A strong performance
|Summary data – £ million||2011||2010||Change|
|* See explanation in note 2 on page 84 of the consolidated financial statements|
|Underlying profit before tax*||1,157||955||+21%|
|Underlying earnings per ordinary share*||48.54p||38.73p||+25%|
|Full year payment to shareholders||17.5p||16.0p||+9%|
|Reported profit before financing||1,189||1,134||+5%|
|Average net funds||320||960|
The difficulties faced by the global economy, by the Eurozone and by those governments with budgetary imbalances are well publicised. However, demand for our products and services remains robust, particularly in developing markets. This demand results from the breadth and diversity of our businesses, customers and programmes, the competitive strength of our products and the relative youth of our installed base.
The visibility of significant growth in the next decade provided by the record order book underpins our continued investment in technology, operations and services. These investments safeguard our competitive advantage, support delivery on our commitments to customers and improve our operational effectiveness. The Group’s 2011 performance was achieved after absorbing a ten per cent increase in net R&D expense to £463 million and a 29 per cent increase in capital expenditure to £467 million.
The Group’s joint venture with Daimler now owns over 99 per cent of Tognum for which Rolls-Royce paid cash consideration of £1.5 billion in 2011. This joint venture investment made a £30 million net contribution (after costs and financing) to underlying profit before tax but did not impact the Group’s 2011 revenues. On January 2, 2012, the Group contributed its Bergen Diesels business to the joint venture, resulting in a cash benefit to the Group of €200 million.
The Group’s proposed sale of its 32.5 per cent shareholding in IAE is subject to regulatory approval and did not impact 2011 financial performance. Rolls-Royce will continue to play an active role as a first tier supplier to IAE of high-pressure compressors and fan blades and remains responsible for the final assembly of 50 per cent of the production engines. The announced new joint venture with Pratt & Whitney to develop an engine to power the next generation of mid-size aircraft is also subject to regulatory approval and had no effect on 2011 financial performance.
Underlying figures are considered more representative of the trading performance by excluding the impact of year end mark-to-market adjustments of outstanding financial instruments on the reported performance, principally relating to the GBP/USD hedge book. In addition the net post-retirement financing is excluded and, in 2011, adjustments have been made to exclude one-off past-service credits on post-retirement schemes and the effect of acquisition accounting. The adjustments between the underlying income statement and the reported income statement are set out in more detail in note 2 of the financial statements. This basis of presentation has been applied consistently since the transition to IFRS in 2005.
Underlying income statement
|Underlying income statement extracts –
|Profit before financing costs and taxation||1,206||1,010||+19%|
|engine holding (Tognum JV)||36||–||–|
|Net financing costs||(49)||(55)||+11%|
|Profit before taxation||1,157||955||+21%|
|Profit for the year||896||719||+25%|
|Payment to shareholders||17.5p||16.0p||+9%|
|Other operating income||70||87||-20%|
|Gross R&D investment||908||923||-2%|
|Net R&D charged to the income statement||463||422||+10%|
Underlying revenue increased four per cent to £11.3 billion. This includes a nine per cent growth in services revenue to £6.0 billion that more than offset a one per cent reduction in original equipment (OE) revenue to £5.3 billion. OE performance included strong 18 per cent growth in civil aerospace offset by a greater than anticipated reduction of 23 per cent in marine OE revenue. Underlying services revenue continues to represent more than half (53 per cent) of the Group’s underlying revenues. In 2011, growth in underlying services revenue was due to a number of factors: the installed base of products grew and the services network expanded; defence aerospace benefited from one-off contract termination settlements resulting from the Strategic Defence and Security Review (SDSR) of the UK Ministry of Defence (MoD); and marine services saw further growth of nine per cent.
Underlying profit before financing costs and taxation increased 21 per cent to £1.16 billion. This was due to a number of factors, a better mix between OE and services, a significant improvement in productivity resulting from the focus on cost, net foreign exchange (FX) benefits of £54 million including an eight cent improvement in the achieved rate on selling USD income, £30 million from Tognum net of the costs of the acquisition and a number of one-off items, the most significant of which relates to a £60 million benefit from the SDSR settlements referred to earlier.
Further discussion of trading is included in the business segment reports.
