Rolls-Royce Holdings plc Annual Report 2015 FOCUS TRANSFORM DELIVER 2015 Annual Report ROLLS-ROYCE IS A PRE-EMINENT ENGINEERING COMPANY FOCUSED ON WORLD-CLASS POWER AND PROPULSION SYSTEMS. This page A Trent 1000 engine for the Boeing 787 Dreamliner is prepared for testing. Strategic Report Financial highlights Contents Order book Free cash flow STRATEGIC REPORT Group at a glance 2 £76,399m £179m Chairman’s statement 4 2014: £73,674m 2014: £447m Chief Executive’s review 6 Review of 2015 8 Strategic priorities 15 Underlying* revenue Reported** revenue Business model 16 Engineering and innovation 18 £13,354m £13,725m Business review 22 2014: £13,864m 2014: £13,736m Financial review 42 Sustainability 48 Underlying* profit before tax Reported** profit before tax Key performance indicators 52 Principal risks 54 £1,432m £160m Going concern and viability statements 57 2014: £1,620m 2014: £67m DIRECTORS’ REPORT Underlying* earnings per share Reported earnings per share Board of Directors 58 Chairman’s introduction 62 Corporate governance 63 58.7p 4.5p Committee reports 69 2014: 65.4p 2014: (3.9)p Nominations & Governance Committee 69 Remuneration Committee 74 Full year payment to shareholders Net cash Audit Committee 91 Safety & Ethics Committee 98 16.37p £(111)m Science & Technology Committee 103 Responsibility statements 105 2014: 23.1p 2014: £666m Other statutory information 178 FINANCIAL STATEMENTS Financial statements contents 106 Group financial statements 107 * Underlying explanation is in note 2 on page 122 Company financial statements 157 **From continuing operations All figures in the narrative of the Strategic Report are underlying unless otherwise stated OTHER INFORMATION Subsidiaries, joint ventures and associates 160 FORWARD-LOOKING STATEMENTS This Annual Report contains forward-looking statements. Any statements that express Independent auditor’s report 167 forecasts, expectations and projections are not guarantees of future performance and guidance Sustainability assurance 175 may be updated from time to time. This report is intended to provide information to shareholders, and is not designed to be relied upon by any other party or for any other purpose, Additional financial information 176 and the Company and its Directors accept no liability to any other person other than that required under English law. Latest information will be made available on the Group’s website. Other statutory information 178 By their nature, these statements involve risk and uncertainty, and a number of factors could Shareholder information 182 cause material differences to the actual results or developments. Glossary 184 Rolls-Royce Holdings plc Annual Report 2015 1 Strategic Report / Group at a glance Group The Group is organised into five customer-facing businesses: Civil Aerospace, Defence Aerospace, Power Systems, Marine and Nuclear. Underlying revenue £13,354m Underlying profit before tax £1,432m Underlying revenue mix Civil Aerospace 52% Defence Aerospace 15% Power Systems 18% Marine 10% GROUP AT Nuclear 5% Order book Invested in R&D A GLANCE £76.4bn £1.2bn Patents applied for Countries 626 46 Engineers (year end) Employees (year average) 15,690 50,500 Rolls-Royce ship design The Far Samson multi-function subsea service vessel is 121.5m long and 26m wide. 2 Rolls-Royce Holdings plc Annual Report 2015 Group at a glance Strategic Report Civil Aerospace Defence Aerospace Underlying revenue Underlying revenue revenue mix mix Underlying revenue UnderlyingUnderlying revenue revenue mix mix £6,933m £2,035m Underlying profit* Underlying profit* £812m £393m OE revenue 47% OE revenue 39% Services revenue 53% Services revenue 61% Power Systems Marine Underlying revenue Underlying revenue revenue mix mix Underlying revenue Underlying revenue revenue mix mix £2,385m £1,324m Underlying profit* Underlying profit* £194m £15m OE revenue 68% OE revenue 58% Services revenue 32% Services revenue 42% Nuclear Underlying revenue Underlying revenue revenue mix mix £687m Underlying profit* £70m OE revenue 37% Services revenue 63% * Underlying profit before financing and taxation Rolls-Royce Holdings plc Annual Report 2015 3 Strategic Report / Chairman’s statement FOCUS We have made some important changes to our management in 2015 and laid the groundwork for further performance improvements as we tackle some near-term challenges.” Ian Davis Chairman Rolls-Royce is a business in transition. The next few years are going to be very important as we capitalise on our outstanding portfolio of products and services and the £76.4bn order book that supports them. Underpinning this journey will be significant changes to our business. Warren East, our new Chief Executive, will talk more about these in the Strategic Report. During this period of transition we should not forget the core strengths of the business. Our products, technologies and customer relationships have been further strengthened as a result of focused investment and the continued hard work of our teams. The sustained strong growth in our order book Underlying EPS shows that our customers recognise the value Rolls-Royce delivers. The fundamentals of our business are unchanged. We are investing today, as we 58.73p have for many years, in building a strong installed base of mission-critical industrial, marine and aerospace power systems. Our Payment to shareholders market share, particularly in powering large civil airliners, will grow significantly over the next ten years providing a cash generative, sustainable platform from which to further develop the business. Investing today to 16.37p secure that future is essential. 