|As a result of our robust business model, strong and maturing
product portfolio and reducing cost base, we believe that the Group
is capable of achieving a ten per cent return on sales across all
our businesses, as measured by earnings before interest and tax
We have started to move forward again, having stabilised the
business after the events of September 11, 2001. Overall
profitability improved during the year and debt levels reduced.
Results for the year
Underlying profit before tax* increased by 12 per cent to £285
million (2002 £255 million), and underlying earnings per share*
were 12.20p (2002 11.10p). Basic earnings per share were 7.04p
* excluding exceptional and non-trading items, defined in note 2.
Sales reduced by £143 million:
The Group is increasingly broadening its business base with engine
deliveries in civil aerospace now accounting for only 20 per cent
of turnover. Group aftermarket services revenues grew by 12 per
cent to £2.8 billion and accounted for 50 per cent of total
revenues. Aftermarket revenues have grown by ten per cent per annum
compound over the last five years.
- Civil aerospace engine deliveries declined by 13 per cent to
746 engines. Civil aftermarket sales grew by 15 per cent.
- Defence turnover reduced as a result of the disposal of Vickers
Defence Systems (VDS), in the fourth quarter of 2002, which
contributed sales of £70 million in 2002.
- Marine sales were down a little, reflecting the slowing down of
the offshore oil and gas support market sector, partially offset by
growth in the naval sector.
- Energy sales fell by nine per cent, reflecting the depressed
power generation market.
The Group reinforced its position as a global business, with 82 per
cent of sales to customers outside the UK.
Gross margin, before exceptional items, increased from 16.3 per
cent to 17.3 per cent, despite the continuing difficult trading
conditions in the civil aerospace sector. Margins benefited from
continuing growth in aftermarket sales and our substantial
The net interest charge reduced from £107 million to £90 million.
This reflected a reduction in the level of average net debt, which
was achieved through the Group’s continuing focus on cash
Group interest was covered 4.9 times, based upon underlying profit
before interest, excluding joint ventures.
The Group completed the restructuring programme announced in 2001
without industrial disruption. At the end of 2003, the number of
employees was 35,200, representing a net reduction of 2,100 during
the year. The Group is on target to achieve annual cost savings of
£270 million from this restructuring exercise. Following the
completion of this major programme, future restructuring will be in
the nature of ongoing operational improvements and charges in this
respect will be included within operating costs.
The Group made an underlying profit before tax of £285 million
(2002 £255 million). After charging exceptional and non-trading
items, profit before tax was £180 million (2002 £105 million).
Net working capital as a percentage of sales, was 6.8 per cent
(2002 6.8 per cent).
An interim dividend of 3.18p was declared with the half year
results in July 2003. The company will announce proposals to issue
B Shares in place of dividends in order to accelerate the recovery
of its advanced corporation tax. Conditional upon approval by
shareholders, a final payment of 5.00p will be paid in the form of
B Shares (see Report of the
directors) resulting in a total payment to shareholders
including B Shares of 8.18p (2002 8.18p).
Included within underlying earnings were a number of charges:
- In the civil aerospace sector, charges against the profit and
loss account in respect of aircraft values and an increase in the
customer financing provision, amounted to £73 million.
- In the financial services sector, restructuring charges of £15
million were taken against international power projects.
During the year Rolls-Royce Group plc was introduced
as the new holding company of the Rolls-Royce Group by
way of a ‘Scheme of Arrangement’. In addition a capital reduction
was undertaken (see note
The order book was £17.4 billion (2002 £16.2 billion). Items are
included in the order book when a signed contract exists.
In civil aerospace it is common for a customer to take options for
future orders in addition to firm orders placed. Such options are
excluded from the order book until they become firm, signed orders.
In defence aerospace, long-term programmes are often ordered for
only one year at a time. In such circumstances, even though there
may be no alternative engine choice available to the customer, only
the contracted business is included in the order book.
Long-term service agreements, including TotalCare packages for
aftermarket services, represented 27 per cent of the order book.
These are long-term contracts where only the first seven years’
revenue is included in the order book.
Business which has been announced but for which contracts have not
yet been signed is excluded from the order book. This amounted to a
further £1.3 billion at the year-end (2002 £0.9 billion).
The Group has been successful in developing its aftermarket
services activities. These accounted for 50 per cent of turnover in
Particular success has been achieved in the development of
TotalCare packages, which cover 45 per cent of flying hours for
engines delivered during the year. TotalCare packages cover
long-term support for customers’ engines, including contracts where
the engine maintenance agreement is linked to, and entered into, at
the same time as the original equipment sale. Sale of spare parts,
support activities and, where relevant, the original equipment sale
will form part of the same long-term contract. The pricing of such
contracts differs from conventional engine sales and support and
reflects the long-term nature of the contract. Profit is taken
progressively on a prudent basis resulting in a net asset of £454
million on the balance sheet.
