Rolls-Royce Holdings plc Annual Report 2016

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Rolls-Royce Holdings plc

Annual Report 2016

Front cover

A Trent 1000 engine being

assembled at our Seletar

plant in Singapore.

This page

A Trent XWB, the world’s

most eﬃcient large

aero engine.

Rolls-Royce is a pre-eminent

engineering company focused

on world-class power and

propulsion systems.

Rolls-Royce Holdings plc Annual Report 2016 FINANCIAL HIGHLIGHTS AND CONTENTS 

Financial highlights

FORWARD-LOOKING STATEMENTS

This Annual Report contains forward-looking statements. Any statements that express forecasts,

expectations and projections are not guarantees of future performance and guidance may be

updated from time to time. This report is intended toprovide information to shareholders,

and is not designed to be relied upon by any other party or for any other purpose, and the Company

and its Directors accept no liability to any other person other than that required under English law.

Latest information will be made available on the Group’s website. Bytheir nature, these statements

involve risk and uncertainty, and a number of factors could cause material differences to the

actual results or developments.

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

Underlying explanation is in note 2 onpage131.

ORDER BOOK

£79,810m

2015: £76,399m

FREE CASH FLOW

£100m

2015: £179m

UNDERLYING* PROFIT BEFORE TAX

£813m

2015: £1,432m

REPORTED (LOSS)/PROFIT BEFORE TAX

£(4,636)m

2015: £160m

UNDERLYING* REVENUE

£13,783m

2015: £13,354m

REPORTED REVENUE

£14,955m

2015: £13,725m

UNDERLYING* EARNINGS PER SHARE

30.1p

2015: 58.7p

REPORTED EARNINGS PER SHARE

(220.1)p

2015: 4.5p

FULL YEAR PAYMENT TO SHAREHOLDERS

11.70p

2015: 16.37p

NET DEBT

£(225)m

2015: £(111)m

Contents

STRATEGIC REPORT

Group at a glance 2

Chairman’s statement 4

Chief Executive’s review 6

Introduction 6

Review of 2016 7

Priorities for 2017 13

Business model 14

Financial summary 16

Business review 18

Financial review 36

Sustainable business 40

Key performance indicators 46

Principal risks 48

Going concern and viability statements 53

DIRECTORS’ REPORT

Board of Directors 54

Chairman’s introduction 58

Corporate governance 59

Committee reports 67

Nominations & Governance Committee 67

Remuneration introduction 72

Remuneration policy 76

Directors’ remuneration report 83

Audit Committee 96

Safety & Ethics Committee 103

Science & Technology Committee 110

Responsibility statements 113

Other statutory information 186

FINANCIAL STATEMENTS

Financial statements contents 114

Group nancial statements 115

Company nancial statements 167

OTHER INFORMATION

Subsidiaries, joint ventures and associates 170

Independent auditor’s report 176

Sustainability assurance statement 183

Additional nancial information 184

Other statutory information 186

Shareholder information 190

Glossary 192

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT GROUP AT A GLANCE

Group at

a glance

ENGINEERS (YEAR END)

16,526

GROSS R&D EXPENDITURE

£1.3bn

ORDER BOOK

£79.8bn

PATENTS APPLIED FOR

672

EMPLOYEES (YEARAVERAGE)

49,900

COUNTRIES

The Group is organised into five

customer-facing businesses:

CivilAerospace, Defence

Aerospace, PowerSystems,

Marine and Nuclear.

UNDERLYING REVENUE

£13,783m

UNDERLYING PROFIT BEFORE FINANCING

£915m

UNDERLYING REVENUE MIX

GROUP

Civil Aerospace 51%

Defence Aerospace 16%

Power Systems 19%

Marine 8%

Nuclear 6%

Our award-winning Unied Bridge is the

result of detailed studies of how crews

use the equipment on the bridge, making

the vessel safer and easier to operate.

GROUP AT A GLANCE Rolls-Royce Holdings plc Annual Report 2016 GROUP AT A GLANCE

CIVIL AEROSPACE

UNDERLYING REVENUE

£7,067m

UNDERLYING PROFIT BEFORE FINANCING

£367m

UNDERLYING REVENUE MIX

PAGES  TO  FOR MORE INFORMATION

DEFENCE AEROSPACE

UNDERLYING REVENUE

£2,209m

UNDERLYING PROFIT BEFORE FINANCING

£384m

UNDERLYING REVENUE MIX

PAGES  TO  FOR MORE INFORMATION

UNDERLYING REVENUE

£777m

UNDERLYING PROFIT BEFORE FINANCING

£45m

UNDERLYING REVENUE MIX

PAGES  TO  FOR MORE INFORMATION

MARINE NUCLEAR

POWER SYSTEMS

UNDERLYING REVENUE

£2,655m

UNDERLYING PROFIT BEFORE FINANCING

£191m

UNDERLYING REVENUE MIX

PAGES  TO  FOR MORE INFORMATION

UNDERLYING REVENUE

£1,114m

UNDERLYING LOSS BEFORE FINANCING

£(27)m

UNDERLYING REVENUE MIX

PAGES  TO  FOR MORE INFORMATION

OE revenue 48%

Services revenue 52%

OE revenue 57%

Services revenue 43%

OE revenue 46%

Services revenue 54%

OE revenue 40%

Services revenue 60%

OE revenue 68%

Services revenue 32%

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT CHAIRMAN’S STATEMENT

Progress in 2016 can be

judged by how we have

overcome our challenges;

we have delivered on our

commitments in a difficult

year while at the same time

embarking on a significant

transformation.”

UNDERLYING EPS

30.1p

PAYMENT TO SHAREHOLDERS

11.7p

conduct we have agreed to pay financial

penalties and costs of around £671m. These

dishonest acts, some as recent as 2013, are a

major blemish on the reputation of the

business and we have apologised unreservedly.

Importantly, the Board has taken extensive

action to strengthen ethics and compliance

procedures across the Group over recent

years,so that high standards of conduct are

embedded as an essential part of the way we

do business. We share a determination to see

that Rolls-Royce comes out of this episode as a

more trusted, resilient and better managed

business that wins right every time. Every

employee, from the bottom to the top of the

Group, is fully aware of the importance of

doing the right thing.

As described in the Nominations &

Governance Committee report (see page 70)

our governance framework was rolled out in

the summer and provides clarity and

accountability, providing additional integrity

to our business.

OTHER STATUTORY INFORMATION P

Ian Davis

Chairman

Chairman’s

statement

Last year I talked about how Rolls-Royce

is a business in transition and how

important the next few years were

going to be, laying the groundwork for

future success. In 2016, we have made

a good start to the transformation

programme, designed to bring

significant and sustainable benefits

over the coming years.

Our core strengths lie in our product portfolio,

admired by our customers and respected by

our competitors. This underpins our

exceptional order book which will drive future

shareholder value. To unlock these benefits, we

need to sustain our investment in our key

competitive advantages, including our

world-leading research & development

capability, as we introduce new products,

ramp up production and expand our service

capability to support our growing aftermarket.

By necessity, the transformation programme

targeted simplifying the way we manage the

business and reducing our fixed cost base.

Ihave been very encouraged by the

engagement across the Group on what is,

understandably, a difficult exercise for

many and which has seen around 20% of

management roles being removed.

There is much more to do in terms of

efficiency and behavioural change to achieve

greater cost competitiveness. Key to this will

be embedding the thinking around pace and

simplicity that Warren East, your Chief

Executive, has brought to the business. He

will talk more about how we are doing

this in the Strategic report.

Corporate governance

The recent settlements, with the UK Serious

Fraud Office and other authorities, are a

salient reminder of how critical it is to

'winright'. As a result of past, unacceptable

Rolls-Royce Holdings plc Annual Report 2016 CHAIRMAN’S STATEMENT 

communication programme in 2016 to

outline the changes, culminating in the capital

markets' event in November. You can read

more about this on pages 66 and 130.

We have noted with interest the

Government’s green paper on UK Corporate

Governance: The Options for Change and we

are actively taking steps to strengthen our

interaction with stakeholders, particularly

employees. Further detail is included in my

introduction to the Directors’ report on

page 58. I look forward to reporting our

progress in our Annual Report next year.

Since taking over as chairman of the

Remuneration Committee in May, Ruth

Cairnie has undertaken a comprehensive

consultation on our proposed new incentive

schemes, ahead of this year’s AGM. You can

read more about our proposed remuneration

policy in the Directors’ remuneration report

on pages 72 to 82.

Feedback from investors suggests that we

have improved the level of engagement,

transparency and openness in many of our

communications. While we can always do

better, I believe the team has made a strong

start in rebuilding trust.

I know Warren looks forward to introducing

Stephen Daintith and Simon Kirby, our new

Chief Operating Officer, to the market in the

coming months to present their combined

views on the strategic priorities for the

business, which will define our future path.

Looking forward

2017 will be another transformative year

for Rolls-Royce. We continue to operate in

uncertain markets and will need to respond

to shifting market dynamics, while at the

same time make progress on our core

priorities both in terms of customer deliveries

and internal organisation changes.

Warren has been building a strong and

experienced management team to help him

achieve his strategic and operational goals.

The Board will continue to both challenge

andsupport their actions as they work to

ensure we transition successfully over the

next few years to a more profitable and

cash-generative future.

Ian Davis

Chairman

13 February 2017

Shareholder payments

Our stated objective in the long term is

to progressively rebuild our payment to

shareholders to an appropriate level, subject

to the short-term cash needs of the business.

This reflects the Board’s long-standing

confidence in the strong future cash

generation of Rolls-Royce.

At this stage, the investment needs of the

business remain high, reflected in the low

level of free cash flow in 2016 and this is

expected again in 2017. In addition, the Board

sees the need to retain a degree of balance

sheet flexibility.

As a result, it is proposed that the final

payment for 2016 is unchanged from 2015

at 7.1 pence per share. Taken together with

the interim payment, this brings the full year

payment to 11.7 pence per share. As with past

payments, the distribution will be in the form

of C Shares.

Board developments

During the year, there have been a number of

important changes to the Board. In March, we

appointed Brad Singer, a partner of ValueAct

Capital, to the Board, at which time he also

joined the Science & Technology Committee.

Sir Kevin Smith took over the role of Senior

Independent Director from Lewis Booth, who

continues as chairman of the Audit

Committee, animportant role for us at the

present time. In May, following the 2016 AGM,

Dame Helen Alexander stepped down from

the Board. In November 2016, Alan Davies

stepped down from the Board.

In addition, we announced in September

thatStephen Daintith will join the Board in

2017 as Chief Financial Officer. His record of

achievement in change management is

particularly relevant to the Group. He will

succeed David Smith.

Colin Smith will be leaving the Company after

43 years of service and will be stepping down

from the Board after this year’s AGM. Colin has

made a major contribution to the success

of the business over many years, including

12 years on the Board. I would like to thank

both David and Colin for their valuable

support during their time with Rolls-Royce.

More detail on the changes to the Board are

set out in the Nominations & Governance

Committee report on page 68.

Overall I believe we have a strong and

experienced Board, fully engaged with the

business and well able to provide both

support and scrutiny in equal measure.

Rebuilding trust and confidence

We made significant efforts in 2016 to

improve our communication with

stakeholders. The foundations laid in the

second half of 2015 were enhanced by a

broad range of engagement, including

formal events such as the corporate

governance seminar in April, which I hosted,

and the capital markets' event in November,

led by Warren and his team. This latter event

brought together senior management from

all of our business units with analysts and

investors. The event gave our guests the

chance to ask questions and improve their

understanding of the business.

Despite the challenges we face as a business,

we know how important it is to sustain our

investment in our people and communities.

This has included maintaining active

graduate and apprenticeship schemes, as well

as investing in our research partnerships

and STEM (science, technology, engineering

and mathematics) programmes. Internally, we

are working hard on employee engagement,

including initiatives around diversity and

wellbeing (see Sustainable business on

page 42 and the Safety & Ethics Committee

report on page 109).

During the year, we have also done significant

work on the new revenue reporting standard,

IFRS 15 Revenue from Contracts with

Customers. Due to be adopted at the start of

2018, this will go a long way to better align the

recognition of profit and cash for our original

equipment business in particular, and will

help make our performance improvements

more transparent. Ibelieve this will be

welcomed by many stakeholders, but may take

time to be properly understood. As a result,

we have undertaken a progressive

These dishonest acts…

are a major blemish

on the reputation of the

business and we have

apologised unreservedly.”

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT CHIEF EXECUTIVE’S REVIEW

Chief Executive’s review

2016 has been an

important year as

we accelerated the

transformation of

Rolls-Royce.”

Overall, we have performed ahead of our expectations for the year as a whole

while delivering significant changes to our management and processes.

We increased our large aero-engine production output by 25%, supported the

needs of our customers, and made good technical progress in the final stages

of the development of the three new large engines, due to enter service over the

next twelve months. At the same time we have improved manufacturing lead

times for our key Civil Aerospace programmes, an important goal as we ramp

up production over the next few years. Progress with our transformation

programme was also better than expected, delivering over £60m of in-year

benefits compared to our initial target of between £30-50m. Overall, the

performance improvements have helped offset a number of changing trading

conditions and higher research & development (R&D) spend.

Introduction

Warren East

Chief Executive

Rolls-Royce Holdings plc Annual Report 2016 REVIEW OF 2016

Priorities for 2017

Our clear focus and priorities for

developing thebusiness.

Business model

How we deliver value from our

products andservices.

Financial review

Explaining our 2016 nancial

performance inmore detail.

Principal risks

Outlining our main risks

together with our risk

management process.

Review of 2016

How the Group performed in a

year ofsignicant change.

Financial summary

Summary of our 2016

nancial performance.

Sustainable business

Setting out the approach

we take to ensure we are

a sustainable business.

Business review

Reviewing each of our ve

customer-facing businesses;

with analysis of their markets.

Key performance indicators

How nancial and

non-nancialindicators are

usedto measure the Group.

This Strategic report describes thebusiness in depth and provides

further information on our nancial position and business performance.

Review of 2016

Performance in 2016

In 2015, we identified a number of significant

headwinds that would hold back performance

in 2016, including mixed market conditions

and the revenue and cost impacts of some key

product transitions.

Looking first at our markets, demand for our

large Civil Aerospace products and services

remained robust, despite some specific

weaknesses for service demand in respect

of older engines. At the same time, demand

for new corporate jets softened, as did the

aftermarket for the regional jets powered

by our AE 3007 engines. Defence Aerospace

markets held up well with a steady demand

for our aftermarket services in particular.

Offshore oil & gas markets for our

Marine business continued to suffer from

the consequences of low oil prices.

Alongside weaker industrial demand, this

also impacted Power Systems.

Other known headwinds transpired broadly

as expected, led by lower Trent 700 volumes

and prices, legacy civil large engine

aftermarket reductions and weakness in

marine markets. At thesame time, we have

continued to invest in products and services

to support our customers and reinforce the

long-term strength of our order book, valued

at the end of the year at around £80bn.

Against this backdrop, Group underlying

revenue reduced by 2% on a constant

currency basis with reductions in both

original equipment and aftermarket

revenues, led by the Marine business where

revenues were down 24%. More details are

included in the Financial summary on page 16

and the Business reviews on pages 18 to 35.

Compared to 2015, underlying profit before

finance charges and tax was 45% lower at

£915m. On this basis, Civil Aerospace

delivered £367m (2015:£812m); Defence

Aerospace delivered £384m (2015: £393m);

Power Systems delivered £191m

(2015: £194m); Marine generated a loss

of £27m (2015: £15m profit) and Nuclear

delivered £45m (2015:£51m excluding the

£19m R&D credit benefits highlighted in

2015). More detail on eachbusiness is

included in the Business review.

After underlying financing costs of £102m

(2015: £60m including a £34m gain from

hedging overseas dividends), underlying

profit before tax was £813m (2015: £1,432m).

Since the EU referendum at the end

of June, the value of sterling relative to the

US dollar has fallen significantly. As a result,

we have recognised a £4.4bn in-year

non-cash mark-to-market valuation

adjustment forour currency hedge book as

part of our reported financing costs of

£(4,677)m (2015:£(1,341)m). While reported

revenue of £14,955m (2015: £13,725m) was

unaffected by this adjustment, it impacted

reported profit. In addition, our reported

results also included a £671m charge for

financial penalties from agreements with

investigating authorities in connection with

historic bribery and corruption involving

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT REVIEW OF 2016

ORDER BOOK (£BN)

2015

2016

0 10 20 30 40 50 60 70 80

0 3 6 9 12

2015

2016

UNDERLYING REVENUE (£BN)

UNDERLYING PROFIT BEFORE FINANCING (£M)

2015

2016

0 300 600 900 1,200 1,500

FREE CASH FLOW (£M)

2015

2016

0 300 600 900 1,200 1,500

intermediaries in a number of overseas

markets. Our reported loss before tax was

£(4,636)m (2015: £160m profit).

After an underlying tax charge of £261m

(2015: £351m), underlying profit after tax

for the year was £552m (2015:£1,081m).

With an average 1,832m shares in issue,

underlying earnings per share were 30.1p

(2015: 58.7p).

After a reported tax credit of £604m

(2015: £76m charge), the reported loss for

the year was £(4,032)m (2015: £84m profit).

Reported earnings per share were (220.1)p

(2015: +4.5p).

A full reconciliation of underlying to

reported profit can be found in note 2

on page 134.

Free cash inflow in the year was £100m

(2015: inflow of £179m), better than

expected, reflecting strong cash collections

from a number of key customers at the very

end of the period and an improvement in

underlying working capital performance.

While some of this positive variance is a

timing impact and likely to reverse early

in 2017, improved efficiencies should drive

a level of sustainable benefit.

A more detailed review of financial

performance is included in the Financial

summary on page 16 and the Financial review

on page 36.

Our focus on clear priorities for 2016

has helped deliver positive outcomes

Our 2016 priorities were threefold: to

strengthen our focus on engineering,

operational and aftermarket excellence

to drive long-term profitable growth; to

deliver a strong start to our transformation

programme; and to start rebuilding

trust and confidence in our long-term

growth prospects.

Payment schedule SFO DoJ MPF Total

2017 £119m* + £13m US$170m US$26m £293m*

2019 £100m* £100m*

2020 £130m* £130m*

2021 £148m* £148m*

* Plus interest.

Agreement reached with various

investigating authorities

In mid-January 2017, we announced that we

had entered into Deferred Prosecution

Agreements (DPAs) with the UK’s Serious

Fraud Office (SFO) and the US Department

of Justice (DoJ) and completed a Leniency

Agreement with Brazil’s Ministério Público

Federal (MPF). These agreements relate to

bribery and corruption involving

intermediaries in a number of overseas

markets, concerns about which we passed

to the SFO from 2012 onwards following

a request from the SFO.

The agreements are voluntary and result in

the suspension of prosecution provided that

the Company fulfils certain requirements,

including the payment of financial penalties.

The agreements will result in the total

payment of around £671m. This is recognised

within our 2016 accounts.

Under the terms of the DPA with the SFO,

we agreed to pay £497m plus interest under

a schedule lasting up to five years, plus a

£13m payment in respect of the SFO’s costs.

We also agreed to make payments to the DoJ

totalling around US$170m and to the MPF

totalling around US$26m. As a result, the

total payment in 2017 is expected to be

£293m (at prevailing exchange rates) with

some elements having already been paid.

It is our intention that these financial

penalties will be paid from existing facilities

and an improved underlying cash flow

performance in the longer term.

Rolls-Royce Holdings plc Annual Report 2016 REVIEW OF 2016

In Civil Aerospace, these investments in

state-of-the-art manufacturing facilities will

enable us to meet the significant growth in

engine deliveries required to match customer

demand for our new Trent engines,

particularly the Trent 1000, Trent XWB and

Trent 7000. At the same time, the

investments lower unit costs and reduce the

net cash outflows related to engine

production. In Defence Aerospace, the

investments have focused on modernisation

of facilities such as in Indianapolis to reduce

costs and improve delivery performance of

both original equipment and spares to

support higher standards of customer

service. In Marine, new facilities will

contribute to a more efficient and scalable

manufacturing capability that will address

the demands of our customers today, while

markets are weak, and tomorrow, when they

have recovered.

The benefits of these investments are

starting to be seen in improved delivery

performance, lower assembly lead times,

lower unit costs and increased capacity.

For example, in Civil Aerospace, large engine

deliveries increased by over 15% to over 355

and capacity is now in place to deliver around

500 engines in 2017; an increase of over

a third.

The focus on improving aftermarket

excellence has been driven business-by-

Increased our focus on engineering,

operational and aftermarket

excellence

Over the last few years, we have invested

significantly in new product development

and manufacturing capabilities. In

engineering, in 2016 we invested over

£1.3bn in gross R&D. The net investment

of £937m was higher than 2015 and our

expectations for 2016. A large proportion

of this was focused on Civil Aerospace

to support delivery of three new engine

programmes which will enter service over

the next 12 months: the Trent 1000 TEN

(Thrust, Efficiency, and New technology)

the Trent XWB-97 and the Trent 7000.

Supporting these investments was a

Group-wide engineering efficiency

programme, known internally as E

which has formed part of our overarching

transformation programme. Within the

engineering team, this change programme

has focused on delivering a lean, resilient,

lower-cost engineering function

through reducing complexity, improving

work prioritisation and simplifying

management structures.

In operations, over £1.4bn has been

invested in new capital equipment since

2011 (£225m in 2016) in transforming our

manufacturing footprint across the business.

business, by customer needs as well as

through the broader transformation

activities. In Civil Aerospace for example,

this has resulted in a progressive change

to the structure of our engine overhaul

services, our commercial TotalCare® and

time and materials product offerings, and

management structures. These have

enabled us to respond to a changing market

and maturing installed engine portfolio by

adapting our resources to focus on areas of

greatest value to the Group and our

customers – such as supporting airframe

transitions and rolling out SelectCare™ and

TotalCare Flex® offerings and preparing for

the launch of LessorCare™. In Defence

Aerospace, the focus has been driven by the

customer need for more embedded support.

This has included increasing our service

presence at key customer facilities in the

UK and overseas, improving response time

and resolving a greater proportion of

issues on-wing.

PRIORITY 

Strengthen focus to drive long-term profitable growth

STRATEGIC REPORT

Engineering

excellence

Operational

excellence

Capturing

aftermarket value

Invested to support delivery of three

new engine programmes to enter

service in the next 12 months.

New powered gearbox design

successfully tested at new

German facility.

Launched a Group-wide engineering

efficiency programme, known as E

– part of our Group-wide

transformation programme.

£225m invested in 2016 in

transforming our manufacturing

footprint across the business.

Increased large aero-engine

production output by 25%.

Started modernisation of Defence

Aerospace facility in Indianapolis to

reduce costs and improve delivery

performance.

Invested to support delivery of the UK’s

new Astute and Dreadnought class

nuclear-powered submarines.

Investment driven business-by-

business, by customer needs.

Restructured our engine overhaul

services including an increased equity

investment in our MRO JVs.

Launched new commercial TotalCare

product offerings to support maturing

installed base.

Embedded aftermarket support for key

Defence Aerospace customers at key

customer facilities in the UK and

overseas.

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT REVIEW OF 2016

Transformation programme ahead

of expectations

In November 2015, we announced a major

transformation programme focused on

simplifying the organisation, streamlining

senior management, reducing fixed costs

and adding greater pace and accountability

to decision making. The initial target was to

deliver incremental gross cost savings of

between £150m-£200m per annum, with

the full benefits accruing from the end of

2017 onwards.

Against these initial objectives, which

included a target of delivering in-year

savings of £30m-50m in 2016, we have made

a better than expected start. In-year savings

in 2016 were above target, at over £60m.

During the year, we also identified

significant opportunities to drive

sustainable cost savings from the business.

As a result, we expect the in-year savings

that can be delivered in 2017 to be between

£80m-£110m and we are on track to achieve

the top end of the target for the programme

as a whole, targeting a run rate of over

£200m by the end 2017.

At the same time, other restructuring

initiatives have delivered their expected

benefits. These included programmes

to improve operational efficiency in

Civil Aerospace and Defence Aerospace

(announced in 2014) and Marine

(announced in May 2015), as well as a back

office cost saving programme in Marine

(announced in October 2015).

In December 2016, an additional

reorganisation of the Marine business was

announced to further rationalise

manufacturing activities in Scandinavia,

targeting incremental annualised savings

of £50m from mid-2017. Reflecting our

cautious near-term outlook for the Marine

business, we have also taken an exceptional

charge of around £200m for the impairment

of goodwill, principally associated with the

acquisition of Vickers in 1999.

In summary, expected ongoing benefits

of all current restructuring programmes

initiated since 2014 will reduce costs by

around £400m by the end of 2018,

compared to a 2014 baseline.

In aggregate, ongoing divisional

restructuring programmes together

with the new programme announced in

November 2015 are expected to reduce

costs by around £400m by the end of 2018,

including the full benefit of the Marine

restructuring announced in December 2016.

The cost reduction breaks down into

incremental legacy Civil Aerospace and

Defence Aerospace restructuring savings of

£80m, Marine savings of now around

£110m and the transformation programme

savings of around £200m.

2016 progress on our US transformation

In January 2016, construction began on a five-year, US$600m

modernisation programme for our manufacturing and technology

research plant in Indianapolis, Indiana, US. This is the largest

investment by the Group in the US since we purchased

the Allison Engine Company in 1995.

In September 2016, we achieved a major milestone by opening a new,

dedicated pre-production facility. This enables us to digitally design,

develop, test and perfect new manufacturing methods for the entire

site as modern production comes online over the next four years.

When complete, the 1.5 million square feet manufacturing facility will

leverage the latest technologies and production methods which,

alongside a highly-skilled workforce, will establish our Indianapolis plant

as one of the most competitive manufacturing facilities in the world.

The site will also house new technology development capabilities which

we will apply to our next-generation engines in the US.

We currently employ about 4,000 people in Indianapolis, where

engines are designed, assembled and tested for US defence aircraft,

civil helicopters, regional and business jets and power systems for

US naval vessels.

PRIORITY 

Deliver a strong start to our transformation programme

1. Turbines manufacturing

and pre-production method

development.

2. Production assembly

and test, and customer

delivery centre.

3. Experimental assembly

and test labs,

and LibertyWorks®.

Rolls-Royce Holdings plc Annual Report 2016 REVIEW OF 2016

Making transformation happen

Power

Systems

Civil

Aerospace

Defence

Aerospace

Marine GroupNuclear

Right behaviours

and culture

Simpler

processes

Simpler

organisation

Competitiveness:

improved productivity and cost

Pace and simplicity:

the right tools to stay ahead of our competitors

Continuous improvement:

embedded change for ongoing results

Accountability:

clear ownership and responsibility to deliver

£200m

cost savings

On track to deliver £200m

of annual cost savings by the

end of 2017.

25%

growth in large engines

Signicant improvement in

Trent 1000 and Trent XWB

lead times enabling a 25%

year-on-year increase in

production output of large

aero engines.

20%

reduction in senior

management positions

Five market-facing businesses

have replaced a divisional

structure with signicant

reduction in management

layers and central bureaucracy.

20%

fewer engine variants

Power Systems has met its

customers’ needs while cutting

engine variants by 20% as a

result of its simplied portfolio

of reciprocating engines.

Increased P&L

accountability

Full accountability for legacy

spares business has allowed

service teams in Defence

Aerospace to react faster to

customer needs and

increase revenues.

Eﬃciencies in

Marine

Restructuring of the Marine

business has placed full

accountability under four

market-facing businesses,

while right-sizing the

organisation to meet

the challenges of the

oﬀshore marine market.

30%

performance improvement

30% improvement in the lead

time and cost of instrumentation

and control products for civil

nuclear reactors.

42,000

employees involved in

improvement activities

42,000 employees involved in

2016 continuous improvement

activities, supported by a

network of over 700 facilitators

and champions.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT REVIEW OF 2016

the next few months, the senior leadership

team will be concluding the review of our

strengths and investment opportunities to

define an appropriate vision for the business

and the best way we can deliver sustainable

shareholder value. Conclusions from this

work will be shared during 2017.

Rebuilding trust and confidence in the

Group and its long-term prospects remains

a key priority for the management team.

The focus remains on progressive, effective

communication combined with strong

operational delivery. While we have made a

steady start, more remains to be done. The

addition of new management and a

renewed focus within the business

leadership teams, with clear goals and

stronger accountabilities, should provide a

strong platform for further progress in 2017.

Acquisition of outstanding 53.1%

stake in Industria de Turbo

Propulsores SA (ITP)

We were notified in early July that SENER

Grupo de Ingeniería SA (SENER) had decided

to exercise the put option in respect of its

53.1% stake in ITP. This decision provides us

with the opportunity to effectively

consolidate several key large engine risk and

revenue sharing arrangements (RRSAs) into

the business, strengthen our position on a

number of important defence aero engine

platforms and will enable us to enjoy greater

benefits from future aftermarket growth.

Under the shareholder agreement, the

consideration of €720m will be settled over

a two-year period following completion in

eight equal, evenly-spaced instalments. The

agreement allows flexibility to settle up to

100% of the consideration in the form of

Rolls-Royce shares. Final consideration as to

whether the payments will be settled in

cash, shares or cash and shares will be

determined by Rolls-Royce during the

payment period. Completion remains

subject to regulatory clearances and is

expected in mid-2017.

The acquisition of ITP strengthens our

position on Civil Aerospace large engine

growth programmes by capturing

significant additional value from its

long-term aftermarket revenues, including

the high volume Trent 1000 and Trent XWB

engines, where ITP has played a key role as

a participant in RRSAs. It also enhances the

Group’s own manufacturing and services

capabilities and adds value to the Defence

Aerospace business, particularly on the

TP400 and EJ200 programmes.

Further details of its impact on the Group

will be made available on completion of

the acquisition.

Rebuilding trust and confidence;

steady year with few major surprises

2016 out-turned ahead of expectations with

only a few unexpected developments from

an operational perspective, despite the

challenges presented by a changing

macro-environment and some known

weaknesses in the business. The expected

headwinds in Civil Aerospace and Marine

transpired largely as forecast. In addition,

the benefits of outperformance on

transformation savings and foreign

exchange hedging more than offset some

additional programme costs in Civil

Aerospace and a range of other smaller

one-off items. As a result, external

expectations remained largely unchanged

throughout the year.

The introduction of the new revenue

reporting standard, IFRS 15 Revenue from

Contracts with Customers, will have a

significant impact on how we present our

revenues and profits, particularly for Civil

Aerospace. As a result, a combination of

significant in-house analysis and

appropriate progressive communication

was undertaken, culminating in a capital

markets’ event in November. This set out in

some detail how we now expect the new

standard to change the presentation of

our financial results, illustrated through a

re-presentation of 2015 performance. All

the materials from this investor event were

shared at the time and are available on the

Company’s website at www.rolls-royce.com.

Priorities for 2017 broadly

unchanged; additional focus on

developing our long-term vision

and strategy

Overall, the priorities for 2017 are largely

unchanged from those set out in 2016.

We will continue to invest in strengthening

our focus on engineering, operational and

aftermarket excellence to drive long-term

profitable growth. At the same time,

2017 will be an important year to drive

incremental savings from our

transformation programme.

At our capital markets’ event in November

2016 we set out how our focus is turning

towards the Group’s long-term goals. Over

PRIORITY 

Rebuild trust and confidence in our long-term growth prospects

New Trents to

enter service

2017 will be a milestone year for our

Civil Aerospace business and its Trent

engine programmes, with three new

engines approaching entry into service.

The Trent 1000 TEN will power all

variants of the Boeing 787 Dreamliner

family and draws on technologies

from the Trent XWB and Advance

engine programmes.

The Trent XWB-97 will be the sole

powerplant for the Airbus A350-1000.

Delivering an increased 97,000lbs

of thrust, the new engine will allow

Airbus to increase the aircraft’s payload,

range and maximum take-off weight.

The Trent 7000 builds on the success of

its predecessor, the Trent 700, delivering

a 10% improvement in specific fuel

consumption while halving noise

output. It will be the sole powerplant

for the Airbus A330neo.

Taken together, these developments

underline the scale of our

commitment to research and

technology and delivering on the

needs of our customers.

Rolls-Royce Holdings plc Annual Report 2016 PRIORITIES FOR 

The successful roll-out of new engines,

led in particular by the Trent XWB, Trent

1000 and Trent 7000, together with

agrowing aftermarket, is expected to drive

significant revenue growth over the coming

ten years as we build towards a 50% plus

share of the installed widebody passenger

market. As a result, we remain confident

that the important investments we are

making to modernise our production will

create a strong platform to drive customer

service and strong cash flows, together with

the current investments in new products

and the streamlining of our existing product

portfolios to ensure we are providing

high-value, cost-competitive products into

our target end markets.

Outlook for 2017

After a better than expected 2016,

year-on-year incremental progress will be

modest. Our medium-term trajectory for

revenue, profit and free cash flow remains

unchanged. On a constant currency basis,

Group revenue for 2017 should be

marginally higher than that achieved in

2016, despite expected further weakening

in offshore oil & gas markets in Marine.

Underlying improvements in performance

should be driven largely by transformation

savings and free cash flow should benefit

from increased aftermarket cash revenues

in Civil Aerospace, further improvements

in working capital efficiency and cost

savings. As a result, we expect a modest

performance improvement overall and we

are targeting free cash flow to be similar to

that achieved in 2016. Individual outlooks

are provided in the Business review starting

on page 18.

Looking further ahead: long-term

outlook remains strong

We continue to see value in the underlying

strengths of our business: the underlying

growth of our long-term markets; the

quality of our mission-critical technology

and services; and the strength of customer

demand for these which is reflected in our

strong order book. While we have near-term

challenges and some core execution

priorities, these constants provide us with

confidence in a strong, profitable and

cash-generative future.

1 Strengthen our focus to drive long-term protable growth

Engineering

excellence

Investing in and developing the

excellence of our engineering

toproduce high-performance

powersystems.

Operational

excellence

Transforming our manufacturing

andsupply chain to embed a lean

approach across our facilities

and processes.

Capturing

aftermarket value

Leveraging our installed base,

product knowledge and capabilities

to provide outstanding services to

customers.

2 Sustain the strong start to our transformation programme.

3 Continue to rebuild trust and condence in our long-term growth prospects.

4 Develop our long-term vision and strategy.

Underpinned by a commitment to developing our people and our culture in a safe

and ethical environment.

Priorities For 2017

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT BUSINESS MODEL

Our business model seeks to

capture value from markets for

high-performance power. We do this

by developing advanced, integrated

power and propulsion systems and

providing long-term aftermarket

support and delivery of outstanding

customer services. We seek to recoup

our investment through developing

superior products, many of which

are selected for use on major

multi-year programmes.

Value creation

Our highly-skilled people create value

through a combination of a deep research

and product development capability,

world-class technology and engineering

expertise, and a substantial and experienced

supply chain with many relationships and

collaborations going back over 25 years.

We make significant investments in

advanced technology and engineering

programmes to deliver market-leading

products together with the manufacturing

capability to produce them.

Outputs

The outputs from the operation of this

business model are: long-term value

creation for our customers; a sustainable

and competitive market position; and the

generation of returns for our shareholders.

Our long-life products typically operate

in challenging environments where they

are expected to deliver sustained levels

of performance, such as fuel efficiency

and reliability. For our customers, they

deliver value through enhancing the

competitiveness of their own product or

service, whether airframe or other transport

or industrial application.

The product offering is often combined with

flexible service options to best suit each

customer’s operating needs. In certain

markets we further strengthen our

customer relationships through long-term

service agreements where we commit to

deliver exceptional standards of service,

including high levels of product operational

availability. This provides significant value

to customers and, in return, we achieve

long-term predictable revenues.

Our long-term competitive position also relies

on having a full lifecycle design, sourcing

and manufacturing platform which is capable

of developing products which incorporate

advanced materials often operating close to

the limits of their capabilities. Our operational

focus is on ensuring we can deliver these

on-time and in increasing scale. As production

levels rise, we will benefit from increasingly

cost-efficient manufacturing and lower

unit costs.

By growing our installed base of power

systems and leveraging our aftermarket

service activities, we enhance our revenue,

profit and cash flow. Cash flow is then

invested to support future product

development and technology programmes,

driving growth while providing

shareholder returns.

Our business model

How we create value

Value creation

Customers:

Differentiated products

aligned to their

operating requirements

Corporate:

Strong market position

World-class development

and production facilities

Shareholders:

Long-term

cash flow generation

Engineering

excellence

Operational

excellence

Capturing

aftermarket value

Inputs

• People and expertise

• R&D capability

• Supply chain collaboration

• Advanced manufacturing

• Customer relationships

• Financial investment

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS MODEL

Develop technology

that anticipates

customer needs

Our deep understanding

ofcustomer needs drives

thedevelopment of new

technologies and products.

Disciplined capital

allocation

We allocate our capital

toachieve abalance of

financial strength

andliquidity to deliver

commercial advantage and

sustainable long-term

shareholder returns.

Grow market share

andinstalled base

Our substantial order

book for both original

equipment and services

provides good visibility

of future revenues and

provides a firm foundation

to invest withconfidence.

Secure and maximise

aftermarket opportunity

Our equipment is in

service for decades.

Our deep design

knowledge and in-service

experience ensures that

weare best placed

to optimise product

performance

and availability.

Invest in R&D

and skilled people

Developing and protecting

leading-edge technology

and deploying it across our

businesses allows us

to compete on a global

basis and creates high

barriers toentry.

Manufacturing capability

We manufacture

cost-efficiently through

a combination

ofeconomies of scale,

developing alean

enterprise and integrated

management of our

supply chain.

Investment in future

programmedevelopment

We make significant investment

indevelopment programmes

which we believe will deliver

cost-efficient and competitive

next-generation products

and services.



Engineering excellence

Industry-leading R&D

Proven product reliability

Exceptional long-life products

Differentiated products and services



Operational excellence

Strong supply chain partnerships

Sustained cost reduction

Transforming to world-class production

capability

Cost-focused lean enterprise

High performance culture



Capturing aftermarket value

Long-term relationships with civiland

defence customers

Decades of in-service experience

Flexible range of service offerings

Growing installed base and global

aftermarket footprint

Design, make and service

world-class products

Wewin and retain customers by

developing and delivering products

and services that provide more capability

and offer better through-life value than

those ofour competitors.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT FINANCIAL SUMMARY

Order book and order intake

During the year, our order book increased

by £3.3bn to £79.8bn, led by Civil Aerospace,

which, alongside strong order intake, also

benefited from a £2.1bn uplift from a

five cent decrease to our long-term US dollar

planning rate. Order intake in our Marine

business was poor, largely as a result of the

continuing weak offshore market. Overall,

orders were also lower in Defence Aerospace,

Power Systems and Nuclear, although we

view the prospects for these businesses as

unchanged, reflecting long-term orders won

in previous years.

Underlying trading

Underlying Group revenue declined 2%

in 2016 compared to 2015 on a constant

currency basis, reflecting declines in both

original equipment revenue (down 2%)

and services (down 3%) and driven almost

entirely by Marine. By business on a

constant currency basis, Civil Aerospace

revenue was unchanged, Defence Aerospace

revenue increased 1%, Power Systems

revenue decreased 1%, Marine revenue

Financial summary

GROUP TRADING SUMMARY

£m 2015*

Underlying

change**

Foreign

exchange*** 2016

Order book 76,399 3,329 82 79,810

Underlying revenue 13,354 (296) 725 13,783

Change -2% +5% +3%

Underlying OE revenue 6,724 (112) 415 7,027

Change -2% +6% +5%

Underlying services revenue 6,630 (184) 310 6,756

Change -3% +5% +2%

Underlying gross margin 3,203 (577) 197 2,823

Gross margin % 24.0% -390bps 20.5%

Commercial and administrative costs (1,025) (71) (67) (1,163)

Restructuring costs (39) 41 (2) –

Research and development costs (765) (47) (50) (862)

Joint ventures and associates 118 (11) 10 117

Underlying profit before financing 1,492 (665) 88 915

Change -45% +6% -39%

Underlying operating margin

11.2% -480bps 6.6%

* 2015 figures have been restated as a result of £21m of costs previously reported in ‘cost of sales’, being reclassified

as ‘other commercial and administrative costs’ to ensure consistent treatment with 2016.

** Order book underlying change includes £2.1bn increase from a change to our long-term US dollar planning rate.

*** Translational foreign exchange impact.

decreased 24% and Nuclear revenue

increased 11%.

Underlying profit before financing of £915m

(2015: £1,492m) was 45% lower on a

constant currency basis, led by a significant

reduction in Civil Aerospace profit. This

reflected the previously communicated

volume and margin reductions on

link-accounted Trent 700 engines, reduced

business jet original equipment volumes,

reduced large engine utilisation and

increased technical costs for large engines.

In addition, reported 2015 numbers

included one-off benefits from a

methodology change in respect of risk

assessment and reversal of impairments

and provisions in respect of a Trent 1000

launch customer, totalling £189m and £65m

respectively. These were partially offset by

strong lifecycle cost improvements on

installed engines and some provision

releases. Profit in Defence Aerospace at

£384m was 8% lower on a constant currency

basis largely reflecting additional costs

related to the TP400 programme. Power

Systems was down 14% year-on-year

principally due to volume reduction and

adverse changes to product mix.

Marine profit was sharply lower led by

continuing weakness in the offshore

markets. Nuclear profit was 37% lower than

2015 due to a lower margin mix in

submarine projects.

Underlying gross margin was £2,823m,

down 390 basis points to 20.5% largely

reflecting the lower margins in Civil

Aerospace, Defence Aerospace and Marine.

Commercial and administrative costs

include accruals for employee incentive

schemes in line with our current policies.

Given the good performance relative to

original plan, these are higher than in the

prior year. This contributed to commercial

and administrative costs being £71m higher

on a constant currency basis year-on-year.

The R&D charge increased by 6% over 2015

on a constant currency basis, reflecting

increased charges in Civil Aerospace and

the adverse year-on-year effect of the

favourable R&D credit adjustment taken

in 2015 in Nuclear.

Underlying restructuring charges reduced by

£41m reflecting the lower level of underlying

restructuring as most costs in 2016 were

taken as exceptional due to the nature of the

restructuring activities within the Group.

The exceptional charge in relation to these

programmes was £129m in 2016. This

included £92m for the transformation

programme launched in November 2015,

which delivered in-year benefits of over £60m

in 2016. The underlying tax rate for 2016

increased to 32.1% (2015: 24.5%). The primary

reasons for the increase are the

non-recognition of deferred tax assets on

losses in Norway, which reflects the current

uncertainty in the oil & gas markets, and

a different profit mix with more profits

arising in countries with higher tax rates.

Reported results

Reported results are impacted by the

mark-to-market adjustments driven by

movements in USD:GBP and EUR:GBP

exchange rates over the year. In addition, we

recognised the £671m charge related to the

agreements reached in respect of regulatory

David Smith

Chief Financial

Officer

Rolls-Royce Holdings plc Annual Report 2016 FINANCIAL SUMMARY 

20162015201420132012

2016

2015201420132012

201620152014201420132012

inc Energy

exc Energy

£14,955m

REPORTED REVENUE

£(4,636)m

REPORTED (LOSS)/PROFIT BEFORE TAX

6.8%

NET R&D AS A PROPORTION OF UNDERLYING REVENUE

2015 £13,725m

2014 £13,736m

2013 £15,513m

2012 £12,161m

2015 £160m

2014 £67m

2013 £1,759m

2012 £2,766m

2015 6.2%

2014 exc 5.9%

2014 inc 5.8%

2013 4.8%

2012 4.7%

201620152014201420132012

inc Energy

exc Energy

201620152014201420132012

inc Energy

exc Energy

Net debt and foreign currency

The Group is committed to maintaining

a robust balance sheet with a healthy,

investment-grade credit rating.

We believe this is important when selling

high-performance products and support

packages which will be in operation for

decades. Standard & Poor’s updated its

rating in January 2017 to BBB+ from

A-/negative outlook and Moody’s

maintained a rating of A3/stable.

During 2016, the Group’s net debt position

increased from £111m to £225m, reflecting

the £100m free cash inflow, shareholder

payments of £301m and £154m for the

increased investment in our approved

maintenance centre joint ventures following

receipt of regulatory approval for the

changes to the joint venture agreements

in June 2016. In April, we increased our

revolving credit facilities by £500m to

£2bn to provide additional liquidity.

The Group hedges the transactional foreign

exchange exposures to reduce volatility to

revenues, costs and resulting margins.

The hedging policy sets maximum and

minimum cover ratios of hedging for net

investigations, a goodwill impairment

charge of £219m largely reflecting a more

cautious outlook for our Marine business

and £129m of exceptional restructuring

cost. As a result, the reported loss before tax

was £(4,636)m (2015: a profit of £160m).

Free cash flow

Free cash inflow in the year was £100m

(2015: £179m), better than expected,

reflecting strong cash collections from a

number of key customers at the very end of

the period and an improvement in underlying

working capital performance. This helped

offset the lower profit before tax and higher

expenditure on property, plant and

equipment and intangibles. The latter reflects

the increased capital investment in new

manufacturing capacity, higher capitalised

R&D, mainly related to the Trent 1000 TEN

and higher certification costs on the Trent

XWB-97. More details on the movement in

trading and free cash are included in the

Funds flow section of the Financial review.

While some of this positive variance is a

timing impact and likely to reverse early in

2017, improved efficiencies should drive a

level of sustainable benefit.

transactional foreign exchange exposure.

It allows us to take advantage of attractive

foreign exchange rates, whilst remaining

within the cover ratios. A level of flexibility

is built into the hedging instruments to

manage changes in exposure from one

period to the next and to reduce volatility

by smoothing the achieved rates over time.

The most significant exposure is the net

US dollar income which is converted into GBP

(currently approximately $5bn per year and

forecast to increase significantly by 2021).

Following the fall in the value of sterling,

which resulted from the outcome of the EU

referendum, additional cover has been taken

out to benefit from the favourable rates.

This has resulted in an increase in the nominal

value of the hedge book to approximately

$38bn at the end of 2016 (end2015: $29bn)

together with a reduction in the average rate

in the hedge book to £/$1.55 (end

2015:£/$1.59). The movement in the average

achieved rate year-on-year was around two

and a half cents, providing a net underlying

Group benefit, after balance sheet effects

(the movement in achieved rate also affects

creditor and debtor balances of hedged

cash flows), of around £20m.

STRATEGIC REPORT

£13,783m

UNDERLYING REVENUE

2015 £13,354m

2014 exc £13,864m

2014 inc £14,588m

2013 £15,505m

2012 £12,209m

£813m

UNDERLYING PROFIT BEFORE TAX

2015 £1,432m

2014 exc £1,617m

2014 inc £1,618m

2013 £1,759m

2012 £1,434m

201620152014201420132012

inc Energy

exc Energy

6.6%

UNDERLYING OPERATING MARGIN

2015 11.2%

2014 exc 12.1%

2014 inc 11.5%

2013 11.8%

2012 12.0%

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT BUSINESS REVIEW

In 2016, the Trent 1000 was selected to

power the rst test ight of the Boeing

787-10 Dreamliner. It has already powered

the rst ights of the 787-8 and 787-9.

Key highlights

Underlying revenue unchanged; gross

margins lower:

• Original equipment (OE): increased

deliveries of newer Trent engines but

lower link-accounted Trent 700 and

business aviation sales reduced

achieved margins.

• Services: growth from in-production

large engine fleet, but declining regional

and older large engine fleet aftermarket

revenues; increase in technical costs for

large engines, including the Trent 700

and Trent 900, largely mitigated by

foreign exchange benefits.

£4.4bn order book growth; includes

£2.1bn benefit from long-term US dollar

planning rate change.

New programmes: Trent 1000 TEN

received EASA certification in July; first

test run of new UltraFan® gearbox; first

flight of the Airbus A350-1000 powered

by the Trent XWB-97.

Supply chain modernisation reducing

costs and increasing capacity for Trent

XWB ramp up.

2017 outlook: modest growth in revenue

and profit; cost improvements offsetting

OE and aftermarket mix effects.

CIVIL

AEROSPACE

Operational review

Financial overview

Overall, underlying revenue for

Civil Aerospace was unchanged (up 2%

at actual exchange rates). OE revenue

was unchanged, with increases from

higher volumes of large engines being

offset by the decline in business jet

engines and V2500 modules. Aftermarket

revenue was down 1% despite strong

growth from our in-production engines.

OE revenue from Large engine: linked

and other* was up 2% reflecting increased

volumes of Trent 900s and a higher

number of spare Trent XWB engines,

partly offset by Trent 700 volume and

price reductions, ahead of the introduction

of the Trent 7000 for the Airbus A330neo.

Sales of spare engines to joint ventures,

included in Large engine: linked and

other*, generated revenue of £288m

(2015: £189m).

OE revenue from Large engine: unlinked

installed* increased 47%, led by higher

volumes of Trent XWBs.

* See table on page 20.

UNDERLYING REVENUE MIX

OE revenue 48%

Services revenue 52%

UNDERLYING REVENUE BY SECTOR

Large engine 66%

Business aviation 17%

Regional 5%

V2500 12%

Business review

Summary

The Civil Aerospace business is a major manufacturer of aero engines for the large

commercial aircraft and corporate jet markets. We power 35 types of commercial

aircraft and have more than 13,000 engines in service around the world.

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW 

Large engine service revenue reflected

double digit growth from our in-production

engines which more than offset the

reduction from older engines, including

the expected lower year-on-year utilisation

of Trent 500 and Trent800 engines. Time

and material revenue reduced, as a result

of fewer overhauls of engines across the

out-of-production fleet.Contract

accounting effects within service revenue

in 2016 were significantly lower than prior

year. As a result, while there was a small

foreign exchange improvement in 2016,

underlying service revenue from large

engines was down 4%. Adjusting for

contract accounting effects, service revenue

from large engines would have been up 2%.

Revenue from business aviation* OE engine

sales was, as expected, lower, particularly

for the BR710 engines, reflecting general

market weakness and a transition to newer

non Rolls-Royce powered platforms. Volumes

of our newer BR725 engine, which powers

the Gulfstream G650 and G650ER, were

stable. Overall, business aviation* OE

revenues declined 25% while aftermarket

revenue was slightly down. Service revenue

from our regional *jet engines declined 14%,

reflecting retirements and reduced

utilisation of relevant fleets by North

American operators in particular.

On the V2500* programme, which powers

aircraft including the Airbus A320, revenue

from OE modules declined 10% reflecting

the production slow-down as Airbus

transitions to the A320neo, powered by

another engine provider. However, V2500*

service revenues were 21% higher, reflecting

price escalation on flying hour payments

together with increased overhaul activity.

Overall gross margins for Civil Aerospace

were 16.8% (2015: 22.0%), declining £397m

from 2015 on a constant currency basis.

The main headwinds were as forecast at the

start of the year: OE reductions to the Trent

700 programme; business aviation engines

and V2500 modules; reduced utilisation and

fewer overhauls of our out-of-production

Trent 500 and Trent 800 and RB211 engines;

and the declining regional aftermarket.

In addition, we also incurred programme

charges of around £30m for engines still

in development. These were partially offset

by the release, after accounting and legal

review, of accruals related to the

termination in prior years of intermediary

services, totalling £53m (2015: £nil). Gross

margin from spare engine sales to joint

ventures contributed £97m (2015: £67m).

The in-year net benefit from long-term

contract accounting adjustments totalled

£90m (2015: total benefit of £222m, which

included a £189m one-off benefit associated

with the refinement of our methodology for

risk assessment of future revenue). The

£90m included a £217m benefit from

lifecycle cost improvements (2015: benefit of

£140m). We also recognised in this period a

£35m benefit from a five cent change (2015:

£nil) to our estimated long-term US dollar

to sterling exchange rate to bring our own

planning rate within updated external

benchmark long-term forecast data. These

benefits were offset by technical costs of

£98m (2015: £24m) for large engines,

including the Trent 900, relating to the need

for increased shop visits in the short term,

and the Trent 700, where we are upgrading

the engine management system, together

with a charge of £64m (2015: £83m),

reflecting other operational changes.

The year-on-year change was also impacted

by a one-off £65m write-back in 2015

of a previously recognised impairment of

contractual aftermarket rights (CARs) for

sales to a launch customer and the release

of a related provision; in 2016 these sales

were capitalised as CARs.

Costs below gross margin were £89m higher

than the previous year at £818m on an

underlying basis. Within this, R&D charges

of £568m were £34m higher, reflecting

higher spend on key programmes,

particularly in respect of the Trent 7000

which are being expensed ahead of

capitalisation and lower development cost

contributions from risk and revenue sharing

partners, partly offset by increased R&D

capitalisation on the Trent 1000 TEN.

Underlying commercial and administrative

costs were £43m higher than 2015 reflecting

increased employee incentive charges.

Underlying restructuring costs of £11m were

£4m higher than 2015 and profits from joint

ventures and associates were down £8m.

As a result, profit before financing and tax

was 55% down, reflecting a combination

of lower overall gross margins, higher

commercial and administrative, R&D and

restructuring costs and reduced joint venture

and associate profits. Taking account of

foreign exchange effects, underlying profit

before financing and tax was £367m

(2015: £812m).

CIVIL AEROSPACE | KEY FINANCIAL DATA

£m 2015

Underlying

change*

Foreign

exchange ** 2016

Order book 67,029 4,395 2 71,426

Engine deliveries 712 (63) 649

Underlying revenue 6,933 (27) 161 7,067

Change – +2% +2%

Underlying OE revenue 3,258 14 85 3,357

Change – +3% +3%

Underlying services revenue 3,675 (41) 76 3,710

Change -1% +2% +1%

Underlying gross margin 1,526 (397) 56 1,185

Gross margin % 22.0% -570bps 16.8%

Commercial and administrative costs (296) (43) (3) (342)

Restructuring costs (7) (4) – (11)

Research and development costs (515) (34) (19) (568)

Joint ventures and associates 104 (8) 7 103

Underlying profit before financing 812 (486) 41 367

Change -60% +5% -55%

Underlying operating margin 11.7% -700bps 5.2%

* Order book underlying change includes £2.1bn increase from a change to our long-term US dollar planning rate.

** Translational foreign exchange impact.

ORDER BOOK

£71.4bn

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT BUSINESS REVIEW

Trading cash flow

Trading cash flow before working capital

movements of £22m declined year-on-year

by £462m, driven by a reduction in

underlying profit before financing of

£445m and increased property, plant and

equipment additions. There were also

increased certification costs driven by the

Trent XWB-97 and higher R&D capitalisation

of the Trent 1000 TEN development costs,

offset in part by other timing differences

including provision movements.

The overall trading cash flow improvement

of £43m resulted largely from a significant

year-on-year improvement in working

capital, due mainly to differences in the

timing of payments to suppliers and

increased deposits, offset in part by an

increase in inventory. In addition, reflecting

the lower profits recorded on our linked

engines such as the Trent 700, net long-term

contract debtor additions were also lower.

TotalCare net assets and contractual

aftermarket rights

TotalCare net assets increased in 2016 by

£230m (2015: £406m) to £2.44bn reflecting

accounting for new linked engines of £432m

(2015: £521m), contract accounting

adjustments taken in the year of £90m

(2015: £222m) offset by the cash inflows and

net other items of £(292)m (2015: £(337)m).

It should be noted that the £230m net asset

increase is different from the £246m used in

the trading cash flow above because of

foreign exchange effects on evaluating

TotalCare net debtor balance movements.

The CARs balance increased by £169m (2015:

increase of £156m) to £574m reflecting

higher sales of unlinked Trent XWB engines

partly offset by engine cost improvements.

Investment and business

development

Order intake of £14.1bn in 2016 for Civil

Aerospace was £1.3bn higher than the

previous year. The order book closed at

£71.4bn, up £4.4bn or 7% from 2015, which

included a £2.1bn benefit from the change

in the long-term planning foreign exchange

rate discussed previously. Excluding this, the

order book was up 3%.

Significant orders in 2016 included a US$2.7bn

order from Norwegian for Trent 1000 engines,

an order from Garuda Indonesia worth $1.2bn

for Trent 7000 engines and a $900m order

from Virgin Atlantic for Trent XWB. All of these

include the provision of long-term TotalCare

engine services.

Foundations for future growth are built from

our investment in engineering excellence

During the year, we committed resources

in order to ensure we made significant

CIVIL AEROSPACE | REVENUE SEGMENTATION

2015

Underlying

change

Underlying

change %

Foreign

exchange

£m

2016

£m % of total % of total £m

Original equipment 3,258 48% 14 – 85 48% 3,357

Large engine: linked and other 1,570 23% 32 +2% 2 23% 1,604

Large engine: unlinked installed 504 7% 237 +47% 1 10% 742

Business aviation 903 14% (228) -25% 82 11% 757

V2500 281 4% (27) -10% – 4% 254

Service 3,675 52% (41) -1% 76 52% 3,710

Large engine 2,371 34% (84) -4% 2 32% 2,289

Business aviation 425 6% (13) -3% 40 6% 452

Regional 360 5% (52) -14% 34 5% 342

V2500 519 7% 108 +21% – 9% 627

CIVIL AEROSPACE | TRADING CASH FLOW

£m 2016 2015 Change

Underlying profit before financing 367 812 (445)

Depreciation and amortisation 491 410 81

Sub-total 858 1,222 (364)

CARs additions (208) (161) (47)

Property, plant, equipment and other intangibles (739) (502) (237)

Other timing differences

111 (75) 186

Trading cash flow pre-working capital movements 22 484 (462)

Net long-term contract debtor movements (246) (406) 160

Other working capital movements 267 (78) 345

Trading cash flow

43 – 43

* Includes timing differences between underlying profit before financing and cash associated with: joint venture profits less dividends received; provision charges higher /(lower) than

cash payments; non-underlying cash and profit timing differences (including restructuring); and financial assets and liabilities movements including the effect of foreign exchange

movements on non-cash balances.

** Trading cash flow is cash flow before: deficit contributions to the pension fund; taxes; payments to shareholders; foreign exchange on cash balances; and acquisitions and disposals.

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW 

progress across all key engineering

programmes in 2016. The Trent 1000 TEN

engine undertook its first test flight in

March and received its European Aviation

Safety Agency (EASA) certification on 11 July.

The Trent 1000 TEN will power all variants of

the Boeing 787 Dreamliner family and will

power the first flight of the 787-10 in 2017.

In November, the latest version of the Trent

XWB, the higher thrust -97 engine,

successfully powered the first flight of the

Airbus A350-1000 in Toulouse. The Trent

7000 engine, which will exclusively power

the Airbus A330neo, undertook ground

testing for the first time and we started

assembly of the first flight test engines.

In respect of future technologies, the

Advance3 large engine demonstrator is

proceeding well. The engine will test the

new core architecture for future engine

families and other key technologies such

as lean burn combustion, ceramic matrix

composites (CMC), CastBond (specialist

turbine manufacturing) plus additive layer

manufacturing (or 3D printing). It is currently

in development at our Bristol, UK, facility with

all core modules advancing well.

In September, we successfully ran the

world’s most powerful aerospace gearbox

for the first time under the joint venture

Aerospace Transmission Technologies (ATT).

The gearbox is designed to reach up to

100,000 horsepower and is a significant step

in the development of the new UltraFan

engine technology.

Supporting our commitment to research

and development, we also announced a

US$30m expansion into a new facility in

Cypress, California, that will be dedicated

to research and development of ceramic

matrix composite materials and processes

for use in next generation aircraft

engine components.

Investing in new aerospace supply chain

capabilities to help drive operational

excellence

In January 2016, we announced plans to

invest more than £30m at our site in

Washington, Tyne & Wear, UK, creating a

new facility to manufacture a range of

aerospace discs for in-service engines. The

new facility is expected to be fully

operational in 2018 and will have the

capacity to manufacture well over 1,500 fan

and turbine discs a year for use in a wide

range of existing engines.

The construction of a £50m extension

to our wide-chord fan blade facility in

Barnoldswick, UK, started in December.

The expanded facility will be able to

manufacture 6,000 large Trent fan blades

a year, almost twice its current capacity.

We also announced the creation of a

centre of excellence in structures

& transmissions at the same site. The new

centre, supported by £20m of investment,

will manufacture many of the complex

structures that feature in all Rolls-Royce

aero engines.

Good progress strengthening our aerospace

aftermarket service offering

We have continued to invest in our service

capabilities to support our customers with

state-of-the-art facilities and relevant

products and services, particularly within

our portfolio of TotalCare offerings.

During the year, we completed changes to

three Approved Maintenance Centre (AMC)

joint ventures. This included investing

£154m to increase our stake in both Hong

Kong Aero Engine Services Limited (HAESL)

and Singapore Aero Engine Services Pte

Limited (SAESL) to 50%. These AMCs support

our strategy to offer a competitive, capable

and flexible Trent service network to meet

the changing needs of customers across the

lifecycle of engines and to support the

growing Trent engine fleet.

Additionally, we announced further details

of a new AMC in Abu Dhabi with Mubadala

Development Company, the emirate-based

investment and development organisation.

This purpose-built facility will carry out

work on the Trent XWB.

We also announced that we are further

expanding our global network of Authorised

Service Centres (ASC) for business aviation

aircraft under our CorporateCare® service

provision for customers. Rolls-Royce now

has 62 ASCs in place with key maintenance

providers worldwide.

Following the launch of SelectCare in 2016,

we secured our first agreement for Trent

800 engines as part of a wide-ranging deal

with Delta Airlines.

Civil Aerospace outlook

On a constant currency basis, our Civil

Aerospace business should deliver modest

growth in revenue and profit in 2017,

supported by large engine aftermarket

growth, further lifecycle cost reductions and

a higher level of R&D capitalisation. Business

jet demand is expected to weaken further,

as will the demand for aftermarket services

to support Rolls-Royce powered regional

aircraft. After a better year for trading cash

flow in 2016, we now expect this to be

broadly unchanged year-on-year reflecting

higher volumes of cash-loss-making engines

offsetting the positive effects of higher

aftermarket cash revenues.

We expect the TotalCare net asset to peak in

the next 12 months at between £2.5bn and

£2.7bn, reflecting further targeted lifecycle

cost improvements and other timing

differences between cost and cash.

Positive market developments continue to

drive long-term growth in Civil Aerospace

The long-term positive market trends for

our leading power and propulsion systems

remain unchanged despite some near-term

uncertainties in Civil Aerospace that continue

to impact business jet engine production

volumes and service activity on older large

engines. The long-term trends driving

demand for growth in large passenger

aircraft, business jets, power systems and

maritime activity remain strong; in particular

a growing aspirational and mobile

middle-class, particularly in Asia, and

globalisation in business, trade and tourism.

While recent political and economic

developments have added some uncertainty

to near-term utilisation, we continue to

expect that strong widebody airframe

demand – driven by the need for newer,

more fuel-efficient aircraft – should provide

resilience to manufacturing schedules over

the next few years as the industry

undergoes a strong replacement cycle.

New airframe growth and transitions are

in line with expectations

Preparations for the transition of the Airbus

A330ceo to A330neo models are also

progressing well and once the transition is

completed we will benefit from an exclusive

position with the new Trent 7000 on

the A330neo.

The roll-out of new engines, including the

Trent XWB for the highly successful Airbus

A350 family, will significantly grow our

market share and the installed base of new

engines that will deliver strong aftermarket

revenues for decades to come.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT BUSINESS REVIEW

Market dynamics

• Overall there has been a slowdown in all

major geographical markets for new aircraft

orders after a period of higher than normal

order placement for new airframe products

in recent years (principally Airbus A350 XWB

and A330neo, and Boeing 787 and 777X).

• Long-term growth in the number of

widebody aircraft in the global fleet has

historically been strongly correlated to global

GDP growth and disposable income.

• Historically, growth has recovered quickly

following major economic shocks. The

geographic spread of our installed base and

wide customer base spreads our risk and

reduces our exposure to any one shock.

• Our current share in the widebody engine

market is at 32% of the installed passenger

fleet and is expected to exceed 50% early in

the next decade.

• Older widebody aircraft are experiencing

reduced utilisation by certain airlines.

• Trent-powered aircraft are starting to

transition from their original operators

to other operators as the fleet matures.

This year, 46 Trent-powered aircraft

transitioned, 13 of which were

Trent 800-powered Boeing 777 aircraft.

• Over 90% of the Rolls-Royce widebody

engine fleet is covered by our TotalCare

service agreements.

• Over 65% of Rolls-Royce business jet engines

are covered by our CorporateCare service

agreements.

• Long-term demand for large business jets is

related to global economic growth and

increases in the number of high net worth

individuals; the sector has historically been

fairly resilient to financial shocks.

• The business jet market is slowly recovering in

the US (our largest market), but is currently

going through a slowdown elsewhere due to

political tensions and customer anticipation

of new models about to enter into service.

• Aftermarket demand for engines on

50-70 seat aircraft is reducing in line

with expectations.

Competition

• GE is the main competitor supplying

engines in the widebody sector. In 2016,

deliveries of engines for widebody passenger

aircraft were split Rolls-Royce 38%, GE 54%,

Engine Alliance 6% and Pratt & Whitney 2%.

• Rolls-Royce is well positioned on all Airbus

widebody airliner programmes and competes

with GE on the Boeing 787 family.

• Rolls-Royce is the sole engine provider on the

Airbus A350 XWB family where 810 aircraft

have been ordered so far.

• GE is the sole engine provider on the Boeing

777X aircraft, scheduled to enter into service

in 2020 where 306 have been ordered so far.

• In large business jets, the main competition is

GE, Pratt & Whitney and Safran.

• Rolls-Royce has 3,100 powered business jets

flying, representing 55% market share of the

large/very large business jet fleet.

Business risks

• If we experience a major product failure

in service, then this could result in significant

adverse financial and reputational

consequences and potential litigation.

• If an external event or severe economic

downturn significantly reduces air travel

and thereby reduces engine flying hours

and demand for aircraft, then our financial

performance may be impacted.

• If our aircraft manufacturer customers

significantly delay their production rates,

then our financial performance may be

impacted.

• If we fail to achieve cost reductions at the

necessary pace, then our ability to invest in

future programmes and technology may

be reduced.

• If we experience significant pricing pressure

from increased competitor challenge in our

key markets, then our financial performance

may be impacted.

• If we suffer a major disruption in our supply

chain, then our delivery schedules may be

delayed, damaging our financial performance

and reputation.

• If there are significant changes to the

regulatory environment for the airline

industry, then our market position may

be impacted.

Key Rolls-Royce diﬀerentiators

Barriers to entry are extremely

high. We invest heavily to maintain

market-leading technologies and

system level integration

capabilities to deliver the best

engine performance for our

customers. We offer a wide range

of aftermarket services which

provide flexible and cost-effective

options to our customers and

build long-term relationships.

Market review

Rolls-Royce is one of the world’s leading civil

aero-engine manufacturers with particular

strengths in engines for civil widebody

aircraft and large business jets, underpinned

by our strength and continued investment

in technology.

We have a strong market position on

widebody aircraft produced by the world’s

two major aircraft manufacturers: Airbus

and Boeing, who are broadly consistent in

forecasting air traffic growth (revenue

passenger kilometres) of approximately

5% compound annual growth rate over

the next 20 years. In the engine market for

narrowbody aircraft, we continue to supply

some parts and services for the IAE V2500

engine family.

We are market leaders in the large business

jet fleet market powering aircraft from

most of the main aircraft manufacturers.

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW 

Opportunities

• Our position and long-term prospects in

the widebody sector are strong across our

Trent family.

• We continue to invest in our technology

demonstrator programmes which underpin

our Advance and UltraFan engine

programmes. We are well positioned for

future aircraft requirements, while also

delivering technologies to enhance our

existing product portfolio.

• The Trent XWB has now been in service for

two years, with 64 Airbus A350s delivered

to ten airlines and one lessor. In November,

the A350-1000 successfully completed its

first flight.

• Rolls-Royce is the sole supplier of engines

for the new Airbus A330neo. The Trent 7000

engine is in development, and the first flight

is expected in 2017.

• The new Trent 1000 TEN for the Boeing 787

is scheduled to enter service in 2017, which

will deliver significant fuel efficiency

improvement and an opportunity for greater

market capture.

• China’s COMAC is also planning a joint

programme with Russia’s UAC to develop

a widebody aircraft, targeting entry into

service around 2025. We remain in close

dialogue with COMAC and UAC to understand

their plans and whether their widebody

programme presents an opportunity

for Rolls-Royce.

• Our business jet market share is likely to fall

in the medium term with the success of new

entrants into the large/very large sector, but

the market remains attractive and we will

continue to invest to improve our position

and retain leadership.

The latest version of the Rolls-Royce

Trent XWB, the most efficient large aero

engine flying in the world today, has

powered the Airbus A350-1000 aircraft to

the skies for the first time. The Trent

XWB-97 is the sole powerplant for the

Trent XWB

longer range A350-1000, which will enter

service in 2017.

The first test flight, which took place in

November at Toulouse, France, marked

another milestone for the Trent XWB, our

largest Civil Aerospace programme.

The Trent XWB-84 has already delivered

outstanding performance and reliability

since it first went into service in January

2015, powering the A350-800 and

A350-900. The Trent XWB, specifically

designed for the A350 XWB, is the fastest-

selling widebody engine ever, with more

than 1,600 already sold or on order.

READ MORE AT WWW.ROLLS-ROYCE.COM

STRATEGIC REPORT

 STRATEGIC REPORT BUSINESS REVIEW Rolls-Royce Holdings plc Annual Report 2016

Summary

We are a leading engine maker for the military transport and patrol market and

the second largest provider of defence aero-engine products and services globally.

Rolls-Royce has 16,000 defence engines in service with 160 customers in over

100 countries.

Key highlights

Underlying revenue up slightly; modest

growth in OE.

Underlying profit before financing down

8%; reflecting adverse product mix and

costs related to the TP400 programme,

partially offset by through-life cost-

savings on a major EJ200 contract.

Investing to enhance manufacturing,

aftermarket service and closer proximity

to core customers.

2017 outlook: revenue steady; margin

and profit expected to soften from

recent levels.

DEFENCE

AEROSPACE

Operational review

Financial overview

Underlying revenue of £2,209m was up

slightly on the prior year. Higher volumes

for TP400 production, together with

increased Adour engine deliveries, helped

original equipment (OE) revenues increase

3%.Service revenues were stable, with lower

demand for spare parts offset by increased

revenues from long-term Eurofighter

Typhoon and C-130J service contracts.

Gross margin declined by £49m, reflecting

lower sales of spare parts, an adverse

change in OE product mix, additional

expenditure of £31m on the TP400

programme and higher payroll costs.

Retrospective contract margin

improvements totalled £82m, £5m lower

than prior year, but ahead of early

expectations.Of this, around half relates

to delivering significant cost saving

benefits on the largest Eurofighter

Typhoon contract, which triggered a

cost-saving incentive award.

UNDERLYING REVENUE MIX

UNDERLYING REVENUE BY SECTOR

OE revenue 40%

Services revenue 60%

Combat 33%

Transport and patrol 45%

Other 22%

The F-35 Lightning II employing the

Rolls-Royce LiftSystem®, demonstrated

its vertical landing capabilities in the

UK for the rst time in 2016.

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEWBUSINESS REVIEW

While overall R&D costs were slightly lower

than the prior year, the business continued

to invest in future programme development

and the Indianapolis transformation.

Restructuring costs were lower due to

reduced level of severance costs and reversal

of a provision for the closure of the defence

facility at Ansty, UK, through better cost

recovery than expected. Underlying

commercial and administrative costs and

other costs were similar to prior year.

Profit before financing of £384m was 8%

lower than the prior period, driven by the

lower gross margin.

Investment and business

development

Order intake for 2016 was £1.5bn (2015:

£1.7bn), reflecting significant follow-on

export orders being delayed to 2017.

Significant activities in 2016 included:

winning orders for the F-35B LiftSystem™;

increased MRTT engines for A330 aircraft;

and contract renewals for services.

Deliveries of engines were slightly higher

in 2016, driven by increased units for TP400

and Adour export. Services revenues were

steady, reflecting higher flying hours from

newer EJ200, F405 Adour and AE 2100

powered aircraft in the UK, North America

and the Middle East.

The first T56 Series 3.5 technology insertion

kits delivered to the US Air Force (USAF)

for its legacy Hercules C-130 fleet have

validated the expected fuel saving and

performance benefits, prompting growing

interest in the upgrade.

The UK and French Governments also

committed to the €2bn UK-France Unmanned

Combat Air System (FCAS) unmanned combat

air system programme in December, enabling

progress through to the demonstrator phase

of the programme in 2017. Our LibertyWorks

development unit was selected to provide

the vertical lift propulsion for the new DARPA

VTOL X-Plane.The unit also launched an

infrared footprint suppression module,

reflecting our diverse and cutting-edge

technology capability.

Within the Services portfolio, the support

contract for the US C-130J transport

fleet was renewed and we signed a

memorandum of understanding with

Pratt & Whitney to extend support for

the UK’s new F-35B Lightning fleet beyond

the Rolls-Royce LiftSystem.

This strategy of strengthening our service

offerings closer to our major customers saw

the opening of new on-base Service Delivery

Centres in the UK (at RAF Brize Norton) and

in the US (at Kingsville, Texas), as well as a

new joint engine support facility for the

USAF Global Hawk fleet.

As part of the TP400 consortium, the focus

was on delivering solutions to improve

the on-wing reliability of the GE-Avio

gearbox.This included an on-wing exchange

procedure which has greatly helped to

reduce the service time and backlog.

Transformation milestones were achieved

as planned, including completion of the first

production cell as part of the investment

activity in Indianapolis. Further

manufacturing changes are due to come

on stream in the first half of 2017.

Defence Aerospace outlook

While revenues should remain steady,

margins are expected to come under

pressure from the essential investments

in efficiency and long-term growth. These

reflect important product development and

manufacturing transformation initiatives

as the business looks to capitalise on its

strong positions, particularly in combat and

transport & patrol, and the absence of

significant incentive arrangements under

remaining long-term service agreements. As

a result, margins and profits are expected to

soften from the recent levels.

ORDER BOOK

£3.9bn

DEFENCE AEROSPACE | KEY FINANCIAL DATA

£m 2015

Underlying

change

Foreign

exchange* 2016

Order book 4,316 (391) 1 3,926

Engine deliveries 649 12 – 661

Underlying revenue 2,035 17 157 2,209

Change +1% +8% +9%

Underlying OE revenue 801 22 67 890

Change +3% +8% +11%

Underlying services revenue 1,234 (5) 90 1,319

Change – +7% +7%

Underlying gross margin 579 (49) 34 564

Gross margin % 28.5% -260bps 25.5%

Commercial and administrative costs (124) (3) (7) (134)

Restructuring (8) 18 – 10

Research and development costs (73) 5 (3) (71)

Joint ventures and associates 19 (4) – 15

Underlying profit before financing 393 (33) 24 384

Change -8% +6% -2%

Underlying operating margin 19.3% -180bps 17.4%

* Translational foreign exchange impact.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT BUSINESS REVIEW

Market dynamics

• Defence budgets are expected to show

modest growth, flat in real terms in the US

and UK, partially offset by growth in other

emerging markets.

• Western customers are seeking to reduce

and minimise costs by delaying or deferring

purchase, improving asset availability and

extending lifecycles of aircraft/engines.

• Increasing levels of economic affluence and

political tension in the Asia Pacific and Middle

East regions are leading to increases in both

OE and services spend.

• Revenue has historically been broadly balanced

between OE sales and aftermarket services,

biased towards the latter.

Business risks

• If we experience a major product failure

in service, then this could result in loss of

life and have a major, negative impact on

our reputation.

• If global defence spending experiences

a further downturn, then our financial

performance may be impacted.

• If we do not continue to invest to improve

the performance and cost of our products,

then we may lose market share.

• If we suffer a major disruption in our supply

chain, then our delivery schedules may be

delayed, damaging our financial performance

and reputation.

• If we do not secure new applications, then our

capabilities may be eroded in the long term.

Competition

• GE, Pratt & Whitney, Honeywell, and Safran

are our main competitors in our sectors.

• In Europe, large defence programmes tend

to be addressed by consortia of two or more

companies due to the political environment.

Examples include our collaboration with ITP,

MTU and Safran on the TP400 engine for

the Airbus A400M and with GE Avio, ITP

and MTU on the EJ200 engine for the

Eurofighter Typhoon.

• We work with our EJ200 engine partners on

campaigns for Eurofighter Typhoon export

sales opportunities as well as new indigenous

combat programmes.

• Barriers to entry are high and we do not

envisage the competitive landscape changing

significantly in the near future.

Opportunities

• The UK’s commitment to the next phase of

the FCAS programme presents a

next-generation combat development

opportunity for Rolls-Royce.

• Our LiftFan system for the F-35B is just

entering service and we expect to deliver

over 400 systems in the next 20 years.

• Developing markets, such as India and Turkey,

are inviting bids on new combat aircraft.

We estimate a potential of over 300 aircraft

for these programmes.

• In transport, we believe the Airbus A400M

transport aircraft and V-22 Osprey have

overseas sales opportunities.

• We see strong growth potential for increased

service provision to the military and we are

well positioned with programmes such as

MissionCare®.

Market review

Rolls-Royce is a market leader in defence

aero engines for military transport and

patrol aircraft and has strong positions in

other sectors, including combat aircraft,

trainer aircraft and helicopters. We are

pursuing new opportunities emerging in

Asia and the Middle East to mitigate flat

defence budgets in the established North

American and European markets.

Key Rolls-Royce diﬀerentiators

We are investing heavily

in technology, integration

capabilities and facility

modernisation to deliver capable,

affordable engines for our

customers. Additionally, we

leverage our large installed base

and strong services capabilities to

provide superior and affordable

service solutions.

