TIDM42XB
RNS Number : 3755L
Rolls-Royce plc
18 April 2018
Rolls-Royce plc
Publication of the Annual Report 2017
Rolls-Royce plc announces that its Annual Report for the year
ended 31 December 2017 is now available on the Group's website at
www.rolls-royce.com
A copy of the above document has been submitted to the National
Storage Mechanism and will shortly be available for inspection at
www.morningstar.co.uk/uk/NSM
In accordance with paragraph 6.3.5 of the Disclosure and
Transparency Rules we set out below a management report extracted
from the annual report in unedited full text. Accordingly, page
references in the text below refer to page numbers in the annual
report.
Enquiries
Investors:
Jennifer Ramsey +44 20 7227 9087
Helen Harman +44 20 7227 9339
Ross Hawley +44 20 7227 9282
Media:
Richard Wray +44 20 7227 9163
Cautionary statement regarding forward-looking statements
This announcement contains forward-looking statements. Any
statements that express forecasts, expectations and projections are
not guarantees of future performance and will not be updated. By
their nature, these statements involve risk and uncertainty, and a
number of factors could cause material differences to the actual
results or developments. This report is intended to provide
information to shareholders, is not designed to be relied upon by
any other party, or for any other purpose and the Company and its
directors accept no liability to any other person other than under
English law.
This announcement contains non-statutory accounts within the
meaning of section 435 of the Companies Act 2006. The statutory
accounts for the year ended 31 December 2017, upon which an
unqualified audit opinion has been given and which did not contain
a statement under Section 498(2) or 498(3) of the Companies Act
2006, will be filed in due course with the Registrar of
Companies.
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 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 7.
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 GBP200m 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
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 40 and 41. We
invested over GBP1bn in self-funded R&D in 2017, part of which
supported the installation of digital engineering tools, producing
our first all-digital engine design.
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 e electrification to the long-term future
of the aerospace industry
Operational excellence - a new operating strategy was developed
and we invested a further GBP764m 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 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
GBP200m 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
15 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 53. On page 124 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 9.
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 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.
2018 priorities
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Customer Technology Resilience Financial progress
mitigate impact focus through through adaptability delivering improving
to rectify in-service product digitisation, with a spotlight free cash flow,
issues, ramp up electrification on safety, diversity strengthening
large engine production, and revitalisation & inclusion, and balance sheet,
grow service capabilities the highest ethical more disciplined
standards capital allocation
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.
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 year, 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.
Our Vision and Strategy
To respond to these key trends, we have refreshed our Group
vision and strategy.
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.
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.
Business Model
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.
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.
Advanced technologies
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.
System solutions
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.
System life
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.
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.
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.
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.
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.
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.
Our power solutions create revenue from:
- 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.
Value creation for our stakeholders in 2017
Customers
We develop product solutions that improve our customers'
competitiveness. Gross R&D expenditure GBP1.4bn
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. Invested in training and development GBP31.2m
Partners
We create partnerships based on collaboration where each partner
benefits from the relationship. Spent with external suppliers
GBP8.7bn
Communities
We improve the communities that we impact locally, nationally
and globally. 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.
Key Performance Indicators
Financial key performance indicators
Description Why we measure it How we have performed
Order book We measure our order The 3% decline principally
GBP78.5bn book as an indicator reflects the current period
of future business where Civil Aerospace engine
volume; however, deliveries have outpaced
its value may not new orders as Civil Aerospace
be reflective of customers focused on delivering
future revenue. 1 against their backlog. Power
Systems and Nuclear order
books improved, reflecting
greater activity.
--------------------------- -------------------------------------
Order intake Order intake is a Order intake was GBP1.9bn
GBP17.2bn measure of new business lower than achieved in 2016
secured during the due to Civil Aerospace customers
year and represents focusing more on delivery
new firm orders, of airframes than new sales
adjusted for the campaigns. All other business
movement in the announced units saw an improvement
order book between in their order books, including
the start and end in Marine from what was a
of the period. 2 low base.
--------------------------- -------------------------------------
Underlying revenue Monitoring of revenue Underlying revenue rose 6%
GBP15,090m provides a measure organically,8 reflecting
of business growth. increased delivery volumes
3 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.
--------------------------- -------------------------------------
Self funded R&D This measure reflects Disciplined control of spend
as a proportion the need to generate kept R&D stable as percentage
of underlying current returns as of sales, with self-funded
revenue well as to invest R&D increasing to GBP1.04bn.
6.9% for the future. 4 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 To deliver on its Capital expenditure rose
as a proportion commitments to customers, as proportion of revenue,
of underlying the Group invests and was GBP764m in absolute
revenue significant amounts terms, reflecting investment
5.1% in its infrastructure. in modernising manufacturing
5 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.
--------------------------- -------------------------------------
Underlying operating This measure reflects Organic 8 growth of 22% driven
profit the Group's underlying by revenue improvement, our
GBP1,175m economic performance focus on reducing fixed costs,
taking account of higher capitalised R&D and
its hedging strategies. product mix. This was despite
6 higher costs incurred from
in-service issues with Trent
1000 and Trent 900 fleets.
Transformation programme
benefits reached the top
end of the targeted GBP200m
run-rate reduction.
--------------------------- -------------------------------------
Free cash flow In a business requiring Cash generation was better
GBP276m significant investment, than expected, notably in
we monitor cash flow Power Systems, driven by
to ensure that profitability improved profitability and
is converted into strong working capital management
cash generation, which saw a GBP546m working
both for future investment capital inflow in the year.
and as a return to These more than offset higher
shareholders. 7 capex and R&D and increased
costs to resolve Civil Aerospace
in-service engine issues.
Non-financial key performance indicators
Description Why we measure it How we have performed
Customer delivery To deliver on our We continued to improve our
91% commitments to our on-time delivery in a period
customers we measure where we are significantly
the percentage of increasing the output of
on-time deliveries our Trent engines.
to our customers
including new equipment,
spare parts, equipment
repair and overhaul.
This is tracked Group-wide
in our scheduling
and order fulfilment
system.
---------------------------- ------------------------------
Employee engagement This is measured We maintained our employee
75 through our employee engagement score of 75 in
opinion survey which 2017, which was the same
produces a composite as in 2016. However we fell
sustainable engagement short of our target of 77.
score. The targets
are based on absolute
scores for six key
questions within
the overall survey.
---------------------------- ------------------------------
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.
Financial Review
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 GBP8bn in new products
and operations, with cumulative tangible capital expenditure of
GBP3.2bn and self-funded R&D investment of GBP4.4bn. 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
GBP15.1bn. Original equipment (OE) revenue of GBP7.7bn 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 GBP7.4bn in 2017, led by growth in Civil
Aerospace.
Underlying operating profit grew 22% organically to GBP1,175m
(reported operating profit of GBP1,287m) 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 GBP227m impact on profit in the
year (2016: GBP98m). Transformation programme benefits have now
reached the top end of our targeted GBP200m run-rate reduction in
fixed costs.
Cash generation was better than expected in 2017, notably in
Power Systems, with GBP276m of Group free cash flow (2016:
GBP120m), driven by improved profitability and strong working
capital performance which saw a GBP546m working capital inflow in
the year. These were more than offset by higher capex, R&D and
the GBP170m cash costs incurred on Trent 1000 and Trent 900
in-service issues (2016: GBP90m). 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 GBP400m excluding ITP Aero (around GBP450m
including ITP Aero). Free cash flow should improve to around
GBP450m excluding ITP Aero, (around GBP400m 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 GBP100m 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.
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
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.
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
2 Continue cost reduction
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
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 53 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.
Group trading summary
Underlying revenue up 6%
Group revenue rose 6% to GBP15,090m, 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 GBP2,973m, 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 GBP1,392m. After funding
from customers and other third parties, self-funded R&D rose 7%
to GBP1,035m. 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 GBP99m to GBP342m due to the stage of development programmes
and included GBP83m from a policy application change. Contributions
from risk & revenue sharing partners declined GBP24m. Overall
the underlying expensed R&D charge fell 18% to GBP737m.
C&A costs down 3%
C&A costs were GBP1,168m, 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.
Exceptional restructuring charges
GBP104m of exceptional restructuring charges were taken in 2017
(2016: GBP129m) primarily due to restructuring in Power Systems and
Defence Aerospace, reflecting actions to remove cost and improve
operational efficiency.
Underlying operating profit up GBP260m
Underlying operating profit of GBP1,175m (2016: GBP915m) was up
22% reflecting a number of factors:
- Civil Aerospace profit increased to GBP520m, 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 GBP227m of costs charged for these.
Expensed R&D fell GBP156m to GBP412m reflecting increased
capitalisation.
- Defence Aerospace profit of GBP374m was down 7% due to lower
demand for engine spares, higher restructuring costs and a GBP14m
reduction in LTSA contract margin improvements taken in 2016. These
more than offset the non-repeat of the TP400 charge of GBP31m in
2016.
- Power Systems made excellent progress in 2017, with profit of
GBP330m 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 GBP25m (a
GBP2m improvement versus 2016).
- Nuclear operating profit of GBP38m was 18% lower versus 2016,
primarily reflecting a higher R&D charge of GBP23m compared
with the GBP6m incurred in 2016 which had benefited from a one-off
positive of GBP7m due to the change in treatment of R&D
credits.
Group trading summary
GBPm 2017 2016 Change Organic change
Order book* 78,476 80,910 -3% -3%
Underlying revenue 15,090 13,783 +9% +6%
Underlying OE revenue 7,687 7,027 +9% +6%
Underlying services revenue 7,403 6,756 +10% +7%
Underlying gross profit 2,973 2,818 +6% +1%
Gross margin % 19.7% 20.4% -70bps -100bps
Commercial and administration
costs (1,168) (1,158) +1% -3%
Research and development
costs (737) (862) -15% -18%
Joint ventures and associates 107 117 -9% -13%
Underlying operating profit 1,175 915 +28% +22%
Underlying operating margin 7.8% 6.6% +120bps +100bps
Financing costs (104) (102) +2%
Underlying profit before
tax 1,071 813 +32%
Tax (328) (261) +26%
Underlying profit for
the year 743 552 +35%
Free Cash Flow 276 120 n/a
* The 2016 opening order book has been restated by GBP1.5bn
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 GBP(441)m.
Reported results
Reported profit before tax was GBP4.9bn, a material increase
over the 2016 loss of GBP4.6bn. This included GBP798m of gains
resulting from the acquisition of ITP Aero, a positive FX
mark-to-market adjustment of our hedge book of GBP2.6bn (GBP4.4bn
negative in 2016), a charge of GBP671m for financial penalties from
agreements with investigating bodies in 2016, a charge (principally
relating to the Vickers Group Pension Scheme) of GBP306m for the
restructuring of the UK pension schemes in 2016 and goodwill/other
impairments of GBP24m versus GBP219m 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 GBP276m
(2016: GBP120m), excluding the GBP14m 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 GBP98m of
higher R&D cash spend in 2017, a GBP188m increase in capital
expenditure and the reversal of the GBP180m working capital
management benefit generated in the first half. Trading cash flow
in Civil Aerospace of GBP38m 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 GBP170m (2016: GBP90m).
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 48.
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 53.
Net debt
In 2017, the Group's net debt position rose from GBP225m to
GBP523m (excluding ITP Aero) largely reflecting the GBP276m free
cash generation offset by shareholder payments of GBP214m and
GBP286m covering payments due in 2017 for the financial penalties
from agreements with investigating bodies. A further GBP378m 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 GBP14m and the consolidation of the net funds of GBP215m
result in Group net debt rising somewhat less to GBP305m.
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 $38.5bn (at
an average rate of USD:GBP 1.55) covering this exposure. We expect
the achieved GBP/$ 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 GBP2m to GBP104m. Net interest payable reduced by
GBP10m to GBP53m. Other underlying financing costs increased by
GBP12m to GBP51m.
Taxation
Underlying taxation was GBP328m (2016: GBP261m), 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.
Civil Aerospace
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.
Civil Aerospace | Key financial data *
2017 Year-on-year Organic
change change
Underlying revenue GBP8,023m +14% +12%
Underlying gross profit GBP1,192m +1% -2%
Underlying operating profit GBP520m +42% +34%
Trading cash flow GBP38m -12% -12%
Order book GBP70.2bn -3% -3%
* See note 2 on page 86 for further segmental detail.
Organic change is at constant translational currency, excluding
M&A.
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 GBP8,023m, with both OE
revenue of GBP3,818m (2016: GBP3,357m) and service revenue of
GBP4,205m (2016: GBP3,710m) 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 I 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 GBP520m, up 34% (2016:
GBP367m). 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 GBP18m headwind (2016: GBP90m benefit) which included a GBP148m
charge (2016: GBP98m charge) for technical cost (including certain
costs relating to the Trent 1000 and Trent 900 in-service issues),
aGBP113m (2016: GBP217m) benefit from lifecycle cost improvements
and a GBP77m benefit from a customer credit rating change, offset
by other charges of GBP60m (2016: GBP64m charge) largely relating
to operational changes. Profit was also impacted by the non-repeat
of the GBP53m 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 GBP67m (2016: GBP97m).
