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Rolls-Royce Holdings plcAnnual Report 2014

BETTER POWER FOR A CHANGING WORLD


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Cover image: Transatlantic Air Exchanges | Airline routes between North America and Europe. Félix Pharand-Deschênes/GlobaïaThis page: Front fan from a Trent 1000 aero engine

Rolls-Royce designs, develops, manufactures and servicesintegrated power systems for use in the air, on land and at sea.

We are one of the world’s leading producers of aero engines for large civil aircraft and corporate jets. We are the second largest provider of defence aero engines and services in the world.For land and sea markets, reciprocating engines and systems from Rolls-Royce are in marine,distributed energy, oil & gas, rail and off -highway vehicle applications. In nuclear, we have a stroninstrumentation, product and service capability in both civil power and submarine propulsion.


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How we manageour business

Board of directors 54Chairman’s introduction 56Corporate governance 59Committee reports: Nominations and governance 64 Safety and ethics 66

Audit 69 Remuneration 74Directors’ remuneration 76Directors’ remuneration policy 86 Responsibility statements 93Other statutory information 162

Our business model andhow we performed

Group at a glance 2Better power 4Chairman’s review 10Chief Executive’s review 14Innovation and technology 20Market outlook 22

Strategy 23Business model 24Chief Financial Officer’s review 26Financial review 28Business reviews: Aerospace 32 Land & Sea 36Our people 42Sustainability 44Key performance indicators 48Principal risks 50

The financial statementsof the Group

Financial statements contents 94 Groupnancial statements 95Company nancial statements 149

Auditor’s report andshareholder information

Subsidiaries, jointly controlledentities and associates 1Independent auditor’s report 1Additionalnancial information 1Shareholder information 1Glossary 1

STRATEGIC REPORT DIRECTORS’ REPORT FINANCIAL STATEMENTS OTHER INFORMATION

What’s inside…

2014 2013 Change

Order book £m 73,674 71,612 +3%

Underlying* revenue £m 14,588 15,505 -6%

Underlying* profit before ta x £m 1,617 1,759 -8%

Underlying* earnings per share 65.3p 65.6p -0.3p

Full year payment to shareholders (excluding buyback) 23.1p 22.0p +5%

Reported revenue £m† 13,736 14,642 -6%

Reported profit before tax £m† 67 1,700 -96%

Reported earnings per share† 3.7p 73.3p -69.6p

Net cash £m 666 1,939 -66%

Free cash flow £m 254 781 -67%

* Underlying explanation is in note 2 on page 110.† 2013 re-presented to reflect Energy as a discontinued operation.

All figures in the narrative of the Strategic Report are underlying unless otherwise stated.

FINANCIALHIGHLIGHTS

How did weperform in 2014?

FORWARD-LOOKING STATEMENTSThis Annual Report contains forward-looking statements. Any statements that express forecasts, expectations and projections are not guarantees of futureperformance and guidance may be updated from time to time. Latest information will be made available on the Group’s website. By their nature, thesestatements involve risk and uncertainty, and a number of factors could cause material diff erences to the actual results or developments. This report isintended 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 itsdirectors accept no liability to any other person other than that required under English law.

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AEROSPACE

LAND & SEA

The Aerospace Division is a leading

producer of aero engines for largecivil aircraft and corporate jets.We are the second largest providerof defence aero engines and

services in the world.

We power more than 50 types ofaircraft across civil and defencemarkets and have over 29,000engines in service.

The Land & Sea Division

comprises Power Systems,Marine and Nuclear.

Our Power Systems businessincludes the world-renownedMTU range of reciprocating

engines. Marine hasequipment installed on over25,000 vessels.

We have a growing civil nuclearbusiness and have 55 years of

experience in nuclear submarinepropulsion.

CIVIL AEROSPACE

POWER SYSTEMS

DEFENCE AEROSPACE

£2,069m

£366m

UNDERLYING REVENUE

UNDERLYING REVENUE

UNDERLYING REVENUE UNDERLYING REVENUEWe sold the Energygas turbines andcompressor businessto Siemens on1 December 2014.

UNDERLYING PROFIT

UNDERLYING PROFIT

UNDERLYING PROFIT UNDERLYING PROFIT

UNDERLYING REVENUE

UNDERLYING PROFIT

£6,837m

£2,720m

£942m

£253m

UNDERLYING REVENUE

UNDERLYING PROFIT

NUCLEAR ENERGY

£684m £724m

£48m £(3)m

MARINE

£1,709m

£138m

UNDERLYING

REVENUE MIX

OE revenue 48%

Services revenue 52%

UNDERLYING

REVENUE MIX

OE revenue 70%


UNDERLYING

REVENUE MIX

OE revenue 63%


UNDERLYING

REVENUE MIX

OE revenue 39%


UNDERLYING

REVENUE MIX

OE revenue 37%


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BETTER POWER FOR A

CHANGINGWORLD

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Our world is changing, the climate

is altering and populations areincreasing. We need more power

but not at any cost to society.The world needs better power.

Rolls-Royce is committed to researchand technology in order to developinnovative and advanced powersystems that can help.

Our vision is to deliver better powerfor a changing world. The followingpages illustrate how we are doingthis in the air, on land and at sea.

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WORLD’S MOST EFFICIENT LARGE AERO ENGINE

Launch customer Qatar Airways took delivery of the firstTrent XWB-powered Airbus A350 XWB at the end of 2014.The Trent XWB is the world’s most efficient large aeroengine and is 10% more fuel efficient than the legacyengines it is designed to replace.

This first delivery signifies the start of a major engineproduction programme for the Group. Customers haveordered over 1,500 Trent XWB engines, representing49% of the Civil aerospace order book.

IN THE AIRBETTER POWER

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LEADING IN LATEST TRANSPORTER POWER

Rolls-Royce is the market leader in powering military transportaircraft with 8,000 engines in service. The new Airbus A400Mtransporter continued to enter service successfully during 2014.

The A400M is powered by the TP400 turboprop engine in whichRolls-Royce is a major partner. We also secured a landmarkagreement during the year with Lockheed Martin for up to600 engines to power its C-130J transporter.

Our fleet of T56 engines has accumulated over 200 millionoperating hours having first entered service in 1954. Werecently introduced an upgrade for the T56 that a US Air Forcestudy predicts could deliver US$240 million in fuel savings forits fleet through to 2040.

FURTHER AND FASTER ON LESS FUEL

Rolls-Royce continues to be a market leader in powering largecorporate jets. The latest version of Cessna’s flagship aircraft, theCitation X+, entered service in June 2014, further cementing ourposition in this important market sector. The improved versionof our AE 3007 engines on the Citation X+ delivers an increase inthrust at take-off, coupled with a reduction in fuel burn – helpingpeople to fly further and faster but using less fuel to do it.

In addition, we strengthened our long-standing relationship withGulfstream when we were selected in 2014 to power its newG650ER corporate jet.

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LOCAL ENERGY – NATURALLY

Efficient, low-emission power systems arein demand across the world for effectivesolutions to local energy needs. ThroughMTU Onsite Energy, Rolls-Royce is providingreliable power for applications such ashealthcare, data centres, airports, farmsand independent power stations.

In Chile for example, two MTU Onsite Energyunits powered by Series 4000 engines arenow generating 6,400MWh of electricitya year from biogas produced by a localpig farm. These units are the first in thecountry to generate electricity from abiogas plant. For our customer they provideeco-friendly and profitable power to 2,500families in the area.

POWERPACKED ON THE RAILWAYS

Power Systems is a major player in enginesfor the rail industry. To date, over 20,000MTU engines have been sold for use in drivesystems and electrical generation in this

global market. 2014 marked the 90th year ofMTU engines being supplied for rail traction.

As well as the anniversary, this year alsosaw an agreement reached with Polish railvehicle manufacturer PESA for the supplyof up to 940 MTU PowerPacks® to be used inrailcars operated by Deutsche Bahn. ThesePowerPacks are among the most advancedin the industry, meeting all the latestEuropean Union requirements on emissions.

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ON LAND

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YEARS OF OFFSHORE FLAGSHIPS

The UT-Design series from Rolls-Royce isrecognised worldwide as the benchmarkfor the offshore industry. Today’s vesselsemploy our wave-piercing hull whichimproves efficiency and reduces fuelconsumption. All major propulsion systemsare fully integrated with the hull designto give optimum performance.

Rolls-Royce UT-Design vessels have beenhelping pioneer oil & gas explorationand providing offshore support for 40 years.So far, more than 800 have been built orare currently under construction.

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CHAIRMAN’S REVIEW

After a decade of strongperformance andgrowth, 2014 was a yearof mixed fortunes forour Company.

IAN DAVISChairman

We are totallyfocused on returning theCompany to its long-termtrajectory of protablegrowth and of superiorshareholder returns.”

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Thefundamentalsof the business

remain strong.”

There have been some real pluses and

achievements alongside a number ofchallenges that held back the Company’snancial performance.