Technical advances for our T56 engines on legacy Lockhead Martin C-130 and P-3 aircraft

have led to significant improvements in fuel economy. The US National Oceanic and

Atmospheric Administration (NOAA) was the launch customer and installed T56 engine

upgrade kits, known as the Series 3.5, on its two ‘Hurricane Hunter’ P-3 aircraft. The result:

fuel economy improvement of 12% on average after more than 3,000 engine flight hours

through and around hurricanes. The USAF completed a Series 3.5 installation on the first

of its fleet of C-130H aircraft and early flights showed similar results. The USAF will roll out

the upgrades into C-130s operated by USAF Reserve and Air National Guard units, leading

the way for installation of the Series 3.5 kits into the global fleet of hundreds of transport

aircraft flown by other customers around the world.

READ MORE AT WWW.ROLLS-ROYCE.COM

Improving fuel

efficiency

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW 

Summary

Power Systems is a leading provider of high-speed and medium-speed reciprocating

engines, complete propulsion systems and distributed energy solutions as well as

key engine components including fuel injection systems and turbochargers. The

business serves the marine, defence, power generation and industrial markets

through its core brands MTU, MTU Onsite Energy and L’Orange.

POWER

SYSTEMS

Operational review

Financial overview

Underlying revenue of £2,655m was 1%

lower at constant currency (11% higher

including the impact of translational foreign

exchange). Overall original equipment (OE)

revenue declined 1%. Growth in sales of

diesel and gas products to power generation

and industrial customers offset reductions

within markets where demand is linked to

low oil and commodity prices, and reduced

activity in naval markets.

Service revenues reduced 2%, largely

reflecting weaker marine medium-speed

markets, once again reflecting low oil prices.

Gross margin reduced by £28m in absolute

terms and by 90 basis points, to 26.6% (2015:

27.5%) with good progress on cost reduction

generated from transformation activity

offsetting some of the impact of volume

reduction, adverse changes in product mix

and a reduction in the discount rate applied

to the warranty provision.

Overall, underlying profit declined £27m or

14%, led by the reduction in gross margin.

Costs below gross margin remained

broadly unchanged on an underlying basis.

The £9m increase in commercial and

Key highlights

Underlying revenue 1% lower; growth in

power generation and industrial markets

offset by reduction in commodity and oil

price driven sales.

Underlying profit before financing 14%

lower; volume reduction and adverse

product mix.

Good start to transformation with new

leadership in place to drive further

performance improvement.

2017 outlook: steady, healthy order

book in key segments offsetting some

challenging markets.

UNDERLYING REVENUE BY SECTOR

Marine 33%

Energy 33%

Industrial 21%

Defence and other 13%

UNDERLYING REVENUE MIX

OE revenue 68%

Services revenue 32%

A 20-cylinder MTU Series 4000 engine

powers a Liebherr mining truck.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT BUSINESS REVIEW

ORDER BOOK

£1.8bn

Order intake later in the year was healthy for

solutions to support data systems in both

Europe and the US and also for independent

power customers. We have also agreed to

establish a 50/50 joint venture with Yuchai

Machinery Company Ltd for the production

under licence of MTU Series 4000 diesel

engines in China, targeting the Chinese

off-highway market.

Demand for our marine products remained

good. Naval orders included gensets for the

UK Royal Navy’s Type 26 Global Combat

Ship and a supply contract for the Italian

Navy relating to a new multi-purpose

ocean-going patrol vessel.Within the land

defence markets, there was a follow-up

order for use in a German armoured vehicle.

In other areas, we continued to attract

new customers in new regional markets

including Japanese high-tech crane producer

Kato. We also made progress within the

rail market in both Europe and Asia. This

included a notable order from Hitachi Rail

Europe for over 100 MTU PowerPacks® for

use in the UK and an order to remanufacture

(an in-house process, known as Reman, to

refurbish and extend the life of existing

systems) around 400 MTU PowerPacks

for Transdev Group in Germany.

Innovation was again strong with some

notable new products coming to market in

the year. We launched new advanced diesel

and gas propulsion systems which meet

new IMO and EPA emissions standards.

administrative costs was offset by a £5m

reduction in R&D reflecting a more focused

approach to future product development

activity together with reduced underlying

restructuring costs. An exceptional

charge of £45m has been taken for

restructuring activity.

Investment and business

development

Power Systems’ customers span a range

of markets from power generation and

defence to marine, industrial and

construction markets. This end-market

diversity has enabled the business to

mitigate some of the weak market

environments and as a result, the order book

ended the year at £1.8bn (2015: £1.9bn).

2016 order intake of £2.4bn (2015: £2.5bn)

was 2% down at constant currency, with

the year-on-year reduction being mainly in

oil & gas and commodity-related markets

including marine, together with lower

government project orders. This was offset

by improvements within power generation,

agricultural and industrial markets.

Within power generation markets, we

delivered 200 gensets (a package of engine

and generator) to the Asian VPower Group,

one of our strategic partners in the region. We

have continued to strengthen our position in

the growing market for back-up power for

larger mission-critical applications.

At the same time, we launched advanced

propulsion systems for the construction

and industrial markets which satisfy new

emission standards in those industries.

Finally, we launched a hybrid power pack

and energy pack battery system for the

rail market.

Power Systems also made progress with

the transformation programme, targeting

reductions in product costs as well as

strengthening sales and service resources

and leveraging digital capabilities to develop

value adding services.

Power Systems outlook

The outlook for Power Systems remains

steady. The business finished the year with

a strong order book for several of its key

markets. Whilst some markets, particularly

those impacted by oil and commodity prices,

remain difficult, we expect the business to

deliver modest growth in revenue and profit

in 2017.

POWER SYSTEMS | KEY FINANCIAL DATA

£m 2015*

Underlying

change

Foreign

exchange** 2016

Order book 1,928 (113) – 1,815

Underlying revenue 2,385 (25) 295 2,655

Change -1% +12% +11%

Underlying OE revenue 1,618 (9) 201 1,810

Change -1% +12% +12%

Underlying services revenue 767 (16) 94 845

Change -2% +12% +10%

Underlying gross margin 656 (28) 79 707

Gross margin % 27.5% -90bps 26.6%

Commercial and administrative costs (296) (9) (35) (340)

Restructuring (4) 4 – –

Research and development costs (162) 5 (20) (177)

Joint ventures and associates – 1 – 1

Underlying profit before financing 194 (27) 24 191

Change -14% +12% -2%

Underlying operating margin 8.1% -110bps 7.2%

* 2015 figures have been restated as a result of costs previously reported in ‘cost of sales’, being reclassified as ‘other commercial and administrative costs’ to ensure consistent

treatment with 2016.

** Translational foreign exchange impact.

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW

Market dynamics

• Population growth and increasing urbanisation

are driving demand for clean, efficient power

and infrastructure investments.

• Global GDP development with particular

growth in Asia and Africa.

• Increasing global and regional trade and

transport of goods.

• Geopolitics and migration are driving modest

defence budget growth (1-2%) in NATO

countries with higher growth in emerging

markets and the Middle East.

• Increasing focus on renewable energy

sources requires decentralised and clean

energy solutions (eg. back-up power).

• Increasing environmental legislation and

efficiency requirements help drive emission

and efficiency technologies.

• Current weak environment in certain end

markets (eg. oil & gas and mining), due to

current low oil and commodity price levels.

Business risks

• Economic: some of our markets, especially

oil & gas and mining, continue to be impacted

by low commodity prices – this has been

partially offset by a resilient performance in

other sectors (eg. power generation and rail).

• Political: increasing political tensions and

uncertainties, and remaining sanctions limit

levels of global trade and customer access in

certain regions.

• Competitive: increasing activities of Asian

competitors and new market entrants in our

core power range of MTU Series 4000 engines

potentially influence volumes and margins.

• Technological: emerging new technologies

with falling costs (eg. battery and solar) might

influence existing solutions such as back-up

power generators.

Competition

• Fragmented competitor landscape in

off-highway engine markets which varies

depending on specific market segments –

multiple players although a few dominate.

• Continuing industry consolidation results

in strong, large-scale and integrated players.

• Expansion of western competitors in our

specific core engine markets.

• Competition from Asia increasingly focusing

on higher power ranges where MTU operates.

• While traditional competition has been

limited to engine suppliers, solution providers

are becoming more relevant.

Opportunities

• Regional growth, especially in China,

India and South East Asia.

• Leveraging partnerships to expand

geographical reach and extend product

scope in core market segments.

• Stricter global emission legislation

strengthens demand for emission and

efficiency technologies (eg. exhaust

after treatment).

• Enhancement of system competence and

solutions to create customer value through

optimised total system functionality and

performance.

• Growth in service and digital offerings

to serve complete lifecycle solutions and

improve customer operations.

• Growth through extended key engine

component offering, including turbochargers.

• Leveraging trend towards increasing

electrification through strengthening

electric capabilities (eg. hybrid

and diesel-electric propulsion systems).

Key Rolls-Royce diﬀerentiators

Technology leadership and

reputation with market-leading

performance and system

solutions; new product innovation

(eg. hybrid/e-drive and mobile

gas solutions); and high level of

customisation.

Market review

The markets served by Power Systems are

driven by long-term global trends such as

increasing population growth, rising

demand for energy, natural resources and

food as well as stricter emissions legislation.

Despite an unprecedented downturn in

commodity prices in recent years, the

utilisation rates in the exploration and

production industry are showing some

early signs of recovery. Demand for

high-specification system solutions such as

power for data centres and rail power packs

has proved robust. We remain confident of

long-term growth in our principal markets.

Power Systems continues to invest in new

technology, improved customer solutions

and aftermarket services to address market

developments and new requirements.

The Intercity Express Programme (IEP) is one of the biggest transport projects in the UK:

122 new high-speed trains built by Hitachi Rail Europe are scheduled to go into service

on the East Coast Main Line and Great West Main Line routes from 2017.

Rolls-Royce is supplying more than 330 MTU PowerPacks each producing up to

700 kilowatts for these super express trains. At the heart of the drive system is the

state-of-the-art, fuel efficient MTU 12V 1600 R80L engine, which meets the stringent EU

Stage IIIB emission standard thanks to an integrated selective catalytic reduction system.

MTU will maintain and guarantee the availability of the engines throughout the entire

27-year lifetime of Hitachi’s contract for IEP.

READ MORE AT WWW.ROLLS-ROYCE.COM

MTU drives for key

British railway projects

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT BUSINESS REVIEW

The Bergensord, a ferry operating between

Norway and Denmark, has won awards for

environmental performance thanks to four

Bergen pure gas engines and a Rolls-Royce

propulsion and steering system.

Summary

Marine is a leading provider of propulsion and handling solutions for the maritime

offshore, merchant and naval markets. The offerings range from standalone

products to complex integrated systems including ship design. The business has

more than 4,000 customers, with 70 naval forces and over 30,000 commercial

vessels using our equipment.

Key highlights

Underlying revenue down 24%; weak

offshore markets impacting both OE

and service revenues.

Underlying profit before financing

negative; lower volumes and reduced

overhead absorption.

Net restructuring benefits from current

and legacy programmes starting to

improve performance.

£200m impairment of goodwill reflecting

a more cautious outlook; further

weakness in offshore oil & gas markets

offset by ongoing cost improvements as

we refocus the business.

UNDERLYING REVENUE MIX

UNDERLYING REVENUE BY SECTOR

MARINE

Operational review

Financial overview

Underlying revenue of £1,114m was 24%

lower on a constant currency basis. Within

this, original equipment (OE) and services

revenues were 26% and 21% lower

respectively. This reflected continued

weakness in offshore and merchant,

as ship owners deferred overhaul and

maintenance on the back of reduced

utilisation of their vessels.

Gross margin was £236m, an improvement

of 170 basis points versus 2015, but £(44)m

lower in absolute terms, as a result of the

lower volume. The improved gross margin

percentage partly resulted from cost

reduction actions. Overall this resulted

in a net loss of £27m.

The announcement in December 2016 of

further organisational changes and

headcount reduction in 2017 has led to an

exceptional £5m restructuring charge.

In addition, £200m of the Group impairment

of goodwill was in Marine and mainly

related to the acquisition of Vickers in 1999.

OE revenue 57%

Services revenue 43%

Offshore 47%

Merchant 28%

Naval 25%

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW

The pace of technology change in the sector

is accelerating, and we continue to invest in

pioneering research into ship intelligence

technologies focused on data-driven,

value-added services that facilitate full

ship automation in the long term.

Marine outlook

Overall, the outlook for Marine remains

cautious. We expect that the market will

continue to feel the impact of low oil prices,

and the general overcapacity in several

segments will take time to reach

equilibrium. This will impact the demand

for our products and services. We will

sustain our active cost reduction

programmes, focusing on manufacturing,

supply chain and overhead costs, in order

to drive a more competitive business

adapted to the current market conditions.

ORDER BOOK

£905m

for a range of vessels. The naval business was

focused on further development work and

supporting customers across Asia, Europe and

the US. These included supporting successful

sea-trials for the US Navy’s most advanced

warship the USS Zumwalt, further MT30

orders for new Italian helicopter landing craft

and selection by the New Zealand Navy for

ship design of its MSC programme.

The Marine business continues to lower its

cost base and build flexibility into the

organisation, particularly across back-office

and operational activities. The restructuring

programmes announced in 2015 have led to

a reduction of around 1,100 headcount with

£65m of annual savings recognised from 2017.

Reflecting the ongoing subdued and

increasingly cost-conscious market

environment, in December further

restructuring to take place in early 2017

was announced, targeting annualised

savings of around £50m. This included a

further headcount reduction of around 800

across operations and back-office functions

as the business continues to shrink

footprint, reduce indirect headcount, and

consolidate manufacturing activity.

At the same time, investments were made

in the strategic enablers of the future,

including upgrading our azimuth thruster

production facility in Rauma, Finland.

The £44m project will create a state-of-the-

art production facility for one of our most

important product groups.

Investment and business

development

Overall, the Marine order book declined

29% during the year at constant currency,

reflecting adjustments for a number of

postponed or cancelled orders and very

weak offshore markets. Orders for new

vessels, projects and services were all

sharply lower than 2015 and, as a result,

order intake was only £715m, 29% down

on the previous year at constant currency.

The offshore market was extremely

challenging, driven by a low oil price and

reduced capital expenditure within the

upstream oil exploration and related

services sectors. Several merchant segments

were also subdued, reflecting generally

weak conditions in the global marine

industry. The business focused on using

its strengths as a system integrator to

leverage across adjacencies, including

designing and equipping the UK’s new polar

research ship, RSS Sir David Attenborough.

It also landed a major deal to design and

equip Hurtigruten’s new explorer cruise

ships, along with battery solutions to make

full electric propulsion possible.

The business announced a contract to supply

the world’s first automatic crossing system

to ferry operator, Fjord 1, and also launched

our new Azipull Carbon thruster with yacht

builder Benetti, reflecting the increasing

importance of newer technologies. The fishing

segment remained strong, with contracts won

MARINE | KEY FINANCIAL DATA

£m 2015

Underlying

change

Foreign

exchange* 2016

Order book 1,164 (337) 78 905

Underlying revenue 1,324 (312) 102 1,114

Change -24% +8% -16%

Underlying OE revenue 773 (198) 56 631

Change -26% +7% -18%

Underlying services revenue 551 (114) 46 483

Change -21% +8% -12%

Underlying gross margin 260 (44) 20 236

Gross margin % 19.6% +170bps 21.2%

Commercial and administrative costs (201) (6) (17) (224)

Restructuring (16) 19 (1) 2

Research and development costs (28) (11) (2) (41)

Underlying profit before financing 15 (42) – (27)

Change -280% -280%

Underlying operating margin 1.1% -380bps -2.4%

* Translational foreign exchange impact.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT BUSINESS REVIEW

Market dynamics

• We operate in three key markets – offshore,

merchant and naval – with growth

fundamentally driven by GDP, trade, oil

price and defence spending.

• Population growth, urbanisation and

industrialisation support growth in demand

for energy and trade, in turn driving demand

for offshore and merchant vessels.

• Exploration and production spending cuts

result in the offshore segment experiencing

very low fleet utilisation, declining charter

rates, lay up of vessels (impacting services

revenue) and increased scrapping.

• We expect exploration activity to return to

growth over time to compensate for the

depletion rate of current wells. However, there

is unlikely to be a positive impact in 2017.

• Merchant segment facing overcapacity and

weak earnings in most cargo segments;

however, good opportunities in cruise and

passenger vessels, and a stable tug and

workboat market.

• Expect strong efficiency and cost focus when

merchant and offshore markets rebound.

• Naval market is forecast to remain stable as

defence expenditure remains consistent.

• Overcapacity in shipbuilding and vessel fleets

leading to consolidation at customer level.

• Asian yards are expected to continue playing

a major role in shipbuilding with further

increased regional vessel ownership,

particularly in China.

• Continuing trend of supply chain moving

east to where the majority of ships are built.

Business risks

• Markets: continuing low oil price results in

sustained pressure in the offshore market

with customer groups reducing costs and

capital commitments, thereby delaying

market recovery.

• Competition: competitors react to a depressed

market by cutting costs, pricing aggressively

and partnering with other players.

• Contracting: order delays and cancellations

impact our revenue, cash and profit but also

put our supply chain under financial stress.

• Customer and supply chain financial

pressure: continuing market downturn

leaves some customers and suppliers

exposed to consolidation and/or market exit.

• Technology: failure to invest in the

right technologies to meet customer

future demand.

• Product failure: risk of failure in the field

resulting in the need for intervention to

rectify the issue with financial and/or

reputational consequences.

Competition

• Array of competitors is diverse but falls

generally into two main groups: systems

integrators with broad portfolios and

specialists in narrow product categories.

• Competitors reacting to current market

dynamics with cost reduction programmes.

• Cross-industry electrical specialists

increasingly active in several vessel

segments to capitalise on marine vessel

electrification trend.

• Key competitors looking to grow into digital

offerings with investment and niche

acquisitions.

• Increased pricing pressure with competition

for fewer orders in challenging market.

Opportunities

• Continue growth in merchant segments

(eg. ferries, tugs and short-sea cargo) and

adjacent offshore markets (eg. special

purpose and offshore wind) with more

advanced offerings.

• Continue to leverage the joint value

proposition in naval markets together with

Power Systems.

• Leverage local partnerships to generate

regional growth in Asia, especially China.

• Owners are increasingly interested in

solutions to improve efficiency and

environmental impact as well as safety

in more diverse and complex operations.

• Increasing role of data and analytics in

optimising asset operations and

reducing costs.

• Growth in intelligent shipping with

greater integration of propulsion and

electric systems.

• Increased modularisation and

standardisation as well as advanced

manufacturing methods.

• Increased uptake of long-term service

agreements to create greater value within

the market.

The commissioning of the world’s most

advanced naval ship, USS Zumwalt, took

place in October. Powered by two

Rolls-Royce MT30 main gas turbine

generators and two auxiliary turbine

generators, and driven by two fixed

pitch Rolls-Royce propellers, the USS

Zumwalt is an all-electric ship at the

cutting edge of naval technology.

Rolls-Royce technicians joined the ship

throughout an extensive period of

sea trials to ensure a successful entry

into service.

READ MORE AT WWW.ROLLS-ROYCE.COM

Market review

We forecast long-term growth

opportunities across our commercial

and naval market segments. Short-term

performance will continue to be impacted

by the weakness in offshore oil & gas

exploration.

Key Rolls-Royce diﬀerentiators

Unique domain knowledge,

portfolio of products with

overlaying levels of systems

integration; joint value proposition

within naval markets with Power

Systems; continuous maritime

innovation and technology

leadership, and leadership in

emerging digital marine markets.

Stealth power

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW

Summary

Nuclear is a leader in propulsion system design and development for

the Royal Navy’s nuclear submarine fleet and is the sole provider and

technical authority, managing all aspects of plant design, safety,

manufacture, performance and through-life support.

In civil nuclear we provide nuclear reactor vendors and utility operators

with integrated, long-term support services and solutions spanning the

whole reactor lifecycle, from concept design through to obsolescence

management and plant-life extension. Safety-critical systems have been

supplied to around 50% of the global nuclear power plants in service.

We have been a key player in the nuclear industry for more than 50 years.

Key highlights

Underlying revenue 11% higher;

strong revenues led by increased

submarine work.

Underlying profit before financing 37%

lower; adverse margin mix in submarine

projects, lower R&D credit than 2015 and

R&D spend on small modular reactor

concept development.

2017 outlook: focus on further delivery

improvements and investing to address

future opportunities.

UNDERLYING REVENUE MIX

UNDERLYING REVENUE BY SECTOR

NUCLEAR

Operational review

Financial overview

Underlying revenue increased by 11%

to £777m, led by growth in several key

programmes in the submarines business,

including support for the next generation

Dreadnought class submarines

(the successor to the Vanguard class),

various refuelling projects and

decommissioning activities. Volumes

on key civil instrumentation and control

programmes in both France and Finland

were also good.

Gross margin was lower at 15.6%, reflecting

the revenue mix favouring lower margin

government-led submarine projects.Below

gross margin, the change in treatment of

R&D credits, which significantly impacted

the full year in 2015, produced an R&D credit

of £7m in 2016. This was offset by additional

costs to support the higher volumes and to

improve delivery performance. In addition,

there were extra payroll costs, as well as

additional R&D to support the initial design

phase for small modular reactors (SMRs).

As a result, underlying profit before

financing excluding the R&D credit was

£37m at constant currency, 27% below

the prior year (2015: £51m adjusted for

the R&D credit). After the R&D credit and

including a £1m foreign exchange benefit,

underlying profit was £45m.

OE revenue 46%

Services revenue 54%

Submarines 79%

Civil nuclear 21%

The Royal Navy Astute class is the latest

submarine powered by a Rolls-Royce

designed nuclear propulsion unit.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT BUSINESS REVIEW

Nuclear outlook

The long-term outlook for Nuclear remains

positive, supported by confirmation from the

UK Government of the ongoing investment in

the Dreadnought class submarines. Together

with renewed activities in the civil market,

particularly in the UK and China, these

provide encouraging growth opportunities.

Performance in 2017 will be impacted by the

loss of R&D credits on investments and

further modest increases in the investment in

SMR technology. As a result, profit is expected

to be around half that achieved in 2016.

The civil nuclear business successfully

concluded the first phase of its major

instrumentation and control modernisation

programme at Fortum's Loviisa plant in

Finland, using our Spinline® technology.

It also continued with its upgrade

programme across the French civil nuclear

fleet as part of a multi-year contract.

The UK government announced final

approval for the Hinkley Point C nuclear

power station in September, where our

Nuclear business was awarded preferred

bidder status for contracts covering waste

treatment systems, heat exchangers and

diesel generators.

The business also announced the

strengthening of the strategic collaboration,

started in 2014, with the China National

Nuclear Corporation, including engineering

and training services. The Chinese market is

expected to sustain strong growth and we

are well positioned with relevant technology.

During the year we started an R&D

programme, together with a number of

partners, to scope out the initial design

phase for SMRs. These smaller, more flexible

nuclear power generation units offer the

potential for a more flexible power

generation in future decades and directly

build on the knowledge and specialist

skills of our Nuclear business. Any significant

further development work will be

dependent on government support for

this technology.

Investment and business

developments

Order intake of £385m was 8% higher than

2015. Notwithstanding, the closing order

book of £1.8bn was 17% below 2015,

reflecting the business working through

the large multi-year orders, particularly

in submarines, received in prior years.

Submarine activities focused on continuing

our support to the Royal Navy’s current

operational fleet of nuclear-powered

submarines, as well as delivery of

propulsion systems for the remaining

Astute class submarines and for the

Dreadnought programme. As well as

implementing a range of performance

improvement initiatives during the year,

we also completed delivery of the nuclear

propulsion system for the fourth (of seven)

Astute class submarine and have made

good progress both in the preparation for

the refuelling programme of HMS

Vanguard and for decommissioning the

Naval Reactor Test Establishment in

Scotland. In conjunction with the UK’s

Ministry of Defence and BAE Systems,

we have also advanced discussions around

a long-term alliance framework for the

Dreadnought programme. Once concluded,

this new framework should ensure that the

delivery structure and commercial benefits

are clarified for all key partners in this

£31bn investment programme.

NUCLEAR | KEY FINANCIAL DATA

£m 2015

Underlying

change

Foreign

exchange* 2016

Order book 2,168 (379) 1 1,790

Underlying revenue 687 74 16 777

Change +11% +2% +13%

Underlying OE revenue 251 95 8 354

Change +38% +3% +41%

Underlying services revenue 436 (21) 8 423

Change -5% +2% -3%

Underlying gross margin 111 6 4 121

Gross margin % 16.2% -80bps 15.6%

Commercial and administrative costs (53) (14) (3) (70)

Restructuring (2) 2 – –

Research and development costs 14 (20) – (6)

Underlying profit before financing 70 (26) 1 45

Change -37% +1% -36%

Underlying operating margin 10.2% -440bps 5.8%

* Translational foreign exchange impact.

ORDER BOOK

£1.8bn

Rolls-Royce Holdings plc Annual Report 2016 BUSINESS REVIEW

Market dynamics

• Population growth and improved living

standards in emerging markets are driving

a rise in demand for electricity.

• Within the future energy mix, low-carbon

energy is expected to increase, with nuclear

energy accounting for a significant share.

• In the US, lower energy prices are putting

nuclear operating costs under pressure.

• Market conditions have changed, notably

the slowdown in western new build

programmes. China and Russia dominate

large reactor new build projects.

Business risks

• If we experience a major product failure in

service, then this could result in loss of life

and significant damage to our reputation.

• Delivery: failure to meet customer

expectations or regulatory requirements.

• Markets: if civil nuclear markets do not grow as

anticipated due to political or other external

events then business will be diminished.

• Customer strategy: if programmes are

cancelled as a result of strategic decisions, or

vertical integration by reactor vendors, then

future revenues will be diminished.

• If we suffer a major disruption in our supply

chain, then our delivery schedules may be

delayed, damaging our financial performance

and reputation.

Competition

• In civil nuclear the competitor landscape is

fragmented and comprises reactor vendors,

original equipment manufacturers,

diversified industrial companies and nuclear

operators in service.

• Plant operators increasingly outsource

service activities.

• Key competitors and independent data

service providers are investing and acquiring

capabilities to further enhance their

digital offerings.

Opportunities

• Increasing the pace of growth of the civil

nuclear business.

• Focusing on growth regions beyond current

core markets.

• Strengthening our position with the rapidly

growing importance of China in the civil

nuclear market.

• Capturing a higher share of the nuclear

service market through extension of our

geographic reach.

• Exploiting our historical data acquisition

coupled with digital investment to launch a

digital service portfolio that enables growth

into asset management.

• Our capabilities in nuclear can be applied

to the development of SMRs for civil

power stations.

Market review

Respected global energy forecasts continue

to predict that nuclear power will play a

significant role in providing low-carbon,

continuous, secure power. More than

80% of today’s civil nuclear capacity is in

the Organisation for Economic Co-operation

and Development (OECD) member

countries; however non-OECD countries,

including some new to nuclear, will account

for the bulk of growth whilst mature

markets will focus on current operations

and life extension.

Key Rolls-Royce diﬀerentiators

Unique key technology capability

in defence and civil nuclear with

substantial credibility (more than

50 years’ experience); broad mix of

offerings over the whole lifecycle;

reactor independent portfolio;

capable of global reach.

SMRs can provide safe, reliable and affordable low-carbon electricity. An SMR

programme presents the opportunity to create a UK nuclear plant through the design

phase, to construction and delivery; establishing a sustainable skills base and supply

chain capability that demonstrates the UK’s overall nuclear excellence to international

export markets. Compared with current large-scale reactors, SMRs can deliver

significant programme risk reduction through controlled offsite modular

manufacturing, compact passive safety systems and easier financing.

With our unique position and over 50 years’ experience in developing nuclear

technologies, Rolls-Royce has the capability to develop proprietary SMR nuclear reactor

technology and bring together its UK industrial and academic partners to deliver an

SMR plant solution which will offer lower build, through-life and decommissioning

costs, as well as increased regulatory and programme certainty.

A Rolls-Royce led UK consortium offers a significant opportunity to position the UK

as a global leader in innovative nuclear technologies.

READ MORE AT WWW.ROLLS-ROYCE.COM

Small modular reactors

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT FINANCIAL REVIEW

principally due to the non-recurrence of

an underlying foreign exchange gain

recognised in 2015, which arose from the

realised gains on foreign exchange contracts

settled to translate overseas dividends

into sterling.

Underlying taxation was £261m (2015:

£351m), an underlying rate of 32.1%

compared with 24.5% in 2015.The primary

Underlying revenue and underlying profit

before financing are discussed in the Review

of 2016 (page 7), the Financial summary

(page 16) and the Business reviews (pages

18 to 35).

Underlying financing costs increased by

£42m to £102m. Net interest payable

increased by £4m to £63m. Other underlying

financing costs increased by £38m to £39m,

reasons for the increase are the

non-recognition of deferred tax assets on

losses in Norway, which reflects the current

uncertainty in the oil & gas market, and

a different profit mix with more profits

arising in countries with higher tax rates.

Underlying EPS decreased 49% to 30.13p,

reflecting the reduction in profit for

the year.

Financial review

UNDERLYING INCOME STATEMENT

Year to 31 December

£m 2016 2015* Change

Revenue – 2015 exchange rates 13,058 13,354 -296

Translation to 2016 exchange rates 725

Revenue 13,783 13,354 +429

Gross profit 2,626 3,203 -577

Commercial and administrative costs (1,096) (1,025) -71

Restructuring 2 (39) +41

Research and development costs (812) (765) -47

Share of results of joint ventures and associates 107 118 -11

Profit before financing at 2015 exchange rates 827 1,492 -665

Translation to 2016 exchange rates 88

Profit before financing 915 1,492 -577

Net financing (102) (60) -42

Profit before tax 813 1,432 -619

Tax (261) (351) +90

Profit for the year 552 1,081 -529

Earnings per share (EPS) 30.13p 58.73p -28.60p

Payment to shareholders 11.70p 16.37p -4.67p

Gross R&D expenditure (1,331) (1,240) -91

Net R&D charge (862) (765) -97

SEGMENTAL ANALYSIS

Revenue Gross profit Profit before financing

Year to 31 December

£m 2016 2015 Change 2016 2015 Change 2016 2015 Change

Civil Aerospace 6,906 6,933 -27 1,129 1,526 -397 326 812 -486

Defence Aerospace 2,052 2,035 +17 530 579 -49 360 393 -33

Power Systems 2,360 2,385 -25 628 656 -28 167 194 -27

Marine 1,012 1,324 -312 216 260 -44 (27) 15 -42

Nuclear 761 687 +74 117 111 +6 44 70 -26

Other 35 96 -61 6 64 -58 1 52 -51

Intra-segment (68) (106) +38 – 7 -7 – 7 -7

Central costs (44) (51) +7

Group at 2015

exchange rates 13,058 13,354 -296 2,626 3,203 -577 827 1,492 -665

Translation to 2016

exchange rates 725 422 88

Group 13,783 13,354 +429 3,048 3,203 -155 915 1,492 -577

* 2015 figures have been restated as a result of £21m of costs previously reported in ‘cost of sales’, being reclassified as ‘other commercial and administrative costs’ to ensure consistent

treatment with 2016.

Rolls-Royce Holdings plc Annual Report 2016 FINANCIAL REVIEW

statements. This basis of presentation has

been applied consistently.

The most significant items included in

the reported income statement, but not

in underlying, are summarised below.

Profit before financing

The impact of measuring revenues and

costs at spot rates rather than rates achieved

on hedging transactions. This increased

revenues by £1,172m (2015: £371m) and

At the Annual General Meeting on 4 May

2017, the Directors will recommend an issue

of 71 CShares with a total nominal value of

7.1 pence for each ordinary share. Together

with the interim issue on 4 January 2017

of 46 C Shares for each ordinary share with

a total nominal value of 4.6 pence, this is the

equivalent of a total annual payment to

ordinary shareholders of 11.7 pence for

each ordinary share. Further details are

included on page 186.

Reported results

The changes in 2016 resulting from

underlying trading are described in the

previous sections.

Consistent with past practice and IFRS,

we provide both reported and underlying

figures. As the Group does not hedge

account in accordance with IAS 39

Financial Instruments, we believe underlying

figures are more representative of the

trading performance, by excluding the

impact of year-end mark-to-market

adjustments, principally the USD:GBP

hedge book, which has had a significant

impact on the reported results in 2016 as

the USD:GBP rate has fallen from 1.48 to

1.23 and the EUR:GBP has fallen from

1.36 to 1.17. The adjustments between

the underlying income statement and

the reported income statement are set

out in note 2 to the Consolidated financial

increased profit before financing by £570m

(2015: £265m).

The effects of acquisition accounting £115m

(2015: £124m), principally relating to the

amortisation of intangible assets arising on

the acquisition of Power Systems in 2013.

The impairment of goodwill of £219m

(2015: £75m), principally relating to the

Marine business as a result of the continued

weakness in the oil & gas market (see note 9).

REPORTED INCOME STATEMENT

Year to 31 December

£m 2016 2015

Revenue 14,955 13,725

Gross profit 3,048 3,277

Other operating income 5 10

Commercial and administrative costs

(2,208) (1,070)

Research and development costs (918) (818)

Share of results of joint ventures and associates 117 100

Operating profit 44 1,499

(Loss)/profit on disposal of businesses (3) 2

Profit before financing 41 1,501

Net financing (4,677) (1,341)

(Loss)/profit before tax (4,636) 160

Tax 604 (76)

(Loss)/profit for the year (4,032) 84

Earnings per share (EPS) (220.08)p 4.51p

2015 figures have been restated as a result of £11m costs previously reported in ‘cost of sales’, being reclassified

as ‘commercial and administrative costs’ to ensure consistent treatment with 2016.

In 2016, ‘commercial and administrative costs’ include £671m for financial penalties from agreements with

investigating bodies and £306m for the restructuring of the UK pension schemes.

RECONCILIATION BETWEEN UNDERLYING AND REPORTED RESULTS

Year to 31 December Revenue Profit before financing Financing (Loss)/profit before tax

£m 2016 2015 2016 2015 2016 2015 2016 2015

Underlying 13,783 13,354 915 1,492 (102) (60) 813 1,432

Revenue recognised at exchange

rate on date of transaction 1,172 371 – – – – – –

Mark-to-market adjustments

on derivatives – – – (9) (4,420) (1,306) (4,420) (1,315)

Related foreign exchange

adjustments – – 570 265 (151) (15) 419 250

Movements on other financial

instruments – – – – (8) 8 (8) 8

Effects of acquisition accounting – – (115) (124) – – (115) (124)

Impairment of goodwill – – (219) (75) – – (219) (75)

Exceptional restructuring – – (129) (49) – – (129) (49)

Acquisitions and disposals – – (3) 2 – – (3) 2

Financial penalties – – (671) – – – (671) –

Post-retirement schemes – – (306) – 3 32 (303) 32

Other – – (1) (1) 1 – – (1)

Reported 14,955 13,725 41 1,501 (4,677) (1,341) (4,636) 160

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT FINANCIAL REVIEW

SUMMARY BALANCE SHEET

At 31 December

£m 2016 2015

Intangible assets 5,080 4,645

Property, plant and equipment 4,114 3,490

Joint ventures and associates 844 576

Net working capital

(1,553) (501)

Net funds

(225) (111)

Provisions (759) (640)

Net post-retirement scheme deficits (29) (77)

Net financial assets and liabilities

(5,751) (1,883)

Other net assets and liabilities

143 (483)

Net assets 1,864 5,016

Other items

US$ hedge book (US$bn) 37.8 28.8

TotalCare assets 3,348 2,994

TotalCare liabilities (907) (783)

Net TotalCare assets 2,441 2,211

Gross customer finance commitments 238 269

Net customer finance commitments 61 54

Net working capital includes inventories, trade and other receivables, trade and other payables and current tax assets

and liabilities.

Net funds includes £358m (2015 £13m) of the fair value of financial instruments which are held to hedge the fair value

of borrowings.

Other includes other investments and deferred tax assets and liabilities.

Balance sheet

Intangible assets (note 9) increased by

£435m mainly due to exchange differences

of £438m. Additions of £631m (including

£154m of certification and participation

fees, £100m of development costs and

£208m of contractual aftermarket rights)

were largely offset by amortisation of

£406m and impairment of £222m (including

£200m on Marine goodwill).

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.

Property, plant and equipment (note 10)

increased by £624m, around half of which

was caused by exchange differences of

£330m. Additions of £701m (including £75m

of TotalCare Flex engines) were offset by

depreciation of £424m and £41m was added

from the reclassification of joint ventures to

joint operations.

Investments in joint ventures and

associates (note 11) increased by £268m,

including an increase of £154m in the

Group’s share of authorised maintenance

centre joint ventures. The other main

movements were: exchange gains of £107m;

and the Group’s share of retained profit

of £43m; offset by a £57m reclassification

of certain joint ventures to joint operations.

Movements in net funds are shown

opposite.

Net working capital reduced by £1,052m,

including a £671m accrual for financial

penalties, £134m increased deposits and

£265m of foreign exchange movements.

This was partially offset by higher inventory

of £194m.

Provisions (note 18) largely relate to

warranties and guarantees provided

to secure the sale of OE and services.

The increase of £119m includes

reclassifications from accruals of £92m,

following a review of accounting

consistency during the period. The

remaining increase of £27m includes net

additional charges of £271m (including

£147m for warranties and guarantees),

and foreign exchange movements of

£75m, offset by utilisation of £227m.

Net post-retirement scheme deficits

(note 19) have reduced by £48m.

In the UK (increase in surplus of £293m),

changes in actuarial estimates increased

the value of the obligations £1.8bn, largely

due to the discount rate reducing from

3.6% to 2.7%. This was more than offset by

returns (in excess of those assumed) on the

scheme assets of £2.3bn. This return is

largely due to the liability-driven investment

policy of the assets being invested to match

changes in value of the obligations (on a

proxy solvency basis, which is more onerous

than the accounting valuation). The net

increase in surplus was reduced by the

recognition of a settlement charge of £301m

on the insurance buy-out of the Vickers

Group Pension Scheme.

The principal movements in overseas

schemes (increase in deficit of £245m)

were exchange differences of £208m.

Net financial assets and liabilities (note 17)

principally relate to the fair value of foreign

exchange, commodity and interest rate

contracts. All contracts continue to be held

for hedging purposes. The fair value of

foreign exchange derivatives is a net

financial liability of £5.6bn, an increase of

£3.9bn in the period, mainly a result of the

Exceptional restructuring costs of £129m

(2015: £49m). These are costs associated

with the substantial closure or exit of a site,

facility or activity and increased as a result

of the ongoing transformation programme.

Financial penalties of £671m from agreements

with investigating bodies (see page 8).

Costs of restructuring the UK pension

schemes in 2016 of £306m, principally a

settlement charge on the transfer of the

Vickers Group Pension Scheme to an

insurance company (see note 19).

Financing and taxation

The mark-to-market adjustments on the

Group’s hedge book of £4,420m (2015:

£1,306m). These reflect: the large hedge

book held by the Group (eg. US$38bn);

and the weakening of sterling, particularly

against the US dollar and the euro, as noted

above. At each year end, our foreign

exchange hedge book is included in the

balance sheet at fair value (mark-to-market)

and the movement in the year included in

reported financing costs.

Appropriate tax rates are applied to these

additional items included in the reported

results, leading to an additional tax credit

of £865m (2015: £275m), largely as a result

of the mark-to-market adjustments.

Rolls-Royce Holdings plc Annual Report 2016 FINANCIAL REVIEW

2015 (111)

2014 666

2013 1,939

2012 1,317

NET (DEBT)/FUNDS

£(225)m

20162015201420132012

2015 179

2014 exc 447

2014 inc 254

2013 781

2012 548

FREE CASH FLOW

£100m

201620152014201420132012

inc Energy

exc Energy

SUMMARY FUNDS FLOW STATEMENT



Year to 31 December

£m 2016 2015 Change

Opening net (debt)/funds (111)

666

Closing net debt (225)

(111)

Change in net (debt)/funds (114)

(777)

Underlying profit before tax 813

1,432 -619

Depreciation and amortisation 720

613 +107

Movement in net working capital (55)

(544) +489

Expenditure on property, plant and equipment and intangible assets (1,201)

(887) -314

Other 47

(229) +276

Trading cash flow 324

385 -61

Contributions to defined benefit pensions in excess of underlying PBT charge (67)

(46) -21

Taxation paid (157)

(160) +3

Free cash flow 100

179 -79

Shareholder payments (301)

(421) +120

Share buyback –

(414) +414

Acquisitions and disposals (153)

(3) -150

Discontinued operations –

(121) +121

Foreign exchange 240

3 +237

Change in net debt (114)

(777)

The derivation of the summary funds flow statement above from the reported cash flow statement is included in note 26 of the condensed consolidated financial statements.

Funds flow

Movement in working capital – the £55m

increase in working capital includes an

increase in inventory, partially offset by a

net reduction in financial working capital.

These movements are largely driven by the

increased sales volumes during 2016.

Expenditure on property, plant and

equipment and intangibles – the major

increases are: £98m higher PPE expenditure

as we build the supply chain; £37m software

costs relating to systems development;

£81m certification costs driven by the Trent

XWB-97 programme; £45m capitalised

development costs largely relating to the

Trent1000TEN; and £46m higher

contractual aftermarket rights, mainly on

Trent XWB sales.

Pensions – the increase in pension

contributions in excess of the underlying

income statement largely reflects changes

in net past service costs of £13m.

Shareholder payments – the change in

shareholder payments reflects the

difference between the 2014 and 2015

payments, which are paid in the following

year.

Acquisitions and disposals include the

£154m increase in stake in joint ventures

described on the opposite page.

weakening of sterling against the US dollar

and euro.

The US$ hedge book increased by 31% to

US$37.8bn. This represents around 5½ years

of net exposure and has an average book

rate of £1 to US$1.55.

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. 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. The

reduction in gross exposures is a result of

guarantees expiring.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT SUSTAINABLE BUSINESS

% CO

or fuel burn

2000 2010 2020 2030 2040 2050

-5

-10

-15

-20

-25

-30

Trent 500

Trent 900

Trent 1000

Trent XWB

Advance

UltraFan

Entry into service

Trent 800

THROUGH

ENGINEERING

AND INNOVATION

A sustainable business

We continue to invest in the resources and capabilities which underpin

our future success as we transform the business.

In 2016, we spent over £1.3bn on gross R&D

to develop the technology we embed in our

products and deliver to market. As a result,

we applied for 672 patents in the year, a

Rolls-Royce record.

Over two-thirds of our R&D expenditure is

dedicated to improving the environmental

performance of our products, helping

our customers do more using less and

minimising the environmental impact

of our engines.

 GROSS R&D EXPENDITURE

£1.3bn

PATENTS FILED

672

Rolls-Royce £936m

UK government £309m

EU funding £20m

US government £18m

German government £31m

Other sources £18m

Trent family

Technology demonstrator

engine targets

Rolls-Royce contribution to

ACARE Flightpath 2050 target

Our investments in world-class technology, research and engineers are

essential for sustaining our competitive advantages and creating new

growth opportunities. Ultimately, our innovations deliver the differentiated

high-technology products and services that attract our customers.

ACARE flightpath 2050 goals

We continue to meet the environmental performance targets for 2050 set by the

Advisory Council for Aviation Research and Innovation in Europe (ACARE).

RSS Sir David Attenborough

Rolls-Royce has designed the UK’s future polar research ship, the RSS Sir David

Attenborough, one of the most advanced scientific maritime vessels ever constructed.

It will be equipped with highly efficient Bergen B33:45 engines, running on low sulphur

fuel, and a supporting electrical system that will reduce the vessel’s fuel consumption,

emissions, noise and vibration, minimising the impact in the sensitive polar environment.

READ MORE AT WWW.ROLLS-ROYCE.COM

Rolls-Royce Holdings plc Annual Report 2016 SUSTAINABLE BUSINESS 

Inspiring future

generations of engineers

We aim to reach six million people

through our science, technology,

engineering and mathematics (STEM)

education outreach programmes

by 2020. Our activities are designed

to demonstrate the life-long

opportunities that STEM careers can

offer, helping to secure a future talent

pipeline for ourselves and the wider

industry. In 2016, we reached 1.2 million

people

, 68% of whom were actively

engaged in our programmes. Since

launching in 2014, we are now 47%

towards our 2020 target.

UTCs

AMRCs

Research partnerships

Engineering expertise

We seek to attract the best and brightest

engineers by providing them with

world-class projects, tools and processes.

Wehave a culture of developing our people

within the Group through opportunities

such as our Specialist Academy and the

Rolls-Royce Fellowship programmes. We

value professional development and work

closely with a number of institutes and

external organisations to encourage our

engineers to earn professional recognition.

In 2016, we invested £21m to enhance our

digital engineering toolset across all our

businesses. These developments include:

• DaVinci

This new software enables our engineers

to create and test whole engine models

virtually. This reduces costs, improves

our designs and removes expensive

physical hardware tests as we develop

new products.

• High performance computing

We have continued investing in upgrades

to our high performance computing

infrastructure to enable our engineers

to make the most of the software tools

we have available.

NUMBER OF ENGINEERS (YEAR END)

16,526

Design 7,611

Manufacturing 3,435

Services 1,623

Electrical 1,622

Other 2,235

Total 16,526

We are also growing our in-house

capabilities to capitalise on emerging

opportunities. In 2016, we established

our digital business to leverage decades

of data-driven in-service product

knowledge to develop new customer

services, and we are leading the way in

the development of intelligent ships.

External assurance over STEM, Energy, GHG and TRI rate data provided by Bureau Veritas. See page 183 for the sustainability assurance statement.

Our total number of engineers rose slightly from 15,564 in 2015. This is primarily due to reclassification of 517 roles in Power Systems, and the recruitment

of around 270 roles at the new engineering campus in Bangalore, India.

For over 25 years, Rolls-Royce has been

co-ordinating research with leading

academic institutions and industry

partners to harness the knowledge of

renowned experts and gain the best value

from our investments.

University Technology Centres (UTCs)

This global network of university research

partners advances our understanding of

specialist science and technologies which

are core to our next-generation products.

Advanced Manufacturing Research

Centres (AMRCs)

These collaborative public/private

partnerships help us to bridge the gap

between early research and industrial

application, with a focus on developing new

manufacturing processes and technologies.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT SUSTAINABLE BUSINESS

We remain committed to protecting and

preserving the human rights of our

employees, those working in our global

supply chain and those who may be

impacted by our operations. Our Global

Code of Conduct and global human rights

policy set out this commitment. More

information on our approach can be found

in our 2016 anti-human trafficking and

modern slavery statement, available at

www.rolls-royce.com.

The skills, knowledge and passion of our

workforce are key enablers to our

transformation programme. We are

embedding a high performance culture

across the organisation that encourages

pace and simplicity.

As part of our people transformation we

have simplified the organisation through

management restructuring and leadership

change. This has included a reduction of

around 700 management positions in 2016

to drive accountability, simplicity and pace

through the organisation and improve

decision making. In addition, we have

continued to make changes to our

headcount mix to align with our markets

and associated challenges. This has affected

our Marine business in particular.

Our transformation is underpinned by

our ongoing commitment to maintain

the highest standards of ethics, safety

and human rights.

In 2016, 97% of Rolls-Royce employees

completed annual ethics training, focused

on dealing with ethical dilemmas. We are

committed to having an environment

where anyone can ask questions or raise

concerns without fear of retaliation,

anonymously if required.

During the year, all of our management

population completed Global Code of

Conduct certification. We also introduced an

ethics e-learning module for new employees

to help familarise them with our approach

and expectations. In 2016, 99% of new

employees who joined us during the year

completed this course within the first three

months of their employment.

We regard the health and safety of our

employees and those working on our

premises, or on our behalf, as paramount.

In 2016, there were no fatalities in the

Group, and our Total Reportable Injury (TRI)

rate was 0.60 per 100 employees

. This

represents a 6% improvement since 2014.

We continue to concentrate on global

improvement programmes aligned to our

risk profile. Electrical safety and process

safety programmes concluded this year

and have now transitioned to form part of

our ongoing Group assurance activity.

For more information see the Safety & Ethics

Committee report, on pages 103 to 109.

External assurance over STEM, Energy, GHG and TRI rate data provided by Bureau Veritas. Seepage 183 for the

sustainability assurance statement.

Headcount data is calculated in terms of average full-time employees.

Other businesses and corporate includes Energy businesses not sold into Siemens in 2014 and corporate employees who

do not provide a shared service to the segments. Where corporate functions provide such a service, employees have

been allocated on an appropriate basis. 2015 figures have been restated on this basis.

Certain joint ventures have been reclassified as joint operations from 1 January 2016. This has increased the Group

reported headcount by 800 employees.

Headcount by business unit

1,2,3

2015 2016

Civil Aerospace 23,100

23,800

Defence Aerospace 6,300

6,000

Power Systems 10,600

10,300

Marine 6,000

5,300

Nuclear 4,100

4,300

Other businesses and corporate 400

200

Total 50,500

49,900

2015 2016

UK 23,200

22,300

US 6,400

6,300

Canada 1,100

1,000

Germany 10,700

10,700

Nordic countries 3,800

3,400

Rest of world 5,300

6,200

Total 50,500

49,900

PERCENTAGE OF EMPLOYEES WHO COMPLETED

ANNUAL ETHICS TRAINING

97%

TOTAL REPORTABLE INJURY RATE

(PER  EMPLOYEES)

0.60

Headcount by location

1,3

THROUGH

OUR PEOPLE

We continue to develop our employee base, ensuring we have the

right skills for our business today and the right capabilities for the future.

Rolls-Royce Holdings plc Annual Report 2016 SUSTAINABLE BUSINESS 

Our sustainable employee engagement

index score declined slightly from 81 in 2015

to 75 in 2016, six points below the high

performance norm.

We consider a subset of the results of our

employee opinion survey when calculating

our non-financial KPIs, recognising that an

engaged workforce is a key measure of

success. For more information see page 47.

We provide a variety of channels to

communicate with employees and

encourage participation and engagement.

Our community investment and education

outreach programmes are a key component

of our employee involvement activities.

We invested £9.5m in supporting

communities in 2016, including £5.6m

in cash contributions and £3.9m in

employee time equivalent.

We are committed to creating an

environment where every employee

can reach his or her full potential, by

encouraging diversity, wellbeing and

development. We have employee resource

groups in our UK, US and Germany

operations. These bring together employees

who share similar characteristics or

experiences.

More information on our approach to

diversity and gender distribution can be

found in the Nominations & Governance

Committee report, on pages 67 and 69.

Our training programmes have helped

employees to embrace and drive change.

In 2016, we invested over £32m in employee

learning and development, delivering over

one million hours of employee training.

• High Performance Culture (HPC)

HPC is our flagship cultural change

programme. It is designed to provide

insights and tools to help our people

operate and collaborate with pace,

simplicity and accountability. More than

80% of employees have been engaged in

the programme to date.

• Columbus Academy

The Columbus Academy is our principal

executive development programme, run

in partnership with Oxford Said Business

School. It challenges our leadership teams

to consider larger, strategic issues as we

continue to transform our business. All our

senior leaders have attended the course.

As part of our cultural change programme,

we have introduced assessments of

individuals’ alignment to our values and

behaviours into our performance

management approach for all employees.

Maintaining employee engagement is

critical during times of change and

transformation. More than 30,000

employees took part in our employee

opinion survey this year, our highest

participation rate to date.

GRADUATES RECRUITED IN 

274

APPRENTICES RECRUITED IN 

327

PERCENTAGE OF OUR GRADUATES WHO ENTERED

ENGINEERING DEVELOPMENT PROGRAMMES

60%

PERCENTAGE OF OUR APPRENTICES WHO JOINED

HIGHER APPRENTICESHIP PROGRAMMES

33%

OUR APPRENTICE SCHEME HAS BEEN

RUNNING FOROVER

100 years

Our early career development programmes

continue to attract large numbers of

high-quality graduates and apprentices,

providing a pipeline of talent into finance,

HS&E, operations, HR and engineering.

Our programmes include technical and

practical engineering, specialist sciences

and corporate function programmes

including accountancy, supply chain

management and project management.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016STRATEGIC REPORT SUSTAINABLE BUSINESS

In 2016, we invested £50m in improvements

to existing facilities and £184m in the

development of new facilities, while at the

same time reducing our global operational

footprint by 2%.

Our investments in state-of-the-art facilities

also enable us to reduce the environmental

impacts of our operations.

Derby Campus, UK

As part of our commitment to retain

manufacturing and engineering

capability in the UK, we launched a

five-year investment programme to

redevelop our Derby Campus.

Over 10,000 employees, including

7,500 engineers

Future product development

programmes

Final assembly of our Trent XWB

and Trent 1000 engines

Our corporate functions

† Regulatory greenhouse gas (GHG) emissions data details on page 188.

External assurance over STEM, Energy, GHG and TRI rate data provided by Bureau Veritas. Seepage 183 for the sustainability assurance statement.

Waste data for 2016 is calculated in accordance with our basis of reporting, as set out on www.rolls-royce.com/sustainability. Whilst we were able to determine the total waste

production and waste to landfill for 2016, we maintain a limited degree of uncertainty in the waste categorisation and quantities which may impact our reported numbers.

We will continue to review historical and source data and if a material impact is identified will restate in accordance with our basis of reporting.

INVESTMENT IN ENERGY EFFICIENCY

IMPROVEMENT PROJECTS

£10m

THROUGH OUR

OPERATIONS

AND FACILITIES

We continue to develop world-class production capabilities while

optimising ouroperational footprint.

2014

baseline

2020

target

2015 2016 2017 2018 2019

120

100

2014

baseline

2015 2016 2017 2018 20202019 2025

target

500

100

200

300

400

2014

baseline

2020

target

2015 2016 2017 2018 2019

2014

baseline

2020

target

2015 2016 2017 2018 2019

Target: reduce energy use in our operations and

facilities by 30%, normalised by revenue, by 2020.

(excluding product test and development)

Our total energy consumption for 2016, excluding

product test, was 95 MWH/£m, which represents

a 17% reduction since 2014. This has been driven

by continued investment in energy efficiency

improvement projects, including upgrading

lighting and heating systems, and building

management systems. Our expenditure for

2016 totalled £10m, our highest annual

investment to date.

Target: reduce total solid and liquid waste in our

operations and facilities by 25%, normalised

by revenue, by 2020.

Our total solid and liquid waste production in

2016 was 4.48 t/£m, a 2% increase from 2014. This

is largely driven by improved data collection and

validation, particularly in Power Systems.

We continue to focus on opportunities to prevent

and reduce the amount of waste we generate.

We expect waste reduction activity to be

accelerated in 2017 through a global waste

action programme.

Target: reduce greenhouse gas (GHG) emissions

in our operations and facilities by 50%,

absolute, by 2025.

(excluding product test and development)

Our total GHG emissions for 2016, excluding

product test, was 424 ktCO

e. This represents a

13% reduction since 2014. This has been achieved

by investing in a number of low carbon and

renewable energy projects across our global

facilities, including completing two large solar

power installations at our Singapore and Bristol,

UK manufacturing sites.

Target: zero waste to landfill in our operations

and facilities, by 2020.

(excluding hazardous waste)

The amount of waste sent to landfill has

decreased by 28% from 6,700 tonnes in 2014 to

4,800 tonnes in 2016, with particularly good

progress in our Defence Aerospace and Power

Systems businesses. This has been accelerated in

2016 by a reduction in output from our two major

foundries. We continue to work closely with our

waste management partners to identify recycling

and recovery alternatives to landfill across a

variety of waste streams.

ENERGY USE (MWH/M)

ABSOLUTE GHG EMISSIONS (KTCO



E) † WASTE TO LANDFILL ( TONNES)



TOTAL SOLID AND LIQUID WASTE (T/M)



Rolls-Royce Holdings plc Annual Report 2016 SUSTAINABLE BUSINESS 

Rolls-Royce spends over £7bn annually with

suppliers. We invest significant resources to

ensure this complex supply chain is resilient,

efficient and able to consistently deliver to

Rolls-Royce standards. Our supply chain is

built on long-term relationships, frequently

based on shared investments and capability.

We also invest in developing new supplier

relationships as we move into new

technologies, new customer markets and

geographies, particularly in the Asia Pacific

region.

At the same time, we are rationalising our

supply base as we continue to streamline our

product portfolio and operational footprint,

particularly in our Marine business where we

have reduced the number of OE suppliers by

40% since 2013.

Our customers expect outstanding product

performance and reliability. They operate

our products for decades, frequently in

combination with aftermarket services. This

leads to a deep understanding of their needs

which we apply to the development of new

technologies and products.

The quality of our customer relationships

is based on mutual trust, as well as our

engineering expertise. As a steering

committee member of the International

Forum on Business Ethical Conduct for the

Aerospace and Defence Industry (IFBEC), we

strive to implement best practice ethical

business standards and continue to apply a

zero tolerance approach to bribery and

corruption.

In addition, we have introduced a

customer delivery metric into our

remuneration policy to ensure continued

focus on the delivery of our commitments

to customers. For more information see

page 47.

We engage collaboratively with key

suppliers to drive out cost and enhance

value, underpinned by full transparency

and agreed joint improvement plans.

Over 65% of our spend is managed through

mature and collaborative supplier

engagement programmes.

We remain committed to maintaining the

highest levels of ethical behaviour across

our supply chain. At the end of 2016, 99% of

our suppliers had contractually agreed to

adhere to our Global Supplier Code of

Conduct. We have also introduced risk-based

compliance monitoring; 22% of our

prioritised suppliers have completed this

assessment, covering business ethics, labour

practices, anti-bribery and human rights.

Our external suppliers

Our customers

50-year partnership with

theRoyal Navy

Rolls-Royce is a world-leader in nuclear

submarine systems and support

services incorporating design,

procurement and operation. For the

past 50 years, we have been the

Technical Authority for the UK Nuclear

Steam Raising Plant, responsible for

powering the UK's Royal Navy

submarine fleet.

A superior supplier to the

US Air Force

In September 2016, the USAF recognised

Rolls-Royce as a Superior Supplier.

We are the only engine manufacturer

to be recognised by the USAF as a Tier 1

Superior Supplier three years in a row.

SUPPLIERS CONTRACTUALLY AGREED TO ADHERE TO

OUR GLOBAL SUPPLIER CODE OF CONDUCT

99%

ANNUAL SPEND WITH OUR SUPPLIERS

>£7bn

THROUGH OUR

SUPPLIER AND

CUSTOMER

RELATIONSHIPS

We pride ourselves on being trusted partners to suppliers and

customers in more than 150 countries worldwide. Our long-term

relationships provide insights and capabilities which enable us to

deliver world-class products and services.

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT KEY PERFORMANCE INDICATORS

Key performance indicators

Description Why we measure it How we have performed

Order book

£79.8bn

We measure our order book in line with industry practice and

believe it is an indicator of future business; however, its value

may not be reflective of future revenue. Wemeasure it at our

long-term planning exchange rate (LTPR) and list prices

andinclude both firm and announced orders. 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. 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.

Conservatively, weonly include the first seven years’ revenue

oflong-term aftermarket contracts.

The order book grew by

£3.4bn. An increase of

£4.4bn in Civil Aerospace

(including £2.1bn from a

five cent improvement in

the LTPR) was offset by a

reductions in the other

segments, reflecting the

current weak market

conditions, particularly in

oil & gas markets.

£bn

60.1

71.6

73.7

76.4

79.8

2012 2013 2014 2015 2016

Order intake

£19.1bn

Order intake is a measure of new business secured during

theyear and represents new firm orders, adjusted for the

movement in the announced order book between thestart

and end of the period. Any orders which were recorded in

previous periods and which are subsequently cancelled,

reducingthe order book, areincluded as a reduction to intake.

We measure order intake at constantexchange rates and list

prices and, consistent with the order book policy of recording

the first seven years’ revenue of long-term aftermarket

contracts, include the addition of the following year of revenue

on long-term aftermarket contracts.

An increase of £1.3bn in

Civil Aerospace order intake

was offset by weaker intake

in Defence Aerospace and

Marine.

£bn

18.2

16.1

26.9

19.4

19.0

19.1

inc Energy

exc Energy

2012

2013

2014

2015

2016

Underlying revenue

£13,783m

Monitoring of revenue provides a measure of business

growth. Underlying revenue is used as it reflects the impact

ofour FXhedging policy by valuing foreign currency revenue

atthe actual exchange rates achieved as a result ofsettling

foreign exchange (FX)contracts in the year. This provides a

clearer measure of the year-on-yeartrend.

At constant exchange rates,

revenue was broadly stable

except in Marine where it

fell by 24%. Improved

achieved rates on currency

hedging increased

underlying revenues by

£0.7bn.

£m

13,354

12,209

15,505

14,588

13,864

13,783

inc Energy

exc Energy

2012

2013

2014

2015

2016

Net R&D expenditure

as a proportion of

underlying revenue

6.8%

Thismeasure reflects the need to generate current returns

aswell as to invest for the future. We measure R&D as the

self-funded expenditure before both amounts capitalised in

theyear and amortisation of previously-capitalised balances.

Weexpect to spend approximately 5% of underlying revenue

onR&D although this proportion will fluctuate depending on

thestage of development of current programmes. We expect

this proportion will reduce modestly over the medium term.

The increase is largely due

to increased expenditure

on three large engine

programmes, Trent 1000

TEN, Trent XWB-97 and

Trent 7000, as they

approach entry into service.

4.7

4.8

5.8

5.9

6.2

6.8

inc Energy

exc Energy

2012

2013

2014

2015

2016

Our key financial and non-financial performance indicators are shown below. The areas of focus ofthe Board and its

committees are described onpages 58 to 112, andother non-financial performance indicators are shown in the

Sustainable business section on pages40to 45 and the Safety & Ethics Committee report on pages 103 to 109.

Rolls-Royce Holdings plc Annual Report 2016 KEY PERFORMANCE INDICATORS

Description Why we measure it How we have performed

Capital expenditure

as a proportion of

underlying revenue

4.5%

To deliver on its commitments to customers, the Group

investssignificant amounts in its infrastructure. All proposed

investments are subject torigorous review to ensure that

they are consistent with forecast activity and will provide

value formoney. We measure annual capital expenditure

asthe cost ofproperty, plant and equipment acquired during

the period and, over the medium term, expect a proportion

of around 4%. (Capital expenditure excludes additions arising

from TotalCare Flex arrangements.)

Expenditure increased to

£626m (2015: £494m)

principally reflecting the

major investment in

aerospace footprint and

capacity.

4.0

4.4

4.6

4.7

3.7

4.5

inc Energy

exc Energy

2012

2013

2014

2015

2016

Underlying profit

before financing

£915m

We measure underlying profit before financing on a basis

thatshows the economic substance of the Group’s hedging

strategies in respect of the transactional exchange rate and

commodity price movements. In particular: (a) revenues and

costs denominated in US dollars and euros are presented

onthe basis of the exchange rates achieved during the year;

(b)similar adjustments are made in respect of commodity

derivatives; and (c)consequential adjustments are made

toreflect the impact ofexchange rates on trading assets

andliabilities, and long-term contracts, on a consistentbasis.

The reduction is

predominantly in Civil

Aerospace reflecting

reductions in: volume and

margin on link accounted

Trent 700 engines; business

jet original equipment

volumes; large engine

aftermarket utilisation; and

increased technical costs

for large engines. In

addition, 2015 benefited

from changes in risk

assessments, partially

offset by strong lifecycle

cost improvements and

provision releases.

£m

1,495

1,831

1,678 1,681

1,492

915

inc Energy

exc Energy

2012

2013

2014

2015

2016

Free cash flow

£100m

In a business requiring significant investment, we monitor

cashflow toensure that profitability is converted into cash

generation, both for future investment and as a return

toshareholders. We measure free cash flow as the movement

innet debt/funds during the year, before movements

arisingfrom payments to shareholders, acquisitions and

disposals, andFX.

The reduction reflects

lower profits and increased

capital expenditure offset

by improvements in net

working capital.

£m

548

781

254

447

179

100

inc Energy

exc Energy

2012

2013

2014

2015

2016

Non-financial key performance indicators

Description Why we measure it How we have performed

Customer delivery

88%

To deliver on our commitments to our customers we measure

the percentage of ‘on-time to purchase order’ including new

equipment, spare parts, equipment repair and overhaul.

This is tracked Group-wide in our scheduling and order

fulfilment system.

As we continue to ramp up our delivery of Trent Engines, the

challenge to improve on-time delivery remains a priority.

The 2016 score of 88% fell slightly short of our target of 90%.

Employee engagement

This is measured through our long-standing employee opinion

survey which produces a composite engagement score.

The targets are based on absolute scores for six key questions

within the overall survey.

Our employee engagement score achieved our target of 75 in

2016. This was the same score as in 2015 and the target reflected

the significant impact of the transformation programme on our

employees in 2016.

* 2016 is the first year that we have included these non-financial performance indicators in our remuneration structure.

REMUNERATION COMMITTEE REPORT ON PAGE 

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT PRINCIPAL RISKS

Principal risks

The Group’s enterprise risk team, led by

the Director of Risk, is responsible for

disseminating the risk policy and processes

and co-ordinating the effective operation

of the RMS. Progress of actions to mitigate

risks and the adequacy of risk controls are

regularly reviewed by the sector audit

committees.

Joint ventures constitute a large part of the

Group’s activities. Responsibility for risk and

internal control in joint ventures lies with

the managers of those operations. We seek

to exert influence over such joint ventures

through board representation. Management

and internal audit regularly review the

activities of these joint ventures.

In 2016, we continued to embed

enhancements to our RMS throughout

the Group, including strengthening risk

governance and building improvements

to our risk operating model, reporting,

infrastructure and assurance processes.

Examples of enhancements implemented

in 2016 include:

• Launching a new risk policy which was

mandated as part of the governance

framework and supported by improved

risk management training, which is

mandatory for new employees.

• Adopting a risk visualisation tool for use

at the Board, Executive Leadership Team

(ELT) and in the businesses to bring risk

discussions to life and enable better

interrogation of risk information.

• Holding more regular ELT risk committee

meetings (quarterly) to conduct deep

dives into specific risks, in particular their

mitigation plans and controls, and to

consider systemic issues and common

root causes.

• Building much closer links to strategic

and business financial planning and

forecasting processes to develop risk

scenarios used to support our viability

statement.

• Updating the way we monitor and

measure the effectiveness of the RMS,

including the use of incident information

to drive learning and continuous

improvement of our risk mitigation

activities.

The Board is aware that the effectiveness

of risk management is highly dependent

on behaviours, as a good process does not

automatically lead to a good outcome. The

roll-out of the Group’s High Performance

Culture programme will continue to

strengthen risk management as part of our

culture. In addition, the emphasis in our

ethics and compliance programme of

providing a culture of speaking up,

reinforces the values and behaviours

required for an effective RMS.

In 2017, we will continue to look for

opportunities to strengthen our RMS

and our corporate culture by focusing

on embedding risk content in leadership

training programmes, discussing our

principal risks in employee communications

and regularly evaluating the effectiveness of

our risk management activities.

Management of principal risks

Our risk framework ensures that risks are identified, managed and communicated throughout the Group.

Identify

principal risks

(PRs)

Impact of

PRs on long-

term viability

Monitor

mitigation and

control of PRs

Governance

of PRs

Set risk appetite

for PRs

Reporting

Assess effectiveness of risk management system (RMS)

Risk management

Risk management is built into our daily

activities and is an integral part of how we

work: from our engineering design, through

to engine production, servicing and how we

run our operations.

The Board is responsible for the Group’s risk

management and internal control systems

and reviews their effectiveness. These

systems are designed to identify and manage,

rather than eliminate, the risk of failure to

achieve business objectives and to provide

reasonable, but not absolute, assurance

against material misstatement or loss.

More information about our internal control

system can be found in the Audit Committee

report on pages 100 and 101.

Our risk management system

Our risk management system (RMS) helps

us make better decisions and to deal with

problems if they occur. It is implemented

through a Group-wide framework

mandated in the Group risk management

policy and a network of trained risk

management facilitators. It is supported

through the use of risk software.

Businesses and functions are accountable

for identifying and managing risks in line

with the Group risk management policy.

Business continuity plans are in place

to mitigate continuity risks and this year

there has been more regular testing of the

adequacy of these plans through exercises

with the businesses.

Rolls-Royce Holdings plc Annual Report 2016 PRINCIPAL RISKS

supported by the ELT risk committee

performing deep dives of related bottom-up

key risks and the actions and controls in

place to manage them. During the year, the

Board or the most appropriate Board

committee has undertaken a deep dive on

all of the Group’s principal risks. The Board

has also conducted a review of our strategic

risks as part of its annual strategy review.

This ongoing review of risks has resulted in a

further principal risk being added this year:

Disruptive technologies and business

models. This risk has been added to reflect

the increasing importance of transformative

technologies and new ways of doing

business, not least digitisation of processes,

products and services, that if not properly

managed, could impact our future growth

and profitability. This risk will be overseen

by the Science & Technology Committee and

was subject to a deep dive by the ELT at its

meeting in December 2016.

The principal risks are also used to help

select scenarios to exercise our Group crisis

management team (CMT). This year an

appropriate scenario was developed based

on the IT vulnerability principal risk. This

provided an opportunity for the CMT to

understand the nature and complexity of

cyber threats and to test the Group’s

response procedures and identify where our

plan can be further strengthened.

The Board gave initial consideration to the

implications of Brexit for the Group, and due

to the prevailing uncertainty of timing and

impact set up a steering group to monitor

developments and report back to the Board.

Rolls-Royce is headquartered in the UK but

across continental Europe the Group has

significant infrastructure, a large workforce,

many business units and a very important

customer and supplier base. Whilst the

details of Brexit are still unclear, we are

working with the UK government and

others to ensure the implications of leaving

the EU are understood and mitigated

if possible. We recognise we have an

obligation to look after our people in the UK,

Europe and beyond, and to ensure that we

take the necessary steps to position the

Group to address both the opportunities

and threats presented so that we can

continue to do business effectively in and

with Europe and the rest of the world with

minimal disruption.

Additionally, Rolls-Royce has significant

operations, a substantial employee base,

and important customers in North America,

where the new US administration has

signalled broad policy changes. Some of

these changes in policy with regard to

trade, tax and defence and infrastructure

spending could affect the industries which

we serve. The North America leadership

team is actively monitoring these

developments to mitigate risk and position

us advantageously in this new environment.

Principal risks

Our RMS is designed so that principal risks

can be identified from multiple sources. Key

bottom-up risks are identified by businesses

and functions and the detail of risks that

meet the Group threshold are subject to

review and challenge by the ELT and the

Board during their risk reviews.

These include monitoring the status of

mitigation actions, adequacy of controls

and any incidents that have occurred since

the last review. Risks captured during the

strategy and business planning activities

also inform the development of the

principal risks.

The Board, assisted by the ELT, has carried

out a robust assessment of, and reviewed

our appetite for, the principal risks facing

the Group. These include those principal

risks that threaten the business model,

future performance, solvency and liquidity

of the Group. These reviews have been

informed by the financial evaluation of

severe but plausible scenarios of our

principal risks which has also been used to

support our viability statement on page 53.

During the year, the Board and ELT reviews

have involved: discussing changes to the

risks; reviewing the risk indicators for

principal risks; understanding any

unplanned incidents that have occurred to

support the Board’s consideration of our risk

appetite; and, discussing with management

about how risks will be managed.

The Board, or the most appropriate Board

committee, undertakes in-depth reviews

(deep dives) of our principal risks in which

it assesses our material controls and the

effectiveness of our risk management and

mitigation activities. These reviews are

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT PRINCIPAL RISKS

Risk or uncertainty and potential impact How we manage it Key controls

Change in

risk level

Strategic

priorities

Disruptive technologies

and business models

Disruptive technologies, new entrants

with alternative business models

or disruptions to key markets or

customers could reduce our ability

to win sustainable future business,

achieve operating results and realise

future growth opportunities.

• Horizon and emerging technology scanning, and understanding

our competitors, including patent searches.

• Investing in innovation and new technologies (see page 9).

• Focusing on enhancing our skills and capabilities to maintain our

technology leadership (see page 41).

• Forming strategic partnerships and conducting joint research

programmes.

• Establishing our digital business.

This principal risk is subject to review by the Science & Technology

Committee.

• Strategic planning

process

• Investment review

committee

• Digital board

• Research &

technology board

Product failure

Product not meeting safety

expectations, or causing signicant

impact to customers or the

environment through failure

in quality control.

• Ensuring a culture that puts safety rst.

• Applying our engineering design and validation process from initial

design, through production and into service.

• Reviewing the scope and eﬀectiveness of the Group’s product

safety policies to ensure that they operate to the highest industry

standards.

• Operating a safety management system (SMS), governed by the

product safety review board, and subject to continual improvement

based on experience and industry best practice. Product safety

training is an integral part of our SMS (see pages 104 and 107).

• Improving our supply chain quality.

This principal risk is subject to review by the Safety & Ethics Committee.

• Product safety

review board

• Quality compliance

audit

• Engineering

technical audit

• Crisis management

team

Business continuity

Breakdown of external supply chain

or internal facilities that could

be caused by destruction of key

facilities, natural disaster, regional

conict, nancial insolvency

of a critical supplier or scarcity of

materials which would reduce

the ability to meet customer

commitments, win future business

or achieve operational results.

• Continuing our investment in adequate capacity and modern

equipment and facilities (see page 21).

• Identifying and assessing points of weakness in our internal

and external supply chain, our IT systems and the skills of our people.

• Selecting stronger suppliers, developing dual sources or

dual capability (see page 45).

• Developing and testing site-level incident management and

business recovery plans.

• Providing improved response to supply chain disruption through

customer excellence centres.

• Understanding potential changes to supply chain responsiveness

and resilience resulting from Brexit and change to the US

administration (eg. due to logistics delays).

This principal risk is subject to review by the Audit Committee.

• Crisis management

team

• Major incidents

board

• Quality board and

process councils

• Operations and

IT executive teams

• Supplier audit

IT vulnerability

Breach of IT security causing

controlled or critical data to be lost,

made inaccessible, corrupted or

accessed by unauthorised users.

• Implementing ‘defence in depth’ through deployment of multiple

layers of software and processes including web gateways, ltering,

rewalls, intrusion, advanced persistent threat detectors and

integrated reporting (see page 100).

• Running security and network operations centres.

• Actively sharing IT security information through industry,

government and security forums.

This principal risk is subject to review by the Audit Committee.

• Operations and

IT executive teams

• IT security

management

• Crisis management

team

Risk management enables our strategy

 Engineering excellence

 Operational excellence

 Capturing aftermarket value

Increased

Decreased

Static

New risk

Change in risk level

PRIORITIES FOR  ON PAGE 

Rolls-Royce Holdings plc Annual Report 2016 PRINCIPAL RISKS

Risk or uncertainty and potential impact How we manage it Key controls

Change in

risk level

Strategic

priorities

Competitive position

The presence of large, nancially

strong competitors in the majority

of our markets means that the Group

is susceptible to signicant price

pressure for original equipment or

services even where our markets are

mature or the competitors few.

Our main competitors have access

to signicant government funding

programmes as well as the ability

to invest heavily in technology and

industrial capability.

• Accessing and developing key technologies and service oﬀerings which

diﬀerentiate us competitively (see page 40).

• Focusing on being responsive to our customers and improving

the quality, delivery and reliability of our products and services.

• Partnering with others eﬀectively.

• Driving down cost and improving margins (see page 10).

• Protecting credit lines.

• Investing in innovation, manufacturing and production,

and continuing governance of technology programmes

(see pages 111 and 112).

• Maintaining a healthy balance sheet to enable access to cost-eﬀective

sources of third-party funding.

• Understanding our competitors.

• Understanding the potential implications on our competitiveness

resulting from Brexit and change to the US administration.

This principal risk is subject to review by the Board.

• Financial

performance review

• Strategic planning

process

• Investment review

committee

• Science &

Technology

Committee

• Research &

technology board

Political risk

Geopolitical factors that lead to an

unfavourable business climate and

signicant tensions between major

trading parties or blocs which could

impact the Group’s operations. For

example: explicit trade protectionism,

diﬀering tax or regulatory regimes,

potential for conict; or broader

political issues.

• Where possible, locating our facilities and supply chain in countries

with a low level of political risk and/or ensuring that we maintain

dual capability.

• Diversifying global operations to avoid excessive concentration

of risks in particular areas.

• The Group’s international network and its businesses proactively

monitoring local situations.

• Maintaining a balanced business portfolio with high barriers

to entry and a diverse customer base (see page 14).

• Proactively inuencing regulation where it aﬀects us.

• Steering committee, chaired by Group President, to co-ordinate

activities across the Group and minimise the impact of Brexit.

• Monitoring the potential impact of changes following the change to

the US administration, relating to tax policy, trade and relationships

with the UK government.

This principal risk is subject to review by the Board.

• Government

relations and

Group tax teams

• Strategic planning

process

• Supplier audit

Major programme delivery

Failure to deliver a major

programme on time, within budget,

to specication, or technical

performance falling signicantly

short of customer expectations,

or not delivering the planned

business benets, would have

potentially signicant adverse

nancial and reputational

consequences, including the risk

of impairment of the carrying value

of the Group’s intangible assets and

the impact of potential litigation.

• Major programmes are subject to Board approval (see page 185).

• Reviewing major programmes at levels and frequencies appropriate

to their criticality and performance, against key nancial and

non-nancial deliverables and potential risks throughout the

programmes lifecycles (see page 185).

• Conducting technical audits at pre-dened points which are

performed by a team that is independent from the programme.

• Requiring programmes to address the actions arising from reviews,

and audits and then monitoring and controlling progress through

to closure.

• Applying knowledge management principles to provide benet to

current and future programmes.

This principal risk is subject to review by the Board.