Underlying financing costs reduced 11 per cent to £49 million, including a small reduction in financial Risk & Revenue Sharing Partnerships (RRSPs) costs and lower funding costs due to the settlement of the Group’s €750 million Eurobond during the year.
Underlying taxation was £261 million, an underlying tax rate of 22.6 per cent compared with 24.7 per cent in 2010. This reduction reflects increased profits from joint ventures (which are accounted for on a post-tax basis) and some adjustments to prior year estimates.
Underlying EPS increased 25 per cent to 48.54 pence, in line with the increase in the underlying profit after tax.
Payments to shareholders At the AGM on May 4, 2012, the directors will recommend an issue of 106 C Shares with a total nominal value of 10.6 pence for each ordinary share. The final issue of C Shares will be made on July 2, 2012 to shareholders on the register on April 27, 2012 and the final day of trading with entitlement to C Shares is April 24, 2012. Together with the interim issue on January 3, 2012 of 69 C Shares for each ordinary share with a total nominal value of 6.9 pence, this is the equivalent of a total annual payment to ordinary shareholders of 17.5 pence for each ordinary share.
The payment to shareholders will, as before, be made in the form of redeemable C Shares which shareholders may either choose to retain or redeem for a cash equivalent. The Registrar, on behalf of the Company, operates a C Share Reinvestment Plan (CRIP) and can, on behalf of shareholders, purchase ordinary shares from the market rather than delivering a cash payment. Shareholders wishing to redeem their C Shares or else redeem and participate in the CRIP must ensure that their instructions are lodged with the Registrar, Computershare Investor Services PLC, no later than 5pm on Friday June 1, 2012.
Other operating income relates to programme receipts from RRSPs, which reimburse past R&D costs. These receipts decreased by 20 per cent in 2011 due to the phasing of major programmes such as the Trent XWB.
Net R&D charged to the income statement increased by ten per cent to £463 million. The Group recruited an additional 1,000 engineers to develop the products of the future and to help improve the in-service performance of the existing installed base of products. This investment and the 29 per cent increase in capital expenditure to £467 million will prepare our infrastructure and global supply chain for significant growth in the next decade. The Group continues to expect net R&D investment to remain within four to five per cent of Group underlying revenue.
|Summary balance sheet – £ million||2011||2010|
|Property, plant and equipment||2,338||2,136|
|Net post-retirement scheme deficits||(397)||(856)|
|Net working capital||(1,098)||(973)|
|Net financial assets and liabilities||(718)||(627)|
|Share of results of joint ventures and associates||1,680||393|
|Assets held for sale||178||9|
|Other net assets and liabilities||(67)||24|
|USD hedge book (US$ million)||22,000||20,900|
|Net TotalCare assets||956||920|
|Gross customer finance contingent liabilities||612||633|
|Net customer finance contingent liabilities||124||121|
Intangible assets relate to goodwill, certification costs, participation fees, development expenditure, recoverable engine costs, software and other costs that represent long-term assets of the Group. In aggregate, these assets remained broadly unchanged at £2.9 billion: this was largely due to increased development, certification and software costs being offset by the reclassification of V2500 assets on the balance sheet as assets held for sale. The carrying values of the intangible assets are assessed for impairment against the present value of forecast cash flows generated by the intangible asset. The principal risks remain: reductions in assumed market share; programme timings; increases in unit cost assumptions; and adverse movements in discount rates. There have been no impairments in 2011. Further details are given in note 8 of the financial statements.
Property, plant and equipment increased by nine per cent to £2.3 billion due to the ongoing development and refreshment of facilities and tooling as the Group prepares for increased production volumes.
Net post-retirement scheme deficits decreased 54 per cent to £397 million, including: (i) the impact of the change in pensions’ indexing to CPI in the UK (£130 million); (ii) revised healthcare benefits in certain overseas schemes (£74 million); and (iii) the reduction in discount rates having a larger impact on the value of the assets than the obligations (calculated on an IAS 19 basis).
Overall funding across the schemes has improved in recent years as the Group has adopted a lower risk investment strategy that reduces volatility going forward and enables the funding position to remain stable: interest rate and inflation risks are largely hedged; exposure to equities has reduced to around 20 per cent of scheme assets, this has been achieved against the headwind of increasing life expectancy assumptions.
