon which management identified the
intangible assets acquired. We assessed whether the measurement
bases used to estimate the fair values of the identified assets were
reasonable, taking account of our experience of similar assets in
other comparable situations and our assessment of the work
performed by the third party expert.
– Our corporate finance expertise and our sector knowledge:
We assessed the basis used by management to value the existing
shareholding in ITP Aero. We challenged the appropriateness of
the key assumptions underlying the forecast cash flows (including
program assumptions and the terminal value growth rate) and
compared these to the Group’s own forecasts where ITP Aero’s
and the Group’s businesses overlapped. We challenged the
discount rate applied and the non-controlling interest discount
deducted from the enterprise value in management’s valuation.
We also assessed whether or not the estimates showed any
evidence of management bias.
– Assessing transparency: We assessed whether the appropriate
disclosures have been provided on the judgements and
estimates applied in arriving at the fair values.
Our findings – We found that the intangible assets identified
were typical of acquisitions of similar businesses and the valuation
bases were in accordance with accounting standards. We have no
concerns with the basis on which the valuer had been instructed by
the Group and found that the valuer was objective and competent
and the estimates used in the valuations were balanced. We found
that the disclosure regarding the provisional nature of the fair values
attributed to the intangible assets was balanced given the timing
of the acquisition and limitations on the information ITP Aero could
provide to the Group prior to completion of the acquisition.
We found that the basis used to value the existing shareholding
in ITP Aero was in accordance with accounting standards and that
the key assumptions applied in the valuation were balanced.
I Disclosure of the impact of adopting IFRS 15
Refer to pages 99 and 100 (Audit Committee report – Financial
reporting), pages 131 to 132 (Note 1 to the financial statements –
Accounting policies – IFRS 15 Revenue from Contracts with
Customers) and pages 170 to 171 (Note 27 to the financial
statements – Impact of IFRS 15)
The risk (Accounting treatment and accounting application) –
IFRS 15 Revenue from Contracts with Customers will be effective
for the year beginning 1 January 2018 and will have a pronounced
impact on the recognition of revenue and profit in the Civil
Aerospace business. The Group has disclosed the estimated
impact of applying the new standard to its 2017 results. The Group’s
contracts can be complex and there is significant judgement applied
in selecting the accounting policies under IFRS 15. There is a risk that
the Group has not captured the correct policies in line with the new
standard and that not all material areas of potential change have
been identified. In addition there is a risk that the policies are not
applied appropriately.
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Independent Auditor’s Report
191
Our response – Our procedures included:
– Accounting analysis and our sector experience: Starting in 2015,
we reviewed the process and outputs of the adoption of IFRS 15
impact analysis, evaluated the appropriateness of the key
judgements and estimates, and assessed whether the policies
adopted are in compliance with IFRS 15. Based on our knowledge
of the business and of the impact of adoption of IFRS 15 on other
companies with similar businesses, we assessed whether all
material areas of potential change under IFRS 15 have been
identified. We considered each significant distinct revenue
stream and our knowledge of the terms of the contracts to
determine the likelihood of there being a material difference
between the current treatment and the requirements of IFRS 15.
Our analysis covered the whole business but we were particularly
focused on the Civil Aerospace business and on the treatment of
long-term contracts in other parts of the Group.
– Test of details: We selected samples of contracts based on a risk
assessment of contracts most likely to be affected by IFRS 15 and
recalculated the impact of applying the accounting policies
developed by the Group.
– Assessing transparency: We assessed whether the disclosure
adequately disclosed the key revenue recognition policies under
IFRS 15 and the estimated impact on the 2017 income statement
and net assets at 31 December 2017.
Our findings – We found that the Group had carried out an analysis
of potential differences between revenue recognition under IFRS 15
and under its current accounting policies commensurate with
describing the effect of applying the new standard. We found that
the Group had made judgements in developing its IFRS 15
accounting policies that were consistent with a balanced
interpretation of the new standard with an objective of faithfully
representing the substance of the Group’s transactions with its
customers. We found that in compiling the estimated impact of
applying IFRS 15, the Group had applied those policies consistently
to similar transactions. We found the resulting disclosure to be ample.
Recoverability of the parent Company’s investment in subsidiaries
(£12 bn; 2016: £12bn)
Refer to page 173 (parent Company financial statements).
The risk (Low risk, high value) – The carrying amount of the parent
Company’s investments in subsidiaries represents 100% (2016:
100%) of its total assets. Their recoverability is not at a high risk
of significant misstatement or subject to significant judgement.
However, due to their materiality in the context of the parent
Company financial statements, this is considered to be the area
that had the greatest effect on our audit of the parent Company’s
financial statements.
Our response – Our procedures included:
– Our sector experience: Having established that the parent
Company owns the whole of the issued share capital of a
company that directly or indirectly owns all other group
companies, we used our understanding of the sectors in which
the Group operates and of the Group’s business to identify
any potential indicators of impairment of the investment in
that company and then carried out analysis to evaluate whether
any of these potential indicators of impairment represented an
indicator of impairment.
Our findings – We identified some potential indicators of
impairment, including the current trading conditions affecting the
Commercial Marine business and the parent Company’s net assets
exceeding the Group’s consolidated net assets. We assessed that
individually and in aggregate these did not amount to an indicator
of impairment.
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 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 and provide proportionate disclosure. However, 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.