Investment in self-funded R&D rose by GBP50m 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 GBP328m (2016:
GBP85m), 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 GBP83m being
capitalised. Contributions from risk and revenue partners decreased
to GBP39m (2016: GBP63m). Overall the expensed R&D charge fell
to GBP412m in 2017 from GBP568m in 2016. Higher restructuring
provisions contributed to the 5% increase in C&A costs.
Trading cash flow
Trading cash flow in Civil Aerospace of GBP38m 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 GBP1.6m
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
GBP119m (2016: GBP45m) and GBP51m (2016: GBP45m) 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 51 and 52. 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 54 and 55.
Order book
Order intake in 2017 was GBP10.5bn (2016: GBP14.1bn including a
GBP2.1bn uplift from a change in the long-term USD planning rate)
with orders placed for 185 widebody engines. The closing order book
was GBP70.2bn (2016: GBP72.0bn) 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 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 GBP150m 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 GBP59m 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 GBP227m (2016: GBP98m) were recognised in the
income statement in relation to accelerated maintenance activity
for the Trent 1000 and Trent 900 in 2017 and GBP170m (2016: GBP90m)
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 GBP170m and reach a peak in 2018, as maintenance
activity intensifies. It is then expected to fall by around GBP100m
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 GBP4.2bn
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 56.
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.
Defence Aerospace
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.
Defence | Key financial data *
2017 Year-on-year Organic change
change
Underlying revenue GBP2,275m +3% -1%
Underlying gross profit GBP575m +2% -2%
Underlying operating profit GBP374m -3% -7%
Underlying operating margin 16.4% -100bps -100bps
Order book GBP3.4bn -18% -14%
* See note 2 on page 86 for further segmental detail.
Organic change is at constant translational currency, excluding
M&A.
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 GBP2,275m 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 GBP575m was 2% lower than prior year reflecting
lower LTSA margin improvements of GBP68m (2016: GBP82m), 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 GBP31m of one-off costs for the TP400
programme. Overall the R&D charge of GBP78m (2016: GBP71m) 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 GBP14m 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 GBP374m was 7% lower
than the prior year. During the year, the Defence Aerospace order
book was restated by GBP(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 GBP1.8bn,
the order book closed at GBP3.4bn.
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 56
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.
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.
- 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.
Power Systems
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.
Power Systems | Key financial data *
2017 Year-on-year Organic change
change
Underlying revenue GBP2,923m +10% +3%
Underlying gross profit GBP842m +20% +12%
Underlying operating profit GBP330m +73% +61%
Underlying operating margin 11.3% +410bps +410bps
Order book GBP2.2bn +8% +4%
* See note 2 on page 132 for further segmental detail.
Organic change is at constant translational currency, excluding
M&A.
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 GBP2,923m 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 GBP177m. C&A costs
reduced 7% to GBP331m reflecting cost reduction activities in the
year. Overall underlying operating profit which increased strongly
to GBP330m (2016: GBP191m).
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 56.
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, t
then we may lose attractiveness and competitive edge.
Marine
Marine manufactures and services propulsion and handling
solutions for the maritime offshore, merchant and naval markets,
ranging from standalone products to complex integrated systems.
Marine | Key financial data *
2017 Year-on-year Organic change
change
Underlying revenue GBP1,077m -3% -9%
Underlying gross profit GBP225m -5% -9%
Underlying operating profit GBP(25)m -7% +15%
Underlying operating margin -2.3% -10bps -10bps
Order book GBP0.8bn -18% -15%
* See note 2 on page 86 for further segmental detail.
Organic change is at constant translational currency, excluding
M&A.
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 GBP1,077m, 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 GBP805m
(2016: GBP875m) and naval was up 10% to GBP272m (2016:
GBP239m).
Underlying operating loss
Despite the 9% decline in underlying revenue there was a GBP2m
reduction in the underlying operating loss for the year to GBP25m
(2016: GBP27m), 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 GBP46m, with the
focus on developing ship intelligence capabilities as well as on
new product development. C&A costs of GBP204m 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.
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 GBP45-50m 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 GBP20m 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 56.
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.
Nuclear
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.
Nuclear| Key financial data *
2017 Year-on-year Organic change
change
Underlying revenue GBP818m +5% +4%
Underlying gross profit GBP133m +10% +7%
Underlying operating profit GBP38m -16% -18%
Underlying operating margin 4.6% -120bps -120bps
Order book GBP2.0bn +8% +7%
* See note 2 on page 86 for further segmental detail.
Organic change is at constant translational currency, excluding
M&A.
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
GBP633m, while civil nuclear revenue grew 9% to GBP185m. 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 GBP17m 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:
GBP7m credit). As a result, underlying operating profit was GBP38m,
GBP7m 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
safetycritical 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 56.
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.
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 of Rolls-Royce Holdings plc 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.
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 39).
Ship intelligence is an important theme in our Marine business,
developing marketshifting system solutions, and improving safety
and efficiency in the industry (see case study on page 32).
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.
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 Further reducing the environmental impact of our products and
services
2 Developing new technologies and capabilities for low emission
products and services
3 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.
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 40
and 41
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.
People
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:
- systems integration
- electrical engineering
- data sciences
Core competencies
Key competencies needed to safeguard our current
competitiveness:
- engineering pre-eminence
- programme management
- business acumen
Growing behaviours
Key behaviours needed to secure emerging opportunities:
- pursue collaboration
- seek simplicity
- embrace agility
- be bold
Core values
Key values needed to safeguard our current competitiveness:
- 'Trusted to Deliver Excellence'
- act with integrity
- operate safely
Our 2017 headcount
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)
2017 2016
Civil Aerospace 24,600 23,800
Defence Aerospace 6,100 6,000
Power Systems 10,100 10,300
Marine 4,600 5,300
Nuclear 4,400 4,300
Other businesses and
corporate 200 200
Total 50,000 49,900
Headcount by region (1)
2017 2016
UK 22,500 22,300
US 6,200 6,300
Canada 1,000 1,000
Germany 10,600 10,700
Nordic countries 3,000 3,400
Rest of world 6,700 6,200
Total 50,000 49,900
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.
Health and safety
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.
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.
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.
Employee engagement
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.
During 2017, we invested GBP31.2m 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.
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,
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.
Our diversity and inclusion targets
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.
30% female
High potential population
30% female
Graduate population
17% female
All employ population
Our global targets are supported by local targets in key regions
where there are specific diversity challenges associated with
ethnicity, nationality and age.
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.
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.
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 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-slavery and human trafficking statement, available at
www.rolls-royce.com.
Ethics in our supply chain
We spent over GBP8.7bn 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.
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 Revenue Profit before financing Financing Profit/(loss) before tax
GBPm 2017 2016 2017 2016 2017 2016 2017 2016
Underlying 15,090 13,783 1,175 915 (104) (102) 1,071 813
Revenue recognised at
exchange rate on date of
transaction (1) 1,217 1,172 - - - - - -
Mark-to-market adjustments on
derivatives (8) -- - 24 - 2,648 (4,420) 2,672 (4,420)
Related foreign exchange
adjustments - - 345 570 257 (151) 602 419
Movements on other financial
instruments - - - - 11 (8) 11 (8)
Effects of acquisition
accounting (2) - - (129) (115) - - (129) (115)
Impairments (3) - - (24) (219) - - (24) (219)
Exceptional restructuring (4) - - (104) (129) - - (104) (129)
Acquisitions and disposals
(5) - - 798 (3) - - 798 (3)
Financial penalties (6) - - -- (671) - - - (671)
Post-retirement schemes - - - (306) 1 3 1 (303)
Other - - - (1) (1) 1 (1) -
Reported 16,307 14,955 2,085 41 2,812 (4,677) 4,897 (4,636)
The changes in 2017 resulting from underlying trading are
described on page 16.
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 GBP1,217m (2016: GBP1,172m) and increased profit before
financing by GBP345m (2016: increased GBP570m).
2. The effects of acquisition accounting GBP129m (2016: GBP115m)
principally relate to the amortisation of intangible assets arising
on the acquisition of Power Systems in 2013.
3. The impairment of goodwill, investments, PPE and inventory of
GBP24m (2016: GBP219m). In 2017, this includes GBP12m as a result
of consolidating a previously unconsolidated subsidiary and GBP12m
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 GBP104m (2016: GBP129m).
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 GBP553m
from the revaluation of the previous joint venture investment and
recognition of a bargain purchase of GBP245m.
6. In 2016, GBP671m of penalties from agreements with
investigating bodies were recognised.
7. In 2016, the UK pension schemes were restructured resulting
in costs of GBP306m, principally a settlement charge on the
transfer of the Vickers Group Pension Scheme to an insurance
company.
Financing and taxation
8. The mark-to-market gain on the Group's hedge book of
GBP2,648m (2016: loss of GBP4,420m). 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 GBP361m (2016: credit GBP865m), largely as a result of
the mark-to-market adjustments GBP(463)m and GBP792m in 2017 and
2016 respectively. In addition, GBP163m of advance corporation tax
credits has been recognised as a result of changes to UK tax laws
in 2017.
Group Funds flow
2017
Summary funds flow statement (1)
GBPm Excl ITP Aero ITP Aero Total 2016 Change excl ITP Aero
Opening net (debt) (225) - (225) (111) -
Closing net (debt)/funds (520) 215 (305) (225) -
Change in net (debt)/funds (295) 215 (80) (114) -
Underlying profit before tax 1,071 - 1,071 813 +258
Depreciation and amortisation 741 - 741 720 +21
Movement in net working capital 546 (14) 532 (55) +601
Expenditure on property, plant and equipment and
intangible assets (1,732) - (1,732) (1,201) -531
Other (164) - (164) 47 -211
Trading cash flow 462 (14) 448 324 +138
Contributions to defined benefit pensions in excess
of underlying PBT charge (9) - (9) (67) +58
Taxation paid (180) - (180) (157) -23
Free cash flow 273 (14) 259 100 +173
Shareholder payments (214) - (214) (301) +87
Net funds acquired/acquisitions (17) 229 212 (153) +136
Payment of financial penalties (286) - (286) - -286
Other 8 - 8 - +8
Foreign exchange (59) - (59) 240 -299
Change in net funds (295) 215 (80) (114)
(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 GBP546m cash inflow from a fall in
working capital were increased receipts from airframers in advance
of discounts payable to the operator (GBP460m) in Civil Aerospace
together with an increase in payables (GBP120m) but partly offset
by increased inventory (GBP330m), all linked with the ramp-up of
our newer programmes. Other significant contributors to the working
capital reduction were improved receivables and deposits (GBP90m)
in Power Systems and the Aviall distribution agreement in Defence
Aerospace (GBP120m) and associated reduced inventory.
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.
Pensions
Cash contributions reduced by GBP22m to GBP249m, split evenly
between the UK and overseas. The UK contributions are net of a
refund of GBP5m from a wound-up scheme. The UK pension cost
increased by GBP21m 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.
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 GBP229m. From the date of
acquisition to 31 December 2017, the net funds outflow in ITP Aero
was GBP14m; excluding the impact of ITP Aero, free cash flow would
have been GBP273m. In addition, the consolidation of MTU Brazil for
the first time resulted in the recognition of net debt of
GBP17m.
Payment of financial penalties
Following the agreements reached with investigating authorities
in January 2017, GBP286m of penalties were paid in the UK, US and
Brazil. Further UK payments of GBP378m (plus interest) will be made
in 2019-2021.
Group - balance sheet
Summary balance sheet
At 31 December
GBPm Excluding the impact of ITP Aero Impact of ITP Aero 2017 2016
Intangible assets 5,646 1,417 7,063 5,080
Property, plant and equipment 4,356 268 4,624 4,114
Joint ventures and associates 892 (204) 688 844
Net working capital(1) (1,874) (444) (2,318) (1,553)
Net funds(2) (523) 215 (305) (225)
Balances with parent company 1,785 - 1,785 1,565
Provisions (815) (68) (883) (759)
Net post-retirement scheme
surpluses/(deficits) 738 - 738 (29)
Net financial assets and liabilities(2) (2,421) (148) (2,569) (5,723)
Other net assets and liabilities(3) (602) (238) (840) 143
Net assets 7,182 798 7,980 3,457
Other items
US$ hedge book (US$bn) 38.5 37.8
TotalCare assets 3,536 3,348
TotalCare liabilities (1,033) (907)
Net TotalCare assets 2,503 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 GBP227m (2016: GBP358m) 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 96) increased by GBP566m. Additions of
GBP973m (including GBP160m of certification and participation fees,
GBP342m of development costs, GBP286m of contractual aftermarket
rights and software of GBP135m) were offset by amortisation of
GBP430m.
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.
Property, plant and equipment
Property, plant and equipment (page 98) increased by GBP242m.
Additions of GBP764m were offset by depreciation of GBP444m.
Additions included an increase to the size of the Civil Aerospace
engine pool (GBP136m) driven by fleet support for new programmes,
investment in industrial footprint consolidation (GBP109m) and in
manufacturing assembly and test (GBP68m).