See the Group cash flow
Net debt for the year reduced by £272 million, to £323 million
(2002 £595 million). The average net debt level reduced from £1,090
million to £950 million.
The average net debt is expected to reduce further in 2004.
Net cash flow from operating activities was £753 million (2002 £778
million), before £80 million which was expended on restructuring
activities. Capital expenditure used £196 million of funds
The overall tax charge on the profit before tax was £64 million
(2002 £52 million), a rate of 35 per cent (2002 50 per cent). This
is higher than the UK tax rate, primarily due to the impact of
goodwill charged against profits for which no tax relief is
The tax charge was reduced by £12 million (2002 £6 million) in
respect of the expected benefit of the UK research and development
tax credit that was introduced with effect from April 1, 2002.
The tax charge on underlying profits was £84 million (2002 £76
million), a rate of 29 per cent (2002 30 per cent).
Acquisitions and disposals
During the year the Group acquired VT Controls, made a number of
disposals of small businesses, and reached agreement on the
completion accounts for the 2002 disposal of Vickers Defence
Systems (see notes 31
For 2003, the charges for pensions costs continue to be calculated
under SSAP 24 and are disclosed in note 30. Although the full
implementation of FRS 17 (Post Retirement Benefits) has been
deferred pending the introduction of International Financial
Reporting Standards, certain disclosures are required, including
the value of pension scheme assets and liabilities using the new
rules specified by FRS 17 (see note 30). Under this
standard a snapshot is taken of pension fund assets and liabilities
at a specific point in time, thus movements in equity markets and
discount rates will create volatility in their calculation.
Additionally FRS 17 requires a memorandum analysis of the profit
and loss charge.
On this basis and after taking account of deferred taxation, there
was a net shortfall of assets over liabilities for the UK Schemes
of £855 million (2002 £1,117 million). Although this deficit takes
into account the revised benefits relating to the
Rolls-Royce Pension Fund, it continues to be
materially impacted by prevailing equity markets and discount
The other two Rolls-Royce pension funds are together
around one third the size of the Rolls-Royce Pension
Fund. The Vickers Group Pension Scheme and the
Rolls-Royce Group Pension Scheme are due for actuarial
reviews in March 2004 and April 2004 respectively.
The Group continues to subject all investments to rigorous
examination of risks and future cash flows to ensure that they
create shareholder value. All major investments require Board
The Group has a portfolio of projects at different stages of their
life cycles. Discounted cash flow analysis of the remaining life of
projects is performed on a regular basis. Sales of engines in
production are assessed against criteria in the original
development programme to ensure that overall value is enhanced.
Gross research and development investment amounted to £619 million
(2002 £590 million). Net research and development was £281 million
(2002 £297 million). Investment in training was £29 million (2002
Capital expenditure, was £186 million (2002 £344 million).
The development of effective partnerships continues to be a key
feature of the Group’s long-term strategy. Major partnerships are
of two types: joint ventures and Risk and Revenue Sharing Partners
Joint ventures are an integral part of our business. They are
involved in engineering and manufacturing, repair and overhaul, and
financial services. They share risk and investment, bring expertise
and access to markets, and provide external objectivity. Our joint
ventures have become substantial businesses. A major proportion of
the debt of the joint ventures is secured on the assets of the
respective companies and is non-recourse to the Group. The recourse
financing obligations total £39 million and are included in
contingent liabilities (see note 28).
Pembroke, the Group’s aircraft leasing and management joint venture
is not regarded as core to the Group’s strategy and, as markets
permit, the Group will be seeking to extract value from this
Investment in the engine leasing joint venture,
Rolls-Royce & Partners Finance, a core business
activity, amounts to £21 million and all of its debt is
non-recourse to the Group.
Risk and Revenue Sharing Partners
RRSPs have enabled the Group to build a broad portfolio of engines,
thereby reducing the exposure of the business to individual product
risk. The primary financial benefit is a reduction of the burden of
research and development (R&D) expenditure on new programmes.
The related R&D expenditure is expensed through the profit and
loss account and the receipts from partners are also recorded in
the profit and loss account, as other operating income.