3 Our application of materiality and an overview
of the scope of our audit
Materiality
Materiality for the Group financial statements as a whole was set at
£40m (2016: £30m), determined with reference to a benchmark of
group profit before tax averaged over the last three years, in order
to take into account the volatility in profits over this period, and
normalised to exclude the impact of 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 benchmark was £950m (2016: £1,039m)
and this materiality measure represents 4.2% (2016: 2.9%) of this
benchmark and 0.8% (2016: 0.6%) of total reported profit/loss
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 £2.6bn gain (2016: £4.4bn loss))
as part of our audit of the Group’s treasury operations.
Materiality for the parent Company financial statements as a whole
was set at £36m (2016: £27m), determined with reference to a
benchmark of net assets, of which it represents 0.3% (2016: 0.2%),
as the parent Company is treated as a component for the purposes
of the audit of the Group financial statements.
We agreed to report to the Audit Committee (i) all material
corrected identified misstatements; (ii) uncorrected identified
misstatements exceeding £2m (2016: £1.5m) for income statement
items; and (iii) other identified misstatements that warranted
reporting on qualitative grounds.
The scope of our audit
Of the Group’s 367 reporting components, we subjected 25
(2016: 34) to full scope audits for group purposes and 7 (2016: 13)
to specified risk-focused audit procedures. The latter were not
individually financially significant enough to require a full scope
audit for group purposes, but did present specific individual risks
that needed to be addressed. This work also provided further
audit coverage.
The components within the scope of our work accounted for
the percentages illustrated opposite.
The remaining 5% of total group revenue, 4% of group profit
before tax and 5% of total group assets is represented by 335
reporting components, none of which individually represented
more than 0.8% of any of total group revenue, group profit before
tax or total group assets. For these residual components, we
performed analysis at an aggregated group level to re-examine
our assessment that there were no significant risks of material
misstatement within these.
OTHER INFORMATION 192
Other Information
Independent Auditor’s Report
Rolls-Royce Holdings plc Annual Report 2017
Revenue
Underlying profit before tax
■ 92% (2016: 94%)
■ 3% (2016: 5%)
■ 5% (2016: 1%)
Total assets
■ 93% (2016: 89%)
■ 3% (2016: 8%)
■ 4% (2016: 3%)
■ 91% (2016: 89%)
■ 4% (2016: 8%)
■ 5% (2016: 3%)
■ Audit for group
reporting purposes
■ Speci�ed risk-focused
audit procedures
■ Group-level procedures only
The Group operates shared service centres for the bulk processing
of financial transactions in Derby (UK), Indianapolis (US) and
Singapore, 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.
The work on 21 of the 32 components (2016: 19 of the 47 components)
was performed by component audit teams and the rest, including
the audit of the parent Company, was performed by the Group audit
team. The Group audit team instructed component auditors and the
audit teams of the shared service centres as to the significant areas
to be covered (including the relevant risks detailed above), the audit
approach to be taken on significant risks and the information to
be reported to the Group audit team. The Group audit team set
the materiality to be used for each component audit, which ranged
from £1.4m to £30m (2016: £0.2m to £30m), having regard to the mix
of size and risk profile of the components.
The Group audit team maintained close contact with the audit teams
on the more significant components through weekly telephone
conference meetings and other ad hoc communications and the
Group team visited 20 (2016: 33) locations in UK, the US, Germany
and Scandinavia meeting with the component audit teams and
component management. The purpose of these communications
was to update the Group team’s understanding of the components’
business and related risks of material misstatement and to monitor
progress of the audit.
For the more significant components (18 components contributing
88% of revenue and 70% profit before tax), the Group audit team
received reporting on audit findings and participated in Sector
Audit Committee meetings and closing meetings with component
management. Towards the conclusion of each component audit,
the Group audit team met the component audit teams (either face
to face or on a telephone conference) and discussed the findings
reported to the Group audit team in more detail and reviewed
and evaluated the audit work of each component audit team on
significant audit risks and other relevant areas. Any further work
required by the Group audit team was then performed by the
component audit team.
The Group audit team communicated the independence and other
ethical requirements that apply to the audit to component audit
teams. Throughout the year, the Group audit team assessed each
non-audit service that the Group requested KPMG undertake
worldwide and only approved the service once it was established
that the service was permissible under auditor independence
regulations and had been pre-approved by the Audit Committee.
4 We have nothing to report on going concern
We are required to report to you if:
– we have anything material to add or draw attention to in relation
to the directors’ statement in Note 1 to the financial statements
on the use of the going concern basis of accounting with no
material uncertainties that may cast significant doubt over the
Group and Company’s use of that basis for a period of at least
twelve months from the date of approval of the financial
statements; or
– the related statement under the Listing Rules set out on page 63
is materially inconsistent with our audit knowledge.
We have nothing to report in these respects.
5 We have nothing to report on the other information
in the Annual Report
The directors are responsible for the other information presented
in the Annual Report together with the financial statements.
Our opinion on the financial statements does not cover this other
information and, accordingly, we do not express an audit opinion
or, except as explicitly stated below, any form of assurance
conclusion thereon.
Our responsibility is to read the other information and, in doing
so, consider whether, based on our financial statements audit work,
the information therein is materially misstated or inconsistent with
the financial statements or our audit knowledge. Based solely on
that work we have not identified material misstatements in the
other information.