• Rolls-Royce

management

system

• Operational

performance review

• Project assurance

• Gated business and

technical reviews

• Quality compliance

audit

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 STRATEGIC REPORT PRINCIPAL RISKS

Risk or uncertainty and potential impact How we manage it Key controls

Change in

risk level

Strategic

priorities

Compliance

Non-compliance by the Group with

legislation or other regulatory

requirements in the heavily regulated

environments in which it operates

(eg. export controls; use of controlled

chemicals and substances; and

anti-bribery and corruption

legislation) compromising the ability

to conduct business in certain

jurisdictions and exposing the Group

to potential: reputational damage;

nancial penalties; debarment from

government contracts for a period of

time; and/or suspension of export

privileges (including export credit

nancing), each of which could have

a material adverse eﬀect.

• Taking an uncompromising approach to compliance.

• Operating an extensive compliance programme. This programme

and the Global Code of Conduct are disseminated throughout

the Group and are updated from time to time to ensure their

continued relevance, and to ensure that they are complied with,

both in spirit and to the letter. The Global Code of Conduct and

the Group’s compliance programme are supported by appropriate

training (see page 105).

• Strengthening of the ethics, anti-bribery and corruption, compliance

and export control teams.

• A legal team is in place to manage regulatory investigations.

• Engaging with external regulatory authorities.

• Implementing a comprehensive Registration, Evaluation,

Authorisation and restriction of CHemicals (REACH) compliance

programme. This includes establishing appropriate data systems

and processes, working with our suppliers, customers and trade

associations and conducting research on alternative materials.

This principal risk is subject to review by the Safety & Ethics Committee.

• Corporate

governance

framework

• Compliance and

export control

teams

• Group Secretariat

• Legal teams

Market and financial shock

The Group is exposed to a number of

market risks, some of which are of a

macro-economic nature (eg. oil price,

exchange rates) and some of which are

more specic to the Group (eg.

liquidity and credit risks, credit rating,

protability post IFRS 15, reduction

in air travel or disruption to other

customer operations). Signicant

extraneous market events could also

materially damage the Group’s

competitiveness and/or

creditworthiness.

This would aﬀect operational results

or the outcomes of nancial

transactions.

• Maintaining a healthy balance sheet, through managing cash balances

and debt levels and maturities (see page 17).

• Providing nancial exibility by maintaining high levels of liquidity

and an investment grade credit rating.

• Sustaining a balanced portfolio through earning revenue both from

the sale of original equipment and aftermarket services, providing a

broad product range and addressing diverse markets that have

diﬀering business cycles (see page 18).

• Deciding where and what currencies to source in, and where and how

much credit risk is extended or taken. The Group has a number of

treasury policies that are designed to hedge residual risks using

nancial derivatives (foreign exchange, interest rates and commodity

price risk – see page 185).

• Review debt nancing and hedging in light of volatility in external

nancial markets caused by external events, such as Brexit and change

of US administration.

This principal risk is subject to review by the Audit Committee.

• Financial

performance review

• Financial risk

committee

• Operational

performance review

• Group nance,

treasury and

taxation teams

Talent and capability

Inability to attract and retain the

critical capabilities and skills needed

in suﬃcient numbers and to

eﬀectively organise, deploy and

incentivise our people to deliver our

strategy, business plan and projects.

• Attracting, rewarding and retaining the right people with the right

skills globally in a planned and targeted way, including regular

benchmarking of remuneration (see pages 70 and 72).

• Developing and enhancing organisational, leadership, technical and

functional capability to deliver global programmes and

transformational change.

• Continuing a strong focus on individual development and

succession planning (see page 58).

• Proactively monitoring retirement in key areas and actively managing

the development and career paths of our people with a special focus

on employees with the highest potential.

• Embedding a lean, agile high performance culture that tightly aligns

Group strategy with individual and team objectives.

• Retaining, incentivising and eﬀectively deploying the critical

capabilities, skills and people needed to deliver our strategic

priorities, plans and projects whilst implementing the Group’s major

programme to transform its business, to be resilient and to act with

pace and simplicity.

• Tracking engagement through our annual employee opinion survey

and a commitment to drive year-on-year improvement to the employee

experience and communications (see page 43).

• Reviewing employee mobility as part of Brexit steering committee.

This principal risk is subject to review by the Nominations

& Governance Committee.

• Remuneration

Committee

• ELT

• HR executive team

Rolls-Royce Holdings plc Annual Report 2016 GOING CONCERN AND VIABILITY

Introduction

Rolls-Royce operates an annual planning

process which includes strategic (greater

than five years), medium-term (five year)

andshort-term (one year) financial forecasts,

based on the inputs from each of the

businesses. These plans and risks to their

achievement are reviewed by the Board

aspart of its strategy review and budget

approval processes. Once approved these

plans are cascaded throughout the Group

and are used as the basis for monitoring

ourperformance, incentivising employees

and providing external guidance to our

shareholders. These were updated to reflect

the impact of the financial penalties from

agreements with investigating bodies.

The processes for identifying and managing

the principal risks are described on pages 48

and 49. As also described there, the risk

management process, and in consequence

the going concern and viability statements,

are designed to provide reasonable, but not

absolute, assurance.

Going concern

The going concern assessment considers

whether it is appropriate to prepare

the financial statements on a going

concern basis.

As described on page 185, the Group meets

its funding requirements through a mixture

of shareholders’ funds, bank borrowings,

bonds and notes. At 31 December 2016, the

Group had borrowing facilities of £5.3bn

and total liquidity of £5.1bn, including cash

and cash equivalents of £2.8bn and

undrawn facilities of £2.3bn. £170m of the

facilities mature in 2017.

The Group’s forecasts and projections,

taking into account reasonably possible

changes in trading performance, show that

the Group has sufficient financial resources.

The Directors have reasonable expectations

that the Company and the Group are well

placed to manage business risks and to

continue inoperational existence for the

foreseeable future (which accounting

standards require to be at least a year

from the date of this report) and have not

identified any material uncertainties to the

Company’s and the Group’s ability to do so.

On the basis described above, the Directors

consider it appropriate to adopt the going

concern basis in preparing the consolidated

financial statements (in accordance with

the Guidance on Risk Management, Internal

Control and Related Financial and Business

Reporting published by the Financial

Reporting Council in September 2014).

Viability

The viability assessment considers solvency

and liquidity over a longer period than for

the purposes of the going concern

assessment above. Inevitably, the degree

of certainty reduces over this longer period.

In making the assessment, severe but

plausible scenarios have been considered

that estimate the potential impact of the

principal risks arising over the assessment

period, for example: the loss of a key

element of the supply chain; the impact

on aircraft travel of a global pandemic; or

a failure to achieve planned cost reductions.

The scenarios assume an appropriate

management response to the specific event,

but not broader mitigating actions which

could be undertaken, which were considered

separately. The impacts of these scenarios

were overlaid on the medium-term forecast

to assess how the Group’s liquidity and

solvency would be affected.

The assessment took account of the Group’s

current funding, forecast requirements and

existing committed borrowing facilities.

It assumed that existing facilities could

be refinanced as they mature. There are

modest maturities over the first two years

of the medium-term forecast with more

significant maturities in 2019 and 2021.

On the basis described above, the Board

confirms that it has a reasonable

expectation that the Company will be able

to continue in operation and meet its

liabilities as they fall due over the next five

years, consistent with the period of the

medium-term forecast.

In making this statement, the Directors have

made the following key assumptions:

• That maturing facilities will be

refinanced. The Group currently has

access to global debt markets and expects

to be able to refinance these facilities

on commercially-acceptable terms.

The Group’s medium-term and long-term

financing plans are designed to allow for

periods of adverse conditions in world

capital markets but not a prolonged

(say 12 month) period where debt markets

were effectively closed to the Group.

• That in the event of a single risk or

multiple lesser risks occurring which have

a particularly severe effect on the Group,

all potential actions, such as constraining

capital spending and reducing or

suspending payments to shareholders,

would be taken on a timely basis. The

Group believes it has the early warning

mechanisms to identify the need for such

actions and the ability to implement them

on a timely basis if necessary.

• That implausible scenarios, whether

involving multiple risks occurring at the

same time or the impact of individual

risks occurring that cannot be mitigated

by management actions to the degree

assumed, do not occur. For instance,

whilst the Directors have considered a

scenario where cost reductions are not

achieved and a major programme is

delayed, they have not considered it

plausible that any other of the key risks

would crystallise in a way that would

create a worse outcome over the five-year

assessment period.

Signed on behalf of the Board

Warren East

Chief Executive

13 February 2017

Going concern

and viability statements

STRATEGIC REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT BOARD OF DIRECTORS

Board of Directors

Appointed to the Board in March

2013 and as Chairman in May 2013

Career, skills and experience

Ian is senior partner emeritus of

McKinsey & Company. He was a

partner at McKinsey for 31 years until

2010 and served as chairman and

worldwide managing director of

McKinsey between 2003 and 2009.

He brings signicant nancial and

strategic experience to the Board.

He has worked with and advised

global organisations and companies

in a wide variety of sectors as well as

in the public sector, enabling him to

draw on knowledge of diverse issues

and outcomes to assist the Board.

His role in the Cabinet Oﬃce, from

which he stepped down in March

2016, gives him a unique perspective

on government aﬀairs.

Other current principal roles

• BP p.l.c., non-executive director

• Johnson & Johnson Inc., director

• Teach for All Inc., director

• Majid Al Futtaim Holding LLC,

director

• McKinsey & Company, senior

partner emeritus

Appointed as an independent

Non-executive Director in January

2014, Warren became Chief

Executive in July 2015

Career, skills and experience

Warren is an engineer by training

and had an outstanding record at

ARM Holdings plc which he joined in

1994 and where he was CEO from

2001 until 2013. He has a deep

understanding of technology and of

developing long-term partnerships

and has proven strategic and

leadership skills in a global business

with a strong record of value creation

– all of which are relevant to

Rolls-Royce particularly as it

undergoes a period of transformation.

He is a fellow of the The Institution of

Engineering and Technology, a fellow

of the Royal Academy of Engineering

and a distinguished fellow of BCS, the

Chartered Institute for IT. He was

awarded a CBE in 2014 for services to

the technology industry.

Other current principal roles

• Dyson James Group Limited,

director

• The Institution of Engineering

and Technology, trustee

Ian Davis

Chairman

Warren East CBE

Chief Executive

Appointed in July 2005

Career, skills and experience

Colin joined Rolls-Royce in 1974. He

has held a variety of key positions

within the Group including Director

– Research & Technology, Director of

Engineering & Technology – Civil

Aerospace, and Group Director –

Engineering & Technology before

being appointed as Group President

in January 2016. Colin is a fellow of

the Royal Society, the Royal Academy

of Engineering, the Royal Aeronautical

Society and the Institute of

Mechanical Engineers. In June 2012,

he was awarded a CBE for services to

UK engineering.

Colin will step down from the Board

at the 2017 AGM.

Other current principal roles

• Council for Science and

Technology, member

Colin Smith CBE

Group President

Appointed in November 2014

Career, skills and experience

David has extensive industrial

experience having worked for over

25 years with Ford and Jaguar Land

Rover and latterly with Edwards

Group Limited, a major manufacturer

of industrial vacuum products. He

joined Rolls-Royce as Chief Financial

Oﬃcer for the Aerospace Division in

January 2014 before being appointed

as CFO to the Group. David’s skills in

developing systems have particular

benet to Rolls-Royce where he has

introduced a new management

information and forecasting system.

He is a member of the Chartered

Institute of Management

Accountants’ Advisory Panel.

David has resigned from Rolls-Royce

and will leave the Group following

he appointment of Stephen Daintith,

whose biography is shown on page 57.

Other current principal roles

• Motability Operations Group plc,

non-executive director

David Smith

Chief Financial Oﬃcer

Committee membership

Nominations &

Governance Committee

Safety & Ethics

Committee

Remuneration

Committee

Science & Technology

Committee

Audit

Committee

Denotes chairman

of committee

Composition of Board

committees

NG R A SE ST

Ian Davis

Lewis Booth

•

Ruth Cairnie

•

Sir Frank Chapman

• •

Irene Dorner

• • •

Lee Hsien Yang

• • •

John McAdam

• • •

Bradley Singer

•

Sir Kevin Smith

• •

Jasmin Staiblin

• •

C Denotes chairman of committee

Rolls-Royce Holdings plc Annual Report 2016 BOARD OF DIRECTORS

Appointed in May 2011

Career, skills and experience

Lewis has considerable nancial

expertise and experience, having

been the former executive vice

president and chief nancial oﬃcer

for Ford Motor Company. He brings

an international perspective, having

worked in Europe, Asia, Africa and the

US during his 34-year career in the

motor industry. After gaining a

bachelor of engineering degree with

honours in mechanical engineering,

Lewis began his career with British

Leyland before joining Ford in 1978.

He was awarded a CBE in 2012 for

services to the UK automotive and

manufacturing industries.

Other current principal roles

• Mondelez International, Inc.,

director

• Gentherm Inc., director

Lewis Booth CBE

Independent

Non-executive Director

Appointed in September 2014

Career, skills and experience

A physicist by background, Ruth has

strong strategic and commercial

experience gained at Royal Dutch

Shell Plc where she held a number of

senior international roles, most

recently as executive vice president

strategy and planning, before her

retirement in 2014.

Ruth also has signicant

remuneration committee experience

having chaired the remuneration

committee at Keller Group plc since

April 2012 and as a member of the

remuneration committee at

Associated British Foods plc. She

chairs the POWERful Women

initiative, supporting the progression

of women to senior positions in the

energy sector, and is a strong

supporter of our diversity and

inclusion initiatives.

Other current principal roles

• Associated British Foods plc,

non-executive director

• Keller Group plc, non-executive

director

• POWERful Women, chairman

Appointed in November 2011

Career, skills and experience

Sir Frank has signicant industrial

and safety experience, having worked

in the oil & gas industry for 38 years

including appointments within Royal

Dutch Shell plc and BP p.l.c. He has a

life-long passion for engineering and

innovation and a deep understanding

of technology, together with an

outstanding record of business

achievement. He was chief executive

of BG Group plc for 12 years until

2012 and chairman of Golar LNG Ltd

from 2014 to 2015. Sir Frank is a fellow

of the Royal Academy of Engineering,

the Institute of Mechanical Engineers

and the Energy Institute. He was

knighted in 2011 for services to the

oil & gas industry.

Other current principal roles

• Myeloma UK, vice chairman

Sir Frank Chapman

Independent

Non-executive Director

Appointed in July 2015

Career, skills and experience

Irene has a strong background in risk

management and is very familiar

with regulatory requirements.

She was chief executive oﬃcer and

president of HSBC, US, until December

2014. Her background in risk

management played a key role in

strengthening the nancial

institution’s risk processes and she

brings this insight as part of her role

on our Audit Committee. During a

29-year career at HSBC, she held a

number of international roles

including leading HSBC in Malaysia

and launching its Islamic banking

unit. Irene is a passionate advocate

of diversity and inclusion and an

active supporter of our employee

resource groups.

Irene was a consultant at

PricewaterhouseCoopers until

February 2016. She is also an honorary

fellow of St Anne’s College, Oxford.

Other current principal roles

• AXA SA, director

• Control Risks International

Limited, non-executive director

• OUTLeadership Advisory Board,

member

Irene Dorner

Independent

Non-executive Director

Ruth Cairnie

Independent

Non-executive Director

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT BOARD OF DIRECTORS

BOARD MEMBERS BY GENDER

Female 3

Male 10

BALANCE OF THE BOARD

Executive Directors 3

Non-executive Directors 10

NON-EXECUTIVE DIRECTORS’ TENURE

0–3 years 4

3–6 years 5

6–9 years 1

NATIONALITIES OF DIRECTORS*

British 10

German 1

Singaporean 1

US 1

* According to the Company’s Articles

of Association, at least 50% of its

Directors must be British citizens.

Appointed in January 2014

Career, skills and experience

A Singaporean, Hsien Yang was

formerly a member of our

International Advisory Board and

combines a strong background in

engineering with extensive

international business experience in

our most important growth markets.

He was chief executive of Singapore

Telecommunications Limited for

12 years until 2007. He served as

chairman and non-executive director

of Fraser and Neave Limited from 2007

to February 2013. He has signicant

industrial and nancial skills.

Other current principal roles

• Civil Aviation Authority of

Singapore, chairman

• The Islamic Bank of Asia Private

Limited, chairman

• The Australian and New Zealand

Banking Group Limited, director

• General Atlantic LLC and associated

funds, special adviser

• Lee Kuan Yew School of Public

Policy, member of the board of

governors

• INSEAD SE Asia Council, president

Appointed in February 2008

Career, skills and experience

John has extensive international and

industrial experience. He was

appointed to the board of ICI plc in

1999 and became chief executive in

2003, a position he held until 2008.

He held a number of senior positions

at Unilever, within its Birds Eye Walls,

Quest International and Unichema

International businesses. He is a

former non-executive director of

Severn Trent plc and Sara Lee

Corporation and stepped down as

senior independent director of

J Sainsbury plc in 2016.

Other current principal roles

• Rentokil Initial plc, chairman

• United Utilities Group PLC,

chairman

• Electra Private Equity PLC, director

John McAdam

Independent

Non-executive Director

Lee Hsien Yang

Independent

Non-executive Director

Appointed in March 2016

Career, skills and experience

Brad has an outstanding record as a

business leader in the US. He brings

with him experience of public

companies during periods of change,

growth and signicant nancial

outperformance, particularly in the

US where Rolls-Royce has important

business interests and a signicant

shareholder base. He has been senior

executive vice president and chief

nancial oﬃcer of Discovery

Communications, Inc. and chief

nancial oﬃcer and treasurer of

American Tower Corp. Before these

appointments, he worked as an

investment banker at Goldman Sachs.

He is a former director of Martha

Stewart Living, Omnimedia, Inc.,

Citizens Communications Corp and

Motorola Solutions Inc.

Other current principal roles

• ValueAct Capital Master Fund P.L.,

partner and chief operating oﬃcer

• Posse Foundation, director

• McIntire School Foundation,

University of Virginia, trustee

Bradley Singer

Non-independent

Non-executive Director

Sir Kevin Smith CBE

Senior Independent

Non-executive Director

Appointed in November 2015

Career, skills and experience

Sir Kevin has extensive industrial

leadership experience and a deep

knowledge of global engineering and

manufacturing businesses, as well as

the aerospace industry. He was chief

executive oﬃcer of GKN plc for nine

years until 31 December 2011. Before

joining GKN, he spent nearly 20 years

with BAE Systems where he held a

number of senior executive positions.

He joined Unitas Capital in 2012 and

served as partner and chairman of its

operating advisor group until

October 2015, based in Hong Kong.

His private equity experience in

operation- intensive businesses

with Unitas is extremely valuable

to Rolls-Royce. He served as a

non-executive director of SSE plc

between June 2004 and July 2008.

He has an honorary fellowship

doctorate from Craneld University,

is an honorary fellow of the University

of Central Lancashire and a fellow of

the Royal Aeronautical Society.

He was awarded a CBE in 1997 and

was knighted in 2006 for services

to industry.

Other current principal roles

• Unitas Capital, senior adviser

• LEK Consulting, European advisory

board member

• University of Central Lancashire,

industry steering group member

Rolls-Royce Holdings plc Annual Report 2016 BOARD OF DIRECTORS

BOARD SKILLS AND EXPERIENCE

Chairman, CEO or

CFO experience

Engineering/technology 4

Related industry/operational 4

Safety/regulatory/risk 3

Financial 2

Remuneration/HR 2

Appointed in October 2014

Career, skills and experience

Pamela is an expert in corporate

governance and company law. She

has been a fellow of the ICSA: The

Governance Institute since 1997. She

has held a variety of company

secretary roles throughout her

career. She joined Rolls-Royce from

Centrica plc, where she was head of

secretariat. Pamela’s previous roles

also include group company

secretary and a member of the

executive committee at The Rank

Group plc and company secretary &

head of legal at RAC plc.

Other current principal roles

• None

Expected to be appointed as Chief Financial Oﬃcer in Spring 2017

Career, skills and experience

Stephen will join Rolls-Royce from Daily Mail and General Trust plc where

he has served on its board of directors since 2011. He was a member of the

Euromoney Institutional Investor plc audit committee, and a non-executive

director of Zoopla Property Group plc, both of which are associated

companies of Daily Mail and General Trust plc. Stephen is a chartered

accountant and has held a number of senior positions at News Corporation,

British American Tobacco, Forte, the Civil Aviation Authority and

PricewaterhouseCoopers. He is currently a non-executive director of

3iGroup plc.

Stephen has extensive experience of strategic nancial management and he

has a deep understanding of international business. His record of achievement

in change management is particularly relevant to Rolls-Royce.

Appointed in May 2012

Career, skills and experience

A German national, Jasmin combines

a strong background in advanced

engineering and deep technology

knowledge with extensive

international business experience,

having worked in Switzerland,

Sweden and Australia. She has been

the chief executive oﬃcer of Alpiq

Holding AG since 2013. She held a

number of senior positions in the ABB

Group becoming chief executive

oﬃcer of ABB Switzerland from 2006

to December 2012.

Other current principal roles

• Alpiq Holding AG,

chief executive oﬃcer

• Georg Fischer AG, board member

Jasmin Staiblin

Independent

Non-executive Director

Pamela Coles

Company Secretary

Stephen Daintith

International Advisory Board (IAB)

The IAB meets annually with the Board in order to provide perspective and

to guide strategy development through discussions on the geo-political and

global economic landscape. The members of the IAB during the year were

as follows:

Lord Powell of Bayswater

(Chairman of the IAB)

Former Foreign Aﬀairs and

Defence Adviser to Prime

Ministers Baroness Thatcher

and Sir John Major.

Vladimír Dlouhý

International advisor to Goldman

Sachs for Central and Eastern

Europe, European deputy chairman

of the Trilateral Commission,

president, Czech Chamber

ofCommerce and a former

member of the Czech Government.

Sir Rod Eddington

Chairman of JP Morgan

(Australia &New Zealand)

andformer chief executive

ofBritish AirwaysPlc.

Dr Fan Gang

Professor at China’s Academy

ofSocial Sciences and director

of National Economic Research

Institute, China.

Dr Pedro Sampaio Malan

Chairman of Itaú Unibanco’s

international advisory board and

a member of the boards ofEDP

– Energias do Brasil, SouzaCruz,

Brazil, Mills Engenharia, adirector

of Thomson Reuters Founders

Share Company and amember of

the Temasek international panel.

Akio Mimura

Senior advisor, honorary chairman

Nippon Steel & Sumitomo

MetalCorporation, Japan, and

chairman of The Japan Chamber

of Commerce and Industry.

Lubna Olayan

CEO and deputy chairperson

ofthe Olayan Financing Company,

Saudi Arabia.

Ratan Tata

Interim chairman of Tata

Sons Limited, India.

Ambassador Robert B Zoellick

Chairman of Goldman Sachs

International Advisors, senior

fellow at the Belfer Center at

Harvard University, former

president of World Bank Group,

US Trade Representative and

USDeputy Secretary of State.

Murad Bayar

Board member and CEO of CCN

Investment Holdings.

DIRECTORS’ REPORT

Ian Davis

Chairman

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT CHAIRMAN’S INTRODUCTION

2016 was a year of significant organisational

transformation, market headwinds and

operational challenges for the Group,

including managing a number of new

product introduction programmes. In

January 2017, after lengthy regulatory

investigations with which we co-operated

fully, we concluded deferred prosecution

and leniency agreements with the UK

Serious Fraud Office, US Department of

Justice and the Brazilian authority, MPF.

It is times such as these when the

importance of corporate governance comes

sharply into focus. It serves to ensure

valuable oversight, guidance and

experienced support to management as it

balances risks and opportunities and

navigate difficult and complex issues at a

time of significant change. The Board’s

oversight and engagement on the critical

issues ensured that decisions were taken in

the Group’s best interests and in pursuit of

its strategic, financial and operational

objectives and transformation milestones.

To facilitate more regular oversight, reporting

and interaction with management we added

Board calls to our annual schedule, in April

and October. We held a number of other

ad-hoc Board and committee meetings

outside of our annual cycle to deal with

matters that required attention between our

regular scheduled meetings. Some of the

Non-executive Directors also spent time

during the year with the business and finance

leadership teams outside of formal meetings

to gain deeper insight into the operational

challenges at a programme and business

level. This combination allowed us to

understand better, and more closely track,

the progress being made by the Group on its

transformation agenda and priorities

throughout the year, so that we could focus

onthe right areas.

In 2016, as part of the simpler governance

workstream of the transformation

programme, we continued to strengthen

aspects of our governance arrangements,

building on the work undertaken in 2015.

We complemented this by increasing focus

on talent and succession planning, including

supporting Warren East as he reshaped his

Executive Leadership Team (ELT).

The 2015 Board effectiveness review

conducted by Independent Audit

highlighted a need to improve the quality of

information presented to the Board. During

the year, the Company Secretary led a major

piece of governance improvement work to

provide tools, templates and training to help

management write more effective and

relevant papers. This has resulted in

significant improvements in the content,

length and insightfulness of our Board and

committee packs, which in turn prompts

more informed discussion and better

decision making. In parallel, new

management information dashboards

developed during 2016 have enabled ‘at a

glance’ views of the status of key

programmes and business performance.

One of the most important responsibilities I

have as Chairman is to ensure the right

balance of skills, experience, independence

and knowledge on the Board to provide

effective support and challenge to

management. There were a number of

Board and ELT changes announced during

the year, which you can read about in more

detail in the Nominations & Governance

Committee report on pages 67 to 71.

In March, we welcomed Brad Singer as a

new member of the Board and the Science

& Technology Committee. Brad is chief

operating officer of ValueAct, a

major shareholder.

Our relationship with ValueAct has been,

and remains, thoughtful and productive.

We have a relationship agreement in place

which, although less usual in the UK, is fairly

standard practice in the US.

In May, Sir Kevin Smith was appointed as

Senior Independent Director.

In September, we announced the

appointment to the Board of Stephen

Daintith as Chief Financial Officer to

succeed David Smith. Stephen will take

up his new post in Spring 2017.

Colin Smith will also be stepping down

from the Board at the 2017 AGM after a

distinguished career with the Group spanning

over 40 years. We are indebted to Colin for his

exemplary contribution to engineering.

In May, Dame Helen Alexander stepped

down from the Board having completed her

nine-year term. Dame Helen has shown

dedication and valued insight throughout

her tenure, including in her leadership of the

Remuneration Committee. On behalf of the

Board, I would like to thank Dame Helen for

her contribution and commitment.

In November 2016, I accepted Alan Davies’

resignation from the Board. Alan was

appointed as a Non-executive Director one

year previously and his contribution,

expertise and perspectives were highly

valued by his colleagues during his period

in office.

The Board resolved in December to propose to

shareholders the appointment of PwC

asauditor with effect from the 2018 AGM.

Details of the tender process are contained in

the Audit Committee report on page 102.

We consulted with major shareholders

during the year on the proposed changes

to our remuneration policy. Further details

of the consultation and the new policy are

in the Directors’ remuneration report on

pages 72 to 82. We also held our first

governance event in the UK and a

governance roadshow for major investors

in the US. Further details of these events

can be found in the Corporate governance

report on page 66.

We note with interest the government’s

green paper on UK corporate governance.

The Board is considering the level of

interaction with stakeholders, particularly

employees. We are planning to hold an

‘AGM for employees’ in 2017, and Irene

Dorner will take the lead at looking at how

we can strengthen our links between the

boardroom and our employees.

I look forward to reporting our progress on

corporate governance in our Annual Report

next year.

Ian Davis

Chairman

13 February 2017

Chairman’s

introduction

Rolls-Royce Holdings plc Annual Report 2016 CORPORATE GOVERNANCE

The Board

The role of the Board

Providing leadership, knowledgeand experience

tosupport and guide the ELT.

Overseeing and monitoring business performance,

internal controls, governance and risk management.

Setting Group strategy and objectives after

considering recommendations from the ELT.

Shareholder engagement.

Oversight of principal risks – competitive position,

political risk, programme delivery.

Chairman

Ian Davis

Effective running of the Board and its

committees in accordance with the highest

standards of corporate governance.

Setting the Board agenda.

Managing the Board to ensure adequate

timefor discussion of all agenda items.

Ensuring the Board receives accurate,

timelyandclear information.

Senior Independent Director

Sir Kevin Smith

Being available to major shareholders if they

haveconcerns which have not been resolved

throughthe normal channels of the Chairman,

Chief Executive or other Executive Directors.

Conducting an annual review of the

performance of the Chairman.

Providing a sounding board for the Chairman.

Other Non-executive Directors

Providing skills and external experience to support theChairman and management.

Chief Executive

Warren East

Overseeing the day-to-day operation

of the Group’s business.

Establishing and maintaining formal

and appropriate delegations of authority.

Developing and implementing the Group’s

strategy as approved by the Board.

Maintaining a close working relationship

with the Chairman.

Other Executive Directors

Providing management perspective to support theBoard’s decision making.

Company Secretary

Pamela Coles

Overseeing the design and effectiveness of the

Group’s governance arrangements.

Acting as Secretary to the Board and itscommittees,

ensuring compliance with Board procedures

andcorporate governance requirements.

Providing governance, advisory and

administrativesupport to all Directors.

Assisting the Nominations & Governance

Committee with plans for Directors’ induction

andongoing training.

The Board committees

Nominations & Governance

Committee

Remuneration

Committee

Audit

Committee

Safety & Ethics

Committee

Science & Technology

Committee

Board composition

Succession planning

Board nominations

Board evaluation

Corporate governance

Oversight of principal risk –

talent & capability

Remuneration policy

Incentive design and setting

of targets

Executive remuneration

review

Financial reporting

Internal controls

Risk management

Internal audit

External auditor

Oversight of principal risks –

IT vulnerability,

business continuity,

market & financial shock

S&E governance framework

S&E policies andpractices

S&E training

S&E risk management

S&E investigations

Sustainability

Oversight of principal risks –

compliance, product failure

R&T/R&D strategy

E&T processes

Technology capabilities

andskills

R&D investments

Technology trends and risks

Oversight of principal risk –

disruptive technologies

& business models

Corporate governance

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT CORPORATE GOVERNANCE

The Board and its committees

The Board is ultimately responsible to shareholders for the direction,

management and performance of the Company.

Details of the Board are set out on pages 54 to 57. Details of the

Executive Directors’ service contracts and the Non-executive

Directors’ letters of appointment are on pages 91 and 92. Details of

their remuneration and share interests are set out in the Directors’

remuneration report on pages 83 to 95.

The Board has a schedule of matters reserved for its approval,

generally being those items which affect the shape, risk profile or

strategic direction of the Group, as well as the key financial items.

The Board reviewed the schedule of matters during the year.

The Board has established certain principal committees to provide

dedicated focus on particular areas, as set out on the previous page.

The chairman of each committee reports to the Board on the

committee’s activities after each committee meeting.

In addition to the Board’s principal committees, it has established a

sub-committee of Directors who each hold an appropriate level of

UK national security clearance for the purpose of receiving and

considering, on behalf of the Board, any UK classified information

relating to the Group's programmes and activities.

Matters that are not reserved to shareholders, the Board or one of its

committees are the responsibility of the Chief Executive who has

established and maintains a schedule of delegations of authority to

members of the ELT and other management.

Key matters reserved to the Board:

• The Group’s long-term objectives, strategy and risk appetite.

• Shareholder engagement and general meetings.

• Overall corporate governance arrangements including Board and

committee composition, committee terms of reference, and Directors’

independence and conicts of interest.

• Internal controls, governance and risk management frameworks.

• Changes to the corporate or capital structure of the Company.

• Annual report and accounts, and nancial and regulatory

announcements.

• Signicant changes in accounting policies or practices.

• Policy on, and declarations of, payments to shareholders.

• Annual budgets and nancial expenditure and commitments above

levels set by the Board.

• Remuneration policy and remuneration of Directors and

senior executives.

• New share incentive or pension plans or major changes to existing plans.

The way in which principles of the UK Corporate Governance Code

(the Code) are applied, including the role of the Board and the

Chairman, Chief Executive, Senior Independent Director and

Company Secretary, the matters reserved to the Board, the terms of

reference of each of the Board committees, and details of Directors’

induction and training have been agreed by the Board and are set

out in our Board governance document available on the corporate

governance pages of the Group’s website www.rolls-royce.com.

Appointments and re-appointments

The Board was advised by the Nominations & Governance Committee

regarding all Board changes. Details of the appointment process,

and the changes made during the course of the year, are set out in the

Nominations & Governance Committee report on pages 67 to 71.

Independence of the Non-executive Directors

The Board conducts a review of the independence of the

Non-executive Directors every year, based on the criteria in the

Code and following consideration by the Nominations &

Governance Committee as detailed on pages 70 and 71. This review

was undertaken in November 2016 and the Board concluded that all

the Non-executive Directors, with the exception of Brad Singer,

remained independent in character and judgement.

Brad Singer is a partner and the chief operating officer of ValueAct,

a major shareholder, and therefore not considered to be an

independent Non-executive Director under the provisions set out in

the Code. The Company has in place a relationship agreement to

manage any conflicts of interest that arise from his connection to

ValueAct. A summary of the relationship agreement is on the

corporate governance pages of the Group’s website.

The Code does not consider the test of independence to be

appropriate to the chairman of a company. However, Ian Davis did

meet the Code’s independence criteria upon his appointment as

Chairman in May 2013. His other external commitments are

described on page 54.

Directors’ indemnities and insurance

In accordance with the Articles, and to the extent permitted by law,

the Company has entered into separate deeds of indemnity with its

Directors, which were in force during the financial year and remain in

force at the date of this report. The Company also maintains directors’

and officers’ liability insurance cover which also extends to directors

of subsidiary companies.

Compliance with the UK Corporate Governance Code

The Company is subject to the principles and provisions of the Code,

a copy of which can be found on the Financial Reporting Council’s

(FRC) website, www.frc.org.uk.

The Board considers that the Company complied in all material

respects with the Code for the whole of the year to 31 December

2016. The Board has agreed that arrangements by which staff may

raise concerns in confidence are considered and reviewed by the

Safety & Ethics Committee. Any matters relating to financial

reporting, the integrity of financial management or fraud are also

reported to the Audit Committee.

Rolls-Royce Holdings plc Annual Report 2016 CORPORATE GOVERNANCE

BOARD AND COMMITTEE ATTENDANCE AT SCHEDULED MEETINGS

Directors as at 31 December 2016

Board

(11 meetings)

Nominations &

Governance

(5 meetings)

Remuneration

(6 meetings)

Audit

(5 meetings)

Safety & Ethics

(4 meetings)

Science &

Technology

(2 meetings)

Ian Davis 11/11 5/5 – – – –

Warren East 11/11 – – – – –

Lewis Booth 11/11 5/5 – 5/5 – 2/2

Ruth Cairnie 11/11 5/5 6/6 – – 2/2

Sir Frank Chapman

10/11 4/5 5/6 – 4/4 –

Irene Dorner 11/11 5/5 – 5/5 4/4 –

Lee Hsien Yang 11/11 5/5 – 5/5 4/4 –

John McAdam

11/11 5/5 6/6 – 3/4 –

Bradley Singer (appointed 2 March 2016) 8/8 – – – – 2/2

Colin Smith 11/11 – – – – –

David Smith 11/11 – – – – –

Sir Kevin Smith 11/11 5/5 6/6 – – 2/2

Jasmin Staiblin

10/11 4/5 – – – 1/2

Former Directors

Dame Helen Alexander (left 5 May 2016) 5/5 1/1 2/2 – 1/1 –

Alan Davies (left 18 November 2016) 8/10 3/4 – 3/4 – –

Sir Frank Chapman missed the meetings of the Board, Nominations & Governance Committee and Remuneration Committee in November for medical reasons.

John McAdam missed the meeting of the Safety & Ethics Committee in December due to an unavoidable diary clash with a Board meeting of Rentokil Initial plc where he is Chairman.

Jasmin Staiblin missed the meeting of the Nominations & Governance Committee in July and the Board meeting in December due to needing to attend to urgent business at

Alpiq Holding AG, where she is CEO. She also missed the meeting of the Science & Technology Committee in May due to unavoidable last-minute travel disruptions.

The unscheduled meetings of the Board in November and

December were held to consider progress towards reaching

agreements with investigating authorities in UK, US and Brazil.

The unscheduled meeting of the Nominations & Governance

Committee held in April was to consider the appointment of

Sir Kevin Smith as Senior Independent Director.

The unscheduled meeting of the Audit Committee in April was to

consider the audit tender process and the potential consequences

of IFRS 15 for the Group’s accounting.

The unscheduled meetings of the Remuneration Committee

held in August and September were to consider:

• Remuneration packages for the new Chief Financial Officer

and Chief Operating Officer.

• Feedback from the initial shareholder consultation on

remuneration policy proposals.

Some of the Directors were unable to participate in the

unscheduled meetings of the Nominations & Governance

Committee held in April and of the Remuneration Committee

held in September as these meetings were called on short notice.

Board and committee meetings held in 2016

Committee meetings

Nominations & Governance Committee

Remuneration Committee

Audit Committee

Safety & Ethics Committee

Science & Technology Committee

Denotes unscheduled meeting

Other meetings

Board

IAB

International Advisory Board

AGM

Annual General Meeting

SE B

B B BB B

IAB

B B B R B BB

AGM

NGNG

January February March April May June July August September October November December

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT CORPORATE GOVERNANCE

Matters considered Outcome Key areas of focus for 2017

Strategy and risk

Progress with the transformation programme. Significant senior management headcount reductions,

tracked to underlying cost base.

Continued oversight of execution of

transformation plans to deliver

targeted benefits.

Board priorities and financial assumptions over the

timeframes of three, five and ten years, including key

risks, assumptions and sensitivities.

Strategic options clarified. Update of strategic priorities

underway to evaluate the best way to deliver enhanced

shareholder value in the long term.

The Group’s vision, values

and culture. Execution of strategic

priorities.

Put option exercised by SENER regarding ITP joint venture. Agreed valuation for acquisition of remaining stake in ITP. Execution of transaction and

integration of ITP into the Group.

Progress with regulatory investigations, with increased

oversight as potential deferred prosecution agreements

(DPAs) were being discussed with the authorities.

Full co-operation with investigating authorities, leading to

agreements with UK, US and Brazilian authorities in

January 2017. Lord Gold continued to attend Audit and

Safety & Ethics Committee meetings to oversee progress

onthe ethics and compliance improvement programme.

Monitoring of compliance with the

terms of the DPAs and leniency

agreement. Considering the

conclusions and recommendations

in Lord Gold’s latest report, and

oversight of actions required.

Principal risks including changes to those risks, the

underlying principal risk indicators and risks related to the

transformation programme.

The Board added a further principal risk: disruptive

technologies and business models. With this addition the

Board confirmed that the principal risks remained

appropriate.

More focus on talent and succession risks and increased

Board time dedicated to updates on major programmes.

Principal risks will be kept under

review, and all will be the subject of

‘deep dives’ by the Board or a Board

committee during 2017.

EU referendum preparations and outcome. A steering group was set up to monitor developments

andreport back to the Board.

Further planning and preparations

for Britain’s exit from the EU.

Coming into force of EU Market Abuse Regulations (MAR). The Group took appropriate steps, including updating its

policies and procedures, to ensure compliance with MAR.

Monitoring of market best practice

and any updates or guidance issued.

Succession and leadership

Board and ELT composition. Key appointments made including Chief Financial Officer,

Chief Operating Officer and Strategy & Marketing Director.

Appointments of Sir Kevin Smith as Senior Independent

Director and Brad Singer as Non-independent

Non-executive Director.

Search for at least one new

Non-executive Director to replace

Alan Davies who resigned in

December 2016 and John McAdam

who will step down in 2017.

Diversity and inclusion. Increasing diversity retained as a key priority for the Group

and as a critical part of the transformation programme.

Continued Board oversight and

sponsorship of diversity and

inclusion within the Group.

Effectiveness of the Board, Chairman and Chief Executive. The Board and its committees operated effectively in 2016.

The Chairman and Chief Executive received constructive

feedback on their respective performance and the Board

supported their continuation in office.

Implementing recommendations

made by Independent Audit as part

of Board effectiveness review. See

page 65 for more details.

Shareholder engagement and governance

Terms of a relationship agreement with ValueAct

following its acquisition of a significant shareholding

andthe appointment of Brad Singer to the Board.

Relationship agreement in place. Continuing constructive

engagement with ValueAct and

other significant shareholders on

appropriate matters.

Investor communications, feedback and governance

events and roadshows in the UK and US.

Increased transparency in investor briefings. The

governance events were well-received with good input

from investors.

Continue shareholder engagement

to build investor confidence.

A further governance event will be

held in 2017.

Private meetings with institutional shareholders to

discuss particular areas of interest to them.

Directors met with several institutional shareholders upon

request during the year. Topics included sustainability and

our ethics and compliance improvement programme.

We will maintain an active

shareholder engagement

programme in 2017.

The Board’s areas of focus

Rolls-Royce Holdings plc Annual Report 2016 CORPORATE GOVERNANCE

Matters considered Outcome Key areas of focus for 2017

US governance under Special Security Agreement (SSA)

Arrangements with the Rolls-Royce North America (RRNA)

board, whose members are appointed with the approval

of the US Department of Defense to oversee and ensure

compliance with laws and regulations concerning security

and technology controls.

Following the retirement of James Guyette in 2015, the role

of President & CEO of RRNA is no longer a Board position.

However, arrangements with the RRNA board continue to

be effective. These arrangements permit the Group, under

the SSA, to operate US security-cleared facilities and

participate in classified technology development and

production programs.

Maintaining a good dialogue with,

and support to, the RRNA board as

required.

Financial performance

Financial performance and outlook, liquidity and funding

including discussions with credit rating agencies.

Regular reports on financial performance and outlook

received throughout the year. Group liquidity and funding

kept under review considering strategic priorities, the

Company’s credit ratings and contingencies.

Regular oversight of financial

performance against 2017 budget,

and of funding plans against strategic

priorities and liquidity needs.

IFRS 15 impact. The Board was briefed on the impact of IFRS 15 on the

Group’s accounting for revenue and profit, by reference to

a notional restatement of 2015 results which was shared

with investors at the Group’s capital markets’ event in

November 2016.

Ongoing oversight of preparations

for introduction of IFRS 15 in 2018.

The Group’s management information (MI) and

forecasting project.

A progress update on the project was provided, including a

demonstration of the new MI system and KPI dashboard

being used by management.

Progress on further improvements

will be monitored in 2017.

Financial support for critical supplier. Reviewed and approved a package of financial support to a

key supplier to ensure continuity of materials supply for

some of the Group’s programmes.

The Group’s risk management

measures to ensure continuity of

supply of critical components and

materials will remain an area of

Audit Committee review as part of

its oversight of the business

continuity principal risk.

Audit tender. The Board resolved to recommend to shareholders the

appointment of PwC as the Company’s auditor with effect

from the 2018 AGM, following recommendations from the

Audit Committee.

Not applicable.

Review of the Group’s pension arrangements. A merger of four of the Group’s pension schemes and the

transfer of one scheme to an insurer.

The level of funding of the remaining

schemes will remain under review.

Operational performance

Civil large engine programmes. The Board undertook detailed reviews of several of the

Group’s civil large engine programmes with the Civil

Aerospace executive team to understand management’s

plans to address operational challenges faced.

More detailed Board oversight will

continue in 2017 as the business

moves through key milestones in

its new product introduction

programmes and transformation

activities.

Product incidents in service and HS&E. Received reports from the Chairman of the Safety & Ethics

Committee and executive management on product-related

incidents in service and HS&E matters.

Continued ‘tone from the top’

emphasising the paramount

importance of product and people

safety, particularly during a period

of transformation.

Sustainability targets. Overall score in the Dow Jones Sustainability Index

improved in 2016.

Progress towards published targets

for 2020 will be monitored in 2017.

Payments to shareholders

The Group’s policy on shareholder payments. Agreed to maintain payments at the level established in

early 2016.

Policy to be kept under review in

balancing the near-term strategic

and operational funding needs with

the desire to return in future to a

position of year-on-year progressive

growth in payments to

shareholders.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT CORPORATE GOVERNANCE

Information included in the Directors’ report

Certain additional information that fulfils the requirements of the

Corporate governance statement can be found in the Other statutory

information section on pages 186 to 189 and is incorporated into, and

forms part of, this Corporate governance report by reference.

Board induction and development

Newly-appointed Directors follow a tailored induction programme,

facilitated by the Company Secretary, which includes dedicated time

with Group executives and scheduled trips to a variety of business

operations. All Directors are encouraged to undertake additional

training and to visit the Group’s facilities. Details are set out in the

Nominations & Governance Committee report on page 70.

Internal control and risk management

In developing our internal governance framework (see page 70)

we looked at how the Group’s risk management and internal control

systems work together. You can read about our risk management

system on page 48 and details of our internal control system are in

the Audit Committee report on pages 100 and 101. As noted on

page 48, these systems are designed to manage, rather than

eliminate, the risk of failure to achieve objectives and so can only

provide reasonable and not absolute assurance against material

misstatement or loss. The Board, with the advice of the Audit

Committee, has reviewed the effectiveness of the risk management

and internal control systems, including controls in relation to the

financial reporting process, for the year under review and to the

date of this report. The Board confirms that the Group continues to

be compliant with the standards in the Code and with the Financial

Conduct Authority’s Disclosure Guidance and Transparency Rules in

this regard.

Financial reporting

The Group has a comprehensive budgeting system with an annual

budget approved by the Board. Revised forecasts for the year are

reported at least quarterly. Actual results, at both a business and

a Group level, are reported monthly against budget and variances

are kept under scrutiny.

Financial managers are required to acknowledge in writing that

their routine financial reporting is based on reliable data and that

results are properly stated in accordance with Group requirements.

In addition, for annual reporting, business presidents and finance

directors are required to confirm that their business has complied

with the Group’s finance manual. This contains the Group’s key

accounting policies.

Executive Leadership Team (ELT)

The ELT is an executive-level forum of the Group’s most senior

leaders, chaired by the Chief Executive. It comes together to

communicate, review and agree on issues and actions of

Group-wide significance. It helps to develop, implement and

monitor strategic and operational plans, considers the continuing

applicability, appropriateness and impact of risks, leads the Group’s

culture and aids the decision-making of the Chief Executive in

managing the business in the performance of his duties.

Chris Barkey

Group Director – Engineering

& Technology

Marion Blakey

President & CEO Rolls-Royce

North America

Chris Cholerton

President – Defence Aerospace

Warren East CBE

Chief Executive

Mark Gregory

General Counsel

Harry Holt

President – Nuclear

Mary Humiston

Group Human Resources Director

Simon Kirby

Chief Operating Officer

Mikael Makinen

President – Marine

Andreas Schell

CEO – Power Systems

Eric Schulz

President – Civil Aerospace

Colin Smith CBE

Group President (until 4 May 2017)

David Smith

Chief Financial Officer

(until 28 February 2017)

Ben Story

Strategy & Marketing Director

Stephen Daintith

Chief Financial Officer

(from Spring 2017)

Board visit to Indianapolis

The Board meeting in September was held in Indianapolis, US,

where the Board visited a number of our key sites in the area

and met the local management teams, the RRNA board and

US-based employee resource groups. They also reviewed

progress with the programme to transform and revitalise our

legacy plant and took the opportunity to celebrate the opening

of the new Rolls-Royce Development Centre building. The

Science & Technology Committee met the teams working on

our advanced technology programmes and received detailed

briefings and practical demonstrations. You can read more on

this in the Science & Technology Committee report on pages

110 to 112.

EXECUTIVE

LEADERSHIP TEAM

Rolls-Royce Holdings plc Annual Report 2016 CORPORATE GOVERNANCE

Board evaluation

The Board and its committees undertake an annual evaluation of

their effectiveness. In 2016, Independent Audit was again asked to

conduct an external evaluation, following up from its reviews in

2014, when first appointed, and 2015. Independent Audit also

supported the Audit Committee in the assessment of KPMG as

external auditor for 2015. It does not have any other connection to

the Company.

The evaluation included a review of Board and committee papers

and interviews with the Directors and the Company Secretary.

Interviews were also held with other senior managers who interact

regularly with the Board and its committees including the General

Counsel, Director of Internal Audit and the Director of Compliance

and Risk.

The 2015 review specifically focused on strategically important

questions and challenges for the Board. The 2016 review noted that

improvements had been made on the provision of information,

although more could be done to ensure greater clarity on the

medium- to long-term development plans. The review recommended

that more time be spent on culture and behaviours, while noting that

the Board was better informed on talent and succession.

Having gone through the effectiveness review described above, the

Directors are satisfied that the Board and each of its committees

operated effectively during 2016.

PROGRESS ON KEY AREAS IDENTIFIED

Key areas identied in 2015 Progress in 2016 Focus for 2017

Focusing Board

debate and improving

Board processes

The Board gave more focus to the transformation agenda and to the

near-term strategy with detailed discussions on cash, cost reductions,

status of key engine programmes and operational performance.

More focus is needed on the main

drivers, levers and challenges faced.

The Company Secretary’s office worked with the ELT and other Board

paper authors, providing training, tools and templates which resulted

in more effective and relevant papers for the Board and committees.

Less time was dedicated to presentations and more to debate and

discussion on presented topics.

The work during the year on Board

papers has resulted in welcome

improvements in their content,

length and insightfulness. However,

more work is needed to show, with more

quantification and detail, progress

against well-defined priorities.

Transformation

andprincipal risks

Particular discussion was held around risks to the transformation

programme identified in the 2015 evaluation. However, it was agreed

that these risks were covered in the principal risks relating to major

programme delivery and competitive position.

More time will be spent discussing

the culture and behavioural aspects

of the transformation programme.

Disruptive technologies and business models was added as a further

principal risk during the year, to reflect the increasing importance of

transformative technologies.

Disruptive technologies and business

models will be an area of focus for the

Science & Technology Committee.

Talent and succession The Board held a deep dive on succession planning in March 2016 and the

Nominations & Governance Committee carried out further reviews and

worked with the Chief Executive to support his work refreshing the ELT.

The Board also took opportunities to meet with senior managers below

ELT level and greater participation by senior managers was encouraged

in Board meetings. Further details can be found in the Nominations &

Governance Committee report on page 70.

The Board has been better informed on

senior personnel issues and changes.

Work should continue to strengthen

lower management levels.

Management

information (MI)

The development of new MI dashboards during the year has helped

to provide the Board and management with ‘at a glance’ indicators of

the status of key programmes and business and function performance.

The output from the MI dashboards

will help support the further

improvements identified for Board

paper content.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT CORPORATE GOVERNANCE

Shareholder engagement

The Board recognises and values the importance of building strong

investor relations through a proactive communication programme.

Having strengthened the investor relations department in mid-2015,

various initiatives were implemented in 2016 to improve further

investors’ understanding of the business. This included enhancing

disclosure and transparency through improved reporting and

engagement, particularly over the forthcoming adoption of IFRS 15

from January 2018.

Our investor relations department plays a key role in building stronger,

clearer discussions with current and potential investors and the

sell-side analysts that help inform them. During the year, the team has

undertaken an extensive investor relations programme involving

formal events, site visits, smaller group and one-to-one investor

meetings. The purpose of the larger events is to highlight particular

issues, themes or announcements that the Group believes develop a

better understanding of the business or which warrant further

explanation or clarification. One-to-one meetings requested by

investors focus on areas of particular interest to them, which in 2016

included our approach to sustainability and our ethics and compliance

improvement programme. These events also provide opportunities

for shareholders to meet members of the senior management team.

Notable events in 2016 included the capital markets’ event held

in November with updates from the Chief Executive on

transformation progress and strategic priorities and the Chief

Financial Officer on the impact of IFRS 15 in particular. The business

leaders each presented the market position of their segments, and

examples of progress being made were discussed in breakout sessions.

The team also hosted a significant number of investors and analysts at

the Farnborough air show and undertook a number of site visits to

facilities both in the UK and Singapore.

The one-to-one and group meetings provide an opportunity for

investors to ask more detailed questions that can improve individual

knowledge or clarify areas of misunderstanding. This is a critical

process in ensuring market participants make decisions based on

a consistent understanding of the information available. In this

way, shareholders should be able to appropriately and fairly value the

Group’s businesses.

We have held over 600 one-to-one and group meetings, led by the

Chief Executive, Chief Financial Officer, the Director of Investor

Relations or members of the investor relations team. The team has also

published five newsletters throughout the year which provide a

summary of the core news flow from around the Group, updates on

future investor relations events and questions and answers on various

topics of current interest to investors.

As a matter of best practice, the Chairman and Senior Independent

Director, together with other members of the Board, make themselves

available to meet with institutional investors upon request and

regularly attend key investor relations events. The Chairman and

Senior Independent Director have each met investors in both the UK

and the US on scheduled roadshows. In addition, the Chairman hosted

a very well-received corporate governance event in April. He was

joined by all Board committee chairmen who presented the key areas

of focus for their individual committees before questions were taken

from major shareholders and corporate governance analysts in

smaller workshop sessions.

In early 2016, we consulted with a number of investors on proposed

changes to the 2016 annual bonus and performance share plan (PSP).

In the autumn, the new chairman of the Remuneration Committee,

Ruth Cairnie, undertook an extensive consultation programme to

discuss the proposals for the new remuneration policy which will be

put to shareholders at the 2017 AGM. Feedback from meetings with

over 20 stakeholders helped to determine the shape and quantum of

the proposed new policy framework (see Remuneration report on

pages 72 to 82).

The Group’s website (www.rolls-royce.com) contains up-to-date

shareholder information, including an online version of the Annual

Report, materials from the capital markets’ and corporate governance

events, share price information, news releases, presentations to the

investment community and information on shareholder services.

Annual general meeting (AGM)

All holders of ordinary shares may attend the Company’s AGM at

which the Chairman and Chief Executive present a review of the key

business developments during the year. This year’s AGM will be held at

11.00am BST on Thursday, 4 May 2017 at the Pride Park Stadium, Pride

Park, Derby, DE24 8XL. Shareholders can ask questions of the Board on

the matters put to the meeting, including the Annual Report and the

running of the Company generally. All Directors are invited to attend

each AGM. Unless unforeseen circumstances arise, all committee

chairmen will be present to take questions at the AGM.

The Company intends to send the AGM notice and any relevant related

papers to shareholders at least 20 working days before the meeting.

The AGM notice will be available to view on the Group’s website.

A poll is conducted on each resolution at all Company general

meetings. All shareholders have the opportunity to cast their votes in

respect of proposed resolutions by proxy, either electronically or by

post. Following the AGM, the voting results for each resolution are

published and are made available on our website.

Shareholders unable to attend the AGM can vote on the business of

the meeting either by post or online.

The Company will propose at the AGM certain changes to the Articles

relating to shareholders who we have been unable to trace for a period

of 12 years. In line with many other companies, the Articles currently

allow the Company to sell any shares held by an untraced shareholder.

The changes to the Articles are intended to clarify when a shareholder

is considered to be untraced and to allow the Company to use the net

proceeds of the sale of an untraced shareholder’s shares to support the

Group’s community investment and education outreach programmes

and to fund other good causes at the Company’s discretion. At the

same time, the Company intends to continue its use of a professional

asset reunification agent to search for shareholders who have not kept

their details up-to-date.

Rolls-Royce Holdings plc Annual Report 2016 NOMINATIONS & GOVERNANCE COMMITTEE REPORT

Principal responsibilities

The key areas of responsibility of the

Committee are:

To review the structure, size and

composition of the Board and its

committees, to ensure that they remain

appropriate, and to make recommendations

to the Board of any changes.

To consider succession plans for

Directors and senior executives.

To oversee the induction plans

for Directors.

To review the independence of the

Non-executive Directors.

To conduct an annual evaluation

of the Chief Executive.

To review the Board’s diversity policy

and its implementation.

To oversee the principal risk relating

to talent and capability.

To report to the Board on the Group’s

corporate governance practices and

procedures to ensure that they remain

appropriate for a group of the size and

complexity of Rolls-Royce, taking account

of best practice principles.

To evaluate any conflicts of interest that

the Directors may have.

The Chairman and the independent

Non-executive Directors are members of

this Committee and the Chief Executive

attends the Committee meetings.

Ian Davis

Chairman of the

Nominations

& Governance

Committee

Nominations & Governance

Committee report

Highlights

Considered and recommended

to the Board:

– appointment of Brad Singer

as a Non-executive Director

– appointment of Sir Kevin Smith

as Senior Independent Director

– appointment of Stephen Daintith

as Chief Financial Oﬃcer

– re-appointment of Ian Davis

as Chairman.

Global governance framework

launched.

Talent, succession and diversity

reviews.

At a glance

Area of focus Matters considered Outcome

Board and

committee

composition

Re-appointment of one Non-executive

Director and of theChairman.

The appointment of a new Senior

Independent Director and changes

to the chairmanship and composition

of Board committees.

The Board made the following appointments after receiving recommendations

from the Committee:

• Sir Kevin Smith was appointed as Senior Independent Director and chairman

of the Science & Technology Committee.

• Lee Hsien Yang and Ian Davis were each re-appointed for a second

three-year term (subject to annual shareholder approval).

• Ruth Cairnie was appointed as chairman of the Remuneration Committee.

Appointments

to the Board

Appointment of Brad Singer, partner

and the chief operating officer of major

shareholder ValueAct Capital.

The appointment of a new

Chief Financial Officer.

Recommended the appointment of Brad Singer to the Board as a Non-executive

Director recognising that he was not considered to be independent.

Members of the Committee were involved in the interview process for the

Chief Financial Officer and the Committee recommended Stephen Daintith’s

appointment to the Board.

Succession

planning

and talent

management

Talent and succession, diversity

andinclusion reviews.

Progress on appointments to theELT.

This will be a continued area of focus. Further details of the reviews are shown

on page 70.

Members of the Committee were involved in the interview process for the

Chief Operating Officer and the Strategy & Marketing Director.

Board inductions,

training and

development

A schedule of site visits by all Directors

and feedback from inductions from

the Directors appointed in 2015.

A number of site visits had been carried out during the year as part of ongoing

induction schedules. It was recommended that each Non-executive Director

undertake at least one site visit each year, in addition to the Board and committee

meetings held outside London.

Governance Roll out of the global governance

framework.

The Group’s global governance framework was communicated to all employees

during the year.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT NOMINATIONS & GOVERNANCE COMMITTEE REPORT

Board and committee composition

The Committee regularly reviews the balance and composition of

the Board, its committees and the executive team. These reviews

identify current needs and consider longer-term succession

planning in light of the Group’s strategy. When reviewing

Non-executive Director appointments the Committee considers the

current skills, experience and tenure of the Directors and assesses

future needs against the longer-term strategy of the Group.

The Committee recommended the appointments of a new Senior

Independent Director and new chairmen for the Remuneration and

Science & Technology committees. We take care to ensure that the

skills and experience of Board members are closely aligned with the

needs of the Board committees.

In February 2016, Lewis Booth indicated his intention to relinquish

his responsibility as Senior Independent Director once a successor

had been appointed. He remains chairman of the Audit Committee.

Sir Kevin Smith, first appointed to the Board in November 2015,

became Senior Independent Director following the AGM in May

2016. He is well known by the UK investor base and the Committee

agreed he would be an excellent successorto Lewis. Sir Kevin was

also appointed as chairman of the Science & Technology Committee

in February 2016. Sir Kevin has significant aerospace industry

knowledge with engineering and manufacturing experience,

gained during a long career at GKN andBAE Systems.

Brad Singer joined the Science & Technology Committee on his

appointment to the Board on 2 March 2016.

Dame Helen Alexander stepped down from the Board after the AGM

in May 2016, having served as a Director for nine years. She was

succeeded as chairman of the Remuneration Committee by Ruth

Cairnie. Ruth first became a member of the Remuneration

Committee when she joined the Board in September 2014. Ruth has

been chairman of the remuneration committee at Keller Group plc

since April 2012 and also sits on the remuneration committee of

Associated British Foods plc. She therefore has both the experience

and skills to chair the Rolls-Royce Remuneration Committee.

Alan Davies stepped down from the Board on 18 November 2016.

As announced in July 2016, he had been appointed to the Safety &

Ethics Committee with effect from 1 September 2016. However,

he stepped down from the Board before any subsequent meetings

of that committee took place.

Colin Smith will step down from the Board at the 2017 AGM after a

distinguished career with the Group spanning over 40 years.

David Smith will leave the Company on 28 February 2017.

The Committee considered and recommended to the Board the

terms of appointment for Lee Hsien Yang for a second three-year

term subject to annual shareholder re-election. It also

recommended my re-appointment, again for a three-year term

subject to annual shareholder re-election. A full evaluation of my

performance as Chairman was carried out by Lewis Booth, as Senior

Independent Director, prior to confirmation of my re-appointment.

Board committee membership is set out on page 54.

The Nominations & Governance Committee is satisfied with the

composition of the Board committees however, with the resignation

of Alan Davies in November 2016 and with the completion of John

McAdam's nine-year term in 2017, we have recommended that the

Board seeks at least one additional Non-executive Director, in

particular someone who can complement the skills and experience

on the Audit Committee.

Appointments to the Board

In November 2015, ValueAct notified us that it had increased its

shareholding in the Company to above 10%. The Committee

discussed the implications of ValueAct increasing its shareholding

and encouraged engagement to understand better its

management's views, noting that it had requested a seat on the

Board. The Committee agreed that any proposed appointee should

be credible and have the appropriate skills and experience tobring

valued contributions as a Non-executive Director on theBoard,

particularly as the Group continued to execute its transformation

programme. Candidates would be required to follow the rigorous

selection process that applies to all Board appointments. The

Committee also considered the implications of having a shareholder

representative as a Director and referred this matter to the Board

for further consideration. The Committee agreed that any

shareholder representative would not be considered independent.

During January and February 2016, Brad Singer, a partner and

thechief operating officer of ValueAct, met with members of the

Committee and with the Executive Directors. I also had several

extended meetings with him and took up a number of references

both on him as an individual and from other chairmen who

haveexperience of having an active shareholder represented

ontheir boards.

Previously, Brad had been senior executive vice president and the

chief financial officer of Discovery Communications Inc, and chief

financial officer and treasurer of American Tower Corp. He has also

worked as an investment banker at Goldman Sachs in New York

andLondon. The Committee agreed that Brad has an excellent

record as a business leader. He has experience of public companies

during periods of change, growth and significant financial

outperformance, particularly in the US where Rolls-Royce has

important business interests and a significant shareholder base.

The Committee considered that Brad was an appropriate candidate

and recommended his appointment. The Board took account of

thediscussion of the Committee and of the terms of the proposed

relationship agreement between the Company, ValueAct and

BradSinger and agreed that appointing him to the Board was inthe

best interests of shareholders.

Both Brad’s appointment and the terms of the relationship

agreement were finalised and published on 2 March 2016. Details

ofthe relationship agreement are available on the corporate

governance page of the Group's website, www.rolls-royce.com.

Stephen Daintith will join the Board as Chief Financial Officer in

Spring 2017. Details of his career, skills and experience can be found

on page 57.

Rolls-Royce Holdings plc Annual Report 2016 NOMINATIONS & GOVERNANCE COMMITTEE REPORT

2016

Female 3 (23%)

Male 10 (77%)

2016

Female 16 (11%)

Male 125 (89%)

2016

Female 7,400 (14.8%)

Male 42,400 (85.0%)

Undeclared

100 (0.2%)

BOARD MEMBERS BY GENDER EMPLOYEE HEADCOUNT BY GENDER

42,400

7,400

100

7,70 0

42,800

8,000

46,100

2014 2015 2016

SENIOR MANAGERS BY GENDER

2014 2015 2016

125

177

168

The Inzito Partnership (Inzito) was engaged as the search consultant

for the Chief Financial Officer. A candidate brief, which included

technical and personal qualities and skills, was drawn up by the

Chief Executive and Group Human Resources Director and shared

with members of the Nominations & Governance Committee. Inzito

drew up a list of potential candidates and the Chief Executive and

Group Human Resources Director interviewed a number of them

before presenting a shortlist of candidates for members of the

Committee to interview. Formal and informal references were

takenon the shortlisted candidates and Stephen Daintith met all

members of the Committee, and met with the Chief Executive and

Chairman several times, before his appointment was recommended

to the Board. The terms of his appointment were also considered

and agreed by the Remuneration Committee in principle before

theBoard formally appointed Stephen.

Each of the Directors continues to be effective and able to devote

sufficient time to the business of the Company and the

Nominations & Governance Committee will continue to keep the

Board's composition under review.

Diversity and inclusion

The Board and Committee actively support the Group’s diversity

andinclusion vision.

Rolls-Royce is a founder patron of the FTSE 100 Cross-Company

Mentoring Programme which aims to widen the pool of eligible

female board candidates. Following the departure of Dame Helen

Alexander the percentage of women on the Board has fallen to

23%(2015:29%). Appointments will always be made on merit,

however, forfuture Board appointments the Committee will

instruct search consultants to identify as a priority female

candidates who meet the skills and experience brief. As with

previous Board appointments, we will consider candidates from

thewidest possible pool and will only engage search firms that

havesigned up to the Voluntary Code of Conduct for Executive

Search firms. The Board has noted the Hampton Alexander

recommendation for FTSE 100 companies to have at least 33% of the

positions in their executive pipeline filled by women by 2020.

Our global diversity and inclusion policy and anti-discrimination

policies aim to ensure that all employees are treated with dignity

and respect and are empowered to deliver without fear of bullying

or harassment (for more information see pages 42 and 43). Weare

making preparations to report under the Gender Pay Gap Reporting

Regulations by April 2018.

The Group acknowledges the challenges of increasing diversity

within our industry. We are working closely with the Royal Academy

of Engineering's Diversity Leadership Group which has launched

working groups to drive change and challenge the status quo for

diversity and inclusion in the engineering sector. We have

representation on its steering group and support four of its five

action groups.

We give full and fair consideration to all employment applications

from people with disabilities, and support disabled employees,

helping them to make the best use of their skills and potential. Our

high performance culture training continues to be rolled out across

the globe to help employees increase their personal effectiveness.

In March 2016, the Group Human Resources Director and Head of

Global Talent Management shared with the Committee key diversity

and inclusion achievements during 2015 and provided current

global demographics and key elements of the diversity and inclusion

strategy and priorities.

Non-executive Directors took positive action to meet a number of

employee groups throughout the year to support these priorities. This

included: an informal lunch with the Women’s Group in Dahlewitz,

Germany, on International Women’s Day; dinner with high potential

women in Derby, UK in May; and a meeting with representatives of

the six employee resource groups (ERGs) in North America during the

Board's visit to Indianapolis in September. In addition, individual

members of the Committee took opportunities to support various

activities by the ERGs in the UK, Germany and the US.

Diversity and inclusion strategy and priorities

• Senior leaders committing to a diverse and inclusive

environment.

• Hiring diverse talent at all levels.

• Continual improvement in the way we act and behave

to ensure full inclusion of all our talent and enable them

to perform at their best.

• Engage and retain our best talent.

• Provide equal opportunity and advance diverse talent on merit.

DIRECTORS’ REPORT

* Changes to our HR management system has enabled employees to choose whether to declare gender information. This has introduced an undeclared category to our

gender reporting in 2016.

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT NOMINATIONS & GOVERNANCE COMMITTEE REPORT

Succession planning and talent management

A principal risk to the business is the inability to attract, retain

andincentivise talented individuals to deliver our strategy. The

Committee is responsible for reviewing talent, capability and

succession at the most senior levels of the business.

Following the announcement of the senior management

restructuring in December 2015, and as part of our continuing

transformation programme, there has been an increase in focus on

our succession planning. Both the Committee and the Board held

deep dives in these areas during 2016. Our desire to increase

diversity, as described above, influences our approach to succession

planning, training and development.

The Chief Executive and Group Human Resources Director led

discussions on succession planning with the Board and the Committee

in March and September 2016 respectively. In March, the Board

considered skills and capability gaps at ELT level and succession

planning both immediately below ELT level and those that would be

ready to take up an ELT position in one or two moves. A new senior

management structure was announced in December 2015 including

the intention to appoint a new Chief Operating Officer. It was also

agreed that a new role, Strategy & Marketing Director, would be

added to the ELT. It was agreed that it was appropriate to recruit these

roles from outside the business to help bring a fresh perspective.

Members of the Committee were involved in the appointments of

Simon Kirby as Chief Operating Officer and Ben Story as Strategy

& Marketing Director.

We recognise that succession planning includes nurturing our own

talent pool and giving opportunities to those who are capable of

growing into more senior roles. Therefore, the review by the

Committee in September focused on the executive pipeline from

which the future leaders of the Company were likely to emerge,

both for ELT roles and other key management areas. The Board also

had dinner with a number of senior managers below ELT level in

November 2016 and certain Non-executive Directors attended the

senior leadership conference during the year to meet and exchange

views with key managers.

Board inductions, training and continuing development

The Company Secretary is responsible for ensuring that new

Directors have a thorough and appropriate induction. Each newly

appointed Director has a structured induction programme and

receives a comprehensive data pack providing detailed information

on the Group. Each induction is based on the individual Director’s

requirements and includes meetings with all other Directors and

members of the ELT as well as other relevant employees, committee

attendees and external advisers. All Directors visit the Group’s main

operating sites as part of their induction and are encouraged to

make at least one visit to other sites each year throughout their

tenure. Often these visits take place in small groups of two or three

Directors together as it is often useful to have a common

understanding and insight into an area of the business that may be

less well known to one or more of them. It also gives the Directors

the chance to spend time with their fellow Board members in a less

formal setting which helps them to understand the concerns of

their colleagues. We regard these site visits as an important part

of continuing education as well as an essential part of the induction

process. They help Directors understand the business through

directexperience of seeing processes in operation and by having

discussions with a range of employees.

A summary of the visits carried out by individual Board members

and Board committee in 2016 (as referred to in the Safety & Ethics

and Science & Technology Committee reports) is shown on

page 71.

Further training is available for all Directors, as appropriate,

including presentations by the ELT on particular aspects of

the business. The transformation team also presented to

Non-executive Directors on progress, and the Board undertook

the Group’s ethics training.

There is a procedure for Directors to take independent professional

advice at the Company’s expense and every Director has independent

access to the Company Secretary, who reports to the Chairman.

Governance

A core element of our transformation is world-class governance:

excellence in how we govern our business, manage risk, and make

sure standards are maintained throughout the Group.

The Group's governance framework, which was approved by the

Committee in December 2015, was deployed Group wide during

theyear in five languages. It was supported by an all-employee

communications campaign which included a video message

fromthe Chief Executive and a dedicated intranet site. Rolling out

the framework has been an important step in clarifying the Group’s

expectations of its employees and supports the work being

undertaken on transformation.

The framework outlines the rules which apply to all Rolls-Royce

employees and is intended to guide them in making the right

decisions on behalf of the Group, faster and with more confidence.

In particular, the framework:

• Describes the Group's organisational structure, accountabilities

and responsibilities.

• Clarifies decision-making authorities.

• Gives employees an overview of our mandatory policies,

processes and procedures.

The Committee was kept up to date on progress as the framework

was rolled out across the Group. The framework is kept under

review and further enhancements will be communicated to

employees in 2017.

Conflicts of interest and independence

The Committee reviews the Non-executive Directors’ external

interests every year to determine whether each of them may

continue to be considered independent. In undertaking the

evaluation the Committee considers, among other things, the

criteria set out in the Code.

Rolls-Royce Holdings plc Annual Report 2016 NOMINATIONS & GOVERNANCE COMMITTEE REPORT

The Committee also reviews any potential conflicts of interest as

they arise and recommends to the Board whether these should be

authorised and whether any conditions should be attached to any

authorisation. Additionally, an annual review of conflicts of interest

is undertaken to ensure that any previously authorised conflicting

situations are still dealt with appropriately.

Brad Singer, as a representative of a significant shareholder, is not

considered to be independent. As noted on page 68, the conflict

of interest is managed by a relationship agreement between the

Company, ValueAct and Brad Singer.

Having carried out the review, the Committee advised the Board

that it considered that each of the remaining Non-executive

Directors, with the exception of the Chairman for whom the test

isnot appropriate, continued to be independent. The Committee

therefore recommended to the Board that each of the Director's

potential conflicts of interest be authorised, without imposing

anyconditions.

Looking forward

We have made good progress on our priorities for 2016 which were

to develop succession plans, to ensure that the transformation of

the business was adequately supported below Board level, and to

oversee the development and roll out of the internal governance

framework. These areas will continue to be priorities for the

Committee in 2017.

Ian Davis

Chairman of the

Nominations & Governance Committee

NON-EXECUTIVE DIRECTORS' SITE VISITS IN 

Montreal

Canada

Board members present

* Advanced Remanufacturing & Technology Centre

USA

Indianapolis

USA

Crosspointe/

Reston

Manufacturing

Technology Centre

Coventry UK

UTCs

Nottingham

Washington

Tyne and Wear

Derby

Seletar and

UTC/ARTC* sites

Singapore

HAESL

Hong Kong

Friedrichshafen

Germany

Norway

Ålesund/

Ulsteinvik

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT REMUNERATION COMMITTEE REPORT

Remuneration

Committee report

Ruth Cairnie

Chairman of the

Remuneration

Committee

2016 overview

Introduction

I am pleased to present my first report as

chairman of the Remuneration Committee

describing what we have done in the

year and how we have reviewed our

remuneration policy.

Policy review

Much of the Committee’s activity in 2016

has focused on reviewing our policy.

Business context

The Group is at a critical stage in undergoing

a major transition of the business including

a ramp-up in delivery of new Trent engines,

the associated modernisation of the

manufacturing footprint and the far-

reaching organisational transformation

that is underway.

Whilst the transition has an expected

short-term negative impact on profit,

performance will improve through

successful delivery of our transformation

programme driving cost reduction and

improving operational execution, and

through achieving the increase in rate

of engine delivery. This underpins our

investment case and remuneration

should be strongly linked to delivering

this programme over the coming years.

Policy drivers

Four key themes have emerged to underpin

our policy design: supporting transformation,

talent, stewardship and simplification.

We focused on the linkage to successful

delivery of the transformation agenda

which is closely matched to shareholder

interests.

We also needed to address the

competitiveness of our current rewards.

Through 2016, we have sought to recruit

into a number of senior positions to

strengthen skills in some areas, or to

support an overall raising of our

leadership capability to deliver the

transformation, bringing in experience

from other sectors. In this we have

encountered real evidence of our rewards

not being sufficiently competitive

to secure some key talent that would

make a strong contribution to Rolls-Royce.

We have continued to focus on aligning

the interests of Executive Directors and

shareholders.

We have also looked for opportunities

to simplify our reward structure, and

to ensure a coherent framework that

can be cascaded to lower levels in the

organisation.

Proposed changes

The overall structure will be unchanged,

comprising base salary, benefits, annual

bonus and a new long-term incentive plan

(LTIP). This reflects our continued focus on

pay for performance.

A number of simplifications are proposed

in the structure of both annual bonus and

LTIP, replacing multiplicative structures,

hurdles and kickers with simpler

additive components.

The performance measures are proposed to

be unchanged for both annual bonus and

LTIP, but with careful consideration having

being given to the weightings of the LTIP

components and a primary focus on growth

in free cash flow.

Cash flow targets will be based on

cumulative cash flow per share (CPS) as

now; earnings per share (EPS) targets will be

set on cumulative EPS over the three-year

performance period; total shareholder

return (TSR) will be measured relative to the

constituents of the FTSE 100 as now, as well

as the S&P Global Industrials Index.

This approach better reflects our status

as a FTSE 100 company and a global

engineering group.

The maximum level of LTIP award is

proposed to be increased to 250% of salary

for the Chief Executive and 225% for other

Executive Directors, to enhance our ability

to attract and retain the talent we need in

competitive markets. We also seek

headroom up to 300% for the Chief

Executive and 250% for other Executive

Directors if this should be necessary for

future recruitment. We have no other

intention to use this headroom. Our current

discretion to award a higher level of annual

bonus on recruitment will be removed.

Shares received upon the vesting of LTIP

awards, following the three-year

performance period, will be subject to a

two-year holding period. This approach

further aligns incentives with long-term

interests of shareholders.

The level of LTIP vesting for threshold

performance will be reduced from 30%

to 20% of the maximum.

Highlights

New remuneration policy.

Outturns for 2016.

Terms of appointment for

Chief Financial Oﬃcer.

Rolls-Royce Holdings plc Annual Report 2016 REMUNERATION COMMITTEE REPORT

Shareholder engagement

We have consulted extensively with major

shareholders throughout the policy review.

Early in the year several shareholders

expressed concerns about retention and

motivation given our more limited incentive

levels. We continued to discuss our thinking

with shareholders as we developed our policy

during the year. The majority of shareholders

who participated in this process:

Recognised the level of challenge in

delivering the transformation and our

need to attract top class talent.

Supported the simplified remuneration

structures.

Welcomed the inclusion of a holding

period and reduced threshold vesting for

LTIP awards.

Strongly supported cash as the most

important measure.

Supported an increase in the LTIP

maximum award in the context of

delivering our transformation.

Some shareholders favoured a more

highly-geared approach to remuneration,

with significantly higher incentive

opportunities. Other shareholders, while

supportive of an increase, were mindful,

as are we, of the increasing attention to high

levels of executive pay and concerns about

inequality. On balance, we have opted for an

operational LTIP maximum that, while a

significant increase, was not as high as

some of our shareholders suggested.

A small number of shareholders suggested

a fundamentally different approach to

remuneration with higher salaries and

lower leverage based on performance.

However, at this time our strong preference

is to link reward firmly with performance

and the delivery of our transformation

programme.

We also consulted widely with shareholders

on LTIP performance measures. We received

a very strong message that cash flow was

the most important performance measure.

Several shareholders asked us to consider

a long-term return measure in the mix.

