Our market sectors present global growth opportunities. We continued to make progress in 2006.

+7%
£26.1bn

Order book - firm and announced

+14%
£7,353m

Underlying sales

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The Group continued to make good progress in 2006, increasing sales to £7,156 million (2005 £6,603 million), with underlying sales growth of 14 per cent, and increasing underlying profit before tax by 19 per cent to £705 million (2005 £593 million). Importantly, our ability to access growing markets on a global basis enabled us to continue to grow our order book, which ended the year at £26.1 billion (2005 £24.4 billion).

We continue to invest in technologies, products, people and capabilities with the objective of broadening and strengthening our product portfolio, improving our efficiency and enhancing the environmental performance of our products. In 2006 total investment in research and development amounted to £747 million (2005 £663 million).

After increasing investment in manufacturing capability and research and development, there was a strong cash inflow of £491 million resulting in an improvement of £410 million in our average cash balance, with a cash balance of £826 million at the end of the year (2005 £335 million). Basic earnings per ordinary share rose to 57.32p (2005 20.11p) with underlying earnings per ordinary share increasing by 22 per cent to 29.81p (2005 24.48p). We propose to increase the final payment to shareholders to 5.92p making a total payment for the year of 9.59p per share, an increase of ten per cent on 2005.

Our overall performance in 2006 was strong in an undoubtedly challenging year. The underlying financial results were achieved after accommodating a further seven cent deterioration in the dollar achieved rate relative to 2005. We expect to absorb similar further deterioration in the exchange rate we achieve in 2007.

We manage our exposure to the US dollar by long-term hedging. Today we have the benefit of a hedge book of approximately US$10 billion, which means that we have clear visibility of the exchange rate we can achieve over the next three years. Whilst it is impossible to offset sustained dollar weakness through hedging, the cover we have taken reduces the volatility that exchange rate fluctuations cause and creates the opportunity for us to take other mitigating actions, such as cost reduction and the 'dollarisation' of our cost base.

Raw material price inflation has been a significant factor for all manufacturing industry. It is helpful that, as a high value-added business, the cost of raw materials forms a relatively small proportion of our total costs. We have maintained our focus on productivity and efficiency measures and, where appropriate, we hedge our exposure in the financial commodities markets. The nature of the business also enables us to enter into long-term procurement contracts, which help protect us from future fluctuations in raw material prices and give us visibility of our cost base.

We are continuing to invest globally in new facilities and to improve the performance of our international supply chain. These changes, which are occurring at the same time as a significant increase in load, have been managed well in tough conditions.

We operate in a competitive and challenging environment and, in doing so, we benefit from a consistent strategy, a strong order book, long programme life cycles and the revenue generated by the provision of value-added services to the users of our products. Consequently we have good visibility of our future workload and market opportunity. The results in 2006 demonstrate the resilience of the Group and its business model.

We are continuing our discussions with the relevant parties about our UK pension funds. Our proposals include a cash injection of £500 million. Our overall intent is to make a significant step towards reducing deficits and limiting the impact on the business of volatility in interest rates and share prices. We expect to make progress in 2007.

A strong balance sheet

The Group ended 2006 with a net cash balance of £826 million. In 2007, a substantial portion of this balance is earmarked to address the pension fund deficit. We believe that a strong balance sheet is essential for a long-term business such as ours. We compete against large competitors across programmes where returns are measured over decades, where we enter into long-term service commitments and where significant investments to gain market access are the norm. It was pleasing to see that both the major credit rating agencies reflected their positive view of our progress by promoting our rating into the 'A' category in 2006. During 2007, we will be reviewing our financial strategy in light of the Group's continuing cash generation, investment needs, progress on resolving the pension deficit and underlying performance.

One of the most frequent questions we are asked by financial analysts is whether we will seek to use our growing cash balances to buy businesses. We can, of course, grow organically, as we have been demonstrating for a number of years. However, we do not rule out acquisitions and, indeed, today's performance benefits from a number of successful past acquisitions. We intend, however, to remain a highly focused power systems business and any potential acquisition must deliver relevant technology, products or routes to market.

Today's business is the result of the implementation of a consistent strategy over many years and we believe that, as a focused power systems business, we can create most value for shareholders by continuing to pursue this strategy.

Priorities

We addressed four priority areas in 2006.

Investment in technology and products

We have a structured approach to technology acquisition, looking ahead over five, ten and 20-year time horizons. We can see significant opportunities for the introduction of new products in each of our markets and our strategy is to ensure that we have innovative technologies 'on the shelf' for future generations of product. Each product investment is subject to a rigorous examination of the risks and rewards to ensure that only business cases that create shareholder value are pursued.

Operational and unit cost reduction

We continued to make progress with the modernisation of our factories, introduction of more efficient working practices, simplification of the supply chain and improvement of business processes. These initiatives remain a priority in 2007, when we will also be introducing measures to reduce overhead costs.

Continued development of aftermarket services

Underlying aftermarket services revenues grew by 13 per cent in 2006 and represented 53 per cent of Group sales. This is a consequence of the successful introduction of new products, the growing installed base of engines in service and the investment we have made in innovative aftermarket service capabilities. We have continued to be successful in the introduction of comprehensive through-life service arrangements in each of our business sectors. These align our interests with those of our customers and enable us to add value through the application of our skills and assets.

Responding to the challenge of climate change

We believe strongly that Rolls-Royce has a positive role to play in the way that we participate in the debate about climate change, including helping to shape the responses to current concerns about the environment.

This is not a new subject for Rolls-Royce. We have an established track record of reducing the emissions of our products and our manufacturing facilities.

We published our first environmental report, 'Powering a better world', in 1998 and over many years, our research programmes have been directed at improving both the energy efficiency of our products and their environmental impact. That experience will stand us in good stead as we respond to the new opportunities presented by climate change.