Strategic report and directors’ report
Based solely on our work on the other information:
– we have not identified material misstatements in the strategic
report and the directors’ report;
– in our opinion the information given in those reports for the
financial year is consistent with the financial statements; and
– in our opinion those reports have been prepared in accordance
with the Companies Act 2006.
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Independent Auditor’s Report
193
Directors’ remuneration report
In our opinion the part of the Directors’ Remuneration Report
to be audited has been properly prepared in accordance with the
Companies Act 2006.
6 We have nothing to report on the other matters on
which we are required to report by exception
Under the Companies Act 2006, we are required to report to you
if, in our opinion:
Disclosures of principal risks and longer-term viability
Based on the knowledge we acquired during our financial
statements audit, we have nothing material to add or draw attention
to in relation to:
– the directors’ confirmation within the Compliance with the UK
Corporate Governance Code 2016 Statement (page 77) that they
have carried out a robust assessment of the principal risks facing
the Group, including those that would threaten its business
model, future performance, solvency and liquidity;
– the Principal Risks disclosures (pages 59 to 62) describing
these risks and explaining how they are being managed and
mitigated; and
– the directors’ explanation in the Going Concern and Viability
Statements (page 63) of how they have assessed the prospects of
the Group, over what period they have done so and why they
considered that period to be appropriate, and their statement
as to whether they have a reasonable expectation that the Group
will be able to continue in operation and meet its liabilities as
they fall due over the period of their assessment, including any
related disclosures drawing attention to any necessary
qualifications or assumptions.
Under the Listing Rules we are required to review the Going
Concern and Viability Statements (page 63). We have nothing
to report in this respect.
Corporate governance disclosures
We are required to report to you if:
– we have identified material inconsistencies between the
knowledge we acquired during our financial statements 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 position and performance,
business model and strategy (page 114); or
– the section of the Annual Report describing the work of the
Audit Committee (pages 97 to 103) does not appropriately
address matters communicated by us to the Audit Committee.
We are required to report to you if the Compliance with the UK
Corporate Governance Code 2016 Statement (pages 77 and 78)
does not properly disclose a departure from the eleven provisions
of the UK Corporate Governance Code specified by the Listing
Rules for our review.
We have nothing to report in these respects.
– 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.
We have nothing to report in these respects.
7 Respective responsibilities
Directors’ responsibilities
As explained more fully in their statement set out on page 114,
the directors are responsible for: the preparation of the financial
statements including being satisfied that they give a true and fair
view; such internal control as they determine is necessary to enable
the preparation of financial statements that are free from material
misstatement, whether due to fraud or error; assessing the Group
and parent Company’s ability to continue as a going concern,
disclosing, as applicable, matters related to going concern; and
using the going concern basis of accounting unless they either
intend to liquidate the Group or the parent Company or to cease
operations, or have no realistic alternative but to do so.
Auditor’s responsibilities
Our objectives are to obtain reasonable assurance about whether
the financial statements as a whole are free from material
misstatement, whether due to fraud or other irregularities (see
below), or error, and to issue our opinion in an auditor’s report.
Reasonable assurance is a high level of assurance, but does not
guarantee that an audit conducted in accordance with ISAs (UK)
will always detect a material misstatement when it exists.
Misstatements can arise from fraud, other irregularities or error
and are considered material if, individually or in aggregate, they
could reasonably be expected to influence the economic decisions
of users taken on the basis of the financial statements.
A fuller description of our responsibilities is provided on the FRC’s
website at www.frc.org.uk/auditorsresponsibilities.
Ability to detect irregularities
We identified areas of laws and regulations that could reasonably
be expected to have a material effect on the financial statements
from our sector experience, through discussion with the directors
and other management personnel (as required by ISAs (UK)), and
from inspection of the Group’s regulatory and legal correspondence.
We had regard to laws and regulations in areas that directly affect
the financial statements including those relating to financial reporting
(and related company legislation) and taxation. We considered the
extent of compliance with those laws and regulations as part of our
procedures on the related financial statements items.
OTHER INFORMATION 194
Other Information
Independent Auditor’s Report
Rolls-Royce Holdings plc Annual Report 2017
In addition, we considered the impact of laws and regulations in
the specific areas of civil aviation safety, export control, defence
contracting and anti-bribery and corruption legislation recognising
the financial and regulated nature of the Group’s activities. With
the exception of any known or possible non-compliance identified
in the course of our audit, as required by ISAs (UK), our work in
respect of these areas was limited to enquiry of the directors and
other management personnel and inspection of regulatory and
legal correspondence. We considered the effect of any known or
possible non-compliance in these areas as part of our procedures
on the related financial statements items.
Additional considerations in respect of bribery and corruption are
set out in the key audit matter disclosures in section 2 of this report.
We communicated these identified areas of laws and regulations
throughout our team and remained alert to any indications of
non-compliance throughout the audit. This included communication
from the Group audit team to component audit teams of relevant laws
and regulations identified at group level, with a request to report on
any indications of the potential existence of non-compliance with
relevant laws and regulations (“irregularities”) in these areas, or other
areas directly identified by the component team.
As with any audit, there remained a higher risk of non-detection of
irregularities, as these may involve collusion, forgery, intentional
omissions, misrepresentations, or the override of internal controls.