During the course of the year, our orderbook reached its highest ever level. We alsocelebrated the delivery of the rst AirbusA350 XWB to our launch customer QatarAirways, powered by Rolls-Royce Trent XWBengines. Our record of customer servicecontinues to improve, in Civil aerospacefor example, we have maintained a recordof 100% on-time delivery to Airbus for thepast two years. In the same period ourMarine business improved originalequipment on-time delivery by 11%, whilespares delivery improved across the Group.We still have more to do here and we aretotally committed to enhancing customersatisfaction with our products and services.However, progress is encouraging andbodes well for the future. Happy customersare a precondition for a successful,long-term business.

Set against these achievements, 2014 wasthe rst year in a decade in which revenueand underlying prots, on a like-for-likebasis, did not grow. The Defence business

was hit hard by constraints in governmentexpenditure. In our Land & Sea Division,we faced tough market conditions,characterised by pricing pressure anddeferred or cancelled orders by customers,particularly in the oil & gas, constructionand mining industries.

In addition to some difficult tradingconditions, we did not make as muchprogress as planned on improving our costand cash performance. We fully recognisethis is a priority if we are to provideattractive returns to shareholders as wellas to fund the investment requirementsthat will underpin long-term growth.Ours is a business that requires signicantup-front cash investment to generatelong-term cash ow.

SHAREHOLDER DISTRIBUTIONS

Despite the short-term challenges, thefundamentals of the business remainstrong. Rolls-Royce is a growth company,well positioned in long-term growthmarkets that off er the prospect ofattractive returns.

We know that shareholders do not investin growth alone, they invest for growththat’s protable. Our payment toshareholders of 23.1p reects the condencethe Board has in the Company’s protabilityand cash generation prospects. At the sametime we are committed to retaining a strongbalance sheet. Civil aerospace in particular,although an attractive long-term business,can still be prone to external market shocks.Our customers, who depend on our serv icesupport for periods of up to 25 years,both expect and demand ananciallyresilient supplier.

STRATEGYRolls-Royce is intrinsically a long-termbusiness and has to be directed andmanaged as such. In Civil aerospacefor example, products take many yearsto develop, test and bring to market, andare quite rightly subject to strict regulatory

process. Revenue from the sale of originalequipment and subsequent aftermarketservices generate cash ows for decades.

The Board reviewed the Group’s productportfolio and corporate structure inlight of these nancial and investmentcharacteristics. This review led to thedecision to divest our Energy businessand we completed its sale to Siemensin December. At the same time westrengthened our position in the coredivision of Land & Sea by completing theacquisition of the shares held by Daimlerin Power Systems. We are focused on thetwin pillars of Aerospace and Land & Seabecause of their technology and servicemodel synergies and their combined abilityto create shared competitive advantage.

Our strong belief is that shareholders,as well as customers and employees, willbe best served if the Company continues tofocus on expanding its position in the highlyattractive global markets for power andpropulsion. We have long-established and

PAYMENT TO SHAREHOLDERS

23.1p (2013: 22.0p)

UNDERLYING EPS

65.3p (2013: 65.6p)

ORDER BOOK

£74bn (2013: £72bn)

RETURN ON SALES

11.5% (2013: 11.8%)

FINANCIAL HIGHLIGHTS

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competitive technology platforms, as well

as customer relationships, in gas turbines,reciprocating engines, nuclear services andcontrols. We see substantial long-term valuecreation and growth potential from theseproducts, not least from aftermarketservices where Rolls-Royce has been apioneer. There will be cyclicality andvolatility – external and internal risks arenot insignicant – however, our long-termaspiration is to build on our positionas a leading global provider of complexintegrated power systems for use in theair, on land and at sea.

INNOVATIONInnovation has been, and is, critical tothe long-term success of Rolls-Royce.We cannot depend on size and scale alonefor competitive advantage. We invest morethan £1 billion a year in research anddevelopment (R&D) to ensure that weconceive, design and deliver world-classtechnology that meets our customers’current and f uture requirements.

Innovation is not just about R&D numbersand not just about product technology.An increasing focus, for example, is on dataanalytics and on control systems to reect

our customers’ increasing requirements forintegrated solutions. Rolls-Royce has longbeen an innovator in services and we willbe looking to build on this. I am especiallyproud of our collaborative approach toinnovation, particularly our work withleading universities across the world ondesignated topics and technologies. We arequite clear that we must improve our capitalefficiency, our cost competitiveness and ourcash generation. However this will not be atthe expense of our strategic commitment toinnovation and development. These will bethe drivers of long-term protable growthand value creation.

TALENT AND CAPABILITIESI would like to touch on some of the keyenablers that will be required to deliverour strategy and our operational plans. Inparticular, we need to attract, develop andretain outstanding talent everywhere weoperate, commercial and functional talentas much as engineering talent. In the past

year we recruited 354 graduates from 112universities in 11 countries and we recruited

357 apprentices across the world. I am

pleased that 26% of our graduate recruitsand 10% of our UK apprentices are female– not good enough but progress. Ourcommunity programmes remain directedtowards encouraging young people,particularly females, to choose science,technology, engineering and maths (STEM)subjects. We are in the process of reviewingour training and leadership developmentprogrammes, particularly for middlemanagers. We are also exploring ways ofaccelerating and broadening career pathsfor our highest potential talent across theworld and for further increasing diversityas an important element of changing andstrengthening our culture.

CORPORATE GOVERNANCEThe Board recognises that stronggovernance is a hallmark of excellentcompanies. We remain committed tobeing a leader in ethical behaviour and inenvironmental and social responsibility. Weare updating and upgrading our governancestructures and controls, with a particularfocus on risk and compliance procedures.The concerns about bribery and corruptioninvolving intermediaries in overseasmarkets, and the subsequent SFO enquiry,

together with wider speculation, have beena body blow to the Company and we haveresponded accordingly. We have expandedsignicantly our compliance team, investedheavily in training and awareness buildingacross the Group and strengthened ourinternal controls. Our staff have received anew Global Code of Conduct, together withmandatory training. We have established orexpanded our own offices in manyinternational markets and reduceddramatically the number of externalintermediaries. Further details are containedin the Safety and Ethics Committee Reporton page 66. We are grateful to Lord Goldwho continues to advise us on complianceand ethics best practice.

BOARD APPOINTMENTS AND CHANGESRuth Cairnie, formerly an executive vicepresident with Royal Dutch Shell, joinedthe Board in September. In addition,Pamela Coles, previously at Centrica, has

joined Rolls-Royce as Company Secretary.We are lucky to have both of them.

We arecommitted to being aleader in environmental

and social responsibilityand to being regarded asa good corporate citizen.”

PEOPLE AND TALENT

We are exploring ways of acceleratingand broadening career paths for ourhighest potential talent across the worldand for further increasing diversity as animportant element of changing andstrengthening our culture.

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I was also very pleased to welcome David

Smith to the Board. David was appointedChief Financial Officer (CFO) in November,replacing Mark Morris who left theCompany. David joined Rolls-Royce atthe beginning of 2014 as the CFO of theAerospace Division. Prior to that, he hadextensive international experience inengineering and technology companies.A particular focus for David will be tostrengthen further our nancial controlsand management information systemsas well as improving our communicationswith the investment community.

I would like to thank Mark Morris for his years of service and contributions to theCompany and to the Board. I would alsolike to thank Iain Conn who stood downfrom the Board after nine years of dedicatedand exemplary service. He was succeeded asSenior Independent Director by Lewis Booth.

After a successful career spanning 17 yearswith Rolls-Royce, James Guyette will stepdown from the Board at the conclusion ofthe 2015 Annual General Meeting (AGM)and retire from his role as President andChief Executive Officer of Rolls-Royce NorthAmerica on 31 May 2015. James has made a

tremendous contribution to the Companyover many years. He has helped guide thebusiness through a period of signicantexpansion, especially in the North Americanmarket. His energy, good humour andcommitment to our customers will bemissed by us all.

John Neill has also indicated that he willstep down from the Board after just oversix years as a Non-Executive Director andwill not therefore put himself forwardfor re-election at the 2015 AGM. I wouldlike to thank John for his tremendouscontribution to the Board and his exemplarycommitment to Rolls-Royce over the lastsix years. He will be missed and we wishhim well for the future.

I am pleased to announce that Irene Dornerwill be joining the Board as a Non-ExecutiveDirector with eff ect from 27 July 2015.She will also become a member of theNominations and Governance Committee

and the Safety and Ethics Committee from

the date of her appointment. She brings awealth of experience from internationalbanking along with a passion for drivingculture change in large organisations.

Irene was CEO and president of HSBCUSA until December 2014 where she wasresponsible for all of HSBC’s operationsin the US and played a key role instrengthening their risk processes. Duringher 29-year career at HSBC, she held anumber of international roles. She wasthe rst woman to lead HSBC in Malaysiaand launched its Islamic banking unit.She is a passionate advocate of diversityand inclusion.

There have been some adjustments to thecommittee structure of the Board, explainedin more detail in my introduction to theDirectors’ Report on page 56. Safety andEthics have been combined into onecommittee under the chairmanshipof Sir Frank Chapman, formerly CEO ofBG Group. I have also established a Scienceand Technology Committee, under thechairmanship of Warren East, formerlyCEO of ARM Holdings. Science andtechnology are critical to the Company’s

success and warrant the attention of afocused committee, in addition to generalboard oversight.