Investments in joint venturesand associates
Investments in joint ventures and associates increased by
GBP48m. The main movements were: additions of GBP48m, including
GBP28m of investment in joint ventures that finance some of the
Civil Aerospace spare engine pool; the Group's share of retained
profit of GBP52m; offset by GBP44m of exchange differences.
Net funds
Movements in net funds are shown on page 49.
Net working capital
Net working capital reduced by GBP321m. As well as the cash
impact of GBP546m described above, the movement reflects the
payment of penalties of GBP286m. The remaining movements are
primarily driven by movements in foreign exchange rates.
Provisions
Provisions largely relate to warranties and guarantees provided
to secure the sale of OE and services. The increase of GBP56m
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 113) have increased
by GBP767m.In the UK (increase in surplus of GBP772m), changes in
actuarial estimates reduced the value of the obligations GBP515m,
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 GBP265m.
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 104. All contracts continue to
be held for hedging purposes. The fair value of foreign exchange
derivatives is a net financial liability of GBP2.3bn, a reduction
of GBP3.2bn 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
GBP1 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 121. 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 GBP648m 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.
Civil Aerospace underlying revenue analysis
GBPm 2017 2016 Change Organic change
Original Equipment 3,818 3,357 +14% +12%
Large engine: linked and
other 1,895 1,604 +18% +18%
Large engine: unlinked
installed 1,103 742 +49% +49%
Business aviation 598 757 -21% -26%
V2500 222 254 -13% -13%
Services 4,205 3,710 +13% +12%
Large engine 2,626 2,289 +15% +15%
Business aviation 527 452 +17% +10%
Regional 343 342 - -5%
V2500 709 627 +13% +13%
Revenue
Overall, underlying revenue for Civil Aerospace rose 12% to
GBP8.0bn, with OE revenue of GBP3.8bn (2016: GBP3.4bn) up 12% and
services revenue of GBP4.2bn (2016: GBP3.7bn) 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:
linkedand other, generated revenue of GBP362m (2016: GBP288m).
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.
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
GBP709m 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.
Contract accounting adjustments
The in-year net charge from long-term contract accounting
adjustments included within the gross margin totalled GBP18m (2016:
GBP90m total benefit, including a GBP35m benefit from a change to
our long-term USD:GBP planning rate).
The benefit from lifecycle cost improvements in 2017 of GBP113m
(2016: benefit of GBP217m) included a GBP70m 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 GBP114m (2016: GBP55m) of the total GBP148m
impact (2016: GBP98m).
The overall benefit in 2017 from other operational changes was
GBP17m (2016: GBP64m charge). This comprised a GBP60m charge driven
by changes in the utilisation pattern of several customers' Trent
700, Trent 800 and RB211 fleets, offset by a GBP77m benefit taken
in the first half arising from a change to a customer credit rating
risk assessment.
Contract accounting adjustments
GBPm 2017 2016
Life-cycle cost improvements 113 217
Change in estimated long-term USD to GBP
planning rate - 35
Technical costs (148) (98)
Operational changes 17 (64)
Total contract accounting adjustments (18) 90
TotalCare net assets
TotalCare net assets increased in 2017 by GBP62m (2016: GBP230m)
to GBP2.5bn. This reflected an increase in the overall cash deficit
combined with higher linked profit driven by increased volumes of
new linked engines of GBP612m (2016: GBP432m), notably the Trent
700.
This increase was offset by adverse contract accounting
adjustments taken in the year of GBP18m (2016: GBP90m benefit),
foreign exchange of GBP(97)m (2016: GBP77m) and cash inflows and
net other items of GBP(435)m (2016: GBP(369)m).
Contractual aftermarket rights (CARs)
The CARs balance increased by GBP230m (2016: increase of
GBP169m) to GBP803m reflecting higher sales of unlinked Trent XWB
engines partly offset by price increases and engine unit cost
improvements.
TotalCare net asset
GBPm 2017 2016
Cash deficit reversal and profit from new "linked"
engines 612 432
Contract accounting adjustments (18) 90
Foreign exchange (97) 77
Cash inflows and net other items (435) (369)
Total change in TotalCare net asset 62 230
Group - impact of adopting IFRS 15
Group underlying results
2017 GBPm Current accounting IFRS 15
Revenue
Civil Aerospace 8,023 6,613
Defence Aerospace 2,275 2,282
Power Systems 2,923 2,919
Marine 1,077 1,075
Nuclear 818 818
Other (26) (25)
Total revenue 15,090 13,682
Operating profit
Civil Aerospace 520 (330)
Defence Aerospace 374 370
Power Systems 330 331
Marine (25) (26)
Nuclear 38 38
Other (62) (62)
Total operating profit 1,175 321
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 GBP(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.
In addition, the overall net impact on operating profit of the
adoption of IFRS 15 within the Defence Aerospace business was
GBP4m. This comprised a GBP34m LTSA margin impact which is broadly
expected to recur in the short term, but was offset by a GBP30m
favourable timing benefit from a spares distribution contract,
which is not expected to repeat in 2018.
Civil Aerospace - impact of adopting IFRS 15
Civil Aerospace underlying income statement summary
2017 Current accounting IFRS 15 Difference
GBPm
Underlying revenue 8,023 6,613 (1,410)
Underlying OE revenue 3,818 2,905 (913)
Underlying services revenue 4,205 3,708 (497)
Underlying gross profit 1,192 381 (811)
Gross Margin 14.9% 5.8%
R&D Costs (412) (451) (39)
Underlying operating profit/(loss) 520 (330) (850)
Underlying operating margin % 6.5% (5.0)%
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 26 to the Consolidated
Financial Statements.
The adoption of IFRS 15 reduces Civil Aerospace underlying
revenue and underlying operating profit by GBP1,410m and GBP850m
respectively.
Underlying OE revenue reduces by GBP913m, 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 GBP497m. 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 GBP299m 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.
2017 Current accounting IFRS15 Difference
GBPm
Original Equipment 3,818 2,905 (913)
------------------- ------------------ ------ ----------
Large engine 2,998 2,104 (894)
Business aviation 598 582 (16)
V2500 222 219 (3)
Services 4,205 3,708 (497)
------------------- ------------------ ------ ----------
Large engine 2,626 2,327 (299)
Business aviation 527 396 (131)
Regional 343 277 (66)
V2500 709 708 (1)
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 53, 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 GBP(96)m from GBP113m under current accounting to
GBP17m under IFRS 15.
On the other hand, the contract margin adjustment associated
with technical costs will be GBP50m lower under IFRS 15.
The benefit from other operational changes totalled GBP17m in
2017 under current accounting. This included a GBP77m 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 Current accounting IFRS 15 Difference
GBPm
Life-cycle cost improvements 113 17 (96)
Technical costs (148) (98) 50
Operational changes 17 (68) (85)
Total contract accounting adjustments (18) (149) (131)
-------------------------------------- ------------------ -------- -----------
Balance sheet adjustments under IFRS 15
The impact of adopting IFRS 15 on the Civil Aerospace balance
sheet is summarised below.
GBP(5.1)bn of the GBP(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 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 GBP(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
Current accounting
2017
GBPbn Current accounting IFRS 15 Difference
Contractual aftermarket rights 0.8 - (0.8)
Participation fees - intangible 0.4 - (0.4)
Participation fees - contract asset - 0.4 0.4
Net contract debtor/(creditor) 2.5 (2.7) (5.2)
Other (0.6) (0.3) 0.3
Risk and revenue sharing agreements (0.3) (0.8) (0.5)
Civil Aerospace net assets (pre-tax) 2.8 (3.4) (6.2)
Tax 1.1
Civil Aerospace reserves impact
(post-tax) (5.1)
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.
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.
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;
- 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
- 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.
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.
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 22) 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.
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 40.
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.
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
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
Risk or uncertainty How we manage it Key controls
and potential impact
Disruptive technologies -- Horizon and emerging - Strategic planning
and business models technology scanning and process
Disruptive technologies, understanding our competitors, - Investment review
new entrants with including patent searches. committee
alternative business -- Investing in innovation - Digital governance
models or disruptions and new technologies. board
to key markets or -- Focusing on enhancing - Research & technology
customers could reduce our skills and capabilities board
our ability to sustainably to maintain our technology - Digital business
win future business, leadership. development
achieve operating -- Forming strategic partnerships board
results and realise and conducting joint research
future growth opportunities. programmes.
-- Establishing our digital
business.
This principal risk is
subject to review by the
Science & Technology Committee
Competitive position -- Accessing and developing - Financial performance
The presence of large, key technologies and service review
financially strong offerings which differentiate - Strategic planning
competitors in the us competitively. process
majority of our markets -- Focusing on being responsive - Investment review
means that the Group to our customers and improving committee
is susceptible to the quality, delivery and - Science & Technology
significant price reliability of our products Committee
pressure for original and services. - Research & technology
equipment or services -- Partnering with others board
even where our markets effectively.
are mature or the -- Driving down cost and
competitors few. improving margins.
Our main competitors -- Protecting credit lines.
have access to significant -- Investing in innovation,
government funding manufacturing and production,
programmes as well and continuing governance
as the ability to of technology programmes.
invest heavily in -- Maintaining a healthy
technology and industrial balance sheet to enable
capability. access to cost-effective
sources of third party
funding.
-- Understanding our competitors.
Major product programme -- Major programmes are - Rolls-Royce management
delivery subject to Board approval. system
Failure to deliver -- Reviewing major programmes - Operational performance
a major programme at levels and frequencies review
on time, within budget, appropriate to their criticality - Project assurance
to specification, and performance, against - Gated business and
or technical performance key financial and non-financial technical
falling significantly deliverables and potential reviews
short of customer risks throughout the programmes - Quality compliance
expectations, or lifecycle. audit
not delivering the -- Investing in facilities - Major quality investigations
planned business and people to minimise board
benefits, would have the level of disruption
potentially significant to our customers from Trent
adverse financial 1000 and Trent 900 in-service
and reputational challenges and developing
consequences, including longer term solutions to
the risk of impairment these issues.
of the carrying value -- Conducting technical
of the Group's intangible audits at pre-defined points
assets and the impact which are performed by
of potential litigation. 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.
Product safety -- Ensuring a culture that - Company product safety
The lives of people puts safety first. assurance board
that our customers -- Applying our engineering - Quality compliance
serve depend on the design and validation process audit
safety of our products from initial design, through - Engineering technical
wherever and whenever production and into service. audit
they operate them. -- Reviewing the scope - Crisis management
Any failure to meet and effectiveness of the team
this expectation, Group's product safety - Environment and sustainability
or if our product policies to ensure that committee
causes significant they operate to the highest
environmental impact, industry standards.
would adversely affect -- Operating a safety management
our reputation and system (SMS), governed
long-term sustainability. 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.
-- Improving our supply
chain quality.
Talent and capability -- Attracting, rewarding - Remuneration Committee
Inability to attract and retaining the right - ELT
and retain the critical people with the right skills - Senior leadership
capabilities and globally in a planned and team
skills needed in targeted way, including - HR executive team
sufficient numbers regular benchmarking of
to effectively organise, remuneration.
deploy and incentivise -- Developing and enhancing
our people to deliver organisational, leadership,
our strategies, business technical and functional
plans and projects. capability to deliver global
programmes.
-- Continuing a strong
focus on individual development
and succession planning.
-- Proactively monitoring
retirement in key areas
and actively managing the
development and career
paths of our people with
a special focus on employees
with the highest potential.
-- Embedding a lean, agile,
high-performance culture
that tightly aligns Group
strategy with individual
and team objectives.
-- Retaining, incentivising
and effectively deploying
the critical capabilities,
skills and people needed
to deliver our strategic
priorities, plans and projects
whilst implementing the
Group's major programme
to transform its business,
to be resilient and to
act with pace and simplicity.
-- Tracking engagement
through our annual employee
opinion survey and a commitment
to drive year-on-year improvement
to the employee experience
and communications.
Business continuity -- Continuing our investment - Crisis management
Breakdown of external in adequate capacity and team
supply chain or internal modern equipment and facilities. - Major incidents board
facilities that could -- Identifying and assessing - Quality board and
be caused by destruction points of weakness in our process
of key facilities, internal and external supply councils
natural disaster chain, our IT systems and - Operations and IT
(including those the skills of our people. executive
caused by climate -- Selecting stronger suppliers, - Supplier audit
change), regional developing dual sources - Environment & sustainability
conflict, financial or dual capability. committee
insolvency of a critical -- Ensuring our suppliers
supplier or scarcity are aware of the 2018 Registration,
of materials which Evaluation, Authorisation
would reduce the and restriction of Chemicals
ability to meet customer (REACH) deadline and conducting
commitments, win research on alternative
future business or materials.
achieve operational -- Crisis management exercises
results. and testing site-level
incident management and
business recovery plans.
-- Providing improved response
to supply chain disruption
through customer excellence
centres.