8 The purpose of our audit work and to whom we
owe our responsibilities
This report is made solely to the parent Company’s members, as
a body, in accordance with Chapter 3 of Part 16 of the Companies
Act 2006 and the terms of our engagement by the parent
Company. Our audit work has been undertaken so that we might
state to the parent Company’s members those matters we are
required to state to them in an auditor’s report and the further
matters we are required to state to them in accordance with the
terms agreed with the parent Company and for no other purpose.
To the fullest extent permitted by law, we do not accept or assume
responsibility to anyone other than the parent Company and the
parent Company’s members, as a body, for our audit work, for this
report, or for the opinions we have formed.
Jimmy Daboo (Senior Statutory Auditor)
for and on behalf of KPMG LLP, Statutory Auditor
Chartered Accountants
15 Canada Square
London E14 5GL
6 March 2018
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Sustainability Assurance Statement
195
Sustainability Assurance Statement
To: the stakeholders of Rolls-Royce Holdings plc
Independent limited assurance statement
Introduction and objectives of work
Bureau Veritas UK Limited (Bureau Veritas) has been engaged by
Rolls-Royce Holdings plc (Rolls-Royce) to provide limited assurance
over selected sustainability performance indicators for inclusion
in its 2017 Annual Report and website. This assurance statement
applies to the related information included within the scope of
work described below.
Scope of work
The scope of our work was limited to assurance over the following
information included within the Rolls-Royce Holdings plc 2017
Annual Report (the Report) for the period 1 January to
31 December 2017 (the selected information):
– energy consumption;
– scope 1 and scope 2 greenhouse gas (GHG) emissions;
– total reportable injury (TRI) rate; and
– the number of people reached through the science, technology,
engineering and mathematics (STEM) education outreach
programmes.
Reporting criteria
The selected information are reported according to the
Rolls-Royce basis of reporting document, as set out at
www.rolls-royce.com/sustainability.
Limitations and exclusions
Excluded from the scope of our work is any verification of
information relating to:
– activities outside the defined verification period; and
– other information included in the Report.
This limited assurance engagement relies on a risk-based selected
sample of sustainability data and the associated limitations that
this entails. This independent statement should not be relied upon
to detect all errors, omissions or misstatements that may exist.
Responsibilities
This preparation and presentation of the selected information
in the Report are the sole responsibility of the management
of Rolls-Royce.
Bureau Veritas was not involved in the drafting of the Report
or of the reporting criteria. Our responsibilities were to:
– obtain limited assurance about whether the selected information
has been prepared in accordance with the reporting criteria;
– form an independent conclusion based on the assurance
procedures performed and evidence obtained; and
– report our conclusions to the management of Rolls-Royce.
Assessment standard
We performed our work in accordance with International Standard
on Assurance Engagements (ISAE) 3000 Revised, Assurance
Engagements Other than Audits or Reviews of Historical Financial
Information (effective for assurance reports dated on or after 15
December 2015), and in accordance with International Standard
on Assurance Engagements (ISAE) 3410, Assurance Engagements
on Greenhouse Gas Statements, issued by the International
Auditing and Assurance Standards Board.
Summary of work performed
As part of its independent verification, Bureau Veritas undertook
the following activities:
– assessed the appropriateness of the reporting criteria for the
selected information;
– conducted interviews with relevant personnel of Rolls-Royce;
– carried out nine site visits, selected employing a risk-based
approach, in the UK, US, Germany, Italy, Norway and Singapore;
– reviewed the data collection and consolidation processes used
to compile the selected information, including assessing
assumptions made, the data scope and reporting boundaries;
– reviewed documentary evidence produced by Rolls-Royce;
– agreed a selection of the selected information to the
corresponding source documentation; and
– re-performed aggregation calculations of the selected information.
Conclusion
On the basis of our methodology and the activities described
above, nothing has come to our attention to indicate that the
selected information has not been properly prepared, in all
material respects, in accordance with the reporting criteria.
Statement of independence, integrity
and competence
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 verification over
environmental, social, ethical and health and safety information,
systems and processes.
Bureau Veritas operates a certified1 Quality Management System
which complies with the requirements of ISO 9001:2008, and
accordingly maintains a comprehensive system of quality control
including documented policies and procedures regarding
compliance with ethical requirements, professional standards
and applicable legal and regulatory requirements.
Bureau Veritas has implemented and applies a Code of Ethics,
which meets the requirements of the International Federation
of Inspections Agencies (IFIA)2 across the business to ensure
that its employees maintain integrity, objectivity, professional
competence and due care, confidentiality, professional behaviour
and high ethical standards in their day-to-day business activities.
The assurance team for this work does not have any involvement
in any other Bureau Veritas projects with Rolls-Royce.
Bureau Veritas UK Limited
London
6 February 2018
1 Certificate of Registration FS 34143 issued by BSI Assurance UK Limited.
2 International Federation of Inspection Agencies – Compliance Code – Third Edition
OTHER INFORMATION 196
Other information
Other Financial Information
Rolls-Royce Holdings plc Annual Report 2017
Other Financial Information
Foreign exchange
Foreign exchange rate movements influence the reported income
statement, the cash flow and closing net funds balance. The average
and spot rates for the principal trading currencies of the Group are
shown in the table below:
USD per GBP Year end spot rate
Average spot rate
EUR per GBP Year end spot rate
Average spot rate
2017
1.35
1.29
1.13
1.14
2016
1.23
1.36
1.17
1.22
Change
+10%
-5%
-3%
-7%
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 116.