We have beneted again from the insightand experience of our International AdvisoryBoard (IAB) the composition of which isdescribed on page 57. The role of the IABis to provide contextual understandingof international economic and politicaldevelopments, and to help managementand the Board bet ter understand long-termgeographical opportunities and risks.Members of the IAB are also available to oursenior management on specic issues andareas of expertise. We are fortunate to havesuch a wealth of experience and knowledgeat our disposal. I am very grateful to themand in particular to Lord Powell for hisexemplary chairmanship of the IAB.

I would like to thank my fellow boardmembers for their diligence andoutstanding commitment to Rolls-Royce.

I would also like to thank John Rishton, his

management team and all our employeesfor their hard work and exceptionaldedication in a demanding year.

I hope this review demonstrates ourunderstanding of the concerns aboutRolls-Royce’snancial performance in 2014and the 2015 outlook. We are totally focusedon returning the Company to its long-termtrajectory of protable growth and ofsuperior shareholder returns. We willcontinue to focus on the 4Cs of Customer,Concentration, Cost and Cash to improveperformance, and we will strengthen ournancial controls and communications. Wewill sustain our commitment to innovationand development.

The fundamentals of the business remainstrong. They are underpinned by our recordorder book and our expanding installedequipment base that will generate valuefor years ahead. This is a sound businesswith continued growth potential.

IAN DAVISChairman12 February 2015

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CHIEF EXECUTIVE’S REVIEW

Rolls-Royce is in businessto deliver better powerfor a changing world.The integrated powersystems that we develop,build and maintain,address the increasingglobal demand for

transport and energy.

JOHN RISHTONChief Executive

We continuallyseek to reduce cost to remaincompetitive and to generatethe funds we need to investin future growth.”


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As society becomes more integrated,

population expands and the world becomesmore affluent, the requirement for thetype of advanced engineering solutionswe provide will grow. These are long-termtrends that require long-term investmentand present us with the opportunity forlong-term protable growth.

The path to growth will not always besmooth. For Rolls-Royce, 2014 has proveda challenging year for reasons that I willexplain in some detail. During 2014, Groupunderlying revenue was 6% lower than in2013 and underlying prot before taxdeclined by 8%. However, the Group orderbook grew to a new record of £73.7 billion,demonstrating the condence ourcustomers continue to place in ourtechnology and the growth that lies ahead.It is encouraging that the Defence aerospaceorder book increased for the rst time since2010, with continued growth in the orderbooks of Civil aerospace and Power Systems.

In this review I will explain why we believeour business model is robust, I will describethe transformation we are driving throughthe Group and the reasons for ourcondence in the future. I will also outline

the challenges we face and the decisiveaction we are taking to accelerate a returnto our long-term trend of protable growth.

So let me start with our business model.We invest in technology in order to meetour customers’ current and future needs.Through constant innovation we create theopportunity to grow sales and expand ourmarket share. We earn revenue both fromthe sale of original equipment and fromservicing the power systems we produce.We continually seek to reduce cost to remaincompetitive and to generate the funds weneed to invest in future growth.

We have evolved and simplied our strategy

to focus on the core areas of: customer, innovation and protable growth.

Customer: we put customers at the heart ofthe organisation. We understand their needsand then focus relentlessly on delivery.

Innovation: is at the core of Rolls-Royceand drives a culture of continuousimprovement. Delivering relevantinnovation is critical to meeting ourcustomers’ current and future needs.

Protable growth: by focusing on ourcustomers and presenting them with acompetitive portfolio of innovative productsand services, we create the opportunityfor long-term protable growth.

This sharper focus enables us to drive ourbusiness model harder and will, over time,deliver improving nancial returns.

From its earliest days Rolls-Royce hasaddressed a range of markets wheredemand exists for advanced engineeringsolutions. Our 1906 articles of associationdescribe the business as producingtechnology for use in the air, on land and atsea. More than a century later this approachremains relevant and we run our businessthrough the two Divisions of Aerospace andLand & Sea that you will see described in thepages of this Annual Report.

There is an industrial, commercial andstrategic logic that ties these two Divisionstogether and generates value for the Group.

Industrially, our knowledge of advancedengineering applies across both ourDivisions. World-class technology is requiredby all of our customers and as the powersystems we produce become moresophisticated, a deep understandingof materials science, electronics, datamanagement and aftermarket servicesare increasingly important in every partof the Group.

BETTER POWEROur Land & Sea Division is well positionedto meet the requirements for cleanerpower that will be driven by future growthin world trade.

£74bn Our order bookincreased in 2014 to a record level

Commercially, we and our competitorsrecognise the requirement of a broadportfolio and exposure to diff ering businessand investment cycles. It is not a coincidencethat there is no pure aerospace powersystem company in the world.

The scale represented by our two Divisionsis important in maintaining a strongbalance sheet and protecting ourinvestment grade rating. Scale has alsoenabled us to maintain a global R&Dnetwork comprising 31 UniversityTechnology Centres and seven AdvancedManufacturing Research Centres. Thesefacilities envisage, develop and testemerging technologies that haveapplications across our portfolio. Ourbreadth increases market access andgenerates opportunity. For example, ourNuclear business is relatively small butextends our inuence and gives us accessto the highest levels of governmentinternationally.


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Strategically, our two Divisions address

markets where long-term growth isassured and where increasinglysophisticated engineering solutions willbe required. We believe both aerospaceand land & sea markets off er attractivereturns and play to our strengths.

The future growth of air travel is widelyunderstood and reected in our £63 billionCivil aerospace order book. To give this someperspective, in the past decade we havedelivered 1,600 Trent engines. In the decadeahead we expect to deliver 4,000. All of theengines in this expanding eet will produceservice revenues that will extend fordecades to come. Our Land & Sea Divisionis well positioned to meet the requirementsfor cleaner power that will be driven byfuture growth in world trade (90% ofwhich is carried by sea), urbanisation,population growth and tighterenvironmental regulations.

Across the Group, we invest in technologythat is continually setting new standardsin power efficiency and environmentalperformance. The complexity of what wedo creates barriers to entry and generatesnew market opportunities. Put simply, there

will be signicant long-term growth indemand for the complex integrated powersystems we deliver, and there are not manycompanies with the ability to do what wecan do.

Despite these fundamental strengths,in 2014 our short-term performance hasbeen negatively aff ected by a number offactors. In Aerospace our Defence revenuesfell by 20%, reecting reduced governmentdefence spending in our main markets ofNorth America and Europe. In Land & Sea,slowing growth in a number of our majormarkets including Continental Europe,South America and China has caused somecustomers to delay or cancel orders. At thesame time, sharp declines in the price of oiland other commodities have led customersto reduce or defer expenditure, especiallyin the oil & gas, mining and constructionindustries.

In response to these adverse conditions,

we have accelerated progress on the 4Csof Customer, Concentration, Cost and Cash– with a part icular emphasis on cost. Thisdecisive action is driving a transformationof the business that will, in time, make usa stronger Group and hasten our returnto protable growth.

On Customer: we continue to make goodprogress improving quality, delivery,reliability and responsiveness; thecharacteristics our customers tell us theyvalue most. The results can be seen acrossa wide range of programmes. At Group levelthere has been a further improvement indelivery times – particularly for spare parts.In Aerospace, the Trent 1000 that powersthe Boeing 787 Dreamliner has achievedan industry-leading 99.9% engine dispatchreliability after completing over 500,000 ying hours in service. Since launch, wehave doubled the time on wing for bothour Trent 700 and Trent 800 eets. In ourCivil Small and Medium Engines business,we achieved a 57 percentage pointsimprovement in restoring operationalavailability for business jets in the past year.

Recognising the progress we have made,

Airbus has presented us with its SupplyChain and Quality Improvement Award.The US Government’s Defense LogisticsAgency recognised Rolls-Royce as a ‘rsttier supplier’ from among 153 companiesand we were awarded joint rst place byAviation International News for the qualityof our business aircraft support.

In Land & Sea, our delivery on time toMarine customers has improved by33 percentage points since 2012. Marinealso signed its rst commercial long-termservice agreement. As the power systems wedeliver in Land & Sea become more complex,we see further opportunities to expand ouraftermarket activities, building on the dataand service capabilities we have developedin Aerospace. In Power Systems, we openedan additional logistics centre in Singapore,enabling a 5% improvement in theavailability of spare parts and settinga new standard for customer service.

Improving performance in this waystrengthens the relationship we have with

CHIEF EXECUTIVE’S REVIEWCONTINUED

INNOVATION

We invest in technology in order to meetour customers’ current and future needs.Through constant innovation we createthe opportunity to grow sales and expandour market share.

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We continueto make good progressimproving quality,

delivery, reliabilityand responsiveness.”


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OUR FIVE PRIORITIES

FOR THE GROUP

DURING WE OUTLINED THE PRIORITIESFOR THE BUSINESS GOING FORWARD.