On reflection, we were of the view that this

would be too opaque as a Group-level

incentive metric given the very diverse

nature of our businesses, differing sources

of R&D funding and their long investment

cycles. Some shareholders were ambivalent

about inclusion of relative TSR, however we

wanted to maintain a portion linked to the

in-period value delivered to shareholders.

Our shareholders also recognised the

significant changes to EPS, as we transition

to reporting under IFRS 15, but understood

the approach we propose to take.

Agreements with investigating

authorities

As announced on 17 January 2017,

agreements were entered into between

Rolls-Royce and the UK Serious Fraud Office

(SFO), US Department of Justice (DoJ) and

Brazilian Federal Prosecution Service (MPF).

These agreements relate to bribery and

corruption involving intermediaries in a

number of overseas markets from January

1989 to November 2013 and will result in

penalties totalling £671m over the next

five years. The agreements that have been

reached relate to legacy behaviour, and,

Lord Justice Leveson, made clear in his

judgment, no current member of the

Board was involved. As set out in his

judgment, the new executive team

demonstrated extraordinary co-operation

and has made essential changes, creating

new policies, practices and cultures.

As a Committee we have considered

remuneration consequences for individuals

who were in office at the time. Our clawback

provisions were introduced in 2014, which

was after the relevant period of these

events. In cases where employees have been

dismissed or resigned as a result of

Rolls-Royce’s own internal investigation,

shares and incentives have been cancelled

in full as a consequence of the termination

of their employment.

Because the SFO, DoJ and MPF agreements

relate to legacy matters, and given that the

legal judgment was very clear that there

was no culpability in relation to existing

management, the Committee has concluded

that the impact of the penalties should be

excluded from the 2016 bonus and from

future incentive targets.

2016 outturns

We have given careful consideration to

both the reported numbers and the external

context in determining the bonus outturns

for 2016.

Group underlying profit and cash flow, our

key financial metrics, were both above the

target levels and therefore a bonus will be

paid for the first time in three years.

Underlying profit is a key measure of

performance and as such does not include

the accounting impacts of non-operational

factors. In particular it excludes our US

dollar hedge book valuation adjustment,

which is a non-cash consequence of

managing our foreign exchange risk,

and is larger this year due to the post-

referendum sterling decline.

In assessing the achievement of bonus

targets, the Committee made overall

downwards adjustments to both profit

and cash flow elements. Adjustments were

made to remove gains from unbudgeted

foreign exchange movements and cash

receipts as well as restructuring payments.

Following these adjustments the Committee

also reviewed the bonus outturn in the

round, taking into account the Company’s

performance and the shareholder context.

2016 was a solid year in which we exceeded

cash and profit expectations and our

transformation programme is off to

a good start. However, reflecting the overall

experience of our shareholders, in a year

when underlying profits have fallen, the

Committee agreed with the management

and Board that it would be appropriate for

the business element of the executive

team’s bonuses to be reduced to

target levels.

The 2014 performance share plan (PSP)

awards will not vest as the performance

conditions were not met over the three-year

performance period to 31 December 2016.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT REMUNERATION COMMITTEE REPORT

Board changes

In September 2016, we announced that

David Smith would leave Rolls-Royce after

two years as Chief Financial Officer and will

be succeeded by Stephen Daintith. Stephen is

expected to take up the role in Spring 2017.

Colin Smith will also be stepping down from

the Board at the 2017 AGM, after 43 years

with Rolls-Royce.

The Committee considered appropriate

terms for David and Colin on their

departure. Their remaining contractual

entitlements will be subject to phasing and

mitigation. PSP awards will be pro-rated for

service and will vest at the normal time,

depending on achievement against the

relevant performance targets. The 2014

awards have lapsed as the targets were not

met and 2015 awards, for all participants,

are not expected to vest either. Neither will

participate in incentive schemes for 2017.

The Committee also considered the

remuneration package for Stephen on his

appointment, and believe his package is

appropriate for the role and for someone of

his experience and capabilities. We will also

make some buyout awards in respect of his

forfeited awards, retaining performance

conditions where relevant and matching or

exceeding time horizons.

2017 salary review

The Committee has reviewed the salary levels

of the Executive Directors and has concluded

that an increase of 2% will be made to

Warren East in line with those made

to other employees. All salary increases

for management are being deferred until

1 September 2017. No increases are being

made for other Executive Directors.

Principal responsibilities

The key areas of responsibility of the

Committee are:

To set and monitor the strategy and policy

for the remuneration of the Executive

Directors, the Chairman and members

of the Executive Leadership Team (ELT).

To determine the design, conditions

and coverage of annual and long-term

incentive plans for senior executives

and approve total and individual

payments under the plans.

To determine targets for any

performance-related pay plans.

To determine the issue and terms of

all share-based plans available to all

employees.

To oversee any major changes in

remuneration.

Resolutions

At our AGM in 2017 we will be asking

shareholders to pass resolutions to approve:

Our new Directors’ remuneration policy.

Our Directors’ remuneration report

which sets out how we have applied our

existing policy during 2016.

Our new LTIP to accommodate the new

remuneration policy.

I would like to thank the shareholders who

contributed to the Committee’s discussions

during the year, and we hope that all our

shareholders will support these resolutions.

Ruth Cairnie

Chairman of the

Remuneration Committee

Rolls-Royce Holdings plc Annual Report 2016 REMUNERATION COMMITTEE REPORT

Remuneration for 2016 – at a glance*

Fixed pay

Base salary No increases for Executive Directors in 2016. Base salaries during the year were:

Warren East – £925,000; Colin Smith – £550,000; David Smith – £540,000.

Pension Pension arrangements during the year were:

• Warren East – cash allowance of 25% of salary.

• Colin Smith – continued participation in dened benet scheme with no further accrual.

– cash allowance of 32% of salary.

• David Smith – cash allowance of 32% of salary.

Other benets Benefits include car or car allowance and related costs, financial planning assistance, certain insurances

and other benefits.

Annual bonus (APRA)

Maximum award** For 2016, the maximum APRA was 180% of salary for the Chief Executive and 150% of salary for other

Executive Directors.

Performance

measures

Group performance for 2016 was based on:

• 75% nancial (prot and cash performance).

• 25% non-nancial (employee and customer metrics).

Group performance outcomes can be multiplied by 0% to 120% based on individual performance.

Deferral 40% of awards are deferred into shares for two years.

Award for 2016

GROUP AND INDIVIDUAL PERFORMANCE AND BONUS OUTCOMES

Group performance

(percentage of max)

Individual multiplier Overall percentage

of salary

Overall percentage

of maximum

Warren East 60% 1.1 99% 55%

Colin Smith 60% 1.0 75% 50%

David Smith 60% 1.0 75% 50%

Discretion was applied to reduce the Group performance outturn to on-target (60% of maximum).

Performance share plan (PSP)

Maximum award** The maximum annual PSP award is normally 180% of salary for the Chief Executive and 150% of salary

for other Executive Directors.

As disclosed last year, for 2016 awards only, the maximum opportunities were reduced to 150% of salary

and 130% of salary respectively as a balance to changes to the measurement of the EPS hurdle.

Performance measures Awards are subject to an aggregate CPS performance condition measured over three years. The number of

shares awarded can then be adjusted (up to 125% for 2016 awards) based on relative TSR versus constituents

of the FTSE 100.

No awards can vest until an EPS hurdle is met. As disclosed last year, for 2016 awards EPS must exceed

the Organisation for Economic Co-operation and Development (OECD) index of consumer prices over the two-year

period 2017 and 2018.

Vesting of 2014 award The 2014 PSP awards will lapse in March 2017 based on performance to 31 December 2016 as the performance

measures were not met.

Shareholding

requirements

The Chief Executive is required to build up a holding equal to 250% of salary. For other Executive Directors

the requirement is 200% of salary.

* Based on current policy which is available on our website at www.rolls-royce.com.

** APRA and PSP awards are subject to malus and clawback in certain circumstances (see page 79).

Fixed pay

+ +

Annual bonus

(APRA)

Performance

share plan (PSP)

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT REMUNERATION POLICY

Remuneration policy from 2017

Introduction

The policy will take effect from 4 May 2017, subject to shareholder

approval at the AGM.

Consideration of shareholder feedback

During the policy review we have had extensive and constructive

consultation with our largest shareholders which has been a

significant factor in shaping the new policy. Further details are

set out on page 73.

The overall consensus that came out of the consultation was:

• Recognition of the level of challenge in delivering transformation

and attracting top talent.

• Support for simplified remuneration structures.

• Strong support for cash as the most important measure of

performance.

• Welcome for the inclusion of a holding period post the

performance period on the LTIP.

• Support for an increase in the LTIP maximum award in the

context of delivering the transformation, linked to appropriately

stretching targets.

• Recognition of the value of having some objective and

quantifiable non-financial measures in addition to financial

measures in our short-term incentive plan.

These views have been reflected in the final policy design for 2017.

Key policy themes

As part of the remuneration policy review, the Committee has taken

the opportunity to take a broad look at our remuneration approach

underpinned by four key themes:

Supporting transformation – our policy should incentivise and

reward the delivery of our transformation programme over the next

three years. This programme aims to simplify the organisation and

processes and embed the right cultural behaviours; these set the

foundation for cost reduction and improved productivity, as well as

greater pace, simplicity and clearer accountability in the way we

work. This programme is essential to achieving both the production

ramp-up and cost efficiencies that underpin the cash flow

generation that is key to our long-term investment case. Our view

is that remuneration should be strongly linked to the successful

delivery of this programme and its financial benefits.

Talent – we must be able to attract and retain the individuals

necessary for business success across a global and diverse talent

pool. Our recent experience has shown that our current level of

reward is not sufficiently competitive to secure some key talent

that would make a strong contribution to the Group.

Stewardship – the system of remuneration should align interests of

executives and shareholders and comprise a significant proportion

of share-based long term incentives.

Simplification – our reward structure and performance measures

should be aligned to the strategy and be simple to communicate to

participants and shareholders. It should reflect the business

priorities in terms of both financial and non-financial parameters

and be seen to incentivise the right behaviours and the right

outcomes for a long term, sustainable and profitable future.

Given the importance of delivering our business transformation

over the next three years, we believe that retaining a strong

emphasis on performance-related incentives is appropriate. We

therefore plan to retain a structure of salary, benefits, annual bonus

and long term incentives, underpinned by appropriate performance

measures and award levels.

Main changes to policy design

Supporting transformation – we will better align the incentive

performance measures and weighting of those measures to our

business strategy. For 2017, LTIP awards will be weighted 60% CPS,

20% EPS, and 20% TSR.

Talent – we will increase the level of award so that we can attract

and retain the talent that we need. Under the new policy the normal

maximum level of long-term incentive award is increased from

180% for the Chief Executive and 150% for the other Executive

Directors to 250% of salary for the Chief Executive and 225% for

other Executive Directors. The overall maximum under the policy

will be 300% for the Chief Executive and 250% for other Executive

Directors (for use in recruitment only).

Stewardship – we will introduce a two-year shareholding period

following the three-year LTIP performance period. This will support

the continued alignment of Executive Directors’ reward to the

interests of shareholders. We will reduce the amount of the

long-term incentive award that vests for threshold performance

from 30% of the award (equivalent to 54% of salary for the Chief

Executive) to 20% of the award (equivalent to 50% of salary).

Simplication – we are simplifying the structure of our bonus

and LTIP replacing multiplicative structures, hurdles and kickers

with simpler additive components.

Rolls-Royce Holdings plc Annual Report 2016 REMUNERATION POLICY

Summary of policy design changes and link to policy themes

Fixed pay

Base Salary

Benets

Pension

Annual bonus Long-term incentive plan

25%

non-nancial

• Customer

• Employee

Malus and clawback

80% Group

performance

20% individual

performance

40% of award deferred into

shares for two years

Three-year performance period followed

by two-year holding period

Shareholding requirement

60%

CPS

20%

EPS

20%

TSR

75%

nancial

• Prot

• Cash

* Weightings and non-financial measures are as applied in 2017.

Element Commentary Policy theme

Fixed pay No changes are proposed to the fixed pay element of the remuneration policy approved by shareholders

at the 2014 AGM. The new remuneration policy to be approved at the 2017 AGM will continue to apply

until the 2020 AGM.

Talent

Annual bonus Performance measures remain appropriate following the introduction of customer and employee

metrics in 2016. Bonuses are determined primarily by Group financial performance but the Committee

may apply non-financial metrics that support the underlying strategic priorities for the forthcoming year.

Transformation

From 2017, Executive Director bonuses will be awarded using a simple additive approach:

• 80% of the award will be based on Group performance.

• 20% of the award will be based on individual performance.

Simplication

40% of any bonus will be deferred into shares for two years. Stewardship

Long-term

incentive plan

CPS, EPS and TSR remain our long-term measures of success and reflect the strategic focus on profitable

growth, the quality of profit, and returns to shareholders. During shareholder consultation we received

strong support for the continued use of cash flow as the central measure of long-term performance.

Transformation

The structure will be amended so elements are measured independently, rather than using an EPS hurdle

and a TSR multiplier.

Simplication

The introduction of a two-year shareholding period following the three-year performance period.

This includes a requirement to continue to hold shares after participants have left the Group.

20% of the maximum award will vest for threshold performance (a reduction from 30% in the current

remuneration policy).

Stewardship

The new remuneration policy includes an overall maximum of up to 300% of salary for the Chief Executive

and 250% for other Executive Directors. The intention is that this flexibility will only be used in recruitment

(to secure talent across a global and diverse talent pool).

The intended operational maximum for the three-year period of this policy is 250% of salary for the

Chief Executive and 225% of salary for other Executive Directors.

Talent

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT REMUNERATION POLICY

Remuneration policy table

The table below sets out each element of Executive Directors’ remuneration.

Pay element – xed pay

Base salary

Purpose and

link to strategy

The Company provides competitive salaries suitable to attract and retain individuals of the right calibre to develop and execute

the business strategy.

Operation Salaries are reviewed, but not necessarily increased, annually. Decisions on salary are informed but not led by reference to

companies of a similar size, complexity and international reach.

Maximum

opportunity

Any salary increases will be assessed annually and will not normally exceed average increases for employees in other appropriate

parts of the Group. The Committee may exercise discretion to make larger increases in circumstances where it is necessary to

address particular issues or risks, including growth in the role for new appointments.

Benets

Purpose and

link to strategy

The Company provides competitive benefits suitable to attract and retain individuals of the right calibre to develop and execute

the business strategy.

Operation Benefits may include car or car allowance and related costs, financial planning assistance, private medical insurance, life assurance

and other appropriate benefits at the discretion of the Committee.

Relocation support or support for accommodation and travel may be offered to executives where necessary.

Executive Directors may participate in all-employee share plans including ShareSave and the Share Incentive Plan.

Maximum

opportunity

Benefits excluding all employee share plans, and any accommodation, relocation and associated tax costs will not exceed £100,000

per annum.

Pension

Purpose and

link to strategy

The Company provides competitive pension schemes suitable to attract and retain individuals of the right calibre to develop

and execute the business strategy.

Operation Executive Directors are offered membership of a defined contribution pension plan. A cash allowance may be payable in lieu

of pension contributions, reduced to allow for additional National Insurance incurred. There are a number of legacy pension

arrangements, including defined benefit plans, which were in place before 27 June 2012 and have not changed. Commitments

to these arrangements will be honoured.

Maximum

opportunity

The maximum employer contribution to defined contribution plans (or to be taken as a cash allowance) is 25% of salary.

Pension contributions are based on base salary only.

Defined benefit legacy plans, now closed to new members, accrue pension up to a maximum of two thirds of final salary.

Rolls-Royce Holdings plc Annual Report 2016 REMUNERATION POLICY

Pay element – variable pay

Annual bonus

Purpose and

link to strategy

To incentivise the execution of the business strategy, delivery of financial targets, and the achievement of personal objectives.

Operation Bonuses are determined primarily by Group financial performance, but the Committee may apply non-financial metrics that support

the underlying strategic priorities for the forthcoming year and/or adjust the payout level to ensure the outturns reflect performance.

The bonuses payable are also linked to personal performance of the Executive Directors.

The financial and non-financial metrics are set with reference to the prior year and to the budgets and business plans for the

coming year, ensuring the levels to achieve base, on-target and maximum payout are appropriately stretching. At least 40%

of the bonus is compulsorily deferred into shares for a further two years, and released subject to continued employment.

Deferred shares may attract an issue of C Shares or equivalent during the deferral period.

Awards are subject to malus and clawback provisions where there has been a material misstatement of audited results;

serious financial irregularity which invalidates the targets set; reputational damage; material failure of risk management

a serious breach of the Group’s Global Code of Conduct; or individual gross misconduct.

These provisions apply from the date of deferral until three years after the release of shares.

Maximum

opportunity

The annual maximum for the Chief Executive is 180% of salary and 150% for other Executive Directors.

Performance

measures

The bonus is weighted 80% on Group metrics, and 20% on individual performance. Within the Group metrics:

• At least 60% is based on Group nancial targets (for example prot and free cash ow).

• Up to 40% of the bonus is based on non-nancial metrics such as employee engagement and customer delivery.

• Individual objectives are set and agreed with the Remuneration Committee at the start of each year, to reect the prevailing

business context.

• The Committee may, in the context of the underlying business strategy, use diﬀerent performance measures.

Long-term incentive plan (LTIP)

Purpose and

link to strategy

To reward the development and execution of the business strategy over a multi-year period.

Operation Executive Directors are granted awards over shares annually with a three-year performance period.

The number of shares relative to the proportion of the award that vests is determined at the end of the performance period

according to the achievement against the performance measures. The proportion of award that vests is then held for a further

two-year holding period.

Awards are subject to malus and clawback provisions where there has been a material misstatement of audited results;

serious financial irregularity which invalidates the targets set; reputational damage; material failure of risk management;

a serious breach of the Group’s Global Code of Conduct; or individual gross misconduct. These provisions apply from the

date of the award until three years from the date of vesting.

Maximum

opportunity

Normal annual awards:

• Chief Executive – 250% of salary.

• Other Executive Directors – 225% of salary.

The maximum face value of annual awards is 300% of salary for the Chief Executive and 250% for other Executive Directors.

This flexibility would only be used in recruitment to secure individuals with the required skills and experience.

This flexibility would not be used in the normal course of business.

Performance

measures

Performance measures may include CPS, EPS, and/or relative TSR.

For 2017 awards the measures will be weighted 60% CPS, 20% EPS, 20% TSR.

No more than 20% of awards will vest for threshold performance.

The Committee may, in the context of the underlying business strategy, use different performance measures and/or

vary the weightings of the measures.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT REMUNERATION POLICY

The table below sets out the main elements of Non-executive Directors’ remuneration.

Pay element

Fees

Purpose and

link to strategy

To reward individuals for fulfilling their role and attract individuals of the skills and calibre required.

Operation The Committee makes recommendations to the Board on the Chairman’s remuneration. The Chairman and the

Executive Directors determine the remuneration of the Non-executive Directors. Levels take into account fees paid

by other companies of a similar size and complexity.

The Chairman is paid a single fee. Other Non-executive Directors are paid a base fee covering Board and Board

Committee membership, with committee chairmen and the Senior Independent Director receiving an additional fee.

Maximum

opportunity

The maximum total remuneration payable to Non-executive Directors, including the Chairman, is £1,600,000

per annum.

Benets

Purpose and

link to strategy

To devote maximum time and attention to the requirements of the role.

Operation The Chairman has occasional use of chauffeur services. Travel, hotel and subsistence incurred in attending meetings

are reimbursed by the Company. The Group may pay tax on such benefits, or provide support with tax matters for

Non-executive Directors based outside the UK.

Maximum

opportunity

Maximum value for chauffeur services will not exceed £15,000 per annum.

£5,000 maximum towards tax advice and filing per annum.

Rolls-Royce Holdings plc Annual Report 2016 REMUNERATION POLICY

Performance measures and targets

The Committee will set Group financial targets for annual bonus

and LTIP awards with reference to the prior year and to

forward-looking business forecasts, ensuring the levels of

performance required to achieve base, on-target and maximum

bonus awards are appropriately challenging.

The Committee may, in the context of the underlying business

strategy, use different performance measures for incentives and/or

vary the weightings of the measures used for LTIP awards. For

example, during the next two years we will transition to IFRS 15

which will impact the reporting of revenue and profit. The

Committee may choose to increase the weighting on EPS as this

new reporting standard becomes more established.

The measurement of performance against performance targets is

at the Committee’s discretion, which may include appropriate

adjustments to financial or non-financial elements and/or

consideration of overall performance in the round.

Performance conditions may also be replaced or varied if an event

occurs or circumstances arise which cause the Committee to

determine that the performance conditions have ceased to be

appropriate. If the performance conditions are varied or replaced,

the amended conditions must, in the opinion of the Committee, be

fair, reasonable and materially no less difficult than the original

condition when set.

Policy on new appointments

The Committee will appoint new Executive Directors with a

package that is in line with the remuneration policy in place and

agreed by shareholders at the time. Base salary may be set at a

higher or lower level than the previous incumbent. The Committee

may use its discretion to make individual incentive awards up to the

maximum policy headroom limits outlined in the policy table.

Remuneration forfeited on resignation from a previous employer

may be compensated. This will be considered on a case-by-case

basis and may comprise cash or shares. In general:

• If such remuneration was in the form of shares, compensation

will be in the Company’s shares.

• If remuneration was subject to achievement of performance

conditions, compensation will be normally be subject to

performance (either Rolls-Royce performance conditions or

actual/forecast performance outturns from the previous

company).

• The timing of any compensation will, where practicable, match

the vesting schedule of the remuneration forfeited.

Legacy terms for internal appointments may be honoured,

including pension entitlements and any outstanding

incentive awards.

If an Executive Director is appointed following a merger or

an acquisition of a company by Rolls-Royce, legacy terms and

conditions may be honoured.

Remuneration policy – worked examples below

2017 POLICY ILLUSTRATION

Chief Executive (£000)

£1,173

£2,006

£3,162

£5,151

Chief Financial Oﬃcer (£000)

£892

£1,402

£2,167

£3,442

Minimum

On-target

cash

On-target

total

On-target

total

Maximum

Minimum

On-target

cash

Maximum

Executive Director (£000)

£730

£1,142

£1,761

£2,792

On-target

total

Minimum

On-target

cash

Maximum

Fixed remuneration (including salary, benefits and pension)

Annual bonus

Long-term incentive plan

Minimum – fixed remuneration (salary, pension, benefits), no bonus award or LTIP vesting.

On-target cash – fixed remuneration, 50% of maximum bonus award, no LTIP vesting.

On-target total – fixed remuneration, 50% of maximum bonus award, 50% of LTIP vesting.

Maximum – fixed remuneration, 100% of maximum bonus award, 100% of LTIP vesting.

Group employee considerations

When setting remuneration for Executive Directors the Committee

takes into account contextual information about pay and conditions

within the Group, including:

• Salary increases for all employees.

• Bonus awards for all employees.

• Pay ratios between Executive Directors and other employees.

We are committed to sharing business success across the

organisation with all employees participating in a short-term

incentive plan. At more senior levels, remuneration is increasingly

long term and larger proportions are dependent on both Group and

individual performance and paid in the form of shares.

The Committee has not consulted all employees when reviewing

the policy, considering the scale and geography of the population.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT REMUNERATION POLICY

Termination

The Company is required to give Executive Directors 12 months’

notice under their service contracts. Payment in lieu of notice will

not exceed the value of 12 months’ salary, benefits and pension

contributions. Both mitigation and the timing of payments through

the notice period will be considered by the Committee where

appropriate, as will the funding of reasonable outplacement and

other professional fees. Pension benefits will normally be payable in

accordance with the rules of the pension plan. There is no automatic

entitlement to annual bonus. Taking into account the circumstances,

the Committee has discretion to award a bonus in respect of

performance in the financial year with appropriate consideration of

time prorating.

Deferred shares will generally be released in cases such as

retirement, death, injury, ill-health, redundancy or any other reason

at the discretion of the Committee. In these cases any annual bonus

awarded immediately prior to leaving may be delivered in cash

rather than deferred shares.

For the LTIP, the rules state that unvested awards may be preserved

at the Committee’s discretion according to the circumstances. In

such cases vesting will be at the normal date, subject to the

established performance conditions, and prorated to employment

in the performance period. In cases such as death and terminal

illness, the Committee also has the discretion to vest the awards

immediately using an estimate of future outturn. If an individual

leaves after the LTIP shares have vested but during the holding

period, shares will not be forfeited but the holding period will

remain in force.

The treatment of leavers in ShareSave and the Share Incentive Plan

is covered by the respective plan rules. Change of control provisions

in respect of employee share plans are set out on page 187.

Any termination payments will be in line with the remuneration

policy agreed by shareholders at that time.

Service contracts

The service contracts for Warren East, Colin Smith and David Smith

include 12 months’ notice of termination from the Company and six

months’ notice from the Executive. The service contracts of Stephen

Daintith, and any new appointee, will include 12 months’ notice

from the Company and 12 months’ notice from the Executive

Director. All contracts include the entitlement to paid holidays, sick

pay, and other standard employment terms including

reimbursement of reasonable business expenses.

The Chairman and Non-executive Directors have letters of

appointment. No compensation is payable to the Chairman or to

any Non-executive Director if the appointment is terminated early

or if they fail to be re-elected at an AGM.

Legacy commitments

Any remuneration payments and/or payments for loss of office

made under legacy arrangements prior to the approval of the

Company’s remuneration policy may be paid out subject to the

terms of any remuneration policy in place at the time they were

agreed. For these purposes ‘payments’ include the Company

satisfying awards of variable remuneration and, in relation to an

award over shares, the terms of the payment are agreed at the time

the award is granted.

This provision includes PSP awards granted under the previous

approved remuneration policy. These awards were subject to CPS

and relative TSR performance conditions, with vesting only possible

if the EPS hurdle was met. The Chief Executive received awards of

180% of salary, and other executives received awards of 150% of

salary (including the relative TSR multiplier).

Minor amendments

The Committee may make minor amendments to the policy (for

regulatory, exchange control, tax or administrative purposes or to

take account of a change in legislation) without obtaining

shareholder approval.

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

Directors’ remuneration report

The table below shows how we have applied the current remuneration policy during 2016. It discloses all the elements of remuneration

received by the Directors during the year. The current remuneration policy, as approved by shareholders in 2014, is available on our website.

Single figure of remuneration (audited)

Salary/fees (A)

£000

Benefits (B)

£000

Bonus (C)

£000

LTIP (D)

£000

Other (E)

£000

Sub-total

£000

Pension (F)

£000

Total

£000

2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015

Executive Directors

Warren East

925 421 17 8 916 – – – – – 1,858 429 231 114 2,089 543

Colin Smith

550 546 156 150 413 – – – – – 1,119 696 176 140 1,295 836

David Smith 540 535 51 35 405 – – – – – 996 570 173 171 1,169 741

Former Executive Directors

James Guyette

– 274 – 47 – – – – – – – 321 – 262 – 583

Mark Morris

– – – – – – – – – 597 – 597 – – – 597

John Rishton

– 519 3 82 – – – – – – 3 601 – 153 3 754

Sub-total 2,015 2,295 227 322 1,734 – – – – 597 3,976 3,214 580 840 4,556 4,054

Chairman and Non-executive Directors

Ian Davis 425 425 2 1 – – – – – – 427 426 – – 427 426

Lewis Booth 100 110 14 11 – – – – – – 114 121 – – 114 121

Ruth Cairnie 83 70 2 3 – – – – – – 85 73 – – 85 73

Sir Frank Chapman 90 90 2 4 – – – – – – 92 94 – – 92 94

Irene Dorner

70 30 – – – – – – – – 70 30 – – 70 30

Lee Hsien Yang 70 70 3 8 – – – – – – 73 78 – – 73 78

John McAdam 70 70 – – – – – – – – 70 70 – – 70 70

Bradley Singer

58 – – – – – – – – – 58 – – – 58 –

Sir Kevin Smith

98 12 2 – – – – – – – 100 12 – – 100 12

Jasmin Staiblin 70 70 4 7 – – – – – – 74 77 – – 74 77

Former Non-executive Directors

Dame Helen

Alexander

31 90 – – – – – – – – 31 90 – – 31 90

Alan Davies

62 12 1 – – – – – – – 63 12 – – 63 12

Warren East

– 45 – – – – – – – – – 45 – – – 45

John Neill

– 25 – 3 – – – – – – – 28 – – – 28

Sub-total 1,227 1,119 30 37 – – – – – – 1,257 1,156 – – 1,257 1,156

Total 3,242 3,414 257 359 1,734 – – – – 597 5,233 4,370 580 840 5,813 5,210

Warren East was appointed as Chief Executive on 3 July 2015, having served as a Non-executive Director from 1 January 2014 to 2 July 2015.

Colin Smith’s benefits have been restated for 2015 due to late receipt of invoices relating to accommodation costs totalling £10,000.

James Guyette left the Board on 8 May 2015.

Mark Morris left the Board on 4 November 2014.

John Rishton stepped down as Chief Executive and left the Board on 2 July 2015. A final payment in settlement of chauffeur expenses was made to John Rishton in December 2016.

Irene Dorner was appointed as a Non-executive Director on 27 July 2015.

Bradley Singer was appointed as a Non-executive Director on 2 March 2016.

Sir Kevin Smith was appointed as a Non-executive Director on 1 November 2015.

Dame Helen Alexander left the Board on 5 May 2016.

Alan Davies was appointed as a Non-executive Director on 1 November 2015 and left the Board on 18 November 2016.

John Neill left the Board on 8 May 2015.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT DIRECTORS’ REMUNERATION REPORT

Notes to the table

A. Salary and fees

BASE SALARY

The Executive Directors’ salaries are normally reviewed, but not necessarily increased, with effect from 1 March each year. In 2016 there

were no increases.

EXECUTIVE DIRECTORS’ BASE SALARY

Base salary as at

1September2017

Base salary as at

1 March 2016

Base salary as at

1 March 2015

Warren East £943,500 £925,000 £925,000

Colin Smith

n/a £550,000 £550,000

David Smith

n/a £540,000 £540,000

Stephen Daintith

£680,000 n/a n/a

Colin Smith will step down as an Executive Director on 4 May 2017.

David Smith will leave the Company on 28 February 2017.

Stephen Daintith is expected to take up his role in Spring 2017.

The Committee reviewed Executive Directors’ salaries in early 2017 and concluded that an increase of 2% will be made to Warren East in

line with those made to other employees. All salary increases for management are being deferred until 1 September 2017. No increases are

being made for other Executive Directors.

NON-EXECUTIVE DIRECTORS’ FEES

The Chairman’s fee is reviewed by the Board as a whole on the recommendation of the Remuneration Committee and the review of the

Non-executive Directors’ fees is reserved to the Executive Directors, who take recommendations from the Chairman. No individual may be

involved in setting his or her own fee. The Executive Directors and the Chairman reviewed Non-executive Directors' fees in December 2016

and resolved that there will be no increase in fees in 2017. The Non-executive Directors’ fees were last increased in 2014.

The Chairman and Non-executive Directors are not eligible to participate in any of the Group’s share schemes, incentive arrangements or

pension schemes. We have in place a facility to enable Non-executive Directors to use some or all of their fees, after the appropriate

statutory deductions, to make market purchases of shares in the Company on a monthly basis. Ruth Cairnie, Sir Frank Chapman, Ian Davis,

Lee Hsien Yang, John McAdam and Sir Kevin Smith participate in this facility.

NON-EXECUTIVE DIRECTORS’ BASE FEES

2017

£000

2016

£000

2015

£000

Chairman 425 425 425

Other Non-executive Directors 70 70 70

Chairman of the Audit Committee 25 25 25

Chairman of the Remuneration Committee 20 20 20

Chairman of the Safety & Ethics Committee 20 20 20

Chairman of the Science & Technology Committee 20 20 20

Senior Independent Director 15 15 15

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

B. Benefits

Benefits are provided to ensure that remuneration packages remain sufficiently competitive to recruit and retain Directors and to enable

them to devote themselves fully to their roles. The benefits for the Non-executive Directors relate predominantly to travel and subsistence

associated with attending Board meetings, although for Directors who are based outside the UK, the Company may pay towards tax advice

and filing. The taxable value of all benefits paid to Executive Directors in the year is shown below.

BENEFITS PAID TO EXECUTIVE DIRECTORS (AUDITED)

Car or car

allowance

including fuel

allowance

£000

Chauffeur

services

£000

Financial

planning

£000

Medical

insurance

£000

Club

membership

fees

£000

Travel and

subsistence

£000

Accommodation

costs

£000

Total

£000

2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 2015

Warren East

15 7 – – – – 2 1 – – – – – – 17 8

Colin Smith

30 30 – – 6 6 2 2 – – 7 4 111 108 156 150

David Smith 28 16 – – – – 2 2 – – 6 5 15 12 51 35

Former Non-executive Directors

James Guyette

– 5 – – – 20 – – – 6 – – – 16 – 47

John Rishton

– 14 3 14 – 6 – 1 – – – – – 47 3 82

Total 73 72 3 14 6 32 6 6 – 6 13 9 126 183 227 322

Warren East was appointed as Chief Executive on 3 July 2015, having served as a Non-executive Director from 1 January 2014 to 2 July 2015.

Colin Smith’s benefits have been restated for 2015 due to late receipt of invoices relating to accommodation costs totalling £10,000.

James Guyette left the Board on 8 May 2015.

John Rishton stepped down as Chief Executive and left the Board on 2 July 2015. A final payment in settlement of chauffeur expenses was made to John Rishton in December 2016.

C. Annual bonus outcome

Annual bonuses may be awarded under the annual performance related award plan (APRA).

Executive Directors receive any annual bonus awarded in March following the performance period. The bonus is paid partially in cash and

partially in deferred shares. The deferred shares are held in trust for two years before being released, subject to the recipient still being

employed by the Group. Ordinary shares held as deferred shares will include the right to receive an enhancement equal in value to the

C Shares issued during the deferral period.

Malus and clawback provisions apply where there has been: a material misstatement of audited results; serious financial irregularity

which invalidates the targets set; reputational damage; material failure of risk management; a serious breach of the Group’s Global Code

of Conduct; or individual gross misconduct. Clawback will apply within three years from the date of grant.

Following consultation with shareholders at the start of 2016, the Committee introduced two new measures relating to customer delivery

and employee engagement, subject to any bonus in relation to these targets being underpinned by the underlying profit threshold. The

maximum bonus opportunity for Executive Directors was 180% for the Chief Executive and 150% of salary for other Executive Directors.

The Remuneration Committee reviewed the 2016 outturn against the performance measures, which are shown below:

APRA  PERFORMANCE MEASURES AND OUTTURN (AUDITED)

GROUP PERFORMANCE

Profit Cash

Customer

delivery

Employee

engagement

Weighting 37.5% 37.5% 12.5% 12.5%

Base (30%) £650m (£250m) 80% 73

Target (60%) £712m (£169m) 90% 75

Maximum (100%) £790m 0 100% 78

2016 performance £713m £48m 88% 75

Bonus outturn (as a % of maximum) 60% 100% 54% 60%

Discretion was applied to reduce the overall Group performance outturn to on-target (60% of maximum).

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT DIRECTORS’ REMUNERATION REPORT

Definitions used for performance measures:

Profit – underlying profit before tax that is reported by the Group for 2016, adjusted to exclude unbudgeted acquisitions and disposals.

Cash – free cash flow which is cash flow before acquisitions and disposals, shareholder payments, foreign exchange and

share buybacks.

Customer delivery – % on-time to purchase order, measured for new equipment, spare parts or equipment repair and overhaul.

Employee engagement – measured through our long-standing global employee opinion survey.

For the purposes of assessing performance the Committee adjusted the actual underlying profit of £813m downwards to £713m and free

cash flow of £100m downwards to £48m to remove gains from unbudgeted foreign exchange movements and cash receipts as well as

restructuring payments.

INDIVIDUAL PERFORMANCE

The individual performance multiplier can increase or decrease the business outturn in a range of 0 – 120%, where on-target is 100%.

Personal performance objectives are set at the beginning of the year and are aligned with the Group’s internal strategic priorities.

For Executive Directors these have included:

• Driving the transformation programme; simplification, cost reduction and improved behaviours.

• Engineering excellence – advancing our world-class technology.

• Operational excellence – embedding a lean enterprise and high-performance culture.

• Capturing aftermarket value and providing outstanding service to customers.

• Restoring investor confidence.

• Developing our people and our culture in a safe and ethical environment.

• Improving profitable growth.

The Committee assesses performance against the objectives and the overall assessed multiplier is based on the Committee’s judgement

and may include other factors and achievements in the year.

The following provides an overview of key achievements during the year for each Executive Director:

Warren East Colin Smith David Smith

Launched transformation including cultural

change and process improvements, delivering

cost reduction at the top end of the target range.

Progressed engineering supply chain interface,

lead time reductions and product cost

improvement ahead of target.

Continued to develop the nance function

including review of management structures

and achievement of key hires.

Drove the reorganisation of the Group with

restructuring at many levels in the organisation.

Built talent within engineering to support

succession planning.

Finalised plan for cost and margin work streams,

tracking transformation and underlying

cost actions.

Strengthened engagement with shareholders. Drove transformation, including cultural and

behavioural change programmes with cost

reduction at the top end of the target range.

Improved eﬀectiveness of forecasting and

management information systems.

BONUS OUTTURN

Warren East Colin Smith David Smith

Group performance (% of salary) 90% 75% 75%

Individual performance multiplier 1.1 1.0 1.0

Total bonus (% of salary) 99% 75% 75%

Total bonus (% of maximum) 55% 50% 50%

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

D. LTIP

PSP  AWARD CPS TARGETS (AUDITED)

The cash flow per share targets for awards made in 2016 were as follows and straight-line vesting will apply between these points.

Aggregate CPS over the three-year period Maximum award released %

Less than 10p 0

10p 30

50p 100

2016 PSP Awards are based on CPS and TSR measures with an EPS hurdle. As disclosed in the 2015 Annual Report, for the 2016 awards, the

EPS hurdle will be measured over the period 2017 and 2018. This change reflected business circumstances and the intended level of stretch

of the EPS hurdle which is used as an underpin rather than a primary performance measure. In recognition of the change the maximum

vesting level for 2016 awards was reduced from 180% to 150% of salary for the Chief Executive and from 150% to 130% of salary for other

Executive Directors.

PSP AWARDS MADE IN MARCH 

In 2016, Executive Directors received PSP awards in line with the remuneration policy as follows:

Date

of award

Number

of shares

awarded

% of

salary

Face values

(% of salary

maximum)

Performance

period

end date

Warren East 1 March 2016 164,202 120 150 31 December 2018

Colin Smith 1 March 2016 81,361 100 130 31 December 2018

David Smith 1 March 2016 79,882 100 130 31 December 2018

All awards are made as performance shares based on a percentage of salary and the value is divided by the average share price over

a three-day period before the date of grant, being 676p for the award on 1 March 2016.

Malus and clawback provisions apply where there has been: a material misstatement of audited results; serious financial irregularity

which invalidates the targets set; reputational damage; material failure of risk management; a serious breach of the Group’s Global Code

of Conduct; or individual gross misconduct. Clawback will apply for three years after the vesting of an award.

If the EPS and base CPS targets are not achieved, no awards vest.

PSP AWARDS VESTING IN MARCH 

The following sets out details in respect of the March 2014 PSP award, for which the final year of performance was the 2016 financial year.

Subject to performance conditions, the vesting date of these awards is in March 2017, three years after the award was made.

Targets for 2014 – 2016 period Performance against targets

EPS growth (hurdle) Awards may vest if EPS growth exceeds the OECD index of consumer prices.

Awards will lapse if hurdle not met.

EPS growth of (53.42%) over the three-year period

underperformed the hurdle which was 3.06%.

Aggregate CPS Aggregate CPS over three-year period of less than 117p – zero vesting.

Aggregate CPS over three-year period of 147p – 100% vesting.

Aggregate CPS performance over three years of 27p.

Relative TSR Relative TSR versus FTSE 100 constituents less than median – 1x multiplier.

Relative TSR versus FTSE 100 constituents equal to median – 1.25x multiplier.

Relative TSR versus FTSE 100 constituents equal to upper quartile –

1.5x multiplier.

Relative TSR performance over three years was

below median versus FTSE 100 companies. No

multiplier applied.

Outcome None of the 2014 awards will vest in March 2017.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT DIRECTORS’ REMUNERATION REPORT

IMPLEMENTATION OF REMUNERATION POLICY FOR *

Base salary Warren East's salary will be increased by 2% in line with increases made to other employees. All salary increases for management are

being deferred until September 2017. Base salaries from September 2017 will be:

• Warren East – £943,500.

• Stephen Daintith – £680,000 (expected to take up his role in Spring 2017).

Benets There will be no change to our approach to benets in 2017, which includes car or car allowance, nancial planning assistance,

insurances and other benets.

Pensions There will be no change to our approach to pensions in 2017. Pension arrangements will be:

• Warren East: cash allowance of 25% of salary.

• Stephen Daintith: cash allowance of 25% of salary.

Annual bonus For 2017, bonuses will be awarded using a simple additive approach:

• 80% of the award will be based on Group performance.

• 20% of the award will be based on individual performance.

For 2017, the Group measures will be unchanged:

• Profit (37.5%).

• Free cash flow (37.5%).

• On-time customer delivery (12.5%).

• Employee engagement (12.5%).

Maximum opportunities will remain unchanged:

• Chief Executive – 180% of salary.

• Other Executive Directors – 150% of salary.

LTIP awards For awards to be granted in 2017 performance measures will be weighted:

• 60% on CPS.

• 20% on EPS.

• 20% on relative TSR (versus FTSE 100 and Global S&P Index, to recognise that Rolls-Royce is a global company).

Performance will be measured over three years to 31 December 2019. Performance targets will be:

CPS EPS Relative TSR

Threshold (20% vesting) 60p 115p Median

Mid (50% vesting) 80p 135p

Between median

and upper quartile

Maximum (100% vesting) 110p 160p Upper quartile

Performance below threshold will result in that element lapsing in full.

The above targets are not an indication of forecast numbers for the three-year period.

Methodologies

CPS – calculated as reported cash ow before the cost of business acquisitions or proceeds of disposals, foreign exchange translation

eﬀects, special payments into pension schemes and payments to shareholders, divided by the weighted average number of shares in

issue. CPS is cumulative over a three-year period. The Committee will review CPS performance to ensure that it is a fair reection of

achievements over the period.

EPS – calculated as cumulative absolute underlying EPS over the three-year performance period. With the introduction of IFRS 15 in

2018, the rst three-year period starting in 2017 will use existing contract accounting, but will be restated in 2018 under IFRS 15. The

Committee will ensure that translated targets are based on the same underlying assumptions under both accounting bases.

Relative TSR – measured 50% against the constituents of the FTSE 100 and 50% against the constituents of the S&P Global Industrials index.

Award sizes for maximum performance

• Chief Executive: 250% of salary.

• Other Executive Directors: 225% of salary.

Threshold vesting at 20% equates to 50% of salary for the Chief Executive and 45% of salary for other Executive Directors.

LTIP awards will be subject to an additional shareholding period of two years following the three-year performance period.

* Subject to shareholder approval at the 2017 AGM.

The SFO, DoJ and MPF agreements relate to legacy matters and the legal judgment was clear that there was no culpability in relation

to existing management. The future impact of these agreements are therefore excluded from incentive targets.

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

E. Other

PAYMENTS FOR LOSS OF OFFICE (AUDITED)

Mark Morris left the Group on 4 November 2014 and contractual payments of £597,000 were made to him in 2015 in respect of the

termination of his employment. No further payments were made in 2016.

PAYMENTS TO PAST DIRECTORS (AUDITED)

Dr Mike Howse retired from the Board on 30June 2005. Following his retirement he was retained by the Company for his expertise in

engineering and received his final payment of £2,520 under this arrangement in January 2016.

No other payments were made to former Directors.

F. Pension entitlements (audited)

The Group’s UK pension schemes are funded, registered schemes and were approved under the regime applying until 6 April 2006. They

include both defined contribution and defined benefit pension schemes. In the defined benefit pension schemes normal retirement age

is 62. During the year, the Group restructured its UK defined benefit arrangements. Four of the five UK schemes merged together into a

consolidated scheme, renamed the Rolls-Royce UK Pension Fund. The merged scheme is estimated to have a material surplus on its

statutory funding basis, with a largely de-risked investment strategy. All future defined benefit accrual will be provided from this scheme

(limited to employees who joined the Group before 1 April 2007). The scheme merger will simplify future administration and governance.

As part of this merger, three transferring schemes are being wound up and over 3,400 former employees with benefits below statutory

limits elected to receive lump sums in exchange for their existing benefits. The liabilities of the fifth scheme, the Vickers Group Pension

Scheme have been fully insured with Legal & General Assurance Company Limited and that scheme is also in the process of being fully

wound up. Neither of these transactions required any additional funding by the Group.

John Rishton, who left the Company and started to receive his pension on 2 July 2015, was a member of one of the Group’s UK defined

contribution pension schemes and received employer contributions restricted to the annual allowance limits with any excess paid as a cash

allowance. The cash allowance was calculated as equivalent to the cost of the pension contributions after allowing for National Insurance costs.

Warren East and David Smith receive a cash allowance in lieu of pension accrual. Stephen Daintith will receive a cash allowance in lieu of

pension accrual.

Colin Smith opted out of future pension accrual with effect from 1 April 2006 and opted out of salary linkage with effect from 30

November 2015. He started to receive his pension from 1 December 2016. He receives a cash allowance in lieu of pension accrual.

DEFINED BENEFIT SCHEME

Details of the defined benefit of the Executive Directors as at 31 December 2016 in the Group’s pension schemes are given below.

2016

£000

2015

£000

Colin Smith 350 385

OTHER INFORMATION

BOARD CHANGES DURING 

On 22 September 2016, it was announced that David Smith would leave the Group after three years to pursue other business interests.

Stephen Daintith is expected to take up his role in Spring 2017. Remuneration arrangements in respect of these changes are set out below.

David Smith

On leaving Rolls-Royce, David Smith will receive payment in lieu of any outstanding portion of his 12 months' notice period, which started

on 21September 2016. He may also receive a payment in respect of any unused leave. He remained eligible for an APRA award for 2016.

He will not participate in the incentive plans for 2017. Mitigation will be applied to reflect his new employment at QinetiQ Group plc.

His outstanding PSP awards will be prorated for time based on his leaving date. The performance conditions will be assessed following

the end of the three-year performance period and any vested shares will be released at the normal vesting date. The 2014 and 2015 awards

are not expected to meet the performance measures.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT DIRECTORS’ REMUNERATION REPORT

Stephen Daintith

On appointment Stephen Daintith’s annual base salary will be £680,000. He will receive a pension allowance of 25% of salary.

For 2017 he will be eligible to participate in annual bonus up to a maximum of 150% of salary per annum. His maximum 2017 LTIP award

will be 225% of salary.

Following his appointment he will be made awards to compensate for unvested incentives awarded to him at Daily Mail and General

Trust plc which were forfeited as a result of him joining Rolls-Royce. All such awards will be of equivalent value to the awards forfeited

and match or exceed the time horizons and reflect performance conditions.

His forfeited bonus awards will be replaced with Rolls-Royce shares vesting over the same time horizons. Buy out awards in respect of

forfeited LTIP awards with a performance period to October 2017 will be assessed against the original Daily Mail and General Trust plc

performance conditions and will vest at that time. For LTIP awards with performance measured to October 2018 and October 2019,

buy-out awards will be assessed against the 2016 Rolls-Royce PSP performance conditions. All awards will be in Rolls-Royce shares and

will be forfeited in the event of resignation within two years of his appointment. Full details of the buy out awards will be provided at

the time the awards are granted and will be included in the 2017 Annual Report.

PAY ACROSS THE ORGANISATION

This section of the report enables our remuneration arrangements to be seen in context by providing:

• A comparison of the year-on-year percentage change in our Chief Executive’s remuneration with the change in average remuneration

across the Group.

• A year-on-year comparison of the total amount spent on employment costs across the Group and shareholder payments.

• An eight-year history of our Chief Executive’s remuneration.

• Our TSR performance over the same period.

PERCENTAGE CHANGE IN CHIEF EXECUTIVE REMUNERATION

The following table compares the percentage change in the Chief Executive’s salary, bonus and benefits to the average percentage change

in salary, bonus and benefits for all UK employees from 2015 to 2016.

CHANGE IN REMUNERATION

Salary Benefits Annual bonus

Chief Executive – (82)% n/a

UK employees

average 2.35% (4.31)% n/a

UK employees were chosen as a comparator group in order to avoid the impact of exchange rate movements over the year. UK employees excluding apprentices, graduates and interns,

make up 43.5% of the total employee population.

No annual bonus was paid for the financial years 2014 or 2015. For 2016, the annual bonus paid out at 78% of the maximum bonus level. The Chief Executive received 55% of his

maximum bonus. The percentage of maximum is shown above. No bonus was paid in 2015.

RELATIVE SPEND ON PAY

The following chart sets out the percentage change in payments to shareholders and overall expenditure on pay across the Group.

+21%

1,000

2,000 3,000

3,822

3,152

GROUP EMPLOYMENT COSTS (£M)

(note 7 – Financial statements)

2016

2015

4,000

-29%

0 100

200 300

400

500

301

421

PAYMENTS TO SHAREHOLDERS (£M)*

(Cash ow statement)

2016

2015

* Value of C Shares issued during the year. ** Includes £306m costs of restructuring the UK

defined benefit pension schemes.

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

CHIEF EXECUTIVE PAY

Year Chief Executive

Single figure

of total

remuneration

£000

Annual bonus

as a % of

maximum

PSP

as a % of

maximum

2016 Warren East 2,089 55 –

2015 Warren East 543 0 –

2015 John Rishton

754 0 –

2014 John Rishton 2,596 0 45

2013 John Rishton 6,228 55 100

2012 John Rishton 4,577 85 –

2011 John Rishton 3,677 63 –

2011 Sir John Rose

3,832 – 75

2010 Sir John Rose 3,914 100 100

2009 Sir John Rose 2,409 29 93

On 31 March 2011, Sir John Rose retired and John Rishton was appointed. John Rishton retired on 2 July 2015 and Warren East was appointed as Chief Executive on 3 July 2015.

John Rishton received a special grant of shares on joining the Company on 1 March 2011 to mirror the shares he forfeited on resigning from his previous employer. The share price

had increased from 483.50p at the time this grant was made to 870p at the end of 2014. These are the main reasons why John Rishton’s remuneration in 2012 and 2013 exceeded

that of his predecessor.

The remuneration for Sir John Rose does not include any pension accrual or contribution as he received his pension from 1 February 2008.

TSR PERFORMANCE

The Company’s TSR performance over the previous eight years compared to a broad equity market index is shown in the graph below. The

FTSE 100 has been chosen as the comparator because it contains a broad range of other UK listed companies. The graph shows the growth

in value of a hypothetical £100 holding in the Company’s ordinary shares over eight years, relative to the FTSE 100 index.

Pence

20092008 2010 2011 2012 2013 2014 2015 2016

100

200

300

400

500

Rolls-Royce

FTSE 100

CONTRACTUAL ARRANGEMENTS

The Executive Directors have service agreements that set out the contract between each Executive Director and the Company.

Executive Directors retain payments received from serving on the boards of external companies, the details of which are given below.

The Chairman and other Non-executive Directors have letters of appointment. Each Non-executive Director serves for a term of three

years, which may be extended twice up to a total of nine years.

EXECUTIVE DIRECTORS’ SERVICE CONTRACTS

Date of contract

Notice period

Company

Notice period

individual

Warren East 21 April 2015 12 months 6 months

Colin Smith 1 July 2005 12 months 6 months

David Smith 19 November 2014 12 months 6 months

Stephen Daintith* 21 September 2016 12 months 12 months

* Stephen Daintith is due to take up his role in Spring 2017.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT DIRECTORS’ REMUNERATION REPORT

PAYMENTS RECEIVED FOR SERVING ON EXTERNAL BOARDS

Directorships held Payments received and retained £000

Warren East Dyson James Group Limited 80

Warren East

Micron Technology, Inc. 6

David Smith Motability Operations Group plc 43

Warren East stepped down from the board of Micron Technology Inc on 27 January 2016.

NON-EXECUTIVE DIRECTORS’ LETTERS OF APPOINTMENT

Appointment date Current letter of appointment end date

Ian Davis 1 March 2013 28 February 2019

Lewis Booth 25 May 2011 24 May 2017

Ruth Cairnie 1 September 2014 31 August 2017

Sir Frank Chapman 10 November 2011 9 November 2017

Irene Dorner 27 July 2015 26 July 2018

Lee Hsien Yang 1 January 2014 31 December 2019

John McAdam 19 February 2008 4 May 2017

Bradley Singer 2 March 2016 3 May 2018

Sir Kevin Smith 1 November 2015 31 October 2018

Jasmin Staiblin 21 May 2012 20 May 2018

DIRECTORS’ INTERESTS IN SHARES (AUDITED)

Each Executive Director’s total shareholding, for the purposes of comparing it with the shareholding requirement, includes shares held: by

connected persons; in the all-employee Share Incentive Plan; and PSP shares that have vested, but does not include unvested PSP awards.

Shareholding requirements are 250% of salary for the Chief Executive and 200% of salary for the other Executive Directors. APRA deferred

shares do not count towards their shareholding requirement. Participants in the PSP are required to retain at least one half of the number

of after-tax shares released from the PSP, until the value of their shareholding reaches the percentage of salary shown in the table below.

When this level is reached it must be maintained until retirement or departure from the Group.

SHAREHOLDING REQUIREMENT

Base salary

£000

Total

shareholding

Shareholding

requirement

as % of salary

Shareholding

requirement

Actual

shareholding

as % of

requirement

Warren East 925 25,365 250 342,086 7

Colin Smith 550 222,798 200 162,722 137

David Smith 540 42,038 200 159,763 26

Salary divided by the March 2016 PSP grant price of 676p multiplied by percentage of salary.

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

The Directors and their connected persons had the following interests in the ordinary shares and C Shares of the Company at 31 December

2016, as shown in the following table.

DIRECTOR’S SHARE INTERESTS

Unvested awards Vested awards

Ordinary

shares C Shares

Conditional

shares not

subject to

performance

conditions

(APRA)

Conditional

subject to

performance

conditions

(PSP)

Options over

shares subject

to savings

contracts

Vested shares

and options

exercised

in 2016

Executive Directors

Warren East 25,365 – – 290,845 1,264 –

Colin Smith 222,798 – – 192,960 758 8,977

David Smith 42,038 – – 155,373 758 –

Chairman and Non-executive Directors

Ian Davis 42,049 – – – – –

Lewis Booth 60,000 – – – – –

Ruth Cairnie 11,137 – – – – –

Sir Frank Chapman 22,091 5,061,879 – – – –

Irene Dorner 5,132 – – – – –

Lee Hsien Yang 4,005 – – – – –

John McAdam 3,230 – – – – –

Bradley Singer – – – – – –

Sir Kevin Smith 20,587 – – – – –

Jasmin Staiblin – – – – – –

Non-cumulative redeemable preference shares of 0.1p each.

DIRECTOR’S CHANGE IN SHARE INTERESTS

Ordinary shares C Shares

31 December

2016

Changes from

31 December

2016 to

13 February 2017

31 December

2016

Changes from

31 December

2016 to

13 February 2017

Executive Directors

Warren East 25,365 174 – –

Colin Smith 222,798 1,525 – –

David Smith 42,038 329 – –

Chairman and Non-executive Directors

Ian Davis 42,049 873 – –

Lewis Booth 60,000 – – –

Ruth Cairnie 11,137 649 – –

Sir Frank Chapman 22,091 1,178 5,061,879 –

Irene Dorner 5,132 35 – –

Lee Hsien Yang 4,005 317 – –

John McAdam 3,230 71 – –

Bradley Singer – – – –

Sir Kevin Smith 20,587 924 – –

Jasmin Staiblin – – – –

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT DIRECTORS’ REMUNERATION REPORT

DIRECTORS’ INTERESTS IN UNVESTED AND VESTED AWARDS

WARREN EAST

31 December

2015

Granted

during year

TSR uplift/

dividend

enhancement

Vested

awards Lapsed

31 December

2016

Market price at

date of award

(p)

Date of

grant

Date of

vesting

Market price

at vesting

(p)

PSP 2015 126,643 – – – – 126,643 730.00 01/09/2015 01/09/2018 –

PSP 2016 – 164,202 – – – 164,202 676.00 01/03/2016 01/03/2019 –

Total 126,643 164,202 – – – 290,845

ShareSave

(options)

1,264 – – – – 1,264 616.80 12/10/2015 01/02/2021 –

Total 1,264 – – – – 1,264

For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award.

COLIN SMITH

31 December

2015

Granted

during year

TSR uplift/

dividend

enhancement

Vested

awards Lapsed

31 December

2016

Market price at

date of award

(p)

Date of

grant

Date of

vesting

Market price

at vesting

(p)

PSP 2013 51,304 – – – 51,304 – 1023.33 01/03/2013 01/03/2016 –

PSP 2014 53,336 – – – – 53,336 984.33 07/05/2014 03/03/2017 –

PSP 2015 58,263 – – – – 58,263 944.00 02/03/2015 02/03/2018 –

PSP 2016 – 81,361 – – – 81,361 676.00 01/03/2016 01/03/2019 –

Total 162,903 81,361 – – 51,304 192,960

APRA 2013 16,000 – 939 16,939 – – 984.40 07/05/2014 03/03/2016 687.78

Total 16,000 – 939 16,939 – –

ShareSave

(options)

758 – – – – 758 616.80 12/10/2015 01/02/2019 –

Total 758 – – – – 758

For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award.

DAVID SMITH

31 December

2015

Granted

during year

TSR uplift/

dividend

enhancement

Vested

awards Lapsed

31 December

2016

Market price at

date of award

(p)

Date of

grant

Date of

vesting

Market price

at vesting

(p)

PSP 2014 18,287 – – – – 18,287 984.33 03/03/2014 03/03/2017 –

PSP 2015 57,204 – – – – 57,204 944.00 02/03/2015 02/03/2018 –

PSP 2016 – 79,882 – – – 79,882 676.00 01/03/2016 01/03/2019 –

Total 75,491 79,882 – – – 155,373

ShareSave

(options)

758 – – – – 758 616.80 12/10/2015 01/02/2019 –

Total 758 – – – – 758

For ShareSave, the share price shown is the exercise price which was 85% of the market price at the date of the award.

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REMUNERATION REPORT

Committee members and attendance

The Committee membership and attendance throughout 2016 is shown on pages 54 and 61. In addition to the Committee members,

the Chairman, the Chief Executive, the Chief Financial Officer and any of the Non-executive Directors may attend one or more meetings

at the Committee’s invitation, although none was present during discussion of his or her own remuneration package.

The Committee is supported by the Company Secretary, the Group Human Resources Director and the Global Performance, Reward &

Pensions Director.

Advisers to the Committee

During the year, the Committee had access to advice from Deloitte LLP’s executive compensation advisory practice. Total fees for advice

provided to the Committee during the year by Deloitte were £159,175 (2015: £125,150). Deloitte also advised the Company on tax,

assurance, pensions and corporate finance and Deloitte MCS Limited provided consulting services. The Committee is exclusively

responsible for reviewing, selecting and appointing its advisers.

Deloitte is a founding member of the Remuneration Consultants Group and adheres to its code in relation to executive remuneration

consulting. The Committee requests Deloitte to attend meetings periodically during the year. The Committee is satisfied that the advice it

has received has been objective and independent.

Statement of shareholder voting

For Against Votes withheld

Results of the resolution approving the 2015 remuneration report at the AGM held on 5 May 2016

Percentage of votes (%) 98.71 1.29 0.85

Number of votes cast 1,370,054,216 17,870,398 11,922,905

The current remuneration policy was approved by shareholders at the 2014 AGM. We monitor carefully shareholder voting on our

remuneration policy and implementation. The full 2014 policy is available on our website, www.rolls-royce.com. We have undertaken a

comprehensive review of our remuneration policy, with significant contribution from shareholders. The 2017 remuneration policy

on pages 76 to 82 and available on our website, will be put to shareholders for approval at the AGM on 4 May 2017.

Statutory requirements

The Directors’ remuneration report has been prepared on behalf of the Board by the Remuneration Committee. We adopt the principles

of good governance as set out in the UK Corporate Governance Code and comply with the regulations contained in Schedule 8 of the Large

and Medium-sized Companies and Groups (Accounts and Reports) (Amendment) Regulations 2013, the Listing Rules of the Financial

Conduct Authority and the relevant schedules of the Companies Act 2006. The Companies Act 2006 and the Listing Rules require the

Company’s auditor to report on the audited information in their report on pages 176 to 182 and to state that this section has been properly

prepared in accordance with these regulations. The Directors’ remuneration report and the Directors’ remuneration policy are subject to

shareholder approval at the AGM on 4 May 2017. The Directors’ remuneration report was approved by the Board on 13 February 2017

and signed on its behalf.

Ruth Cairnie

Chairman of the Remuneration Committee

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT AUDIT COMMITTEE REPORT

Audit Committee report

Lewis Booth

Chairman of the

Audit Committee

2016 overview

Introduction

I am pleased to present the 2016 report of the

Audit Committee which describes how the

Committee has carried out its responsibilities

during the year. I would like to thank the

members of the Committee, the executive

management team and KPMG for the open

discussions that take place at our meetings

and the importance they all attach to its work.

All members of the Committee are

independent Non-executive Directors.

Alan Davies stepped down from the Board

and the Committee in November 2016.

For the purposes of the Code, Irene Dorner

and I have recent and relevant financial

experience. Our biographies are on pages

55 and 56.

Operation of the Committee

The Committee’s responsibilities are outlined

in its terms of reference which we review

annually and refer to the Board for approval.

During 2016, we recommended revisions

to reflect the review of Directors’ and senior

managers’ expenses that we undertake

and to remove the requirements for the

Committee to review payments to

shareholders, which are considered by the

Board as a whole.

The Committee met six times in 2016.

In addition, the audit tender steering

group (see page 102) also met six times.

The Chief Financial Officer, Deputy CFO &

Group Controller, Group Chief Accountant,

Director of Internal Audit, General Counsel,

Director of Risk and representatives from our

external auditor are also invited to attend.

Lord Gold also attended the Committee’s

meetings in July and December.

Principal responsibilities

The principal responsibilities of the

Committee are to assist the Board in

fulfilling its oversight responsibilities.

Financial reporting

Review financial results announcements

and financial statements, focusing on:

• the appropriateness of critical

accounting policies, judgements and

estimates and consistent application

of those accounting policies;

• inclusion of appropriate disclosures;

• compliance with relevant regulations;

and

• reporting to the Board as to whether

the Annual Report, as a whole, is fair,

balanced and understandable.

Risk and control environment

Assess the scope and effectiveness of the

systems to identify, manage and monitor

financial and non-financial risks.

Assess the management of principal risks

allocated to the Committee: business

continuity, market and financial shock

and IT vulnerability.

Review the procedures for detecting,

monitoring and managing the risk of fraud.

Review the system of internal control

over the business processes and the

risks identified through the risk

management process.

Internal audit

Review the scope, resources, results

and effectiveness of internal audit.

External auditor

Oversee the relationship with the external

auditor, review the effectiveness of the

external audit process and make

recommendations to the Board for the

external auditor’s appointment and fees.

Areas of focus for 2016

Overseeing the ongoing projects to

enhance the systems for risk

management and internal control.

Assessing the effectiveness of internal

control over financial reporting.

Reviewing key accounting judgements

and estimates and the consistent

application of accounting policies which

had the most significant impacts on the

financial results in 2016. In addition,

we requested a comprehensive review

of the application of all accounting

policies across the Group.

Reviewing the Group’s basis for the

viability statement.

Overseeing the project for the

implementation of IFRS 15 Revenue from

Contracts with Customers, which will be

adopted in 2018.

Reviewing the progress of the

management information systems project.

Reviewing principal risks on behalf

of the Board.

Leading the audit tender process.

Highlights

Implementation of enhanced

risk management system.

Issue of governance framework

for internal controls.

Review of key judgements and

estimates and consistency of

accounting policies.

Signicant progress on the

adoption of IFRS 15.

PwC selected as auditor

for 2018.

Rolls-Royce Holdings plc Annual Report 2016 AUDIT COMMITTEE REPORT

At a glance

Area of focus Matters considered Outcome

Financial

reporting

The appropriateness of accounting policies and key accounting judgements

and estimates, including:

• estimates used in accounting for long-term contractual arrangements,

including the regular review of the methodologies for taking account of

uncertainties in these estimates and the nancial impact;

• further impairment of goodwill in Marine;

• carrying value of goodwill in Rolls-Royce Power Systems AG; and

• disclosures of contingent liabilities.

The consistency of the application of accounting policies across the Group.

The form and content of the Annual Report.

The implementation project for IFRS 15 and the communication to investors

in November 2016.

The accounting policies and key

judgements and estimates are

appropriate and key estimates used

are balanced.

The reviews of consistent application

of accounting policies identified some

minor differences, which have now

been amended.

The Annual Report, taken as a whole,

is fair, balanced and understandable.

IFRS 15 will introduce some very

significant changes in accounting

policies, particularly in the Civil

Aerospace business.

Risk and control

environment

Improvements to the risk management and internal controls systems to address

requirements of the Code.

Management’s assessment of the risk of a disruptive event.

The procedures for preventing, monitoring and combatting breaches of the security

of the Group’s IT systems.

The processes for identifying and managing risks.

The model for assessing the effectiveness of the Group’s systems of internal control.

The process and assumptions underlying the viability statement.

Appropriate procedures are in place

to identify and manage principal risks

and all of these have been subject to a

review by the Board or an appropriate

Board committee.

Appropriate procedures are in place

to manage business continuity,

cyber-security and market shock risks.

The internal control system meets

the requirements of the Code. It will

continue to be enhanced during 2017.

Reported to the Board that an

appropriate process is in place to make

the viability statement.

Internal audit The effectiveness of the internal audit function, its key findings and trends arising,

and the resolution of these matters.

The scope, extent and effectiveness

of internal audit are appropriate.

External audit The approach and scope of external audit and the effectiveness and independence

of the external auditor and the review of the 2015 Rolls-Royce audit by the FRC’s

Audit Quality Review team.

The extent of non-audit services provided by KPMG and the tendering firms during

the tender process.

The requirements of the FRC’s new Ethical Standard on non-audit services.

The audit tender process.

Assessed KPMG as effective and

independent and recommended their

re-appointment at the 2017 AGM.

No concerns over the nature and scale

of the non-audit services provided.

Approved a revised policy on the

provision of non-audit services.

A thorough process resulted in the

Committee recommending to the Board

that PricewaterhouseCoopers LLP (PwC)

be proposed at the 2018 AGM to succeed

KPMG as the Group’s auditor.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT AUDIT COMMITTEE REPORT

Business and function presentations

We have a regular schedule of presentations from each of the

Group’s businesses and its key functions. During 2016, we received

presentations from the following:

• Civil Aerospace – key business risks (including major product

failure, on-time and profitable delivery of new programmes,

business continuity risks including supply chain disruption

and market shock due to external events or factors reducing

air travel); accounting policies; key accounting judgements,

estimates and controls; credit risks associated with customers;

and TotalCare and CorporateCare accounting.

• Defence Aerospace – key business risks (including the impact

of government spending and pricing in the traditional

UK and US markets and the protection of our position in the

transport and patrol markets); and key accounting estimates

(which principally relate to long-term contracts, in particular

the contract loss provisions on the contract for TP400

development and production); and controls.

• Marine – key business risks (including the impact of the current

low oil price to the offshore business and the restructuring

programme); and key accounting estimates (which principally

relate to the carrying value of goodwill and inventory, warranty

and restructuring provisions); and controls.

• Group Tax Director – approach to managing the Group’s tax

affairs; key tax risks and how they are managed (with specific

consideration of tax disputes); key sources of estimation

uncertainty (in particular the recognition of deferred tax assets);

and key tax-related disclosures (in particular we considered the

disclosure of the Group’s approach to managing its tax affairs).

We also reviewed the introduction of enhanced management

information systems. To date, these have covered the introduction

of new dashboards and forecasting processes which have improved

visibility to the ELT and the Board, although more work is required.

The full benefits will also be dependent on the implementation of

improvements to underlying IT systems over the next few years.

Financial reporting

We place considerable emphasis on making sure that the

accounting policies are appropriate and are consistently applied so

that the financial statements faithfully represent the results and

financial position of the Group and its underlying contractual

arrangements.

Given the long-term nature of the Group’s businesses, most of the

accounting policies subject to significant judgement do not change

materially year-on-year. However, the facts and circumstances on

which those judgements are based do vary over time, with a

consequential impact on the application of the policies. The key

areas of focus in 2016 are set out in the table opposite. In part, these

reflect the current weak trading conditions in Marine. Overall, we

are satisfied that the judgements and estimates made are balanced.

In July, the FRC wrote to the Company following its review of the

2015 Annual Report. This review, which was based solely on the

Annual Report, did not identify any questions or queries which the

FRC wished to pursue, although a number of suggestions for

improvements were noted, and these have been taken into account

in preparing the 2016 Annual Report.

During the year, we reviewed the conclusions reached by the

implementation project on IFRS 15, which will be applicable

for 2018.

This new standard will have a significant impact on our accounting

policies for revenue recognition, most particularly in our Civil

Aerospace business. We agreed with the conclusions reached that

will require us to account for OE and aftermarket contracts

separately and to recognise aftermarket revenues based on

activities performed rather than flying hours.

These changes were presented at an investor event in November

2016 and are discussed further in the accounting policies on

page130.

The Group continues to consult with other companies in the

aerospace and defence sector. We believe that the new policies will

be broadly comparable across the sector.

Since the year end, we have reviewed the form and content of the

Company’s 2016 Annual Report together with the processes used to

prepare and verify it. We have reported to the Board that, taken as

a whole, we consider the Annual Report to be fair, balanced and

understandable. We further believe the Annual Report provides

the necessary information for shareholders to adequately assess the

Company’s performance, business model and strategy. In making

this assessment, we considered:

• The process for preparing the Annual Report, including a steering

committee, the core team, and instructions to contributors.

• Written representations from management in respect of the

business reviews, sustainability, principal risks and financial

statements.

• The completion of a regulatory compliance checklist.

• All reviews performed (including the Board, the ELT and KPMG).

We ensured that all feedback was appropriately reflected.

Rolls-Royce Holdings plc Annual Report 2016 AUDIT COMMITTEE REPORT

Financial reporting: key areas of focus

Key issues Matters considered Outcome

Indications of impairment of

the carrying values of intangible

assets in Civil Aerospace

The assessments of the value-in-use

of the principal intangible assets,

including the key assumptions and

estimates on which they are based.*

We are satisfied that there were no indications of impairment.

The estimates used in accounting

for long-term contractual

arrangements in Civil Aerospace are

appropriate

The basis on which the estimates

are prepared and, in particular,

how the inherent uncertainties are

reflected in these estimates.

In particular:

• Lifecycle cost improvements.

• Long-term exchange rates.

We are satisfied that the process produces balanced estimates,

with appropriate consideration of the uncertainties.

The Civil Aerospace business continued to review the estimates

and compare them to the actual outcome. Based on this actual

experience, which was generally better than previously assumed,

this led to a revision to the estimates, which resulted in a net profit

benefit of £90m.

The estimates for long-term exchange rates were reviewed against

third-party forecasts. This led to a reduction in these forecasts,

resulting in a one-off profit benefit of £35m.

The sale of engines to joint ventures The basis for assessing the selling price. We are satisfied that the price represents the fair value

of the engines.

Impairment of goodwill in Marine The forecasts for each of the relevant

cash generating units, including the key

assumptions on which they are based.*

We are satisfied with the analysis and that impairments should

be recognised where these did not support the carrying value

of the goodwill.

Whether there is any impairment

to the carrying value of the goodwill

in Rolls-Royce Power Systems AG

The business plan and the underlying

assumptions on which it is based.*

We are satisfied that, although the headroom has reduced as

a result of the current trading environment, there is no indication

of impairment.

Warranty and contractual

provisions in Marine

The basis for specific warranty and

contractual provisions.

We are satisfied that the estimates reflect a balanced assessment

of the likely outcome.

Post-retirement benets The impact of the restructuring

of the five UK defined benefit schemes.

We are satisfied that the impacts are reflected in accordance

with IAS 19 Employee Benefits, in particular their recognition in the

Income Statement and Other Comprehensive Income.

We were also satisfied that the exclusion of the settlement and

related costs of £306m from the underlying results is appropriate

(see page 157).

Deferred tax assets (DTAs) The recognition of DTAs arising from

tax losses in the UK and Norway.

Based on the Group’s forecasts, we are satisfied that it is appropriate

to continue to recognise the UK DTAs, and that, given the current

uncertainty in the oil & gas market, those in Norway should cease

to be recognised.

* See note 9 to the financial statements for further details of the assumptions.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT AUDIT COMMITTEE REPORT

Sector audit committees

In support of our work, each of the Group’s businesses and principal

functions has its own sector audit committee, each of which

comprises senior finance personnel and is attended by business

and functional leaders and KPMG. Thesecommittees:

• Allow the review of accounting policies and their consistent

application, risk management, internal systems and issues arising

at a more detailed level.

• Give us further assurance as to the extent of management

control and accountability.

• Promote the governance culture within the Group.

• Inform areas for further consideration at our meetings.

All the committees meet twice a year to consider the accounting

policies, judgements and estimates and the internal control

environment. They are chaired by the Director of Internal Audit,

who then reports to us. During the year, both Irene Dorner and I

attended sector audit committee meetings.

In 2016, the sector audit committees have focused on the improvement

project for internal control and risk management processes.

Risk and control environment

Assessment of principal risks

Risk management is a fundamental and integral part of how we

work. All risks are managed through a risk management system

(RMS) (described on page 48) in accordance with policies and

guidance established by the Director of Risk and his team and

approved by the Board.

Judgement is required in evaluating the risks facing the Group in

achieving its objectives, in determining the risks that are considered

acceptable, in determining the likelihood of those risks materialising,

inidentifying the Group’s ability to reduce the incidence and impact

onthe business of risks that do materialise, and in ensuring the costs of

operating particular controls are proportionate to the benefit provided.

On behalf of the Board, we monitored the RMS. During 2016, we

focused on the continued implementation of the enhancements

identified in 2015. These are described in more detail on page 48.

This process and the principal risks arising (see page 50) then

formed the basis for our assessment of the going concern and

viability statements which are discussed later in this report.

The processes are designed to identify and manage, rather than

eliminate, the risk of failure to achieve our business objectives.

We satisfied ourselves that the processes for identifying and

managing the principal risks are appropriate and that all risks and

mitigating actions had been subject, during the year, to a detailed

review by the Board or an appropriate committee. Based on this

and on our other activities, including consideration of the work

of internal and external audit and presentations from senior

management of each business which include risk management,

we reported to the Board that a robust assessment of the

principal risks facing the Company had been undertaken.

Review of principal risks

We considered in detail the principal risks that have been allocated

to us by the Board. We reviewed:

Business continuity

• The generic design of the Civil Aerospace supply chain and the risks

that arise due to constraints (such as single sources of supply).

• The management of these risks using business continuity

processes and controls.

• Improvements planned to enhance the visibility of key risks.

IT vulnerability

• The changing threat landscape (in particular the Nation State

threat has diminished, but there has been an increase in targeting

of supply chain, joint ventures and other partners, and a very

significant increase in organised crime threats).

• How the principal risks are being tracked and managed.

• Improvement activities over the past year.

• Plans for the future.

Market and financial shock

• The Group’s exposure to market risks (in particular: exchange

rates, oil prices, interest rates, liquidity, credit risk reductions in

air travel or other disruption to customers’ operations).

• The Group’s policies, procedures and controls for identifying,

managing and mitigating these risks, in particular through the

Financial Risk Committee which meets quarterly, chaired by the

Chief Financial Officer.

We are satisfied that appropriate procedures are in place to monitor

and manage these risks.

Internal control

The Board has overall responsibility to the shareholders for the

Group’s system of internal control over its business and risk

management processes and the risks identified through the risk

management process. The Committee has responsibility for

reviewing the system’s operation and effectiveness.

The Group has a long-standing process for identifying risks and

planning mitigating actions and for assessing the effectiveness of

internal control. In assessing the Code requirements in 2015, the

Group identified improvements to the existing processes. In 2016,

the implementation of these improvements has continued. Our

model for representing the system comprises:

• Entity-level controls covering leadership and direction from the top.

• Specific control activities, covering detailed process controls, and

internal and external assurance activities.

In 2016, the Group issued a governance framework providing an

overview of how internal control frameworks to manage risk in key

business activities are established. This gives a framework for the

entity-level controls. The Group has continued to document and

assess the effectiveness of core financial controls, and we routinely

review controls over the Group’s principal risks, and the key risks

and critical processes in each of the Group’s businesses. Both the

sector audit committees and this Committee also consider KPMG’s

observations on the Group’s control environment. We noted a

general improvement in the control environment, including the

ongoing improvements to the controls around the accounting for

long-term aftermarket contracts in Civil Aerospace referred to in

the Independent auditor’s report on pages 177 and 178.

Rolls-Royce Holdings plc Annual Report 2016 AUDIT COMMITTEE REPORT

The Group has also used the internal control framework as an

opportunity to improve the consistency of reporting, in particular

fromthe Group’s smaller operations. We paid particular attention

to internal controls over financial reporting and have implemented

a wide-ranging plan to improve controls in this area.

We have conducted a review of the effectiveness of the Group’s

systems of risk management and internal control, including those

relating to the financial reporting process, in accordance with the

Code. The Group’s systems of risk management and internal control

have been in place throughout 2016. We consider that these existing

systems, together with the enhancements made in 2016, are

sufficient to meet the requirements of the Code and the FCA’s

Disclosure Guidance and Transparency Rules.