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;
(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 2017 were £180m.
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 34.9%
(2016: 37.5%). The underlying tax rate including joint ventures and
associates can be found on pages 19 and 50. 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 99) – The group tax director 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 (pages 125 and
127) – Details of key areas of uncertainty and accounting policies
for tax; and
– Note 5 to the Consolidated Financial Statements (pages 138 to
140) – Details of the tax balances in the Consolidated Financial
Statements together with a tax reconciliation. 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 impact of significant adjustments to reported profits,
in particular the net unrealised fair value changes to derivative
contracts and the recognition of advance corporation tax.
Information on the Group’s approach to managing its tax affairs
can be found at www.rolls-royce.com/sustainability.
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
lifecycles. Discounted cash flow analysis of the remaining life
of projects is performed on a regular basis.
Sales of engines in production are assessed against criteria in
the original development programme to ensure that overall value
is enhanced.
Financial risk management
The Board has established a structured approach to financial risk
management. The Financial risk committee (Frc) is accountable for
managing, reporting and mitigating the Group’s financial risks and
exposures. These risks include the Group’s principal counterparty,
currency, interest rate, commodity price, liquidity and credit rating
risks outlined in more depth in note 17. The Frc is chaired by the
Chief Financial Officer. The Group has a comprehensive financial
risk policy that advocates the use of financial instruments to
manage and hedge business operations risks that arise from
movements in financial, commodities, credit or money markets.
The Group’s policy is not to engage in speculative financial
transactions. The Frc sits quarterly to review and assess the
key risks and agree any mitigating actions required.
Rolls-Royce Holdings plc Annual Report 2017
Other information
Other Financial Information
197
Capital structure
Credit rating
£m
Total equity
Cash flow hedges
Group capital
Net funds
2017
5,849
112
5,961
(305)
2016
1,864
107
1,971
(225)
Operations are funded through various shareholders’ funds, bank
borrowings, bonds and notes. The capital structure of the Group
reflects the judgement of the Board as to the appropriate balance
of funding required. Funding is secured by the Group’s continued
access to the global debt markets. Borrowings are funded in various
currencies using derivatives where appropriate to achieve a required
currency and interest rate profile. The Board’s objective is to retain
sufficient financial investments and undrawn facilities to ensure that
the Group can both meet its medium-term operational commitments
and cope with unforeseen obligations and opportunities.
The Group holds cash and short-term investments which, together
with the undrawn committed facilities, enable it to manage its
liquidity risk.
During the year, the Group extended the maturity of the £1,500m
committed bank borrowing facility from 2021 to 2022 and extended
the maturity of the £500m committed bank borrowing facility from
2019 to 2020. Both of these facilities were undrawn at the period
end. Also during 2017, the Group drew a committed loan of £280m,
maturing in 2024. At the year end, the Group retained aggregate
liquidity of £5.1bn, including cash and cash equivalents of £3.0bn
and undrawn borrowing facilities of £2.1bn. Circa £80m of
borrowings mature in 2018 and £745m in 2019.
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.
Moody’s Investors Service
Standard & Poor’s
Rating
A3
BBB+
Outlook
Grade
Negative Investment
Stable 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 its 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 2017.
The impacts of changes to IFRS, in particular IFRS 15 Revenue from
Contracts with Customers and IFRS 9 Financial Instruments which
are effective from 1 January 2018 are included within the
accounting policies in note 1.
Share price
During the year, the share price increased by 27% from 668p to 847p,
compared to a 5% increase in the FTSE aerospace and defence
sector and a 8% increase in the FTSE 100. The Company’s share price
ranged from 640p in January 2017 to 981p in November 2016.
OTHER INFORMATION 198
Other Information
Other Statutory Information
Rolls-Royce Holdings plc Annual Report 2017
Other Statutory Information
Share capital
Share class rights
On 31 December 2017 the Company’s issued share capital
comprised of:
1,840,597,108
28,429,035,421
1
Ordinary shares
C Shares
Special Share
20p each
1p each
£1
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 in July 2018 must ensure that their instructions are lodged
with the Registrar no later than 5.00pm (BST) on 1 June 2018 (CREST
holders must submit their election in CREST before 3.00pm (BST)
on 1 June 2018). Redemption will take place on 5 July 2017.
At the 2018 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 2 July 2018 to shareholders on the
register on 27 April 2018 and the final day of trading with entitlement
to C Shares is 25 April 2018. Together with the interim issue
on 3 January 2018 of 46 C Shares for each ordinary share with a total
nominal value of 4.6p, this is the equivalent of a total annual payment
to ordinary shareholders of 11.7p for each ordinary share.
Further information for shareholders is on pages 202 and 203.
The full share class rights are set out in the Company’s Articles
of Association (Articles), which are available at www.rolls-royce.com.
The rights 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
C Shares have limited voting rights and attract a preferential
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 on or prior to that time or the event
of a capital restructuring of the Company; the introduction of a new
holding company; the acquisition of the Company by another
company; or a demerger from the Group.
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 that resolution.
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Other Statutory Information
199
Special Share
Certain rights attach to the special rights non-voting share
(Special Share) issued to the UK Secretary of State for Business,
Energy & Industrial Strategy (Special Shareholder). These rights are
set out in the Articles. Subject to the provisions of the Companies
Act 2006 (the Act), the Treasury Solicitor may redeem the Special
Share at par value 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 that holding.