4 Rolls-Royce Holdings plc Annual Report 2015 Chairman’s statement take away several important learnings from engineering and manufacturing experience, Strategic Report In summary… different events, I have been impressed by after a long career at GKN and BAE Systems. how your Board and senior management at Fundamental strengths Lewis Booth, a US resident and an independent Rolls-Royce have performed at a difficult time. of the business unchanged Non-executive Director since 2011 has This has not been an easy year for the indicated his intention to relinquish his Continue to invest in market- Company, its employees, investors or other responsibility as Senior Independent Director leading products, technologies stakeholders. We have had to communicate once a successor has been appointed. He will and customer services some challenging messages both internally continue as Chairman of the Audit Committee. and externally about our market outlook, Lay stronger foundations to rebuild our performance and, very importantly, the Dame Helen Alexander, an independent trust and confidence in a world- essential changes we will be making to cut Non-executive Director since 2007, will be class engineering business waste and restore confidence in the business. stepping down from the Board after the AGM in May 2016 having completed her nine-year We have not taken our eye off some of the term. At that time she will be succeeded as At the same time, we are facing some historic issues that have undermined confidence Chairman of the Remuneration Committee challenges in key markets, particularly in in the business in the past. Concerns about by Ruth Cairnie, who joined the Board in Marine, and are managing a major change bribery and corruption involving intermediaries September 2014. On behalf of the Board in product mix within Civil Aerospace, which in overseas markets remain subject to I would like to thank Dame Helen for her has a direct impact on how we recognise examination by the Serious Fraud Office and dedicated service to the Company. She has revenues and profits. This meant we took the other authorities and these investigations been a wise and insightful member of the decision to undertake a major restructuring are not yet complete. We have done much to Board and her well-judged advice and of the business. Warren’s recent review of address the root of these problems and this leadership of our Remuneration Committee operations, unanimously supported by work is being continually reinforced to ensure have been highly valued by her colleagues. the Board, highlighted a number of areas we all meet the high standards expected of us. where, over time, costs have grown in an unsustainable way. This clearly needs to Rebuilding trust and confidence change. We have approved a plan to reduce our Board developments In the first months since his appointment last fixed cost base by £150m to £200m per annum During the year there have been a number of and simplify the way we manage the business. July, Warren has made an enormous impact important changes to the Board. On 22 April on the business with a clear, well-structured we announced that John Rishton had decided review. This has examined the strengths and Shareholder payments to retire as Chief Executive on 2 July, to be weaknesses of our businesses and highlighted succeeded by Warren East. At the AGM on the critical investment priorities required The pace of investment required to transform 8 May James Guyette, President and Chief to develop our competitive advantages and the business creates near-term pressure Executive Officer of Rolls-Royce North market position. I have also been pleased on free cash flow. At the same time, we need America, retired and stepped down from the by the steps he and his team have taken to sustain a healthy balance sheet to ensure Board. John Neill also stood down at the AGM to improve communication to our investors. we have the financial flexibility to maintain after six years as a Non-executive Director. While it is early days, I believe his approach a strong investment-grade credit rating. has been well received and has laid good As a result, the Board is recommending Irene Dorner, formerly CEO and President foundations from which we can rebuild trust that the payment to shareholders is halved of HSBC USA, joined the Board in July. and confidence in the business. in cash terms at the full year and the next Alan Davies, Chief Executive of Rio Tinto’s half year.