FIX THE BASICS (THE Cs)This is about improving the bedrock of theorganisation: focusing on our customersand their needs; concentrating on what weare good at; attacking cost across the Groupand managing our cash position eff ectively.

CULTUREWe want a business-orientated, innovativeand cost-conscious culture, one thatunderstands our customers and delivers ontheir behalf. We must have a culture whereethical behaviour is fully embedded, so thatwe don’t just win but win right.

CIVIL WIDEBODYWe are building on success. In the last decadewe delivered 1,600 Trents and in the next wewill deliver 4,000. We power over 50% of newwidebody aircraft. Our next generationengines, Advance and UltraFan™, will helpmaintain our leading market position.

CIVIL NARROWBODYNarrowbodies represent 70% of the civilaircraft market by volume and 50% by value.We have the requisite skills and technologyto return to this market and are determinedto do so when the opportunity arises.This is important in the longer term,not just because of the scale this marketsegment off ers but also because of thechance it presents to develop greatercustomer intimacy.

MEDIUM-SPEED RECIPROCATING ENGINESMedium-speed reciprocating engines powerthe vast majority of the marine vessels thatwe design and equip. We have world-classtechnology, but it is characteristic of thisindustry that the engine supplier isparticularly well placed to pull throughother technologies, so our lack of scalein medium-speed engines confers adisadvantage we need to address.

our customers, and generates opportunities

for us to secure additional business.

Concentration: means deciding wherewe want to invest and where not to.

In August, we were pleased to acquireDaimler’s 50% shareholding in Rolls-RoycePower Systems for £1.94 billion. PowerSystems adds scale and capability to ourreciprocating engines portfolio. It hasoutstanding technology, operates inlong-term growth markets and hasproved a valuable addition to ourLand & Sea Division.

We also divested a signicant business inDecember, completing the sale of our Energygas turbines and compressor business toSiemens. This is a business that has excellenttechnology and a talented workforce, but itlacks the scale required to prosper as part ofRolls-Royce. Siemens has a far bigger powergeneration business and is a more suitableowner. The sale generated proceeds ofaround £1 billion. We are returning this toshareholders by way of a share buyback thatstarted in December 2014.

Turning to Cost: we have taken action to

improve cost performance in every part ofthe business and in every cost category. Wehave made good progress in some areas andas a result, Group gross margins improvedby 1.7 percentage points in 2014. In Defence,we have improved margins despite decliningrevenue. In Land & Sea, we closed ve plantsand are rationalising other parts of thebusiness. For example, we are consolidatingproduction of steering gear in Norway andwaterjets into Finland. We are driving downcost by improving quality, simplifyinglogistics, reducing waste, and adoptingprocesses that allow us to make thingsbetter and faster.

In November, we announced a restructuringprogramme in our Aerospace Division andcentral functions, which is expected toreduce headcount by 2,600. By the end of2014, 545 people had left the business, withthe majority of the reductions expected in2015. This programme is expected to resultin restructuring charges of around£120 million, of which £56 million wasrecognised in our 2014 results.

We anticipate annualised cost benets of

around £80 million from 2016 onwards,with £50 million in benets expected in2015. Our total Aerospace 2014restructuring activities cost £164 million(of which £139 million was underlying).

However, in a complex and highly-regulatedbusiness, we recognise that it will takesome time for the full benet of our costprogrammes to feed through. There arealso a number of headwinds in our Civilaerospace business associated with ourfuture growth. For example, we haveinvested in the capacity required to deliverour record order book, but delay in a numberof our customers’ major programmes hasmeant some of this new capacity has comeon stream before it is needed, leaving uswith under-utilised production facilities.We have also constructed a number of newworld-class facilities to replace older, lessproductive plants. For a period of transitionwe are carrying the cost of both the oldand new facilities.

Group restructuring costs in 2014 were£188 million, of which £149 million wasunderlying. Over the past two years, theGroup has reduced indirect headcount

by 18%. We expect Group underlyingrestructuring costs to be between £90and £100 million in 2015.

Cost performance will continue to be amajor focus, and as we rationalise andtransform the Group, we have targeted a20% reduction in our footprint and adoubling of our lower-cost country sourcingby 2020. We are now accelerating progresstowards these targets.

Cash: we continue to focus on improvingour free cash ow, particularly in the faceof near-term headwinds. Our programmesto reduce product and aftermarket costs,lower our headcount and to reduce ourfootprint all require upfront investmentbut will deliver cost and cash benets inthe medium term. As revenue increases,we expect to reduce our capital expenditureand R&D as a percentage of sales. Thecustomer progress highlighted earlier isimproving our operational performance.


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Combined with increasing volumes, this will

enable us to reduce our inventory buff ers.

While a great deal of attention has beenfocused, quite rightly, on the nancialperformance of the Group, it is importantto recognise signicant achievements in2014 that will support the Group’s futureprotable growth.

1,500 Trent XWBengines are on order. The rstengines were delivered toQatar Airways in 2014

In Aerospace in December, we weredelighted to celebrate the rst delivery of theTrent XWB, powering the new Airbus A350XWB for launch customer Qatar Airways.The Trent XWB is the most fuel efficientlarge aero engine operating in the worldtoday. I would like to congratulate everyoneat Rolls-Royce who has worked so hardover many years to support the successfuldelivery of this exceptional aircraft, forwhich Rolls-Royce is the sole engine provider.

At the Farnborough International Airshow

in July, we announced the seventh memberof the Trent engine family, the Trent 7000,that will power the new Airbus A330neo.This new engine will incorporate technologyfrom our most recent Trents and will delivera 10% improvement in specic fuelconsumption and halve the noise energyoutput compared to the current engine onthe A330. Rolls-Royce will be the exclusiveengine supplier on the A330neo, due toenter service in 2017.

We have continued to bring new world-classfacilities on stream in 2014. These includethe opening of our new advanced discmanufacturing facility at Washington inthe UK and the rst production aerofoilfrom our new Advanced AerofoilManufacturing Facility at Crosspointe,Virginia in the US. 2014 saw theinauguration of our new large engine testbed in Dahlewitz, Germany and the openingof a new marine customer training centreoutside Rio de Janeiro in Brazil.

We marked a major milestone in the

development of carbon titanium (CTi) fanblades with the launch of a test ightprogramme on board a Boeing 747 yingtest bed. CTi technology delivers lighter fanblades that will be incorporated into futureaero engines. Combined with a compositefan casing, it forms a system that can reduceweight by up to 1,500lb per aircraft, theequivalent of seven passengers.

In Land & Sea we have also continued tostrengthen our portfolio, bringing newtechnology to market across the Division.In September, we unveiled the rst of anew family of medium-speed reciprocatingengines for use on land and at sea. Thenew Bergen B33:45 off ers a 20% increasein power per cylinder, while reducing fuelconsumption, emissions and operatingcosts. It is our rst new product to combinethe engineering strengths of our traditionalBergen engines operation and our newPower Systems business. Because of itsgreater power range, the new engineincreases our addressable market inmedium-speed engines by 20%.

In the naval market two important newships powered by our MT30 gas turbines

were officially named: the multi-missiondestroyer USS Zumwalt and the Royal Navyaircraft carrier Queen Elizabeth.

In the rail sector, Power Systems hasdeveloped an MTU hybrid PowerPack thatgenerates additional power through thebraking control system. This technologyoff ers a fuel saving of up to 25% with aproportional reduction in emissions.

For off -highway vehicles, MTU’s latestSeries 4000 engine has improved fuelconsumption by 5%. For a typical applicationthis can represent a saving of up to 100,000litres of fuel and reduction of 350 tonnes ofCO2 emissions each year.

TECHNOLOGY

We have continued to invest in ourLand & Sea Division, bringing newtechnology to market across the portfolio.In September, we unveiled the rst of anew family of medium-speed reciprocatingengines for power on land and at sea.The new Bergen B33:45 off ers a 20%increase in power per cylinder, whilereducing fuel consumption, emissionsand operating costs.

MORE INFORMATIONON PAGE


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MTU’s latest Series 4000engine has improved fuelconsumption by

5%In our Nuclear business, we wereencouraged that, in October, the EuropeanCommission approved the constructionof the rst new commercial nuclear powerstation to be built for a generation inthe UK, at Hinkley Point in Somerset. TheCommission concluded that new nuclearpower is vital for Britain’s energy securityand will be key to reducing carbon emissionsfrom the UK’s electricity industry. HinkleyPoint C is the rst of at least 11 new reactorsplanned for the UK, for which Rolls-Royceis well positioned to supply components,

systems and engineering services.

31 University TechnologyCentres. This research networkextends relationships we havewith world-leading universities

As the Chairman said, we continued tostrengthen the governance of the Group.We expect the highest standards ofbehaviour from our employees and wehave been explicit that we will not toleratebusiness misconduct of any sort. TheSerious Fraud Office investigation intoconcerns about bribery and corruptioninvolving intermediaries in overseasmarkets continues and we are cooperatingfully with the investigating authorities.Lord Gold is heading a review of our processand procedures regarding compliance andbusiness ethics.