The Special Share may only be issued to, held by and transferred
to the Special Shareholder or his successor or nominee.
Shareholder agreements and consent requirements
The Company and Bradley Singer are party to a relationship
agreement with ValueAct (a summary of which can be found at
www.rolls-royce.com). The agreement will expire on 3 May 2018
but will be replaced with a new agreement covering treatment
of confidential information and conflicts of interest only.
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 propulsion business or the assets of the Group as a whole,
without the consent of the Special Shareholder.
Authority to issue shares
At the AGM in 2017, authority was given to the Directors to allot
new C Shares up to a nominal value of £500m as an alternative
to a cash dividend.
In addition, a special resolution was passed authorising the
Directors to allot new ordinary shares up to a nominal value
of £122,588,225 equivalent to one-third of the issued share capital
of the Company. This resolution also authorised the Directors
to allot up to two thirds of the total issued share capital of the
Company, but only in the case of a rights issue.
A further 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 2018, and the Directors
propose to renew each of them at that AGM. The Board believes
that these authorities will allow the Company to retain flexibility
to respond to circumstances and opportunities as they arise.
Authority to purchase own shares
At the AGM in 2017, the Company was authorised by shareholders
to purchase up to 183,882,337 of its own ordinary shares
representing 10% of its issued ordinary share capital.
The authority for the Company to purchase its own shares expires
at the conclusion of the AGM in 2018 or 15 months from 4 May 2017,
whichever is the earlier. A resolution to renew it will be proposed
at the 2018 meeting.
Deadlines for exercising voting rights
Electronic and paper proxy appointments, and voting instructions,
must be received by the Registrar not less than 48 hours before a
general meeting.
Voting rights for employee share plan shares
Shares are held in an employee benefit trust 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.
OTHER INFORMATION 200
Other Information
Other Statutory Information
Rolls-Royce Holdings plc Annual Report 2017
Change of control
Major shareholdings
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 2017,
these facilities were less than 22% drawn (2016: 15%).
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.
At 6 March 2018 the following shareholders had notified an interest
in the issued ordinary share capital of the Company in accordance
with the DTR.
Date notified
% of issued ordinary
share capital
1 February 2018
13 October 2017
3 May 2017
10.94
5.07
3.91
Shareholder
ValueAct Capital Master
Fund, L.P.
The Capital Group
Companies, Inc.
Credit Suisse Group AG
Directors
The names of the Directors who held office during the year are
set out on page 70.
Disclosures in the Strategic Report
The Board has taken advantage of Section 414C(11) of the Act
to include disclosures in the Strategic Report including:
– employee involvement;
– the future development, performance and position of the Group;
– the financial position of the Group;
– R&D activities; and
– the principal risks and uncertainties.
– APRA deferred shares – the shares would be released from
trust immediately.
Political donations
– Sharesave – options would become exercisable immediately.
The new controlling company might offer an equivalent option
in exchange for cancellation of the existing option.
– 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.
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 Act. The resolution to be proposed at the
AGM, authorising political donations and expenditure, is to ensure
that the Group does not commit any technical breach of the Act.
– LTIP – awards would vest on the change of control, subject to
the Remuneration Committee’s judgement of performance
and may be reduced pro rata to service in the vesting period.
Any applicable holding period will cease in the event of a
change in control.
During the year, expenses incurred by Rolls-Royce North America,
Inc. in providing administrative support for the Rolls-Royce
North America political action committee (PAC) was US$118,104
(2016: US$42,742). 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 Group cannot affect how they are applied,
although under US law, the business expenses are paid by the
employee’s company. Such contributions 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 2017 AGM.
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Other Statutory Information
201
Greenhouse gas emissions
Branches
In 2017, our total greenhouse gas (GHG) emissions were 715
kilotonnes carbon dioxide equivalent (ktCO2e). This represents
a increase of 1% compared with 705 ktCO2e in 2016. This is a result
of increased production and product testing as new engine variants
enter service.
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 175 to 182.
719
852
749
704
715
Financial instruments
We have revised our total GHG emissions for 2016 to reflect the
actual figures for the full year, rather than estimated figures
prepared in line with our basis of reporting. This revision is not
material (< ±5%) but does impact the year-on-year trend.
We have included the reporting of fugitive emissions of
hydroflurocarbons (HFCs), associated with air conditioning
equipment, into our GHG emissions figures for 2016 and 2017.
These include emissions from our facilities in the UK, US, Canada
and France only. We do not anticipate that emissions from other
facilities will have a material impact. Figures from prior years (2013
to 2015) exclude emissions associated with HFCs.
2013 */**
2014
2015
2016
2017
394
456
374
368
379
325
396
375
336
336
Total GHG emissions (ktCO2e)
Direct emissions
(Scope 1)
Indirect emissions
(Scope 2)
Total emissions
(Scope 1 + Scope 2)
Intensity ratio
(total emissions normalised
by revenue)
(ktCO2e/£m)
0.063 0.062 0.055 0.047 0.043
*
Figures for 2013 do not include GHG emissions associated with Power Systems and
therefore are not directly comparable.
** The intensity ratio for 2013 has been restated to reflect the exclusion of revenues
associated with Power Systems.