Going concern and viability statements

We reviewed the processes and assumptions underlying the

statements set out on page 53. In particular, we considered:

• The Group’s forecast funding position over the next five years.

• An analysis of impacts of severe but plausible risk scenarios,

ensuring that these were consistent with the risks reviewed by

the Board as part of its strategy review.

• The impact of multiple risks occurring simultaneously.

• Additional mitigating actions that Group could take in extreme

circumstances.

• The current borrowing facilities in place and the availability

of future facilities.

As a result, we were satisfied that the going concern and viability

statements have been prepared on an appropriate basis.

Internal audit

We receive a quarterly dashboard from the Director of Internal

Audit identifying key trends and findings from internal audit

reports, and the resolution of actions agreed. Twice a year, we

review detailed updates of significant findings. In particular,

we review the nature andnumber of issues raised by internal

audit and the time to complete the related actions. The small

number of overdue actions received particular attention and the

time to complete all actions has reduced, and is now in line with

expectations. In November, we reviewed and approved the internal

audit plan. I am confident that the plan is strongly correlated to the

key risks facing the business, and we monitor changes during the

course of the year.

We also receive two reports each year setting out the Director of

Internal Audit’s perspectives on the internal control environment.

These are used to drive management responses to underlying root

causes and systemic issues. Topics discussed in 2016 included:

process and control design; compliance to process; data integrity;

and management behaviours.

The Committee considered and reviewed the effectiveness

of the Group’s internal audit function, including resources, plans

and performance as well as the function’s interaction with

management. The outcome of the 2016 review was positive

and identified opportunities for ongoing improvement which

have been implemented.

I meet the Director of Internal Audit privately before each meeting

and on an ad-hoc basis throughout the year, as do other members

of the Committee. As a whole we have a private meeting with him

at least once a year. These discussions cover the activities, findings,

resolution of control weaknesses, progress against the agreed plan

and the resourcing of the department.

We are satisfied that the scope, extent and effectiveness of internal

audit work are appropriate for the Group and that there is a sound

plan for ensuring that this continues to be the case as our business

progresses and risks change.

External audit

2016 audit

During the year, KPMG presented the audit strategy, which

identified their assessment of the key audit risks and the proposed

scope of audit work. We agreed the approach and scope of audit

work to be undertaken. Key risks and the audit approach to these

risks are discussed in the Independent auditor’s report (pages 176

to 182), which also highlights the other significant risks that KPMG

drew to our attention.

As part of the reporting of the half-year and full-year results, in July

2016 and February 2017, KPMG reported to the Committee on its

assessment of the Group’s judgements and estimates in respect of

these risks and the adequacy of the reporting. KPMG also reported

on its assessment of the Group’s control environment.

We also undertook an assessment of KPMG’s qualifications,

expertise and resources, independence and the effectiveness of the

external audit process. This included:

• A presentation to the Committee of KPMG’s Quality Control

Framework and Internal Quality Evaluation, the experience of the

key members of the audit team and the extent of their individual

involvement in the audit work. This also included KPMG’s

responses to matters identified by management in a survey

conducted following the 2015 audit.

• Consideration of the FRC’s Audit Quality Inspection (AQI) Annual

Report 2015/16 on KPMG.

• The results of the AQI review of KPMG’s audit of Rolls-Royce. The

FRC’s Audit Quality Review (AQR) team monitors the quality of audit

work of UK audit firms, including inspections of a sample of audits.

During 2016, the AQR reviewed the 2015 audit. The review findings

noted limited areas for improvement and commended KPMG on the

particularly high standard of its auditor’s report. We have discussed

these findings with the AQR and KPMG; KPMG’s responses to the

areas for improvement were incorporated into the 2016 audit work.

The Committee does not consider any of the findings to have a

significant impact on KPMG’s audit approach. We also reviewed the

fees of the external auditor. Our conclusions were that the external

audit was carried out effectively, efficiently and with the necessary

objectivity and independence.

We continue to support the extended auditor’s report and KPMG’s

approach which goes beyond the minimum requirements,

providing additional clarity on the key judgements and estimates.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT AUDIT COMMITTEE REPORT

I meet with the lead partner prior to each meeting and the whole

Committee has a private meeting with KPMG at least once a year.

Re-appointment of KPMG

The Committee reviews and makes recommendations to the Board

with regard to the re-appointment of the external auditor. In doing

so, we take into account auditor independence and audit partner

rotation. KPMG was appointed as auditor in 1990. No contractual

obligations restrict our choice of external auditor. The lead audit

partner is required to rotate every five years and other key audit

partners are required to rotate every seven years. Jimmy Daboo

tookover as lead audit partner in 2013, and will be required to

rotate after the 2018 AGM. For the first time since KPMG’s

appointment, in 2016, we have tendered the audit for appointment

in 2018, coinciding with Jimmy Daboo’s rotation.

The Committee and the Board have recommended KPMG’s

re-appointment at the 2017 AGM.

Non-audit services provided by KPMG

In order to safeguard the auditor’s independence and objectivity,

wedo not engage KPMG for any non-audit services except where it

is work that they must, or are clearly best suited to, perform. Fees

paid to KPMG for audit, audit-related and other services are set out

in note 8 to the Financial Statements and summarised below.

All proposed services must be pre-approved in accordance with the

non-audit services policy which is reviewed and approved annually.

Above defined levels, my pre-approval is required. The Committee

also reviews the non-audit fees charged by KPMG quarterly.

Non-audit related fees paid to KPMG during the year were 12%

(2015:29%) of the audit fee. Our annual review of the external auditor

takes into account the nature and level of all services provided.

2016 2015

£m % £m %

Audit 6.8 5.9

Audit-related

0.6 9 1.3 22

Tax compliance 0.5 7 0.4 7

Other 0.1 1 – –

Non-audit 1.2 17 1.7 29

Includes £0.3m for the review of the half-year report.

Based on our review of the services provided by KPMG and

discussion with the lead audit partner, we concluded that neither

the nature nor the scale of these services gave any concerns

regarding the objectivity or independence of KPMG.

As part of the EU audit reform, with effect from 1 January 2017,

theFRC’s Ethical Standard places further restrictions on auditors

undertaking non-audit services. Accordingly, we have revised our

policies for the engagement of the auditor to undertake non-audit

services, broadly limiting these to audit-related services such as

reporting to lenders and grant providers.

During the audit tender process, we also implemented additional

procedures to monitor engagements with each potential future

auditor to ensure that we can discontinue or transition any

engagements with the new auditor as required.

Audit tender

As reported last year, we are required to appoint a new auditor no

later than 2020. As planned, we tendered the audit in 2016, for the

appointment of a new external auditor for the financial year 2018.

The process was led by an audit tender steering group (comprising

the Committee members, the Chief Financial Officer and the

Director of Internal Audit and supported by Group Finance and

Purchasing), which met six times from May until November.

We issued a request for proposal in August 2016 to suitable,

appropriately experienced candidates to participate in the tender.

The process included: provision of data on the Group operations,

finances and processes; meetings with key management from the

businesses and Group functions and two presentations to the

Committee. In December, the Committee concluded that PwC was

the preferred firm to conduct the audit engagement, judged

against the selection criteria including quality of the proposed

team, experience within the aerospace and defence industry, and

available resources and organisation.

The Committee recommended that the Board propose, to the

2018AGM, the appointment of PwC as the external auditor of the

Company for the financial year 2018. On behalf of the Committee,

Iwould like to thank all the candidates for the quality and

professionalism of their proposals.

The Committee considers that the Company has, throughout the

year ended 31 December 2016, complied with The Statutory Audit

Services for Large Companies Market Investigation (Mandatory Use

of Competitive Tender Processes and Audit Committee

Responsibilities) Order 2014.

Looking forward

During 2017, we will monitor the transition activities so that PwC

can take over the audit in 2018 in a seamless manner.

We will also continue to monitor:

• The implementation of IFRS 15, focusing on the development of

the supporting processes and controls.

• The key accounting judgements and estimates.

• The continuous improvements planned for the documentation of

controls.

• The continuing development of the management information

systems and improvements to the underlying systems and tools.

IFRS 16 Leases will be applicable to the Group in 2019. The Group will

address its implementation during 2017, and we will review the

development of these plans.

In addition to the continuing oversight by the Safety & Ethics

Committee of the Company’s ethics and compliance programme

(see pages 105 and 106), we will monitor the Group’s actions relating

to risk management, internal controls and other matters relevant

to the Committee that arise out of Lord Gold’s recommendations,

and from the agreements with prosecuting authorities.

Lewis Booth

Chairman of the Audit Committee

Rolls-Royce Holdings plc Annual Report 2016 SAFETY & ETHICS COMMITTEE REPORT

Safety & Ethics

Committee report

Sir Frank Chapman

Chairman of the

Safety & Ethics

Committee

2016 overview

Introduction

The Committee assists the Board in fulfilling

its oversight responsibilities in respect of

safety and ethics matters, which include:

Product safety.

HS&E (occupational health, process

safety, asset integrity, personal security

and the environment).

Sustainability.

Ethics (business ethics, anti-bribery and

corruption, data privacy and export

controls compliance).

The Committee has been allocated

responsibility on behalf of the Board for

overseeing the Group’s principal risks of

product failure and compliance (see pages

50 and 52). These topics form a core part of

discussions at our meetings.

In addition to its oversight role for the Board,

the Committee supports management in its

aim to create, promote and maintain an

ethical, compliant, safety-conscious,

environmentally-aware and socially-

responsible culture across the Group as a

means of delivering its safety and ethics goals.

Principal responsibilities

Under its wide remit, the Committee’s key

responsibilities are:

To maintain an understanding of and

keep under review the Group’s

frameworks for the effective governance

of safety and ethics and the Group’s

culture in these areas.

To oversee and review annually the

Group’s key safety and ethics policies,

including: the Global Code of Conduct,

anti-bribery and corruption and export

controls, product safety, HS&E and

sustainability policies, and ensuring

appropriate independent scrutiny of

policies and practices.

To review compliance with relevant

legislation and regulations and make

recommendations in key policy areas.

To oversee training in respect of safety

and ethics, including ensuring adequate

arrangements exist to enable employees

and contractors to raise concerns in

confidence.

To review reports on issues raised

through the Ethics Line and review the

results of any investigations into ethical

or compliance breaches or allegations of

misconduct.

To review reports on risks in relation to

products not meeting safety

expectations.

To review reports on health and safety

risks and proposed actions to manage

such risks.

To review remedial actions and lessons

learned in relation to material

investigations.

To review disciplinary action taken

following safety and ethics concerns.

To keep under review the key

performance indicators in relation

to safety and ethics.

The Committee regularly reports to the

Board and refers any concerns about

possible financial improprieties to the

Audit Committee. Two of the four members

are also members of the Audit Committee;

this enables strong links to be made

between the oversight of behavioural and

cultural issues, and the detection and

control of the consequential financial risks

and implications.

The Group President, Group Director

– Engineering and Technology, General

Counsel, Director of Risk and other senior

safety and risk executives attend Committee

meetings. Lord Gold attended the

Committee’s meetings in July and

December. More on Lord Gold’s role and his

work is on page 105.

The Committee considered its terms of

reference during the year and proposed

certain revisions for the Board to consider.

This included: the deletion of reference to

oversight of fraud policy, since fraud

prevention and risk management

procedures are reviewed by the Audit

Committee; and minor definitional

amendments to reflect the breadth of topics

overseen by the Committee. The terms of

reference otherwise remained appropriate.

Highlights

Ethics and compliance

improvement programmes

well embedded and reaching

sustainable steady state.

Detailed review of product

safety management in Marine

undertaken, providing good

levels of assurance.

Key safety and ethics Group

policies rolled out to Power

Systems.

Improved score in Dow Jones

Sustainability Index.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT SAFETY & ETHICS COMMITTEE REPORT

At a glance

Area of focus Matters considered Outcome

Ethics and

compliance

Progress with ethics and compliance improvement

programme.

Continuing very good progress made in implementing plans and

Lord Gold’s independent recommendations. Lord Gold relayed his

views to the Committee from his participation in employee focus

groups at various locations during 2016.

Ethics and compliance KPIs established.

Monitoring deployment of anti-bribery and corruption

(ABC) policies.

Global ABC policies adopted and published by Power Systems

after approval by works councils.

Promotion of an ethical culture, and handling of cases

of unethical behaviour.

Employee performance assessments now include review of

behaviours including creating trust and being a positive role

model for ethical behaviour, fairness and integrity.

Review of maturity of ethics and compliance processes

and policies at joint ventures.

Mixed picture highlighting areas where more focus is required to

increase maturity.

Impact of local ethics advisers (LEAs). Met with LEAs to discuss their experiences. Presence of LEAs means

more concerns being raised and dealt with locally.

Use of commercial intermediaries and advisers. Significant reduction in number of commercial intermediaries

and advisers used.

Response to the General Data Protection Regulations. Application made to the Information Commissioner's office for

Binding Corporate Rules.

Product safety Product safety incidents in service and the Group’s

response. Annual review of product safety metrics and

the product failure principal risk dashboard.

Satisfactory response to incidents and support to investigations.

Product failure risk can never be fully mitigated but the Group’s

exposure is well-managed and reducing through better identification

and controls.

Management of personal and product safety risks

during transformation and organisational changes.

The role and impact of culture on product safety.

Consistent, regular messaging from senior leadership and the safety

teams serve to keep safety front of mind to reduce risk. Expected

cultural safety behaviours defined and endorsed. Plans are in place

to drive improvement where gaps identified.

The product safety policy, elements of the product

safety assurance framework and aspects of safety

management systems.

The framework and systems are robust and provide appropriate

governance and accountability.

Workshop on product safety in Marine, followed by

visit to facilities in Norway.

The Marine business has made significant improvements in its

governance of product safety, the maturity of its processes and

the embedding of its safety culture.

Sustainability Consideration of Modern Slavery Act disclosure

requirements, and the mechanism for imposing

assurance requirement on suppliers.

We reviewed and strengthened the policy and processes relating

to human rights and facilitated the disclosure statement that will

be required in 2017.

The Group’s Dow Jones Sustainability Index submission

and results.

Improved score versus 2015 and industry-best scores in several

categories.

Travel security Review of travel security programme. Robust and well-managed arrangements are in place.

Rolls-Royce Holdings plc Annual Report 2016 SAFETY & ETHICS COMMITTEE REPORT

Area of focus Matters considered Outcome

Health,

safety & the

environment

(HS&E)

Review of HS&E risk profile, total reportable injuries

(TRI) performance reports, learning from incidents

and global HS&E improvement programmes.

Risk profile updated to reflect identified risks and their likelihood.

TRI performance improved in all businesses, though remains high

in Power Systems. We reviewed Power Systems’ improvement plan

concluding that it was robust. New standards and procedures on

control of contractors are being implemented and electrical safety

will remain an area of focus.

Review of HS&E governance as adjusted following

removal of the Aerospace and Land & Sea divisions in

January 2016.

Governance changes considered appropriate for new organisational

structure.

Review of HS&E strategy and assurance. We endorsed the HS&E strategy. HS&E assurance methodology

was adapted to improve quality of audits.

Implementation of new HS&E management system. Progress is being made which will facilitate better reporting and

shared learning across the Group.

HS&E learning and development. Strong crossover between product safety and HS&E could be better

exploited. The new human resources system will allow training

requirements to be added to employees’ work plans.

Visit to the Group’s Precision Castings Facility

examining HS&E management of processes.

HS&E methodologies and good practices common with other

facilities were observed.

Ethics and compliance

Ethics and compliance are at the heart of the Group’s culture and

are part of everything that we do at Rolls-Royce. There is continued

recognition that the Board and the ELT must demonstrate

leadership around ethical and behavioural standards. The Board is

determined to ensure that ethical conduct remains embedded in

the culture of the business. The Committee plays a vital role in

providing dedicated focus and attention on behalf of the Board to

this critical area.

Regulatory investigations

Following a lengthy period of investigation into allegations of

bribery and corruption, in January 2017 the Group entered into

deferred prosecution agreements with the UK Serious Fraud Office

and the US Department of Justice, and a leniency agreement with

the Brazilian authority, MPF (together the DPAs). During 2016, the

Committee was kept informed on the ongoing status of the

investigations and developments and discussions with the relevant

authorities. We fully supported and endorsed the Group’s approach

of full and open co-operation with the investigations, for which the

Group was highly praised in the judgment of Lord Justice Leveson.

Lord Gold’s work

Lord Gold, a leading expert on regulatory compliance matters, was

appointed by the Group in 2013 to conduct an independent review

of its ethics and compliance procedures and to provide oversight of

the Group’s ethics and compliance improvement programme, under

which the recommendations contained in his interim reports to the

Company in 2013 and December 2014 have been implemented.

As part of his work, Lord Gold has reviewed the Group’s policies and

procedures, met with many members of management, the ethics

and compliance teams, and a wide range of other employees to gain

an understanding of the extent to which ethics and compliance

awareness and adherence to the Group’s Global Code of Conduct

(Global Code) is embedded in the Group’s culture, and the

robustness of the risk management, controls and assurance

framework that supports this.

Lord Gold is invited to meetings of the Committee, and attended

in July and December 2016. He updated us on his findings and

observations to date, including insights from the latest focus groups

that he held with a range of employees in different businesses

across different countries. We discussed his observations and

identified areas for continued focus. Lord Gold’s latest report was

issued to the Company in January 2017, and will be considered

by the Committee during this year.

Lord Gold will continue his role as an independent specialist in

2017 and beyond, to report on findings and where appropriate

advise and make recommendations to be implemented. His ongoing

oversight is an important factor that led to the investigating

authorities deciding not to appoint their own monitor to oversee

the Group’s adherence to the terms of the DPAs. We welcome

Lord Gold’s ongoing valuable insight and counsel as we maintain

our focus on sustaining a culture of compliance and zero tolerance

for unethical behaviour and misconduct.

Our ethics and compliance programme

Over the last few years the Group has continued to invest significantly

in its ethics and compliance programme. The Committee and the

Group’s management recognise that companies that are run ethically

and have a strong compliance culture are sustainable, enabling

profitable and long-term partnerships with their customers,

suppliers and investors.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT SAFETY & ETHICS COMMITTEE REPORT

We have continued to oversee significant progress in the Group’s

ethics and compliance improvement programme throughout 2016.

Having established the programme, there was increased focus in

2016 on the oversight and assurance of ethics and compliance

issues ensuring that ‘we do what we say we do’.

The size, structure and skills of the risk function were kept under

review during the year with regard to the required resourcing to

deliver and maintain the appropriate level of focus. This included a

restructuring of the Power Systems’ senior ethics and compliance

leadership to allow more central oversight, specialist expertise and

better integration.

Anti-bribery and corruption (ABC) policies

During 2016, the full suite of ABC Group policies, which had been

revised in 2014 and 2015, were rolled out into the Power Systems

business following approval by the local works councils, providing

coverage across the entire Group for the first time.

Since the introduction of the Group’s new adviser policy in 2014, all

advisers engaged by the Group are rigorously vetted through the

Group’s advisers panel, presently comprised of the Director of Risk,

Lord Gold, and a partner from an external law firm. The new adviser

policy has significantly reduced the number of advisers engaged by

the Group including at Power Systems which has a large network of

distributors and is more reliant on the services of third parties to

sell, distribute and support its products, in a similar way to

automotive dealerships. In 2016, the review of Power Systems’

advisers in accordance with the Group adviser policy progressed

well towards completion during 2017.

Ethics Line and local ethics advisers

Ethical questions and concerns that are raised by employees and

other stakeholders are recorded as contacts in the Ethics Line

system, the Group’s confidential reporting helpline. The total

number of Ethics Line contacts marginally decreased in 2016 to 683

(2015: 729 contacts) with the number of ethical concerns discussed

remaining at a similar level to last year at 428 (2015: 439 concerns).

The Ethics Line oversight group continued to review cases, analyse

the contact trends, focus on the root cause of reported cases and

provide updates to the Committee, highlighting any high-risk cases.

We share any concerns about possible improprieties in matters of

financial reporting with the Audit Committee.

In December 2016, the Committee met with some of the Group’s

local ethics advisers (LEAs) to hear from them about their

experiences and engagement with employees on ethics issues. The

LEAs are appointed from the existing workforce, are trained in how

to respond to ethical issues raised, and are in place to promote

speaking up and tackling of ethical issues locally where appropriate

to provide staff with an alternative to using the Ethics Line. At the

end of 2016 there were a total of 80 LEA roles across the Group.

Data privacy

Recognising the importance of data privacy to employees,

customers, suppliers and other stakeholders, the Group is investing

in data privacy compliance by preparing to adopt the Binding

Corporate Rules regime. We were briefed on the implications for the

Group of the rules, which are due to come into force in May 2018,

and reviewed the Group’s plans to ensure compliance with them.

Training

The Committee attaches significant importance to regular, relevant

and focused training and therefore has spent time reviewing the

Group’s ethics and compliance training programme including the

levels of participation and feedback from the 2015 business ethics

training programme. It approved the proposal for the 2016 business

ethics training, built on manager-led group discussions based on

real ethical dilemma scenarios. Annual ethics training is mandatory

for all employees across the Group.

ABC training is mandatory for all employees who have dealings with

persons outside of the Company and focused face-to-face training is

provided to those employees whose roles have higher exposure to

ABC risk. Monthly dilemma-based stories drawn from real cases also

continued to be published on the Group’s intranet during 2016

inviting employees to vote on what action they would take.

Mandatory training programmes will continue in 2017.

Certification

Training

2015 2016

100

ETHICS EMPLOYEE CERTIFICATION AND TRAINING (% OF EMPLOYEES)

,

2015 certification by managers only.

2016 certification excludes Power Systems.

Disciplinary proceedings under the Global Code of Conduct

If an employee is found to have acted in breach of the Global Code, the

Group takes appropriate action to address that breach. That action may

include giving a disciplinary warning, imposing another penalty or,

ultimately, terminating employment in the most serious of cases.

In 2016, there were 38 employees (2015: 33 employees) whose

employment ended for reasons relating to breaches of the Global Code.

An improved investigations protocol was introduced in 2016 to

underpin the Global Code and the suite of ABC Group policies, and to

support faster resolution of issues.

Behavioural expectations linked to performance and reward

In 2016, the Group updated its performance review process so that it

provided an increased focus on behavioural expectations as a core

assessment feature in all employees’ formal performance reviews. The

required behaviours include creating trust and a baseline by which

employees will be recognised and rewarded for acting as a positive

role model for ethical behaviour. From 2016, manager bonuses include

an element based on what objectives managers have achieved and the

behaviours they have demonstrated. The Committee welcomed this

positive step as a means of embedding expectations and maintaining

individuals’ focus.

Rolls-Royce Holdings plc Annual Report 2016 SAFETY & ETHICS COMMITTEE REPORT

Product safety

The Group recognises that its products are critical to its customers,

and the people its customers serve, all over the world. As Rolls-Royce

products become increasingly technologically advanced, they are

expected to always be reliable and safe whenever they are used,

often in harsh operating environments. Our commitment to meet

this expectation is essential to the Group’s business, its reputation

and its sustainability. As a Committee, we draw on our collective

industry and regulatory experience to oversee the Group’s work in

achieving this.

A key theme in 2016 was to ensure that safety of people and

product remained front of mind across the workforce during the

Group’s current period of transformation. We discussed this topic

regularly during the year and reviewed the risk implications for

safety of organisational and role changes, and the lack of focus that

can emerge in times of uncertainty and change. We were pleased to

see that regular and clear communications, including videos from

senior leaders and poster campaigns, were taking place in order to

reinforce these messages.

We discussed and endorsed a set of expected behaviours that will

promote and strengthen a culture where safety is prevalent. These

behaviours are aligned to many of the expectations and principles

within the Group’s values, the Global Code of Conduct and the

product safety Group policy, as well as features of the Group’s high

performance culture training. Assessments against the expected

behaviours have led to plans for targeted improvements.

Again this year, the Committee received detailed briefings in

relation to further elements of the product safety assurance

framework and safety management system. In February 2016, we

reviewed the work of the product safety process council that was

completed in 2015 and its plans for 2016. This body is responsible for

the definition and implementation of product safety processes,

process effectiveness, compliance, governance of improvements,

development and training, and sharing of knowledge and best

practice in the area of product safety within the Group. We also

considered the role of external learning and regulation in product

safety. We concluded that the framework and system remain robust

and provide appropriate governance and accountability.

Rolls-Royce recognises in its product safety Group policy, reviewed

annually by the Committee, that robust quality is an essential

building block of product safety. In 2016, we looked at the increasing

role of product quality planning which links the ‘design’ and ‘make’

parts of product safety. We also reviewed product conformity

performance metrics which showed that process compliance, as

indicated by audit findings, is improving. We conducted a review of

the product safety training programme, and considered how the

Group manages the competency of its purchasing function given

the high proportion of components produced in the supply chain.

Throughout the year, we were kept regularly updated on product-

related safety incidents in service and considered the potential

impact on the Group and its products. This included the Airbus

A400M crash near Seville, Spain in May 2015, and the Group’s

response to an issue detected on Trent 1000 intermediate pressure

turbine (IPT) blades on All Nippon Airways’ Boeing 787 aircraft.

We also reviewed the learnings from a fire arising in an engine

assembled into an MTU railcar powerpack on a London Midland

diesel locomotive, and had an initial briefing on the grounding

of a vessel in the Scottish Hebrides.

Our work in reviewing incidents in service involved: monitoring

management’s progress in root cause identification; being briefed

on the development and deployment of technical solutions

required; testing the Group’s approach in engaging with affected

operators; and overseeing plans for the timely mitigation and

retirement of any safety risk including through applying lessons

learned back into product design. The Committee was again

satisfied with the Group’s response in swiftly deploying its safety

assessment process to mitigate, control and monitor any potential

product safety risks as they emerged. As well as incidents in service,

we were also assured by seeing examples of eradication of

conformity issues identified between the manufacturing and

assembly phases, through design and build instruction changes.

We conducted our annual review of the product safety metrics used

as a management information indicator of the performance of the

safety management system. This includes trend data on the number

of ‘Red Tops’ raised by each of the Rolls-Royce businesses, which is the

document raised when a safety issue is identified on a product.

We also reviewed the Group’s product failure principal risk

dashboard. Although product failure can never be fully mitigated,

the Group’s approach to risk identification and management,

assurance and controls gave us confidence that the likelihood of

incidents is very low.

During the year, the Committee continued the work started in

2015 to gain a deep understanding of how the product safety

management system is applied in the Marine business. This started

with a half-day workshop in March 2016 with members of the

Marine leadership and product safety teams, where we covered the

applicable legislative and industry regulatory framework, accident

prevention methodology, and each of the detailed product safety

processes that underpin the product safety Group policy.

This provided a good foundation upon which we were able to

examine the maturity of implementation of these processes during

a visit by the Committee members in September to the Group’s

Marine facilities in Ålesund and Ulsteinvik, Norway. We met with

local management and explored the product safety framework and

processes as they apply to design, manufacturing engineering,

production, assembly and testing, operator training, operational

performance monitoring and servicing of some of the business’

core products. It was very valuable to gain an understanding

of the history and development of the business from the local

teams, as well as to see up close the current and planned products

and technology. This helped the Committee to understand better

the journey the business had undertaken to increase the maturity

of product safety governance, and the areas of continued focus

for improvement.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT SAFETY & ETHICS COMMITTEE REPORT

Sustainability

The Committee oversees and helps guide the Group’s approach to

sustainability, as well as monitoring progress towards goals in

this area.

In September, Rolls-Royce once again improved its overall score in

the Dow Jones Sustainability Index (DJSI), remaining listed in the

DJSI World and Europe Indexes and achieving a bronze class award.

We achieved industry best scores for corporate governance,

materiality, product stewardship and human capital development,

and significantly improved our scores in the social reporting and

risk and crisis management categories. This recognition reflects the

Group’s continuing focus on public disclosure and transparency,

with the breadth of the 2016 submission enhanced by the inclusion

of social and HS&E data sets from Power Systems.

The Committee reviewed the Group’s approach and steps being

taken in preparation for the statement required to be made in 2017

under the UK Modern Slavery Act 2015. This statement outlines the

steps the Group has taken to minimise the risk of slavery and human

trafficking taking place in any part of the Group’s supply chain. Our

2016 anti-human trafficking and modern slavery statement is

available at www.rolls-royce.com.

We also discussed the growing importance, underpinned by

developing legislation, on engaging external suppliers on

sustainability issues. The Group’s principal enabler for this is its

Global Supplier Code of Conduct (the Supplier Code), adherence to

which is mandated through contractual terms. In 2016, the Group

focused on embedding sustainability and ethical considerations

into sourcing and supplier selection, on strengthening

understanding and application of the Supplier Code, and on

monitoring compliance with it.

You can read more about the Group’s approach to sustainability

on pages 40 to 45.

Travel security

In July 2016, the Committee reviewed the Group’s programme

and arrangements for ensuring the security of its workforce while

travelling on business and were assured that these were robust

and managed well.

Health, safety and the environment

During the year, we received a number of briefings and

presentations as part of an annual agreed cycle of HS&E topics.

This enables oversight, discussion and year-on-year monitoring

of the Group’s progress on key aspects of its HS&E management,

performance and assurance.

The HS&E strategy and corporate strategic plan were presented to

the Committee, including measures and targets aligned to delivery

of the strategic themes.

In February 2016, the Committee reviewed the 2015 Group HS&E

performance report and a balanced scorecard showing

performance trends against the Group’s published target objectives

on protecting health, preventing injury and reducing environmental

impact. We then looked at in-year progress in June and again in

December. Overall, with recovery improvements to be made in some

areas, performance remained on track towards achievement of the

target objectives (see the Sustainable business section on page 42),

with the exception of our 2020 targets for the total reportable injury

(TRI) rate and for total solid and liquid waste reduction, which

remain challenging. The TRI rate for all our businesses has however

improved. From 2015, the inclusion of Power Systems’ TRI data has

significantly impacted the Group’s overall TRI rate. Extraordinary

effort has been applied to improve Power Systems’ performance in

this area and significant improvements were achieved in 2016, but

there is more to do to drive this to a level matching that of the

remainder of the Group.

0.2

0.4

0.6

0.8

2015

2016 2017 2018 2019 2020

target

TRI RATE (PER  EMPLOYEES)*

Power Systems

Rest of Group

* External assurance over STEM, Energy, GHG and TRI rate data provided by Bureau Veritas.

Seepage 183 for the sustainability assurance statement.

In December, representatives from Power Systems attended the

Committee meeting to report on their HS&E recovery plans based

on implementation of Group standards, policies and processes. We

were assured that the team recognised the need for improvements

and are actively progressing with robust plans, supported by the

central Group HS&E team.

The Committee also oversees the learning from incidents process

that examines root causes of significant and major incidents,

identifies any systemic issues, and defines measures to mitigate

against the risk of similar incidents. We focused on the global

improvement programmes, in particular on electrical safety,

infrastructure integrity and control of contractors which continue

to be higher risk areas for the Group contributing to several serious

incidents in the year. The implementation of new Group-wide

control standards and the continued use of HS&E bulletins are

expected to contribute to better risk identification and hazard and

incident reduction in these and other areas.

The Group’s HS&E experts also provided updates to the Committee

during the year on the HS&E improvement programme for field

services, and on the wellbeing element of the occupational health

strategy. The Committee was satisfied that good progress was

being made on these programmes.

Rolls-Royce Holdings plc Annual Report 2016 SAFETY & ETHICS COMMITTEE REPORT

We conducted an annual review of HS&E governance, which

includes a rolling calendar of executive level reviews. The

governance structure was adapted following the removal of the

Aerospace and Land & Sea divisional structures from the start of

2016. We concluded that this remained satisfactory.

The Committee examined the HS&E Group risk profile twice in the

year, which remained largely stable against the previous reporting

period. We reviewed the steps taken to contain known issues and to

mitigate against the effects of future emerging risks. We were also

briefed on a revised approach to corporate HS&E auditing and

assurance, which had been adapted to make this more focused,

effective and efficient.

The Committee reviewed the overall HS&E learning and

development programme, and were satisfied that a comprehensive

enhancement of the programme through standardised global HS&E

training had been endorsed and was underway. This included

working with a selected training provider to produce new courses

to close identified gaps, as well as making existing modules

available in more languages.

In October, a Group-wide HS&E week was held with all employees

encouraged to take part in activities and discussions, with very

positive feedback having been received.

In December, we received an update on implementation of the

Group’s new HS&E management system, which provides more

capability to support risk identification and reporting. This is being

deployed across all of the businesses.

We also maintained our oversight of the Group’s occupational

health strategy, with further increase in the level of focus and

resources being applied in promoting health risk management,

resilience and wellbeing among the workforce. We are committed to

creating workplaces that enhance the wellbeing of our people. At

the end of 2016, 35% of our sites have achieved a LiveWell Award,

recognising the steps they have taken to create an environment that

supports employee wellbeing, where our people are motivated and

enabled to make healthy choices and lead healthier lives.

100

2015

2016 2017 2018 2019 2020

target

LIVEWELL SITE ACCREDITATION (%)



SEE FURTHER HS&E KPIS ON PAGES  AND 

Looking forward

The Group continues to have a high degree of focus on the

management of product safety, peoples’ health and safety,

environmental, ethics and compliance risks, with constant

improvements being sought. With sustained support from senior

leadership and the central expert teams, there is encouraging

evidence that consideration and awareness of these topics is

becoming ever more a part of everyday life for the Group’s

employees. We observe a growing peer culture of being curious,

speaking up and challenging any potentially unsafe, unhealthy,

unethical or wasteful behaviour. The Committee and I look forward

to supporting and seeing this culture develop in 2017 and beyond.

In particular, the Committee will oversee the implementation of

all outstanding recommendations made by Lord Gold and monitor

compliance with the Group’s obligations under the DPAs.

Sir Frank Chapman

Chairman of the Safety & Ethics Committee

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT SCIENCE & TECHNOLOGY COMMITTEE REPORT

Sir Kevin Smith

Chairman of the

Science & Technology

Committee

Principal responsibilities

The remit of the Committee is to:

Review the strategic direction of the

Group’s research, technology and

development activities.

Provide assurance that significant trends

in science, technology, software and data

are identified and incorporated into

management plans.

Assist the Board in its oversight of major

R&D investment and provide assurance

on its competitiveness and adequacy.

Oversee the effectiveness of key

engineering and technology processes and

operations, including delivery of major

product development and technology

programmes, intellectual property

management and interactions with

professional and academic institutions.

Provide assurance on the identification

and management of key technological risks.

Oversee processes for ensuring effective

resourcing and development of required

technological capability and skills.

Conduct visits to research and

development facilities.

Ensure dialogue with the Group’s

engineering and technology leaders and

employees.

Review industry and scientific benchmark

data and best practices.

Review and consider any other topics or

risks appropriate to the overall remit of

the Committee as delegated by the Board.

The Group President, Director – Engineering

& Technology and other senior engineering

and technology executives attend the

Committee meetings.

Highlights

Review of small modular reactor

nuclear technology.

Review of technology

acquisition process.

Review of Advance3,

UltraFan and MTU Series 5000

programmes.

Visit to University Technology

Centres in Nottingham, UK.

Detailed brieng on

manufacturing R&T strategy

and programme.

Visit to facilities in Indianapolis,

US and Coventry, UK to review

manufacturing technologies.

Science & Technology

Committee report

At a glance

Area of focus Matters considered Outcome

Technology acquisition

process 2016 outcome

How the Group develops and acquires new technology, and the

outcome of the process during 2016.

The technology process was appropriate and

supported the technology development strategy

of the businesses.

Technology deep

dive reviews

The Committee received briefings on key technologies for small

modular reactors (SMRs), and on required manufacturing

capabilities and potential partnerships.

The Group’s core nuclear technologies and potential

partners position it well to address SMR opportunities,

and the Group is focused on developing and deploying

competitive manufacturing solutions.

New product

programme reviews

Status of the Advance3, UltraFan and MTU Series 5000

programmes.

These programmes will bring a step-change in

technology to key products enhancing their efficiency

and effectiveness.

University Technology

Centres (UTCs)

Review of the UTCs’ role in partnering with Rolls-Royce, and tour

of the work of the Gas Turbine Transmission Systems and

Manufacturing Technology UTCs at Nottingham, UK.

The UTC model is highly beneficial in supporting R&D

by leading academics in key technology areas for

improving the Group’s tools and processes and for

application in future products.

Manufacturing

technology

As well as the visit to the Nottingham UTCs, review of

manufacturing technology strategy and development

programme, including visits to facilities in Indianapolis, US and

the Manufacturing Technology Centre at Coventry, UK.

The manufacturing technology strategy and

programme are well defined across the businesses

and there are visible signs of new technologies

starting to be deployed.

Rolls-Royce Holdings plc Annual Report 2016 SCIENCE & TECHNOLOGY COMMITTEE REPORT

2016 overview

Introduction

The Group invests more than £1 billion each year in R&D to enable it

to conceive, design and deliver world-class technology that meets

customers’ current and future needs. The Committee was

established by the Board to provide dedicated focus and support to

this key area of the business especially in helping with the

formulation of strategic direction. It is the aim of the Committee to

provide high-level oversight and assurance of the Group’s scientific

and technological strategy, processes and investments.

Work of the Committee in 2016

In 2016, the Committee focused on deepening our understanding

of some of the Group’s existing and developing core technologies

differentiators and enablers, and on reviewing critical technology

programmes. These technologies help differentiate us from our

competitors and enable us to meet customers’ needs. We covered

technologies deployed inside the Group’s products as well as

technologies that support their design and manufacture.

In May, the Committee undertook a review with the Group’s

experts of the technology capabilities necessary to address SMR

opportunities. The Group has decades of experience in the design

and manufacture of small nuclear-powered propulsion plants for

the UK Royal Navy’s submarine fleet. We also have extensive

knowledge of civil nuclear reactor technology, components and

systems through our instrumentation & controls and nuclear

services businesses. These factors, together with proven expertise

in high-volume, high-tech precision manufacturing through the

aerospace businesses, provide the Group with a very strong and

credible technology proposition. The Committee therefore

supported the Group’s initial investment in progressing the SMR

opportunity as the UK Government considers its future energy

options to meet projected demand.

We received a briefing on the new ‘innovation accelerator’ network

introduced across the Group to engage our people worldwide

enabling them to turn ideas into value-generating activities.

The Committee visited two UTCs at Nottingham, UK. The Group’s

established global network of UTCs enables long-term funded

research as well as close contact with world-class academic

institutions and access to leading talent and innovation in key

engineering and technology disciplines.

We first met with researchers and staff at the Gas Turbine

Transmissions Systems UTC where we were shown some of the

expert work being undertaken in advanced fluid mechanics. This

enables the modelling of fluid flow and heat transfer in complex oil

flows within the gas turbine core and transmissions architectures,

and analysis of the behaviours of seals, shafts, bearings and support

structures in different conditions. This work impacts directly on the

development of new engines in considering material strength and

wear at high temperatures.

We then moved on to the UTC in Manufacturing Technology where

we saw some of the innovative work being undertaken in the fields

of robotic inspection and repair, and in miniature machine tools.

It is easy to see the potential this brings for enabling high-precision

work in restricted space environments such as within engines.

The Committee was hugely impressed by the quality of work

undertaken at the UTCs and the strength of the relationships.

We were also satisfied with arrangements for the protection

and management of intellectual property.

At our meeting in July, we examined progress with the Group’s

research and technology programmes, reviewing the 2016

technology themes and master programmes for each of the Group’s

businesses, and the planned sources of R&T co-funding. We

conducted a review of the key technologies within the Advance and

UltraFan programmes, including the Rolls-Royce Power Gearbox,

which are driving changes to engine architecture and component

technologies to form the core of the next generation of more

efficient Rolls-Royce aero engines. Representatives from Rolls-Royce

Power Systems also briefed us on the core technologies planned for

the new MTU Series 5000 engine programme and the modular

nature of its design.

The Committee endorsed the Group’s critical programmes and will

continue to keep them, and their key contributing technologies,

under review.

The Committee was updated in July on the Group’s technology

strategy and programme in the field of manufacturing technology.

This is an important area as the Group drives operational

improvements in the near-term, as well as positioning the Group

competitively for the future. We were briefed on the activities

undertaken through the Group’s global advanced manufacturing

research centre network, and the particular areas of focus within

each of the Group’s businesses. This helped provide context for the

Committee’s visit in September to some of the Group’s facilities in

Indianapolis, US where we were briefed on advanced technology

across several of the Group’s businesses and programmes.

This included: technology used in the Advance1 engine core

architecture; development by LibertyWorks of engine infrared

suppression technology; a review of CastBond technology which

combines cooling and manufacturing techniques; and a briefing on

the Group’s investment in ceramic matrix composites (CMC) in

Cypress, California to serve as a dedicated centre for CMC R&D to

support the development of next-generation turbine materials.

During this visit, we also received briefings on advanced methods to

reduce cost and shorten schedules for development programmes,

and on repair technologies that decrease lifecycle cost and enhance

fleet readiness. The LibertyWorks team provided a briefing on some

of their areas of technology development. This included: engine

infrared signature suppression technology that provides a benefit

to defence customers; integrated power and thermal management;

and other aspects of improving the Group’s electrical capability in

all business sectors. The DARPA VTOL X-Plane project was

highlighted, that will lead to a demonstration of a distributed

turbo-electric powered vertical take-off/landing aircraft.

DIRECTORS’ REPORT

Rolls-Royce Holdings plc Annual Report 2016 DIRECTORS’ REPORT SCIENCE & TECHNOLOGY COMMITTEE REPORT

In December, the Committee visited the Manufacturing Technology

Centre (MTC) at Coventry, UK, the largest of a network of advanced

manufacturing research centres. Here, we saw close up how

advanced technologies, in particular in additive layer

manufacturing and laser welding, are being applied to bring

step-change efficiency improvements to the production process.

We were particularly impressed by the capability of the MTC

personnel, a team of industrially experienced process experts who,

together with the world-class facilities at the MTC, provide fantastic

capability in manufacturing solutions to Rolls-Royce and others.

I was delighted to attend this year’s Rolls-Royce Science Prize finals.

This flagship annual event at the London Science Museum gives

recognition and reward to teachers that have undertaken innovative

work in implementing science teaching ideas in their schools and

colleges across the UK. The passion and enthusiasm of all of the

finalists for their projects was evident, and their achievements in

inspiring the next generation to pursue learning in STEM subjects

in novel and engaging ways were truly deserving of this recognition.

Looking forward

The Committee will continue to support management in overseeing

the Group’s technology strategy and its response to emerging

technology risks and opportunities. In December 2016, the Committee

was allocated responsibility for overseeing management of the

Group’s new principal risk of disruptive technologies and business

models, which we will be examining more in 2017.

Building on the understanding we have developed on the Group’s

technologies and plans, in 2017, the Committee expects to have a

particular focus on how they contribute to sustaining

competitiveness in our key business areas. We will also review the

impact of transformation on our R&T strategy. We are excited by the

possibilities ahead to build on the Group’s strengths and harness new

technologies to create and address future market opportunities.

Sir Kevin Smith

Chairman of the Science & Technology Committee

The Rolls-Royce Science Prize

The Rolls-Royce Science Prize is an annual awards programme

launched in 2004 as part of the Group’s continuing commitment

to science education, designed to foster, recognise and reward

outstanding work in science and maths teaching. It promotes

innovative and sustainable strategies for teaching science and

at the same time contributes to teachers’ continuing

professional development. Since its launch, over £1,250,000 of

prize money has been awarded to over 550 schools.

Rolls-Royce works with the National STEM Learning Centre and

Network, The National Centre for Excellence in Teaching

Mathematics (NCETM) and the Institute of Mathematics and its

Applications (IMA) to invite teachers, technicians and teaching

assistants throughout the UK to submit a proposal for any

science, or combined maths and science, project that meets a

need in their school or college.

Up to 60 special merit awards of £1,000 are awarded by

Rolls-Royce to selected schools that have submitted proposals of

a very high standard. From these shortlisted schools up to six

finalists receive an additional £5,000 from Rolls-Royce to

develop and enhance their projects. Finalists are lent a video

camera which records their progress and are aligned to a

Rolls-Royce STEM Ambassador mentor to support them through

to successful project completion.

The winning entrant is announced at an annual awards

ceremony held at the London Science Museum, and the school

receives a prize of £10,000. You can read about the 2016

finalists and their projects on the Group’s website

www.rolls-royce.com.

Rolls-Royce Holdings plc Annual Report 2016 RESPONSIBILITY STATEMENTS

Responsibility statements

STATEMENT OF DIRECTORS’ RESPONSIBILITIES IN RESPECT

OFTHEANNUAL REPORT AND THE FINANCIAL STATEMENTS

The Directors, as listed on pages 54 to 57, are responsible

for preparing the Annual Report and the Group and parent

company financial statements in accordance with applicable

law and regulations.

Company law requires the Directors to prepare Group and parent

company financial statements for each financial year. Under that

law they are required to prepare the Group financial statements

in accordance with IFRS as adopted by the EU and applicable law

and have elected to prepare the parent company financial

statements in accordance with UK Accounting Standards and

applicable law.

Under company law, the Directors must not approve the financial

statements unless they are satisfied that they give a true and fair

view of the state of affairs of the Group and parent company and

oftheir profit or loss for that period.

In preparing each of the Group and parent company financial

statements, the Directors are required to:

• Select suitable accounting policies and then apply them

consistently.

• Make judgements and estimates that are reasonable and

prudent.

• For the Group financial statements, state whether they have been

prepared in accordance with IFRS as adopted by the EU.

• For the parent company financial statements, state whether

applicable UK Accounting Standards have been followed, subject

to any material departures disclosed and explained in the parent

company financial statements.

• Prepare the financial statements on the going concern basis

unless it is inappropriate to presume that the Group and the

parent company will continue in business.

The Directors are responsible for keeping adequate accounting

records that are sufficient to show and explain the parent and

Group’s transactions and disclose with reasonable accuracy at any

time the financial position of the parent company and enable them

to ensure that its financial statements comply with the Companies

Act 2006. They have general responsibility for taking such steps as

are reasonably open to them to safeguard the assets of the Group

and to prevent and detect fraud and other irregularities.

Under applicable law and regulations, the Directors are also

responsible for preparing a Directors’ report, Directors’

remuneration report and Corporate governance statement

thatcomplies with that law and those regulations.

The Directors are responsible for the maintenance and integrity

ofthe corporate and financial information included on the Group’s

website. Legislation in the UK governing the preparation and

dissemination of financial statements may differ from legislation

inother jurisdictions.

RESPONSIBILITY STATEMENTS UNDER THE DISCLOSURE GUIDANCE

ANDTRANSPARENCY RULES

Each of the persons who is a Director at the date of approval of this

report confirms that to the best of his or her knowledge:

• Each of the Group and parent company financial statements,

prepared in accordance with IFRS and UK Accounting Standards

respectively, gives a true and fair view of the assets, liabilities,

financial position and profit or loss of the Company and the

undertakings included in the consolidation taken as a whole.

• The Strategic report on pages 2 to 53 and Directors’ Report

onpages 54 to 113 and pages 186 to 189 include a fair review

ofthe development and performance of the business and the

position of the Company and the undertakings included in

theconsolidation taken as a whole, together with a description

ofthe principal risks and uncertainties that they face.

• The Annual Report, taken as a whole, is fair, balanced and

understandable and provides the information necessary for

shareholders to assess the Group’s position and performance,

business model and strategy.

By order of the Board

Pamela Coles

Company Secretary

13 February 2017

DIRECTORS’ REPORT

Financial

statements

CONSOLIDATED FINANCIAL STATEMENTS

Consolidated income statement 115

Consolidated statement

of comprehensive income 116

Consolidated balance sheet 117

Consolidated cash ow statement 118

Consolidated statement

of changes in equity 120

Notes to the consolidated

nancial statements 121

1 Accounting policies 121

2 Segmental analysis 131

3 Research and development 136

4 Net nancing 136

5 Taxation 137

6 Earnings per ordinary share 139

7 Employee information 139

8 Auditors’ remuneration 140

9 Intangible assets 140

10 Property, plant and equipment 143

11 Investments 144

12 Inventories 146

13 Trade and other receivables 146

14 Cash and cash equivalents 147

15 Borrowings 147

16 Trade and other payables 147

17 Financial instruments 148

18 Provisions for liabilities

and charges 156

19 Post-retirement benets 157

20 Share capital 161

21 Share-based payments 161

22 Leases 162

23 Contingent liabilities 163

24 Related party transactions 164

25 Acquisitions and disposals 164

26 Derivation of summary funds

ow statement 165

COMPANY FINANCIAL STATEMENTS

Company balance sheet 167

Company statement of changes in equity 167

Notes to the Company

nancial statements 168

1 Accounting policies 168

2 Investments –

subsidiary undertakings 168

3 Financial liabilities 168

4 Share capital 169

5 Contingent liabilities 169

6 Other Information 169

Rolls-Royce Holdings plc Annual Report 2016

FINANCIAL STATEMENTS

Consolidated income statement

For the year ended 31 December 2016

Notes

2016

£m

2015

£m

Revenue 2 14,955 13,725

Cost of sales (11,907) (10,448)

Gross profit 3,048 3,277

Other operating income 5 10

Commercial and administrative costs

(2,208) (1,070)

Research and development costs

3 (918) (818)

Share of results of joint ventures and associates 11 117 100

Operating profit 44 1,499

(Loss)/profit on disposal of businesses (3) 2

Profit before financing and taxation

2 41 1,501

Financing income

4 96 115

Financing costs

4 (4,773) (1,456)

Net financing (4,677) (1,341)

(Loss)/profit before taxation

(4,636) 160

Taxation

5 604 (76)

(Loss)/profit for the year (4,032) 84

Attributable to:

Ordinary shareholders (4,032) 83

Non-controlling interests – 1

(Loss)/profit for the year (4,032) 84

Earnings per ordinary share attributable to ordinary shareholders:

Basic (220.08)p 4.51p

Diluted (220.08)p 4.48p

Payments to ordinary shareholders in respect of the year:

Per share 11.70p 16.37p

Total 215 301

Underlying profit before taxation 2 813 1,432

2015 figures have been restated as a result of £11m of Power Systems costs previously reported in ‘cost of sales’, being reclassified as ‘commercial and administrative costs’ to ensure

consistent treatment with 2016. The applicable notes have also been restated.

In 2016, ‘commercial and administrative costs’ include £671m for financial penalties from agreements with investigating bodies (see note 23) and £306m for the restructuring of the

UK pension schemes (see note 19).

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Consolidated statement of comprehensive income

For the year ended 31 December 2016

Notes

2016

£m

2015

£m

(Loss)/profit for the year (4,032) 84

Other comprehensive income (OCI)

Movements in post-retirement schemes

19 495 (722)

Share of OCI of joint ventures and associates

11 (2) –

Related tax movements 5 (179) 257

Items that will not be reclassified to profit or loss 314 (465)

Foreign exchange translation differences on foreign operations 861 (129)

Reclassified to income statement on disposal of businesses – 1

Share of OCI of joint ventures and associates

11 (7) (19)

Related tax movements

5 4 (2)

Items that may be reclassified to profit or loss 858 (149)

Total comprehensive income for the year (2,860) (530)

Attributable to:

Ordinary shareholders (2,860) (530)

Non-controlling interests – –

Total comprehensive income for the year (2,860) (530)

Rolls-Royce Holdings plc Annual Report 2016

FINANCIAL STATEMENTS CONSOLIDATED

Notes

2016

£m

2015

£m

ASSETS

Intangible assets

9 5,080 4,645

Property, plant and equipment

10 4,114 3,490

Investments – joint ventures and associates

11 844 576

Investments – other 11 38 33

Other financial assets

17 382 83

Deferred tax assets

5 876 318

Post-retirement scheme surpluses

19 1,346 1,063

Non-current assets 12,680 10,208

Inventories

12 3,086 2,637

Trade and other receivables

13 6,956 6,244

Taxation recoverable 32 23

Other financial assets

17 5 29

Short-term investments 3 2

Cash and cash equivalents

14 2,771 3,176

Assets held for sale 5 5

Current assets 12,858 12,116

TOTAL ASSETS 25,538 22,324

LIABILITIES

Borrowings

15 (172) (419)

Other financial liabilities 17 (651) (331)

Trade and other payables

16 (7,957) (6,923)

Current tax liabilities (211) (164)

Provisions for liabilities and charges

18 (543) (336)

Current liabilities (9,534) (8,173)

Borrowings

15 (3,185) (2,883)

Other financial liabilities

17 (5,129) (1,651)

Trade and other payables

16 (3,459) (2,317)

Non-current tax liabilities – (1)

Deferred tax liabilities

5 (776) (839)

Provisions for liabilities and charges

18 (216) (304)

Post-retirement scheme deficits

19 (1,375) (1,140)

Non-current liabilities (14,140) (9,135)

TOTAL LIABILITIES (23,674) (17,308)

NET ASSETS 1,864 5,016

EQUITY

Called-up share capital

20 367 367

Share premium account 181 180

Capital redemption reserve 162 161

Cash flow hedging reserve (107) (100)

Other reserves 814 (51)

Retained earnings 445 4,457

Equity attributable to ordinary shareholders 1,862 5,014

Non-controlling interests 2 2

TOTAL EQUITY 1,864 5,016

The financial statements on pages 115 to 166 were approved by the Board on 13 February 2017 and signed on its behalf by:

WARREN EAST DAVID SMITH

Chief Executive Chief Financial Officer

Consolidated balance sheet

At 31 December 2016

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Consolidated cash flow statement

For the year ended 31 December 2016

Notes

2016

£m

2015

£m

Operating profit 44 1,499

Loss on disposal of property, plant and equipment 5 8

Share of results of joint ventures and associates

11 (117) (100)

Dividends received from joint ventures and associates

11 74 63

Amortisation and impairment of intangible assets

9 628 432

Depreciation and impairment of property, plant and equipment 10 426 378

Impairment of investments

11 – 2

Increase/(decrease) in provisions 44 (151)

(Increase)/decrease in inventories (161) 63

Decrease/(increase) in trade and other receivables 54 (836)

Accruals for financial penalties from agreements with investigating bodies 671 –

Other increase in trade and other payables 234 242

Cash flows on other financial assets and liabilities held for operating purposes (608) (305)

Net defined benefit post-retirement cost recognised in profit before financing

19 510 213

Cash funding of defined benefit post-retirement schemes 19 (271) (259)

Share-based payments

21 35 5

Net cash inflow from operating activities before taxation 1,568 1,254

Taxation paid (157) (160)

Net cash inflow from operating activities 1,411 1,094

Cash flows from investing activities

Additions of unlisted investments

11 – (6)

Additions of intangible assets

9 (631) (408)

Disposals of intangible assets

9 8 4

Purchases of property, plant and equipment (585) (487)

Government grants received 15 8

Disposals of property, plant and equipment 8 33

Acquisitions of businesses

25 (6) (5)

Disposal of discontinued operations – (121)

Disposals of other businesses

25 7 2

Increase in share in joint ventures

11 (154) –

Other investments in joint ventures and associates

11 (30) (15)

Cash and cash equivalents of joint ventures reclassified as joint operations 5 –

Net cash outflow from investing activities (1,363) (995)

Cash flows from financing activities

Repayment of loans (434) (54)

Proceeds from increase in loans and finance leases 93 1,150

Capital element of finance lease payments (4) (1)

Net cash flow from (decrease)/increase in borrowings and finance leases (345) 1,095

Interest received 14 5

Interest paid (84) (58)

Interest element of finance lease payments (2) (2)

(Increase)/decrease in short-term investments (1) 5

Issue of ordinary shares (net of expenses) 1 32

Purchase of ordinary shares – share buyback – (433)

Purchase of ordinary shares – other (21) (2)

Redemption of C Shares (301) (421)

Net cash (outflow)/inflow from financing activities (739) 221

Change in cash and cash equivalents (691) 320

Cash and cash equivalents at 1 January 3,176 2,862

Exchange gains/(losses) on cash and cash equivalents 286 (6)

Cash and cash equivalents at 31 December 2,771 3,176

Rolls-Royce Holdings plc Annual Report 2016

FINANCIAL STATEMENTS CONSOLIDATED

2016

£m

2015

£m

Reconciliation of movements in cash and cash equivalents to movements in net debt

Change in cash and cash equivalents (691) 320

Cash flow from decrease/(increase) in borrowings and finance leases 345 (1,095)

Cash flow from increase/(decrease) in short-term investments 1 (5)

Change in net debt resulting from cash flows (345) (780)

Net debt (excluding cash and cash equivalents) of joint ventures reclassified as joint operations (9) –

Exchange gains on net debt 240 3

Fair value adjustments (345) 45

Movement in net debt (459) (732)

Net debt at 1 January excluding the fair value of swaps (124) 608

Net debt at 31 December excluding the fair value of swaps (583) (124)

Fair value of swaps hedging fixed rate borrowings 358 13

Net debt at 31 December (225) (111)

The movement in net debt (defined by the Group as including the items shown below) is as follows:

1 January

2016

£m

Funds

flow

£m

Reclassification

of joint ventures

to joint

operations

£m

Exchange

differences

£m

Fair value

adjustments

£m

Reclassifications

£m

31 December

2016

£m

Cash at bank and in hand 662 96 5 109 – – 872

Money-market funds 783 (260) – 29 – – 552

Short-term deposits 1,731 (532) – 148 – – 1,347

Cash and cash equivalents 3,176 (696) 5 286 – – 2,771

Short-term investments 2 1 – – – – 3

Other current borrowings (417) 350 (9) (24) – (69) (169)

Non-current borrowings (2,833) (1) – (11) (345) 69 (3,121)

Finance leases (52) (4) – (11) – –

(67)

Net debt excluding fair value of swaps (124) (350) (4) 240 (345) – (583)

Fair value of swaps hedging fixed rate borrowings 13 345 358

Net debt (111) (350) (4) 240 – – (225)

Consolidated cash flow statement continued

For the year ended 31 December 2016

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Consolidated statement of changes in equity

For the year ended 31 December 2016

Attributable to ordinary shareholders

Non-

controlling

interests

(NCI)

£m

Notes

capital

£m

premium

£m

Capital

redemption

reserve

£m

Cash flow

hedging

reserve

£m

Other

reserves

£m

Retained

earnings

£m

Total

£m

Total

equity

£m

At 1 January 2015

376 179 159 (81) 78 5,671 6,382 5 6,387

Profit for the year – – – – – 83 83 1 84

Foreign exchange translation differences on foreign

operations – – – – (128) – (128) (1) (129)

Reclassified to income statement on disposal

ofbusinesses – – – – 1 – 1 – 1

Movement on post-retirement schemes

19 – – – – – (722) (722) – (722)

Share of other comprehensive income of joint ventures

andassociates

11 – – – (19) – – (19) – (19)

Related tax movements

5 – – – – (2) 257 255 – 255

Total comprehensive income for the year

– – – (19) (129) (382) (530) – (530)

Arising on issues of ordinary shares – 1 – – – – 1 – 1

Issue of C Shares

17 – – (430) – – 2 (428) – (428)

Redemption of C Shares

17 – – 423 – – (423) – – –

Ordinary shares purchased – share buyback

– – – – – (433) (433) – (433)

Ordinary shares cancelled

20 (9) – 9 – – – – – –

Ordinary shares purchased – other – – – – – (2) (2) – (2)

Share-based payments – direct to equity

– – – – – 30 30 – 30

Transactions with NCI – – – – – – – (3) (3)

Related tax movements

5 – – – – – (6) (6) – (6)

Other changes in equity in the year (9) 1 2 – – (832) (838) (3) (841)

At 1 January 2016 367 180 161 (100) (51) 4,457 5,014 2 5,016

Loss for the year – – – – – (4,032) (4,032) – (4,032)

Foreign exchange translation differences on foreign

operations – – – – 861 – 861 – 861

Movement on post-retirement schemes

19 – – – – – 495 495 – 495

Share of other comprehensive income of joint ventures

andassociates

11 – – – (7) – (2) (9) – (9)

Related tax movements

5 – – – – 4 (179) (175) – (175)

Total comprehensive income for the year – – – (7) 865 (3,718) (2,860) – (2,860)

Arising on issues of ordinary shares – 1 – – – – 1 – 1

Issue of C Shares

17 – – (301) – – 1 (300) – (300)

Redemption of C Shares

17 – – 302 – – (302) – – –

Ordinary shares purchased – – – – – (21) (21) – (21)

Share-based payments – direct to equity

– – – – – 30 30 – 30

Related tax movements

5 – – – – – (2) (2) – (2)

Other changes in equity in the year – 1 1 – – (294) (292) – (292)

At 31 December 2016 367 181 162 (107) 814 445 1,862 2 1,864

See accounting policies note 1.

Other reserves include a merger reserve of £3m (2015: £3m, 2014: £3m) and a translation reserve of £811m (2015: £(54)m, 2014: £75m).

At 31 December 2016, 6,854,216 ordinary shares with a net book value of £56m (2015: 5,894,064, 2014: 14,561,097 ordinary shares with net book values of £52m and £129m

respectively) were held for the purpose of share-based payment plans and included in retained earnings. During the year, 1,955,390 ordinary shares with a net book value of £17m

(2015: 10,892,026 shares with a net book value of £98m) vested in share-based payment plans. During the year, the Company acquired 165,542 (2015: 224,993) of its ordinary shares via

reinvestment of dividends received on its own shares and purchased 2,750,000 (2015: 2,000,000) of its ordinary shares through purchases on the London Stock Exchange.

In Rolls-Royce Holdings plc’s own financial statements, C Shares are issued from the merger reserve. As this reserve is eliminated on consolidation, in the consolidated financial

statements, the C Shares are shown as being issued from the capital redemption reserve.

Following the completion of the sale of the Energy business to Siemens on 1 December 2014 and further to the announcement on 19 June 2014 of a £1bn share buyback, the Company

put in place a programme to enable the purchase of its ordinary shares. The aim of the buyback was to reduce the issued share capital of the Company, helping enhance returns

forshareholders. Inthe year to 31 December 2015, 46,016,303 shares were purchased at an average price of 937p. 44,016,303 of these shares were cancelled and 2,000,000 were

retained for use inshare-based payment programmes. On 6 July 2015, the Company announced that the share buyback programme had been curtailed at the to-date total of £500m.

Share-based payments – direct to equity is the net of the credit to equity in respect of the share-based payment charge to the income statement and the actual cost of shares vesting,

excluding those vesting from own shares.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

Notes to the consolidated financial statements

1 Accounting policies

THE COMPANY

Rolls-Royce Holdings plc (the ‘Company’) is a company domiciled in the United Kingdom. The consolidated nancial statements

of the Company for the year ended 31 December 2016 consist of the consolidation of the nancial statements of the Company

and its subsidiaries (together referred to as the ‘Group’) and include the Group’s interest in jointly controlled and associated entities.

BASIS OF PREPARATION AND STATEMENT OF COMPLIANCE

In accordance with European Union (EU) regulations, these nancial statements have been prepared in accordance with International

Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board (IASB), as adopted for use in the EU eﬀective

at 31 December 2016 (Adopted IFRS).

The Company has elected to prepare its individual company nancial statements under FRS 101 Reduced Disclosure Framework. They are

set out on pages 167 to 169 and the accounting policies in respect of Company nancial statements are set out on page 168.

These consolidated nancial statements have been prepared on the historical cost basis except where Adopted IFRS requires the

revaluation of nancial instruments to fair value and certain other assets and liabilities on an alternative basis – most signicantly

post-retirement scheme obligations are valued on the basis required by IAS 19 Employee Benets – and on a going concern basis

as described on page 53.

The consolidated nancial statements are presented in sterling which is the Company’s functional currency.

The preparation of nancial statements in conformity with Adopted IFRS requires management to make judgements and estimates that

aﬀect the reported amounts of assets and liabilities at the date of the nancial statements and the reported amounts of revenues and

expenses during the reporting period. Actual results could diﬀer from those estimates.

KEY AREAS OF JUDGEMENT

Introduction

The Group generates a signicant portion of its revenues and prot on aftermarket arrangements arising from the installed original

equipment (OE) eet. As a consequence, the Group will often agree contractual prices for OE deliveries that take into account the

anticipated aftermarket arrangements. Accounting policies reect this aspect of the business model, in particular thepolicies for

the recognition of contractual aftermarket rights and the linkage of OE and actual aftermarket arrangements.

When a civil large engine is sold, the economic benets received usually far exceed the cash receivable under the contract, due to the

rightsto valuable aftermarket spare parts business. However, because the value of this right cannot be estimated with enough precision,

accounting standards require that the revenue recognised in the accounts on sale of the engine is restricted to a total amount that results

in a break even position. The amount of the revenue recognised in excess of cash receivable is recognised as an intangible asset, which is

called a contractual aftermarket right (CAR).

There is only one circumstance where accounting standards require the recognition of more of the value of the aftermarket rights

whenanengine is sold. This occurs where a long-term aftermarket contract (generally a TotalCare agreement – TCA) and an engine

salecontract have been negotiated together. In this circumstance, the part of the aftermarket rights covered by the TCA can be valued

much more precisely and is recognised at the time of the engine sale through accounting for the engine sale and TCA as a single contract.

Nevertheless, the accounting prot recognised is still less than the economic benets on the sale as there will be other valuable

aftermarket rights (for instance for the period beyond the TCA term or for the sale of parts which are outside the scope of the TCA)

whichcannot be recognised.

The Group enters into arrangements with long-term suppliers to share the risks and rewards of major programmes – risk and revenue

sharing arrangements (RRSAs). The accounting policy for these arrangements has been chosen, consistent with Adopted IFRS, to reect

their commercial eﬀect.

The key judgements in determining these accounting policies are described below.

Contractual aftermarket rights

On delivery of Civil Aerospace engines, the Group has contractual rights to supply aftermarket parts to the customers and its intellectual

rights, warranty arrangements and, where relevant, statutory airworthiness or other regulatory requirements provide reasonable control

over this supply. The Directors consider that these rights meet the denition of an intangible asset in IAS 38 Intangible Assets. However,

the Directors do not consider that it is possible to determine a reliable fair value for this intangible asset. Accordingly, an intangible asset

(CAR) is only recognised on the occasions where the contractual price of the engine is below the cost of manufacture and then only to the

extent of this decit, as this amount is reliably measurable. An equal amount of revenue is recognised at the same point. Where a long-term

aftermarket contract is linked to the OE contract (see page 122), the contractual price of the engine (including amounts allocated from

the aftermarket contract) is above its cost of manufacture; consequently no CAR is recognised.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

1 Accounting policies continued

Measure of performance on long-term aftermarket contracts

A large proportion of the Group’s activities relate to long-term aftermarket contracts, in particular TotalCare and similar arrangements

in Civil Aerospace. Under these contracts, the Group’s primary obligation is to maintain customers’ equipment in an operational condition

and it achieves this by undertaking various activities, such as engine monitoring, line maintenance and repair and overhaul, over the

period of the contract. In general, the Directors consider that the stage of performance of the contract should be by reference to the

obligation to maintain an operational eet and that this is best measured by the operation of the eet. Accordingly, stage of performance

is measured by reference to ying hours of each eet under contract.

Linkage of OE and long-term aftermarket contracts

Where the key terms of a long-term aftermarket contract are substantively agreed (eg. in a term sheet) at the same time as an OE contract

with the operator, the Directors consider these to be linked for accounting purposes and they are treated as a single contract, as this best

reects the overall commercial eﬀect. Where the OE contract is not with the operator, eg. where it is with an OE manufacturer or a lessor,

the contracts are not linked as they were not negotiated on a unied basis.

Sales of spare engines to joint ventures

Whether the sales price reects fair value when the Group sells spare engines to a joint venture company.

Risk and revenue sharing arrangements

RRSAs with key suppliers (workshare partners) are a feature of our Civil Aerospace business. Under these contractual arrangements, the

key commercial objectives are that: (i) during the development phase the workshare partner shares in the risks of developing an engine

by performing its own development work, providing development parts and paying a non-refundable cash entry fee; and (ii) during the

production phase it supplies components in return for a share of the programme revenues as a ‘life of type’ supplier (ie. as long as the

engine remains in service). The share of development costs borne by the workshare partner and of the revenues it receives reect the

partner’s proportionate cost of providing its production parts compared to the overall manufacturing cost of the engine. The share is

based on a jointly-agreed forecast at the commencement of the arrangement.

These arrangements are complex and have features that could be indicative of: a collaboration agreement, including sharing of risk and

cost in a development programme; a long-term supply agreement; sharing of intellectual property; or a combination of these. In summary,

and as described below, the Directors’ view is that the development and production phases of the contract should be considered separately

in accounting for the RRSA, which results in the entry fee being matched against the non-recurring costs incurred by the Group.

Having considered the features above, the Directors consider that there is no directly applicable IFRS to determine an accounting policy for

the recognition of entry fees of this nature in the income statement. Consequently, in developing an accounting treatment for such entry

fees that best reects the commercial objectives of the contractual arrangement, the Directors have analysed these features in the context

of relevant accounting pronouncements (including those of other standard setters where these do not conict with IFRS) and have

weighed the importance of each feature in faithfully representing the overall commercial eﬀect. The most important considerations that

need to be balanced are: the transfer of development risk; the workshare partner receiving little standalone value from the payment of the

entry fee; and the overall eﬀect being collaboration between the parties which falls short of being a joint venture as the Group controls the

programme. Also important in the analysis is the fact that, whilst the Group and the workshare partner share risks and rewards through

the life of the contract, these risks and rewards are very diﬀerent during the development and production phases.

In this context, the entry fee might be considered to represent: an amount paid as an equalisation of development costs; a payment to

secure a long-term supply arrangement; a purchase of intellectual property; or some combination thereof. The accounting under these

diﬀerent scenarios could include: recognition of the entry fee to match the associated costs in the income statement; being spread over

the life of the programme as a reduction in the cost of supply during production; or being spread over the time period of the access to the

intellectual property by the workshare partner.

The Directors consider that the most important features of the arrangement are the risk sharing and that the entry fee represents a

contribution to the development costs that the Group incurs in excess of its proportionate programme share. The key judgements taken in

reaching this view are: the entry fee is determined by the parties on that basis and the contract species that, in the event that a derivative

engine is to be developed, additional entry fees will also be calculated on this basis; the workshare partners describe the entry fee in this

way; although the workshare partner receives little stand-alone value from paying the entry fee, the entry fee together with its own

development activities represent its aggregate investment in the collaboration; the amount of the entry fee does not include any amount

in excess of that necessary to equalise forecast development costs; the Group is not ‘on risk’ for the full development costs it incurs but for

that amount less the entry fees received.

The resulting accounting policy (described on page 125) represents the commercial eﬀect of the contractual arrangements in that the

Group recognises only those development costs to which it is exposed (and thus reects the signicant transfer of development risk to

the workshare partner) and the costs of supply of parts during the production phase is measured at the workshare partner’s share of

programme revenues (which we consider to be a commercial fair value). The Directors do not consider that accounting which would result

in entry fees only being recognised in the production phase would appropriately reect the sharing of development risk. Accordingly, the

Directors believe that the policy adopted best reects the commercial objectives of the arrangements, the nature of the relationship with

the workshare partner and is in accordance with Adopted IFRS.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

1 Accounting policies continued

As described in the 2013 Annual Report, an alternative view is that the RRSA contract cannot be divided into separate development and

production phases, as the fees and development components received by the Group during the development phase are exchanged for

the obligation to pay the supplier a predetermined share of any sales receipts during the production phase. On this basis, the entry fees

received would be deferred in their entirety and recognised over the period of production. The size of the diﬀerence between the two

approaches is monitored and is not currently expected to become material in the foreseeable future. The impact of the diﬀerent

approaches on prot before tax and net assets, which is not considered to be material, is as follows:

2016 2015

Reported

profit before tax

£m

Underlying profit

before tax

£m

Net assets

£m

Reported

profit before tax

£m

Underlying profit

before tax

£m

Net assets

£m

Adopted policy (4,636) 813 1,864 160 1,432 5,016

Difference (2) (2) (442) (28)

(28) (435)

Alternative policy

(4,638) 811 1,422 132 1,404 4,581

If the alternative policy were adopted, the difference would be included in profit before financing, which would change from £41m as reported to £39m (2015: £1,501m to £1,473m).

Internally-generated development costs

IAS 38 requires that internally-generated development costs should only be recognised if strict criteria are met, in particular relating to

technical feasibility and generation of future economic benets. The Directors consider that, due to the complex nature of new equipment

programmes, these criteria are not met until relatively late in the programme – Civil Aerospace programmes represent around half of

development costs recognised; for these, the criteria are generally satised around the time of the initial engine certication.

Customer nancing contingent liabilities

The Group has contingent liabilities in respect of nancing support provided to customers. In order to assess whether a provision should

berecognised, judgement as to the likelihood of these crystallising is required. This judgement is based on an assessment on the knowledge

of the customers’ eet plans, the underlying value of the security provided and, where appropriate, the customers’ creditworthiness.

KEY SOURCES OF ESTIMATION UNCERTAINTY

In applying the accounting policies, estimates are made in many areas; the actual outcome may diﬀer from that calculated. The key sources of

estimation uncertainty at the balance sheet date, that have a signicant risk of causing material adjustment to the carrying amounts of assets

and liabilities within the next nancial year, are set out below. The estimation of the relevant assets and liabilities involves the combination

ofanumber of assumptions. Sensitivities are disclosed in the relevant notes where this is appropriate and practicable.

Forecasts and discount rates

The carrying values of a number of items on the balance sheet are dependent on the estimates of future cash ows arising from the

Group’s operations, in particular:

• The assessment of whether the goodwill (carrying value at 31 December 2016: £1,537m, 31 December 2015:£1,503m) arising on the

consolidation of acquired businesses is impaired is dependent of the present value of the future cash flows expected to be generated

by the business.

• The assessment as to whether there are any indications of impairment of development, participation, certification, customer relationships

andcontractual aftermarket rights recognised as intangible assets (carrying values at 31 December 2016: £2,846m, 31 December 2015:

£2,533m) is dependent on estimates of cash flows generated by the relevant assets and the discount rate used to calculate a present value.

These estimates include the performance of long-term contractual arrangements as described below, as well as estimates for future market

share, pricing and unit cost for uncontracted business. The risk of impairment is generally higher for newer programmes and for customer

specific intangible assets (CARs) for launch customers and typically reduces as programmes become more established.

Assessment of long-term contractual arrangements

The Group has long-term contracts that fall into diﬀerent accounting periods and which can extend over signicant periods – the most

signicant of these are long-term service arrangements in the Civil Aerospace business. The estimated revenues and costs are inherently

imprecise and signicant estimates are required to assess: engine ying hours, time on wing and other operating parameters; the pattern

of future maintenance activity and the costs to be incurred; life-cycle cost improvements over the term of the contracts and escalation of

revenues and costs. The estimates take account of the inherent uncertainties and the risk of non-recovery of any resulting contract

balances. In addition many of the revenues and costs are denominated in currencies other than that of the relevant Group undertaking.

These are translated at an estimated long-term exchange rate, based on historical trends. In 2016, the US dollar long-term exchange rate

was reduced by ve cents, resulting in a one-oﬀ benet to prot before tax of £35m.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

1 Accounting policies continued

Post-retirement benets

The Group’s dened benet pension schemes and similar arrangements are assessed annually in accordance with IAS 19. The accounting

valuation, which is based on assumptions determined with independent actuarial advice, resulted in a net decit of £29m before deferred

taxation being recognised on the balance sheet at 31 December 2016 (31 December 2015: net decit £77m). The size of the net surplus/

decit is sensitive to the market value of the assets held by the schemes and to actuarial assumptions, which include price ination,

pension and salary increases, the discount rate used in assessing actuarial liabilities, mortality and other demographic assumptions and

the levels of contributions. Further details are included in note 19.

Provisions

As described in the accounting policy on page 128, the Group measures provisions (carrying value at 31 December 2016: £759m,

31December 2015: £640m) at the Directors’ best estimate of the expenditure required to settle the obligation at the balance sheet date.

These estimates take account of information available and diﬀerent possible outcomes.

Taxation

The tax payable on prots is determined based on tax laws and regulations that apply in each of the numerous jurisdictions in which the

Group operates. Where the precise impact of these laws and regulations is unclear, or uncertain, then reasonable estimates may be used

todetermine the tax charge included in the nancial statements.

The main area of uncertainty is in relation to cross-border transactions, entered into in the normal course of business, as the amount of

income or prot taxable in each country involved can be subjective and therefore open to interpretation by the relevant tax authorities.

This can result in disputes and possibly litigation.

Tax provisions require management to make judgements and estimates of exposures in relation to tax audit issues and other areas of

uncertainty. Contingent liabilities, including in respect of any tax disputes or litigation, are covered in note 23 (contingent liabilities).

Allprovisions are in current liabilities. Any liability relating to interest or penalties on tax liabilities is included in the tax charge.

Deferred tax assets are recognised to the extent it is probable that future taxable prots will be available, against which the deductible

temporary diﬀerence can be utilised, based on management’s assumptions relating to the amounts and timing of future taxable prots.

Further details on the Group’s tax position can be found on page 184.

SIGNIFICANT ACCOUNTING POLICIES

The Group’s signicant accounting policies are set out below. These accounting policies have been applied consistently to all periods

presented in these consolidated nancial statements and by all Group entities.

Basis of consolidation

The Group consolidated nancial statements include the nancial statements of the Company and its subsidiary undertakings together

with the Group’s share of the results of joint arrangements and associates made up to 31 December. In line with common practice in

Germany, a small number of immaterial subsidiaries of Rolls-Royce Power Systems are not consolidated and are carried at cost in other

investments.

A subsidiary is an entity controlled by the Company. Control exists when the Company has power over an entity, exposure to variable

returns from its involvement with an entity and the ability to use its power over an entity so as to aﬀect the Company’s returns.