IT vulnerability -- Implementing 'defence - Operations and IT
Breach of cyber security in depth' through deployment executive
causing controlled of multiple layers of software - IT security management
or critical data and processes including - Crisis management
to be lost, made web gateways, filtering, team
inaccessible, corrupted firewalls, intrusion, advanced
or accessed by unauthorised persistent threat detectors
users. and integrated reporting.
-- Running security and
network operations centres.
-- Actively sharing cyber
security information through
industry, government and
security forums.
Market and financial -- Maintaining a strong - Financial performance
shock balance sheet, through review
The Group is exposed managing cash balances - Financial risk committee
to a number of market and debt levels. - Operational performance
risks, some of which -- Providing financial review
are of a macro-economic flexibility by maintaining - Group finance, treasury
nature (e.g. foreign high levels of liquidity and tax teams
currency, oil price, and an investment grade
rates) and some of credit rating.
which are more specific -- Sustaining a balanced
to the Group (e.g. portfolio through earning
liquidity and credit revenue both from the sale
risks, reduction of original equipment and
in air travel or aftermarket services, providing
disruption to other a broad product range and
customer operations). addressing diverse markets
Significant extraneous that have differing business
market events could cycles.
also materially damage -- Deciding where and what
the Group's competitiveness currencies to source in,
and/or creditworthiness. and where and how much
credit risk is extended
This would affect or taken. The Group has
operational results a number of treasury policies
or the outcomes of that are designed to hedge
financial transactions. 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.
Political risk -- Where possible, locating - Government relations
Geopolitical factors our facilities and supply and
that lead to an unfavourable chain in countries with Group tax teams
business climate a low level of political - Strategic planning
and significant tensions risk and/or ensuring that process
between major trading we maintain dual capability. - Supplier audit
parties or blocs -- Diversifying global
which could impact operations to avoid excessive
the Group's operations. concentration of risks
Examples include: in particular areas.
explicit trade protectionism, -- The Group's businesses
differing tax or and its strategic marketing
regulatory regimes, network proactively monitoring
potential for conflict local situations.
or broader political -- Maintaining a balanced
issues. business portfolio with
high barriers to entry
and a diverse customer
base.
-- Proactively influencing
regulation where it affects
us.
-- Steering Committee to
co-ordinate activities
across the Group and minimise
the impact of Brexit.
Compliance -- Taking an uncompromising - Corporate governance
Non-compliance by approach to compliance. framework
the Group with legislation, -- Operating an extensive - Compliance and export
the terms of the compliance programme. This control teams
deferred prosecution programme and the Global - Group Secretariat
agreements or other Code of Conduct are disseminated - Legal team
regulatory requirements throughout the Group and
in the heavily regulated are updated from time to
environment in which time to ensure their continued
it operates (e.g. relevance, and to ensure
export controls; that they are complied
use of controlled with, both in spirit and
chemicals and substances; to the letter. The Global
and anti-bribery Code of Conduct and the
and corruption legislation) Group's compliance programme
compromising the are supported by appropriate
ability to conduct training.
business in certain -- Strengthening of the
jurisdictions and ethics, anti-bribery and
exposing the Group corruption, compliance
to potential: reputational and export control teams.
damage; financial -- A legal team is in place
penalties; debarment to manage any ongoing regulatory
from government contracts investigations.
for a period of time; -- Engaging with external
and/or suspension regulatory authorities.
of export privileges -- Implementing a comprehensive
(including export REACH compliance programme.
credit financing), This includes ensuring
each of which could that we and our supply
have a material adverse chain are covered by REACH
effect. 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.
Responsibility Statements
Statement of Directors' responsibilities in respect of the
Annual Report and the Financial Statements
The Directors, as detailed on pages 61 to 63, 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 60 and Directors' Report on
pages 61 to 68 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.
The going concern assessment considers whether it is appropriate
to prepare the Financial Statements on a going concern basis.
As described on page 167, 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 GBP5.4bn and total liquidity of GBP5.1bn,
including cash and cash equivalents of GBP3.0bn and undrawn
facilities of GBP2.1bn. GBP82m 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 Financial Reporting Council in
September 2014).
By order of the Board
Pamela Coles
Company Secretary
6 March 2018
Related party transactions
2017 2016
GBPm GBPm
Sales of goods and services to joint ventures
and associates 2,469 2,022
Purchases of goods and services from joint
ventures and associates (2,224) (1,881)
Operating lease payments to joint ventures
and associates (127) (101)
Guarantees of joint ventures' and associates'
borrowings 5 5
Dividends received from joint ventures and
associates 79 74
RRSA receipts from joint ventures and associates - 22
Other income received from joint ventures and
associates 2 2
Included in sales of goods and services to joint ventures and associates
are sales of spare engines amounting to GBP418m (2016: GBP356m). Profit
recognised in the year on such sales amounted to GBP75m (2016: GBP119m),
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 GBP67m (2016:
GBP97m).
The aggregated balances with joint ventures are shown in notes 12 and
15. Transactions with Group pension schemes are shown in note 18.
In the course of normal operations, related party transactions entered
into by the Group have been contracted on an arms-length basis. Key
management personnel are deemed to be the Directors and the members
of the ELT. Remuneration for key management personnel is shown below:
2017 2016
GBPm GBPm
Salaries and short-term benefits 16 13
Post-retirement schemes - -
Share-based payments 7 1
23 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 of Rolls-Royce Holdings plc. 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.
Condensed consolidated financial statements
Condensed consolidated income statement
For the year ended 31 December 2017
2017 2016
Notes GBPm GBPm
-------------------------------------------------- --- ------ --------- ---------
Revenue 2 16,307 14,955
-------------------------------------------------------- ------ --------- ---------
Cost of sales (13,134) (11,907)
-------------------------------------------------------- ------ --------- ---------
Gross profit 3,173 3,048
-------------------------------------------------------- ------ --------- ---------
Commercial and administrative costs (1) (1,222) (2,203)
-------------------------------------------------------- ------ --------- ---------
Research and development costs 3 (795) (918)
-------------------------------------------------------- ------ --------- ---------
Share of results of joint ventures and associates 131 117
-------------------------------------------------------- ------ --------- ---------
Operating profit (*) 2 1,287 44
-------------------------------------------------------- ------ --------- ---------
Gains arising on the acquisition of ITP Aero 14 798 -
-------------------------------------------------------- ------ --------- ---------
Loss on disposal of business - (3)
-------------------------------------------------------- ------ --------- ---------
Profit before financing and taxation 2 2,085 41
-------------------------------------------------------- ------ --------- ---------
Financing income 4 2,973 96
-------------------------------------------------------- ------ --------- ---------
Financing costs 4 (161) (4,773)
-------------------------------------------------------- ------ --------- ---------
Net financing 2,812 (4,677)
-------------------------------------------------------- ------ --------- ---------
Profit/(loss) before taxation 4,897 (4,636)
-------------------------------------------------------- ------ --------- ---------
Taxation 5 (689) 604
-------------------------------------------------------- ------ --------- ---------
Profit/(loss) for the year 4,208 (4,032)
-------------------------------------------------------- ------ --------- ---------
Attributable to:
================================================== === ====== ========= =========
Ordinary shareholders 4,207 (4,032)
======================================================== ====== ========= =========
Non-controlling interests 1 -
-------------------------------------------------- --- ------ --------- ---------
Profit/(loss) for the year 4,208 (4,032)
-------------------------------------------------------- ------ --------- ---------
1 In 2016, commercial and administrative costs include GBP671m
for financial penalties from agreements with investigating bodies
and GBP306m for the restructuring of the UK pension schemes.
All activities comprise continuing operations.
Condensed consolidated statement of comprehensive income
For the year ended 31 December 2017
2017 2016
Notes GBPm GBPm
----------------------------------------------------------------- ------ ------ --------
Profit/(loss) for the period 4,208 (4,032)
------------------------------------------------------------------- ------ ------ --------
Other comprehensive income (OCI)
----------------------------------------------------------------- ------ ------ --------
Movements in post-retirement schemes 11 735 495
------------------------------------------------------------------- ------ ------ --------
Share of OCI of joint ventures and associates (1) (2)
------------------------------------------------------------------- ------ ------ --------
Related tax movements (307) (179)
------------------------------------------------------------------- ------ ------ --------
Items that will not be reclassified to profit or loss 427 314
------------------------------------------------------------------- ------ ------ --------
Foreign exchange translation differences on foreign operations (142) 861
------------------------------------------------------------------- ------ ------ --------
Share of OCI of joint ventures and associates (5) (7)
------------------------------------------------------------------- ------ ------ --------
Related tax movements 1 4
------------------------------------------------------------------- ------ ------ --------
Items that may be reclassified to profit or loss (146) 858
------------------------------------------------------------------- ------ ------ --------
Total comprehensive income for the year 4,489 (2,860)
------------------------------------------------------------------- ------ ------ --------
Attributable to:
----------------------------------------------------------------- ------ ------ --------
Ordinary shareholders 4,488 (2,860)
------------------------------------------------------------------- ------ ------ --------
Non-controlling interests 1 -
----------------------------------------------------------------- ------ ------ --------
Total comprehensive expense for the year 4,489 (2,860)
------------------------------------------------------------------- ------ ------ --------
Condensed consolidated balance sheet
At 31 December 2017
2017 2016
Notes GBPm GBPm
-------------------------------------------- ------ --------- ---------
ASSETS
-------------------------------------------- ------ --------- ---------
Non-current assets
-------------------------------------------- ------ --------- ---------
Intangible assets 8 7,063 5,080
-------------------------------------------- ------ --------- ---------
Property, plant and equipment 9 4,624 4,114
-------------------------------------------- ------ --------- ---------
Investments - joint ventures and associates 688 844
-------------------------------------------- ------ --------- ---------
Investments - other 26 38
-------------------------------------------- ------ --------- ---------
Other financial assets 10 610 382
-------------------------------------------- ------ --------- ---------
Deferred tax assets 271 876
-------------------------------------------- ------ --------- ---------
Post-retirement scheme surpluses 11 2,125 1,346
-------------------------------------------- ------ --------- ---------
15,407 12,680
-------------------------------------------- ------ --------- ---------
Current assets
============================================ ====== ========= =========
Inventories 3,660 3,086
============================================ ====== ========= =========
Trade and other receivables 9,715 9,506
============================================ ====== ========= =========
Taxation recoverable 17 32
============================================ ====== ========= =========
Other financial assets 10 36 5
============================================ ====== ========= =========
Short-term investments 3 3
============================================ ====== ========= =========
Cash and cash equivalents 2,950 2,771
============================================ ====== ========= =========
Assets held for sale 7 5
-------------------------------------------- ------ --------- ---------
16,388 15,408
-------------------------------------------- ------ --------- ---------
Total assets 31,795 28,088
-------------------------------------------- ------ --------- ---------
LIABILITIES
-------------------------------------------- ------ --------- ---------
Current liabilities
-------------------------------------------- ------ --------- ---------
Borrowings (82) (172)
-------------------------------------------- ------ --------- ---------
Other financial liabilities 10 (553) (623)
-------------------------------------------- ------ --------- ---------
Trade and other payables (9,538) (8,942)
-------------------------------------------- ------ --------- ---------
Current tax liabilities (209) (211)
-------------------------------------------- ------ --------- ---------
Provisions for liabilities and charges (526) (543)
-------------------------------------------- ------ --------- ---------
(10,908) (10,491)
-------------------------------------------- ------ --------- ---------
Non-current liabilities
-------------------------------------------- ------ --------- ---------
Borrowings (3,406) (3,185)
-------------------------------------------- ------ --------- ---------
Other financial liabilities 10 (2,435) (5,129)
-------------------------------------------- ------ --------- ---------
Trade and other payables (4,178) (3,459)
-------------------------------------------- ------ --------- ---------
Deferred tax liabilities (1,144) (776)
-------------------------------------------- ------ --------- ---------
Provisions for liabilities and charges (357) (216)
-------------------------------------------- ------ --------- ---------
Post-retirement scheme deficits 11 (1,387) (1,375)
-------------------------------------------- ------ --------- ---------
(12,907) (14,140)
-------------------------------------------- ------ --------- ---------
Total liabilities (23,815) (24,631)
-------------------------------------------- ------ --------- ---------
Net assets 7,980 3,457
-------------------------------------------- ------ --------- ---------
EQUITY
-------------------------------------------- ------ --------- ---------
Attributable to ordinary shareholders
-------------------------------------------- ------ --------- ---------
Called-up share capital 326 326
-------------------------------------------- ------ --------- ---------
Share premium account 631 631
-------------------------------------------- ------ --------- ---------
Cash flow hedging reserve (112) (107)
-------------------------------------------- ------ --------- ---------
Other reserves 670 811
-------------------------------------------- ------ --------- ---------
Retained earnings 6,462 1,794
-------------------------------------------- ------ --------- ---------
7,977 3,455
-------------------------------------------- ------ --------- ---------
Non-controlling interests 3 2
-------------------------------------------- ------ --------- ---------
Total equity 7,980 3,457
-------------------------------------------- ------ --------- ---------
Condensed consolidated cash flow statement
For the year ended 31 December 2017
2017 2016
Notes GBPm GBPm
------------------------------------------------------------------------------------------ ------ -------- --------
Reconciliation of cash flows from operating activities
------------------------------------------------------------------------------------------ ------ -------- --------
Operating profit 1,287 44
------------------------------------------------------------------------------------------ ------ -------- --------
Loss on disposal of property, plant and equipment 11 5
------------------------------------------------------------------------------------------ ------ -------- --------
Share of results of joint ventures and associates (131) (117)
------------------------------------------------------------------------------------------ ------ -------- --------
Dividends received from joint ventures and associates 79 74