In 2011, the Group made further arrangements to reduce volatility and enable future funding to be predicted with more certainty. A longevity swap was transacted with a third party to eliminate the risk of increasing life expectancy of pensioners in the largest UK defined benefit scheme. No significant change is expected to the ongoing funding levels of the UK pension schemes in 2012.
Net funds decreased by 85 per cent to £223 million largely due to the £1.5 billion consideration paid during the year for the Group’s shared investment in Tognum. As a result, average net funds fell by £640 million to £320 million (£805 million excluding acquisitions).
Investment – joint ventures and associates increased in the year as a result of the investment in Tognum.
Assets held for sale represent the assets and liabilities expected to be derecognised as a result of the anticipated restructuring of IAE.
Provisions largely relate to warranties and guarantees provided to secure the sale of OE and services. These provisions reduced modestly during the year.
Net financial assets and liabilities relate to financial RRSPs and the fair value of foreign exchange, commodity and interest rate contracts, set out in detail in note 17 to the financial statements. The change largely reflects the impact of the change in the GBP/USD exchange rate on the valuation of foreign exchange contracts.
The USD hedge book increased five per cent to US$22.0 billion. This represents around four and a half years of net exposure and has an average book rate of £1 to US$1.60. Current forward market exchange rates are similar to current average book rates.
Net TotalCare® assets relate to long-term service agreement (LTSA) contracts in the civil aerospace business, including the flagship services product TotalCare. These assets represent the timing difference between the recognition of income and costs in the income statement and cash receipts and payments.
Customer financing facilitates the sale of OE and services by providing financing support to certain customers. Where such support is provided by the Group, it is generally to customers of the civil aerospace business and takes the form of various types of credit and asset value guarantees. These exposures produce contingent liabilities that are outlined in note 23 to the financial statements. The contingent liabilities represent the maximum aggregate discounted gross and net exposure in respect of delivered aircraft, regardless of the point in time at which such exposures may arise.
During 2011, the Group’s exposure remained stable with gross and net exposures of £612 million and £124 million respectively. As has been well-publicised, some banks that have been active in recent years in providing funds for aircraft financing have chosen during 2011 to substantially reduce their exposure in this market segment. Although this may have some effect on the terms and pricing of new aircraft finance transactions in the near future, the Group expects that other providers of USD funding and ongoing support from the export credit agencies will largely fill the gap left by these banks.
Group 2012 guidance
Excluding the impact of the Tognum acquisition and the proposed IAE transaction, in 2012 the Group expects to see good growth in underlying revenue and underlying profit with a cash flow around breakeven as we continue to invest for future growth.
In civil aerospace, we anticipate good growth in underlying revenue and strong growth in underlying profit. In defence aerospace, we expect modest growth in underlying revenue and profit. In marine, we expect a modest increase in underlying revenue, with underlying profit broadly flat. And in energy, we see growth in revenue and some improvement in profit.
Other relevant data
Foreign exchange: neutral.
Taxation: the underlying tax rate is expected to be around 24 per cent.
R&D: a modest increase in expenditure combined with lower net capitalisation and higher amortisation due to the phasing of new programmes.
Capital expenditure: a modest increase, including increased investment in IT.
Pensions: no material changes expected to funding levels.
Intangible assets: modest increase compared with 2011 due to a modest increase in recoverable engine costs partially offset by a decrease in development costs due to the phasing of new programmes.
Property, plant and equipment: modest increase compared with 2011 as we continue to invest in capability and infrastructure.
Tognum: Tognum is expected to contribute in the first half to the Group’s share of results of joint ventures and associates. Tognum’s results are expected to be fully consolidated around the half year with Daimler’s 50 per cent share of the result recorded as a non-controlling interest. For 2012, Tognum will be reported separately. As Tognum remains a listed company and will issue its preliminary results on March 8, 2012, the Group is not providing guidance at this time.
IAE: The sale of the Group’s 32.5 per cent shareholding in IAE is expected to receive regulatory approval during 2012, at which time the initial cash consideration of US$1.5 billion will be received. For the first full year following settlement, the impact of the sale on subsequent trading will have a small negative effect on underlying revenue and a positive effect of around £140 million on underlying profit. The impact on the order book will be a reduction of around £4 billion.
Additional financial information can be found here