A joint arrangement is an entity in which the Group holds a long-term interest and which is jointly controlled by the Group and one or more

other venturers under a contractual arrangement. Joint arrangements may be either joint ventures or joint operations. An associate is an

entity, being neither a subsidiary nor a joint arrangement, in which the Group holds a long-term interest and where the Group has a

signicant inuence. The results of joint ventures and associates are accounted for using the equity method of accounting. Joint operations

are accounted for using proportionate accounting.

During the year, the Group has reassessed the categorisation of joint arrangements. As a result of this review, certain entities, previously

classied as joint ventures, have been reclassied as joint operations from 1 January 2016. This reclassication does not aﬀect prot before

tax or net assets, but the Group’s share of the individual income statement and balance sheet categories are included on a proportional

basis, rather than as a single gure. The adjustment to the opening balance was to reclassify £57m of investments in joint ventures to:

property, plant and equipment (£41m), inventory (£19m), receivables (£18m), cash (£5m), payables (£17m) and borrowings (£9m). Prior year

gures have not been restated.

Any subsidiary undertakings, joint arrangements or associates sold or acquired during the year are included up to, or from, the date

ofchange of control. Transactions with non-controlling interests are recorded directly in equity.

All intra-group transactions, balances, income and expenses are eliminated on consolidation. Adjustments are made to eliminate the

protor loss arising on transactions with joint arrangements and associates to the extent of the Group’s interest in the entity.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

1 Accounting policies continued

Revenue recognition

Revenues comprise sales to outside customers after discounts, excluding value added taxes.

Sales of products (both OE and spare parts) are recognised when the signicant risks and rewards of ownership of the goods aretransferred to

the customer, the sales price agreed and the receipt of payment can be assured – this is generally on delivery. On occasion, theGroup may

participate in the nancing of OE, most commonly by the provision of guarantees as described in note 18. In such circumstances, the contingent

obligations arising under these arrangements are taken into account in assessing when the signicant risks and rewards of ownership have been

transferred to the customer. As described on page 121, a sale of OE at a contractual price below its cost of manufacture isconsidered to give rise

to revenue to the extent that an intangible asset (contractual aftermarket right) is recognised at the same time.

Sales of services are recognised by reference to the stage of completion based on services performed to date. As described on page 122,

the assessment of the stage of completion is dependent on the nature of the contract, but will generally be based on: ying hours or

equivalent for long-term aftermarket arrangements where the service is provided on a continuous basis; costs incurred to the extent these

relate to services performed up to the reporting date; or achievement of contractual milestones where relevant.

As described on page 122, sales of products and services are treated as though they are a single contract where these components have

been negotiated as a single commercial package and are so closely interrelated that they do not operate independently of each other and

are considered to form a single transaction with an overall prot margin. The total revenue is allocated between the two components such

that the total agreed discount to list prices is allocated to revenue for each of the two components pro rata, based on list prices. The

revenue is then recognised for each component on this basis as the products are delivered and services provided, as described above.

Where the contractual price of the OE component is below the revenue allocated from the combined arrangement, this will give rise

toanasset included in ‘amounts recoverable on contracts’. This asset reduces as services are provided, increases as costs are incurred,

andreduces to zero by the end of the contract. Where the balance is a liability, it is recognised in ‘accruals and deferred income’.

Provided that the outcome of construction contracts can be assessed with reasonable certainty, the revenues and costs on such contracts are

recognised based on stage of completion and the overall contract protability. Full provision is made for any estimated losses to completion

ofcontracts, having regard to the overall substance of the arrangements.

Progress payments received, when greater than recorded revenue, are deducted from the value of work in progress except to the extent

that payments on account exceed the value of work in progress on any contract where the excess is included in accruals and deferred

income within trade and other payables. The amount by which recorded revenue of long-term contracts is in excess of payments on

account is classied as amounts recoverable on contracts and is separately disclosed within trade and other receivables.

TotalCare arrangements

As described above, these are accounted for on a stage of completion basis, with the stage of completion based on the proportion of ying

hours completed compared to the total estimated under the contract. In making the assessment of future revenues, costs and the level of

prot recognised the Group takes account of: (i) the forecast utilisation of the engines by the operator; (ii) the forecast costs to maintain the

engines in accordance with the contractual requirements – the principal variables being the time between shop visits and the cost of each

shop visit; and (iii) the recoverability of any contract asset arising. The Group benchmarks the forecast costs against previous programmes,

recognising that the reliability of the forecasts will improve as operational experience of the engine increases. To the extent that actual

costs diﬀer from forecast costs or that forecast costs change, the cumulative impact is recognised in the period. An allowance is made

against forecast contract revenues given the potential for reduced engine ying hours based on historical forecasting accuracy, the risk of

aircraft being parked by the customer and the customer’s creditworthiness. Again, changes in this allowance are recognised in the period.

Risk and revenue sharing arrangements (RRSAs)

As described on page 122, the Group enters into arrangements with certain workshare partners under which these suppliers: (i)contribute

to the forecast costs of developing an engine by performing their own development work, providing development parts and paying a

non-refundable cash entry fee; and (ii) supply components for the production phase for which they receive consideration, which isan

agreed proportion of the total programme revenues. Both the suppliers’ contributions to the forecast non-recurring development costs

and their consideration are determined by reference to their proportionate forecast scopes of supply relative to that of the engine overall.

Once the forecast costs and the scopes of supply have been agreed at the inception of the contract, each party is then accountable for its

own incurred costs. No accounting entries are recorded when the suppliers undertake development work or when development

components are supplied. Cash sums received are recognised in the income statement, as a reduction in research and development costs

incurred, to match the expensing of the Group’s related costs – where the cash sums are received in advance of the related costs being

expensed or where the related costs are capitalised as intangible assets, the recognition of the cash received is deferred (in accruals and

deferred income) to match the recognition of the related expense or the amortisation of the related intangible asset respectively. The

payments to suppliers of their shares of the programme revenues for their production components are charged to cost of sales as

programme revenues arise.

The Group has arrangements with partners who do not undertake development work or supply parts. Such arrangements are considered

to be nancial instruments as dened by IAS 32 Financial Instruments: Presentation and are accounted for using the amortised costmethod.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

1 Accounting policies continued

Government investment

Where a government or similar body has previously invested in a development programme, the Group treats payments to that body

as royalty payments, which are matched to related sales.

Government grants

Government grants are recognised in the income statement so as to match them with the related expenses that they are intended to

compensate. Where grants are received in advance of the related expenses, they are included in the balance sheet as deferred income.

Non-monetary grants are recognised at fair value.

Interest

Interest receivable/payable is credited/charged to the income statement using the eﬀective interest method. Where borrowing costs are

attributable to the acquisition, construction or production of a qualifying asset, such costs are capitalised as part of the specic asset.

Taxation

The tax charge/credit on the prot or loss for the year comprises current and deferred tax:

• Current tax is the expected tax payable for the year, using tax rates enacted or substantively enacted at the balance sheet date, and

anyadjustment to tax payable in respect of previous years.

• Deferred tax is provided using the balance sheet liability method, providing for temporary differences between the carrying amounts

ofthe assets and liabilities for financial reporting purposes and the amounts used for tax purposes and is calculated using the enacted

or substantively enacted rates that are expected to apply when the asset or liability is settled.

Tax is charged or credited in the income statement or other comprehensive income (OCI) as appropriate, except when it relates to items

credited or charged directly to equity in which case the tax is also dealt with in equity.

Deferred tax liabilities are recognised for taxable temporary diﬀerences arising on investments in subsidiaries and joint arrangements,

except where the Group is able to control the reversal of the temporary diﬀerence and it is probable that the temporary diﬀerence will not

reverse in the foreseeable future. Deferred tax is not recognised on taxable temporary diﬀerences arising on the initial recognition of

goodwill or for temporary diﬀerences arising from the initial recognition of assets and liabilities in a transaction that is not a business

combination and that aﬀects neither accounting nor taxable prot.

Deferred tax assets are recognised only to the extent that it is probable that future taxable prots will be available against which the

assets can be utilised.

Foreign currency translation

Transactions denominated in currencies other than the functional currency of the transacting Group undertaking are translated into

thefunctional currency at the exchange rates ruling on the date of the transaction. Monetary assets and liabilities denominated in foreign

currencies are translated into the relevant functional currency at the rate ruling at the year end. Exchange diﬀerences arising on foreign

exchange transactions and the retranslation of assets and liabilities into functional currencies at the rate ruling at the year end are taken

into account in determining prot before taxation.

The trading results of Group undertakings are translated into sterling at the average exchange rates for the year. The assets and liabilities of

overseas undertakings, including goodwill and fair value adjustments arising on acquisition, are translated at the exchange rates ruling at the

year end. Exchange adjustments arising from the retranslation of the opening net investments, and from the translation of the prots or losses

ataverage rates, are recognised in OCI. The cumulative amount of exchange adjustments was, on transition to IFRS in 2004, deemed to be nil.

Financial instruments

IAS 39 Financial Instruments: Recognition and Measurement requires the classication of nancial instruments into separate categories

forwhich the accounting requirement is diﬀerent. The Group has classied its nancial instruments as follows:

• Short-term investments are generally classified as available for sale.

• Short-term deposits (principally comprising funds held with banks and other financial institutions), trade receivables and short-term

investments not designated as available for sale are classified as loans and receivables.

• Borrowings, trade payables, financial RRSAs, and C Shares are classified as other liabilities.

• Derivatives, comprising foreign exchange contracts, interest rate swaps and commodity swaps are classified as fair value through

profit or loss.

Financial instruments are recognised at the contract date and initially measured at fair value. Their subsequent measurement depends

ontheir classication:

• Available for sale assets are held at fair value. Changes in fair value arising from changes in exchange rates are included in the income

statement. All other changes in fair value are taken to equity. On disposal, the accumulated changes in value recorded in equity are

included in the gain or loss recorded in the income statement.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

1 Accounting policies continued

• Loans and receivables and other liabilities are held at amortised cost and not revalued (except for changes in exchange rates and

forecast contractual cash flows, which are included in the income statement) unless they are included in a fair value hedge accounting

relationship. Where such a hedging relationship exists, the instruments are revalued in respect of the risk being hedged, with the change

in value included in the income statement.

• Fair value through profit or loss items are held at fair value. Changes in fair value are included in the income statement unless the

instrument is included in a cash flow hedge. If the instruments are included in an effective cash flow hedging relationship, changes

invalue are taken to equity. When the hedged forecast transaction occurs, amounts previously recorded in equity are recognised

intheincome statement.

Financial instruments are derecognised on expiry or when all contractual rights and obligations are transferred.

Hedge accounting

The Group does not generally apply hedge accounting in respect of forward foreign exchange contracts or commodity swaps held

to manage the cash ow exposures of forecast transactions denominated in foreign currencies or in commodities respectively.

The Group applies hedge accounting in respect of transactions entered into to manage the fair value and cash ow exposures of its

borrowings. Forward foreign exchange contracts are held to manage the fair value exposures of borrowings denominated in foreign

currencies and are designated as fair value hedges. Interest rate swaps are held to manage the interest rate exposures and are designated

as fair value or cash ow hedges of xed and oating rate borrowings respectively.

Changes in the fair values of derivatives designated as fair value hedges and changes in fair value of the related hedged item are

recognised directly in the income statement.

Changes in the fair values of derivatives that are designated as cash ow hedges and are eﬀective are recognised directly in equity.

Any ineﬀectiveness in the hedging relationships is included in the income statement. The amounts deferred in equity are recognised

in the income statement to match the recognition of the hedged item.

Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated, exercised, or no longer qualies for hedge

accounting. At that time, for cash ow hedges and if the forecast transaction remains probable, any cumulative gain or loss on the hedging

instrument recognised in equity is retained in equity until the forecast transaction occurs. If a hedged transaction is no longer expected

to occur, the net cumulative gain or loss previously recognised in equity is transferred to the income statement.

The portion of a gain or loss on an instrument used to hedge a net investment in a foreign operation that is determined to be an eﬀective

hedge is recognised directly in equity. The ineﬀective portion is recognised immediately in the income statement. Gains and losses

accumulated in the translation reserve will be recycled to prot when the foreign operation is sold.

Business combinations and goodwill

On the acquisition of a business, fair values are attributed to the identiable assets and liabilities and contingent liabilities unless the fair value

cannot be measured reliably, in which case the value is subsumed into goodwill. Where fair values of acquired contingent liabilities cannot be

measured reliably, the assumed contingent liability is not recognised but is disclosed in the same manner as other contingentliabilities.

Goodwill recognised represents the excess of the fair value of the purchase consideration over the fair value to the Group of the net of

theidentiable assets acquired and the liabilities assumed. On transition to IFRS on 1 January 2004, business combinations were not

retrospectively adjusted to comply with Adopted IFRS and goodwill was recognised based on the carrying value under the previous

accounting policies. Goodwill in respect of the acquisition of a subsidiary is recognised as an intangible asset. Goodwill arising on the

acquisition of joint arrangements and associates is included in the carrying value of the investment.

Certication costs and participation fees

Costs incurred in respect of meeting regulatory certication requirements for new civil aero engine/aircraft combinations including

payments made to airframe manufacturers for this and participation fees are carried forward in intangible assets to the extent that they

can be recovered out of future sales and are charged to the income statement over the programme life on a straight-line basis, up to a

maximum of 15 years from the entry into service of the product.

Research and development

In accordance with IAS 38 Intangible Assets, expenditure incurred on research and development is distinguished as relating either

to a research phase or to a development phase.

All research phase expenditure is charged to the income statement. Development expenditure is capitalised as an internally generated

intangible asset only if it meets strict criteria, relating in particular to technical feasibility and generation of future economic benets.

As described on page 123, the Group considers that it is not possible to distinguish reliably between research and development activities

until relatively late in the programme.

Expenditure capitalised is amortised over its useful economic life on a straight-line basis, up to a maximum of 15 years from the entry into

service of the product.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

1 Accounting policies continued

Contractual aftermarket rights

As described under key judgements on page 121, the Group may sell OE to customers at a price below its cost, on the basis that it also

receives valuable aftermarket rights. Such a sale is considered to give rise to an intangible asset which is recognised, in accordance with

IAS 38, at the same time as the revenue at an amount equal to the cash decit and is amortised on a straight-line basis over the period

that highly probable aftermarket sales are expected to be earned.

Customer relationships

The fair value of customer relationships recognised as a result of a business combination relate to the acquired company’s established

relationships with its existing customers that result in repeat purchases and customer loyalty. Amortisation occurs on a straight-line

basis over its useful economic life, up to a maximum of 15 years.

Software

The cost of acquiring software that is not specic to an item of property, plant and equipment is classied as an intangible asset and

amortised on a straight-line basis over its useful economic life, up to a maximum of ve years.

Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation and any provision for impairment in value.

Depreciation is provided on a straight-line basis to write oﬀ the cost, less the estimated residual value, of property, plant and equipment

over their estimated useful lives. No depreciation is provided on assets in the course of construction. Estimated useful lives are as follows:

• Land and buildings, as advised by the Group’s professional advisers:

– freehold buildings – ve to 45 years (average 26 years);

– leasehold buildings – lower of adviser’s estimates or period of lease;

– no depreciation is provided on freehold land.

• Plant and equipment – five to 25 years (average 12 years).

• Aircraft and engines – five to 20 years (average 13 years).

Where the Group obtains eﬀective control of customers’ installed engines as a result of a TotalCare Flex arrangement, the fair value

of these engines is recognised as an addition (shown separately in note 10). The corresponding liability is recognised either as deferred

revenue or a nancial liability depending on the precise nature of the arrangement.

Operating leases

Payments made and rentals received under operating lease arrangements are charged/credited to the income statement on a straight-

linebasis.

Impairment of non-current assets

Impairment of non-current assets is considered in accordance with IAS 36 Impairment of Assets. Where the asset does not generate cash

ows that are independent of other assets, impairment is considered for the cash-generating unit to which the asset belongs. Goodwill

and intangible assets not yet available for use are tested for impairment annually. Other intangible assets, property, plant and equipment

and investments are assessed for any indications of impairment annually. If any indication of impairment is identied, an impairment

test is performed to estimate the recoverable amount.

If the recoverable amount of an asset (or cash-generating unit) is estimated to be below the carrying value, the carrying value is reduced

to the recoverable amount and the impairment loss recognised as an expense. The recoverable amount is the higher of value in use or fair

value less costs to sell, if this is readily available. The value in use is the present value of future cash ows using a pre-tax discount rate

that reects the time value of money and the risk specic to the asset.

Inventories

Inventories and work in progress are valued at the lower of cost and net realisable value on a rst-in, rst-out basis. Cost comprises direct

materials and, where applicable, direct labour costs and those overheads, including depreciation of property, plant and equipment, that

have been incurred in bringing the inventories to their present location and condition. Net realisable value represents the estimated

selling prices less all estimated costs of completion and costs to be incurred in marketing, selling and distribution.

Cash and cash equivalents

Cash and cash equivalents include cash at bank and in hand, investments in money-market funds and short-term deposits with

a maturity of three months or less on inception. The Group considers overdrafts (repayable on demand) to be an integral part of its

cash management activities and these are included in cash and cash equivalents for the purposes of the cash ow statement.

Provisions

Provisions are recognised when the Group has a present obligation as a result of a past event, and it is probable that the Group will

be required to settle that obligation. Provisions are measured at the Directors’ best estimate of the expenditure required to settle the

obligation at the balance sheet date, and are discounted to present value where the eﬀect is material.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

1 Accounting policies continued

Post-retirement benets

Pensions and similar benets (principally healthcare) are accounted for under IAS 19 Employee Benets.

For dened benet plans, obligations are measured at discounted present value, using a discount rate derived from high-quality corporate

bonds denominated in the currency of the plan, whilst plan assets are recorded at fair value. Surpluses in schemes are recognised as assets

only if they represent economic benets available to the Group in the future. A liability is recognised to the extent that the minimum

funding requirements in respect of past service will give rise to an unrecognisable surplus.

The service and nancing costs of such plans are recognised separately in the income statement:

• Current service costs are spread systematically over the lives of employees.

• Past service costs and settlements are recognised immediately.

• Financing costs are recognised in the periods in which they arise.

Actuarial gains and losses and movements in unrecognised surpluses and minimum funding liabilities are recognised immediately in OCI.

Payments to dened contribution schemes are charged as an expense as they fall due.

Share-based payments

The Group provides share-based payment arrangements to certain employees. These are principally equity-settled arrangements and

are measured at fair value (excluding the eﬀect of non-market based vesting conditions) at the date of grant. The fair value is expensed

on a straight-line basis over the vesting period. The amount recognised as an expense is adjusted to reect the actual number of shares

or options that will vest, except where additional shares vest as a result of the total shareholder return (TSR) performance condition

in the Performance Share Plan (PSP).

Cash-settled share options (grants in the International ShareSave plan) are measured at fair value at the balance sheet date. The Group

recognises a liability at the balance sheet date based on these fair values, taking into account the estimated number of options that will

actually vest and the relative completion of the vesting period. Changes in the value of this liability are recognised in the income statement

for the year.

The cost of shares of Rolls-Royce Holdings plc held by the Group for the purpose of fullling obligations in respect of employee share plans

is deducted from equity in the consolidated balance sheet. See note 21 for a further description of the share-based payment plans.

Customer nancing support

In connection with the sale of its products, the Group will, on occasion, provide nancing support for its customers. These arrangements

fall into two categories: credit-based guarantees and asset-value guarantees. In accordance with the requirements of IAS 39 and IFRS 4

Insurance Contracts, credit-based guarantees are treated as insurance contracts. The Group considers asset-value guarantees to be

non-nancial liabilities and accordingly these are also treated as insurance contracts. As described on page 123, the Directors consider the

likelihood of crystallisation in assessing whether provision is required for any contingent liabilities.

The Group’s contingent liabilities relating to nancing arrangements are spread over many years and relate to a number of customers

and a broad product portfolio, and are reported on a discounted basis.

Revisions to Adopted IFRS in 2016

There were no changes to accounting standards that had a material impact on the 2016 nancial statements.

Revisions to IFRS not applicable in 2016

Standards and interpretations issued by the IASB are only applicable if endorsed by the EU.

IFRS 9 Financial Instruments will simplify the classication of nancial assets for measurement purposes, but is not anticipated to have a

signicant impact on the nancial statements.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

1 Accounting policies continued

IFRS 15 Revenue from Contracts with Customers (eﬀective for the year beginning 1 January 2018), provides a single, principles-based ve-step

model to be applied to all sales contracts, based on the transfer of control of goods and services to customers. It replaces the separate models

for goods, services and construction contracts currently included in IAS 11 Construction Contracts and IAS 18 Revenue.

The Group has undertaken signicant analysis of how IFRS 15 should be implemented and has taken tentative accounting policy decisions.

Based on this analysis, we expect that adoption of IFRS 15 will have a signicant impact on the timing of recognition of revenue on individual

long-term contracts, most particularly in the Civil Aerospace business. The most signicant changes are:

• IFRS 15 contains more specific requirements on the combination of contracts. Contracts can only be combined if they are with the same

counterparty or related counterparties. The existing standards require contracts with different counterparties to be combined where

that reflects the overall substance of a transaction. As a result, it will no longer be possible to link contracts entered into at the same

time for: (i) installed OE, with an airframer; and (ii) long-term service agreements (LTSAs), relating to that OE, with the aircraft operator.

• For similar reasons, it will no longer be possible to recognise an intangible asset in respect of contractual aftermarket rights (relating

to future aftermarket business with an operator) when OE is sold to an airframer.

• For each performance obligation identified, IFRS 15 requires revenue to be recognised based on the transfer of control of the relevant

goods or services. In contrast, under the existing standards, revenue is recognised based on when risk and reward is transferred. As a

result it will no longer be possible to use flying hours (or equivalent) as a basis for measuring the stage of completion of LTSAs.

• Compared to IAS 11, IFRS 15 includes only limited guidance on accounting for costs incurred to fulfil a performance obligation and in

general these will be recognised as incurred. It is no longer possible to defer or accrue costs to report a consistent margin percentage

over the term of the LTSAs.

In summary, the impact of these changes will be that, upon adoption of IFRS 15:

• Revenues and costs relating to deliveries of engines will be recognised when they are is delivered. The revenue recognised will comprise

that included in the contract with the airframer reduced (if applicable) by any OE concession agreed with the operator (which IFRS 15

describes as a payment to a ‘customer’s customer’). Consequently, the revenues and costs recognised on OE deliveries will more closely

match the related cash flows. No contractual aftermarket revenue will be allocated to the OE delivery (where contracts are currently

combined – ‘linked accounting’) and no intangible asset will be recognised (where contracts are not currently combined – ‘unlinked

accounting’). This will result in a loss being recognised on engine deliveries when the direct costs exceed the direct revenues.

• Revenues on LTSAs will be recognised as services are performed rather than as the equipment is used (engine flying hours) as is the case

under the current accounting policy. The stage of completion will be measured using the actual costs incurred to date compared to the

estimated costs to complete the performance obligation. In practice the bulk of the revenue and costs will relate to overhaul activity

which occurs at distinct points of time during the period of the LTSA. As the first major overhaul typically occurs some years after

delivery, this change will generally defer the recognition of revenue on LTSAs, as compared to the current accounting policy.

Taken together, had IFRS 15 been applicable with eﬀect from 1 January 2015, the Group currently estimates the results for the year ended

31 December 2015 would have been as follows:

IAS 11 and IAS 18 IFRS 15

Reported

£bn

Underlying

£bn

Reported

£bn

Underlying

£bn

Revenue

Civil Aerospace original equipment 3.3 2.6

Civil Aerospace aftermarket services 3.7 3.5

Other segments 6.4 6.4

Total revenue 13.7 13.4 12.8 12.5

Gross profit

Civil Aerospace 1.5 0.6

Other segments 1.7 1.7

Total gross profit 3.3 3.2 2.4 2.3

Profit before financing and taxation 1.5 1.5 0.6 0.6

Net financing (1.3) (0.1) (1.3) (0.1)

Taxation (0.1) (0.3) 0.1 (0.1)

Profit for the year 0.1 1.1 (0.6) 0.4

Net assets 5.0 2.0

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

1 Accounting policies continued

The Group plans to adopt IFRS 15 in 2018 using the ‘full’ retrospective approach. The comparative 2017 results included in the 2018

nancial statements will be restated, with an adjustment to equity as at 1 January 2017.

The Group will continue to work during 2017 to design, implement and rene procedures to apply the new requirements of IFRS 15 and to

nalise accounting policy choices. As a result of this ongoing work, it is possible that some changes to the impact above may result.

IFRS 16 Leases (eﬀective for the year ending 31 December 2019, not yet endorsed by the EU) will require all leases to be recognised on the

balance sheet. Currently, IAS 17 Leases only requires leases categorised as nance leases to be recognised on the balance sheet, with leases

categorised as operating leases not recognised. In broad terms, the impact will be to recognise a lease liability and corresponding asset

forthe operating lease commitments set out in note 22.

The Group does not consider that any other standards, amendments or interpretations issued by the IASB, but not yet applicable, will have

a signicant impact on the nancial statements.

2 Segmental analysis

The analysis by business segment is presented in accordance with IFRS 8 Operating Segments, on the basis of those segments whose

operating results are regularly reviewed by the Board (the Chief Operating Decision Maker as dened by IFRS 8), as follows:

Civil Aerospace – development, manufacture, marketing and sales of commercial aero engines and aftermarket services.

Defence Aerospace – development, manufacture, marketing and sales of military aero engines and aftermarket services.

Power Systems – development, manufacture, marketing and sales of reciprocating engines and power systems.

Marine – development, manufacture, marketing and sales of marine-power propulsion systems and aftermarket services.

Nuclear – development, manufacture, marketing and sales of nuclear systems for civil power generation and naval

propulsion systems.

The operating results are reviewed by the Board and are prepared on an underlying basis, which the Board considers reects better the

economic substance of the Group’s trading during the year and provides nancial measures that, together with the results prepared in

accordance with Adopted IFRS, allow better analysis of the factors aﬀecting the year’s results compared to the prior year. The principles

adopted to determine underlying results are:

Underlying revenues and costs

Where revenues and costs are denominated in a currency other than the functional currency of the Group undertaking and the Group

hedges the net exposure, these reect the achieved exchange rates arising on derivative contracts settled to cover the net exposure. These

achieved exchange rates are applied to all relevant revenues and costs, including those for which there is a natural oﬀsetting position,

rather than translating the oﬀsetting transactions at spot rates. The underlying prots would be the same under both approaches, but the

Board considers that the approach taken provides a better indication of trends over time.

Underlying prot before nancing

In addition to the impact of exchange rates on revenues and costs above, adjustments have been made to exclude one-oﬀ past service

costs or credits on post-retirement schemes, exceptional restructuring costs (associated with the substantial closure or exit of a site,

facility or line of business or other major transformation activities), the eﬀect of acquisition accounting, the eﬀect of business disposals,

the impairment of goodwill, and in 2016 nancial penalties from agreements with investigating bodies.

Underlying prot before taxation

In addition to those adjustments in underlying prot before nancing:

• Includes amounts realised from settled derivative contracts and revaluation of relevant assets and liabilities to exchange rates forecast

to be achieved from future settlement of derivative contracts.

• Excludes unrealised amounts arising from revaluations required by IAS 39 Financial Instruments: Recognition and Measurement,

changesin value of financial RRSA contracts arising from changes in forecast payments andthe net impact of financing costs related

to post-retirement scheme benefits.

Taxation

The tax eﬀect of the adjustments above are excluded from the underlying tax charge. In addition changes in the amount ofrecoverable

advance corporation tax recognised and the impact of changes in tax rates are also excluded.

This analysis also includes a reconciliation of the underlying results to those reported in the consolidated income statement.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

2 Segmental analysis continued

Civil

£m

Defence

£m

Power

Systems

£m

Marine

£m

Nuclear

£m

Inter-

segment

£m

Total

reportable

segments

£m

Year ended 31 December 2016

Underlying revenue from sale of original equipment 3,272 823 1,609 575 346 (33) 6,592

Underlying revenue from aftermarket services 3,634 1,229 751 437 415 (35) 6,431

Total underlying revenue at 2015 exchange rates 6,906 2,052 2,360 1,012 761 (68) 13,023

Translation to 2016 exchange rates 161 157 295 102 16 (8) 723

Total underlying revenue 7,067 2,209 2,655 1,114 777 (76) 13,746

Gross profit 1,129 530 628 216 117 – 2,620

Commercial and administrative costs (339) (127) (305) (207) (67) – (1,045)

Restructuring (11) 10 – 3 – – 2

Research and development costs (549) (68) (157) (39) (6) – (819)

Share of results of joint ventures and associates 96 15 1 – – – 112

Underlying profit/(loss) before financing and taxation at 2015 exchange rates 326 360 167 (27) 44 – 870

Translation to 2016 exchange rates 41 24 24 – 1 – 90

Underlying profit/(loss) before financing and taxation 367 384 191 (27) 45 – 960

Segment assets 13,030 1,755 3,828 1,518 351 (1,223) 19,259

Investments in joint ventures and associates 826 4 9 2 1 – 842

Segment liabilities (14,510) (1,996) (1,151) (903) (435) 1,223 (17,772)

Net (liabilities)/assets (654) (237) 2,686 617 (83) – 2,329

Investment in intangible assets, property, plant and equipment

and joint ventures and associates 1,215 112 123 37 19 – 1,506

Depreciation, amortisation and impairment 491 67 207 239 39 – 1,043

Year ended 31 December 2015

Underlying revenue from sale of original equipment 3,258 801 1,618 773 251 (53) 6,648

Underlying revenue from aftermarket services 3,675 1,234 767 551 436 (53) 6,610

Total underlying revenue 6,933 2,035 2,385 1,324 687 (106) 13,258

Gross profit 1,526 579 656 260 111 7 3,139

Commercial and administrative costs (296) (124) (296) (201) (53) – (970)

Restructuring (7) (8) (4) (16) (2) – (37)

Research and development costs (515) (73) (162) (28) 14 – (764)

Share of results of joint ventures and associates 104 19 – – – – 123

Underlying profit before financing and taxation 812 393 194 15 70 7 1,491

Segment assets 11,229 1,437 3,376 1,481 300 (850) 16,973

Investments in joint ventures and associates 545 12 8 7 3 – 575

Segment liabilities (8,709) (1,698) (1,017) (783) (324) 850 (11,681)

Net assets/(liabilities) 3,065 (249) 2,367 705 (21) – 5,867

Investment in intangible assets, property, plant and equipment

and joint ventures and associates 668 84 108 36 18 – 914

Depreciation, amortisation and impairment 410 58 197 111 23 – 799

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

2 Segmental analysis continued

RECONCILIATION TO REPORTED RESULTS

Total reportable

segments

£m

Other business

and corporate

£m

Total

underlying

£m

Underlying

adjustments and

foreign exchange

£m

Group at actual

exchange rates

£m

Year ended 31 December 2016

Revenue from sale of original equipment 6,592 20 6,612 976 7,588

Revenue from aftermarket services 6,431 15 6,446 921 7,367

Total underlying revenue at 2015 exchange rates 13,023 35 13,058 1,897 14,955

Translation to 2016 exchange rates

723 2 725 (725) –

Total revenue

13,746 37 13,783 1,172 14,955

Gross profit 2,620 6 2,626 422 3,048

Other operating income – – – 5 5

Commercial and administrative costs (1,045) (51) (1,096) (1,112) (2,208)

Restructuring 2 – 2 (2) –

Research and development costs (819) 7 (812) (106) (918)

Share of results of joint ventures and associates 112 (5) 107 10 117

Profit/(loss) before financing and taxation at 2015 exchange rates 870 (43) 827 (783) 44

Translation to 2016 exchange rates 90 (2) 88 (88) –

Loss on disposal of businesses – – – (3) (3)

Profit/(loss) before financing and taxation 960 (45) 915 (874) 41

Net financing (102) (102) (4,575) (4,677)

Profit/(loss) before taxation (147) 813 (5,449) (4,636)

Taxation (261) (261) 865 604

Profit/(loss) for the year 552 (4,584) (4,032)

Attributable to:

Ordinary shareholders 552 (4,584) (4,032)

Non-controlling interests – – –

Year ended 31 December 2015

Revenue from sale of original equipment 6,648 76 6,724 215 6,939

Revenue from aftermarket services 6,610 20 6,630 156 6,786

Total revenue 13,258 96 13,354 371 13,725

Gross profit 3,139 64 3,203 74 3,277

Other operating income – – – 10 10

Commercial and administrative costs (970) (55) (1,025) (45) (1,070)

Restructuring (37) (2) (39) 39 –

Research and development costs (764) (1) (765) (53) (818)

Share of results of joint ventures and associates 123 (5) 118 (18) 100

Profit on disposal of businesses – – – 2 2

Profit before financing and taxation 1,491 1 1,492 9 1,501

Net financing (60) (60) (1,281) (1,341)

Profit/(loss) before taxation (59) 1,432 (1,272) 160

Taxation (351) (351) 275 (76)

Profit/(loss) for the year (410) 1,081 (997) 84

Attributable to:

Ordinary shareholders 1,080 (997) 83

Non-controlling interests 1 – 1

Other businesses comprise former Energy businesses not included in the disposal to Siemens in 2014.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

2 Segmental analysis continued

UNDERLYING ADJUSTMENTS

2016 2015

Revenue

£m

Profit before

financing

£m

Net

financing

£m

Taxation

£m

Revenue

£m

Profit before

financing

£m

Net

financing

£m

Taxation

£m

Underlying performance 13,783 915 (102) (261) 13,354 1,492 (60) (351)

Revenue recognised at exchange rate

ondate of transaction 1,172 – – – 371 – – –

Realised losses/(gains) on settled

derivative contracts

– 426 162 (107) – 287 (35) (51)

Net unrealised fair value changes to

derivative contracts

– – (4,420) 792 – (9) (1,306) 270

Effect of currency on contract

accounting – 77 – (14) – (9) – 2

Revaluation of trading assets and

liabilities – 67 (313) 56 – (13) 20 (6)

Financial RRSAs – foreign exchange

differences and changes in forecast

payments – – (8) (1) – – 8 (1)

Effect of acquisition accounting

– (115) – 35 – (124) – 31

Impairment of goodwill – (219) – – – (75) – –

Pension restructuring

– (306) – 107 – – – –

Net post-retirement scheme financing – – 3 (2) – – 32 (12)

Disposal of businesses – (3) – – – 2 – 15

Exceptional restructuring – (129) – 34 – (49) – 11

Financial penalties from agreements

with investigating bodies – (671) – – – – – –

Other – (1) 1 (5) – (1) – (2)

Reduction in rate of UK corporation tax

–

– – (30) – – – 18

Total underlying adjustments 1,172 (874) (4,575) 865 371 9 (1,281) 275

Reported per consolidated

incomestatement 14,955 41 (4,677) 604 13,725 1,501 (1,341) (76)

Realised (gains)/losses on settled derivative contracts include adjustments to reflect the losses/(gains) in the same year as the related trading cash flows.

Unrealised fair value changes to derivative contracts included in profit before financing: (i) include those of equity accounted joint ventures; and (ii) exclude those for which the related

trading contracts have been cancelled when the fair value changes are recognised immediately in underlying profit.

The adjustment eliminates charges recognised as a result of recognising assets in acquired businesses at fair value.

In the UK, tax is provided on pension surpluses at a rate of 35%, which is the relevant rate if the surpluses were to be returned to the Group.

The reconciliation of underlying earnings per ordinary share is shown in note 6.

RECONCILIATION TO THE BALANCE SHEET

2016

£m

2015

£m

Reportable segment assets 19,259 16,973

Investments in joint ventures and associates 844 576

Other businesses and corporate 49 119

Cash and cash equivalents and short-term investments 2,774 3,178

Fair value of swaps hedging fixed rate borrowings 358 74

Income tax assets 908 341

Post-retirement scheme surpluses 1,346 1,063

Total assets 25,538 22,324

Reportable segment liabilities (17,772) (11,681)

Other businesses and corporate (183) (120)

Borrowings (3,357) (3,302)

Fair value of swaps hedging fixed rate borrowings – (61)

Income tax liabilities (987) (1,004)

Post-retirement scheme deficits (1,375) (1,140)

Total liabilities (23,674) (17,308)

Net assets 1,864 5,016

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

2 Segmental analysis continued

GEOGRAPHICAL SEGMENTS

The Group’s revenue by destination is as follows:

2016

£m

2015

£m

United Kingdom 1,821 1,780

Germany 850 642

Switzerland 745 782

France 294 249

Spain 289 200

Norway 279 280

Italy 232 222

Russia 75 59

Rest of Europe 700 786

Europe 5,285 5,000

United States 4,176 3,591

Canada 341 475

North America 4,517 4,066

South America 314 425

Saudi Arabia 486 365

Rest of Middle East 570 445

Middle East 1,056 810

China 1,417 1,236

Singapore 518 549

Japan 333 136

South Korea 251 278

Malaysia 117 78

India 99 99

Rest of Asia 508 546

Asia 3,243 2,922

Africa 290 144

Australasia 188 278

Other 62 80

14,955 13,725

No single customer represented 10% or more of the Group’s revenue.

The carrying amounts of the Group’s non-current assets, excluding nancial instruments, deferred tax assets and post-employment

benet surpluses, by the geographical area in which the assets are located, are as follows:

2016

£m

2015

£m

United Kingdom 4,643 4,072

Germany 2,714 2,339

United States 1,046 835

Nordic countries 512 598

Other 1,161 900

10,076 8,744

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

3 Research and development

2016

£m

2015

£m

Expenditure in the year (937) (831)

Capitalised as intangible assets 99 51

Amortisation of capitalised costs (147) (136)

Impairment of capitalised costs (2) –

Net research and development cost (987) (916)

Entry fees received 73 83

Entry fees deferred in respect of charges in future years (40) (28)

Recognition of previously deferred entry fees 36 43

Net cost recognised in the income statement (918) (818)

Underlying adjustments relating to effects of acquisition accounting and foreign exchange 56 53

Net underlying cost recognised in the income statement (862) (765)

Translation to 2015 exchange rates 50 –

Net underlying cost at 2015 exchange rates (812) (765)

4 Net financing

Notes

2016 2015

Per

consolidated

income

statement

£m

Underlying

financing

£m

Per

consolidated

income

statement

£m

Underlying

financing

£m

Financing income

Interest receivable 14 14 12 12

Net fair value gains on foreign currency contracts

17 1 – – –

Financial RRSAs – foreign exchange differences and changes in forecast payments

17 23 – 21 –

Net fair value gains on commodity contracts

17 16 –

Financing on post-retirement scheme surpluses

19 42 – 65 –

Net foreign exchange gains

– – 17 32

96 14 115 44

Financing costs

Interest payable (77) (77) (71) (71)

Net fair value losses on foreign currency contracts

17 (4,437) – (1,217) –

Financial RRSAs – foreign exchange differences and changes in forecast payments

17 (31) – (13) –

Financial charge relating to financial RRSAs

17 (6) (6) (8) (8)

Net fair value losses on commodity contracts

17 – – (89) –

Financing on post-retirement scheme deficits

19 (39) – (33) –

Net foreign exchange losses (145) – – –

Other financing charges (38) (33) (25) (25)

(4,773) (116) (1,456) (104)

Net financing (4,677) (102) (1,341) (60)

Analysed as:

Net interest payable (63) (63) (59) (59)

Net fair value losses on derivative contracts (4,420) –

(1,306) –

Net post-retirement scheme financing 3 – 32 –

Net other financing (197) (39) (8) (1)

Net financing (4,677) (102) (1,341) (60)

Net loss on fair value items through profit or loss (4,420) – (1,306) –

See note 2.

The underlying financing income includes nil (2015: £34m) from gains on settlement of foreign exchange contracts following the receipt in the UK of dividends from overseas subsidiaries.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

5 Taxation

UK Overseas Total

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Current tax

Current tax charge for the year 12 9 187 157 199 166

Less double tax relief – – – – – –

12 9 187 157 199 166

Adjustments in respect of prior years (8) 6 4 (23) (4) (17)

4 15 191 134 195 149

Deferred tax

Deferred tax credit for the year (804) (37) (44) (23) (848) (60)

Adjustments in respect of prior years (5) 10 24 (5) 19 5

Deferred tax charge/(credit) resulting from reduction in tax rates 30 (18) – – 30 (18)

(779) (45) (20) (28) (799) (73)

Recognised in the income statement (775) (30) 171 106 (604) 76

OTHER TAX (CHARGES)/CREDITS

OCI Equity

Items that will not

be reclassified

Items that may

be reclassified

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Deferred tax:

Movement in post-retirement schemes (179) 257

Share-based payments – direct to equity (2) (6)

Net investment hedge 4 (2)

(179) 257 4 (2) (2) (6)

TAX RECONCILIATION

2016

£m

2015

£m

(Loss)/profit before taxation (4,636) 160

Less share of results of joint ventures and associates (note 11) (117) (100)

(Loss)/profit before taxation excluding joint ventures and associates (4,753) 60

Nominal tax (credit)/charge at UK corporation tax rate 20% (2015: 20.25%) (951) 12

UK tax rate differential

41 20

Overseas rate differences

25 43

Impairment of goodwill 44 13

Financial penalties from agreements with investigating bodies 153 –

Other permanent differences 11 5

Benefit to deferred tax from previously unrecognised tax losses and temporary differences (2) (7)

Tax losses in year not recognised in deferred tax 30 20

Adjustments in respect of prior years

15 (12)

Reduction in closing deferred taxes resulting from decrease in tax rates 30 (18)

(604) 76

Underlying items (note 2) 261 351

Non-underlying items (865) (275)

(604) 76

The UK tax rate differential arises on the difference between the appropriate deferred tax rate and the UK statutory tax rate.

Overseas rate differences mainly relate to tax on profits in countries, such as the US, which have higher tax rates than the UK.

The adjustments in respect of prior years include a £14m charge relating to losses in Norway no longer recognised due to the current uncertainty in the oil & gas market (see note 9).

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

5 Taxation continued

DEFERRED TAXATION ASSETS AND LIABILITIES

2016

£m

2015

£m

At 1 January (521) (859)

Amount credited to income statement 799 73

Amount (charged)/credited to other comprehensive income (175) 255

Amount charged to equity (2) (6)

Exchange differences (1) 16

At 31 December 100 (521)

Deferred tax assets 876 318

Deferred tax liabilities (776) (839)

100 (521)

The analysis of the deferred tax position is as follows:

1 January

2016

£m

Recognised

in income

statement

£m

Recognised

in OCI

£m

Recognised

in equity

£m

Exchange

differences

£m

31 December

2016

£m

Intangible assets (392) 11 – – (8) (389)

Property, plant and equipment (190) 14 – – (15) (191)

Other temporary differences 21 15 4 – (12) 28

Amounts recoverable on contracts (539) 27 – – – (512)

Pensions and other post-retirement scheme benefits (90) 103 (179) – 35 (131)

Foreign exchange and commodity financial assets andliabilities 306 620 – – – 926

Losses 343 (1) – (2) (1) 339

R&D expenditure credit 20 10 – – – 30

(521) 799 (175) (2) (1) 100

1 January

2015

£m

Recognised

in income

statement

£m

Recognised

in OCI

£m

Recognised

in equity

£m

Exchange

differences

£m

31 December

2015

£m

Intangible assets (455) 52 – – 11 (392)

Property, plant and equipment (195) 7 – – (2) (190)

Other temporary differences 97 (69) (2) (7) 2 21

Amounts recoverable on contracts (526) (13) – – – (539)

Pensions and other post-retirement scheme benefits (324) (30) 257 – 7 (90)

Foreign exchange and commodity financial assets andliabilities 135 171 – – – 306

Losses 393 (49) – 1 (2) 343

R&D expenditure credit 16 4 – – – 20

(859) 73 255 (6) 16 (521)

UNRECOGNISED DEFERRED TAX ASSETS

2016

£m

2015

£m

Advance corporation tax 182 182

Losses and other unrecognised deferred tax assets 71 36

Deferred tax not recognised on unused tax losses and other items on the basis that future economic benefit is uncertain

253 218

Advance corporation tax, tax losses and other deductible temporary differences are not expected to expire under current legislation.

DEFERRED TAXATION ASSETS AND LIABILITIES

Following announcements in the Summer Budget 2015 and the Budget 2016, the UK corporation tax rate will reduce to 19% from 1 April

2017 and 17% from 1 April 2020. The Summer Budget 2015 had originally announced that the rate would reduce to 18% from 1 April 2020.

This reduction was substantively enacted on 26 October 2015 and so the prior year deferred tax assets and liabilities were calculated at

this rate. The subsequent announcement in the Budget 2016 that the rate will reduce to 17% from 1 April 2020 was substantively enacted

on 6 September 2016. As this reduction was substantively enacted prior to the year end, the closing deferred tax assets and liabilities have

been calculated at this rate.

The resulting charges or credits have been recognised in the income statement except to the extent that they relate to items previously

charged or credited to OCI or equity. Accordingly, in 2016, £30m has been charged to the income statement (2015: £18m credited) and £2m

has been charged directly to equity (2015: £3m).

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

5 Taxation continued

The temporary diﬀerences associated with investments in subsidiaries, joint ventures and associates, for which a deferred tax liability has

not been recognised, aggregate to £276m (2015: £347m). No deferred tax liability has been recognised on the potential withholding tax

due on the remittance of undistributed prots as the Group is able to control the timing of such remittances and it is probable that

consent will not be given in the foreseeable future.

6 Earnings per ordinary share

Basic earnings per ordinary share (EPS) are calculated by dividing the prot attributable to ordinary shareholders by the weighted average

number of ordinary shares in issue during the year, excluding ordinary shares held under trust, which have been treated as if they had

beencancelled.

Diluted EPS are calculated by adjusting the weighted average number of ordinary shares in issue during the year for the bonus element

ofshare options.

2016 2015

Basic

Potentially

dilutive

share options

Diluted Basic

Potentially

dilutive

share options Diluted

(Loss)/profit attributable to ordinary shareholders (£m) (4,032) (4,032) 83 83

Weighted average number of ordinary shares (millions) 1,832 – 1,832 1,839 12 1,851

EPS (pence) (220.08) – (220.08) 4.51 (0.03) 4.48

As there is a loss, the effect of potentially dilutive ordinary shares is anti-dilutive.

The reconciliation between underlying EPS and basic EPS is as follows:

2016 2015

Pence £m Pence £m

Underlying EPS/Underlying profit attributable to ordinary shareholders 30.13 552 58.73 1,080

Total underlying adjustments to profit before tax (note 2) (297.43) (5,449) (69.17) (1,272)

Related tax effects 47.22 865 14.95 275

EPS/(Loss)/profit attributable to ordinary shareholders (220.08) (4,032) 4.51 83

Diluted underlying EPS 30.08 58.35

7 Employee information

2016 2015

Average number of employees

United Kingdom 22,300 23,200

Germany 10,700 10,700

United States 6,300 6,400

Nordics 3,400 3,800

Canada 1,000 1,100

Rest of world 6,200 5,300

49,900 50,500

Civil Aerospace 23,800 23,100

Defence Aerospace 6,000 6,300

Power Systems 10,300 10,600

Marine 5,300 6,000

Nuclear 4,300 4,100

Other businesses and corporate

1, 2

200 400

49,900 50,500

£m £m

Group employment costs

Wages, salaries and benefits 2,788 2,514

Social security costs 376 334

Share-based payments (note 21) 35 5

Pensions and other post-retirement scheme benefits (note 19) 623 299

3,822 3,152

Other businesses and corporate includes the Energy businesses not sold to Siemens in 2014 and corporate employees who do not provide a shared service to the segments. Where

corporate functions provide such a service, employees have been allocated to the segments on an appropriate basis. 2015 figures have been restated on this basis.

As described in note 1, the Group has reclassified certain joint ventures to joint operations from 1 January 2016. This increased the reported Group employees by 800.

Remuneration of key management personnel is shown in note 24.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

8 Auditors’ remuneration

Fees payable to the Company’s auditors and its associates were as follows:

2016

£m

2015

£m

Fees payable to the Company's auditors for the audit of the Company's annual financial statements

0.3 0.3

Fees payable to the Company's auditors and its associates for the audit of the Company's subsidiaries pursuant to legislation

6.5 5.6

Total fees payable for audit services 6.8 5.9

Fees payable to the Company's auditors and its associates for other services:

Audit related assurance services

0.6 1.3

Taxation compliance services 0.5 0.4

All other services 0.1 –

8.0 7.6

Fees payable in respect of the Group's pension schemes:

Audit 0.3 0.2

The level of fees payable to the Company’s auditors for the audit of the Company’s annual financial statements reflects the fact that limited incremental work is required in respect

of the audit of these financial statements. Rolls-Royce plc, a subsidiary of the Company, is also required to prepare consolidated financial statements and the fees payable to the

Company’s auditors for the audit of those financial statements, including the audit of the sub-consolidation, is included in the audit of the Company’s subsidiaries pursuant

to legislation.

Audit fees for overseas entities are reported at the average exchange rate for the year. The weakening of sterling during 2016 gave rise to an increase of £0.4m compared to 2015.

This includes £0.3m (2015: £0.3m) for the review of the half-year report.

9 Intangible assets

Goodwill

£m

Certification

costs and

participation

fees

£m

Development

expenditure

£m

Contractual

aftermarket

rights

£m

Customer

relationships

£m

Software

£m

Other

£m

Total

£m

Cost

At 1 January 2015 1,675 1,079 1,707 638 469 543 518 6,629

Exchange differences (87) (7) (32) – (14) – (16) (156)

Additions – 73 55 161 – 79 40 408

Acquisitions of businesses 1 – – – 1 – 1 3

Disposals – – – – – (6) – (6)

At 1 January 2016 1,589 1,145 1,730 799 456 616 543 6,878

Exchange differences 284 26 116 – 84 16 66 592

Additions – 154 100 208 – 116 53 631

Acquisitions of businesses 1 – – – – – 1 2

Disposals – – (2) – – (6) – (8)

At 31 December 2016 1,874 1,325 1,944 1,007 540 742 663 8,095

Accumulated amortisation

At 1 January 2015 16 311 564 389 96 259 190 1,825

Exchange differences (5) (1) (10) – (3) – (3) (22)

Charge for the year

– 63 137 55 46 68 38 407

Impairment 75 – – – – – – 75

Reversal of impairment – – – (50) – – – (50)

Disposals – – – – – (2) – (2)

At 1 January 2016 86 373 691 394 139 325 225 2,233

Exchange differences 32 3 48 – 28 8 35 154

Charge for the year

– 64 147 39 42 81 33 406

Impairment 219 – 2 – – – 1 222

At 31 December 2016 337 440 888 433 209 414 294 3,015

Net book value

At 31 December 2016 1,537 885 1,056 574 331 328 369 5,080

At 31 December 2015 1,503 772 1,039 405 317 291 318 4,645

At 1 January 2015 1,659 768 1,143 249 373 284 328 4,804

Charged to cost of sales except development costs, which are charged to research and development costs.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

9 Intangible assets continued

GOODWILL

In accordance with the requirements of IAS 36 Impairment of Assets, goodwill is allocated to the Group’s cash-generating units, or groups of

cash-generating units, that are expected to benet from the synergies of the business combination that gave rise to the goodwill as follows:

CASH-GENERATING UNIT (CGU) OR GROUP OF CGUs

Primary reporting

segment

2016

£m

2015

£m

Rolls-Royce Power Systems AG Power Systems 871 739

Marine – arising from the acquisitions of Vinters Limited, Scandinavian Electric Holding AS and ODIM ASA Marine 401 516

Rolls-Royce Deutschland Ltd & Co KG Civil Aerospace 236 202

Other Various 29 46

1,537 1,503

Goodwill has been tested for impairment during 2016 on the following basis:

• The carrying values of goodwill have been assessed by reference to value in use. These have been estimated using cash flows from the

most recent forecasts prepared by management, which are consistent with past experience and external sources of information on

market conditions. Given the long-term and established nature of many of the Group’s products (product lives are often measured in

decades), these forecasts generally cover the next five-ten years. Growth rates for the period not covered by the forecasts are based on a

range of growth rates (2.0-3.5%) that reflect the products, industries and countries in which the relevant CGU or group of CGUs operate.

• The key assumptions for the impairment tests are the discount rate and, in the cash flow projections, the programme assumptions, the

growth rates and the impact of foreign exchange rates on the relationship between selling prices and costs. Impairment tests are

performed using prevailing exchange rates.

Prior to 2016, goodwill in the Marine business was considered as separate CGUs, based on the original acquisitions (including ODIM ASA,

Scandinavian Electric Holdings and Vinters Limited (formerly Vickers plc)). However, following re-organisations, including those resulting

from the current transformation programme, we now consider that the Marine business (excluding the UK marine defence business) is a

single CGU.

The Marine business has continued to be impacted by the low crude oil price and over supply of vessels to its oﬀshore support customers.

The downturn has been deeper and more prolonged than forecast a year ago and, as a consequence, the Group has recognised an

impairment loss of £200m to the carrying value of goodwill of the CGU. This is included in cost of sales in the income statement, but

excluded from the underlying results. The impairment loss is based on a value in use calculation using cash ows forecast over a ten-year

period (which is considered to take account of the cyclicality of the market). The impairment test indicated a recoverable amount of £473m

(including allowance for identied risks of £18m) compared with a pre-impairment carrying value of £673m.

The Group has also recognised other impairments to goodwill of £19m, including £14m in relation to its North American civil nuclear

business. This reects the current weakness in the services market, although the Directors expect these to recover in the medium term.

The principal value in use assumptions for goodwill balances considered to be individually signicant are:

• Rolls-Royce Power Systems AG – Discount rate 11.7% (2015: 11.7%). Volume of equipment deliveries, pricing achieved and cost escalation.

These are based on current and known future programmes, estimates of capture of market share and long-term economic forecasts. The

principal foreign exchange exposures are on translating income in a variety of non-functional currencies into euros. For the purposes of

the impairment only, cash flows from recent management forecasts for a five-year period have been included. Cash flows beyond five

years are assumed to grow at 2% (2015: 2%). Reasonably possible changes in the key assumptions would cause the value in use of the

goodwill to fall below its carrying value, which include a reduction in the level of cash generation of 13%, or an increase in the assumed

discount rate of 1.5%. At 31 December 2016, the value in use exceeded the carrying value by £440m.

• Marine business – Discount rate 13%, including an allowance of 0.8% to reflect uncertainties in market recovery and the achievement of

cost savings, (2015: 13%). Volume of equipment deliveries, capture of aftermarket and cost escalation. These are based on current and

known future programmes, estimates of customers’ fleet requirements and long-term economic forecasts. The principal foreign

exchange exposures are on translating income in a variety of non-functional currencies into Norwegian kroner. For the purposes of the

impairment test only, cash flows beyond the ten-year forecasts are assumed to grow at 2.5% (2015: 2.5%). Any further deterioration of

the market would require additional impairment. For example if the market recovery were delayed by one year, compared to that

assumed, this would result in an additional impairment of around £60m.

• Rolls-Royce Deutschland Ltd & Co KG – Discount rate 13% (2015: 13%). Volume of engine deliveries, flying hours of installed fleet and cost

escalation. These are based on current and known future programmes, estimates of customers’ fleet requirements and long-term

economic forecasts. The principal foreign exchange exposure is on translating US dollar income into euros. For the purposes of the

impairment test only, cash flows beyond the ten-year forecasts are assumed to grow at 2.5% (2015: 2.5%). The Directors do not consider

that any reasonably possible change in the key assumptions would cause the value in use of the goodwill to fall below its carrying value.

The overall level of business would need to reduce by around 70% to cause an impairment of this balance.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

9 Intangible assets continued

OTHER INTANGIBLE ASSETS

Certication costs and participation fees, development costs and contractual aftermarket rights have been reviewed for impairment

inaccordance with the requirements of IAS 36 Impairment of Assets. Where an impairment test was considered necessary, it has been

performed on the following basis:

• The carrying values have been assessed by reference to value in use. These have been estimated using cash flows from the most recent

forecasts prepared by management, which are consistent with past experience and external sources of information on market

conditions over the lives of the respective programmes.

• The key assumptions underlying cash flow projections are assumed market share, programme timings, unit cost assumptions, discount

rates, and foreign exchange rates.

• The pre-tax cash flow projections have been discounted at 9-13% (2015: 9-13%), based on the Group’s weighted average cost of capital,

adjusted for the estimated programme risk, for example taking account of whether or not the forecast cash flows arise from contracted

business.

No impairment is required on this basis. However, a combination of adverse changes in assumptions (eg. market size and share, unit costs

and programme delays) and other variables (eg. discount rate and foreign exchange rates), could result in impairment in future years.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

10 Property, plant and equipment

Land and

buildings

£m

Plant and

equipment

£m

Aircraft

and engines

£m

In course of

construction

£m

Total

£m

Cost

At 1 January 2015 1,334 3,600 321 795 6,050

Exchange differences (20) (39) (2) (3) (64)

Additions 18 117 19 340 494

Acquisitions of businesses – 1 – – 1

Disposals of businesses – (1) – – (1)

Reclassifications 81 335 7 (423) –

Transferred to assets held for sale (8) (23) (2) – (33)

Disposals/write-offs (30) (96) (4) (1) (131)

At 1 January 2016 1,375 3,894 339 708 6,316

Exchange differences 141 352 12 55 560

Reclassification of joint ventures to joint operations 7 87 – – 94

Additions – purchased 25 124 51 426 626

Additions – arising from TotalCare Flex contracts (non-cash) – – 75 – 75

Disposals of businesses (1) (3) – – (4)

Reclassifications 131 230 63 (424) –

Disposals/write-offs (11) (85) (49) – (145)

At 31 December 2016 1,667 4,599 491 765 7,522

Accumulated depreciation

At 1 January 2015 391 2,109 103 1 2,604

Exchange differences (7) (24) (1) – (32)

Charge for the year

48 299 26 – 373

Impairment 3 2 – – 5

Disposals of businesses – (1) – – (1)

Transferred to assets held for sale (5) (20) (1) – (26)

Disposals/write-offs (14) (81) (2) – (97)

At 1 January 2016 416 2,284 125 1 2,826

Exchange differences 44 182 4 – 230

Reclassification of joint ventures to joint operations 1 52 – – 53

Charge for the year

63 333 28 – 424

Impairment 1 – – 1 2

Disposals of businesses – (2) – – (2)

Reclassifications – (9) 9 – –

Disposals/write-offs

(10) (75) (40) – (125)

At 31 December 2016 515 2,765 126 2 3,408

Net book value

At 31 December 2016 1,152 1,834 365 763 4,114

At 31 December 2015 959 1,610 214 707 3,490

At 1 January 2015 943 1,491 218 794 3,446

Depreciation charged during the year is included in the income statement or included in the cost of inventory as appropriate.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

10 Property, plant and equipment continued

Property, plant and equipment includes:

2016

£m

2015

£m

Net book value of finance leased assets:

Land and buildings 5 5

Plant and equipment 6 7

Aircraft and engines 42 40

Assets held for use in operating leases:

Cost 413 321

Depreciation (108) (87)

Net book value 305 234

Capital expenditure commitments 252 167

Cost of fully depreciated assets 1,059 853

The Group’s share of equity accounted entities’ capital commitments is £72m (2015: £75m).

11 Investments

COMPOSITION OF THE GROUP

The entities contributing to the Group’s nancial results are listed on pages 170 to 175.

NON-CONTROLLING INTERESTS

The Group does not have any material non-wholly owned subsidiaries.

EQUITY ACCOUNTED AND OTHER INVESTMENTS

Equity accounted Other

Joint ventures

£m

Associates

£m

Total

£m

Unlisted

£m

At 1 January 2015 535 4 539 31

Exchange differences 7 – 7 (2)

Additions 12 3 15 6

Taxation paid by the Group (3) – (3) –

Share of retained profit/(loss) 42 (5) 37 –

Impairment – – – (2)

Share of OCI – may be reclassified to profit or loss (19) – (19) –

At 1 January 2016 574 2 576 33

Exchange differences 109 (2) 107 5

Increase in share in joint ventures 154 – 154 –

Other additions 20 10 30 –

Reclassification of joint ventures to joint operations (57) – (57) –

Share of retained profit/(loss) 44 (1) 43 –

Share of OCI – will not be reclassified to profit or loss (2) – (2) –

Share of OCI – may be reclassified to profit or loss (7) – (7) –

At 31 December 2016 835 9 844 38

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

11 Investments continued

The following joint ventures are considered to be individually material to the Group:

Principal location Activity Ownership interest

Alpha Partners Leasing Limited (APL) UK Aero engine leasing 50.0%

Hong Kong Aero Engine Services Limited (HAESL) Hong Kong Aero engine repair and overhaul 50.0% (45.0%)

Singapore Aero Engine Services Pte Limited (SAESL) Singapore Aero engine repair and overhaul 50.0% (39.0%)

Industria de Turbo Propulsores SA (ITP) Spain Aero engine component manufacture and maintenance 46.9%

Figures in brackets are 2015 ownership interest, if different. During 2016, the Group completed the changes to the Approved Maintenance Centres announced in November 2015,

resulting in increases in the ownership interests in HAESL and SAESL.

Summarised nancial information of the Group’s individually material joint ventures is as follows:

APL HAESL SAESL ITP

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Revenue 151 130 799 652 763 626 615 520

Profit for the year 58 65 233 27 33 46 50 40

Other comprehensive income – – – – – – – –

Total comprehensive income for the year 58 65 233 27 33 46 50 40

Dividends received during the year (27) (29) (237) (23) (24) (35) (19) (19)

Profit for the year included the following:

Depreciation and amortisation (82) (59) (10) (8) (12) (5) (45) (37)

Interest income – – – – – – 11 10

Interest expense (24) (17) (1) (1) (2) – (16) (16)

Income tax expense (5) (7) (8) (5) – – 7 7

Current assets 176 129 248 223 307 218 731 576

Non-current assets 1,888 1,349 105 85 167 125 701 626

Current liabilities (348) (70) (88) (116) (146) (75) (497) (416)

Non-current liabilities (1,296) (1,123) (79) (38) (143) (136) (485) (431)

Net assets 420 285 186 154 185 132 450 355

Included in the above:

Cash and cash equivalents 21 20 12 4 7 10 274 225

Current financial liabilities

(292) (19) (7) – – – (12) (25)

Non-current financial liabilities

(1,111) (969) (71) (30) (143) (136) (331) (273)

Excluding trade and other payables.

Reconciliation to the carrying amount recognised in the consolidated nancial statements

Ownership interest 50.0% 50.0% 50.0% 45.0% 50.0% 39.0% 46.9% 46.9%

Group share of net assets above 210 143 93 69 93 51 211 166

Goodwill – – 38 – 100 – – –

Adjustments for intercompany trading – – – – – – (43) (33)

Included in the consolidated balance sheet 210 143 131 69 193 51 168 133

On 11 July 2016, the Group announced that it will purchase the outstanding 53.1% shareholding in ITP owned by SENER Grupo de

Ingeniería SA (SENER). This follows a decision by SENER to exercise its put option. On 28 November 2016, and following due diligence, the

Group conrmed the valuation of €720m. Under the agreement, consideration will be settled over a two-year period following completion

in eight evenly spaced instalments of equal value. The updated agreement allows exibility to settle the consideration either in cash, in the

form of Rolls-Royce shares or any mixture of the two, as preferred by Rolls-Royce. A decision as to whether each payment will be settled in

cash, shares or cash and shares will be determined by Rolls-Royce during the payment period.

Completion remains subject to regulatory clearances and is expected in 2017.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

11 Investments continued

The summarised aggregated results of the Group’s share of all equity accounted investments is as follows:

Individually material

joint ventures (above) Other joint ventures Associates Total

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Assets:

Non-current assets 1,503 1,016 921 982 8 – 2,432 1,998

Current assets 710 523 383 320 1 2 1,094 845

Liabilities:

Current liabilities (524) (312) (266) (229) – – (790) (541)

Non-current liabilities (987) (831) (905) (895) – – (1,892) (1,726)

702 396 133 178 9 2 844 576

Liabilities include borrowings of (970) (700) (761) (773) – – (1,731) (1,473)

Profit for the year 84 82 34 23 (1) (5) 117 100

Other comprehensive income – – (7) (19) – – (7) (19)

Total comprehensive income for the year 84 82 27 4 (1) (5) 110 81

12 Inventories

2016

£m

2015

£m

Raw materials 529 509

Work in progress 1,199 882

Long-term contracts work in progress 18 23

Finished goods 1,312 1,173

Payments on account 28 50

3,086 2,637

Inventories stated at net realisable value 271 221

Amount of inventory write-down 74 64

Reversal of inventory write-down 8 14

13 Trade and other receivables

2016

£m

2015

£m

Trade receivables 1,945 1,612

Amounts recoverable on contracts

3,514 3,179

Amounts owed by joint ventures and associates 297 252

Other receivables 1,003 1,006

Prepayments and accrued income 197 195

6,956 6,244

Analysed as:

Financial instruments (note 17):

Trade receivables and similar items 2,470 2,061

Other non-derivative financial assets 811 843

Non-financial instruments 3,675 3,340

6,956 6,244

Trade and other receivables expected to be recovered in more than one year:

Trade receivables 81 57

Amounts recoverable on contracts 3,020 2,768

Amounts owed by joint ventures and associates – 1

Other receivables 109 131

Prepayments and accrued income 69 68

3,279 3,025

Amounts recoverable on contracts include £3,348m (2015: £2,994m) of TotalCare assets.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

14 Cash and cash equivalents

2016

£m

2015

£m

Cash at bank and in hand 872 662

Money-market funds 552 783

Short-term deposits 1,347 1,731

2,771 3,176

Overdrafts (note 15) – –

Cash and cash equivalents per cash flow statement (page 118) 2,771 3,176

Cash held as collateral against third party obligations (note 18) 38 35

Cash and cash equivalents at 31 December 2016 include £34m (2015: £21m) that is not available for general use by the Group. This balance

relates to cash held in non-wholly owned subsidiaries and the Group’s captive insurance company.

15 Borrowings

Current Non-current Total

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Unsecured

Overdrafts – – – – – –

Bank loans 169 217 271 330 440 547

⁄

% Notes 2016 £200m – 200 – – – 200

6.75% Notes 2019 £500m

– – 534 536 534 536

2.375% Notes 2020 US$500m

– – 403 333 403 333

2.125% Notes 2021 €750m

– – 682 576 682 576

3.625% Notes 2025 US$1,000m

– – 814 668 814 668

3.375% Notes 2026 £375m

– – 417 390 417 390

Secured

Obligations under finance leases

3 2 64 50 67 52

172 419 3,185 2,883 3,357 3,302

These notes are the subject of interest rate swap agreements under which the Group has undertaken to pay ﬂoating rates of interest which form a fair value hedge.

These notes are the subject of interest rate swap agreements under which the Group has undertaken to pay ﬂoating rates of interest, and currency swaps which form a fair value hedge.

Obligations under ﬁnance leases are secured by related leased assets.

16 Trade and other payables

Current Non-current Total

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Payments received on account

1,246 1,491 1,024 516 2,270 2,007

Trade payables 1,981 1,397 – 23 1,981 1,420

Amounts owed to joint ventures and associates 268 197 3 2 271 199

Other taxation and social security 93 90 – 1 93 91

Other payables 2,243 1,784 784 361 3,027 2,145

Accruals and deferred income 2,126 1,964 1,648 1,414 3,774 3,378

7,957 6,923 3,459 2,317 11,416 9,240

Includes payments received on account from joint ventures andassociates 140 161 17 35 157 196

Included within trade and other payables are government grants of £75m (2015: £64m). During the year, £11m (2015:£21m) of

government grants were released to the income statement.

Included in accruals and deferred income are deferred receipts from RRSA workshare partners of £233m (2015: £228m), £907m

(2015:£783m) of TotalCare liabilities and £671m (2015: nil) for nancial penalties from agreements with investigating bodies.

Trade and other payables are analysed as follows:

2016

£m

2015

£m

Financial instruments (note 17):

Trade payables and similar items 3,889 3,101

Other non-derivative financial liabilities 1,660 817

Non-financial instruments 5,867 5,322

11,416 9,240

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

17 Financial instruments

CARRYING VALUES AND FAIR VALUES OF FINANCIAL INSTRUMENTS

Notes

Basis for

determining

fair value

Assets Liabilities Total

Fair value

through

profit or loss

£m

Loans and

receivables

£m

Available

for sale

£m

Cash

£m

Fair value

through

profit or loss

£m

Other

£m £m

2016

Unlisted non-current asset investments

11 A – 38 – – – – 38

Trade receivables and similar items

13 B – 2,470 – – – – 2,470

Other non-derivative financial assets

13 B – 811 – – – – 811

Derivative financial assets

C 387 – – – – – 387

Short-term investments B – 3 – – – – 3

Cash and cash equivalents

14 B – 1,347 552 872 – – 2,771

Borrowings

15 D – – – – – (3,357) (3,357)

Derivative financial liabilities

C – – – – (5,636) – (5,636)

Financial RRSAs E – – – – – (101) (101)

TotalCare Flex

D – – – – – (15) (15)

C Shares

B – – – – – (28) (28)

Trade payables and similar items

16 B – – – – – (3,889) (3,889)

Other non-derivative financial liabilities

16 B – – – – – (1,660) (1,660)

387 4,669 552 872 (5,636) (9,050) (8,206)

2015

Unlisted non-current asset investments

11 A – 33 – – – – 33

Trade receivables and similar items 13 B – 2,061 – – – – 2,061

Other non-derivative financial assets

13 B – 843 – – – – 843

Derivative financial assets

C 112 – – – – – 112

Short-term investments

B – 2 – – – – 2

Cash and cash equivalents

14 B – 1,731 783 662 – – 3,176

Borrowings 15 D – – – – – (3,302) (3,302)

Derivative financial liabilities

C – – – – (1,843) – (1,843)

Financial RRSAs

E – – – – – (110) (110)

C Shares

B – – – – – (29) (29)

Trade payables and similar items 16 B – – – – – (3,101) (3,101)

Other non-derivative financial liabilities

16 B – – – – – (817) (817)

112 4,670 783 662 (1,843) (7,359) (2,975)

In the event of counterparty default relating to derivative financial assets and liabilities, offsetting would apply and financial assets and liabilities held with the same counterparty

would net off. If this occurred with every counterparty, total financial assets would be nil and liabilities £5,249m.

Fair values equate to book values for both 2016 and 2015, with the following exceptions:

2016 2015

Book value

£m

Fair value

£m

Book value

£m

Fair value

£m

Borrowings (3,357) (3,413) (3,302) (3,312)

Financial RRSAs (101) (109) (110) (110)

The fair value of a nancial instrument is the price at which an asset could be exchanged, or a liability settled, between knowledgeable,

willing parties in an arms-length transaction. Fair values have been determined with reference to available market information at the

balance sheet date, using the methodologies described below.

A These primarily comprise unconsolidated companies where fair value approximates to the book value.

B Fair values are assumed to approximate to cost either due to the short-term maturity of the instruments or because the interest rate of the investments is reset after periods not

exceeding six months.

C Fair values of derivative financial assets and liabilities are estimated by discounting expected future contractual cash ﬂows using prevailing interest rate curves. Amounts

denominated in foreign currencies are valued at the exchange rate prevailing at the balance sheet date. These financial instruments are included on the balance sheet at fair value,

derived from observable market prices (Level 2 as defined by IFRS 13 Fair Value Measurement).

D Borrowings and TotalCare Flex liabilities are carried at amortised cost. Amounts denominated in foreign currencies are valued at the exchange rate prevailing at the balance sheet

date. The fair value of borrowings is estimated by discounting contractual future cash flows. (Level 2 as defined by IFRS 13 Fair Value Measurement).

E The fair value of RRSAs is estimated by discounting expected future cash flows. The contractual cash flows are based on future trading activity, which is estimated based on latest

forecasts (Level 3 as defined by IFRS 13).

IFRS 13 Fair Value Measurement defines a three-level valuation hierarchy:

Level 1 – quoted prices for similar instruments

Level 2 – directly observable market inputs other than Level 1 inputs

Level 3 – inputs not based on observable market data

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

17 Financial instruments continued

CARRYING VALUES OF OTHER FINANCIAL ASSETS AND LIABILITIES

Foreign

exchange

contracts

£m

Commodity

contracts

£m

Interest rate

contracts

£m

Total

derivatives

£m

Financial

RRSAs

£m

TotalCare

Flex

£m

C Shares

£m

Total

£m

2016

Non-current assets 13 5 364 382 – – – 382

Current assets 4 1 – 5 – – – 5

Assets 17 6 364 387 – – – 387

Current liabilities (566) (24) – (590) (33) – (28) (651)

Non-current liabilities (5,002) (38) (6) (5,046) (68) (15) – (5,129)

Liabilities (5,568) (62) (6) (5,636) (101) (15) (28) (5,780)

(5,551) (56) 358 (5,249) (101) (15) (28) (5,393)

2015

Non-current assets 3 – 80 83 – – – 83

Current assets 29 – – 29 – – – 29

Assets 32 – 80 112 – – – 112

Current liabilities (244) (39) – (283) (19) – (29) (331)

Non-current liabilities (1,428) (65) (67) (1,560) (91) – – (1,651)

Liabilities (1,672) (104) (67) (1,843) (110) – (29) (1,982)

(1,640) (104) 13 (1,731) (110) – (29) (1,870)

Includes the foreign exchange impact of cross-currency interest rate swaps.

DERIVATIVE FINANCIAL INSTRUMENTS

The Group uses various ﬁnancial instruments to manage its exposure to movements in foreign exchange rates. Where the eﬀectiveness

ofa hedging relationship in a cash ow hedge is demonstrated, changes in the fair value that are deemed eﬀective are included in the cash

ow hedge reserve and released to match actual payments on the hedged item. The Group uses commodity swaps to manage its exposure

to movements in the price of commodities (jet fuel and base metals). To hedge the currency risk associated with a borrowing denominated

in US dollars, the Group has currency derivatives designated as part of fair value hedges. The Group uses interest rate swaps and forward

rate agreements to manage its exposure to movements in interest rates.

Movements in the fair values of derivative nancial assets and liabilities were as follows:

Foreign exchange instruments Commodity instruments Interest rate instruments Total

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

At 1 January (1,640) (639) (104) (43) 13 52 (1,731) (630)

Currency options at inception

(33) (20) – – – – (33) (20)

Movements in fair value hedges

– 1 – – 345 (36) 345 (35)

Movements in other derivativecontracts

(4,436) (1,217) 16 (89) – – (4,420) (1,306)

Contracts settled

558 235 32 28 – (3) 590 260

At 31 December (5,551) (1,640) (56) (104) 358 13 (5,249) (1,731)

The Group has written currency options to sell USD and buy GBP as part of a commercial agreement. The fair values of these options on inception are treated as a discount to the

customer.

Loss on related hedged items £345m (2015: £35m gain).

Included in financing.

Includes nil contracts settled in fair value hedges (2015: £8m).

FINANCIAL RISK AND REVENUE SHARING ARRANGEMENTS (RRSAS) AND OTHER FINANCIAL LIABILITIES

The Group has ﬁnancial liabilities arising from ﬁnancial RRSAs. These ﬁnancial liabilities are valued at each reporting date using the

amortised cost method. This involves calculating the present value of the forecast cash ﬂows of the arrangements using the internal rate

of return at the inception of the arrangements as the discount rate.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

17 Financial instruments continued

Movements in the carrying values were as follows:

Financial RRSAs TotalCare Flex

2016

£m

2015

£m

2016

£m

At 1 January (110) (145) –

Exchange adjustments included in OCI 5 – –

Additions – – (14)

Financing charge

(6) (8) (1)

Excluded from underlying profit:

Changes in forecast payments

5 11 –

Exchange adjustments

(13) (3) (3)

Cash paid to partners 18 35 –

Other –

–

At 31 December (101) (110) (15)

Included in financing.

RISK MANAGEMENT POLICIES AND HEDGING ACTIVITIES

The principal ﬁnancial risks to which the Group is exposed are: foreign currency exchange rate risk; liquidity risk; credit risk; interest rate

risk; and commodity price risk. The Board has approved policies for the management of these risks.

Foreign currency exchange rate risk – The Group has signiﬁcant cash ﬂows (most signiﬁcantly US dollars, followed by the euro)

denominated in currencies other than the functional currency of the relevant trading entity. To manage its exposures to changes in values

of future foreign currency cash ﬂows, so as to maintain relatively stable long-term foreign exchange rates on settled transactions, the

Group enters into derivative forward foreign currency transactions. For accounting purposes, these derivative contracts are not

designated as hedging instruments.

The Group also has exposures to the fair values of non-derivative ﬁnancial instruments denominated in foreign currencies. To manage the

risk of changes in these fair values, the Group enters into derivative forward foreign exchange contracts, which are designated as fair value

hedges for accounting purposes.

The Group regards its interests in overseas subsidiary companies as long-term investments. The Group aims to match its translational

exposures by matching the currencies of assets and liabilities. Where appropriate, foreign currency ﬁnancial liabilities may be designated

as hedges of the net investment.

Liquidity risk – The Group’s policy is to hold ﬁnancial investments and maintain undrawn committed facilities at a level sufﬁcient to

ensure that the Group has available funds to meet its medium-term capital and funding obligations and to meet any unforeseen

obligations and opportunities. The Group holds cash and short-term investments, which together with the undrawn committed facilities,

enable the Group to manage its liquidity risk.