------------------------------------------------------------------------------------------ ------ -------- --------
Amortisation and impairment of intangible assets 8 430 628
------------------------------------------------------------------------------------------ ------ -------- --------
Depreciation and impairment of property, plant and equipment 9 450 426
------------------------------------------------------------------------------------------ ------ -------- --------
Impairment of investments 14 -
------------------------------------------------------------------------------------------ ------ -------- --------
Increase in provisions 58 44
------------------------------------------------------------------------------------------ ------ -------- --------
Increase in inventories (235) (161)
------------------------------------------------------------------------------------------ ------ -------- --------
(Increase)/decrease in trade and other receivables (462) 54
------------------------------------------------------------------------------------------ ------ -------- --------
(Decrease)/increase in amounts payable for financial penalties from agreements with
investigating
bodies (286) 671
------------------------------------------------------------------------------------------ ------ -------- --------
Other increase in trade and other payables 1,411 234
------------------------------------------------------------------------------------------ ------ -------- --------
Cash flows on other financial assets and liabilities held for operating purposes (661) (608)
------------------------------------------------------------------------------------------ ------ -------- --------
Net defined benefit post-retirement cost recognised in profit before financing 11 240 510
------------------------------------------------------------------------------------------ ------ -------- --------
Cash funding of defined benefit post-retirement schemes 11 (249) (271)
------------------------------------------------------------------------------------------ ------ -------- --------
Share-based payments 34 35
------------------------------------------------------------------------------------------ ------ -------- --------
Net cash inflow from operating activities before taxation 1,990 1,568
------------------------------------------------------------------------------------------ ------ -------- --------
Taxation paid (180) (157)
------------------------------------------------------------------------------------------ ------ -------- --------
Net cash inflow from operating activities 1,810 1,411
------------------------------------------------------------------------------------------ ------ -------- --------
Cash flows from investing activities
------------------------------------------------------------------------------------------ ------ -------- --------
Additions of unlisted investments (4) -
------------------------------------------------------------------------------------------ ------ -------- --------
Additions of intangible assets 8 (973) (631)
------------------------------------------------------------------------------------------ ------ -------- --------
Disposals of intangible assets 8 7 8
------------------------------------------------------------------------------------------ ------ -------- --------
Purchases of property, plant and equipment (773) (585)
------------------------------------------------------------------------------------------ ------ -------- --------
Government grants received 14 15
------------------------------------------------------------------------------------------ ------ -------- --------
Disposals of property, plant and equipment 4 8
------------------------------------------------------------------------------------------ ------ -------- --------
Acquisitions of business 14 263 (6)
------------------------------------------------------------------------------------------ ------ -------- --------
Consolidation of previously unconsolidated subsidiary 1 -
------------------------------------------------------------------------------------------ ------ -------- --------
Disposals of other businesses - 7
------------------------------------------------------------------------------------------ ------ -------- --------
Increase in share in joint ventures - (154)
------------------------------------------------------------------------------------------ ------ -------- --------
Other investments in joint ventures and associates (48) (30)
------------------------------------------------------------------------------------------ ------ -------- --------
Cash and cash equivalents in joint ventures reclassified as joint operations - 5
------------------------------------------------------------------------------------------ ------ -------- --------
Net cash outflow from investing activities (1,509) (1,363)
------------------------------------------------------------------------------------------ ------ -------- --------
Cash flows from financing activities
------------------------------------------------------------------------------------------ ------ -------- --------
Repayment of loans (160) (434)
------------------------------------------------------------------------------------------ ------ -------- --------
Proceeds from increase in loans and finance leases 366 93
------------------------------------------------------------------------------------------ ------ -------- --------
Capital element of finance lease payments (6) (4)
------------------------------------------------------------------------------------------ ------ -------- --------
Net cash flow from increase/(decrease) in borrowings and finance leases 200 (345)
------------------------------------------------------------------------------------------ ------ -------- --------
Interest received 14 14
------------------------------------------------------------------------------------------ ------ -------- --------
Interest paid (64) (84)
------------------------------------------------------------------------------------------ ------ -------- --------
Interest element of finance lease payments (3) (2)
------------------------------------------------------------------------------------------ ------ -------- --------
Increase in short-term investments - (1)
------------------------------------------------------------------------------------------ ------ -------- --------
Movement on balances with parent company (220) (321)
------------------------------------------------------------------------------------------ ------ -------- --------
Net cash outflow from financing activities (73) (739)
------------------------------------------------------------------------------------------ ------ -------- --------
Change in cash and cash equivalents 228 (691)
------------------------------------------------------------------------------------------ ------ -------- --------
Cash and cash equivalents at 1 January 2,771 3,176
------------------------------------------------------------------------------------------ ------ -------- --------
Exchange (losses)/gains on cash and cash equivalents (69) 286
------------------------------------------------------------------------------------------ ------ -------- --------
Cash and cash equivalents at 31 December 2,930 2,771
------------------------------------------------------------------------------------------ ------ -------- --------
2017 2016
GBPm GBPm
--------------------------------------------------------------------------------------------------- ------ ------
Reconciliation of movements in cash and cash equivalents to movements in net funds
--------------------------------------------------------------------------------------------------- ------ ------
Change in cash and cash equivalents 228 (691)
--------------------------------------------------------------------------------------------------- ------ ------
Cash flow from (increase)/decrease in borrowings and finance leases (200) 345
--------------------------------------------------------------------------------------------------- ------ ------
Cash flow from increase in short-term investments - 1
--------------------------------------------------------------------------------------------------- ------ ------
Change in net funds resulting from cash flows 28 (345)
--------------------------------------------------------------------------------------------------- ------ ------
Net funds (excluding cash and cash equivalents) on acquisition of ITP Aero (34) -
--------------------------------------------------------------------------------------------------- ------ ------
Net funds (excluding cash and cash equivalents) of previously unconsolidated subsidiary (18) -
--------------------------------------------------------------------------------------------------- ------ ------
Net funds (excluding cash and cash equivalents) of joint ventures reclassified as joint operations - (9)
--------------------------------------------------------------------------------------------------- ------ ------
Exchange (losses)/gains on net funds (59) 240
--------------------------------------------------------------------------------------------------- ------ ------
Fair value adjustments 131 (345)
--------------------------------------------------------------------------------------------------- ------ ------
Movement in net funds 48 (459)
--------------------------------------------------------------------------------------------------- ------ ------
Net funds at 1 January excluding the fair value of swaps (583) (124)
--------------------------------------------------------------------------------------------------- ------ ------
Net funds at 31 December excluding the fair value of swaps (535) (583)
--------------------------------------------------------------------------------------------------- ------ ------
Fair value of swaps hedging fixed rate borrowings 227 358
--------------------------------------------------------------------------------------------------- ------ ------
Net funds at 31 December (308) (225)
--------------------------------------------------------------------------------------------------- ------ ------
The movement in net funds (defined by the Group as including the
items shown below) is as follows:
Net funds on
Net funds consolidation
At 1 on of previously At 31
January Funds acquisition unconsolidated Exchange Fair value December
2017 flow of business subsidiary differences adjustments Reclassifications 2017
GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Cash at bank
and in hand 872 (8) - - (29) - - 835
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Money market
funds 552 44 - - (7) - - 589
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Short-term
deposits 1,347 212 - - (33) - - 1,526
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Overdrafts - (20) - - - - - (20)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Cash and
cash
equivalents 2,771 228 - - (69) - - 2,930
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Short-term
investments 3 - - - - - - 3
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Other
current
borrowings (169) 159 (6) (18) 3 - (8) (39)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Non-current
borrowings (3,121) (280) (28) - (2) 131 8 (3,292)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Finance
leases (67) (79) - - 9 - - (137)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Financial
liabilities (3,357) (200) (34) (18) 10 131 - (3,468)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Net funds
excluding
the fair
value of
swaps (583) 28 (34) (18) (59) 131 - (535)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Fair value
of swaps
hedging
fixed rate
borrowings 358 (131) 227
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Net funds (225) 28 (34) (18) (59) - - (308)
------------ -------- ------ ------------ --------------- ------------- ------------ ------------------ ---------
Condensed consolidated statement of changes in equity
For the year ended 31 December 2017
Attributable to ordinary shareholders
------------------------------------------------------------------
Cash
flow
Share Share hedging Other Retained Non-controlling Total
capital premium reserve reserves earnings Total interests (NCI) equity
GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
At 1 January
2016 326 631 (100) (54) 5,484 6,287 2 6,289
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Loss for the
year - - - - (4,032) (4,032) - (4,032)
================ ========== ========== ========= ========== ========== ======= ================ ==========
Foreign exchange
translation
differences on
foreign
operations - - - 861 - 861 - 861
================ ========== ========== ========= ========== ========== ======= ================ ==========
Movements on
post-retirement
schemes - - - - 495 495 - 495
================ ========== ========== ========= ========== ========== ======= ================ ==========
Share of other
comprehensive
income of joint
ventures and
associates - - (7) - (2) (9) - (9)
================ ========== ========== ========= ========== ========== ======= ================ ==========
Related tax
movements - - - 4 (179) (175) - (175)
================ ========== ========== ========= ========== ========== ======= ================ ==========
Total
comprehensive
income for the
year - - (7) 865 (3,718) (2,860) - (2,860)
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Share-based
payments -
direct to
equity (1) - - - - 30 30 - 30
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Related tax
movements - - - - (2) (2) - (2)
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Other changes in
equity in the
year - 1 - - 28 28 - 28
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
At 1 January
2017 326 631 (107) 811 1,794 3,455 2 3,457
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Profit for the
year - - - - 4,207 4,207 1 4,208
================ ========== ========== ========= ========== ========== ======= ================ ==========
Foreign exchange
translation
differences on
foreign
operations - - - (142) - (142) - (142)
================ ========== ========== ========= ========== ========== ======= ================ ==========
Movements on
post-retirement
schemes - - - - 735 735 - 735
================ ========== ========== ========= ========== ========== ======= ================ ==========
Share of other
comprehensive
income of joint
ventures and
associates - - (5) - (1) (6) - (6)
================ ========== ========== ========= ========== ========== ======= ================ ==========
Related tax
movements - - - 1 (307) (306) - (306)
================ ========== ========== ========= ========== ========== ======= ================ ==========
Total
comprehensive
income for the
year - - (5) (141) 4,634 4,488 1 4,489
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Share-based
payments -
direct to
equity (1) - - - - 31 31 - 31
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Related tax
movements - - - - 3 3 - 3
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
Other changes in
equity in the
year - - - - 34 34 - 34
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
At 31 December
2017 326 631 (112) 670 6,462 7,977 3 7,980
---------------- ---------- ---------- --------- ---------- ---------- ------- ---------------- ----------
(1) 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.
1 Basis of preparation and accounting policies
Reporting entity
Rolls--Royce plc (the 'Company') is a company domiciled in the
UK. These condensed consolidated financial statements of the
Company as at and for the year ended 31 December 2017 comprise the
Company and its subsidiaries (together referred to as the "Group")
and the Group's interests in joint arrangements and associates.
The consolidated financial statements of the Group as at and for
the year ended 31 December 2017 (2017 Annual Report) are available
upon request from the Company Secretary, Rolls-Royce plc, 62
Buckingham Gate, London SW1E 6AT.
Statement of compliance
These condensed consolidated financial statements have been
prepared in accordance with International Financial Reporting
Standards (IFRS) adopted for use in the EU. They do not include all
of the information required for full annual statements, and should
be read in conjunction with the 2017 Annual Report.
The comparative figures for the financial year 31 December 2016
are not the Group's statutory accounts for that financial year.
Those accounts have been reported on by the Group's auditors and
delivered to the registrar of companies. The report of the auditors
was (i) unqualified, (ii) did not include a reference to any
matters to which the auditors drew attention by way of emphasis
without qualifying their report, and (iii) did not contain a
statement under section 498(2) or (3) of the Companies Act
2006.
The Board of directors approved the condensed consolidated
financial statements on 6 March 2018.
Significant accounting policies
No new accounting policies had a significant impact in 2017.
Revisions to IFRS not applicable in 2017
Standards and interpretations issues 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 on adoption on its financial
statements.
-- The Group can sell trade receivables of certain customers
before the due date. The trade receivables of these customers that
are not sold will be classified and disclosed at 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 performed a
preliminary assessment of the adoption of the standard on the basis
of average default risk of customers and will continue to work
during 2018 to analyse the impact. This will not have a significant
impact on the income statement.
-- The Group 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 a significant impact on
the financial statements.