Rolls-Royce offers a centre of excellence in terms of the engineering and technical skills which we can apply to these new challenges, and we can contribute to a proper understanding of the science and facts on which the current debate on climate change should be based. That is why we see Rolls-Royce as representing part of the solution to climate change.

We do, of course, accept that our gas turbines and diesels have an environmental impact through carbon dioxide, other emissions and noise. However, they also enable fast and reliable trade and travel, help safeguard world security, generate efficient electricity and contribute to the quality of life enjoyed by millions of people all over the world. Our challenge is to preserve these critical benefits on a sustainable basis.

Improving the environmental performance of our products

We invest over £100 million every year on research and technology, two thirds of which is directed at improving the environmental performance of our products. In addition, we spend around £350 million a year on the development and introduction of new products which embody these technologies and therefore have significantly enhanced environmental performance. In the aviation sector Rolls-Royce is playing a leading role in the achievement of the long-term environmental goals set by the Advisory Council for Aeronautics Research in Europe (ACARE). Under the ACARE programme, fuel burn and carbon dioxide emissions are targeted to be reduced by 50 per cent by 2020, noise by 50 per cent and nitrous oxide by 80 per cent, all from a 2000 baseline.

Working towards a more sustainable future

As a technology based company, we believe we can help society identify new solutions to environmental concerns. We are committed to developing low carbon technologies, including alternative energy sources. For example, we are investing in a major programme to develop solid oxide fuel cells, a technology which will reduce carbon dioxide emissions and offer other environmental benefits such as low noise and improved air quality.

We are also engaging in 'blue skies' research, including the feasibility of using synthetic kerosene to power aircraft of the future.

Reducing the environmental impact of our operations

Our manufacturing facilities already operate to world–class levels of environmental performance as recognised by a number of external bodies. Over a number of years we have delivered significant reductions in greenhouse gas emissions, waste, the use of solvents and water. There has also been a significant increase in recycling. We will continue to seek opportunities to minimise our environmental impact. Over the period 1998 - 2005, our revenues increased by 47 per cent but, in absolute terms, the energy used in our facilities reduced by 15 per cent and greenhouse gas emissions by 30 per cent. A programme of continuous improvement is in place to maintain this performance.

In 2006, we were again placed first in our business sector in the Business in the Environment index of corporate environmental management, retaining our 'Premier League' status.

A global business

Our market sectors each present global opportunities, with our business split evenly between the Americas, Asia and Europe.

In 2006, we expanded our international presence with new partners in Japan, Korea, Germany and Canada, covering a range of activities to improve the performance of our gas turbine engines. Our fuel cell business launched a subsidiary in the US and announced a partnership with Ohio-based, American Electric Power (AEP).

Collaboration agreements were extended in Europe, for helicopter engine manufacture; in China, for the training and development of senior aviation executives; and in India, for engine component design and manufacture.

We continued to develop and globalise our manufacturing facilities, including our factory modernisation programme in the UK, the transfer of V2500 engine assembly to Germany and a new outdoor jet engine testing facility in the US. We have begun the process of considering options for potential new facilities in various locations, to cater for the anticipated growth in each of our businesses.

Of our 38,000 employees, 22,700 are in the UK with the balance primarily in the US, Asia, Germany, Scandinavia and Brazil. Our sales and order book are evenly spread across Europe, Asia and the Americas. Research and development is conducted in facilities in the UK, Germany, Italy, Singapore, Japan, the US and Scandinavia, including important relationships with 27 universities where we have University Technology Centres. Our international presence means we have facilities in over 50 countries.

Reflecting the global nature of our business, we established a new International Advisory Board (IAB) in 2006. This board will provide the Group with an invaluable high level source of advice about international, economic, political and business trends. Details of the IAB can be found on the Board of directors' page.

There have been a number of changes recently in the international management team. Dr Saul Lanyado is retiring after helping build our marine business into a global leader. He is succeeded by John Paterson who also has a strong international background, and was previously running our global repair and overhaul (R&O) business. The R&O business now forms part of the Group's overall services activity, led by Miles Cowdry, President - Services.

Future prospects

Each of our businesses offers significant opportunities for organic growth. Over the next 20 years, we estimate the global accessible market to be worth some two trillion US dollars, of which about half will relate to the provision of aftermarket services.

The civil aerospace business is developing as we predicted and we expect the installed base of jet engines in service to continue to grow, providing the basis for sustained growth in our aftermarket services revenues. We are developing our market positions, such as those on the Boeing 787 and Airbus A350 XWB, which will ensure long-term growth for the business.

The defence aerospace business has proved resilient as a result of our broad portfolio of engine programmes. We are continuing to strengthen our presence in defence markets through new programmes such as the Joint Strike Fighter and the Airbus A400M transport aircraft, whilst also extending the range of aftermarket services which we offer. Consequently we expect steady growth from our defence business.

Our marine business is experiencing strong growth as a result of the high level of demand in the offshore oil and gas sector and our success as a systems supplier. Our order book, at over £2 billion, is at a record level and we are developing, with our customers, a series of innovative support initiatives.

In the energy sector, we see opportunities to strengthen our market presence. Our oil & gas business performed strongly in 2006. In power generation, where we are building a relatively new business, we achieved an encouraging order intake which bodes well for the future. The cost of developing our fuel cell technology will continue to affect the bottom line for the energy business, leading again to modest losses in 2007.

For 2007, we are confident that the measures we are taking to improve productivity, coupled with the underlying growth of the Group and the robust business model, will enable us to continue to grow underlying revenues and profits and generate a positive cash flow.

Finally, I would like to take this opportunity to thank all our employees for their hard work and commitment.