Credit risk – The Group is exposed to credit risk to the extent of non-payment by either its customers or the counterparties of its ﬁnancial

instruments. The eﬀective monitoring and controlling of credit risk is a key component of the Group’s risk management activities. The

Group has credit policies covering both trading and ﬁnancial exposures. Credit risks arising from treasury activities are managed by a

central treasury function in accordance with the Group credit policy. The objective of the policy is to diversify and minimise the Group’s

exposure to credit risk from its treasury activities by ensuring the Group transacts strictly with ‘BBB+’ or higher-rated nancial institutions

based on pre-established limits per nancial institution. At the balance sheet date, there were no signiﬁcant concentrations of credit risk to

individual customers or counterparties. The maximum exposure to credit risk at the balance sheet date is represented by the carrying

value of each ﬁnancial asset, including derivative ﬁnancial instruments.

Interest rate risk – The Group’s interest rate risk is primarily in relation to its ﬁxed rate borrowings (fair value risk), ﬂoating rate borrowings

and cash and cash equivalents (cash ﬂow risk). Interest rate derivatives are used to manage the overall interest rate proﬁle within the

Group policy, which is to maintain a higher proportion of net debt at oating rates of interest as a natural hedge to the net cash position.

These are designated as either fair value or cash ﬂow hedges as appropriate.

Commodity risk – The Group has exposures to the price of jet fuel and base metals arising from business operations. To minimise its cash

ﬂow exposures to changes in commodity prices, the Group enters into derivative commodity transactions. For accounting purposes, these

derivative contracts are not designated as hedging instruments.

Other price risk – The Group’s cash equivalent balances represent investments in money-market instruments, with a term of up to three

months. The Group does not consider that these are subject to signiﬁcant price risk.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

17 Financial instruments continued

DERIVATIVE FINANCIAL INSTRUMENTS

The nominal amounts, analysed by year of expected maturity, and fair values of derivative nancial instruments are as follows:

Expected maturity Fair value

Nominal

amount

£m

Within

one year

£m

Between

one and

two years

£m

Between

two and

five years

£m

After

five years

£m

Assets

£m

Liabilities

£m

At 31 December 2016

Foreign exchange contracts:

Non-hedge accounted 29,327 5,826 4,867 15,011 3,623 17 (5,568)

Interest rate contracts:

Fair value hedges 2,735 – – 1,548 1,187 358 –

Non-hedge accounted – – – – – 6 (6)

Commodity contracts:

Non-hedge accounted 300 83 80 122 15 6 (62)

32,362 5,909 4,947 16,681 4,825 387 (5,636)

At 31 December 2015

Foreign exchange contracts:

Non-hedge accounted 22,418 5,736 4,266 11,637 779 32 (1,672)

Interest rate contracts:

Fair value hedges 2,437 – – 500 1,937 74 (61)

Non-hedge accounted – – – – – 6 (6)

Commodity contracts:

Non-hedge accounted 268 90 72 83 23 – (104)

25,123 5,826 4,338 12,220 2,739 112 (1,843)

As described above, all derivative ﬁnancial instruments are entered into for risk management purposes, although these may not be

designated into hedging relationships for accounting purposes.

CURRENCY ANALYSIS

Derivative nancial instruments related to foreign exchange risks are denominated in the following currencies:

Currencies purchased forward

Sterling

£m

US dollar

£m

Euro

£m

Other

£m

Total

£m

At 31 December 2016

Currencies sold forward:

Sterling – – 246 274 520

US dollar 25,330 – 1,885 984 28,199

Euro 36 148 – 196 380

Other 13 101 105 9 228

At 31 December 2015

Currencies sold forward:

Sterling – 383 – 221 604

US dollar 18,869 – 1,552 902 21,323

Euro 2 76 – 125 203

Other 131 12 143 2 288

Other derivative nancial instruments are denominated in the following currencies:

2016

£m

2015

£m

Sterling 875 875

US dollar 1,515 1,279

Euro 645 550

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

17 Financial instruments continued

Non-derivative nancial instruments are denominated in the following currencies:

Sterling

£m

US dollar

£m

Euro

£m

Other

£m

Total

£m

At 31 December 2016

Unlisted non-current investments – 1 36 1 38

Trade receivables and similar items 160 1,567 653 90 2,470

Other non-derivative financial assets 284 271 123 133 811

Short-term investments – – – 3 3

Cash and cash equivalents 1,134 831 507 299 2,771

Assets 1,578 2,670 1,319 526 6,093

Borrowings (1,194) (1,374) (783) (6) (3,357)

Financial RRSAs 9 (78) (32) – (101)

TotalCare Flex – (15) – – (15)

C Shares (28) – – – (28)

Trade payables and similar items (1,730) (1,437) (573) (149) (3,889)

Other non-derivative financial liabilities (889) (588) (138) (45) (1,660)

Liabilities (3,832) (3,492) (1,526) (200) (9,050)

(2,254) (822) (207) 326 (2,957)

At 31 December 2015

Unlisted non-current investments – 1 31 1 33

Trade receivables and similar items 131 1,228 613 89 2,061

Other non-derivative financial assets 280 350 102 111 843

Short-term investments – – – 2 2

Cash and cash equivalents 1,554 959 446 217 3,176

Assets 1,965 2,538 1,192 420 6,115

Borrowings (1,369) (1,162) (768) (3) (3,302)

Financial RRSAs – (75) (35) – (110)

C Shares (29) – – – (29)

Trade payables and similar items (1,536) (859) (523) (183) (3,101)

Other non-derivative financial liabilities (242) (303) (139) (133) (817)

Liabilities (3,176) (2,399) (1,465) (319) (7,359)

(1,211) 139 (273) 101 (1,244)

CURRENCY EXPOSURES

The Group’s actual currency exposures after taking account of derivative foreign currency contracts, which are not designated as hedging

instruments for accounting purposes are as follows:

Functional currency of Group operations

Sterling

£m

US dollar

£m

Euro

£m

Other

£m

Total

£m

At 31 December 2016

Sterling – (1) 3 – 2

US dollar (22) – (2) 19 (5)

Euro (2) (1) – 1 (2)

Other 3 9 18 2 32

At 31 December 2015

Sterling

– – 1 27 28

US dollar (12) 1 – 8 (3)

Euro 4 – – – 4

Other – 3 1 (1) 3

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

17 Financial instruments continued

AGEING BEYOND CONTRACTUAL DUE DATE OF FINANCIAL ASSETS

Within

terms

£m

Up to

three

months

overdue

£m

Between

three

months and

one year

overdue

£m

More than

one year

overdue

£m

Total

£m

At 31 December 2016

Unlisted non-current asset investments 38 – – – 38

Trade receivables and similar items 2,133 218 85 34 2,470

Other non-derivative financial assets 796 13 – 2 811

Derivative financial assets 387 – – – 387

Short-term investments 3 – – – 3

Cash and cash equivalents 2,771 – – – 2,771

6,128 231 85 36 6,480

At 31 December 2015

Unlisted non-current asset investments 33 – – – 33

Trade receivables and similar items 1,745 184 98 34 2,061

Other non-derivative financial assets 835 5 1 2 843

Derivative financial assets 112 – – – 112

Short-term investments 2 – – – 2

Cash and cash equivalents 3,176 – – – 3,176

5,903 189 99 36 6,227

CONTRACTUAL MATURITY ANALYSIS OF FINANCIAL LIABILITIES

Gross values

Within

one year

£m

Between

one and

two years

£m

Between

two and

five years

£m

After

five years

£m

Discounting

£m

Carrying

value

£m

At 31 December 2016

Borrowings (276) (114) (2,007) (1,458) 498 (3,357)

Derivative financial liabilities (604) (1,297) (3,190) (1,418) 873 (5,636)

Financial RRSAs (24) (26) (66) (2) 17 (101)

TotalCare Flex – – (18) – 3 (15)

C Shares (28) – – – – (28)

Trade payables and similar items (3,860) (15) – (14) – (3,889)

Other non-derivative financial liabilities (1,080) (68) (438) (74) – (1,660)

(5,872) (1,520) (5,719) (2,966) 1,391 (14,686)

At 31 December 2015

Borrowings (530) (161) (1,317) (1,897) 603 (3,302)

Derivative financial liabilities (286) (329) (1,026) (314) 112 (1,843)

Financial RRSAs (16) (20) (76) (10) 12 (110)

C Shares (29) – – – – (29)

Trade payables and similar items (3,059) (38) (4) – – (3,101)

Other non-derivative financial liabilities (640) (43) (74) (60) – (817)

(4,560) (591) (2,497) (2,281) 727 (9,202)

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

17 Financial instruments continued

INTEREST RATE RISK

In respect of income earning ﬁnancial assets and interest bearing ﬁnancial liabilities, the following table indicates their eﬀective interest

rates and the periods in which they reprice. The value shown is the carrying amount.

At 31 December 2016

Period in which interest

rate reprices

Effective

interest rate

Total

£m

6 months

or less

£m

6-12 months

£m

Short-term investments

3 1 2

Cash and cash equivalents

2,771 2,771 –

Unsecured bank loans

Other borrowings

(107) – –

£200m floating rate loan

GBP LIBOR + 1.26 (200) (200) –

£43m floating rate loan

GBP LIBOR + 0.402 (43) (43) –

€125m fixed rate loan

2.6000% – – –

€75m fixed rate loan

2.0600% (64) – –

€50m fixed rate loan

2.3500% (26) – –

Unsecured bond issues

6.75% Notes 2019 £500m

6.7500% (534) – –

Effect of interest rate swaps

GBP LIBOR + 2.9824 – (534) –

2.375% Notes 2020 $500m

2.3750% (403) – –

Effect of interest rate swaps

GBP LIBOR + 0.8410 – (403) –

2.125% Notes 2021 €750m

2.1250% (682) – –

Effect of interest rate swaps

GBP LIBOR +0.7005 – (682) –

3.625% Notes 2025 $1,000m

3.6250% (814) – –

Effect of interest rate swaps

GBP LIBOR + 1.4658 – (814) –

3.375% Notes 2026 £375m

3.3750% (417) – –

Effect of interest rate swaps

GBP LIBOR + 0.8930 – (417) –

Other secured

Obligations under finance leases

4.5488% (67) – –

(583)

At 31 December 2015

Period in which interest

rate reprices

Effective

interest rate

Total

£m

6 months

or less

£m

6-12 months

£m

Short-term investments

2 2 –

Cash and cash equivalents

3,176 3,176 –

Unsecured bank loans

Other borrowings (129) (1) –

£200m floating rate loan GBP LIBOR + 1.26 (200) (200) –

£43m floating rate loan GBP LIBOR + 0.402 (43) (43) –

€125m fixed rate loan 2.6000% (92) – –

€75m fixed rate loan 2.0600% (55) – –

€50m fixed rate loan 2.3500% (28) – –

Unsecured bond issues

⁄

% Notes 2016 £200m 7.3750% (200) – –

6.75% Notes 2019 £500m 6.7500% (536) – –

Effect of interest rate swaps GBP LIBOR + 2.9824 – (536) –

2.375% Notes 2020 $500m 2.3750% (333) – –

Effect of interest rate swaps GBP LIBOR + 0.8410 – (333) –

2.125% Notes 2021 €750m 2.1250% (576) – –

Effect of interest rate swaps GBP LIBOR + 0.7005 – (576) –

3.625% Notes 2025 $1,000m 3.6250% (668) – –

Effect of interest rate swaps GBP LIBOR + 1.4658 – (668) –

3.375% Notes 2026 £375m 3.3750% (390) – –

Effect of interest rate swaps GBP LIBOR + 0.8930 – (390) –

Other secured

Obligations under finance leases 4.1089% (52)

(124)

Interest on the short-term investments are at fixed rates.

Cash and cash equivalents comprise bank balances and demand deposits and earn interest at rates based on daily deposit rates.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

17 Financial instruments continued

Some of the Group’s borrowings are subject to the Group meeting certain obligations, including customary ﬁnancial covenants. If the

Group fails to meet its obligations these arrangements give rights to the lenders, upon agreement, to accelerate repayment of the

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.

In addition, the Group has £2,280m (2015: £1,780m) of undrawn committed borrowing facilities available for at least the next two years.

SENSITIVITY ANALYSIS

Sensitivities at 31 December (all other variables held constant) – impact on profit after tax and equity

2016

£m

2015

£m

Sterling 10% weaker against the US dollar (2,552) (1,574)

Sterling 10% stronger against the US dollar 2,089 1,288

Euro 10% weaker against the US dollar (158) (130)

Euro 10% stronger against the US dollar 133 111

Sterling 10% weaker against the Euro 26 18

Sterling 10% stronger against the Euro (21) (15)

Commodity prices 10% lower (19) (13)

Commodity prices 10% higher 19 13

At 31 December 2016 the Group had no material sensitivity to changes in interest rates on that date. The main interest rate sensitivity for

the Group arises as a result of the gross up of net cash and this is mitigated as described under the interest rate risk management policies

on page 185.

C SHARES AND PAYMENTS TO SHAREHOLDERS

The Company issues non-cumulative redeemable preference shares (C Shares) as an alternative to paying a cash dividend. C Shares in

respect of a year are issued in the following year. Shareholders are able to redeem any number of their C Shares for cash. Any C Shares

retained attract a dividend of 75% of LIBOR on the 0.1p nominal value of each share, paid on a twice-yearly basis, and have limited voting

rights. The Company has the option to compulsorily redeem the C Shares, at any time, if the aggregate number of C Shares in issue is less

than 10% of the aggregate number of C Shares issued, or on the acquisition or capital restructuring of the Company.

Movements in issued and fully paid C Shares during the year were as follows:

2016 2015

Millions

Nominal

value

£m Millions

Nominal

value

£m

At 1 January 28,960 29 22,005 22

Issued 300,993 301 429,536 430

Redeemed (301,828) (302) (422,581) (423)

At 31 December 28,125 28 28,960 29

Payments to shareholders in respect of the year represent the value of C Shares to be issued in respect of the results for the year. Issues of

CShares were declared as follows:

2016 2015

Pence

per share £m

Pence

per share £m

Interim 4.60 85 9.27 170

Final 7.10 130 7.10 131

11.70 215 16.37 301

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

18 Provisions for liabilities and charges

1 January

2016

£m

Exchange

differences

£m

Unused

amounts

reversed

£m

Charged to

income

statement

£m

Utilised

£m

31 December

2016

£m

Warranties and guarantees

381 55 (24) 171 (109) 474

Contract loss 36 7 (4) 18 (3) 54

Restructuring 66 3 (19) 35 (41) 44

Customer financing 20 – – 5 (6) 19

Insurance 67 – (24) 36 (11) 68

Other 70 10 (27) 104 (57) 100

640 75 (98) 369 (227) 759

Current liabilities 336 543

Non-current liabilities 304 216

During 2016, following a review of consistency, £92m of accruals have been reclassified as provisions. Prior figures have not been restated.

Provisions for warranties and guarantees primarily relate to products sold and generally cover a period of up to three years.

Provisions for contract loss and restructuring are generally expected to be utilised within two years.

In connection with the sale of its products the Group will, on some occasions, provide ﬁnancing support for its customers – generally inrespect

of civil aircraft. The Group’s commitments relating to these ﬁnancing arrangements are spread over many years, relate toanumber of customers

and a broad product portfolio and are generally secured on the asset subject to the nancing. These include commitments of US$3.2bn

(2015:US$3.1bn) to provide borrowing facilities to enable customers to purchase aircraft (of which approximately US$421m could be called

during 2017). These facilities may only be used if the customer is unable to obtain nancing elsewhere and are priced at a premium to the market

rate. Consequently the Directors do not consider that there is a signicant exposure arising from the provision ofthese facilities.

Customer nancing provisions cover guarantees provided for asset value and/or nancing. These guarantees, the risks arising and the

process used to assess the extent of the risk are described under the heading ‘Customer nancing’ in the Financial review on page 39.

It is estimated that the provision will be utilised as follows:

2016

£m

2015

£m

Potential claims with specific claim dates:

In one year or less 2 3

In more than one year but less than five years 12 12

In more than five years 5 5

19 20

Commitments on delivered aircraft in excess of the amounts provided are shown in the table below. These are reported on a discounted

basis at the Group’s borrowing rate to reﬂect better the time span over which these exposures could arise. These amounts do not represent

values that are expected to crystallise. The commitments are denominated in US dollars. As the Group does not generally adopt cash ow

hedge accounting for future foreign exchange transactions, this amount is reported, together with the sterling equivalent at the reporting

date spot rate. The values of aircraft providing security are based on advice from a specialist aircraft appraiser.

2016 2015

£m $m £m $m

Gross commitments 238 293 269 399

Value of security

(103) (126) (136) (201)

Indemnities (74) (91) (79) (118)

Net commitments 61 76 54 80

Net commitments with security reduced by 20%

86 106 78 115

Security includes unrestricted cash collateral of: 38 47 35 52

Although sensitivity calculations are complex, the reduction of relevant security by 20% illustrates the sensitivity to changes in this assumption.

The Group’s captive insurance company retains a portion of the exposures it insures on behalf of the remainder of the Group. Signicant

delays occur in the notication and settlement of claims and judgement is involved in assessing outstanding liabilities, the ultimate cost

and timing of which cannot be known with certainty at the balance sheet date. The insurance provisions are based on information

currently available, however it is inherent in the nature of the business that ultimate liabilities may vary. Provisions for outstanding claims

are established to cover the outstanding expected liability as well as claims incurred but not yet reported.

Other provisions comprise a number of liabilities with varying expected utilisation rates.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

19 Post-retirement benefits

The Group operates a number of dened benet and dened contribution schemes:

• The UK defined benefit scheme is funded, with the assets held in a separate trustee administered funds. Employees are entitled to

retirement benefits based on either their final or career average salaries and length of service.

• Overseas defined benefit schemes are a mixture of funded and unfunded plans and provide benefits in line with local practice.

Additionally in the US, and to a lesser extent in some other countries, the Group’s employment practices include the provision of

healthcare and life insurance benefits for retired employees. These schemes are unfunded.

The valuations of the dened benet schemes are based on the most recent funding valuations, where relevant, updated by the scheme

actuaries to 31 December 2016.

The dened benet schemes expose the Group to actuarial risks such as longevity, interest rate, ination and investment risks. In the UK,

and in the principal US pension schemes, the Group has adopted investment policies to mitigate some of these risks. This involves

investing a signicant proportion of the schemes’ assets in Liability Driven Investment portfolios, which hold investments designed to

oﬀset interest rate and ination rate risks. In addition, in the UK, the scheme has invested in a longevity swap, which is designed to oﬀset

longevity risks in respect of approximately two thirds of current pensioners.

During the year, the Group has restructured its UK dened benet arrangements. Four of the ve UK schemes have been merged together

into a consolidated scheme, renamed the ‘Rolls-Royce UK Pension Fund’. All future dened benet accrual will be provided from this

scheme, limited to employees who joined the Company before 1 April 2007. The scheme merger will simplify future administration and

governance. As part of this merger, the three transferring schemes are being wound up. Members of these schemes with benets below

statutory limits were oﬀered lump sums in exchange for their existing benets, which resulted in a settlement charge of £2m.

The liabilities of the fth scheme, the Vickers Group Pension Scheme, have been fully bought-out with a UK insurance company, Legal &

General Assurance Company Limited, resulting in a settlement charge of £301m. This scheme is expected to be wound up in 2017.

Neither of these transactions required any additional funding by the Group.

AMOUNTS RECOGNISED IN THE INCOME STATEMENT

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

Defined benefit schemes:

Current service cost and administrative expenses

169 50 219 169 52 221

Past-service (credit)/cost (22) 1 (21) (16) 8 (8)

Settlements

302 10 312 – – –

449 61 510 153 60 213

Defined contribution schemes 29 87 116 33 85 118

Operating cost 478 148 626 186 145 331

Net financing (credit)/charge in respect of defined benefit schemes (41) 38 (3) (65) 33 (32)

Total income statement charge 437 186 623 121 178 299

£306m of costs have been excluded from the underlying results, comprising: £301m settlement cost on the buy-out of the Vickers Group Pension Scheme; £3m of administrative expenses on the

restructuring all the UK defined benefit plans; and £2m settlement cost in relation to winding-up lump sums on small pensions as a consequence of the restructuring.

The operating cost is charged as follows:

Defined benefit Defined contribution Total

2016

£m

2015

£m

2016

£m

2015

£m

2016

£m

2015

£m

Cost of sales 133 147 72 80 205 227

Commercial and administrative costs 343 32 27 21 370 53

Research and development 34 34 17 17 51 51

510 213 116 118 626 331

Pension contributions to UK pension arrangements are generally paid via a salary sacrice scheme under which employees agree to a

reduction in gross contractual pay in return for the Group making additional pension contributions on their behalf. As a result, there is a

decrease in wages and salaries and a corresponding increase in pension costs of £31m (2015 £32m) in the year.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

19 Post-retirement benefits continued

Net nancing comprises:

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

Financing on scheme obligations 385 65 450 375 57 432

Financing on scheme assets (426) (27) (453) (440) (24) (464)

Net financing (income)/charge in respect of defined benefit schemes (41) 38 (3) (65) 33 (32)

Financing income on scheme surpluses (41) (1) (42) (65) – (65)

Financing cost on scheme deficits – 39 39 – 33 33

AMOUNTS RECOGNISED IN OCI IN RESPECT OF DEFINED BENEFIT SCHEMES

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

Actuarial gains and losses arising from demographic assumptions 566 12 578 (185) 8 (177)

Actuarial gains and losses arising from financial assumptions (2,360) (90) (2,450) (70) 70 –

Actuarial gains and losses arising from experience adjustments (16) 52 36 56 8 64

Return on scheme assets excluding financing income 2,326 5 2,331 (593) (16) (609)

516 (21) 495 (792) 70 (722)

AMOUNTS RECOGNISED IN THE BALANCE SHEET IN RESPECT OF DEFINED BENEFIT SCHEMES

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

Present value of funded obligations (12,014) (798) (12,812) (10,914) (650) (11,564)

Fair value of scheme assets 13,350 747 14,097 11,957 597 12,554

Net asset/(liability) on funded schemes 1,336 (51) 1,285 1,043 (53) 990

Present value of unfunded obligations – (1,314) (1,314) – (1,067) (1,067)

Net asset

/(liability) recognised in the balance sheet 1,336 (1,365) (29) 1,043 (1,120) (77)

Post-retirement scheme surpluses 1,336 10 1,346 1,059 4 1,063

Post-retirement scheme deficits – (1,375) (1,375) (16) (1,124) (1,140)

The surplus in the UK scheme is recognised as, on ultimate wind-up when there are no longer any remaining beneficiaries, any surplus would be returned to the Group, which has the

power to prevent the surplus being used for other purposes in advance of this event.

Overseas schemes are located in the following countries:

2016 2015

Assets

£m

Obligations

£m

Net

£m

Assets

£m

Obligations

£m

Net

£m

Canada 194 (243) (49) 152 (188) (36)

Germany – (717) (717) – (553) (553)

US pension schemes 553 (631) (78) 429 (513) (84)

US healthcare schemes – (497) (497) – (426) (426)

Other – (24) (24) 16 (37) (21)

Net asset/(liability) recognised in the balance sheet 747 (2,112) (1,365) 597 (1,717) (1,120)

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

19 Post-retirement benefits continued

DEFINED BENEFIT SCHEMES’ ASSUMPTIONS

Signicant actuarial assumptions for the UK schemes used at the balance sheet date were as follows:

2016 2015

Discount rate 2.70% 3.60%

Inflation assumption (RPI)

3.50% 3.25%

Rate of increase in salaries 4.25% 4.00%

Life expectancy from age 65: current male pensioner 22.7 years 22.8 years

future male pensioner currently aged 45 24.3 years 24.8 years

current female pensioner 24.1 years 24.2 years

future female pensioner currently aged 45 26.4 years 27.0 years

This is the assumption for the Retail Price Index. The Consumer Price Index is assumed to be 1.1% lower.

Discount rates are determined by reference to the market yields on AA rated corporate bonds. The rate is determined by using the prole

of forecast benet payments to derive a weighted average discount rate from the yield curve.

The ination assumption is determined by the market implied assumption based on the yields on long-term indexed linked government

securities and increases in salaries are based on actual experience, allowing for promotion, of the real increase above ination.

The mortality assumptions adopted for the UK pension schemes are derived from the SAP actuarial tables, with future improvements in

line with the CMI 2016 Proposed 2015 core projections and long-term improvements of 1.5%. Where appropriate, these are adjusted to

take account of the relevant scheme’s actual experience.

Other assumptions have been set on advice from the relevant actuary, having regard to the latest trends in scheme experience and the

assumptions used in the most recent funding valuation. The rate of increase of pensions in payment is based on the rules of the relevant

scheme, combined with the ination assumption where the increase is capped.

Assumptions for overseas schemes are less signicant and are based on advice from local actuaries. The principal assumptions are:

2016 2015

Discount rate 3.3% 3.6%

Inflation assumption 2.1% 2.2%

Long-term healthcare cost trend rate 4.8% 5.0%

Male life expectancy from age 65: current pensioner 21.0 years 21.1 years

future pensioner currently aged 45 22.5 years 23.3 years

Changes in present value of dened benet obligations

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

At 1 January (10,914) (1,717) (12,631) (10,606) (1,773) (12,379)

Exchange differences – (339) (339) – 17 17

Current service cost (160) (48) (208) (164) (50) (214)

Past service cost 22 (1) 21 16 (5) 11

Finance cost (385) (64) (449) (375) (58) (433)

Contributions by employees (3) (2) (5) (3) (4) (7)

Benefits paid out 430 79 509 417 75 492

Actuarial (losses)/gains (1,810) (27) (1,837) (199) 84 (115)

Settlement 806 10 816 – – –

Other movements

–

(3) (3) – (3) (3)

At 31 December (12,014) (2,112) (14,126) (10,914) (1,717) (12,631)

Funded schemes (12,014) (798) (12,812) (10,914) (650) (11,564)

Unfunded schemes – (1,314) (1,314) – (1,067) (1,067)

The defined benefit obligations are in respect of:

Active plan participants (5,279) (1,120) (6,399) (4,273) (921) (5,194)

Deferred plan participants (2,146) (154) (2,300) (1,946) (130) (2,076)

Pensioners (4,589) (838) (5,427) (4,695) (666) (5,361)

Weighted average duration of obligations (years) 20 16 19 18 16 17

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

19 Post-retirement benefits continued

Changes in fair value of scheme assets

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

At 1 January 11,957 597 12,554 12,341 593 12,934

Exchange differences – 131 131 – (2) (2)

Administrative expenses (9) (2) (11) (5) (2) (7)

Financing 426 27 453 440 24 464

Return on plan assets excluding financing 2,326 5 2,331 (593) (16) (609)

Contributions by employer 185 86 271 188 71 259

Contributions by employees 3 2 5 3 4 7

Benefits paid out (430) (79) (509) (417) (75) (492)

Settlements/curtailment (1,108) (20) (1,128) – – –

At 31 December 13,350 747 14,097 11,957 597 12,554

Total return on scheme assets 2,752 32 2,784 (153) 8 (145)

Fair value of scheme assets at 31 December

2016 2015

schemes

£m

Overseas

schemes

£m

Total

£m

schemes

£m

Overseas

schemes

£m

Total

£m

Sovereign debt 7,574 335 7,909 7,283 297 7,580

Derivatives on sovereign debt – 3 3 (5) (1) (6)

Corporate debt instruments 3,061 297 3,358 1,977 239 2,216

Interest rate swaps 2,063 – 2,063 1,868 – 1,868

Inflation swaps (420) – (420) (477) – (477)

Cash and similar instruments (51) 18 (33) 118 21 139

Liability driven investment (LDI) portfolios

12,227 653 12,880 10,764 556 11,320

Longevity swap

(175) – (175) (142) – (142)

Listed equities 969 82 1,051 810 1 811

Unlisted equities 214 – 214 232 – 232

Sovereign debt – 4 4 110 3 113

Corporate debt instruments – – – 24 – 24

Cash 25 9 34 68 21 89

Other 90 (1) 89 91 16 107

13,350 747 14,097 11,957 597 12,554

A portfolio of gilt and swap contracts, backed by investment grade credit instruments and LIBOR generating assets, that is designed to hedge the majority of the interest rate and

inflation risks associated with the schemes’ obligations.

Under the longevity swap, the Rolls-Royce UK Pension Fund has agreed an average life expectancy of pensioners with a counterparty. If pensioners live longer than expected the

counterparty will make payments to the Fund to offset the additional cost of paying pensioners. If the reverse applies the cost of paying pensioners will be reduced but the scheme

will be required to make payments to the counterparty. The longevity swap is valued at fair value in accordance with IFRS 13 (Level 3).

The investment strategy for the UK scheme is controlled by the Trustee in consultation with the Company. The scheme assets do not include any

of the Group’s own ﬁnancial instruments, nor any property occupied by, or other assets used by, the Group. The longevity swap is valued by the

scheme actuaries based on the diﬀerence between the agreed longevity assumptions at inception and actual longevity experience. All other fair

values are provided by the fund managers. Where available, the fair values are quoted prices (eg. listed equity, sovereign debt and corporate

bonds). Unlisted investments (private equity) are included at values provided by the fund manager in accordance with relevant guidance. Other

signicant assets are valued based on observable inputs such as yield curves.

FUTURE CONTRIBUTIONS

The Group expects to contribute approximately £210m to its dened benet schemes in 2017.

In the UK, the funding is based on a statutory triennial funding valuation process. This includes a negotiation between the Group and the

Trustee on actuarial assumptions used to value obligations (Technical Provisions or TPs) which may diﬀer from those used for accounting

set out above. In particular, the discount rate used to value TPs must be prudent and take account of the investment strategy, rather than

being based on yields of AA corporate bonds. Following the triennial valuation process, a Schedule of Contributions (SoC) must be agreed

which sets out the required contribution for current service. If the scheme is in decit, the SoC must also include agreed contributions

from the employer to eliminate any decit. The most recent update provided to the Trustee, as at 30 September 2016, showed that the UK

scheme was estimated to be 108% funded on a provisional TPs basis calculated using a discount rate equal to UK Government bond yields

plus 0.5%. Contributions to this scheme are currently being paid in line with the SoCs of the predecessor schemes in place pre-merger,

which result in an average contribution rate of 30.8% of salary.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

19 Post-retirement benefits continued

The rst consolidated funding valuation is planned to be undertaken as at 31 March 2017. Any adjustment to contributions payable

following this valuation are expected to take eﬀect in 2018.

Sensitivities

The calculations of the dened benet obligations are sensitive to the assumptions set out above. The following table summarises how the

estimated impact of a change in a signicant assumption would aﬀect the UK dened benet obligation at 31 December 2016, while holding all

other assumptions constant. This sensitivity analysis may not be representative of the actual change in the dened benet obligation as it is

unlikely that the change in assumptions would occur in isolation of one another as some of the assumptions may be correlated.

For the most signicant funded schemes, the investment strategies hedge the risks from interest rates and ination measured on a proxy

solvency basis. For the UK scheme, the interest rate and ination hedging is currently based on UK Government bond yields without any

adjustment for any credit spread . The longevity risk of approximately two thirds of UK pensioner liabilities is also hedged. Where appropriate, the

table also includes the corresponding movement in the value of the plan assets.

2016

£m

2015

£m

Reduction in the discount rate of 0.25%

Obligation (625) (524)

Plan assets (LDI portfolio) 630 569

Increase in inflation of 0.25%

Obligation (320) (249)

Plan assets (LDI portfolio) 272 231

Real increase in salaries of 0.25% Obligations

(115) (91)

One year increase in life expectancy Obligations 415 (308)

The differences between the sensitivities on obligations and plan assets arise largely due to differences in the methods used to value the obligations for accounting purposes and the

adopted proxy solvency basis. On a UK Government bond yield basis the correlation is approximately 86% for discount rates and 89% for inflation.

20 Share capital

Non-equity Equity

Special

of £1

Nominal

value

£m

Ordinary

of 20p each

millions

Nominal

value

£m

Issued and fully paid

At 1 January 2015 1 – 1,882 376

Purchase and cancellation of ordinary shares (44) (9)

At 1 January 2016 1 – 1,838 367

Purchase and cancellation of ordinary shares – – – –

At 31 December 2016 1 – 1,838 367

The rights attaching to each class of share are set out on page 186.

In accordance with IAS 32 Financial Instruments: Presentation, the Company’s non-cumulative redeemable preference shares (C Shares) are

classied as nancial liabilities. Accordingly, movements in C Shares are included in note 17.

21 Share-based payments

EFFECT OF SHARE-BASED PAYMENT TRANSACTIONS ON THE GROUP’S RESULTS AND FINANCIAL POSITION

2016

£m

2015

£m

Total expense recognised for equity-settled share-based payments transactions 34 6

Total credit recognised for cash-settled share-based payments transactions 1 (1)

Share-based payments recognised in the consolidated income statement 35 5

Liability for cash-settled share-based payment transactions 1 –

A description of the share-based payment plans is included in the Directors’ remuneration report on pages 83 to 95.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

21 Share-based payments continued

MOVEMENTS IN THE GROUP’S SHARE-BASED PAYMENT PLANS DURING THE YEAR

ShareSave PSP APRA

Number

Millions

Weighted

average

exercise price

Pence

Number

Millions

Number

Millions

Outstanding at 1 January 2015 24.5 660 9.8 2.4

Granted 13.0 617 3.0 –

Additional entitlements arising from TSR performance – – 0.5 –

Forfeited (4.6) 908 (2.9) (0.1)

Exercised (9.7) 445 (1.7) (1.4)

Outstanding at 1 January 2016

23.2 677 8.7 0.9

Granted

– – 7.3 –

Forfeited

(1.7) 752 (3.4) –

Exercised

(0.1) 538 (1.0) (0.9)

Outstanding 31 December 2016

21.4 672 11.6 –

Exercisable at 31 December 2016

– – – –

Exercisable at 31 December 2015

– – – –

As share options are exercised throughout the year, the weighted average share price during the year of 682p (2015: 820p) is representative

of the weighted average share price at the date of exercise. The closing price at 31 December 2016 was 668p (2015: 575p).

FAIR VALUES OF SHARE-BASED PAYMENT PLANS

The weighted average fair value per share of equity-settled share-based payment plans granted during the year, estimated at the date

ofgrant, are as follows:

2016 2015

PSP – 25% TSR uplift 714p 1,015p

PSP – 30% TSR uplift 731p n/a

PSP – 50% TSR uplift 795p 1,036p

ShareSave – three-year grant n/a 192p

ShareSave – five-year grant n/a 219p

APRA n/a n/a

PSP

The fair value of shares awarded under the PSP is calculated using a pricing model that takes account of the non-entitlement to dividends

(orequivalent) during the vesting period and the market-based performance condition based on expectations about volatility and the correlation

of share price returns in the group of FTSE 100 companies and which incorporates into the valuation the interdependency between share price

performance and TSR vesting. This adjustment increases the fair value of the award relative to the share price at the date of grant.

ShareSave

The fair value of the options granted under the ShareSave plan is calculated using a binomial pricing model that assumes that participants

will exercise their options at the beginning of the six-month window if the share price is greater than the exercise price. Otherwise it

assumes that options are held until the expiration of their contractual term. This results in an expected life that falls somewhere between

the start and end of the exercise window.

APRA

The fair value of shares awarded under APRA is calculated as the share price on the date of the award, excluding expected dividends

(orequivalent).

22 Leases

OPERATING LEASES

Leases as lessee

2016

£m

2015

£m

Rentals paid – hire of plant and machinery 48 24

– hire of other assets 176 222

Non-cancellable operating lease rentals are payable as follows:

Within one year 200 190

Between one and five years 548 488

After five years 469 496

1,217 1,174

2015 figures have been re-presented to follow the ‘property, plant and equipment’ classification of aero engines, with aero engine costs of £98m previously reported as ‘hire of plant

and machinery’ being reclassified as ‘hire of other assets’ to ensure consistent treatment with 2016.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

22 Leases continued

Leases as lessor

2016

£m

2015

£m

Rentals received – credited within revenue from aftermarket services 35 25

Non-cancellable operating lease rentals are receivable as follows:

Within one year 11 12

Between one and five years 35 18

After five years 27 8

73 38

The Group acts as lessee and lessor for both land and buildings and gas turbine engines, and acts as lessee for some plant and equipment.

• Sublease payments of £1m (2015: £1m) and sublease receipts of £35m (2015: £25m) were recognised in the income statement in the year.

• Purchase options exist on aero engines, land and buildings and plant and equipment with the period to the purchase option date

varying between one to eight years.

• Renewal options exist on aero engines, land and buildings and plant and equipment with the period to the renewal option varying

between one to 51 years at terms to be negotiated upon renewal.

• Escalation clauses exist on some leases and are linked to LIBOR.

• The total future minimum sublease payments expected to be made is £2m (2015: £3m) and sublease receipts expected to be received

are £49m (2015: £24m).

FINANCE LEASES

Finance lease liabilities are payable as follows:

2016 2015

Payments

£m

Interest

£m

Principal

£m

Payments

£m

Interest

£m

Principal

£m

Within one year 7 3 4 5 2 3

Between one and five years 30 10 20 18 8 10

After five years 54 8 46 46 7 39

91 21 70 69 17 52

23 Contingent liabilities

Contingent liabilities in respect of customer nancing commitments are described in note 18.

On 6 December 2012, the Company announced that it had passed information to the Serious Fraud Oﬃce (SFO), following a request from

the SFO for information about allegations of malpractice in overseas markets. On 23 December 2013, the Company announced that it had

been informed by the SFO that it had commenced a formal investigation. Since the initial announcement, the Company continued its

investigations and engaged with the SFO and other authorities in the UK, the US and elsewhere in relation to the matters of concern.

In January 2017, after full cooperation, the Company concluded deferred prosecution agreements with the SFO and the US Department of Justice

and a leniency agreement with the MPF, the Brazilian federal prosecutors which are described on page 8. Prosecutions of individuals may follow

and investigations may be commenced in other jurisdictions. In addition, we could still be aﬀected by actions from customers and customers’

nanciers. The Directors are not currently aware of any matters that are likely to lead to a nancial loss, but cannot anticipate all the possible

actions that may be taken or their potential consequences.

Contingent liabilities exist in respect of guarantees provided by the Group in the ordinary course of business for product delivery,

performance and reliability. The Group has, in the normal course of business, entered into arrangements in respect of export ﬁnance,

performance bonds, countertrade obligations and minor miscellaneous items. Various Group undertakings are parties to legal actions

and claims which arise in the ordinary course of business, some of which are for substantial amounts. As a consequence of the

insolvency of an insurer as previously reported, the Group is no longer fully insured against known and potential claims from

employees who worked for certain of the Group’s UK-based businesses for a period prior to the acquisition of those businesses by the

Group. While the outcome of some of these matters cannot precisely be foreseen, the Directors do not expect any of these

arrangements, legal actions or claims, after allowing for provisions already made, to result in signiﬁcant loss to the Group.

The Group’s share of equity accounted entities’ contingent liabilities is £12m (2015: £11m).

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

24 Related party transactions

2016

£m

2015

£m

Sales of goods and services to joint ventures and associates 2,022 1,896

Purchases of goods and services from joint ventures and associates (1,881) (2,266)

Operating lease payments to joint ventures and associates (101) (88)

Guarantees of joint ventures' and associates' borrowings 5 9

Dividends received from joint ventures and associates 74 63

RRSA receipts from joint ventures and associates 22 16

Other income received from joint ventures and associates 2 2

Included in sales of goods and services to joint ventures and associates are sales of spare engines amounting to £356m (2015: £189m).

Protrecognised in the year on such sales amounted to £119m (2015: £71m), including prot on current year sales and recognition of

prot deferred on sales in previous years. On an underlying basis (at actual achieved rates on settled derivative transactions), the amounts

were £97m (2015: £67m).

The aggregated balances with joint ventures are shown in notes 13 and 16. Transactions with Group pension schemes are shown in note 19.

In the course of normal operations, related party transactions entered into by the Group have been contracted on an arms-length basis.

Key management personnel are deemed to be the Directors and the members of the ELT as set out on pages 54 to 57 and 64. Remuneration

for key management personnel is shown below:

2016

£m

2015

£m

Salaries and short-term benefits 13 8

Post-retirement schemes – –

Share-based payments 1 –

14 8

More detailed information regarding the Directors’ remuneration, shareholdings, pension entitlements, share options and other long-term

incentive plans is shown in the Directors’ Remuneration Report on pages 83 to 95. The charge for share-based payments above is based on

when the award is charged to the income statement in accordance with IFRS 2 Share-Based Payments, rather than when the shares vest,

which is the basis used in the Directors’ Remuneration Report.

25 Acquisitions and disposals

ACQUISITIONS

During 2016, the Group acquired trade and assets from Fluid Mechanics Inc. for £6m, giving rise to goodwill of £1m.

DISPOSALS

During 2016, the Group completed the sales of: its rigid pipes business in the UK and China to Sigma Precision Components Limited for

consideration of £4m; and Allen Diesels for consideration of £3m.

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

26 Derivation of summary funds flow statement

2016 2015

£m £m £m £m

Source

*Underlying profit before tax (PBT) – page 166 813  1,432 

Depreciation of property, plant and equipment 426 378  Cash flow statement (CFS)

Amortisation of intangible assets 628 432  CFS

Impairment of goodwill (219) (75) Reversal of adjustment in underlying PBT

Impairment of investments – 2 CFS

Acquisition accounting

(115) (124)

 Reversal of adjustment in underlying PBT

*Depreciation and amortisation 720  613 

(Increase)/decrease in inventories (161) 63  CFS

Decrease/(increase) in trade and other receivables 312 (836) 

CFS adjusted for non-underlying exchanges

differences of £258m

(Decrease)/increase in trade and other payables (273) 242 

CFS adjusted for non-underlying exchanges

differences of £507m

Revaluation of trading assets

67 (13)

Reversal of adjustment in underlying PBT

*Movement on net working capital (55)  (544) 

Additions of intangible assets (631) (408)  CFS

Purchases of property, plant and equipment (585) (487)  CFS

Government grants received

15 8

CFS

* Expenditure on PP&E and intangible assets (1,201)  (887) 

Realised losses on hedging instruments 426 287  Reversal of adjustment in underlying PBT

Net unrealised fair value to changes to derivatives – (9)  Reversal of adjustment in underlying PBT

Foreign exchange on contract accounting 77 (9)  Reversal of adjustment in underlying PBT

Exceptional restructuring (129) (49)  Reversal of adjustment in underlying PBT

Other (1) (1)  Reversal of adjustment in underlying PBT

Underlying financing 102 60  Reversal of charge in underlying PBT

Non-underlying exchange differences on receivables (258) −  Reversal of adjustment above

Non-underlying exchange differences on payables 507 −  Reversal of adjustment above

Loss on disposal of property, plant and equipment 5 8  CFS

Joint ventures (43) (37)  JV dividends less share of results – CFS

Increase/(decrease) in provisions 44 (151)  CFS

Cash flows on other financial assets and liabilities (608) (305)  CFS

Share-based payments 35 5  CFS

Additions of unlisted investments – (6) CFS

Disposal of intangible assets 8 4 CFS

Disposal of property, plant and equipment 8 33  CFS

Investments in joint ventures and associates (30) (15)  CFS

Net interest (72) (55)  Interest received and paid – CFS

Net funds of JVs reclassified to joint operations (4) Net cash and borrowings reclassified – CFS

Issue of ordinary shares 1 32 CFS

Purchase of ordinary shares for share schemes

(21) (21)

 CFS, 2015 includes £19m from share buyback

*Other 47  (229) 

*Trading cash flow 324  385 

Net defined benefit plans – underlying operating charge 204 213  CFS

Cash funding of defined benefit plans

(271) (259)

 CFS

*Contributions to defined benefit schemes

in excess of underlying PBT charge (67) (46)

*Tax (157)  (160) CFS

*Free cash flow 100  179 

*Shareholder payments (301) (421) Redemption of C Shares – CFS

*Share buyback – (414)

CFS, 2015 excludes £19m

retained for share incentive schemes

* Increase in share of JVs and other acquisitions

and disposals (153) (3) CFS

*Discontinued operations – (121) CFS

*Foreign exchange 240 3 CFS

*Change in net funds (114)  (777) 

This table shows the derivation of the summary funds ow statement (lines marked *) on page 39 from the cash ow statement on page 118.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 CONSOLIDATED 

Notes to the consolidated financial statements continued

Free cash ow is a measure of nancial performance of the business’s cash ow to see what is available for distribution among those

stakeholders funding the business (including debt holders and shareholders). Free cash ow is calculated as trading cash ow less

recurring tax and post-employment benet expenses excluding capital expenditures, payments made to shareholders, amounts spent (or

received) on business acquisitions and foreign exchange changes on net funds. The Board considers that free cash ow reects cash

generated from the Group’s underlying trading.

2016 2015

£m £m £m £m

Source

Reported operating profit 44  1,499 

Realised losses on hedging instruments (426) (287)  Reported to underlying adjustment (note 2)

Net unrealised fair value to changes to derivatives – 9  Reported to underlying adjustment (note 2)

Foreign exchange on contract accounting (77) 9  Reported to underlying adjustment (note 2)

Revaluation of trading assets and liabilities (67) 13  Reported to underlying adjustment (note 2)

Effect of acquisition accounting 115 124  Reported to underlying adjustment (note 2)

UK pension restructuring 306 – Reported to underlying adjustment (note 2)

Impairment of goodwill 219 75 Reported to underlying adjustment (note 2)

Exceptional restructuring 129 49  Reported to underlying adjustment (note 2)

Deferred prosecution agreement costs 671 – Reported to underlying adjustment (note 2)

Other

1 1

 Reported to underlying adjustment (note 2)

Adjustments to reported operating profit

871 (7)

Underlying profit before financing 915  1,492 

Underlying financing (102) (60) Underlying income statement (note 2)

Underlying profit before tax 813  1,432 

The table below shows a reconciliation of free cash ow to the change in cash and cash equivalents presented in the consolidated cash

ow statement.

2016 2015

£m £m £m £m

Change in cash and cash equivalents (691) 320

Shareholder payments 301 421

Share buy back − 433

Less amount retained for share incentive schemes

− (19)

Returns to shareholders 301 835

Net cash flow from changes in borrowings and finance leases 345 (1,095)

Increase/decrease in short-term investments 1 (5)

Increase in share in joint ventures 154 −

Debt of joint ventures reclassified as joint operations (9) −

Disposal of discontinued operations − 121

Acquisition of businesses 6 5

Disposal of other businesses

(7) (2)

Changes in group strucuture 144 124

Free cash flow 100 179

26 Derivation of summary funds flow statement continued

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS CONSOLIDATED

Notes

2016

£m

2015

£m

Assets

Non-current assets

Investments – subsidiary undertakings 2 12,046 12,016

Current assets

Trade and other receivables – –

TOTAL ASSETS 12,046 12,016

Liabilities

Current liabilities

Other financial liabilities 3 (28) (29)

Trade and other payables (1,204) (842)

TOTAL LIABILITIES (1,232) (871)

NET ASSETS 10,814 11,145

Equity

Called-up share capital 4 367 367

Share premium account 181 180

Merger reserve 7,058 7,359

Capital redemption reserve 2,001 1,699

Other reserve 156 126

Retained earnings 1,051 1,414

TOTAL EQUITY 10,814 11,145

The nancial statements on pages 167 to 169 were approved by the Board on 13 February 2017 and signed on its behalf by:

WARREN EAST DAVID SMITH

Chief Executive Chief Financial Oﬃcer

Company’s registered number: 7524813

Company statement of changes in equity

For the year ended 31 December 2016

Attributable to ordinary shareholders

capital

£m

premium

£m

Merger

reserve

£m

Capital

redemption

reserve

£m

Other

reserve

£m

Retained

earnings

£m

Total

equity

£m

At 1 January 2016 367 180 7,359 1,699 126 1,414 11,145

Profit for the year – – – – – – –

Shares issued to share trust – 1 – – – – 1

Issue of C Shares – – (301) – – – (301)

Redemption of C Shares – – – 302 – (302) –

Acquisition of own shares

– – – – – (45) (45)

Share-based payments – direct to equity – – – – 30 (16) 14

At 31 December 2016 367 181 7,058 2,001 156 1,051 10,814

The ‘Other reserve’ represents the value of share-based payments in respect of employees of subsidiary undertakings for which payment has not been received.

On 2 December 2016, the Company acquired 6,854,216 of its ordinary shares (including the group’s share-based payment trust) from its subsidiary, Rolls-Royce Group plc (RRG plc) for

£45m which represented fair value of those shares at that date. RRG plc had previously held these shares in a share trust for the purpose of the group’s share-based payment plans.

Company balance sheet

At 31 December 2016

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 COMPANY

1 Accounting policies

BASIS OF ACCOUNTING

These nancial statements have been prepared in accordance with Financial Reporting Standard 101 Reduced Disclosure Framework

(FRS101) on the historical cost basis.

In preparing these nancial statements, the Company applies the recognition, measurement and disclosure requirements of International

Financial Reporting Standards as adopted by the EU (Adopted IFRS), but makes amendments where necessary in order to comply with the

Companies Act 2006.

In these nancial statements the Company has applied the exemptions available under FRS 101 in respect of the following disclosures:

• A cash flow statement and related notes.

• Comparative period reconciliations for share capital.

• The effects of new, but not yet effective accounting standards.

• The requirements of IAS 24 Related Party Transactions and has, therefore, not disclosed transactions between the Company and

itswholly-owned subsidiaries.

The accounting policies set out below have, unless otherwise stated, been applied consistently to all periods presented in these nancial

statements.

As permitted by Section 408 of the Companies Act 2006, a separate income statement for the Company has not been included in these

nancial statements. As permitted by the audit fee disclosure regulations, disclosure of non-audit fees information is not included in

respect oftheCompany.

INVESTMENTS IN SUBSIDIARY UNDERTAKINGS

Investments in subsidiary undertakings are reported at cost less any amounts written oﬀ.

SHARE-BASED PAYMENTS

As described in the Directors’ remuneration report on pages 83 to 95, the Company grants awards of its own shares to employees of its

subsidiary undertakings (see note 21 of the consolidated nancial statements). The costs of share-based payments in respect of these

awards are accounted for, by the Company, as an additional investment in its subsidiary undertakings. The costs are determined in

accordance with IFRS 2 Share-based Payment. Any payments made by the subsidiary undertakings in respect of these arrangements are

treated as a return of this investment.

FINANCIAL INSTRUMENTS

In accordance with IAS 32 Financial Instruments: Presentation, the Company’s C Shares are classied as nancial liabilities and held

atamortised cost from the date of issue until redeemed.

2 Investments – subsidiary undertakings

£m

Cost:

At 1 January 2016 12,016

Additions –

Cost of share-based payments in respect of employees of subsidiary undertakings

less receipts from subsidiaries in respect of those payments 30

At 31 December 2016 12,046

3 Financial liabilities

C SHARES

Movements during the year of issued and fully paid C Shares were as follows:

C Shares

of 0.1p

millions

Nominal

value

£m

At 1 January 2016 28,960 29

Shares issued 300,993 301

Shares redeemed (301,828) (302)

At 31 December 2016 28,125 28

The rights attaching to C Shares are set out on page 186.

Notes to the Company financial statements

Rolls-Royce Holdings plc Annual Report 2016FINANCIAL STATEMENTS COMPANY

4 Share capital

Non-equity Equity

Special

of £1

Preference

shares of

£1 each

Nominal

value

£m

Ordinary

shares of

20p each

millions

Nominal

value

£m

Issued and fully paid

At 1 January and 31 December 2016 1 – – 1,838 367

The rights attaching to each class of share are set out on page 186.

In accordance with IAS 32, the Company’s non-cumulative redeemable preference shares (C Shares) areclassied as nancial liabilities.

Accordingly, movements in C Shares are included in note 3.

5 Contingent liabilities

Where the Company enters into nancial guarantee contracts to guarantee the indebtedness of other companies within its group, the

Company considers these to be insurance arrangements, and accounts for them as such. In this respect, the Company treats the guarantee

contract as a contingent liability until such time as it becomes probable that the Company will be required to make a payment under

theguarantee.

At 31 December 2016, these guarantees amounted to £2,235m (2015: £1,937m).

6 Other information

EMOLUMENTS OF DIRECTORS

The remuneration of the Directors of the Company is shown in the Directors’ remuneration report on pages 83 to 95.

EMPLOYEES

The Company had no employees in 2016.

SHARE-BASED PAYMENTS

Shares in the Company have been granted to employees of the Group as part of share-based payment plans, and are charged in the

employing company.

FINANCIAL STATEMENTS

Rolls-Royce Holdings plc Annual Report 2016 COMPANY

Subsidiaries

* Dormant entity.

Moor Lane, Derby, DE24 8BJ, England.

Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE19808, United States.

62 Buckingham Gate, London, SW1E 6AT, England.

Company name Address

Class

of shares

% of

class held

A. F. C. Wultex Limited* Derby

Ordinary 90

A.P.E. – Allen Gears Limited* Derby

Ordinary 100

Allen Power Engineering Limited* Derby

Ordinary 100

Amalgamated Power Engineering Limited* Derby

Deferred 100

Ordinary 100

Bergen Engines AS Hordvikneset 125, N-5108, Hordvik, Bergen 1201, Norway Ordinary 100

Bergen Engines Bangladesh Private Limited Green Granduer, 6th Floor, Plot n.58 E, Kamal Ataturk Avenue Banani, C/A

Dhaka, 1213, Bangladesh

Ordinary 100

Bergen Engines BV Werfdĳk 2, 3195HV Pernis, Rotterdam, Netherlands Ordinary 100

Bergen Engines Denmark A/S Værftsvej 23, 9000 Ålborg, Denmark Ordinary 100

Bergen Engines India Private Limited 52-b, 2nd Floor, Okhla Industrial Estate, Phase III, New Delhi 110020, India Ordinary 100

Bergen Engines Limited Derby

Ordinary 100

Bergen Engines PropertyCo AS Hordvikneset 125, N-5108, Hordvik, Bergen 1201, Norway Ordinary 100

Bergen Engines S.L. Calle Dinamarca s/n (esquina Calle Alemania), Poligono Industrial de

Constanti, 43120 Constanti, Tarragona, Spain

Social

participation

100

Bergen Engines S.r.l. 13 Via Castel Morrone, 16161, Genoa, Italy Social capital 100

Bristol Siddeley Engines Limited* Derby

Ordinary 100

Brooks Inspection Solutions Limited* Derby

Ordinary 100

Brown Brothers & Company Limited* Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Fife,

Scotland, KY11 9JT

Ordinary 100

C.A. Parsons & Company Limited* Derby

Ordinary 100

Composite Technology and Applications Limited Derby

Ordinary 100

Croydon Energy Limited* Derby

Ordinary 100

Data Systems & Solutions, LLC Wilmington

Partnership 100

Deeside Titanium Limited* Derby

Ordinary 82.5

Derby Cogeneration Limited* Derby

Ordinary 100

Derby Specialist Fabrications Limited* Derby

Ordinary 100

Europea Microfusioni Aerospaziali S.p.A. Zona Industriale AS1, 83040 Morra de Sanctis, Avellino, Italy Ordinary 100

Exeter Power Limited* Derby

Ordinary 100

Fluid Mechanics LLC Wilmington

Partnership 100

Heartlands Power Limited* Derby

Ordinary 100

Heaton Power Limited* Derby

Ordinary 100

John Thompson Cochran Limited* Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Fife,

Scotland, KY11 9JT

6% Cumulative

preference

100

Ordinary 100

John Thompson Limited* Derby

Ordinary 100

Kalvet Engineering (Proprietary) Limited* Corner Marconi Road and 3rd Street Montague Gardens, Western Cape,

7441, South Africa

Ordinary 100

Kamewa AB* Box 1010, S-68129, Kristinehamn, Sweden Ordinary 100

Kamewa do Brazil Equipmentos Maritimos

Limitada*

401 Rua Visconde de Pitaja 433, Rio de Janeiro, Brazil Quotas 100

Kamewa Holding AB* Box 1010, S-68129, Kristinehamn, Sweden Ordinary 100

Kamewa UK Limited* Derby

Deferred

Preference

100

Ordinary 100

Karl Maybach-Hilfe GmbH Maybachplatz 1, 88045, Friedrichshafen, Germany Capital Stock 100

L'Orange Fuel Injection (Ningbo) Co, Limited #3 Hall, No.55 South Qihang Road, Yinzhou Economic Development Zone,

Ningbo City, 315145, China

Capital Stock 100

L'Orange Fuel Injection Trading (Suzhou) Co. Limited No. 88 Suhong Middle Road, Suzhou Industrial Park, Suzhou 215000, China Capital Stock 100

L'Orange GmbH Porschestrasse 30, 70435 Stuttgart, Germany Capital Stock 100

L'Orange Unterstützungskasse GmbH Rudolph-L'Orange-Strasse 1, 72293 Glatten, Germany Capital Stock 100

Manseld Holdings Limited* Derby

Ordinary 100

MTU America Inc. Wilmington

Ordinary 100

MTU Asia PTE Limited 112 Robinson Road, #05-01, The Corporate Oﬃce, 068902, Singapore Ordinary 100

MTU Benelux B.V. Merwedestraat 86, 3313 CS, Dordrecht, Netherlands Ordinary 100

MTU China Company Limited Room 1801 - 1803 18/F Ascendas Plaza, No.333 Tian Yao Qiao Road, Xuhai

District, Shanghai, 200030, China

Ordinary 100

MTU do Brasil Limitada Via Anhanguera, KM 29203, 05276-000 Sao Paulo - SP, Brazil Ordinary 100

MTU Engineering (Suzhou) Company Limited 9 Long Yun Road, Suzhou Industrial Park, Suzhou 215024, Jiang Su, China Ordinary 100

MTU France S.A.S. 281 Chaussée Jules César, 95250 Beauchamp, France Ordinary 100

MTU Friedrichshafen GmbH Maybachplatz 1, 88045, Friedrichshafen, Germany Capital Stock 100

MTU Hong Kong Limited 36/F Tower Two, Time Square, 1 Matheson Street, Causeway Bay, Hong Kong Ordinary 100

MTU Ibérica Propulsión y Energia S.L. Calle Copérnico 26-28, 28823 Coslada, Madrid, Spain Ordinary 100

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION SUBSIDIARIES

Company name Address

Class

of shares

% of

class held

MTU India Private Limited HM Geneva House, Unit No. 303, 3rd Floor, No. 14 Cunningham Road,

Bangalore, KA 560052, India

Ordinary 100

MTU Israel Limited 4 Ha’Alon Street, South Building, Third Floor, 4059300 Kfar Neter, Israel Ordinary 100

MTU Italia S.r.l. Via Aurelia Nord, 328, 19021 Arcola (SP), Italy Capital Stock 100

MTU Japan Co. Limited Takanawa-Meiko Building, 2-Chome 15-19, Takanawa, Minato-ku, 108-0074

Tokyo, Japan

Ordinary 100

MTU Korea Limited 22nd Floor, Olive Tower, 41 Sejongdaero 9 gil, Junggu, 100-737 Seoul,

Republic of Korea

Ordinary 100

MTU Middle East FZE S3B5SR06 , Jebel Ali Free Zone, P.O. Box 61141, Dubai, United Arab Emirates Ordinary 100

MTU Motor Türbin Sanayi ve Ticaret. A.Ş. Hatira Sokak, No. 5, Ömerli Mahellesi, 34555 Arnavutköy, Istanbul, Turkey Ordinary 100

MTU Onsite Energy Corporation 100 Power Drive, Mankato, Minnesota 56001, United States Common Stock 100

MTU Onsite Energy GmbH Dasinger Strasse 11, 86165, Augsburg, Germany Capital Stock 100

MTU Onsite Energy Systems GmbH Rotthofer Strasse 8, 94099 Ruhstorf a.d. Rott, Germany Capital Stock 100

MTU Polska Sp. Z o.o. Ul. Śląska, Nr 9. Raum, Ort: Stargard Szczeciński, Plz: 73-110, Poland Ordinary 100

MTU Reman Technologies GmbH Friedrich-List-Strasse 8, 39122 Magdeburg, Germany Capital Stock 100

MTU Rus Limited Liability Company Vashutinskoye Sh. 24 B, Khimki, 141402, Moscow, Russian Federation Ordinary 100

MTU South Africa (Proprietary) Limited Corner Marconi Road and 3rd Street Montague Gardens, Western Cape,

7441, South Africa

Ordinary 100

MTU UK Limited Derby

Ordinary 100

Navis Consult d.o.o. Ul. Bartola Kašića 5/4, HR-51000, Rĳeka, Croatia Ordinary 75

NEI Combustion Engineering Limited* Derby

A Ordinary 100

B Ordinary 100

Deferred 100

NEI International Combustion Limited* Derby

Ordinary 100

NEI Mining Equipment Limited* Derby

Ordinary 100

NEI Nuclear Systems Limited* Derby

Ordinary 100

NEI Overseas Holdings Limited* Derby

Ordinary 100

NEI Parsons Limited* Derby

Ordinary 100

NEI Peebles Limited* Derby

Ordinary 100

NEI Power Projects Limited* Derby

Ordinary 100

NEI Services Limited* Derby

Ordinary 100

Nightingale Insurance Limited Maison Trinity, Trinity Square, St. Peter Port, Guernsey, GY1 4AT Ordinary 100

Optimized Systems and Solutions (US) LLC Wilmington

Partnership 100

Redeemable

non-cumulative

preference

100

PKMJ Technical Services, Inc. Wilmington

Ordinary 100

Powereld Limited* Derby

Ordinary 100

Powereld Specialist Engines Limited* Derby

Ordinary 100

Prokura Diesel Services (Proprietary) Limited Corner Marconi Road and 3rd Street Montague Gardens, Western Cape,

7441, South Africa

Ordinary 100

PT MTU Indonesia Secure Building Blok B, Jl. Raya Protokol Halim, Perdanakusuma, Jakarta,

13610, Indonesia

Ordinary 100

PT Rolls-Royce Mid Plaza 2 , Lantai 16 Jl. Jenderal Sudirman 10-11, Jakarta, Pusat, 10220,

Indonesia

Ordinary 100

R.O.V. Technologies, Inc. Corporation Service Company, 100 North Main Street, Suite 2, Barre, VT

05641, United States

Ordinary 100

Rallyswift Limited* Derby

Ordinary 100

Reyrolle Belmos Limited* Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Fife,

Scotland, KY11 9JT

Ordinary 100

Rolls-Royce (Ireland) Unlimited Company* Ulster International Finance, 1st Floor, IFSC House, IFSC, Dublin 1, Ireland Ordinary 100

Rolls-Royce (Thailand) Limited 900, 11th Floor Tonson Tower, Ploenchit Road, Lumpini, Pathumwan,

Bangkok, Thailand

Ordinary 100

Rolls-Royce AB Box 1010, S-68129, Kristinehamn, Sweden Ordinary 100

Rolls-Royce Aero Engine Services Limited* Derby

Ordinary 100

Rolls-Royce Australia Limited* Suite 102, 2-4 Lyonpark Road, Macquarie Park, NSW 2113, Australia Ordinary 100

Rolls-Royce Australia Services PTY Limited Suite 102, 2-4 Lyonpark Road, Macquarie Park, NSW 2113, Australia Ordinary 100

Rolls-Royce Brasil Limitada Rua dr Cincinato Braga 47, Planalto, São Bernando do Campo/SP, 09890-900,

Brazil

Quotas 100

Rolls-Royce Canada Limited 9500 Côte de Liesse, Lachine, Québec H8T 1A2, Canada Common Stock 100

Rolls-Royce Capital Limited* London

Ordinary 100

Rolls-Royce Civil Nuclear Canada Limited 597 The Queensway, Peterborough ON K9J7J6, Canada Class A Preferred 100

Common Shares 100

Rolls-Royce Civil Nuclear S.A.S. 23 Chemin du Vieux Chêne, 38240, Meylan, France Ordinary 100

* Dormant entity.

Moor Lane, Derby, DE24 8BJ, England.

Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE19808, United States.

62 Buckingham Gate, London, SW1E 6AT, England.

Rolls-Royce Holdings plc Annual Report 2016 

OTHER INFORMATION

SUBSIDIARIES

Subsidiaries continued

* Dormant entity.

Moor Lane, Derby, DE24 8BJ, England.

Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE19808, United States.

62Buckingham Gate, London, England, SW1E6AT.

Company name Address

Class

of shares

% of

class held

Rolls-Royce Commercial (Beĳing) Co., Limited 305-306 Indigo Building 1, 20 Jiuxianqiao Road, Beĳing, 100016, China Registered

capital

100

Rolls-Royce Commercial Aero Engines Limited* Derby

Ordinary 100

Rolls-Royce Control Systems Holdings Co Wilmington

Common Stock 100

Rolls-Royce Controls and Data Services (NZ) Limited Level 7 Bayleys Building, 36 Brandon Street, Wellington, 6011, New Zealand Ordinary 100

Rolls-Royce Controls and Data Services Controls

and Data Services (UK) Limited

Derby

Ordinary 100

Rolls-Royce Controls and Data Services Inc. Wilmington

Common Stock 100

Rolls-Royce Controls and Data Services Limited Derby

Ordinary 100

Rolls-Royce Corporation Wilmington

Common Stock 100

Rolls-Royce Côte d'Ivoire Sarl 7 Boulevard Latrille, Abidjan-Cocody, 25 BP 945, Abidjan 25, Côte d'Ivoire Ordinary 100

Rolls-Royce Crosspointe LLC Wilmington

Partnership 100

Rolls-Royce de Venezuela SA* Avenida 3E, entre Calles 78 y 79, Torre Empresarial Claret, Piso 10, Ocina

10-3, Sector Valle Frio, Maracaibo, Estado Zulia, Venezuela

Registered shares 100

Rolls-Royce Defense Products and Solutions Inc. Wilmington

Common Stock 100

Rolls-Royce Defense Services Inc. Wilmington

Common Stock 100

Rolls-Royce Deutschland Ltd & Co KG Eschenweg 11, 15827 Blankenfelde-Mahlow, Germany Ordinary 100

Rolls-Royce Energy Angola, Limitada* Rua Rei Katyavala, Edicio Rei Katyavala, Entrada B, Piso 8, Luanda, Angola Quota 100

Rolls-Royce Energy Systems Inc. Wilmington

Common Stock 100

Rolls-Royce Engine Controls Holdings Limited Derby

Ordinary 100

Rolls-Royce Engine Services – Oakland Inc. Corporation Service Company, 2710 Gateway Oaks Dr., Suite 150N,

Sacramento, CA 95833, United States

Common Stock 100

Rolls-Royce Engine Services Holdings Co Wilmington

Common Stock 100

Rolls-Royce Engine Services Limitada Inc.* Bldg 06 Berthaphil Compound, Jose Abad Santos Avenue, Clark Special

Economic Zone, Clark, Pampanga, Philippines

Capital Stock 100

Rolls-Royce Erste Beteiligungs GmbH Eschenweg 11, 15827 Blankenfelde-Mahlow, Germany Capital Stock 100

Rolls-Royce Finance Company Limited Derby

Deferred 100

Ordinary 100

Rolls-Royce Finance Holdings Co Wilmington

Common Stock 100

Rolls-Royce Fuel Cell Systems Limited Derby

Ordinary 100

Rolls-Royce General Partner Limited Derby

Ordinary 100

Rolls-Royce Group plc London

Ordinary 100

Rolls-Royce High Temperature Composites Inc. Corporation Service Company, 2710 Gateway Oaks Dr., Suite 150N,

Sacramento, CA 95833, United States

Ordinary 100

Rolls-Royce Holdings Canada Inc. 9500 Côte de Liesse, Lachine, Québec H8T 1A2, Canada Common C

100

Rolls-Royce India Limited* Derby

Ordinary 100

Rolls-Royce India Private Limited Birla Tower West, 2nd Floor 25, Barakhamba Road, New Delhi, 110001, India Equity 100

Rolls-Royce Industrial & Marine Power Limited* Derby

Ordinary 100

Rolls-Royce Industrial Power (India) Limited* Derby

Ordinary 100

Rolls-Royce Industrial Power

(Overseas Projects) Limited*

Derby

Ordinary 100

Rolls-Royce Industrial Power Engineering

(Overseas Projects) Limited

Derby

Ordinary 100

Rolls-Royce Industrial Power Investments Limited* Derby

2.8% cumulative

redeemable

preference stock

100

4.9% cumulative

preference stock

100

Ordinary 100

Rolls-Royce Industries Limited* Derby

Ordinary 100

Rolls-Royce International Limited Derby

Ordinary 100

Rolls-Royce International LLC Oﬃce 41N, Lit. A, 32-34 Nevsky Prospect, St. Petersburg, 19186, Russia Ordinary 100

Rolls-Royce International s.r.o. Pobřežní 620/3, postal code 186 00, Karlín - Prague 8, Czech Republic Ordinary 100

Rolls-Royce Italia S.r.l. 13 Via Castel Morrone, 16161, Genoa, Italy Ordinary 100

Rolls-Royce Japan Co Limited 31st Floor, Kasumigaseki Building, 3-2-5 Kasumigaseki, Chiyoda-Ku,

Tokyo, 100-6031, Japan

Ordinary 100

Rolls-Royce JSF Holdings Inc. Wilmington

Common Stock 100

Rolls-Royce Leasing Limited Derby

Ordinary 100

Rolls-Royce Malaysia Sdn. Bhd. Suite 13.03, 13th Floor, Menara Tan & Tan, 207 Jalan Tun Razak, 50400

Kuala Lumpur, Malaysia

Ordinary 100

Rolls-Royce Marine A/S Værftsvej 23, 9000 Ålborg, Denmark Ordinary 100

Rolls-Royce Marine AS Borgundvegen 340, Ålesund, 6009, Norway Ordinary 100

Rolls-Royce Marine Asia Limited G/F, No 1-3 Wing Yip Street, Kwai Chung, New Territories, Hong Kong Ordinary 100

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION SUBSIDIARIES

Company name Address

Class

of shares

% of

class held

Rolls-Royce Marine Australia PTY. Limited Unit 2/8 Wallace Way, Fremantle WA 6160, Australia Ordinary 100

Rolls-Royce Marine Benelux BV Werfdĳk 2, 3195 HV Pernis, Rotterdam, Netherlands Ordinary 100

Rolls-Royce Marine Chile S.A. Alcantara 200, 6th oor, oﬃce 601, Las Condes, Santiago, Chile Ordinary 100

Rolls-Royce Marine Deutschland GmbH Fährstieg 9, 21107, Hamburg, Germany Ordinary 100

Rolls-Royce Marine Electrical Systems Limited* Derby

Ordinary 100

Rolls-Royce Marine Espana S.A. Calle Dinamarca s/n (esquina Calle Alemania), Poligono Industrial de

Constanti, 43120 Constanti, Tarragona, Spain

Ordinary 100

Rolls-Royce Marine France SARL 122 avenue Charles de Gaulle, 92200 Neuilly sur Seine, France Ordinary 100

Rolls-Royce Marine Hellas S.A. 25 Atki Poseidonos str. & Makrigianni str., Moschato, Athens, GR-18344,

Greece

Ordinary 100

Rolls-Royce Marine Hong Kong Limited G/F, Chung Shun Knitting Centre, No.’s 1-3 Wing Yip Street, Kwai Chung,

New Territories, Hong Kong

Ordinary 100

Rolls-Royce Marine India Private Limited Plot D-505, TTC Industrial Area, MIDC, Turbhe, Navi Mumbai, 400703

Maharashtra, India

Ordinary 100

Rolls-Royce Marine Korea Limited 197 Noksan SanEop Buk-Ro, (Songjeong-dong) Gangseo-gu, Busan 46753,

Republic of Korea

Ordinary 100

Rolls-Royce Marine Manufacturing (Shanghai)

Limited

No.1 Xuanzhong Road, Xuanqiao Town, Pudong New Area, Shanghai, 201399,

China

Ordinary 100

Rolls-Royce Marine North America Inc. Wilmington

Common Stock 100

Rolls-Royce Marine Power Operations Limited Derby

A Ordinary 100

B Ordinary 100

Rolls-Royce Mechanical Test Operations Centre

GmbH

Kiefernstrasse 1, 15827 Blankenfelde-Mahlow OT, Dahlewitz, Germany Ordinary 100

Rolls-Royce Mexico Administration S de RL de CV Boulevard Adolfo Ruiz Cortinez 3642-403, Fracc Costa de Oro, Verzcruz CP

94299 6, Mexico

Ordinary 100

Rolls-Royce Mexico S de RL de CV Boulevard Adolfo Ruiz Cortinez 3642-403, Fracc Costa de Oro, Verzcruz CP

94299 6, Mexico

Ordinary 100

Rolls-Royce Militiary Aero Engines Limited* Derby

Ordinary 100

Rolls-Royce Namibia (Proprietary) Limited 2nd Floor, Unit 4, LA Chambers, Ausspann Plaza, Dr Agostinho Neto Road,

Ausspannplatz, Windhoek, Namibia

Ordinary 100

Rolls-Royce New Zealand Limited Level 7 Bayleys Building, 36 Brandon Street, Wellington, 6011, New Zealand Ordinary 100

Rolls-Royce Nigeria Limited* 7th Floor Marble House, 1 Kingsway Road, Falomo, Ikoyi, Lagos, Nigeria Ordinary 100

Rolls-Royce North America (USA) Holdings Co. Wilmington

Common Stock 100

Rolls-Royce North America Holdings Inc. Wilmington

Common Stock 100

Rolls-Royce North America Inc. Wilmington

Common Stock 100

Rolls-Royce North America Ventures Inc. Wilmington

Common Stock 100

Rolls-Royce North American Technologies Inc. Wilmington

Common Stock 100

Rolls-Royce Nuclear Field Services France S.A.S ZA Notre-Dame, 84430, Mondragon, France Ordinary 100

Rolls-Royce Nuclear Field Services Inc.

Corporation Service Company, 80 State Street, Albany, NY 12207, United States

Common Stock 100

Rolls-Royce Oman LLC

Bait Al Reem, Business Oﬃce #131, Building No 81, Way No 3409, Block No 234,

Al Thaqafa Street, Al Khuwair, Sultanate of Oman, PO Box 20, Postal Code 103

Ordinary 100

Rolls-Royce Operations (India) Private Limited RMZ-NXT, Campus 2A, Unit 001 Ground Floor, Near to SAP, Whiteeld Road,

EPIP Zone, Mahadevapura, Bangalore 560066, Karnataka, India

Ordinary 100

Rolls-Royce Overseas Holdings Limited Derby

Ordinary 100

Rolls-Royce Overseas Investments Limited Derby

Ordinary 100

Rolls-Royce Oy Ab PO Box 220, Suojantie 5, 26101, Rauma, Finland A Shares 100

Rolls-Royce Placements Limited Derby

Ordinary 100

Rolls-Royce plc London

Ordinary 100

Rolls-Royce Poland Sp. z.o.o. Gniew 83-140, ul. Kopernika 1, Poland Ordinary 99.9

Rolls-Royce Power Development Limited Derby

Ordinary 100

Rolls-Royce Power Engineering plc Derby

Ordinary 100

Rolls-Royce Power Systems AG Maybachplatz 1, 88045, Friedrichshafen, Germany Ordinary 100

Rolls-Royce Saudi Arabia Limited PO Box 88545, Riyadh, 11672, Saudi Arabia Cash shares 100

Rolls-Royce Singapore Pte. Limited 1 Marina Boulevard, #28-00 One Marina Boulevard, Singapore, 018989 Ordinary 100

Rolls-Royce Technical Support Sarl Centreda I, Avenue Didier Daurat, 31700 Blagnac, Toulouse, France Ordinary 100

Rolls-Royce Total Care Services Limited Derby

Ordinary 100

Rolls-Royce Turkey Power Solutions Industry

and Trade Limited

Meclis-i Mebusan Cad No 1, Ekemen Han, 34427 Kabataş Istanbul, Turkey Cash shares 100

Rolls-Royce UK Pension Fund Trustees Limited* Derby

Ordinary 100

Rolls-Royce Vietnam Limited Dông Xuyên Industrial Zone, Rach Dùa Ward, Vũng Tàu City, Bà Ria-Vũng

Tàu Province, Vietnam

Capital Stock 100

Rolls-Royce Zweite Beteiligungs GmbH Eschenweg 11, 15827 Blankenfelde-Mahlow, Germany Capital Stock 100

Ross Ceramics Limited Derby

Ordinary 100

Scandinavian Electric Gdansk Sp. z.o.o. ul. Reja No.3, 80-404, Gdansk, Poland Ordinary 67

Scandinavian Electric Systems do Brazil Limitada Rua Sao Jose 90, salas 1406 e 1407, Centro, Rio De Janeiro, Brazil Quotas 66

* Dormant entity.

Moor Lane, Derby, DE24 8BJ, England.

Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE19808, United States.

62Buckingham Gate, London, England, SW1E6AT.