RRSP agreements are a standard form of cooperation in the civil
aero-engine industry. They bring benefits to the engine
manufacturer and the partner. For the manufacturer they bring some
or all of the following benefits: additional financial and
engineering resource; sharing of risk; and initial programme
investment contribution. As appropriate, the partner supplies
components free of charge and subsequently receives a share of the
long-term revenues generated by the engine programme in proportion
to its purchased programme share.
The sharing of risk is fundamental to RRSP agreements. In general,
partners share financial investment in the programme; they share
market risk as they receive their return from future sales; they
share currency risk as their returns are denominated in US dollars;
they share sales financing obligations; they share warranty costs;
and, where they are manufacturing or development partners, they
share technical and cost risk.
All receipts from RRSPs are recorded as ‘other operating income’.
In 2003 other operating income in respect of RRSP agreements
amounted to £153 million (2002 £158 million).
Payments to RRSPs are recorded within cost of sales and will
increase as the related programme sales increase. These amounted to
£179 million (2002 £139 million).
The Group carried forward £863 million of intangible assets,
including purchased goodwill of £759 million, engine certification
costs carried forward amounted to £61 million and application
engineering costs carried forward amounted to £43 million.
The Board has an established structured approach to risk
management. The risk committee (see Report of the
directors) has accountability for the system of risk management
and reporting the key risks and associated mitigating actions. The
Director of Risk reports to the Finance Director. The Group’s
policy is to preserve the resources upon which its continuing
reputation, viability and profitability are built, in order to
enable the corporate objectives to be achieved through the
operation of the Rolls-Royce business processes. Risks
are formally identified and recorded in a corporate risk register,
which is reviewed and updated on a regular basis, with risk
mitigation plans identified for all significant risks.
Financial risk management
The Group uses various financial instruments in order to manage the
exposures that arise from its business operations as a result of
movements in financial markets. All treasury activities are focused
on the management and hedging of risk. It is the Group policy not
to trade financial instruments or to engage in speculative
financial transactions. There have been no significant changes in
the Group’s policies in the last year.
The principal economic and market risks continue to be movements in
foreign currency exchange rates, interest rates and commodity
prices. The Board regularly reviews the Group’s exposures and risk
management and a specialist committee also considers these in
detail. All such exposures are managed by the Group Treasury
function, which reports to the Finance Director and which operates
within written policies approved by the Board and within the
internal control framework described in the report of the directors.
The Group’s policy is to monitor and manage its exposure to
counterparties. Credit limits are set to cover all financial
instruments for each counterparty. The Group’s policy is that where
exposure is only linked to the credit quality of the counterparty,
the related long-term credit rating should be A3/A or better.
Funding and liquidity risk
The Group finances its operations through a mixture of
shareholders’ funds, bank borrowings, bonds, notes and finance
leases. The Group borrows in the major global markets in a range of
currencies. It employs derivatives where appropriate to generate
the desired currency and interest rate profile.
During 2003 the Group, through the normal course of business,
refinanced £380 million of borrowing facilities in a number of
currencies and a range of maturities. As at December 31, 2003 the
Group had total committed borrowing facilities of £2.2 billion.
The terms for the recently completed refinancings are substantially
similar to the Group’s previous facilities.
There are no rating triggers contained in any of the Group’s
facilities that could require the Group to accelerate or repay any
facility for a given movement in the Group’s credit rating and no
material impact on the Group’s interest charge is expected to arise
from a movement in the Group’s credit rating.
The Group holds financial investments and maintains undrawn
committed facilities at a level sufficient to ensure the Group has
available funds to meet its medium-term capital and funding
obligations and to meet any unforeseen obligations and
opportunities. The Group from time to time holds cash and
short-term investments which, together with the undrawn committed
facilities, enable the Group to manage its liquidity risk.
The Group is exposed to movements in exchange rates for both
foreign currency transactions and the translation of net assets and
profit and loss accounts of foreign subsidiaries.
The Group regards its interests in overseas subsidiary companies as
long-term investments. Consequently, it does not normally hedge the
translation effect of exchange rate movements on the profit and
loss account for these businesses.
The Group is exposed to a number of foreign currencies. The most
significant transactional currency exposure is the US dollar
followed by the Euro. US dollar income, net of expenditure
represents 23 per cent of Group turnover.
The Group operates a hedging policy using a variety of financial
instruments with the objective of minimising the impact of
fluctuations in exchange rates on future transactions and cash
The permitted range of the amount of cover taken is determined by
the written policies set by the Board, based on known and forecast
income levels. The forward cover is managed within the parameters
of these policies in order to achieve the Group’s objectives,
having regard to the Group’s view of long-term exchange rates.
