Rolls-Royce continued to make good financial progress in 2005, with a substantial increase in our profitability and cash flow. By cutting costs and working more efficiently, we were able to counter the impact of higher commodity prices and an adverse trend in our achieved US dollar exchange rate. It was good to see the results reflected in a rising share price.
We continue to grow organically and our sales increased in 2005 by 11 per cent to £6,603 million, with growth achieved in each of the Group's market sectors. Our underlying profit, on a like-for-like basis, increased by 49 per cent and a strong cash inflow of £552 million resulted in positive net funds of £335 million on the balance sheet at the year-end. Average net debt was reduced by a further 59 per cent, to £260 million.
Underlying earnings per share rose 55 per cent to 24.14p and basic earnings per share rose 29 per cent to 20.11p. A final payment to shareholders has been proposed of 5.38p per share, making a total payment for the year of 8.72p per share, a 6.6 per cent increase compared to the payment in 2004.
We attach great importance to minimising the impact on our finances of volatility in the global currency markets. We continued in 2005 to pursue our strategy of hedging future net dollar revenues and at the end of the year we had approximately US$10.5 billion of forward cover, at an average exchange rate of 1.67 dollars to the pound. The achieved rate in 2005 deteriorated by four cents relative to 2004.
We will use this hedge book - in conjunction with cost-reduction initiatives and further 'dollarisation' of our cost base - to manage our future foreign exchange exposure.
We believe it desirable to continue to increase the strength of the balance sheet, reflecting the long-term nature of the business. This will also stand us in good stead as we manage pension obligations over the coming years.
New orders in 2005 reached a record level of £11.3 billion, and brought the year-end firm order book to a record £22.9 billion, an increase of 21 per cent over 2004. Over the past ten years, the order book has grown at an annual compound rate of 14 per cent. Over the past five years, Asia has been a significant source of new business and it now represents 33 per cent of the order book.
Progress in Asia
Growth in Asia is prompting more air travel, both for business and for pleasure, increasing the energy requirements to support industrial development and larger numbers of affluent homes. It is stimulating investment in oil and gas exploration and transmission and it is boosting orders for marine propulsion systems from Asia's ship building industries, now the largest and fastest growing in the world. These are all target markets for Rolls-Royce and we are benefiting accordingly. In 2005 sales to the region increased by 18 per cent and the order book for the region increased by 70 per cent.
Our physical presence in Asia is also growing. We incorporated a new subsidiary in Bangalore, in order to expand engineering capacity over a range of new programmes. We established a joint venture in Singapore, to develop a commercially viable power system based on solid oxide fuel cell technology. We opened a new marine factory in Shanghai, from which the Group's £300 million turnover merchant business will be managed. And we established new sources of supply in markets such as China, Indonesia, Malaysia, Singapore and Taiwan.
All this added to the increasingly international nature of the Group. Today 40 per cent of our employees work outside the UK, 87 per cent of our sales are to destinations outside the UK and we have offices, manufacturing and locally-supported service facilities in 50 countries.
Priorities
We focused on three priority areas in 2005.
- Investment in technology and products
Acquisition of new technologies is conducted very methodically. We aim to have 'on-the-shelf' innovations ready to incorporate into our next generation of products, whilst at the same time exploring what might be possible further into the future. We see no shortage of market opportunities and expect the level of self-funded investment in our research and development work to remain at approximately five per cent of Group sales.
The impact of this investment on our income in any one year will reflect the mix and maturity of our current development programmes. During 2005 we launched a number of new programmes, notably the Trent 1700 for the Airbus A350 and the Avon 200, an upgrade of the existing Avon engine that has been so successful in the energy sector. - Operational and unit cost reduction
We made further progress in improving efficiency, thereby offsetting the impact of higher commodity prices by cutting costs. We achieved this by increasing productivity in our plants, managing our supply chain better and buying more from low-cost sources. Where we had to carry higher inventories to facilitate our factory-modernisation programme, we more than offset their financial impact through a rigorous management of our working capital. Importantly, more efficient working practices were implemented as a pre-condition for new factory investment. A significantly higher work load, particularly in relation to our civil aerospace engines, has challenged the ability of our supply chain to match our needs and this remains an area for attention. - Continued development of aftermarket services
Aftermarket service revenues, including 100 per cent of our repair and overhaul joint ventures, increased by 12 per cent in 2005 and have grown at 11 per cent per annum compound over the past ten years. Services now represent 54 per cent of our revenues. This is a consequence of the successful broadening of the Group's product range, the steady increase in the number of our engines in service and the investment we have made in a comprehensive range of aftermarket-service capabilities
Increasingly, we are taking responsibility for the maintenance of our engines and systems under long-term service agreements. This aligns our commercial interests closely with those of our customers, and maximises the value that our skills and assets can add. During 2005 a number of innovative service agreements were announced in each of the Group's business sectors.