Rolls-Royce Holdings plc Annual Report 2016 SUBSIDIARIES 

OTHER INFORMATION

Company name Address

Class

of shares

% of

class held

Group

interest

held %

Aero Gearbox International SAS

***

18 boulevard Louis Seguin, 92700 Colombes, France Ordinary 50 50

Aerospace Transmission Technologies GmbH

***

Adelheidstrasse 40, D-88046, Friedrichshafen,

Germany

Capital Stock 50 50

Airtanker Holdings Limited One London Wall, London, England EC2Y 5EB Ordinary 20 20

Airtanker Services Limited Airtanker Hub, RAF Brize Norton, Carterton,

Oxfordshire, England OX18 3LX

Ordinary 22 22

Alpha Leasing (US) LLC, Alpha Leasing (US) (No.2) LLC, Alpha

Leasing (US) (No.4) LLC, Alpha Leasing (US) (No.5) LLC, Alpha

Leasing (US) (No.6) LLC, Alpha Leasing (US) (No.7) LLC, Alpha

Leasing (US) (No.8) LLC

Wilmington

Partnerships

(no equity held)

– 50

Alpha Partners Leasing Limited London

A Ordinary 100 50

Anecom Aerotest GmbH 122 Freiheitstrasse, Wildau, D-15745, Germany Capital Stock 24.9 24.9

CFMS Limited Victoria House, 51 Victoria Street, Bristol, England,

BS1 6AD

Limited by

guarantee

n/a 50

Clarke Chapman Portia Port Services Limited Maritime Centre, Port of Liverpool, Liverpool,

England, L21 1LA

A Ordinary 100 50

Egypt Aero Management Services EgyptAir Engine Workshop, Cairo International

Airport, Cairo, Egypt

Ordinary 50 50

Subsidiaries continued

Joint ventures and associates

The following companies were dissolved on 3 January 2017 - NEI Allen Limited, NEI Limited, Oxygenaire Limited, R-R Industrial Controls Limited, Rolls-Royce Industrial & Marine Gas

Turbines Limited, Rolls-Royce Industrial Power Systems Limited, Rolls-Royce Transmission & Distribution Limited, Spare IPG (CEL) Limited, Spare IPG 3 Limited, Spare IPG 11 Limited, Spare

IPG 22 Limited, Spare IPG28 Limited and Spare IPG 30 Limited. Crossley-Premier Engine (Sales) Limited was dissolved on 10 January 2017. John Hastie of Greenock (Holdings) Limited and

Spare RRPD (BEL) Limited were dissolved on 17 January 2017.

* Dormant entity.

The entity is not included in the consolidation as Rolls-Royce plc does not have a beneficial interest in the net assets of the entity.

***

As at 31 December 2016, these entities are accounted for as joint operations (see note 1 accounting policies).

Moor Lane, Derby, DE24 8BJ, England.

Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE19808, United States.

62Buckingham Gate, London, England, SW1E6AT.

Company name Address

Class

of shares

% of

class held

Sharing in Growth UK Limited

Derby

Limited by

Guarantee

100

Spare IPG (AGL) Limited* Derby

Ordinary 100

Spare IPG 4 Limited* Derby

Ordinary 100

Spare IPG 15 Limited* Derby

Ordinary 100

Spare IPG 18 Limited* Derby

Ordinary 90

Spare IPG 20 Limited* Derby

Ordinary 100

Spare IPG 24 Limited* Derby

Ordinary 100

Spare IPG 27 Limited* Taxiway, Hillend Industrial Estate, Dalgety Bay, Dunfermline, Fife,

Scotland, KY11 9JT

Ordinary 100

Spare IPG 32 Limited* Derby

7.25% cumulative

preference

Ordinary

10 0

100

Stone Vickers Limited* Derby

Ordinary 100

The Bushing Company Limited* Derby

Ordinary 100

Timec 1487 Limited* Derby

Ordinary 100

Trigno Energy S.R.L. Zona Industriale, 66050 San Salvo, Italy Ordinary 100

Ulstein Holdings AS Sjøgata 80, 6065 Ulsteinvik, Norway Ordinary 100

Ulstein Maritime Limited 96 North Bend Street, Coquitlam, British Columbia V3K 6H1 Canada Common 100

Vessel Lifter Inc.* Corporation Service Company, 1201 Hays Street, Tallahassee, FL32301,

United States

Common Stock 100

Vickers Pension Trustees Limited* Derby

Ordinary 100

Vickers Pressings Limited* Derby

Ordinary 100

Viking Power Limited* Derby

Ordinary 100

Vinters Defence Systems Limited* Derby

Ordinary 100

Vinters Engineering Limited Derby

Ordinary 100

Vinters International Limited Derby

Ordinary 100

Vinters Limited Derby

Ordinary 100

Vinters-Armstrongs (Engineers) Limited* Derby

Ordinary 100

Vinters-Armstrongs Limited* Derby

Ordinary B 100

Wultex Machine Company Limited* Derby

Ordinary 100

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION SUBSIDIARIES

Company name Address

Class

of shares

% of

class held

Group

interest

held %

EPI Europrop International GmbH Dachauer Strasse 655, 80995 Munich, Germany Capital Stock 28 Eﬀective 35.5

Eurojet Turbo GmbH Lilienthalstrasse 2b, 85399 Hallbergmoos, Germany Capital Stock 33 Eﬀective 39

GE Rolls-Royce Fighter Engine Team LLC The Corporation Trust Company, 1209, Orange

Street, Wilmington, DE19801, United States

Partnership

(no equity held)

– 40

Genistics Holdings Limited Derby

Ordinary A 100 50

Global Aerospace Centre for Icing and Environmental

ResearchInc.

1000 Marie-Victorin Boulevard, Longueuil,

Québec, J4G1A1, Canada

Ordinary 50 50

Hong Kong Aero Engine Services Limited 33rd Floor, One Pacic Place, 88 Queensway,

Hong Kong

Ordinary 50 50

Hovden Klubbhus AS Stålhaugen 5, Ulsteinvik, 6065 Norway Ordinary 69 69

Industria De Turbo Propulsores SA Parque Technológico Edicio 300, 48170 Zamudio,

Vizcaya, Spain

Ordinary 46.9 46.9

International Aerospace Manufacturing Private Ltd** Survey No.3 Kempapura Village, Varthur Hobli,

Bangalore, KA 560037, India

Ordinary 50 50

LG Fuel Cell Systems Inc. Wilmington

Common Stock 25 25

Light Helicopter Turbine Engine Company

(unincorporated partnership)

Suite 119, 9238 Madison Boulevard, Madison,

AL35758, USA

Partnership

(no equity held)

– 50

Metlase Limited Unipart House, Garsington Road, Cowley, Oxford,

England, OX4 2PG

Ordinary B 100 20

MTU Turbomeca Rolls-Royce GmbH Am Söldnermoos 17, 85399 Hallbergmoos, Germany Capital Stock 33.3 33.3

MTU Turbomeca Rolls-Royce ITP GmbH Am Söldnermoos 17, 85399 Hallbergmoos, Germany Capital Stock 25 Eﬀective 37

N3 Engine Overhaul Services GmbH & Co KG Gerhard-Höltje-Strasse 1, D-99310, Arnstadt,

Germany

Capital Stock 50 50

N3 Engine Overhaul Services Verwaltungsgesellschaft Mbh Gerhard-Höltje-Strasse 1, D-99310, Arnstadt,

Germany

Capital Stock 50 50

Oﬀshore Simulator Centre AS Borgundvegen 340, 6009, Ålesund, Norway Ordinary 25 25

Rolls Laval Heat Exchangers Limited* Derby

Ordinary A 100 50

Rolls-Royce & Partners Finance (US) LLC, Rolls-Royce & Partners

Finance (US) (No.2) LLC

Wilmington

Partnerships

(no equity held)

– 50

Rolls-Royce Snecma Limited Derby

Ordinary B 100 50

Shanxi North MTU Diesel Co. Limited No. 97 Daqing West Road, Datong City, Shanxi

Province, China

Ordinary 49 49

Singapore Aero Engine Services Private Limited 11 Calshot Road, 509932, Singapore Ordinary 50 50

Techjet Aerofoils Limited** Tefen Industrial Zone, PO Box 16, 24959, Israel Ordinary A

Ordinary B

Texas Aero Engine Services LLC The Corporation Trust Company, 1209, Orange

Street, Wilmington, DE19801, United States

Partnership

(no equity held)

– 50

TRT Limited Derby

Ordinary B 100 49.5

Turbine Surface Technologies Limited** Derby

Ordinary B 100 50

Turbo-Union Limited Derby

Shares A

Ordinary

37.5

UK Nuclear Restoration Limited* Booths Park, Chelford Road, Knutsford, Cheshire,

England, WA16 8QZ

Ordinary 20 20

Viking Reisebyra AS Stålhaugen 10, 6065 Ulsteinvik, Norway Ordinary 50 50

Xian XR Aero Components Co., Limited** Xujiawan, Beĳiao, PO Box 13, Xian 710021, Shaanxi

China

Ordinary 49 49

* Dormant entity.

** As at 31 December 2016, these entities are accounted for as joint operations (see note 1 accounting policies).

Moor Lane, Derby, DE24 8BJ, England.

Corporation Service Company, 2711 Centerville Road, Suite 400, Wilmington, DE19808, United States.

Rolls-Royce Holdings plc Annual Report 2016 

OTHER INFORMATION

JOINT VENTURES AND ASSOCIATES

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION INDEPENDENT AUDITOR’S REPORT

OPINIONS AND CONCLUSIONS ARISING FROM OUR AUDIT

1 OUR OPINION ON THE FINANCIAL STATEMENTS IS

UNMODIFIED

We have audited the financial statements of Rolls-Royce Holdings plc

for the year ended 31 December 2016 set out on pages 115 to 175.

In our opinion:

• the financial statements give a true and fair view of the state of

the Group’s and of the parent company’s affairs as at 31 December

2016 and of the Group’s loss for the year then ended;

• the Group financial statements have been properly prepared in

accordance with International Financial Reporting Standards as

adopted by the European Union (Adopted IFRS);

• the parent company financial statements have been properly

prepared in accordance with UK Accounting Standards, including

FRS 101 Reduced Disclosure Framework; and

• the financial statements have been prepared in accordance with

the requirements of the Companies Act 2006 and, as regards the

Group financial statements, Article 4 of the IAS Regulation.

2 OUR ASSESSMENT OF RISKS OF MATERIAL

MISSTATEMENT

When planning our audit, we made an assessment of the relative

significance of the key risks of material misstatement to the Group

financial statements, initially without taking account of the

effectiveness of controls implemented by the Group. (This year

our testing generally showed these controls to have increased

in effectiveness.)

This initial assessment is shown below in the output from our

Dynamic Audit planning tool. As there has been no significant change

in the Group’s operations and as the reduction in our assessment of

materiality did not change the ranking of risks, the key risks are the

same as in the prior year, though there have been some changes in

the relative significance to our audit of some of the risks. (For last

year's audit, the risk relating to Bribery and corruption covered both

(i) the risk that the Group had entered into corrupt transactions that

could materially affect the financial statements and (ii) the risk that

the consequences of the then ongoing investigations into bribery and

corruption in overseas markets were not properly reflected in the

financial statements. These are now shown as separate risks as,

following the conclusion of the investigations by the UK, US and

Brazilian investigating authorities, the significance of the second

element of the risk has reduced substantially.)

Of the 19 key risks identified, we describe below (i) the eight risks

of material misstatement that had the greatest effect on our audit

(those in dark blue on the risk map – the descriptions of risks include

an explanation for the changes in significance of these risks from last

year), (ii) our key audit procedures to address those risks and (iii) our

findings from those procedures in order that the Company’s

members as a body may better understand the process by which we

arrived at our audit opinion. Our findings are the result of procedures

undertaken in the context of and solely for the purpose of our

statutory audit opinion on the financial statements as a whole and

consequently are incidental to that opinion, and we do not express

discrete opinions on separate elements of the financial statements.

Our 2015 audit was reviewed by the Financial Reporting Council’s

Audit Quality Review (AQR) team. The review findings noted limited

areas for improvement. These have been incorporated into our

continuous improvement process for our approach to the 2016

audit and are reflected in the descriptions of the audit procedures

set out below.

Independent auditor’s report

to the members of Rolls-Royce Holdings plc only

Dynamic Audit planning tool

(Relative signicance of audit risks before taking account of controls)

The pressure on and incentives for

management to meet revenue and

profit targets

The basis of accounting for revenue

and profit in the Civil Aerospace

business

The measurement of revenue and

profit in the Civil Aerospace business

Recoverability of intangible assets in

the Civil Aerospace business

Liabilities arising from customer

financing arrangements

Bribery and corruption

The presentation of

‘underlyingprofit’

Disclosure of the effect on the trend

in profit of items which are uneven

in frequency or amount

Measurement of revenue and profit on

long-term contracts outside the Civil

Aerospace business (see page 123)

Determination of development costs

to be capitalised (see page 123)

The basis of accounting for

contractual aftermarket rights

(see page 121)

Determination of the amortisation

period of development costs and

CARs (see page 128)

The basis of accounting for Risk

and Revenue Sharing Arrangements

(see pages 122 and 123)

Estimating provisions for warranties

and guarantees (see page 124)

Valuation of derivatives and hedge

accounting (see pages 126 and 127)

Measurement of post-retirement

benefits (see page 124)

Accounting for uncertain tax positions

and deferred tax assets (see page 124)

Valuation of goodwill (see page 123)

Consequences of investigations into

bribery and corruption in overseas

markets (see page 163)

Potential impact on financial statements

Likelihood of material misstatement

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 INDEPENDENT AUDITOR’S REPORT

The pressure on and incentives for management to meet

revenue and profit targets

Refer to pages 18 to 35 (Business review) and pages 98 and 99

(Audit Committee report – Financial reporting)

The risk – In recent years the Group has published a number

of revisions to its revenue and profit guidance with a generally

decreasing trend in profit and revenue and there have been

significant associated decreases in the Group’s share price. The

Group's employee incentive schemes include profit targets. Clear

instructions were given to the Executive Leadership Team and the

senior finance executives on more than one occasion not to take

any account of the pressure to meet forecasts in preparing the

financial results and to manage and be alert to how this pressure

might affect personnel across the wider Group. Nevertheless, the

continuing pressure on and incentives for management to meet

targets increases the inherent risk of manipulation of the Group

financial statements. The financial results are sensitive to

significant estimates and judgements, particularly in respect of

revenues and costs associated with long-term contracts, and there

is a broad range of acceptable outcomes of these that could lead to

different levels of profit and revenue being reported in the financial

statements. Relatively small changes in the basis of those

judgements and estimates could result in the Group meeting,

exceeding or falling short of forecasts, guidance or targets.

The significance of this risk increased marginally following changes

to the Group's employee incentive schemes that involved the

introduction of individual business profit targets as well as a Group

profit target.

Our response – We have: (i) extended our enquiries designed to

assess whether judgements and estimates exhibited unconscious

bias or whether management had taken systematic actions to

manipulate the reported results; (ii) compared the results to

forecasts, guidance and targets, and challenged variances at a

much lower level than we would otherwise have done based on

our understanding of factors affecting business performance with

corroboration using external data where possible; and (iii) applied

an increased level of scepticism throughout the audit by increasing

the involvement of the senior audit team personnel, with particular

focus on audit procedures designed to assess whether revenues and

costs have been recognised in the correct accounting period,

whether central adjustments were appropriate and whether the

segmental analysis has been properly prepared.

In particular:

• when considering the risk relating to The measurement of revenue

and profit in the Civil Aerospace business (

refer to page 178), we

challenged the basis for changes in the estimated revenues and

costs in long-term contracts, with a heightened awareness of the

possibility of unconscious or systematic bias;

• when considering the risk relating to Recoverability of intangible

assets in the Civil Aerospace business (

refer to pages 178 and

179), we challenged with a heightened awareness of the

possibility of unconscious or systematic bias the basis for an

increase in the estimated market size and share of the Trent 900

engine which offset the significant reduction in the recoverable

amount of Trent 900 programme assets arising from new

technical issues on these engines, the response to which is

forecast to be costly; and

• when considering the risk relating to The presentation of

underlying profit (

refer to pages 179 and 180) and the risk

relating to Disclosure of the effect on the trend in profit of items

which are uneven in frequency or amount (

refer to pages 180

and 181), we sought to identify items that affected profit (and/or

the trend in profit) unevenly in frequency or amount (especially

those where management had a greater degree of discretion over

the timing or scale of transactions entered into) at a much lower

level than we would otherwise have done and we assessed the

balance and transparency of disclosure of these items.

Our findings – Our testing did not identify any indication of

manipulation of results (2015 audit finding: none). We found the

degree of caution/optimism adopted in estimates to be balanced

overall (2015 audit finding: balanced). We found that there was

ample unbiased disclosure of items affecting the trend in profit.

The basis of accounting for revenue and profit in the Civil

Aerospace business

Refer to pages 121 and 122 (Key areas of judgement – Introduction,

Contractual aftermarket rights, Linkage of original and long-term

aftermarket contracts), page 125 (Significant accounting policies

– Revenue recognition) and pages 98 and 99 (Audit Committee report

– Financial reporting)

The risk – The amount of revenue and profit recognised in a year on

the sale of engines and aftermarket services is dependent, inter alia,

on the appropriate assessment of whether or not each long-term

aftermarket contract for services is linked to or separate from the

contract for sale of the related engines as this drives the accounting

basis to be applied. As the commercial arrangements can be

complex, significant judgement is applied in selecting the

accounting basis in each case. The most significant risk is that the

Group might inappropriately account for sales of engines and

long-term service agreements as a single arrangement as this

would usually lead to revenue and profit being recognised too early

because the margin in the long-term service agreement is usually

higher than the margin in the engine sale agreement.

The significance of the risk has not changed during the year.

Our response – We re-evaluated the appropriateness of the

accounting bases the Group applies in the Civil Aerospace business

by reference to accounting standards and re-examining historical

long-term aftermarket contracts. We considered whether the

disclosure included in the financial statements enables shareholders

to understand how the accounting policies represent the commercial

substance of the Group’s contracts with its customers. We made our

own independent assessment, with reference to the relevant

accounting standards, of the accounting basis that should be applied

to each long-term aftermarket contract entered into during the year

and compared this to the accounting basis applied by the Group.

Our findings – We found that the Group has developed a framework

for selecting the accounting bases which is consistent with a

balanced interpretation of accounting standards and has applied

this consistently. We found that the disclosure was ample.

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION INDEPENDENT AUDITOR’S REPORT

Independent auditor’s report continued

For the agreements entered into during this year, it was clear which

accounting basis should apply.

The measurement of revenue and profit in the Civil

Aerospace business

Refer to pages 122 (Key areas of judgement – Measurement of

performance on long-term aftermarket contracts), page 125

(Significant accounting policies – Revenue recognition and TotalCare

arrangements) and pages 98 and 99 (Audit Committee report –

Financial reporting)

The risk – The amount of revenue and profit recognised in a year on

the sale of engines and aftermarket services is dependent, inter alia,

on the assessment of the percentage of completion of long-term

aftermarket contracts and the forecast cost profile of each

arrangement. As long-term aftermarket contracts can extend over

significant periods and the profitability of these arrangements

typically assumes significant lifecycle cost improvement over the

term of the contracts, the estimated outturn requires significant

judgement to be applied in estimating future engine flying hours,

time on wing and other operating parameters, the pattern of future

maintenance activity and the costs to be incurred. The nature of

these estimates means that their continual refinement can have an

impact on the profits of the Civil Aerospace business that can be

significant in an individual financial year. The assessment of the

estimated outturn for each arrangement involves detailed

calculations using large and complex databases with a significant

level of manual intervention.

The significance of the risk has not changed during the year.

Our response – We tested the controls designed and applied by the

Group to provide assurance that the estimates used in assessing

revenue and cost profiles are appropriate and that the resulting

estimated cumulative profit on these contracts is accurately

reflected in the financial statements; these controls operated over

both the inputs and the outputs of the calculations. We challenged

the appropriateness of these estimates for each programme and

assessed whether or not the estimates showed any evidence of

systematic or unconscious management bias in the context of the

heightened pressure on and incentives for management to meet

forecasts, guidance and targets discussed above. Our challenge was

based on our assessment of the historical accuracy of the Group’s

estimates in previous periods, identification and analysis of

changes in assumptions from prior periods and an assessment

of the consistency of assumptions within programmes.

In terms of future cost estimates, we undertook detailed

assessments of the achievability of the Group’s plans to reduce

lifecycle costs and an analysis of the impact of these plans on

forecast cost profiles taking account of contingencies and analysis

of the impact of known technical issues on cost forecasts. We

focused on the estimates of costs expected to be incurred to

respond to new technical issues emerging during the year, notably

in relation to the Trent 700 and 900 programmes.

Our analysis of forecast revenues considered each significant

airframe that is powered by the Group’s engines and was based

on discussions with commercial and operational management and

our own experience, supplemented by discussions with an aircraft

valuation specialist engaged by the Group. We assessed whether

the valuation specialist was objective and suitably qualified.

We also checked the mathematical accuracy of the revenue and

profit for each arrangement and considered the implications of

identified errors and changes in estimates.

Our findings – We focused our controls testing on controls that we

assessed as likely to provide effective audit evidence, largely those

relating to revenue estimates. We also considered the operation of

other controls in order to provide relevant comment to

management and the audit committee. We found that the

remediation of control weaknesses identified in earlier periods had

continued. The scope and depth of our detailed testing and analysis

was expanded to take account of the remaining control weaknesses.

Overall, our assessment is that the assumptions and resulting

estimates (including appropriate contingencies) resulted in

balanced (2015 audit finding: balanced) profit recognition.

Recoverability of intangible assets (certification costs and

participation fees, development expenditure and contractual

aftermarket rights) in the Civil Aerospace business

Refer to page 123 (Key sources of estimation uncertainty – Forecasts

and discount rates), pages 127 and 128 (Significant accounting

policies – Certification costs and participation fees, Research and

development, Contractual aftermarket rights and Impairment of

non-current assets), pages 140 to 142 (Note 9 to the financial

statements – Intangible assets) and pages 98 and 99 (Audit

Committee report – Financial reporting)

The risk – The recovery of these assets depends on a combination of

achieving sufficiently profitable business in the future as well as the

ability of customers to pay amounts due under contracts often over

a long period of time. Assets relating to a particular engine

programme are more prone to the risk of impairment in the early

years of a programme as the engine’s market position is established.

In addition, the pricing of business with launch customers makes

assets relating to these engines more prone to the risk of impairment.

The significance of the risk has increased somewhat during the year

due to the emergence of new technical issues on the Trent 900

engines, the response to which is forecast to be costly.

Our response – We tested the controls designed and applied by the

Group to provide assurance that the assumptions used in preparing

the impairment calculations are regularly updated, that changes are

monitored, scrutinised and approved by appropriate personnel and

that the final assumptions used in impairment testing have been

appropriately approved. We challenged the appropriateness of the

key assumptions in the impairment tests (including market size,

market share, pricing, engine and aftermarket unit costs, individual

programme assumptions, price and cost escalation, discount rate

and exchange rates). Our challenge was based on our assessment of

the historical accuracy of the Group’s estimates in previous periods,

our understanding of the commercial prospects of key engine

programmes, identification and analysis of changes in assumptions

from prior periods and an assessment of the consistency of

assumptions across programmes and customers and comparison of

assumptions with public data where this was available. We focused

on the Trent 900 programme assets where the impact of the

estimated cost of responding to new technical issues would have led

to a significant impairment had the effect not been offset by an

increase in estimated market size and share. We tested the

mathematical accuracy of the impairment calculations. We

considered whether the disclosures in Note 9 to the financial

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 INDEPENDENT AUDITOR’S REPORT

statements describe the inherent degree of subjectivity in the

estimates and the potential impact on future periods of revisions

to these estimates.

Our findings – Our testing did not identify weaknesses in the

design and operation of controls that would have required us to

expand the nature or scope of our planned detailed test work. We

found that the assumptions and resulting estimates were balanced

(2015 audit finding: balanced) and that the disclosures were

proportionate (2015 audit finding: proportionate). We found no

errors in calculations (2015 audit finding: none).

With regard to the Trent 900 programme assets, we found no

evidence that the increase in estimated market size and share that

resulted in no impairment being recognised was motivated by the

impact on profit and we found that this estimate was based on a

balanced assessment of the data available.

Liabilities arising from customer financing arrangements

Refer to page 123 (Key areas of judgement – Customer financing

contingent liabilities), page 129 (Significant accounting policies –

Customer financing support), page 156 (Note 18 to the financial

statements – Provisions for liabilities and charges) and pages 98

and 99 (Audit Committee report – Financial reporting)

The risk – The Group has contingent liabilities in respect of financing

and asset value support provided to customers. This support typically

takes the form of a guarantee with respect to the value of an aircraft

at a future date, a commitment to buy used aircraft or a guarantee

of a customer’s future payments under an aircraft financing

arrangement. The Group also provides standby credit lines to certain

customers that can be accessed if they fail to arrange alternative

financing at the time they take delivery of engines. Judgement is

required to assess the likelihood of these liabilities crystallising, in

order to assess whether a provision should be recognised and, if so,

the amount of that provision. The total potential liability is significant

and can be affected by the assessment of the residual value of the

aircraft and the creditworthiness of the customers.

The significance of the risk has not changed during the year.

Our response – We analysed the terms of guarantees on aircraft

delivered during the year in detail and obtained aircraft values from

and held discussions with aircraft valuation specialists engaged by

the Group. We assessed whether the valuer was objective and

suitably qualified, had been appropriately instructed and had been

provided with complete, accurate data on which to base its

evaluation. For all contracts on delivered aircraft, we assessed the

commercial factors relevant to the likelihood of the guarantees

being called, including the credit ratings and recent financial

performance of the relevant customers and their fleet plans, and

critically assessed the Group’s estimate of the required provisions

for those liabilities. We considered movements in aircraft values

and potential changes in the assessed probability of a liability

crystallising since the previous year end and considered whether

the evidence supported the Group’s assessment as to whether or

not a liability needs to be recognised and the amount of the liability

recognised or contingent liability disclosed. We considered whether

the related disclosure in Note 18 to the financial statements

appropriately explains the potential liability in excess of the amount

provided for in the financial statements for delivered aircraft and

highlights the significant but unquantifiable contingent liability in

respect of aircraft which will be delivered in the future.

Our findings – We found that the assumptions and estimates were

balanced (2015 audit finding: balanced) and that the disclosures

were proportionate (2015 audit finding: proportionate).

Bribery and corruption

Refer to pages 105 and 106 (Safety & Ethics Committee report – Ethics

and compliance)

The risk – A large part of the Group’s business is characterised by

competition for individually significant contracts with customers,

which are often directly or indirectly associated with governments,

and the award of individually significant contracts to suppliers. The

procurement processes associated with these activities are highly

susceptible to the risk of corruption. In addition, the Group operates

in a number of territories where the use of commercial intermediaries

is either required by the government or is common practice.

The significance of the risk has not changed during the year.

Our response – We designed an approach to provide reasonable

assurance that we would identify bribery and corruption that would

have a material impact on the financial statements. We evaluated

and tested the Group’s policies, procedures and controls over the

selection and renewal of intermediaries, contracting arrangements,

ongoing management and payments and over responses to

suspected breaches of policy. We sought to identify payments made

to intermediaries during the year using data analysis techniques,

including focusing on intermediaries that have been rejected

through the Group's selection process or were identified during

investigations. We tested whether these had been subject to the

Group's controls, made enquiries of appropriate personnel and

evaluated the tone set by the Board and the Executive Leadership

Team and the Group’s approach to managing this risk. Having

enquired of management, the Audit Committee and the Board as

to whether the Group is in compliance with laws and regulations

relating to bribery and corruption, we made written enquiries of

and/or met with the Group’s legal advisers to cross check the results

of those enquiries with third parties and maintained a high level of

vigilance to possible indications of significant non-compliance with

laws and regulations relating to bribery and corruption whilst

carrying out our other audit procedures.

Our findings – We did not find any evidence of payments of bribes

or other corrupt behaviour during the year that would have had a

material impact on the financial statements (2015 audit finding: none).

Presentation and explanation of results

Refer to pages 18 to 35 (Business review), pages 36 to 39 (Financial

review), pages 131 to 135 (Note 2 to the financial statements –

Segmental analysis) and pages 98 and 98 (Audit Committee report

– Financial reporting)

The presentation of ‘underlying profit’

The risk – In addition to its Adopted IFRS financial statements, the

Group presents an alternative income statement on an ‘underlying’

basis. The Directors believe the ‘underlying’ income statement

reflects better the Group’s trading performance during the year.

The basis of adjusting between the Adopted IFRS and ‘underlying’

income statements and a full reconciliation between them is set

out in Note 2 to the financial statements on pages 133 and 134.

A significant recurring adjustment between the Adopted IFRS

income statement and the ‘underlying’ income statement relates

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION INDEPENDENT AUDITOR’S REPORT

Independent auditor’s report continued

to the foreign exchange rates used to translate foreign currency

transactions. The Group uses forward foreign exchange contracts

to manage the cash flow exposures of forecast transactions

denominated in foreign currencies but does not generally apply

hedge accounting in its Adopted IFRS income statement. The

‘underlying’ income statement translates these amounts at the

achieved foreign exchange rate on forward foreign exchange

contracts settled in the period, retranslates assets and liabilities

at exchange rates forecast to be achieved from future settlement

of such contracts and excludes unrealised gains and losses on such

contracts which are included in the Adopted IFRS income statement.

The Group has discretion over which forward foreign exchange

contracts are settled in each financial year, which could impact

the achieved rate both for the period and in the future.

In addition, adjustments are made to exclude one-off past-service

costs on post-retirement schemes, the cost of restructuring

programmes that involve the substantial closure or exit from a site,

facility or line of business or other major transformation activities,

the effect of acquisition accounting (including any subsequent

impairments of goodwill or other intangible assets) and a number

of other items, including this year the £671m financial penalties

from agreements with investigating authorities in connection

with historic bribery and corruption involving intermediaries in

a number of overseas markets.

Alternative performance measures can provide shareholders with

appropriate additional information if properly used and presented.

In such cases, measures such as these can assist shareholders in

gaining a more detailed and hence better understanding of a

company’s financial performance and strategy. However, when

improperly used and presented, these kinds of measures might

prevent the Annual Report being fair, balanced and understandable

by hiding the real financial position and results or by making the

profitability of the reporting entity seem more attractive.

The significance of the risk has not changed during the year.

Our response – We assessed the appropriateness of the basis for the

adjustments between the Adopted IFRS income statement and the

‘underlying’ income statement and the consistency of application

of this basis and we recalculated the adjustments with a particular

focus on the impact of the foreign exchange rates used to translate

foreign currency amounts in the ‘underlying’ income statement. We

assessed whether or not the selection of forward foreign exchange

contracts settled in the year showed any evidence of management

bias. We also assessed: (i) the extent to which the prominence given

to the ‘underlying’ financial information and related commentary in

the Annual Report compared to the Adopted IFRS financial

information and related commentary could be misleading; (ii)

whether the Adopted IFRS and ‘underlying’ financial information

are reconciled with sufficient prominence given to that

reconciliation; (iii) whether the basis of the ‘underlying’ financial

information is clearly and accurately described and consistently

applied; and (iv) whether the ‘underlying’ financial information is

not otherwise misleading in the form and context in which it

appears in the Annual Report.

Our findings – We found no concerns regarding the basis of the

‘underlying’ financial information or its calculation and no

indication of management bias in the settlement of forward foreign

exchange contracts. We consider that there is proportionate (and

somewhat improved) disclosure of the nature and amounts of the

adjustments to allow shareholders to understand the implications

of the two bases on the financial measures being presented (2015

audit finding: proportionate). We found the overall presentation of

the ‘underlying’ financial information to be balanced (2015 audit

finding: balanced).

Disclosure of the effect on the trend in profit of items which are

uneven in frequency or amount

The risk – The Group’s profits are significantly impacted by items

such as cumulative adjustments to profit recognised on long-term

contracts, impairments (and reversals of impairments) of goodwill,

CARs and other intangible assets, sale and leasebacks of spare

engines to joint ventures, research and development charges,

reorganisation costs and foreign exchange translation which can

be uneven in frequency and/or amount. If significant either to the

profit for the year or to the trend in profit, appropriate disclosure

of the effect of these items is necessary in the Annual Report and

financial statements to provide the information necessary to enable

shareholders to assess the Group’s performance.

The significance of the risk has not changed during the year.

Our response – We undertook detailed analysis of business

performance at Group and segment level that sought to identify

items that affect profit (and the trend in profit) which are uneven

in frequency or amount at a much lower level than we would

otherwise have done and to assess the transparency of disclosure

of these items.

Our findings – We identified a number of significant items that

had affected profit for the year or the prior year that required

appropriate disclosure in the Annual Report to enable shareholders

to assess the Group’s performance. The key items are:

(1) the £4,420m unrealised fair value losses (2015: £1,315m losses) on

derivative contracts;

(2) the £217m profit (2015: £140m profit) arising from the impact of

improvements in lifecycle costs on long-term contracts;

(3) the £35m profit (2015: nil) arising from the impact of revising the

forecast long-term US dollar to sterling exchange rate on

long-term contracts;

(4) the £98m loss (2015: £24m loss) on long-term contracts arising

from new technical issues on Civil Aerospace large engines;

(5) the £64m loss (2015: £83m loss) arising from other estimate

changes on long-term contracts;

(6) the £30m loss (2015: nil) arising on Civil Aerospace new engine

programmes;

(7) the £918m (2015: £818m) of research and development charges;

(8) the £127m, net of a release of prior year provisions of £19m,

(2015: £88m, net of a £30m release) of restructuring charges;

(9) the £119m (2015: £71m) profit arising from sales of spare

engines to joint ventures;

(10) the £219m (2015: £75m) impairments of goodwill;

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 INDEPENDENT AUDITOR’S REPORT

(11) the £671m (2015: nil) financial penalties from agreements with

investigating authorities in connection with historic bribery

and corruption involving intermediaries in a number of

overseas markets;

(12) the £53m (2015: nil) release of accruals relating to termination

in prior years of intermediary services;

(13) the £306m loss (2015: nil) from the restructuring of the

UK pension schemes, including the buyout of the Vickers Group

Pension Scheme;

(14) the £189m profit arising from refinement in the basis of

measurement of the risk contingency for forecasts of future

revenue to be earned under long-term contracts in 2015; and

(15) the £65m profit arising from the release of provisions against

previously impaired intangible assets for contractual

aftermarket rights in 2015.

We found that ample disclosure of these items had been provided in

the Annual Report and financial statements taken as a whole (2015

audit finding: ample).

In reaching our audit opinion on the financial statements we took

into account the findings that we describe above and those for

other, lower risk areas included in the output from our Dynamic

Audit planning tool set out above. Overall the findings from across

the whole audit are that the financial statements have been

prepared on the basis of appropriate accounting policies, reflect

balanced estimates, and provide proportionate disclosure. Having

assessed these findings and evaluated uncorrected misstatements

in the context of materiality and considered the qualitative aspects

of the financial statements as a whole, we have not modified our

opinion on the financial statements.

3 OUR APPLICATION OF MATERIALITY AND AN OVERVIEW

OF THE SCOPE OF OUR AUDIT

Our measure of materiality for the Group financial statements as a

whole has reduced in line with the reduction in the Group’s profit.

This was set at £30m (2015: £66m) and was determined with

reference to a benchmark of Group profit before taxation, averaged

over the last three years in order to take into account the volatility in

profits over this period, and normalised to exclude the impact of

gains and losses on revaluation of foreign currency and other

derivative financial instruments which could otherwise result in an

inappropriate materiality level being determined. This materiality

measure represents 2.9% (2015: 4.5%) of this benchmark and 0.6%

(2015: 41.3%) of total reported profit/loss before tax. We carry out

audit procedures to assess the accuracy of the gains and losses on

these derivative financial instruments (which this year amounted to

a £4.4bn loss (2015: £1.3bn loss)) as part of our audit of the Group’s

treasury operations.

We report to the Audit Committee: (i) all material corrected

identified misstatements; (ii) uncorrected identified misstatements

exceeding £1.5m (2015: £3m) for income statement items; and

(iii) other identified misstatements that warrant reporting on

qualitative grounds.

We subjected 34 (2015: 31) of the Group’s reporting components to

audits for group reporting purposes and 13 (2015: 11) to specified

risk-focused audit procedures. The latter were not individually

sufficiently financially significant to require an audit for group

reporting purposes, but did present specific individual risks that

needed to be addressed. This work also provided further audit

coverage. For the remaining components, the Group audit team

performed analysis at an aggregated group level to re-examine

our assessment that there were no significant risks of material

misstatement within these components.

The Group operates shared service centres for the bulk processing of

financial transactions in Derby (UK), Indianapolis (US) and Singapore,

the outputs of which are included in the financial information of the

reporting components they service and therefore they are not

separate reporting components. Each of the service centres is subject

to specified risk-focused audit procedures, predominantly the testing

of transaction processing and review controls. Additional audit

procedures are performed at certain reporting components to

address the audit risks not covered by the work performed over

the shared service centres.

SUMMARY AUDIT SCOPE

94% (2015: 94%)

5% (2015: 5%)

1% (2015: 1%)

REVENUE

Audit for group reporting purposes

Specified risk-focused

audit procedures

Group-level procedures only

89% (2015: 92%)

8% (2015: 6%)

3% (2015: 2%)

UNDERLYING PROFIT BEFORE TAX

89% (2015: 91%)

8% (2015: 7%)

3% (2015: 2%)

TOTAL ASSETS

The Group audit team instructed component auditors, and the

auditors of the shared service centres, as to the significant areas to

be covered, including the relevant risks detailed above, and the

information to be reported back. The Group audit team approved

the component materiality assessments, which ranged from £0.3m

to £24m (2015: £0.2m to £52m), having regard to the mix of size and

risk profile of the Group across the components. The work on 19 of

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION INDEPENDENT AUDITOR’S REPORT

Independent auditor’s report continued

the 47 (2015: 21 of 42) components was performed by component

auditors and the rest by the Group audit team. The Group audit

team visited 33 (2015: 31) component locations in the UK, the US,

Germany and Scandinavia, the purpose of which included an

assessment of the audit risk and strategy. Telephone conference

meetings were also held with these component auditors and with

those of the higher risk components that were not physically visited.

At these visits and meetings, the findings reported to the Group

audit team were discussed in more detail, and any further work

required by the Group audit team was then performed by the

component auditor.

4 OUR OPINION ON OTHER MATTERS PRESCRIBED BY THE

COMPANIES ACT 2006 IS UNMODIFIED

In our opinion:

• the part of the Directors’ remuneration report to be audited has

been properly prepared in accordance with the Companies Act

2006; and

• the information given in the Strategic report and the Directors’

report for the financial year is consistent with the financial

statements.

Based solely on the work required to be undertaken in the course of

the audit of the financial statements and from reading the Strategic

report and the Directors’ report:

• we have not identified material misstatements in those reports;

and

• in our opinion, those reports have been prepared in accordance

with the Companies Act 2006.

5 WE HAVE NOTHING TO REPORT ON THE DISCLOSURES

OF PRINCIPAL RISKS

Based on the knowledge we acquired during our audit, we have

nothing material to add or draw attention to in relation to:

• the Directors’ viability statement on page 53, concerning the

principal risks, their management, and, based on that, the

Directors’ assessment and expectations of the Group’s continuing

in operation over the five years to 31 December 2021; or

• the disclosures on page 53 and in Note 1 to the financial

statements concerning the use of the going concern basis

of accounting.

6 WE HAVE NOTHING TO REPORT IN RESPECT OF THE

MATTERS ON WHICH WE ARE REQUIRED TO REPORT

BY EXCEPTION

Under ISA (UK and Ireland) we are required to report to you if, based

on the knowledge we acquired during our audit, we have identified

other information in the Annual Report that contains a material

inconsistency with either that knowledge or the financial

statements, a material misstatement of fact, or that is otherwise

misleading. In particular, we are required to report to you if:

• we have identified material inconsistencies between the

knowledge we acquired during our audit and the Directors’

statement that they consider that the Annual Report and financial

statements taken as a whole is fair, balanced and understandable

and provides the information necessary for shareholders to assess

the Group’s performance, business model and strategy; or

• the Audit Committee report does not appropriately address

matters communicated by us to the Audit Committee.

Under the Companies Act 2006 we are required to report to you if,

in our opinion:

• adequate accounting records have not been kept by the parent

company, or returns adequate for our audit have not been

received from branches not visited by us; or

• the parent company financial statements and the part of the

Directors’ remuneration report to be audited are not in

agreement with the accounting records and returns; or

• certain disclosures of Directors’ remuneration specified by law are

not made; or

• we have not received all the information and explanations we

require for our audit.

Under the Listing Rules we are required to review:

• the Directors’ statements, set out on page 53, in relation to going

concern and longer term viability; and

• the part of the corporate governance report on page 60 relating to

the Company’s compliance with the eleven provisions of the 2014

UK Corporate Governance Code specified for our review.

We have nothing to report in respect of the above responsibilities.

SCOPE OF REPORT AND RESPONSIBILITIES

As explained more fully in the Directors’ responsibilities statement

set out on page 113, the Directors are responsible for the preparation

of the financial statements and for being satisfied that they give a

true and fair view. A description of the scope of an audit of financial

statements is provided on the Financial Reporting Council’s website

at www.frc.org.uk/auditscopeukprivate. This report is made solely

to the Company’s members as a body and is subject to important

explanations and disclaimers regarding our responsibilities, published

on our website at www.kpmg.com/uk/auditscopeukco2014b, which

are incorporated into this report as if set out in full and should be

read to provide an understanding of the purpose of this report, the

work we have undertaken and the basis of our opinions.

JIMMY DABOO (SENIOR STATUTORY AUDITOR)

for and on behalf of KPMG LLP, Statutory Auditor

Chartered Accountants

15 Canada Square

London E14 5GL

13 February 2017

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 SUSTAINABILITY ASSURANCE STATEMENT

Independent limited assurance statement

INTRODUCTION AND OBJECTIVES OF WORK

Bureau Veritas UK Limited (Bureau Veritas) has been engaged by

Rolls-Royce Holdings plc (Rolls-Royce) to provide limited assurance

of selected sustainability performance indicators for inclusion in its

2016 Annual Report and website. This assurance statement applies

to the related information included within the scope of work

described below.

SELECTED INFORMATION

The scope of our work was limited to assurance over the following

information included within Rolls-Royce’s 2016 Annual Report (the

Report) for the period 1 of January to 31 of December 2016 (the

Selected Information):

• Energy consumption;

• Scope 1 and scope 2 greenhouse gas (GHG) emissions;

• Total reportable injury (TRI) rate; and

• The number of people reached through the science, technology,

engineering and mathematics (STEM) education outreach

programmes.

REPORTING CRITERIA

The Selected Information needs to be read and understood

together with the basis of reporting document, as set out at

www.rolls-royce.com/sustainability.

LIMITATIONS AND EXCLUSIONS

Excluded from the scope of our work is any verification of

information relating to:

• Activities outside the defined verification period; and

• Other information included in the Report.

This limited assurance engagement relies on a risk-based selected

sample of sustainability data and the associated limitations that

this entails. This independent statement should not be relied upon

to detect all errors, omissions or misstatements that may exist.

RESPONSIBILITIES

This preparation and presentation of the Selected Information in the

Report are the sole responsibility of the management of Rolls-Royce.

Bureau Veritas was not involved in the drafting of the Report or of

the Reporting Criteria. Our responsibilities were to:

• obtain limited assurance about whether the Selected Information

has been prepared in accordance with the Reporting Criteria;

• form an independent conclusion based on the assurance

procedures performed and evidence obtained; and

• report our conclusions to the Directors of Rolls-Royce.

ASSESSMENT STANDARD

We performed our work in accordance with International Standard

on Assurance Engagements (ISAE) 3000 Revised, Assurance

Engagements Other than Audits or Reviews of Historical Financial

Information (effective for assurance reports dated on or after

15 December 2015), and in accordance with International Standard

on Assurance Engagements (ISAE) 3410, Assurance Engagements on

Greenhouse Gas Statements, issued by the International Auditing

and Assurance Standards Board.

SUMMARY OF WORK PERFORMED

As part of its independent verification, Bureau Veritas undertook

the following activities:

1. Assessed the appropriateness of the Reporting Criteria for the

Selected Information;

2. Conducted interviews with relevant personnel of Rolls-Royce;

3. Carried out nine site visits, selected employing a risk-based

approach, in the UK, US, Germany, Italy and Singapore;

4. Reviewed the data collection and consolidation processes used

to compile the Selected Information, including assessing

assumptions made, the data scope and reporting boundaries;

5. Reviewed documentary evidence produced by Rolls-Royce;

6. Agreed a selection of the Selected Information to the

corresponding source documentation; and

7. Re-performed aggregation calculations of the Selected Information.

CONCLUSION

On the basis of our methodology and the activities described above,

nothing has come to our attention to indicate that the Selected

Information has not been properly prepared, in all material

respects, in accordance with the Reporting Criteria.

STATEMENT OF INDEPENDENCE, INTEGRITY AND COMPETENCE

Bureau Veritas is an independent professional services company

that specialises in quality, environmental, health, safety and social

accountability with over 185 years’ history. Its assurance team has

extensive experience in conducting verification over environmental,

social, ethical and health and safety information, systems

and processes.

Bureau Veritas operates a certified

Quality Management System

which complies with the requirements of ISO 9001:2008, and

accordingly maintains a comprehensive system of quality control

including documented policies and procedures regarding

compliance with ethical requirements, professional standards and

applicable legal and regulatory requirements.

Bureau Veritas has implemented and applies a Code of Ethics, which

meets the requirements of the International Federation of

Inspections Agencies (IFIA)

across the business to ensure that its

employees maintain integrity, objectivity, professional competence

and due care, confidentiality, professional behaviour and high

ethical standards in their day-to-day business activities.

The assurance team for this work does not have any involvement in

any other Bureau Veritas projects with Rolls-Royce.

Bureau Veritas UK Limited

London

2 February 2017

Sustainability assurance statement

To: The stakeholders of Rolls-Royce Holdings plc

Certificate of Registration FS 34143 issued by BSI Assurance UK Limited.

International Federation of Inspection Agencies – Compliance Code – Third Edition.

Rolls-Royce Holdings plc Annual Report 2016OTHER INFORMATION ADDITIONAL FINANCIAL INFORMATION

Additional financial information

Foreign exchange

Foreign exchange rate movements influence the reported income

statement, the cash flow and closing net debt balance. The average

and spot rates for the principal trading currencies of the Group are

shown in the table below:

2016 2015 Change

USD per GBP

Year end spot rate 1.23 1.48 -17%

Average spot rate 1.36 1.53 -11%

EUR per GBP

Year end spot rate 1.17 1.36 -14%

Average spot rate 1.22 1.38 -12%

The Group’s approach to managing its tax affairs

Introduction

Rolls-Royce is committed to (i) complying with laws in a responsible

manner and (ii) building and maintaining professional and

constructive working relationships with tax authorities based on

principles of mutual transparency and trust.

These commitments, which are explained in more detail below,

apply to all countries and all employees.

1. Tax planning

The Group manages tax costs through maximising the tax

efficiency of business transactions which includes taking advantage

of available tax incentives and exemptions. This must be done in a

way which is aligned with the Group’s commercial objectives and

meets its legal obligations and ethical standards. It must also be

done in a way that gives a tax result the Group reasonably believes

is not contrary to the clear intentions of the legislation concerned.

2. Relationships with tax authorities

The Group is committed to building constructive working

relationships with tax authorities based on a policy of full disclosure

in order to remove uncertainty in its business transactions and

allow the authorities to review possible risks.

Where appropriate and possible, the Group enters into consultation

with tax authorities to help shape proposed legislation and future

tax policy.

3. Transfer pricing

The Group seeks to price transactions between Rolls-Royce group

companies as if they were between unrelated parties, in compliance

with the OECD Transfer Pricing Guidelines and the laws of the

relevant jurisdictions.

4. Governance

The Board has approved this approach.

The Group Audit Committee oversees the Group’s tax affairs and

risks through periodic reviews.

The Group’s governance framework is used to manage tax risks,

establish controls and monitor their effectiveness.

The Group Tax Director is responsible for ensuring that appropriate

policies, processes and systems are in place and that the global tax

team has the required skills and support to implement this approach.

The Group’s global corporate income tax contribution

Around 85% of the Group’s underlying profit before tax (excluding

joint ventures and associates) is generated in the UK, the US,

Germany, Norway, Finland and Singapore. This is lower than 2015

(95%) due to losses in the Marine businesses. The remaining profits

are generated across more than 40 other countries. This reflects the

fact that the majority of the Group’s business is undertaken, and

employees are based, in the above countries.

In common with most multinational groups the total of all profits

in respect of which corporate income tax is paid is not the same as

the consolidated profit before tax reported on page 115. The main

reasons for this are:

i) the consolidated income statement is prepared under adopted

IFRS whereas tax is paid on the profits of each Group company,

which are determined by local accounting rules;

ii) accounting rules require certain income and costs relating toour

commercial activities to be eliminated from, or added to, the

aggregate of all the profits of the Group companies when

preparing the consolidated income statement (‘consolidation

adjustments’); and

iii) specific tax rules including exemptions or incentives

asdetermined by the tax laws in each country.

The Group’s total corporation tax payments in 2016 were £157m.

The level of tax paid in each country is impacted by the above.

Inmost cases, (i) and (ii) are only a matter of timing and therefore

tax will be paid in an earlier or later year. As a result they only have

anegligible impact on the Group’s underlying tax rate, which,

excluding joint ventures and associates, would be 37.5%

(2015:26.6%). Theunderlying tax rate including joint ventures and

associates can be found on pages 16 and 36. This is due to deferred

tax accounting, details of which can be found in note 5 to the

Consolidated Financial Statements. The impact of (iii) will often be

permanent depending on the relevant tax law.

Further information on the tax position of the Group can be found

as follows:

• Audit Committee report (page 98) – The Group Tax Director gave

a presentation to the Audit Committee during the year which

covered various matters including tax risks and how they are

managed;

• Note 1 to the Consolidated financial statements (pages 124 and

126) – Details of key areas of uncertainty and accounting policies

for tax;

• Note 5 to the Consolidated financial statements (pages 137 to 139)

– Details of the tax balances in the Consolidated financial

statements together with a tax reconciliation. This explains the

main drivers of the tax rate.

At this stage we expect these items to continue to influence the

underlying tax rate. The reported tax rate is more difficult to

forecast due to the volatility of significant items in reported profits,

in particular the net unrealised fair value changes to derivative

contracts.

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 ADDITIONAL FINANCIAL INFORMATION 

Investments and capital expenditure

The Group subjects all major investments and capital expenditure

to a rigorous examination of risks and future cash flows to ensure

that they create shareholder value. All major investments, including

the launch of major programmes, require Board approval.

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.

Financial risk management

The Board has established a structured approach to financial risk

management. The Financial risk committee (Frc) is accountable for

managing, reporting and mitigating the Group’s financial risks and

exposures. These risks include the Group’s principal counterparty,

currency, interest rate, commodity price, liquidity and credit rating

risks outlined in more depth in note 17. The Frc is chaired by the

Chief Financial Officer. The Group has a comprehensive financial

risk policy that advocates the use of financial instruments to

manage and hedge business operations risks that arise from

movements in financial, commodities, credit or money markets.

TheGroup’s policy is not to engage in speculative financial

transactions. The Frc sits quarterly to review and assess the key

risksand agree any mitigating actions required.

Capital structure

£m 2016 2015

Total equity 1,864 5,016

Cash flow hedges 107 100

Group capital 1,971 5,116

Net debt (225) (111)

Operations are funded through various shareholders’ funds, bank

borrowings, bonds and notes. The capital structure of the Group

reflects the judgement of the Board as to the appropriate balance of

funding required. Funding is secured by the Group’s continued

access to the global debt markets. Borrowings are funded in various

currencies using derivatives where appropriate to achieve a

required currency and interest rate profile. The Board’s objective is

to retain sufficient financial investments and undrawn facilities to

ensure that the Group can both meet its medium-term operational

commitments and cope with unforeseen obligations and

opportunities.

The Group holds cash and short-term investments which, together

with the undrawn committed facilities, enable it to manage its

liquidity risk.

During the year the Group extended the maturity of the £1,500m

committed bank borrowing facility from 2020 to 2021. The Group

also added a further £500m committed bank borrowing facility

with a maturity of 2019. Both of these facilities were undrawn at

the period end. At the year end, the Group retained aggregate

liquidity of £5.1bn, including cash and cash equivalents of £2.8bn

and undrawn borrowing facilities of £2.3bn. Circa £170m of the

facilities mature in 2017.

The maturity profile of the borrowing facilities is regularly reviewed

to ensure that refinancing levels are manageable in the context of

the business and market conditions. There are no rating triggers in

any borrowing facility that would require the facility to be

accelerated or repaid due to an adverse movement in the Group’s

credit rating. The Group conducts some of its business through a

number of joint ventures. A major proportion of the debt of these

joint ventures is secured on the assets of the respective companies

and is non-recourse to the Group. This debt is further outlined in

note 11.

Credit rating

Rating Outlook Grade

Moody’s Investors Service A3 Stable Investment

Standard & Poor’s BBB+ Stable Investment

The Group subscribes to both Moody’s Investors Service and

Standard & Poor’s for independent long-term credit ratings. Atthe

date of this report, the Group maintained investment grade ratings

from both agencies.

As a capital-intensive business making long-term commitments

toour customers, the Group attaches significant importance

tomaintaining or improving the current investment grade

creditratings.

Accounting

The Consolidated financial statements have been prepared in

accordance with International Financial Reporting Standards (IFRS),

as adopted by the EU.

No new accounting standards had a material impact in 2016.

Theimpact of changes to IFRS, in particular IFRS 15 Revenue from

Contracts with Customers which have not been adopted in 2016

isincluded within the accounting policies in note 1.

Share price

During the year, the share price increased by 16% from 575p

to668p, compared to a 12% increase in the FTSE aerospace and

defence sector and a 14% increase in the FTSE 100. The Company’s

share price ranged from 504p in February 2016 to 826p inJuly 2016.

Rolls-Royce Holdings plc Annual Report 2016OTHER INFORMATION OTHER STATUTORY INFORMATION

Other statutory information

Share capital

On 31 December 2016 1,838,796,763 ordinary shares of 20p each,

28,124,943,825 C Shares of 0.1p each and one Special Share of £1

were in issue. The ordinary shares are listed on the London Stock

Exchange.

Payment to shareholders

The Company issues non-cumulative redeemable preference shares

(C Shares) as an alternative to paying a cash dividend.

Shareholders can choose to:

• Redeem all C Shares for cash.

• Redeem all C Shares for cash and reinvest the proceeds in the

CShare Reinvestment Plan (CRIP).

• Keep the C Shares.

The CRIP is operated by Computershare Investor Services PLC

(theRegistrar). The Registrar will purchase ordinary shares in the

market for shareholders electing to reinvest their C Share proceeds.

Shareholders wishing to participate in the CRIP or redeem their

CShares in July 2017 must ensure that their instructions are lodged

with the Registrar no later than 5.00pm (BST) on 1 June 2017 (CREST

holders must submit their election in CREST before 3.00pm (BST)

on 1June2017). Redemption will take place on 5 July 2017.

At the 2017 AGM, the Directors will recommend an issue of 71

CShares with a total nominal value of 7.1p for each ordinary share.

TheCShares will be issued on 3 July 2017 to shareholders on the

entitlement toCShares is 26 April 2017. Together with the interim

issue on4January 2017 of 46 C Shares for each ordinary share with

atotal nominal value of 4.6p, this is the equivalent of a total annual

payment to ordinary shareholders of 11.7p for each ordinaryshare.

Further information for shareholders is on pages 190 and 191.

Share class rights

The full share class rights are set out in the Company’s Articles

ofAssociation (Articles), which are available on the Group’s website

at www.rolls-royce.com, and are summarised below.

ORDINARY SHARES

Each member has one vote for each ordinary share held. Holders

ofordinary shares are entitled to: receive the Company’s Annual

Report; attend and speak at general meetings of the Company;

appoint one or more proxies or, if they are corporations, corporate

representatives; and exercise voting rights. Holders of ordinary

shares may receive a bonus issue of C Shares or a dividend and on

liquidation may share in the assets of the Company.

C SHARES

C Shares have limited voting rights and attract a dividend of 75%

ofLIBOR on the 0.1p nominal value of each share, paid on a

twice-yearly basis. The Company has the option to redeem the

CShares compulsorily, at any time, if the aggregate number of

CShares inissue is less than 10% of the aggregate number of all

CShares issued, or on the acquisition or capital restructuring of

theCompany.

On a return of capital on a winding-up, the holders of CShares shall

be entitled, in priority to any payment to the holders of ordinary

shares, to the repayment of the nominal capital paid-up or credited

as paid-up on the C Shares held by them, together with a sum equal

to the outstanding preferential dividend which will have been

accrued but not been paid until the date of return of capital.

The holders of C Shares are only entitled to attend, speak and vote

ata general meeting if a resolution to wind up the Company is to

be considered, in which case they may vote only on that resolution.

SPECIAL SHARE

Certain rights attach to the special rights non-voting share

(SpecialShare) issued to HM Government (Special Shareholder).

These rights are set out in the Articles. Subject to the provisions

ofthe Companies Act 2006, the Treasury Solicitor may redeem the

Special Share at par at any time. The Special Share confers no rights

to dividends but in the event of a winding-up it shall be repaid at

itsnominal value in priority to any other shares.

Certain Articles (in particular those relating to the foreign

shareholding limit, disposals and the nationality of the Company’s

Directors) that relate to the rights attached to the Special Share may

only be altered with the consent of the Special Shareholder. The

Special Shareholder is not entitled to vote at any general meeting

orany other meeting of any class of shareholders.

RESTRICTIONS ON TRANSFER OF SHARES AND LIMITATIONS

ONHOLDINGS

There are no restrictions on transfer or limitations on the holding

ofthe ordinary shares or C Shares other than under the Articles

(asdescribed here), under restrictions imposed by law or regulation

(for example, insider trading laws) or pursuant to the Company’s

share dealing code. The Articles provide that the Company should

beand remain under UK control. As such, an individual foreign

shareholding limit is set at 15% of the aggregate votes attaching

tothe share capital of all classes (taken as a whole) and capable

ofbeing cast on a poll and to all other shares that the Directors

determine are to be included in the calculation of that holding.

TheSpecial Share may only be issued to, held by and transferred

tothe Special Shareholder or his successor or nominee.

SHAREHOLDER AGREEMENTS AND CONSENT REQUIREMENTS

There are no known arrangements under which financial rights

carried by any of the shares in the Company are held by a person

other than the holder of the shares and no known agreements

between the holders of shares with restrictions on the transfer of

shares or exercise of voting rights. No disposal may be made to a

non-Group member which, alone or when aggregated with

thesame or a connected transaction, constitutes a disposal of the

whole or a material part ofeither the Nuclear propulsion business

or the assets of the Group as a whole, without the consent of the

Special Shareholder.

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 OTHER STATUTORY INFORMATION 

Authority to issue shares

At the AGM in 2016, authority was given to the Directors to allot

new C Shares up to a nominal value of £500m as an alternative to a

cash dividend.

In addition, a special resolution was passed authorising the

Directors to allot new ordinary shares up to a nominal value of

£122,579,775 equivalent to one-third of the issued share capital of

the Company. This resolution also authorised the Directors to allot

up to two thirds of the total issued share capital of the Company,

but only in the case of a rights issue.

A further special resolution was passed to effect a disapplication of

pre-emption rights for a maximum of 5% of the issued share capital

of the Company.

These authorities are valid until the AGM in 2017, and the Directors

propose to renew each of them at that AGM. The Board believes that

these authorities will allow the Company to retain flexibility to

respond to circumstances and opportunities as they arise.

Authority to purchase own shares

At the AGM in 2016, the Company was authorised by shareholders

to purchase up to 183,869,662 of its own ordinary shares

representing 10% of its issued ordinary share capital.

The authority for the Company to purchase its own shares expires

at the conclusion of the AGM in 2017 or 18 months from 5 May 2016

whichever is the earlier. A resolution to renew it will be proposed at

the 2017 meeting.

Deadlines for exercising voting rights

Electronic and paper proxy appointments, and voting instructions,

must be received by the Company’s Registrar not less than 48 hours

before a general meeting.

Voting rights for employee share plan shares

Shares are held in various employee benefit trusts for the purpose

of satisfying awards made under the various employee share plans.

For shares held in a nominee capacity or if plan/trust rules provide

the participant with the right to vote in respect of specifically

allocated shares, the trustee votes in line with the participants’

instructions. For shares that are not held absolutely on behalf of

specific individuals, the general policy of the trustees, in accordance

with investor protection guidelines, is to abstain from voting in

respect of those shares.

Change of control

CONTRACTS AND JOINT VENTURE AGREEMENTS

There are a number of contracts and joint venture agreements

which would allow the counterparties to terminate or alter those

arrangements in the event of a change of control of the Company.

These arrangements are commercially confidential and their

disclosure could be seriously prejudicial to the Company.

BORROWINGS AND OTHER FINANCIAL INSTRUMENTS

The Group has a number of borrowing facilities provided by various

banks. These facilities generally include provisions which may

require any outstanding borrowings to be repaid or the alteration or

termination of the facility upon the occurrence of a change of

control of the Company. At 31 December 2016, these facilities were

less than 15% drawn (2015: 22%).

The Group has entered into a series of financial instruments to

hedge its currency, interest rate and commodity exposures. These

contracts provide for termination or alteration in the event that a

change of control of the Company materially weakens the

creditworthiness of the Group.

EMPLOYEE SHARE PLANS

In the event of a change of control of the Company, the effect

on the employee share plans would be as follows:

• PSP – awards would vest pro rata to service in the performance

period, subject to Remuneration Committee judgement of

Group performance.

• APRA deferred shares – the shares would be released from

trust immediately.

• ShareSave – options would become exercisable immediately.

The new company might offer an equivalent option in exchange

for cancellation of the existing option.

• Share Incentive Plan (SIP) – consideration received as shares would

be held within the SIP, if possible, otherwise the consideration

would be treated as a disposal from the SIP.

• New LTIP (subject to shareholder approval) – awards would vest on

the change of control, subject to the Remuneration Committee's

judgement of performance and may be reduced pro rata to

service in the vesting period. Any applicable holding period will

cease in the event of a change in control.

Rolls-Royce Holdings plc Annual Report 2016OTHER INFORMATION OTHER STATUTORY INFORMATION

Greenhouse gas emissions

In 2016, our total greenhouse gas (GHG) emissions from our

facilities and processes, including product test and development,

was 587kilotonnes carbon dioxide equivalent (ktCO

e). This

represents adecrease of 3%compared with 602 ktCO

e in 2015.

We have introduced reporting of fugitive emissions of

hydroflurocarbons (HFCs), associated with air conditioning

equipment, into our GHG emissions figures for 2016. These include

emissions from our facilities in the UK, US, Canada and France only.

We do not anticipate that emissions from other facilities will have a

material impact. Figures from prior years (2012 to 2015) exclude

emissions associated with HFCs.

Total GHG emissions (ktCO

e) 2012 2013 2014* 2015 2016

Direct emissions – facilities,

processes, product test and

development (Scope 1) 219 241 301 242 240

Indirect emissions – facilities,

processes, product test and

development (Scope 2) 313 313 382 360 347

Total for facilities, processes,

product test and development 532 554 683 602 587

Direct emissions – power

generation to grid (Scope 1) 153 155 132 132

Indirect emissions – power

generation to grid (Scope 2) 12 14 15 11

Total for facilities, processes,

product test and development,

and power generation to grid 719 852 749 730

Intensity ratio (total emissions

normalised by revenue) for

facilities, processes, product test

and development, and power

generation to grid (ktCO

e/£m) 0.048 0.062 0.055 0.052

* 2014 data has been restated to reflect the inclusion of greenhouse gas emissions data

from Power Systems. Figures for prior years (2012 to 2013) do not include data from

Power Systems and therefore are not directly comparable.

We engaged Bureau Veritas to undertake a limited assurance engagement, reporting

to Rolls-Royce Holdings plc, using the assurance standards ISAE 3000 and ISAE 3410 over

the energy, GHG, TRI rate and STEM data that has been highlighted with

and as set out

on pages 41 to 44 and in the table above. The sustainability assurance statement is

included on page 183.

With the exceptions noted above, we have reported on all of

theemission sources required under the Companies Act 2006

(StrategicReport and Directors' Report) Regulations 2013.

Thesesources fall within our consolidated financial statements.

Wedo nothave responsibility for any emission sources that are

notincluded in our consolidated financial statements.

We have used the GHG Protocol Corporate Accounting and

Reporting Standard (revised edition) as of 31 December 2014, data

gathered to fulfil our requirements under the Carbon Reduction

Commitment (CRC) Energy Efficiency scheme, and emission factors

from the UK government’s GHG Conversion Factors for Company

Reporting 2016.

Further details on our methodology for reporting and the criteria

used can be found within our basis of reporting, available to

download from our website at www.rolls-royce.com/sustainability.

Major shareholdings

At 13 February 2017 the following shareholders had notified an

interest in the issued ordinary share capital of the Company in

accordance with the Financial Conduct Authority’s (FCA's) Disclosure

Guidance and Transparency Rules.

Shareholder Date notified

% of issued ordinary

share capital

BlackRock, Inc. 23 November 2016 5.00

The Capital Group Companies, Inc. 6 January 2017 4.69

ValueAct Capital Master Fund, L.P. 27 January 2017 11.01

Harbor International Fund 2 February 2017 3.98

Directors

The names of the Directors who held office during the year are

set out on page 61.

Disclosures in the Strategic report

The Board has taken advantage of Section 414C(11) of the

Companies Act 2006 to include disclosures in the Strategic

report including:

• Employee involvement.

• The future development, performance and position oftheGroup.

• The financial position of the Group.

• R&D activities.

• The principal risks and uncertainties.

Political donations

The Group’s policy is not to make political donations and therefore

did not donate any money to any political party during the year.

However, it is possible that certain activities undertaken by

theGroup may unintentionally fall within the broad scope

oftheprovisions contained in the Companies Act 2006 (the Act).

Theresolution to be proposed at the AGM is to ensure that the

Group does not commit any technical breach of the Act.

During the year, expenses incurred by Rolls-Royce North America

Inc. in providing administrative support for the Rolls-Royce

NorthAmerica political action committee (PAC) was US$42,742

(2015: US$45,021). PACs are a common feature of the USpolitical

system and are governed by the Federal Election CampaignAct.

The PAC is independent of the Group and independent of any

political party. The PAC funds are contributed voluntarily by

employees and the Group cannot affect how they are applied,

although under US Law, the business expenses are paid by the

employee's company. Such contributions do not require

authorisation by shareholders under the Act and therefore do not

count towards the limits for political donations and expenditure

forwhich shareholder approval will be sought at this year’s AGM

torenew the authority given at the 2016 AGM.

Other statutory information continued

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 OTHER STATUTORY INFORMATION 

Management report

The Strategic report and the Directors’ report together are the

management report for the purposes of Rule 4.1.8R of the FCA’s

Disclosure Guidance and Transparency Rules.

Disclosure of information to auditors

Each of the persons who is a Director at the date of approval of this

report confirms that:

• So far as the Director is aware, there is no relevant audit

information of which the Company’s auditor is unaware.

• The Director has taken all steps that he or she ought to have taken

as a director in order to make himself or herself aware of any

relevant audit information and to establish that the Company’s

auditor is aware of that information.

This confirmation is given, and should be interpreted, in accordance

with the provisions of Section 418 of the Companies Act 2006.

Branches

Rolls-Royce is a global company and our activities and interests

are operated through subsidiaries, branches of subsidiaries,

joint ventures and associates which are subject to the laws and

regulations of many different jurisdictions. Our subsidiaries, joint

ventures and associates are listed on pages 170 to 175.

Post balance sheet events

In January 2017, the Group entered into Deferred Prosecution

Agreements with the UK Serious Fraud Office and the US

Department of Justice, and a leniency agreement with the Brazilian

authority, MPF. These agreements require that the Group pays

financial penalties, the details of which are set out on page 8.

There have been no other events affecting the Group since

31 December 2016 which need to be reflected in the 2016

Consolidated financial statements.

Financial instruments

Details of the Group’s financial instruments are set out in note17

to the consolidated financial statements.

Related party transactions

Related party transactions are set out in note 24 to the Consolidated

financialstatements.

Information required by UK Listing Rule (LR) 9.8.4

There are no disclosures to be made under LR 9.8.4.

Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION SHAREHOLDER INFORMATION

Share dealing

The Registrar offers existing shareholders an internet dealing

service available from its website www.computershare.co.uk and a

telephone dealing service (+44(0)370 703 0084). The service is

available during market hours, 8.00am to 4.30pm, Monday to Friday

excluding bank holidays. The fee for internet dealing is 1% of the

transaction value subject to a minimum fee of £30. The fee for

telephone dealing is 1% of the transaction plus £35. Stamp duty of

0.5% is payable on all purchases. Other share dealing facilities are

available but you should always use a firm regulated by the FCA

(see www.fca.org.uk/register).

Your share certificate

Your share certificate is an important document. If you sell or

transfer your shares you must make sure that you have a valid share

certificate in the name of Rolls-Royce Holdings plc. If you place an

instruction to sell your shares and cannot provide a valid share

certificate, the transaction cannot be completed and you may be

liable for any costs incurred by the broker. Share certificates issued

in the name of Rolls-Royce plc or Rolls-Royce Group plc are invalid

and should be destroyed. If you are unable to find your share

certificate please inform the Registrar immediately.

American Depositary Receipts (ADR)

ADR holders should contact the depositary, JP Morgan,

bycalling+1(800) 990 1135 (toll free within the US) or emailing

[email protected].

Managing your shareholding

Your shareholding is managed by Computershare InvestorServices

PLC (the Registrar). When making contact with the Registrar please

quote your Shareholder Reference Number (SRN), a 10-digit number

prefixed with the letter ‘C’ that can be found on the right-hand side

of your share certificate or in any other shareholder correspondence.

It is very important that you keep your shareholding account details

up to date by notifying the Registrar ofany changes in your

circumstances.

You can manage your shareholding at www.investorcentre.co.uk,

speak to the Registrar on +44 (0)370 703 0162 (8.30am to 5.30pm

Monday to Friday) or you can write to the Registrar at Computershare

Investor Services PLC, The Pavilions, Bridgwater Road, Bristol BS13 8AE.

Payments to shareholders

The Company makes payments to shareholders by issuing

redeemable C Shares of 0.1p each. You can redeem C Shares for cash

and either take the cash or reinvest the cash to purchase additional

ordinary shares providing you complete a payment instruction

form, which is available from the Registrar. Once you have

submitted your payment instruction form, you will receive cash or

additional ordinary shares each time the Company issues CShares. If

you choose to receive cash we strongly recommend that you include

your bank details on the payment instruction form and have

payments credited directly to your bank account. This removes the

risk of a cheque going astray and means that cleared payments will

be credited to your bank account on the payment date.

Financial calendar 2017-2018

APR



JUN



AUG



OCT



DEC



FEB



MAR



MAY



JUL



SEP



NOV



JAN



 OCTOBER

Ex-entitlement

to C Shares

 OCTOBER

Record date for

entitlement to

C Shares

FEBRUARY/

MARCH

Announcement

of full-year results

and Annual Report

published

 APRIL

Ex-entitlement

to CShares

 APRIL

Record date for

entitlement to

C Shares

 JUNE .PM

Deadline for receipt

by Registrar of C Share

instructions (3:00pm

for CREST holders)

 JUNE

Record date for cash

dividend on C Shares

 DECEMBER

.PM

Deadline for receipt

by Registrar of C Share

instructions (3:00pm

for CREST holders)

 DECEMBER

Financial year end

 MAY . AM

AGM

Pride Park Stadium

Pride Park

Derby

DE24 8XL

 JULY

Payment of cash dividend on C Shares

 JULY

Allotment of C Shares

 JULY

Payment of C Share redemption monies

 JULY

Purchase of ordinary shares for

CRIP participants (at the latest)

 AUGUST

Announcement of half-year results

 NOVEMBER

Record date for cash

dividend on C Shares

 JANUARY

Payment of cash dividend on CShares

 JANUARY

Allotment of C Shares

 JANUARY

Payment of C Share redemption monies

 JANUARY

Purchase of ordinary shares for

CRIPparticipants (at the latest)

Shareholder information

OTHER INFORMATION

Rolls-Royce Holdings plc Annual Report 2016 SHAREHOLDER INFORMATION

Warning to shareholders – investment scams

We are aware that some of our shareholders have received

unsolicited telephone calls or correspondence, offering to buy or sell

their shares at very favourable terms. The callers can be very

persuasive and extremely persistent and often have professional

websites and telephone numbers to support their activities. These

callers will sometimes imply a connection to Rolls-Royce and provide

incorrect ormisleading information. This type of call should be

treated as an investment scam – the safest thing to do is hang up.

You should always check that any firm contacting you about

potential investment opportunities is properly authorised by the

FCA. If you deal with an unauthorised firm you will not be eligible

for compensation under the Financial Services Compensation

Scheme. You can find out more about protecting yourself from

investment scams by visiting the FCA’s website

www.fca.org.uk/consumers, orby calling the FCA’s consumer

helpline on 08001116768 (overseas callers dial +442070661000).

Ifyou have already paid money to share fraudsters contact Action

Fraud immediately on 0300 123 2040, whose website is at

www.actionfraud.police.uk.

Remember: if it sounds too good to be true it probably is.

Visit Rolls-Royce online

Visit www.rolls-royce.com to find out more about the latest

financial results, the share price, payments to shareholders,

thefinancial calendar and shareholder services.

DIVIDENDS PAID ON C SHARES HELD

C Share calculation period C Share dividend rate (%)

Record date for

C Share dividend Payment date

1 July 2016 – 31 December 2016 0.254 11 November 2016 4 January 2017

1 January 2016 – 30 June 2016 0.282 3 June 2016 1 July 2016

PREVIOUS C SHARE ISSUES

Apportionment values CGT apportionment

Issue date

No. of

C Shares issued

per ordinary

Record date

for

entitlement

to C Shares

Latest date

for receipt of

payment

instruction

forms by

Registrar

Price of

ordinary

shares on first

day of trading

(p)

Value of

C Share issues

per ordinary

shares (p)

Ordinary

shares (%) C Shares (%)

Date of

redemption

of C Shares

CRIP

purchase

date

CRIP

purchase

price (p)

4 January

2017 46

21 October

2016

1 December

2016 670.00 4.60 99.32 0.68

6 January

2017

12 January

2017 665.4883

1 July

2016 71

29 April

2016

1 June

2016 711.25 7.10 99.01 0.99

4 July

2016

5 July

2016 709.4997

For information on earlier C Share issues, please refer to the Group’s website www.rolls-royce.com.

ANALYSIS OF ORDINARY SHAREHOLDERS AT  DECEMBER 

Type of holder

Number of

shareholders

% of total

shareholders

Number

of shares

% of total

Individuals 186,217 97.46 95,144,774 5.17

Institutional and other investors 4,850 2.54 1,743,651,989 94.83

Total 191,067 100.00 1,838,796,763 100.00

Size of holding

1 – 150 62,115 32.51 5,793,739 0.32

151 – 500 94,927 49.68 26,096,749 1.42

501 – 10,000 32,319 16.91 52,267,639 2.84

10,001 – 100,000 1,163 0.61 32,145,373 1.75

100,001 – 1,000,000 378 0.20 125,958,367 6.85

1,000,001 and over 165 0.09 1,596,534,896 86.82

Total 191,067 100.00 1,838,796,763 100.00

Keeping up to date

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Rolls-Royce Holdings plc Annual Report 2016 OTHER INFORMATION GLOSSARY

Glossary

IASB International Accounting Standards Board

IFRS International financial reporting standards

KPIs key performance indicators

ktCO

e kilotonnes carbon dioxide equivalent

LIBOR London inter-bank offered rate

LTIP long-term incentive plan

LTPR long-term planning exchange rate

LTSA long-term service agreement

MPF Ministério Público Federal, Brazil

MRO maintenance repair and overhaul

MTC Manufacturing Technology Centre

NCI non-controlling interest

OCI other comprehensive income

OE original equipment

OECD Organisation for Economic Co-operation and Development

P&L profit and loss

PBT profit before tax

PPE property, plant and equipment

PSP performance share plan

R&D research and development

R&T research and technology

Registrar Computershare Investor Services PLC

RMS risk management system

RRSAs risk and revenue sharing arrangements

SFO UK Serious Fraud Office

SMR small modular reactors

SMS safety management system

SSA Special Security Agreement

STEM science, technology, engineering and mathematics

the Code UK Corporate Governance Code

Trent 1000

TEN

Thrust, Efficiency and New Technology

TRI total reportable injuries

TSR total shareholder return

USD/US$ United States dollar

UTCs University Technology Centres

ABC anti-bribery and corruption

AGM Annual General Meeting

AMC Approved Maintenance Centre

AMRCs Advanced Manufacturing Research Centres

APRA annual performance related award plan

Articles Articles of Association of Rolls-Royce Holdings plc

ASC Authorised Service Centres

Brexit UK exit from the European Union

C Shares non-cumulative redeemable preference shares

C&A commercial and administrative

CARs contractual aftermarket rights

CEO chief executive officer

CFO chief financial officer

Company Rolls-Royce Holdings plc

CPS cash flow per share

CRIP C Share reinvestment plan

DARPA Defense Advanced Research Projects Agency

DoJ US Department of Justice

DPA Deferred Prosecution Agreements

EASA European Aviation Safety Agency

ELT Executive Leadership Team

EPS earnings per share

EU European Union

EUR euro

FCA Financial Conduct Authority

FCAS UK-France Unmanned Combat Air System

FRC Financial Reporting Council

FX foreign exchange

GBP Great British pound or pound sterling

GHG greenhouse gas

Global Code Global Code of Conduct

Group Rolls-Royce Holdings plc and its subsidiaries

HPC high performance culture

HS&E health, safety and environment

IAB International Advisory Board

IAS International accounting standards

Designed and produced by

The paper used in the report contains 75% recycled

content, of which 75% is de-inked post-consumer.

All of the pulp is bleached using an elemental chlorine

free process (ECF).

Printed in the UK by PurePrint using their

environmental printing technology, using vegetable inks

throughout. PurePrint is a CarbonNeutral® company. Both

the paper manufacturing mill and the printer are registered

to the Environmental Management System ISO 14001 and are

Forest Stewardship Council® (FSC) chain-of-custody certified.

Rolls-Royce Holdings plc

Registered office:

62 Buckingham Gate

London

SW1E 6AT

T +44 (0)20 7222 9020

www.rolls-royce.com

Company number 7524813