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
and as
over the energy, GHG, TRI rate and STEM data that has been highlighted with
set out on pages 44 to 48 and in the table above. The sustainability assurance statement
is included on page 195.
With the exceptions noted above, we have reported on all of
the emission sources required under the Companies Act 2006
(Strategic Report and Directors’ Report) 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 Statements.
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 2016.
Further details on our methodology for reporting and the criteria
used can be found within our basis of reporting, available to
download at www.rolls-royce.com/sustainability.
ITP Aero post balance sheet events
Following approval from the relevant authorities in Spain in
December 2017, the Company has now concluded the acquisition
of a 53.1% shareholding in ITP Aero from SENER resulting in ITP
Aero becoming a wholly-owned subsidiary of the Company.
The consideration of €718m will be settled over a two-year payment
period, payable in eight equal instalments, and the agreement with
SENER allows the Company flexibility to settle up to 100% of the
consideration in the form of ordinary shares. The first instalment
was settled by issuing 9,612,581 ordinary shares on 15 January 2018
and the Company has notified SENER of its intention to settle the
second instalment in the form of ordinary shares. Final consideration
as to whether the remaining six instalments will be settled in the form
of cash or ordinary shares will be determined by the Company
during the remaining payment period.
Details of the Group’s financial instruments are set out in note 17
to the Consolidated 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.
Management report
The Strategic Report and the Directors’ Report together are the
management report for the purposes of Rule 4.1.8R of the DTR.
Disclosure of information to auditors
Each of the persons who is a Director at the date of approval of this
report confirms that:
– So far as the Director is aware, there is no relevant audit
information of which the Company’s auditor is unaware. 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 Act.
OTHER INFORMATION 202
Other Information
Shareholder Information
Rolls-Royce Holdings plc Annual Report 2017
Shareholder Information
Financial calendar 2018-2019
3 MAY 11.00AM
AGM
Pride Park Stadium
Pride Park
Derby
DE24 8XL
2 JULY
Allotment of C Shares
3 JULY
Payment of cash dividend on C Shares
5 JULY
Payment of C Share redemption monies
23 JULY
New share certificates issued (at the latest)
1 AUGUST
Announcement of half-year results
16 NOVEMBER
Record date for
cash dividend on
C Shares
3 JANUARY
Allotment of C Shares
3 JANUARY
Payment of cash dividend on C Shares
7 JANUARY
Payment of C Share redemption
monies
21 JANUARY
New share certificates issued
(at the latest)
APR
2018
MAY
2018
JUN
2018
JUL
2018
AUG
2018
SEP
2018
OCT
2018
NOV
2018
DEC
2018
JAN
2019
FEB
2019
MAR
2019
26 APRIL
Ex-entitlement
to C Shares
27 APRIL
Record date for
entitlement to
C Shares
1 JUNE 5.00PM
Deadline for receipt
by Registrar of C Share
instructions (3.00pm
for CREST holders)
4 JUNE
Record date for cash
dividend on C Shares
25 OCTOBER
Ex-entitlement
to C Shares
26 OCTOBER
Record date for
entitlement to
C Shares
3 DECEMBER
5.00PM
Deadline for receipt
by Registrar of C Share
instructions (3.00pm
for CREST holders)
31 DECEMBER
Financial year end
FEBRUARY/
MARCH
Announcement
of full-year results
and 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), a 10-digit number
prefixed 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 the Registrar at
Computershare Investor Services PLC, The Pavilions, Bridgwater
Road, Bristol BS13 8AE.
The Registrar offers shareholders an internet dealing service
available from its website www.computershare.co.uk and
a telephone dealing service (+44 (0)370 703 0084). Real-time
dealing is available during market hours, 8.00am to 4.30pm,
Monday to Friday excluding bank holidays. Orders can still be
placed outside of market hours. 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 value plus
£35. Stamp duty of 0.5% is payable on all purchases. This service
is only available to shareholders resident in certain jurisdictions.
Before you can trade you must register to use the service. Other
share dealing facilities are available but you should always use
a firm regulated by the FCA (see www.fca.org.uk/register).
Payments to shareholders
The Company makes payments to shareholders by issuing
redeemable C Shares of 0.1p each. You can redeem C Shares for
cash and either take the cash or reinvest the cash to purchase
additional ordinary shares 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.
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. 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.
Rolls-Royce Holdings plc Annual Report 2017
Other Information
Shareholder Information
203
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 will not
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
www.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
www.actionfraud.police.uk.
Remember: if it sounds too good to be true it probably is.
Visit www.rolls-royce.com to find out more about the latest financial
results, the share price, payments to shareholders, the financial
calendar and shareholder services.
Keeping up to date
You can sign up to receive the latest news updates to your phone
or email address by visiting www.rolls-royce.com and registering
for our alert service.
Dividends paid on C Shares held
C Share calculation period
1 July 2017 – 31 December 2017
1 January 2017 – 30 June 2017
Previous C Share issues
C Share dividend rate (%)
0.17
0.20
Record date for
C Share dividend
17 November 2017
2 June 2017
Payment date
3 January 2018
3 July 2017
Apportionment values
Record
date for
entitlement
to C Shares
26 October
2017
28 April
2017
Latest date
for receipt
of payment
instruction
forms by
Registrar
1 December
2017
1 June
2017
No. of C
Shares
issued per
ordinary
share
46
71
Price of
ordinary
shares on
first day
of trading
(p)
851.20
896.50
Issue date
3 January
2018
3 July
2017
CGT apportionment
Value of
C Share
issues per
ordinary
shares (p)
Ordinary
shares (%) C Shares (%)
4.6
7.1
99.46
99.21
0.54
0.79
Date of
redemption
of C Shares
5 January
2018
5 July
2017
CRIP
purchase
date
9 January
2018
7 July
2017
CRIP
purchase
price (p)
867.7115
925.5883
For information on earlier C Share issues, please refer to www.rolls-royce.com.