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;
-- 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 original equipment 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 original equipment (OE). These aftermarket contracts,
such as TotalCare and CorporateCare agreements in Civil Aerospace,
cover a range of services and often 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 our accounting
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.
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 16. Overall, the adoption of IFRS 15 is expected to result
in a reduction in 2017 underlying revenue and operating profit of
GBP1,408m and GBP854m respectively and a reduction of net assets of
GBP5.2bn 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, system 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
initially 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.
-- 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 Analysis by business segment
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).
Civil - development, manufacture, marketing and sales of
commercial aero engines and aftermarket services.
Defence - development, manufacture, marketing and sales of
military aero engines and aftermarket services.
Power Systems - development, manufacture, marketing and sales of
reciprocating engines and power systems.
Marine - development, manufacture, marketing and sales of
marine-power propulsion systems and aftermarket services.
Nuclear - development, manufacture, marketing and sales of
nuclear systems for civil power generation and naval 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 revenues and cost of sales - Where revenues 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 revenues 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 revenues 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.
Underlying profit before taxation - In addition to those
adjustments in underlying profit before financing:
-- Includes amounts realised from settled derivative contracts
and revaluation of relevant assets and liabilities to exchange
rates forecast to be achieved from future settlement of derivative
contracts.
-- Excludes unrealised amounts arising from revaluations
required by IAS 39 Financial Instruments: Recognition and
Measurement, changes in value of financial 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. The 2017 underlying results below
are shown at 2016 exchange rates, with the adjustment to 2017
exchange rates shown separately.
Total reportable
Civil (1) Defence Power Systems Marine Nuclear Inter-segment segments
GBPm GBPm GBPm GBPm GBPm GBPm GBPm
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Year ended 31 December
2017
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying revenue from
sale of original
equipment 3,775 928 1,828 534 377 (27) 7,415
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying revenue from
aftermarket services 4,158 1,264 897 483 430 (37) 7,195
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Total underlying revenue
at 2016 exchange rates 7,933 2,192 2,725 1,017 807 (64) 14,610
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Translation to 2017
exchange rates 90 83 198 60 11 (6) 436
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Total underlying revenue
at 2017 exchange rates 8,023 2,275 2,923 1,077 818 (70) 15,046
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Gross profit 1,157 555 786 214 130 - 2,842
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Commercial and
administrative costs (370) (126) (310) (193) (71) - (1,070)
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Research and development
costs (403) (77) (166) (44) (22) - (712)
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Share of results of joint
ventures and associates 109 7 (3) - - - 113
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying operating
profit/(loss) at 2016
exchange rates 493 359 307 (23) 37 - 1,173
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Translation to 2017
exchange rates 27 15 23 (2) 1 - 64
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying operating
profit/(loss) at 2017
exchange rates 520 374 330 (25) 38 - 1,237
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Year ended 31 December
2016
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying revenue from
sale of original
equipment 3,357 890 1,810 631 354 (36) 7,006
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying revenue from
aftermarket services 3,710 1,319 845 483 423 (40) 6,740
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Total underlying revenue 7,067 2,209 2,655 1,114 777 (76) 13,746
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Gross profit 1,185 564 702 236 121 - 2,808
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Commercial and
administrative costs (353) (124) (335) (222) (70) - (1,104)
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Research and development
costs (568) (71) (177) (41) (6) - (863)
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Share of results of joint
ventures and associates 103 15 1 - - - 119
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
Underlying operating
profit/(loss) 367 384 191 (27) 45 - 960
------------------------- --------- ------- ------------- ------ ------- ------------- ------------------------
(1) Included within the results for the Civil Sector in 2017 is
a charge of GBP227m (2016: GBP98m) related to in-service engine
issues for the Trent 1000 and Trent 900.
Reconciliation to Underlying
reported results adjustments and Group results at
Total reportable Other businesses adjustments to actual exchange
segments (1) and corporate Total underlying foreign exchange rates
GBPm GBPm GBPm GBPm GBPm
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Year ended 31
December 2017
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Revenue from sale
of original
equipment 7,415 21 7,436 654 8,090
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Revenue from
aftermarket
services 7,195 20 7,215 1,002 8,217
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Total revenue at
2016 exchange
rates 14,610 41 14,651 1,656 16,307
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Translation to 2017
exchange rates 436 3 439 (439) -
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Total revenue at
2017 exchange
rates 15,046 44 15,090 1,217 16,307
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Gross profit 2,842 4 2,846 327 3,173
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Commercial and
administrative
costs (1,070) (54) (1,124) (98) (1,222)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Research and
development costs (712) 1 (711) (84) (795)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Share of results of
joint ventures and
associates 113 (11) 102 29 131
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Operating
profit/(loss) at
2016 exchange
rates 1,173 (60) 1,113 174 1,287
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Translation to 2017
exchange rates 64 (2) 62 (62) -
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Operating
profit/(loss) at
2017 exchange
rates 1,237 (62) 1,175 112 1,287
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Gains arising on
the acquisition of
ITP Aero - - - 798 798
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Profit/(loss)
before financing
and taxation 1,237 (62) 1,175 910 2,085
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Net financing (104) (104) 2,916 2,812
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Profit/(loss)
before taxation (166) 1,071 3,826 4,897
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Taxation (328) (328) (361) (689)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Profit for the year 743 3,465 4,208
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Attributable to:
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Ordinary
shareholders 742 3,465 4,207
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Non-controlling
interests 1 - 1
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Year ended 31
December 2016
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Revenue from sale
of original
equipment 7,006 21 7,027 561 7,588
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Revenue from
aftermarket
services 6,740 16 6,756 611 7,367
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Total revenue 13,746 37 13,783 1,172 14,955
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Gross profit 2,808 10 2,818 230 3,048
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Commercial and
administrative
costs (1,104) (54) (1,158) (1,045) (2,203)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Research and
development costs (863) 1 (862) (56) (918)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Share of results of
joint ventures and
associates 119 (2) 117 - 117
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Operating
profit/(loss) 960 (45) 915 (871) 44
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Loss on disposal of
businesses - - - (3) (3)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Profit before
financing and
taxation 960 (45) 915 (874) 41
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Net financing (102) (102) (4,575) (4,677)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Profit/(loss)
before taxation (147) 813 (5,449) (4,636)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Taxation (261) (261) 865 604
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Profit/(loss) for
the year 552 (4,584) (4,032)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Attributable to:
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Ordinary
shareholders 552 (4,584) (4,032)
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
Non-controlling
interests - - -
------------------- ------------------- ------------------ ---------------- ------------------ ------------------
(1) Other businesses comprise former Energy businesses not
included in the disposal to Siemens in 2014.
Total assets Total liabilities Net assets/(liabilities)
-----
2017 2016 2017 2016 2017 2016
GBPm GBPm GBPm GBPm GBPm GBPm
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Civil 17,175 15,438 (13,148) (15,104) 4,027 334
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Defence 2,067 2,243 (1,834) (2,178) 233 65
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Power Systems 3,810 3,888 (1,256) (1,170) 2,554 2,718
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Marine 1,425 1,774 (759) (998) 666 776
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Nuclear 513 531 (425) (502) 88 29
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Inter-segment (1,360) (1,223) 1,360 1,223 - -
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Reportable segments 23,630 22,651 (16,062) (18,729) 7,568 3,922
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Other businesses and
corporate (1) 2,572 51 (1,525) (183) 1,047 (132)
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Net funds/(debt) 3,180 3,132 (3,488) (3,357) (308) (225)
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Tax assets/(liabilities) 288 908 (1,353) (987) (1,065) (79)
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
Post-retirement scheme
surpluses/(deficits) 2,125 1,346 (1,387) (1,375) 738 (29)
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
31,795 28,088 (23,815) (24,631) 7,980 3,457
---------------------------- ------- ------- ----------------- -------- ------------------------ -----
(1) Includes ITP Aero
Group employees average during the year 2017 2016
---------------------------------------- ------ ------
Civil Aerospace 24,600 23,800
---------------------------------------- ------ ------
Defence Aerospace 6,100 6,000
---------------------------------------- ------ ------
Power Systems 10,100 10,300
---------------------------------------- ------ ------
Marine 4,600 5,300
---------------------------------------- ------ ------
Nuclear 4,400 4,300
---------------------------------------- ------ ------
Other businesses and corporate (1) 200 200
---------------------------------------- ------ ------
50,000 49,900
---------------------------------------- ------ ------
(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.
Underlying
adjustments 2017 2016
Profit
before Profit before
Revenue financing Net financing Taxation Revenue financing Net financing Taxation
GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Underlying
performance 15,090 1,175 (104) (328) 13,783 915 (102) (261)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Recognise revenue
at exchange rate
on date of
transaction 1,217 - - - 1,172 - - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Realised
(gains)/losses
on settled
derivative
contracts (1) - 475 173 (111) - 426 162 (107)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Net unrealised
fair value
changes to
derivative
contracts (2) - 24 2,648 (463) - - (4,420) 792
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Effect of
currency on
contract
accounting - (124) - 21 - 77 - (14)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Revaluation of
trading assets
and liabilities - (6) 84 (12) - 67 (313) 56
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Financial RRSAs -
exchange
differences and
changes in
forecast
payments - - 11 (3) - - (8) (1)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Effect of
acquisition
accounting (3) - (129) - 35 - (115) - 35
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Impairment
goodwill - - - - - (219) - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Impairment of
assets - (12) - - - - - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Pension
restructuring
(4) - - - - - (306) - 107
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Net
post-retirement
scheme financing - - 1 (1) - - 3 (2)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Disposal of
business - - - - - (3) - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Exceptional
restructuring - (104) - 31 - (129) - 34
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Financial
penalties from
agreements with
investigating
bodies - - - - - (671) - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Gains arising on
the acquisition
of ITP Aero - 798 - - - - - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Consolidation of
previously
non-consolidated
subsidiary - (12) - - - - - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Other - - (1) 4 - (1) 1 (5)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Recognition of
advance
corporation tax - - - 163 - - - -
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Reduction in
corporate tax
rates (5) - - - (25) - - - (30)
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Total underlying
adjustments 1,217 910 2,916 (361) 1,172 (874) (4,575) 865
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
Reported per
consolidated
income statement 16,307 2,085 2,812 (689) 14,955 41 (4,677) 604
----------------- -------- ------------ ------------- -------- -------- ------------- ------------- --------
(1) Realised (gains)/losses on settled derivative contracts
include adjustments to reflect the (gains)/losses in the same year
as the related trading cash flows.
(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 deduction 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.
3 Research and development
2017 2016
GBPm GBPm
---------------------------------------------------------------------------------------------- -------- ------
Expenditure in the year (1,035) (937)
---------------------------------------------------------------------------------------------- -------- ------
Capitalised as intangible assets 342 99
---------------------------------------------------------------------------------------------- -------- ------
Amortisation of capitalised costs (150) (147)
============================================================================================== ======== ======
Impairment of capitalised costs - (2)
---------------------------------------------------------------------------------------------- -------- ------
Net research and development cost (843) (987)
---------------------------------------------------------------------------------------------- -------- ------
Entry fees received 64 73
---------------------------------------------------------------------------------------------- -------- ------
Entry fees deferred in respect of charges in future years (44) (40)
---------------------------------------------------------------------------------------------- -------- ------
Recognition of previously deferred entry fees 28 36
---------------------------------------------------------------------------------------------- -------- ------
Net cost recognised in the income statement (795) (918)
---------------------------------------------------------------------------------------------- -------- ------
Underlying adjustments relating to the effects of acquisition accounting and foreign exchange 58 56
---------------------------------------------------------------------------------------------- -------- ======
Net underlying cost recognised in the income statement (737) (862)
============================================================================================== ======== ======
Translation to 2016 exchange rates 26 -
---------------------------------------------------------------------------------------------- -------- ------
Net underlying cost at 2016 exchange rates (711) (862)
---------------------------------------------------------------------------------------------- -------- ------
4 Net financing
2017 2016
Per consolidated Per consolidated
income statement Underlying financing income statement Underlying financing
GBPm GBPm GBPm GBPm
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financing income
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Interest receivable 11 11 14 14
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net fair value gains on
foreign currency
contracts 2,611 - 1 -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financial RRSAs -
foreign exchange
differences and
changes in forecast
payments 17 - 23 -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net fair value gains on
commodity contracts 37 - 16 -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financing on
post-retirement scheme
surpluses 39 - 42 -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net foreign exchange
gains 258 - - -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
2,973 11 96 14
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financing costs
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Interest payable (67) (64) (77) (77)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net fair value losses
on foreign currency
contracts - - (4,437) -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financial RRSAs -
foreign exchange
differences and
changes in forecast
payments (6) - (31) -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financial charge
relating to financial
RRSAs (5) (5) (6) (6)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Financing on
post-retirement scheme
deficits (38) - (39) -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net foreign exchange
losses - (145) -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Other financing charges (45) (46) (38) (33)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
(161) (115) (4,773) (116)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net financing 2,812 (104) (4,677) (102)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Analysed as:
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net interest payable (56) (53) (63) (63)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net fair value
gains/(losses) on
derivative contracts 2,648 - (4,420) -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net post-retirement
scheme financing 1 - 3 -
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net other financing 219 (51) (197) (39)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
Net financing 2,812 (104) (4,677) (102)
----------------------- ---------------------- --------------------- ----------------------- ---------------------
5 Taxation
The effective reported tax rate for the year is 14.1% (2016
13.0%). The 2017 reported profit before tax (2016: loss) includes
significant mark to market adjustments on the foreign currency
derivatives which arise mainly in the UK and the key driver of the
reported rate is therefore the UK tax rate. The recognition of UK
advance corporation tax and the profit on reclassification of joint
ventures to subsidiaries which is not taxable then reduce the 2017
tax rate.