Technology and the environment
We continued to pay particular attention in 2005 to the environmental impact of our products and of our manufacturing operations. In civil aerospace, our strategy is to seek to maintain the benefits to society of the growth in air travel, whilst helping to rein back as much as possible the negative consequences of air travel for the global environment. We are accordingly pursuing new technologies that should enable us to meet a series of highly demanding environmental targets.
We will succeed in this because our engineers and scientists have the skills and dedication to tackle some daunting technical challenges. Their talents are a timely reminder of the importance of attracting gifted individuals to a career in the sciences. As a Group, we are increasingly impressed by the commitment to science teaching in many countries, especially in Asia. The picture in the UK, though, is very different with increasing evidence that young people's enthusiasm for the physical sciences is in decline.
To help address this issue, in 2004 we introduced the Rolls-Royce Science Prize. It has been designed to reward imaginative science-teaching projects in the classrooms of the UK and Ireland each year, across all ages.
It offers substantial cash awards for the winning entrants. It gathered momentum encouragingly in 2005, with a 55 per cent increase in the number of schools taking part in the prize as compared with its inaugural year.
Community
The Group's other community activities in 2005 were far ranging. They involved the active participation and generosity of our employees. This was notably true of our response to the sad consequences of both the tsunami that struck in the Indian Ocean just before the start of the year and the Gulf of Mexico hurricanes that swept across the southern US in September. Employees added over £250,000 of their own money to our corporate donations of £500,000 for recovery projects in Asia. Several of these were supported by Rolls-Royce managers and engineers based in the region. In the US, where three sites with 136 employees were directly affected, Group assistance was similarly backed up by generous support from Rolls-Royce colleagues.
We received a Gold Award from the UK Institute of Fundraising in 2005 for our Payroll Giving Scheme. This provides and pays for the administration of employees' donations to charity, enabling them to be made regularly and in a tax-efficient way. Employees last year gave in excess of £396,000 to charities of their own choosing.
Employees
Our contribution to community activities reflects a strong corporate culture that remains one of the Group's most valuable assets. It owes much to the unusually long average tenure of our employees, many of whom spend their entire careers with Rolls-Royce. It is therefore especially pleasing that the rise in our share price will benefit a broad constituency of shareholders within the company, with a significant number of our employees participating in 'sharesave' schemes and a large number owning shares directly.
Our improved financial performance has also meant that, for the first time in many years, executive share options have vested. The vesting of this component of executive remuneration is tied to performance criteria designed with a view to securing and rewarding long-term success. It is worth noting that our executive directors all own, either directly or in trust, substantial shareholdings in Rolls-Royce. This demonstrates their commitment to the Group, and has the added benefit of aligning their personal interests with those of all other shareholders.
Future prospects
Rolls-Royce is addressing four long-term growth markets. Their aggregate demand for engines and services over the next 20 years is estimated to be worth approximately two trillion dollars. The Group's consistent investment in technology and in new products and services enables us to respond effectively to new developments, creating opportunities for organic growth in each of the four markets.
In civil aerospace, we see the market continuing to recover from the recession that began at the start of this decade, the impact of which was exacerbated by the events of 9/11, SARS and the Gulf War. We expect to benefit further from this recovery. The number of Rolls-Royce jet engines in service is increasing and flying hours across our fleet are accumulating steadily. This growth, combined with our broadening of the services we make available, is expected to lead to a steady increase in our service revenues.
In defence aerospace, we have developed a broad product portfolio that addresses all of the major market sectors, from combat and trainer aircraft to transport and tactical aircraft and helicopters. Our mix of mature programmes, new production programmes, development programmes and service revenues is expected to enable the Group to make good progress in spite of the volatility that may be experienced on individual programmes, as exemplified by the uncertainties surrounding the alternate engine for the Joint Strike Fighter in the wake of the US Quadrennial Defense Review.
Our marine business is benefiting from its broad access to naval and commercial markets. Here again, we are bringing new products to market, from gas turbines such as the MT30 to rim-driven tunnel thrusters, which we believe are likely to have a major impact on marine propulsion systems. Boosted by the rise in oil and gas prices, the commercial offshore market remains very strong - and we are confident that we can continue to capture a good share of the available business.
Our energy business is strengthening its presence in emerging oil and gas markets and is well positioned to secure a growing share of the power-generation market. Its profitability will be constrained for some time by the investments it is making in new technology - including the development of solid-oxide fuel cell systems.
In aggregate, we are expecting continued progress in 2006, underpinned by the rising order book, the growth in service revenues and sustained cost reduction. As a result, though we see no likelihood of any reduction in competitive intensity in our markets, we do expect increased profits and a positive cash flow for the year.
The proposed increase in the payment to shareholders for 2005 represents an increase of 6.6 per cent over the payment made in 2004. This reflects our confidence in the future prospects of the business. I would like here to acknowledge the hard work and dedication of all the people in Rolls-Royce around the world that have helped us establish this position.
Sir John Rose
Chief Executive