Analysis of ordinary shareholders at 31 December 2017
Type of holder
Individuals
Institutional and other investors
Total
Size of holding (number of ordinary shares)
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
175,005
4,552
179,557
56,788
87,879
33,203
1,177
342
168
179,557
% of total
shareholders
97.46
2.54
100.00
31.63
48.94
18.49
0.66
0.19
0.09
100.00
Number
of shares
90,662,315
1,749,934,793
1,840,597,108
5,258,063
23,755,565
51,515,559
32,369,515
114,444,596
1,613,253,810
1,840,597,108
% of total
shares
4.93
95.07
100.00
0.28
1.29
2.80
1.76
6.22
87.65
100.00
OTHER INFORMATION 204
Other Information
Glossary
Glossary
Rolls-Royce Holdings plc Annual Report 2017
ABC
ACARE
AGM
AMC
AMRCs
APRA
Articles
ASC
bps
Brexit
C Shares
C&A
CARs
CEO
CFO
COO
Company
CPS
CRIP
DARPA
DJSI
DoJ
DPA
DTR
anti-bribery and corruption
Advisory Council for Aviation Research
and Innovation in Europe
Annual General Meeting
Approved Maintenance Centre
Advanced Manufacturing Research Centres
annual performance related award plan
Articles of Association of Rolls-Royce Holdings plc
Authorised Service Centres
basis points
UK exit from the European Union
non-cumulative redeemable preference shares
commercial and administrative
contractual aftermarket rights
chief executive officer
chief financial officer
chief operating officer
Rolls-Royce Holdings plc
cash flow per share
C Share reinvestment plan
Defense Advanced Research Projects Agency
Dow Jones Sustainability Index
US Department of Justice
deferred prosecution agreements
the FCA’s Disclosure Guidance and
Transparency Rules
European Aviation Safety Agency
Executive Leadership Team
earnings per share
employee resource group
European Union
euro
Financial Conduct Authority
UK-France Unmanned Combat Air System
free cash flow
Financial Reporting Council
foreign exchange
Great British pound or pound sterling
greenhouse gas
Rolls-Royce Holdings plc and its subsidiaries
hydroflurocarbons
health, safety and environment
International Advisory Board
EASA
ELT
EPS
ERG
EU
EUR
FCA
FCAS
FCF
FRC
FX
GBP
GHG
Global Code Global Code of Conduct
Group
HFCs
HSE
IAB
IAE
IASB
IFRS
ITP Aero
KPIs
ktCO2e
LGBT
LIBOR
LTIP
LTPR
LTSA
MPF
MRO
MTC
NCI
OCI
OE
OECD
P&L
PBT
PGB
PPE
PSP
R&D
R&T
Registrar
RMS
RRSAs
SDC
SENER
SFO
SMR
SMS
SSA
STEM
TCFD
the Code
Trent 1000
TEN
TRI
TSR
USD/US$
UTCs
International Aero Engines AG
International Accounting Standards Board
International financial reporting standards
Industria de Turbo Propulsores S.A.
key performance indicators
kilotonnes carbon dioxide equivalent
lesbian, gay, bisexual and transgender
London inter-bank offered rate
long-term incentive plan
long-term planning exchange rate
long-term service agreement
Ministério Público Federal, Brazil
maintenance repair and overhaul
Manufacturing Technology Centre
non-controlling interest
other comprehensive income
original equipment
Organisation for Economic Co-operation
and Development
profit and loss
profit before tax
power gearbox
property, plant and equipment
performance share plan
research and development
research and technology
Computershare Investor Services PLC
risk management system
risk and revenue sharing arrangements
service delivery centres
SENER Grupo de Ingeniería, S.A.
UK Serious Fraud Office
small modular reactors
safety management system
Special Security Agreement
science, technology, engineering and mathematics
Taskforce on Climate-related Financial Disclosures
UK Corporate Governance Code
Thrust, Efficiency and New technology
total reportable injuries
total shareholder return
United States dollar
University Technology Centres
Trade marks
Photo credit
The following trade marks which appear throughout this
Annual Report are trade marks registered and owned by
companies within the Rolls-Royce Group:
Pictures on pages 37 and 38: Crown copyright. Contains
public sector information licensed under the Open
Government Licence v3.0.
BR710®
CorporateCare®
Flex®
Gnome®
LiftSystem™
MTU®
MTU PowerPacks®
RB211®
Reman®
TotalCare®
Trent®
UltraFan®
Designed and produced by
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recycled content, of which 75% is de-inked
post-consumer. All of the pulp is bleached using
an elemental chlorine free process (ECF).
Printed in the UK by PurePrint using their
environmental printing technology,
using vegetable inks throughout. PurePrint
is a CarbonNeutral® company. Both the paper
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© Rolls-Royce plc 2018
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