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, GBP25m has been charged to the income
statement and GBP45m has been charged to OCI.
6 Intangible assets
Certification
costs and Contractual
participation Development aftermarket Customer
Goodwill fees expenditure rights relationships Software Other Total
GBPm GBPm GBPm GBPm GBPm GBPm GBPm GBPm
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Cost:
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
At 1 January 2017 1,874 1,325 1,944 1,007 540 742 663 8,095
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Exchange
differences (5) 8 16 - (3) (3) 8 21
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Reclassifications - - (9) - - - 9 -
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Additions - 160 342 286 135 50 973
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Acquisition of
business - 128 202 70 996 7 44 1,417
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Disposals - - - - - (13) - (13)
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
At 31 December
2017 1,869 1,621 2,495 1,363 1,503 868 774 10,493
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Accumulated
amortisation:
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
At 1 January 2017 337 440 888 433 209 414 294 3,015
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Exchange
differences (13) 1 8 - (4) (1) - (9)
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Charge for the
year - 63 149 57 51 81 29 430
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Disposals - - - - - (6) - (6)
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
At 31 December
2017 324 504 1,045 490 256 488 323 3,430
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
Net book value at:
================== ======== ============= ============= ============= ============== ======== ===== ======
31 December 2017 1,545 1,117 1,450 873 1,247 380 451 7,063
================== ======== ============= ============= ============= ============== ======== ===== ======
31 December 2016 1,537 885 1,056 574 331 328 369 5,080
------------------ -------- ------------- ------------- ------------- -------------- -------- ----- ------
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 GBP50m 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 GBP50m if alternative trading assumptions resulted
in forecast cash flows reducing by 10%, by approximately GBP60m if
the discount rate increased by 1% and by approximately GBP100m 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 reliably determine the financial impact.
Certification costs and participation fees, development
expenditure 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 GBP873m, which
will itself significantly reduce the risk of impairment on other
intangible assets.
7 Property, plant and equipment
In course of
Land and buildings Plant and equipment Aircraft and engines construction Total
GBPm GBPm GBPm GBPm GBPm
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Cost:
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
At 1 January 2017 1,667 4,599 491 765 7,522
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Exchange differences (18) (61) (5) (11) (95)
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Additions - purchased 36 155 127 446 764
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Additions arising from
TotalCare Flex
arrangements
(non-cash) - - 1 - 1
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Acquisition of business 74 155 28 11 268
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Consolidation of
previously
non-consolidated
subsidiary 9 1 - - 10
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Reclassifications 92 308 29 (429) -
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Transferred to assets
held for sale (5) (11) - - (16)
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Disposals/write-offs (13) (111) (4) (9) (137)
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Adjustment (1) - - 20 - 20
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
At 31 December 2017 1,842 5,035 687 773 8,337
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Accumulated
amortisation:
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
At 1 January 2017 515 2,765 126 2 3,408
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Exchange differences (9) (32) (1) - (42)
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Charge for the year 58 351 35 - 444
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Impairment 3 3 - - 6
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Reclassifications (7) 7 - - -
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Transferred to assets
held for sale (3) (10) - - (13)
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Disposals/write-offs (3) (100) (1) - (104)
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Adjustment (1) - - 14 - 14
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
At 31 December 2017 554 2,984 173 2 3,713
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
Net book value at:
======================= ================== =================== ==================== ======================= =====
31 December 2017 1,288 2,051 514 771 4,624
======================= ================== =================== ==================== ======================= =====
31 December 2016 1,152 1,834 365 763 4,114
----------------------- ------------------ ------------------- -------------------- ----------------------- -----
(1) Adjustment relates to industrial engines sold with the
Energy business in 2014.
8 Financial assets and liabilities
Other financial assets and liabilities comprise:
Derivatives
----------------------------------------
Foreign Interest
exchange Commodity rate Total Financial TotalCare
contracts contracts contracts Derivatives RRSAs Flex Total
GBPm GBPm GBPm GBPm GBPm GBPm GBPm
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
2017
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Non-current
assets 362 16 232 610 - - 610
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Current
assets 27 9 - 36 - - 36
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Current
liabilities (493) (10) - (503) (50) - (553)
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Non-current
liabilities (2,208) (14) (5) (2,227) (194) (14) (2,435)
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
(2,312) 1 227 (2,084) (244) (14) (2,342)
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
2016
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Non-current
assets 13 5 364 382 - - 382
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Current
assets 4 1 - 5 - - 5
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Current
liabilities (566) (24) - (590) (33) - (623)
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Non-current
liabilities (5,002) (38) (6) (5,046) (68) (15) (5,129)
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
(5,551) (56) 358 (5,249) (101) (15) (5,365)
------------- ------------ ------------ ------------ ------------- ------------- ------------- --------
Derivative financial instruments 2017 2016 (1)
-------------------------------------------------------
Foreign exchange Commodity Interest rate Total Total
GBPm GBPm GBPm GBPm GBPm
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
At 1 January (5,551) (56) 358 (5,249) (1,731)
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
Currency options at inception - - - - (33)
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
Acquisition of business 7 2 - 9
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
Movements in fair value hedges (2) - - (131) (131) 345
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
Movements in other derivative contracts (3) 2,611 37 - 2,648 (4,420)
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
Contracts settled 621 18 - 639 590
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
At 31 December (2,312) 1 227 (2,084) (5,249)
-------------------------------------------- ----------------- ---------- -------------- -------- ---------
(1) In 2016, the Group wrote currency options to sell USD and
buy GBP as part of a commercial agreement. The fair value of this
option on inception was treated as a discount to the customer.
(2) Loss on related hedged items GBP131m (2016: GBP343m loss).
(3) Include in financing.
Financial risk and revenue sharing arrangements (RRSAs) and other financial
liabilities Financial RRSAs TotalCare Flex
------------------ -----------------
2017 2016 2017 2016
GBPm GBPm GBPm GBPm
------------------------------------------------------------------------------- -------- -------- -------- -------
At 1 January (101) (110) (15) --
------------------------------------------------------------------------------- -------- -------- -------- -------
Exchange adjustments included in OCI (14) 5 - -
------------------------------------------------------------------------------- -------- -------- -------- -------
Acquisition of business (157) - - -
------------------------------------------------------------------------------- -------- -------- -------- -------
Additions - - - (14)
------------------------------------------------------------------------------- -------- -------- -------- -------
Financing charge (1) (5) (6) - (1)
------------------------------------------------------------------------------- -------- -------- -------- -------
Excluded from underlying profit:
------------------------------------------------------------------------------- -------- -------- -------- -------
Changes in forecast payments (1) 1 5
------------------------------------------------------------------------------- -------- -------- -------- -------
Exchange adjustments (1) 10 (13) 1 (3)
------------------------------------------------------------------------------- -------- -------- -------- -------
Cash paid to partners 22 18
------------------------------------------------------------------------------- -------- -------- -------- -------
Other - - - 3
------------------------------------------------------------------------------- -------- -------- -------- -------
At 31 December (244) (101) (14) (15)
------------------------------------------------------------------------------- -------- -------- -------- -------
(1) Included in net financing.
Fair values of financial instruments equate to book values with
the following exceptions:
2017 2016
------------------------ ------------------------
Book value Fair value Book value Fair value
GBPm GBPm GBPm GBPm
-------------------- ----------- ----------- ----------- -----------
Borrowings (3,488) (3,557) (3,357) (3,413)
==================== =========== =========== =========== ===========
Financial RRSAs (244) (247) (101) (109)
-------------------- ----------- ----------- ----------- -----------
Fair values
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.
-- Unlisted non-current investments primarily comprise bank
deposits where the fair value approximates to the book value.
-- The fair values of trade receivables and payables, other
non-derivative financial assets and liabilities, short-term
investments and cash and cash equivalents 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.
-- 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).
-- Borrowings are carried at amortised cost. The fair value is
estimated by discounting contractual future cash flows (Level 2 as
defined by IFRS 13 Fair Value Measurement).
-- Financial RRSAs and TotalCare Flex liabilities are carried at
amortised cost. The fair value is estimated by discounting
contractual future cash flows. Contractual cash flows are based on
future trading activity, based on latest forecasts. Amounts
denominated in foreign currencies are valued at the exchange rate
prevailing at the balance sheet date (Level 3 as defined by IFRS 13
Fair Value Measurement).
Borrowings
During the year, the Group has repaid GBP166m of short-term
borrowings and entered into new facilities of GBP366m.
9 Pensions and other post-retirement benefits
Movements in the net post-retirement position recognised in the
balance sheet were as follows:
UK schemes Overseas schemes Total
GBPm GBPm GBPm
---------------------------------------------------------------------- ---------- ---------------- -------
At 1 January 2017 1,336 (1,365) (29)
====================================================================== ========== ================ =======
Exchange adjustments - 25 25
====================================================================== ========== ================ =======
Current service cost and administrative expenses (190) (58) (248)
====================================================================== ========== ================ =======
Past service credit/(cost) 8 - 8
====================================================================== ========== ================ =======
Financing recognised in the income statement 38 (37) 1
====================================================================== ========== ================ =======
Contributions by employer 174 75 249
====================================================================== ========== ================ =======
Actuarial gains/(losses) recognised in OCI (1) 477 (64) 413
====================================================================== ========== ================ =======
Returns on plan assets excluding financing recognised in OCI (1) 265 57 322
====================================================================== ========== ================ =======
Other - (3) (3)
---------------------------------------------------------------------- ---------- ---------------- -------
At 31 December 2017 2,108 (1,370) 738
---------------------------------------------------------------------- ---------- ---------------- -------
Analysed as:
====================================================================== ========== ================ =======
Post-retirement scheme surpluses - included in non-current assets 2,108 17 2,125
====================================================================== ========== ================ =======
Post-retirement scheme deficits - included in non-current liabilities - (1,387) (1,387)
---------------------------------------------------------------------- ---------- ---------------- -------
2,108 (1,370) 738
---------------------------------------------------------------------- ---------- ---------------- -------
(1) The net actuarial gains in the UK arose principally due to
changes in the yield curves used to value the assets and the
liabilities.
10 Contingent liabilities
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
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.
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.
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.
31 December 2017 31 December 2016
------------------ ------------------
GBPm $m GBPm $m
------------------------------------------------------- -------- -------- -------- --------
Gross commitments 145 196 238 293
------------------------------------------------------- -------- -------- -------- --------
Value of security (1) (41) (55) (103) (126)
------------------------------------------------------- -------- -------- -------- --------
Indemnities (51) (69) (74) (91)
------------------------------------------------------- -------- -------- -------- --------
Net commitments 53 72 61 76
------------------------------------------------------- -------- -------- -------- --------
Net commitments with security reduced by 20% (2) 64 86 86 106
------------------------------------------------------- -------- -------- -------- --------
(1) Security includes unrestricted cash collateral of: 22 29 38 47
------------------------------------------------------- -------- -------- -------- --------
(2) Although sensitivity calculations are complex, the reduction
of the relevant security by 20% illustrates the sensitivity to
changes in this assumption.
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.
11 Related party transactions
Transactions with related parties are shown on page 120 of the
2017 Annual Report. Significant transactions in the current
financial period are as follows:
2017 2016
GBPm GBPm
------------------------------------------------------------------- ------- -------
Sales of goods and services to joint ventures and associates 2,469 2,022
------------------------------------------------------------------- ------- -------
Purchases of goods and services from joint ventures and associates (2,224) (1,881)
------------------------------------------------------------------- ------- -------
Included in sales of goods and services to joint ventures and
associates are sales of spare engines amounting to GBP418m (2016:
GBP356m).
Profit recognised in the year on such sales amounted to GBP75m
(2016: GBP119m), including profit on current year sales and
recognition of profit deferred on similar sales in previous years.
On an underlying basis (at actual achieved rates on settled
derivative transactions), the amounts were GBP67m (2016:
GBP97m).
12 Acquisition
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 EUR718m 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 GBP204m 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 GBP553m.
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 GBP1,650m
of which a significant value was allocated to intangible assets.