Forward cover extends for periods of up to eight years and is in
the form of standard foreign exchange contracts and instruments on
which the exchange rates achieved may be dependent on future
interest rates. The Group also writes currency options against a
portion of the unhedged dollar income at a rate which is consistent
with the Group’s long-term target rate. The premium received from
the sale of the options is included in the Group’s achieved
exchange rate. Total US dollar cover approximated to four and a
half years’ net US dollar income at December 31, 2003 (2002 five
The consequence of this policy has been to maintain a relatively
stable long-term foreign exchange rate. Note 24, financial
instruments, includes the impact of revaluing forward currency
contracts at market values on December 31, 2003, showing an
increase in value of £724 million. This figure, which for 2002 was
an increase in value of £151 million, will fluctuate with exchange
rates over time. The Group has entered into these forward contracts
as part of the hedging policy, described above, in order to
mitigate the impact of volatile exchange rates.
Interest rate risk
The Group uses fixed rate bonds and floating rate debt as funding
sources. The Group’s policy is to maintain a higher proportion of
net debt at fixed rates of interest having regard to the prevailing
interest rate outlook. To implement this policy the Group utilises
a combination of interest rate swaps, forward rate agreements and
interest caps to manage the exposure.
The Group has an ongoing exposure to the price of jet fuel arising
from business operations. The Group’s objective is to minimise the
impact of price fluctuations. The exposure is hedged in accordance
with parameters contained in a written policy set by the Board.
Hedging is conducted using commodity swaps that extend for periods
of up to four years.
In connection with the sale of its products, the Group will, on
some occasions, provide financing support for its customers. This
may involve the Group guaranteeing financing for customers,
providing asset value guarantees on aircraft for a proportion of
their expected future value, or entering into leasing transactions.
The Group manages and monitors its sales finance related exposures
to customers and products within written policies approved by the
Board and within the internal framework described in the report of
the directors. The permitted levels of gross and net exposure are
limited in aggregate by counterparty, by product type and by
The Board regularly reviews the Group’s sales finance related
exposures and risk management activities. Each financing commitment
is subject to a credit and asset review process and prior approval
by the Chief Executive, and Finance Director. The Group operates a
sophisticated risk-pricing model to assess risk and exposure. Costs
and exposures associated with providing financing support are
incorporated in any decision to secure new business.
The Group’s exposure management process falls into three phases:
Each of the above forms an active part of the Group’s exposure
- minimising the level of exposure that is assumed by the Group
from sales finance commitments through the use of third party
non-recourse debt where appropriate or through other
- reducing the level of exposure that has been assumed by the
Group through the transfer, sale, or re-insurance of risks;
- ensuring the proportionate flow down of risk and exposure to
relevant Risk and Revenue Sharing Partners (RRSPs).
Where exposures arise, the strategy has been, and continues to be,
to assume where possible liquid forms of financing commitment that
may be sold or transferred to third parties when the opportunity
Note 28 to the accounts
describes the Group’s contingent liabilities under sales financing
The gross contingent liability reduced slightly to £1,090 million
(2002 £1,093 million), of which £39 million (2002 £35 million)
related to sales financing support provided to joint ventures. The
gross contingent liability figure is calculated by aggregating the
maximum exposure on all such sales financing commitments, before
applying the value of the underlying security, but offsetting sums
separately insured and sums provided for in the balance sheet. In
2003 provisions against customer financing exposures were increased
by £38 million and £10 million of existing provisions were
utilised. Provisions of £92 million were carried forward in respect
of sales financing commitments (see note 22).
The Group’s contingent liabilities are divided approximately 60:40
between asset value guarantees (AVGs) and credit guarantees. They
spread over many years and relate to a number of customers and a
broad product portfolio. The contingent liabilities represent the
maximum aggregate gross and net exposure that the Group has in
respect of delivered aircraft, regardless of the point in time at
which such exposures may arise. Exposures are not reduced to a net
present value for the purposes of reporting the Group’s contingent
The Group uses Airclaims Limited as an independent appraiser to
value its security portfolio at both the half-year and year-end.
Airclaims provides specific values (both current and forecast
future values) for each asset in the security portfolio. These
values are then used to assess the Group’s net exposure. They
incorporate Airclaims’ assessment of aircraft values.
After taking account of the underlying security, the Group’s net
contingent liability reduced slightly to £184 million (2002 £186
million). The year on year movement in reported contingent
liabilities reflects the utilisation of sales finance commitments
in the last year, the attrition of existing contingent liabilities
through natural debt retirement or risk transfer, and, additionally
in the case of net contingent liabilities, the changes in the
level, form, and value of any underlying security.