This year our Global Code of Conduct has

been ranked by the Red Flag Group as thirdamong those within the FTSE 100 companiesthat were assessed. Following the roll-outof our Global Code, dilemma-based ethicstraining has been deployed to allour employees to ensure continuingattention on this important topic. Trainingin ethics and compliance will continue in2015. All employees will be required tocertify annually that they have completedtheir training. We will be setting similarstandards for our supply chain through thepublication of our Supplier Code of Conduct.

Responding to the difficult circumstancesof 2014 has required fortitude and resiliencefrom the talented men and women whowork for Rolls-Royce. I would like to thankthem for their hard work and for theenthusiasm I encounter wherever in theCompany I travel. I am grateful to oursuppliers and partners who make such animportant contribution to Rolls-Royce andshare our commitment to continuousimprovement. I would like to thank ourcustomers who continue to place their faithin our technology. Meeting their currentand future needs is our highest priority.

This year we held our inaugural Trustedto Deliver Excellence Awards to recogniseRolls-Royce teams who have achievedoutstanding results for their customers.The imagination, passion and abilityto execute demonstrated by all the nalistsis inspiring. You can read more about theseawards on pages 42 to 43.

Returning our Group to protable growthwill demand rm resolve and commitmentand will take some time. However, as I havedescribed in this review, the businessfundamentals of Rolls-Royce remain sound,we have the right strategy and we are clearabout the action that is required. EverythingI know about this great Company makesme condent that the team will rise tothe challenge.

JOHN RISHTONChief Executive12 February 2015

Strategically,our two Divisionsaddress marketswhere long-term growthis assured and whereincreasingly sophisticatedengineering solutionswill be required.”

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ENGINEERING STRENGTH

Our 15,500* engineers, along with oursupply chain, commercialise and deploythe continuous stream of science developedby our university partners into technologythen products. Competitive technologycomes from combining great people, toolsand processes. These fundamental buildingblocks are used across our two Divisions,Aerospace and Land & Sea. We alsocontinually invest in new talent and in 2014we recruited 354 graduates (254 of whichwent into engineering) and 357 apprentices.Technical people are the lifeblood of theCompany. Our investment in technical andleadership training allows us to continuouslydevelop world-class professionals.

INNOVATIONWe have a track record over many yearsof creating new products and services andwe continue to strive to be leading edge ineverything we do. Innovation cannot be leftto chance. It needs to be encouraged,managed, selected and pulled through intoproducts and services. Harnessing the totalintellectual power of our people takesenthusiasm and eff ort. Our new InnovationPortal, Big Ideas Forums and OpenInnovation challenge have been successful

and each year we reward the most

innovative ideas at our Sir Henry Royce

Technology Awards. We look at innovationin terms of technology and services andalso in the way we conduct engineeringand manufacturing. This ensures thatwe continuously simplify and improveprocesses in order to be efficient andremove waste.

RESEARCH AND DEVELOPMENTThe strength of our current product portfolioresults from consistent and long-terminvestment in R&D and our ability to bringtechnology to industrial applications.In addition to our extensive in-housetechnology capability, we have partnershipswith world-leading universities in order tocreate new technology. We continuouslyinvest in our global network of 31 world-classUniversity Technology Centres (UTCs) wherewe build the foundation for the nextgeneration of products. These technologiesfeed into our demonstration programmes,where robust validation takes place beforeproceeding in a structured and controlledway into new production.

£1.2bnR&D INVESTMENT

DEMONSTRATOR PROGRAMMESDuring 2014, progress was made on ourmany new technologies, for example, thecarbon titanium fan has own for the rsttime this year in the advanced low-pressuresystems (ALPS) demonstrator, a modiedTrent. The composite fan system has beendeveloped with the help of four UTCs andve AMRCs and will off er over 750lbs ofweight saving on our future large engines.We have demonstrated a new mobile MTUgas engine which has been in developmentsince 2013. This high-speed gas engine off ersa fuel alternative whilst maintaining thelevel of performance expected from ourhigh-speed diesel engines. At our Dahlewitzsite in Germany, we are building a new testfacility for power gearboxes. Thesegearboxes will be used on the nextgeneration UltraFan engine and should off era 25% improvement in fuel efficiency whencompared to the Trent 700.

* total as at end of 2014

Our partnership in seven AdvancedManufacturing Research Centres (AMRCs)bridges the gap between research andindustrial application; providing facilitiesfor industrial partners and academics todevelop new manufacturing technology.

For example, innovative manufacturingtechniques developed in our AMRC inSheffield, UK, are now deployed in ourstate-of-the-art disc facility inWashington, UK.

OUR ‘VISION’ APPROACH

WE LOOK AT TECHNOLOGY ACQUISITIONOVER A , AND -YEAR HORIZON.

VISIONVision 5 describes near-term technologiesthat are ready to introduce into our products.For instance, this year we have successfullydemonstrated our low observabilitypropulsion and exhaust system integrationcapability on the BAE Systems Taranisunmanned aerial vehicle. On reciprocatingengines our dual-fuel injector design enablespre-mixed high pressure gas combustionand allows the operator to switch fromgas to liquid fuel during operation.

VISIONVision 10 describes leading-edge, validatedtechnologies for application in the ‘mediumterm’. Most of these are at demonstrationlevel today and will feature in the nextgeneration of products. For example, thelean burn combustion system for aero gasturbines has been in development for some

years and off ers a 60% reduction in thepollutant NOx and particulate matter (smoke)compared to year 2000 levels. It will reach

ight test in 2015 and is supportedby the European Clean Sky Programme.

VISIONVision 20 describes emerging, or as yetunproven, technologies which may beapplied across our product range in bothAerospace and Land & Sea. For example,we are developing concepts for autonomousships to reduce operating costs and radicallysimplify onboard facilities.

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MARKET OUTLOOK

AEROSPACE DIVISION

CIVIL AEROSPACEWe estimate that the global civil enginemarket will be worth approximatelyUS$1,900 billion over the next 20 years,with US$1,250 billion being for original

equipment (OE) and US$650 billion foraftermarket services. Over half of this valuecomprises engines for twin-aisle airlinersand large business jets.

DEFENCE AEROSPACEThe defence market opportunity over thenext 20 years is US$125-150 billion in OEand US$225-250 billion in services.

LAND & SEA DIVISION

POWER SYSTEMSWe estimate the off -highway reciprocatingengine markets we address off er anopportunity of £500 billion over the next20 years for OE. The total service-related

market will off er a potential of arounda third of that OE value, or £150 billion.

MARINEWe forecast a business opportunity(excluding reciprocating engines) acrossthe off shore, merchant and naval marketsegments over the next 20 years of£170 billion for OE and £80 billion forassociated services.

NUCLEARThe demand for mission-critical equipment,systems and engineering services forcivil nuclear could reach £220 billion overthe next 20 years, while the demand forassociated reactor support servicescould amount to £140 billion over thesame period.

The Group has identied markets where our skills andtechnology add value for our customers and deliver valuefor shareholders. As a long-term business we assess themarket potential over a 20-year horizon.

† Rounded to the nearest 100bn

Through the customer-facingbusinesses that make up our two

Divisions, we are delivering betterpower in the air, on land and at sea.

Our technology, skills and customerinsight position us to have the right

products and services today andfor the future.

Aerospace potential for OE and servicesover the next 20 years

US$2,300bn†

Land & Sea potentialfor OE and servicesover the next 20 years

£1,300bn†


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STRATEGY

We are a power systems company competing globally. We winin our chosen markets by focusing on, and connecting, threepowerful themes: customer, innovation and protable growth.

By focusing on our customersand offering them a competitiveportfolio of products and services,

we create the opportunity to growour market share. We have tomake sure that we are not justgrowing, but growing profitably.

That means ensuring our costsare competitive. We look afterour cash and we win right.

Placing the customer at the heartof our organisation is key. Welisten to our customers, share

ideas, really understand theirneeds and then relentlessly focuson delivering our promises.

This is our lifeblood. Wecontinually innovate to remaincompetitive. To drive innovation,

we create the right environment– curious, challenging, unafraidof failure, disciplined, open-minded and able to change with

pace. Most importantly, we ensureour innovation is relevant to ourcustomers’ needs.

CUSTOMER INNOVATION PROFITABLE GROWTH

PEOPLE

Our people are the key enabler of our strategy. We are committed torecruiting, developing and retaining the best and to creating a climate

for success. We are building a business-orientated, innovative andcost-conscious culture, where our people feel connected to the needsof our customers, the needs of our shareholders and the needs of ourbroader communities.

SEE PAGES TO FOR MORE INFORM ATION ON HOW SUSTAINABILITY PL AYS A PIVOTAL ROLE IN THEDELIVERY OF OUR STRATEGY

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We bring advanced technologyto market through integratedpower and propulsion systemsand services for use in the air,on land and at sea.Engineering excellence is a fundamental source of competitiveadvantage across the Group. Our methods, processes andexperience enable us to deliver complex, high-value programmes.Our ability to optimise and integrate entire systems is a corecompetence informed by a close understanding of customerneeds and decades of domain knowledge.