The valuation indicated a bargain purchase of GBP245m, 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:
2017
GBPm
---------------------------------------------------- -------
Intangible assets 1,417
==================================================== =======
Property, plant and equipment 268
==================================================== =======
Deferred tax assets 148
==================================================== =======
Inventory 316
==================================================== =======
Trade and other receivables 497
==================================================== =======
Taxation recoverable 2
==================================================== =======
Cash and cash equivalents 263
==================================================== =======
Trade and other payables (625)
==================================================== =======
Borrowings (34)
==================================================== =======
Other financial assets and liabilities (148)
==================================================== =======
Deferred tax liability (386)
==================================================== =======
Provisions (68)
---------------------------------------------------- -------
Total identifiable assets and liabilities 1,650
---------------------------------------------------- -------
Total consideration (1,405)
---------------------------------------------------- -------
Bargain purchase gain arising 245
---------------------------------------------------- -------
Consideration satisfied by:
==================================================== =======
Deferred consideration to be paid in cash or shares 648
==================================================== =======
Existing shareholding 757
---------------------------------------------------- =======
1,405
---------------------------------------------------- -------
Net cash outflow arising on acquisition:
==================================================== =======
Cash consideration -
==================================================== =======
Less: cash and cash equivalents acquired (263)
---------------------------------------------------- =======
Cash inflow per the cash flow statement (263)
---------------------------------------------------- -------
Identifiable intangible assets comprise:
==================================================== =======
Technology, patents and licences 245
==================================================== =======
Customer relationships 833
==================================================== =======
Trademark 44
==================================================== =======
In-process development 91
==================================================== =======
Other 204
---------------------------------------------------- =======
1,417
---------------------------------------------------- -------
13 Derivation of summary funds flow statement
The table below shows the derivation of the summary funds flow
statement (lines marked *) on page 49 from the cash flow statement
on page 73.
2017 2016
=== ====================================== ---------------- ---------------- =====================================
GBPm GBPm GBPm GBPm Source
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Underlying profit before tax (PBT) -
* page 123 1,071 813
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Depreciation and impairment of property,
plant and equipment 450 426 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Amortisation of intangible assets 430 628 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Impairment of goodwill - (219) Reversal of underlying adjustment
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Impairment of property, plant and
equipment (6) - Reversal of underlying adjustment
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Acquisition accounting (129) (115) Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
* Depreciation and amortisation 745 720
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Increase in inventories (235) (161) Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Reversal of underlying adjustment
(included in GBP12m impairment of
Non-underlying impairment (6) - assets)
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Decrease in trade and other
receivables/payables 946 288 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Realised losses on settled foreign Reported to underlying adjustment
exchange derivatives in financing (173) (162) (note 2)
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Revaluation of trading assets (6) 67 Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
* Movement on net working capital 526 32
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Additions of intangible assets (973) (631) Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Purchases of property, plant and
equipment (773) (585) Cash flow statement
------------------------------------------ ====== -------- ====== -------- -------------------------------------
Government grants received 14 15 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Expenditure on property, plant and
* equipment and intangible assets (1,732) (1,201)
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Realised losses on hedging instruments 475 426 Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Net unrealised fair value to changes
to derivatives 24 - Reversal of underlying adjustment
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Foreign exchange on contract accounting (124) 77 Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Exceptional restructuring (104) (129) Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Other (3) (1) Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Underlying financing 104 102 Reversal of underlying adjustment
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Loss on disposal of property, plant and
equipment 11 5 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Joint venture dividends less share
Joint ventures (52) (43) of results - cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Increase in provisions 58 44 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Cash flows on other financial assets and
liabilities included in underlying
operating profit (488) (446) Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Share based payments 34 35 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Additions of unlisted investments (4) - Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Disposal of intangible assets 7 8 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Disposal of property, plant and equipment 4 8 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Investments in joint ventures and
associates (48) (30) Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Interest received and paid - cash
Net interest (53) (72) flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Net funds of joint ventures Net cash and borrowings reclassified
reclassified to joint operations - (4) - cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Other (159) 20
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Trading cash flow 451 344
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Net defined benefit plans - underlying
operating charge 240 204 Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Cash funding of defined benefit plans (249) (271) Cash flow statement
------------------------------------------ ------ -------- ------ -------- -------------------------------------
Contributions to defined benefit
schemes in excess of underlying PBT
* charge (9) (67)
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Tax (180) (157) Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Free cash flow 262 120
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Movements on balances with parent
* company (220) (321) Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Payment of penalties to investigating
authorities (286) - Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Acquisition of ITP Aero 229 - Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Other acquisitions and disposals (17) (153) Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
Other 8 -
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Foreign exchange (59) 240 Cash flow statement
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
* Change in net funds (83) (114)
--- -------------------------------------- ------ -------- ------ -------- -------------------------------------
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.
2017 2016
========================================== --------------- -------------- =========================================
GBPm GBPm GBPm GBPm Source
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported operating profit 1,287 44
--------------------------------------------------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
Realised losses on hedging instruments (475) (426) 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Net unrealised fair value to changes to Reported to underlying adjustment (note
derivatives (24) - 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
Foreign exchange on contract accounting 124 (77) 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Revaluation of trading assets and Reported to underlying adjustment (note
liabilities 6 (67) 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
Effect of acquisition accounting 129 115 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
UK pension restructuring - 306 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
Impairments 24 219 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
Exceptional restructuring 104 129 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Accrual for deferred prosecution Reported to underlying adjustment (note
agreement penalties - 671 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Reported to underlying adjustment (note
Other - 1 2)
------------------------------------------ ------- ------ ------ ------ -----------------------------------------
Adjustments to reported operating profit (112) 871
--------------------------------------------------- ------ ------ ------ -----------------------------------------
Underlying profit before financing 1,175 915
--------------------------------------------------- ------ ------ ------ -----------------------------------------
Underlying financing (104) (102) Underlying income statement (note 2)
--------------------------------------------------- ------ ------ ------ -----------------------------------------
Underlying profit before tax 1,071 813
--------------------------------------------------- ------ ------ ------ -----------------------------------------
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 on page 74.
2017 2016
------------ ------------
GBPm GBPm GBPm GBPm
------------------------------------------------------------ ----- ----- ----- -----
Change in cash and cash equivalents 228 (691)
------------------------------------------------------------ ----- ----- ----- -----
Returns to shareholders 220 321
------------------------------------------------------------ ----- ----- ----- -----
Net cash flow from changes in borrowings and finance leases (200) 345
------------------------------------------------------------ ----- ----- ----- -----
Increase/decrease in short-term investments - 1
------------------------------------------------------------ ----- ----- ----- -----
Acquisition of business (263) 6
------------------------------------------------------------ ----- ----- ----- -----
Consolidation of previously unconsolidated subsidiary (1) -
------------------------------------------------------------ ----- ----- ----- -----
Increase in share in joint ventures - (154)
------------------------------------------------------------ ----- ----- ----- -----
Debt of joint ventures reclassified as joint operations - (9)
------------------------------------------------------------ ----- ----- ----- -----
Disposal of other businesses - (7)
------------------------------------------------------------ ----- ----- ----- -----
Changes in group structure (264) 144
------------------------------------------------------------ ----- ----- ----- -----
Payment of deferred prosecution agreement penalties 286 -
------------------------------------------------------------ ----- ----- ----- -----
Other (8) -
------------------------------------------------------------ ----- ----- ----- -----
Free cash flow 262 120
------------------------------------------------------------ ----- ----- ----- -----
Exclude cash outflow of ITP Aero 14 -
------------------------------------------------------------ ----- ----- ----- -----
Free cash flow excluding ITP Aero 276 120
------------------------------------------------------------ ----- ----- ----- -----
14 Impact of adoption of IFRS 15
The segmental analysis shown in note 2 would have been as
follows under the IFRS 15 policies set out in note 1:
Civil Defence Power Systems Marine Nuclear Inter-segment Total reportable segments
GBPm GBPm GBPm GBPm GBPm GBPm GBPm
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Year ended 31 December 2017
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Underlying revenue from sale
of original equipment 2,862 911 1,825 539 377 (27) 6,487
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Underlying revenue from
aftermarket services 3,671 1,287 896 476 430 (37) 6,723
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Total underlying revenue at
2016 exchange rates 6,533 2,198 2,721 1,015 807 (64) 13,210
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Translation to 2017 exchange
rates 80 84 198 60 11 (5) 428
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Total underlying revenue at
2017 exchange rates 6,613 2,282 2,919 1,075 818 (69) 13,638
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Gross profit 350 551 786 213 131 - 2,031
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Commercial and
administrative costs (370) (126) (310) (193) (71) - (1,070)
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Research and development
costs (442) (77) (165) (44) (23) - (751)
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Share of results of joint
ventures and associates 109 7 (3) - - - 113
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Underlying operating
profit/(loss) at 2016
exchange rates (353) 355 308 (24) 37 - 323
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Translation to 2017 exchange
rates 23 15 23 (2) 1 - 60
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Underlying operating
profit/(loss) at 2017
exchange rates (330) 370 331 (26) 38 - 383
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
2017 accounting policies
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Total underlying revenue 8,023 2,275 2,923 1,077 818 (70) 15,046
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Underlying operating profit 520 374 330 (25) 38 - 1,237
---------------------------- ----- ------- ------------- ------ ------- ------------- -------------------------
Reconciliation Group at actual
to reported Underlying exchange
results Total Other adjustments and rates - 2017
reportable businesses and Total foreign Group at actual accounting
segments corporate underlying exchange exchange rates policies
GBPm GBPm GBPm GBPm GBPm GBPm
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Year ended 31
December 2017
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Revenue from
sale of
original
equipment 6,487 22 6,509 771 7,280 8,090
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Revenue from
aftermarket
services 6,723 20 6,743 775 7,518 8,217
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Total underlying
revenue at 2016
exchange rates 13,210 42 13,252 1,546 14,798 16,307
================ =============== =============== =============== =============== =============== ===============
Translation to
2017 exchange
rates 428 2 430 (430) - -
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Total revenue at
2017 exchange
rates 13,638 44 13,682 1,116 14,798 16,307
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Gross profit 2,031 4 2,035 244 2,279 3,173
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Commercial and
administrative
costs (1,070) (54) (1,124) (98) (1,222) (1,222)
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Research and
development
costs (751) - (751) (83) (834) (795)
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Share of results
of joint
ventures and
associates 113 (10) 103 29 132 131
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Operating
profit/(loss)
at 2016
exchange rates 323 (60) 263 92 355 1,287
---------------- =============== --------------- --------------- --------------- --------------- ---------------
Translation to
2017 exchange
rates 60 (2) 58 (58) - -
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Operating
profit/(loss)
at 2017
exchange rates 383 (62) 321 34 355 1,287
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Gains arising on
the acquisition
of ITP Aero - - - 798 798 798
---------------- ---------------
Profit/(loss)
before
financing and
taxation 383 (62) 321 832 1,153 2,085
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Net financing (112) (112) 2,966 2,854 2,812
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Profit/(loss)
before taxation (174) 209 3,798 4,007 4,897
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Taxation (166) (166) (381) (547) (689)
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Profit for the
year 43 3,417 3,460 4,208
---------------- --------------- --------------- --------------- --------------- --------------- ---------------
Underlying adjustments 2017
Revenue Profit before financing Net financing Taxation
GBPm GBPm GBPm GBPm
---------------------------------------------------------- -------- ----------------------- ------------- --------
Underlying performance 13,682 321 (112) (166)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Recognise revenue at exchange rate on date of transaction 1,116 - - -
---------------------------------------------------------- -------- ----------------------- ------------- --------
Realised (gains)/losses on settled derivative contracts - 453 195 (111)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Net unrealised fair value changes to derivative contracts - 24 2,648 (463)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Effect of currency on contract accounting - (180) - 21
---------------------------------------------------------- -------- ----------------------- ------------- --------
Revaluation of trading assets and liabilities - (6) 113 (12)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Financial RRSAs - foreign exchange differences and changes
in forecast payments - - 11 (3)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Effect of acquisition accounting - (129) - 35
---------------------------------------------------------- -------- ----------------------- ------------- --------
Impairment of assets - (12) - -
---------------------------------------------------------- -------- ----------------------- ------------- --------
Net post-retirement scheme financing - - 1 (1)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Exceptional restructuring - (104) - 31
---------------------------------------------------------- -------- ----------------------- ------------- --------
Gains arising on the acquisition of ITP Aero - 798 - -
---------------------------------------------------------- -------- ----------------------- ------------- --------
Consolidation of previously non-consolidated subsidiary - (12) - -
---------------------------------------------------------- -------- ----------------------- ------------- --------
Other - - (2) 9
---------------------------------------------------------- -------- ----------------------- ------------- --------
Recognition of advance corporation tax - - - 163
---------------------------------------------------------- -------- ----------------------- ------------- --------
Reduction in corporate tax rates - - - (50)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Total underlying adjustments 1,116 832 2,966 (381)
---------------------------------------------------------- -------- ----------------------- ------------- --------
Reported per consolidated income statement 14,798 1,153 2,854 (547)
---------------------------------------------------------- -------- ----------------------- ------------- --------
As processes and procedures are further embedded during 2018, it
is possible that some changes to the information above may
result.
This information is provided by RNS
The company news service from the London Stock Exchange
END
ACSGGUMGCUPRGAR
(END) Dow Jones Newswires
April 18, 2018 11:24 ET (15:24 GMT)
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