In reporting the Group’s contingent liability with respect to sales
financing, the Group includes a net exposure stress test which
incorporates the impact of a 20 per cent fall in the value of all
securities compared to the Airclaims current and future values.
Application of this stress test results in a net contingent
liability of £262 million (2002 £251 million).
The directors regard the possibility that there will be any
significant loss arising from these contingencies as remote.
AVGs require a period of notice to be given before they can be
exercised. No such notice has been received that would enable AVGs
to crystallise in 2004. The Group took charges and made prudent
provisions against credit exposures in 2003.
International Financial Reporting Standards
All European Union listed companies are required to adopt
International Financial Reporting Standards (IFRS) for their
financial statements from 2005, which will include comparative
information for 2004. The Group has been undertaking a detailed
assessment of the impact of IFRS on its published financial
statements. Although these standards are themselves evolving and
undergoing improvement, the review has identified that the key
areas of impact include: the mark-to-market of financial
instruments; the requirement to capitalise a portion of research
and development expenditure; and the accounting treatment for
defined benefit pension schemes.
As noted earlier, a significant element of the Group’s trading is
denominated in US dollars. In order to protect itself from the
associated currency volatility, the Group takes significant levels
of forward cover, which approximates to four and a half years’ net
US dollar income. Currently, gains or losses arising on these
forward exchange contracts are taken to the profit and loss account
in the same period as the underlying transaction.
IAS 39 (Financial instruments) requires all hedges to be strictly
designated against specific income and the hedge effectiveness
tested. All such instruments are required to be revalued to market
values at the balance sheet date. If the hedging criteria are not
achieved, then the change in value is taken to the profit and loss
As contracts may be signed several years in advance of delivery,
the delivery dates and hence payment dates on contracts may, and
frequently do, change. Thus meeting the strict hedging criteria for
all contracts may not be practicable, resulting in potential
volatility in the reported profit and loss account and balance
sheet. In assessing the adoption of IAS 39, the Group has no plans
to amend the underlying policy for the economic hedging of its
The Group’s expenditure on self-funded research and development is
of the order of £300 million per annum. Since privatisation in
1987, such expenditure has prudently been expensed as incurred, a
policy which the Group believes conforms with industry practice.
IAS 38 (Intangible assets) requires development expenditure meeting
certain recognition criteria to be capitalised on the balance
sheet. This standard is to be applied retrospectively; hence the
intangible asset will include amounts expensed in previous years.
Impairment testing will be required at each balance sheet date,
which could introduce significant profit and loss account
volatility. As noted earlier, RRSP receipts reduce the burden of
research and development expenditure, and therefore a change to the
Group’s policy in respect of research and development would also
necessitate consideration of the treatment of RRSP receipts.
Under IAS 19 (Employment benefits) the net position on the Group’s
pension schemes based on market values will be included on the
balance sheet. This is expected to be broadly in line with FRS 17
amounts disclosed in note
The application of these and other standards is being further
During the year Rolls-Royce shares increased by 66 per
cent from 107p to 177.25p per share, compared to a 23 per cent
increase for the aerospace and defence sector and a 14 per cent
increase for the FTSE100.
The Company’s shares ranged in price from 64p in March to 190p in
The number of shares in issue at the end of the year was 1,667
million, an increase of 50 million of which one million related to
share options and 49 million related to scrip dividends.
The average number of shares in issue was 1,647 million (2002 1,612
million). Underlying earnings per share were 12.2p an increase of
ten per cent over 2002.
The proposed final payment per share will result in a total payment
of 8.18p per share (see Report of the
The financial services businesses comprise: engine leasing
(Rolls-Royce & Partners Finance), aircraft leasing
(Pembroke), and electrical power project development
(Rolls-Royce Power Ventures).
Rolls-Royce & Partners Finance, the Group’s joint
venture engine leasing business, owns a portfolio of 259 engines
with 35 customers. The proportion of engines on lease remains high,
at 98 per cent, by value.
Pembroke, the Group’s joint venture aircraft leasing business, owns
28 aircraft on lease to 14 customers, 96 per cent, by value, of the
owned aircraft fleet is on lease. A major refinancing of Boeing 737
aircraft was concluded during the year, without parent company
support. The shareholders of Pembroke are discussing ways of
realising value from the company as markets improve.
Rolls-Royce Power Ventures, the Group’s power project
developer, has 13 power generation projects in operation and four
in construction or commissioning. The business is being
restructured, reflecting the general weakness in power generation
markets. Charges of £15 million were taken as the process of
realising capital from the assets started.
|Joint ventures Rolls-Royce share £m