Addressing complementary markets from a shared capability andtechnology base brings breadth and scale, diversity and balance,enabling us to invest efficiently, and providing the resiliencerequired to off set new project risk. Our manufacturing modelis consistent across the Group; we only produce parts ourselveswhere we can create and sustain a competitive advantage.

The balance of our supply chain is built around close andlong-standing relationships with key partners and suppliers,a model that provides exibility of capacity and secures accessto world-class capability. Some partners, as well as supplyingparts, share in the risks and rewards of the whole programmefrom research and development to manufacture, through risk

and revenue sharing arrangements.

Services are an essential part of our business, building customerrelationships and providing revenue stability by moderating theeff ects of new equipment order cycles. Services off er strong growthpotential and the opportunity to align incentives through long-termservice contracts, providing visibility of costs to our customers andhelping us secure future revenues. This is particularly the casein Civil aerospace where contractual and air safety considerationsmean that we have rights that secure a large part of theaftermarket spare parts business even where we do not havea TotalCare® agreement.

The operation of our business model over decades has resultedin a substantial and growing installed base of engines at all stagesof the product life cycle. Cash ows today from investments made,in some cases many years ago, support investment for the future.We are focused on making this proven business model moreeff ective through relentless focus on costs to generate the fundsto sustain the investment necessary to remain competitive.

BUSINESS MODEL

Strategic Report


CONNECT TECHNOLOGYTO CUSTOMER NEEDS

Our deep understanding of customerneeds drives the development of newtechnologies and products.

ALLOCATE CAPITAL TONEW GROWTH

We operate a disciplined capital allocationprocess across the Group. We invest only

where we believe we can create andsustain a competitive advantage andachieve a good return for shareholders.

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SECURE AND MAXIMISESERVICE OPPORTUNITY

Our equipment is in service for decades.Our deep design knowledge and in-service

experience ensures that we are bestplaced to optimise product performanceand availability.

GROW MARKET SHAREAND INSTALLED BASE

Our substantial order book for bothoriginal equipment and services provides

good visibility of future revenues andprovides a rm foundation to investwith condence.

LAND & SEA

INVEST IN R&D ANDSKILLED PEOPLE

Developing and protecting leading-edgetechnology and deploying it across ourbusinesses allows us to compete on a globalbasis and creates high barriers to entry.

DESIGN AND MAKEWORLD-CLASS PRODUCTS

We diff erentiate on performance. We winand retain customers by developing anddelivering products that provide morecapability and off er better through-lifevalue than those of our competitors.

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Strategic Report

CHIEF FINANCIAL OFFICER’S REVIEW

This has clearly not been an easy year.However, the Group is fundamentally strong.We are in the enviable position of havinga £74 billion order book of products andservices that will deliver revenue for decadesto come. We operate in markets withexcellent long-term growth dynamics andhigh barriers to entry. We are valued by ourcustomers. Our innovative team is creatingproducts at the forefront of technology. Wehave set out rmly on the path to transformour industrial structure. Our objective nowis to translate these product successes,growth markets and internal transformationinto attractive returns and cash ow in the

medium term.

In 2014, we made good progress on ourbusiness transformation, delivering bothin-year improvements on our 4Cs such ascustomer delivery performance and creatingthe medium-term platform for improvingmargins and cash ow.

For example, in Aerospace we have reducedour aftermarket costs for our volume engine,the Trent 700, and also made good progresson our corporate jet and defence contracts.Over the past two years, the Group hasreduced indirect headcount by 18%. We alsosold our Energy gas turbines and compressorbusiness to Siemens on 1 December 2014.

As I reect on my new roleas Chief Financial Officerat Rolls-Royce, I would liketo underline the progresswe’ve made in 2014 andoutline my priorities for2015 and beyond.

DAVID SMITHChief Financial Officer


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accounting and technical skills, which arecritical in our complex business. I will beworking to deliver nancial and non-nancial KPIs that are more forward-lookingand have a greater focus on the businessfundamentals which are driving our cashand prot performance.

I will also be working to ensure that ourcommunications with shareholders areclear, consistent and helpful. As part of this,we have started to provide a medium-termoutlook and will continue to look atadditional ways to communicate moreclearly. Our share buyback programmeis already underway and will return to

We know we need to accelerate our eff ortson cost and cash. In November, weannounced a restructuring and costreduction plan that will deliver £80 millionin annualised savings and we will makefurther announcements at the appropriatetime. We will also look to reduce ourfacilities’ footprint, increase our activities

in lower-cost countries, pursue furtheraftermarket cost reductions and continueto make progress on inventory, investmentefficiency and cash management.

A personal priority is strengthening andstreamlining our nancial controls andbusiness information. We have excellent

SUMMARY

2014 2013 Change

Order book £m 73,674 71,612 +3%

Underlying* revenue £m 14,588 15,505 -6%

Underlying* profit before tax £m 1,617 1,759 -8%

Return on sales 11.5% 11.8% -0.3pp

Underlying* earnings per share 65.3p 65.6p -0.3p

Full year payment to shareholders 23.1p 22.0p +5%

Reported revenue† 13,736 14,642 -6%

Reported profit before tax† 67 1,700 -96%

Reported earnings per share† 3.7p 73.3p -69.6p

Net cash 666 1,939 -66%

Free cash flow £m 254 781 -67%

* Underlying explanation is in note 2 on page 110.† 2013 re-presented to reflect Energy as a discontinued operation.All figures in the narrative of the Strategic Report are underlying unless otherwise stated.

RETURN ONSALES (%)

10.7

12.0 11.811.5

2011 2012 2013 2014 2010 2011 2012 2013 2014

GROUP UNDERLYINGPROFIT BEFORETAXATION (£m)

955

1,157

1,434

1,759

1,617

2010 2011 2012 2013 2014

GROUP UNDERLYINGREVENUE (£m)

10,866 11,277

12,209

15,505

14,588

shareholders £1 billion in proceeds from

the sale of our Energy gas turbines andcompressor business.

Amid these changes there are certainfundamentals that we will continueto support. These include:• maintaining a strong balance sheet that

gives condence to our customers andenables our business to invest in futureprogrammes;

• continuing to rene our capital allocationprocesses and invest in R&D to developthe next generation of products; and

• managing risk prudently includinghedging our foreign currency exposuresto reduce volatility.

There’s no doubt that the recent changesin oil and commodity prices, currenciesand geopolitical strains have increaseduncertainty. We therefore need to plancautiously while accelerating our businessimprovement activity. In 2015, we expectunderlying revenue to be at overall andunderlying prot before tax to be downsomewhat, reecting the present phaseof our business transformation. We alsoexpect free cash ow to be lower givenour restructuring spend.

Looking ahead, our product portfoliotransition will see rising deliveries of newcivil engines that will signicantly increaseour installed base. We will also continue togrow our Land & Sea businesses. This andour investment in new technology andindustrial transformation will constrainnear-term margins and cash generation.However, as we move towards the mediumterm and this growth and investment phasemoderates, we expect both margins andcash conversion to improve in line with ourmedium-term guidance.

PAGES TO CONSOLIDATED FINANCIAL STATEMENTS

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FINANCIAL REVIEW

2014 has been a mixed year during which underlyingrevenue fell for therst time in a decade, reecting reducedspending by our defence customers, macro economicuncertainty and falling commodity prices.

GROUP UNDERLYING REVENUE

£14,588m

GROUP UNDERLYING PROFIT BEFORE

TAXATION

£1,617m

GROUP UNDERLYING INCOME STATEMENT

£ million 2014 2013 Change

Revenue 14,588 15,505 (917)

Profit before financing 1,678 1,831 (153)

Net financing (61) (72) 11

Profit before taxation 1,617 1,759 (142)

Taxation (387) (434) 47

Profit for the year 1,230 1,325 (95)Earnings per share (EPS) 65.31p 65.59p (0.28)

Payments to shareholders 23.1p 22.0p 1.1p

Gross R&D investment 1,249 1,118 131

Net R&D charge 755 624 131

Underlying prot before nancing andtaxation reduced 8% to £1.7 billion. Wesaw a negative impact from lower volumes,especially in Defence and Land & Sea,increased R&D investment (£140 million)and higher restructuring charges(£100 million), a one-off Marine charge(£30 million), and adverse FX (£49 million).These factors were off set by an improvedtrading margin which includedapproximately £150 million benet fromimproved retrospective TotalCare contractprotability (£110 million deteriorationin 2013), reecting lower cost, changingoperating patterns and reduced contractrisk. Trading margins in Defence also

Underlying revenue reduced £0.9 billionto £14.6 billion, a reduction of 6%, of which3% is due to adverse year-on-year foreignexchange (FX) rate movements. Theremaining reduction reects a 5% declinein original equipment (OE) revenue anda 1% decline in services revenue. Underlyingservices revenue continues to representaround half (48%) of the Group’s underlyingrevenue. Group services revenue includedincreases in Defence aerospace and PowerSystems partially off set by reductions in ourMarine, Nuclear and Energy businesses.

SEGMENTAL ANALYSIS

Revenue Profit before financing

£ million 2014 2013 Change 2014 2013 Change

Civil 6,837 6,655 182 942 844 98

Defence 2,069 2,591 (522) 366 438 (72)

Aerospace Division 8,906 9,246 (340) 1,308 1,282 26

Power Systems 2,720 2,831 (111) 253 294 (41)

Marine 1,709 2,037 (328) 138 233 (95)Nuclear 684 667 17 48 10 38

Intra-segment (155) (147) (8) (13) 2 (15)

Land & Sea Division (excluding Energy) 4,958 5,388 (430) 426 539 (113)

Energy 724 871 (147) (3) 64 (67)

Land & Sea Division 5,682 6,259 (577) 423 603 (180)

Central costs (53) (54) 1

Group (excluding Energy) 13,864 14,634 (770) 1,681 1,767 (86)

Group 14,588 15,505 (917) 1,678 1,831 (153)


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improved, driven by both cost reduction

action and an improved mix. In Land & Seawe incurred a loss at our Bergen subsidiary(£33 million), reecting weaker tradingperformance. Lower bonus and shareincentive costs resulted in a savingof £178 million.

PAGES TO FURTHER DISCUSSION OF TRADING IS INCLUDEDIN THE BUSINESS REVIEWS

Underlyingnancing costs reduced by 15%to £61 million reecting reduced nancialrisk and revenue sharing arrangements(RRSAs) liabilities and other improvements.

Underlying taxation of £387 millionrepresents an underlying tax rate of 23.9%,compared with 24.7% in 2013.

PAGE THE GROUP’S TAX PAYMENTS

Underlying EPS was marginally lowerat 65.31p, with the impact of the lowerunderlying prot after tax largely off setby the improvement in the underlying taxrate and a lower non-controlling interest inPower Systems, following Daimler’s exerciseof the put option in April 2014.

At the Annual General Meeting on 8 May

2015, the directors will recommend an issueof 141 C Shares with a total nominal valueof 14.1 pence for each ordinary share.Together with the interim issue on 2 January2015 of 90 C Shares for each ordinary sharewith a total nominal value of 9.0 pence, thisis the equivalent of a total annual paymentto ordinary shareholders of 23.1 pencefor each ordinary share. Further details areon page 162.

Net underlying R&D charged to the incomestatement increased by 21% to £755 million,reecting a combination of increasednet investment of £98 million and lowernet capitalisation of £21 million (dueto the phasing of major new programmes,in particular the certication of theTrent XWB-84) and £12 million lower netdeferral of RRSA entry fees — see page 115.The net investment spend represents 5.8%of Group underlying revenue, although it isexpected that this will reduce slightly in thefuture towards the longer-term target ofaround 5%. Our gross R&D expenditure of£1.2 billion includes funded programmes.

23.1p payment to shareholders

REPORTED PROFIT BEFORE TAX

Consistent with IFRS and past practice,the Group provides both reported andunderlying gures. We believe underlyinggures are more representative of thetrading performance, by excluding theimpact of year-end mark-to-marketadjustments, principally the GBP:USD hedgebook. In addition, post-retirement nancingand the eff ects of acquisition accounting areexcluded. The adjustments between theunderlying income statement and thereported income statement are set out in

more detail in note 2 to the FinancialStatements. This basis of presentation hasbeen applied consistently.

The mark-to-market adjustments areprincipally driven by movements in theGBP:USD exchange rate which moved from1.65 to 1.56 during 2014.

Movement on other nancial instruments primarily relate to the change in value ofthe put option on the Power Systemsnon-controlling interest, which has nowbeen exercised.

The eff ects of acquisition accounting in accordance with IFRS 3 are excludedfrom underlying prot so that all businessesare measured on an equivalent basis.

Costs associated with the substantial closureor exit of a site, facility or activity areclassied as exceptional restructuring andexcluded.

Prots and losses arising on acquisitions

and disposals during the year are excluded.

Net nancing on post-retirement schemes is excluded from underlying prot and, in2013, the cost of providing a discretionaryincrease to pensions was also excluded.

Appropriate tax rates are applied to theseadjustments, the net eff ect of which was

PROFIT BEFORE TAXATION

£ million 2014 2013

Underlying 1,617 1,759

Mark-to-market adjustments on derivatives (1,254) 217

Movements on other financial instruments (87) (251)

Effect of acquisition accounting (142) (265)

Exceptional restructuring (39) –

Acquisitions and disposals 8 335

Post-retirement schemes (29) (90)

Other (including discontinued operations) (7) (5)

Reported (2013 restated to exclude discontinued operations) 67 1,700

UNDERLYINGREVENUE(£m)

10,86611,277

12,209

14,58815,505

2010 2011 2012 2013 2014

UNDERLYING PROFITBEFORE TAXATION(£m)

955

1,157

1,434

1,617

1,759

2010 2011 2012 2013 2014

NET R&D AS APROPORTION OF REVENUE(%)

4.7 4.6 4.7 4.8

5.8

2010 2011 2012 2013 2014

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FINANCIAL REVIEWCONTINUED

The Groupcontinues to maintaina strong balance sheet,providing reassuranceto our customers.”

a £239 million reduction in the reported taxcharge (2013 £54 million reduction). Theadjustment includes a £64 million reductionin the value of recoverable advancecorporation tax recognised. A reconciliationof the tax charge is included in note 5.

BALANCE SHEETIntangible assets (note 9) representlong-term assets of the Group. These assetsdecreased by £77 million with additionaldevelopment, contractual aftermarket rights,certication and software costs being morethan off set by annual amortisation charges.

The carrying values of the intangible assetsare assessed for impairment against thepresent value of forecast cash owsgenerated by the intangible asset. Theprincipal risks remain: reductions in assumedmarket share; programme timings; increasesin unit cost assumptions; and adverse

movements in discount rates. There havebeen no signicant impairments in 2014.

Property, plant and equipment (note 10)increased by £241 million due to theongoing development and refreshment offacilities and tooling as the Group prepares

for increased production volumes.

Investments in joint ventures and associates(note 11) remain stable as the share ofretained prot was off set by dividendsreceived.

Provisions (note 18) largely relate towarranties and guarantees provided tosecure the sale of OE and services. Theincrease is largely a result of the recognitionof restructuring costs.

Net post-retirement scheme surpluses/(decits) (note 19) increased by£1,348 million, principally due to relativemovements in the yield curves used to valuethe underlying assets and liabilities inaccordance with IAS 19. In addition, thescheme rules on the largest UK schemewere amended during the year, resultingin the surplus being recognised(£544 million impact).

The Group’s principal pension schemesadopt a low risk investment strategy that

reduces volatility going forward and enablesthe funding position to remain stable:interest rate and ination risks are largelyhedged and the exposure to equities isaround 8% of scheme assets.

Net nancial assets and liabilities (note 17)

include the fair value of derivatives, nancialRRSAs, the put option on the non-controllinginterest of Power Systems and C Shares. Thereduction primarily reects the settlementof the put option (£1,937 million) off setby a reduction in value of the foreignexchange derivatives (£1,137 million) dueto the strengthening of the US dollar.

The USD hedge book increased by 4% toUS$25.6 billion. This represents around fourand a half years of net exposure and has anaverage book rate of £1 to US$1.61.

Net TotalCare assets relate to long-termservice agreement (LTSA) contracts (andwhere appropriate the linked OE contract)in the Civil aerospace business, includingthe agship services product TotalCare.These assets represent the timing diff erencebetween the recognition of income andcosts in the income statement and cashreceipts and payments. The increaselargely reects high levels of linked Trent 700and increasing Trent 1000 engine sales inthe year.

SUMMARY BALANCE SHEET

£ million 2014 Other changesEnergy disposal

(note 25) 2013

Intangible assets 4,804 (77) (106) 4,987

Property, plant and equipment 3,446 241 (187) 3,392

Joint ventures and associates 539 (6) (56) 601

Net working capital (1,134) 229 (393) (970)

Net funds 666 (1,269) (4) 1,939

Provisions (807) (108) 34 (733)

Net post-retirement scheme surpluses/(deficits) 555 1,348 – (793)

Net financial assets and liabilities (855) 732 – (1,587)

Other net assets and liabilities (827) (294) – (533)

Net assets 6,387 796 (712) 6,303

Other items

USD hedge book US$ billion 25.6 24.7

TotalCare assets 2,492 1,901TotalCare liabilities (2013 includes £245m not previously included) (687) (559)

Net TotalCare assets 1,805 1,342

Customer financing contingent commitments:

Gross 388 356

Net 59 59


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Customer nancing facilitates the sale

of OE and services by providing nancingsupport to certain customers. Where suchsupport is provided by the Group, it is almostexclusively to customers of the Civilaerospace business and takes the formof various types of credit and asset valueguarantees. These exposures producecontingent liabilities that are outlined innote 18. The contingent liabilities representthe maximum aggregate discounted grossand net exposure in respect of deliveredaircraft, regardless of the point in time atwhich such exposures may arise.

During 2014, the Group’s gross exposure ondelivered aircraft increased by £32 million,due largely to the strengthening of the USdollar. On a net basis, exposures remainedunchanged with a small reduction beingoff set by the exchange rate movement.

FUNDS FLOWMovement in working capital – the increasereects the growth of the net TotalCare assetoff set by a reduction in the amount ofcustomer deposits. This increase comparesto a modest decrease in the previous yearwhich is primarily a result of the phasingof customer deposit utilisation.

SUMMARY FUNDS FLOW

£ million 2014 2013 Change

Opening net funds 1,939 1,317

Closing net funds 666 1,939

Change in net funds (1,273) 622

Underlying profit before tax 1,617 1,759 (142)

Depreciation and amortisation 600 608 (8)

Movement in net working capital (509) 91 (600)

Expenditure on property, plant and equipment and intangible assets (1,114) (1,172) 58

Other 88 (231) 319

Trading cash flow 682 1,055 (373)

Contributions to defined benefit post-retirement schemes in excess of PBT charge (152) (36) (116)Tax (276) (238) (38)

Free cash flow 254 781 (527)

Shareholder payments (482) (417) (65)

Share buyback (69) – (69)

Acquisitions and disposals (965) 265 (1,230)

Net funds of businesses acquired (30) 36 (66)

Foreign exchange 19 (43) 62

Change in net funds (1,273) 622

Average net funds (38) 350 (388)

FREE CASH FLOW(£m)

714

581548

254

2010 2011 2012 2013 2014

781

Expenditure on property, plant and

equipment and intangibles – the decreasereects a reduction in additions to property,plant and equipment (£32 million),participation fees and certication costs(£26 million) and software and otherintangible assets (£41 million), off set byincreased expenditure on contractualaftermarket rights (£41 million).

Pensions – contributions to denedbenet pension schemes in 2014 included£33 million to UK schemes to fund thediscretionary increases agreed in 2013.The service cost included a past-servicecredit of £31 million – largely relatingto restructuring (2013 past-service cost£71 million – largely relating to thediscretionary increases above), whichis the main reason for the £116 millionincrease in the cash contributions in excessof the PBT charge.

The Group’s funding of its dened benetschemes is expected to reduce by around30% in 2015, as a result of decit fundingrequirements ending and thenon-recurrence of the payment fordiscretionary increases.

Shareholder payments – the increasereects the C Share issues in 2014(£51 million increase) and thePower Systems dividend to Daimler(£14 million increase).

Acquisitions and disposals include thepayment of £2,013 million (includingthe fair value of derivatives held to hedgethe cost) for the additional 50% of PowerSystems off set by £1,027 million ofnet proceeds from the disposal of theEnergy business.

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CIVIL AEROSPACE

DEFENCE AEROSPACE

CIVIL UNDERLYING

REVENUE MIX

■ OE revenue 48%

■ Services revenue 52%

CIVIL UNDERLYING

REVENUE BY SECTOR

■ Widebody 61%

■ Corporate & regional39%

CIVIL

Underlying revenue (£m)

4,9195,572

6,437 6,655

2010

6,837

2011 2012 2013 2014

DEFENCE UNDERLYING

REVENUE MIX

■ OE revenue 35%

■ Services revenue 61%

■ Development 4%

DEFENCE UNDERLYING

REVENUE BY SECTOR

■ Combat 39%

■ Transport 51%

■ UAV/trainer 10%

DEFENCE

Underlying revenue (£m)

2,123 2,235 2,417

2,591

2010

2,069

2011 2012 2013 2014

KEY HIGHLIGHTS

• First Trent XWB delivered and Trent XWB-97 version on test• Trent 7000 chosen to power new Airbus A330neo

• Latest Trent 1000 entered service on Boeing 787-9and Trent 1000-TEN on test• BR725 selected for Gulfstream G650ER and AE 3007C2

entered service on Cessna Citation X+

KEY HIGHLIGHTS

• Lockheed Martin agreement signed for 600 AE 2100 engines• A330 MRTT now fully operational in UK and selected by

France and Singapore• A400M transporter deliveries continue• Business resizing to reduce costs and improve

competitiveness is progressing

23,900 Employees

7,000 Employees

BUSINESS REVIEW – AEROSPACE

As a leading manufacturer

of aero engines for the civillarge aircraft, corporate jetand defence markets, thegrowing global requirementfor cleaner, more efficient,better power, continues tocreate opportunities for ourAerospace Division.

TONY WOODPresident – Aerospace

Within the civil market we continue to see

increasing numbers of people travellingby air. The International Air TransportAssociation (IATA) reported that availableseat kilometres (a measure of civil air traffic)grew by nearly 6% in 2014 and the long-termgrowth outlook remains at around 5% perannum for the foreseeable future.

In the defence market, despite ongoingpressure on budgets, aviation remains avital component of defence forces aroundthe world and we secured several importantnew orders during the year.

In 2014, our engines powered the rstdeliveries of two new airliners; one for eachof our major airframe customers, Airbusand Boeing. We launched the seventhmember of our Trent engine family, achievedmajor milestones for existing Trent engine

OVERVIEW


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programmes and made important

announcements about civil enginetechnologies for the future.

Business jet owners and operators continueto seek greater speed, range and the highestlevels of service. 2014 saw Rolls-Royceselected by Gulfstream for a new ultra-longrange business jet and we powered a newversion of the fastest civilian aircraft in theworld into service for Cessna. We continueto invest for the next generation of largebusiness jet engines.

Our defence customers are focused onextending the lives and improving theefficiency of their in-service aircraft.Rolls-Royce is helping air forces to do morewith less by delivering new or improvedengines and services. Looking to the future,we see opportunities to power new

programmes, such as the Korean K-FX

combat aircraft and the Anglo-French FutureCombat Air System.

We continue to focus on reducing coststo support our strategy of customer,innovation and protable growth. Theinvestments we have made in newtechnology and capacity will enable usto increase output and improve efficiency.Delay in a number of customer programmesdid result in some capacity being readyearlier than needed, however theseprogrammes are now coming on stream. InJune, we opened a new facilityin Washington, UK, specialising in advancedmanufacturing techniques and roboticswhich will halve the time to manufacturefan and turbine discs. We are acceleratingour plans to consolidate older facilities andtransition to newer ones. Towards the end

of the year we announced a programme to

further improve operational efficiency andreduce costs across the Aerospace Divisionover the next 18 months.

Although revenue remained broadly atthrough 2014 due to current marketconditions and lower defence spending,our cost reduction actions have yieldedbenets during the year and laid thefoundations required to support mid-termmargin improvement for the Division.

CIVIL AEROSPACE

PERFORMANCE REVIEW

WHO WE ARE

The Civil aerospace business is a majormanufacturer of aero engines for thecommercial large aircraft and corporate jetmarkets. We power 35 types of commercialaircraft and have more than 13,000 enginesin service around the world.

FINANCIAL REVIEW

The Civil order book increased 5%. Our netorder intake was £11.7 billion. Aftermarketservices now constitute 31% of the Civil

order book.

Underlying revenue grew 3% (up 4% atconstant foreign exchange), on 8% growthin OE that was partially off set by a 1%decline in services. OE growth was primarilydriven by a ramp up in Trent 1000 engineproduction. This was partially off set bya 9% reduction in business jet enginedeliveries. The decline in serv ices reectsthe expected 24% decline in the RB211programme. Aftermarket revenue fromour Trent eet increased 6%.

Underlying prot improved by 12%,driven by higher volumes and improvedaftermarket margins. Prot beneted fromapproximately £150 million in improvedretrospective TotalCare contractprotability, reecting lower cost, changingoperating patterns and reduced contractrisk. Prot also beneted from lowercommercial and administrative (C&A)and bonus costs. This was partially off setby £63 million in higher restructuringcosts and £151 million in higher R&D costs.

England 18

Germany 3

Scotland 2

Singapore 2

Multiple Aerospace locations:

Key

Aerospace locations

Corporate locations Aerospace and Corporate

AEROSPACE LOCATIONS

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Dahlewitz, Germany, representing an

investment of €65 million. An additionaltest bed for future extra-large engines ofup to 150,000lbs thrust was also openedin Dahlewitz in November. We maintainedour leading position in the business jetmarket. Our BR725 was selected to powerGulfstream’s new ultra-long-range business

jet, the G650ER. The year also saw the entryinto service of the world’s fastest civilianaircraft, the AE 3007C2-powered Citation X+.

To support operators of Rolls-Royce poweredbusiness jets we continued to expand ourglobal network of authorised servicecentres. The number of engines poweringcorporate aircraft covered by ourCorporateCare® programme reached morethan 1,600. The level of TotalCare coveragein the commercial transport installed enginebase increased to 83% this year and 210incremental corporate jets were signedup to our CorporateCare programme.

LOOKING AHEAD

In support of our future growth strategy,we will make investments that enable usto deliver our signicant order book anddevelop the next generation of civil engineswith new technologies, advanced

manufacturing techniques and moreefficient processes.

We will develop TotalCare in line withchanging market requirements for ser

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