Rolls-Royce Regulatory News (RR.)

11 March 2021

ROLLS-ROYCE HOLDINGS PLC - 2020 Full Year Results

· Severe impact of COVID-19 pandemic on Group performance and near-term outlook

· More than £1bn saved in 2020 from in-year cash mitigations, compared to pre-COVID plans

· Strengthened liquidity to £9bn and protected financial position with £7.3bn of new debt and equity and launched programme to raise at least £2.0bn from disposals

· Strong progress on fundamental restructuring programme; around 7,000 roles removed in 2020

· Targeting free cash flow (FCF) to turn positive during second half 2021 and at least £750m as early as 2022, dependent on the pace of the recovery in engine flying hours and underpinned by the restructuring programme

Warren East, Chief Executive said:

"2020 was an unprecedented year and I would like to thank everyone at Rolls-Royce for their hard work, dedication and sacrifice to help secure the Group's future. The impact of the COVID-19 pandemic on the Group was felt most acutely by our Civil Aerospace business. In response, we took immediate actions to address our cost base, launching the largest restructuring in our recent history, consolidating our global manufacturing footprint and delivering significant cost reduction measures. We have taken decisive actions to enhance our financial resilience and permanently improve our operational efficiency, resulting in a regrettable, but unfortunately very necessary, reduction in the size of our workforce. With the support of our stakeholders we successfully secured additional liquidity with a rights issue, bond issuance and further credit facilities put in place during the year. We have made a good start on our programme of disposals and will continue with this in 2021. We continue to invest in developing market-leading technology and low carbon opportunities in all our end markets, to create value for our stakeholders and ensure we are well positioned to take advantage of the transition to a lower carbon economy and growing demand for more sustainable power solutions."

Group financial performance

1 Underlying financing charge of £1,705m reflects the cost of closing $11.8bn over-hedged £/US$ position across 2020-26 (£1,689m) and cost of closing over-hedged jet fuel position in 2020 (£16m). £202m of the cash cost was realised in 2020 with £1,503m cash cost across 2021-26.

2 2019 EPS restated to reflect the impact of the 2020 rights issue.

Summary of 2020 financial performance and financial impact of COVID-19

Our financial performance in 2020 was significantly affected by the COVID-19 pandemic. The global spread of the virus from March resulted in a sudden deterioration of some of our end markets. A positive albeit reduced contribution from Power Systems and growth in Defence were important to the Group's overall performance, partly offsetting the severe impact to our Civil Aerospace business.

Cash flow

· FCF of £(4.2)bn, reflecting deterioration in underlying performance as a result of the impact of COVID-19 on Civil Aerospace in particular, and a deterioration in working capital which included a £(1.1)bn impact from the cessation of invoice discounting.

· Actions to reduce non-critical spend and payroll delivered more than £1bn of savings in year compared to pre-COVID plans partly mitigating the impact of lower flying hour receipts.

· Reported movement in net funds of £(2.9)bn was helped by £2.0bn inflow from the rights issue.

Underlying performance

· Underlying revenue of £11.8bn reflected lower activity and included a £(1.1)bn revenue impact from Civil Aerospace LTSA contract accounting catch-ups.

· Underlying operating loss of £(2.0)bn included £(1.3)bn of one-off charges largely due to COVID-19 comprising charges for LTSA catch-ups, contracts that have become loss-making in the year and customer provisions.

· Underlying loss before tax of £(4.0)bn included a £(1.7)bn underlying finance charge related to the FX hedge book reduction, due to lower USD receipts in 2020 and forecast future years.

Reported performance

· Reported operating loss of £(2.1)bn included £(1.3)bn net exceptional charges, largely as a result of COVID-19, including £(1.4)bn from impairments and write offs, £(489)m from restructuring, and a £620m exceptional provision release on the Trent 1000 programme.

· A full reconciliation of reported results to underlying results is presented on page 6.

Financial and liquidity position at year end

· Liquidity of £9.0bn at year end comprised £3.5bn cash and £5.5bn undrawn credit facilities.

· A total of £7.3bn additional liquidity was secured during 2020, including £2.0bn rights issue and £5.3bn new credit through bonds, bank loan facilities and commercial paper.

· Net debt of £(1.5)bn excluding leases (£(3.6)bn including leases).

· Under the terms of recent loan agreements, we are restricted from making or declaring payments to our shareholders until after 31 December 2022. Regardless of these restrictions, the Board recognises that it would be inappropriate to make payments at this time due to the Group's financial position.

2020 Business unit performance summary

1 Organic change at constant translational currency (constant currency) applying 2019 average rates to 2020 and excluding M&A. All commentary is provided on an organic basis unless otherwise stated.

2 The underlying results for Power Systems for 2019 have been restated to reclassify Bergen Engines AS and the Civil Nuclear Instrumentation and Control business as non-core.

Responding to the impact of COVID-19

We reacted quickly to the outbreak and rapidly implemented a number of proactive safety measures, in line with local and national guidelines, which helped us to protect our people and ensure continuity of our operations. We also increased our focus on employee mental health and wellbeing through our Employee Assistance Programme and additional resources. Additionally, we have supported the countries and communities in which we operate, providing practical assistance including support with PPE supply, ventilator production and educational tools. Furthermore, we launched the Emergent Alliance, a global community that uses data analytics to assist the global recovery.

To help mitigate the financial impact of COVID-19, we promptly implemented a number of cash cost saving actions to reduce our cash outflow in 2020. These included tighter controls on all discretionary expenditure and a 10% salary reduction for senior managers and executives. Our early response, with many of these measures in place by April, enabled us to achieve more than £1.0bn in-year cash cost savings for 2020 compared to our pre-COVID-19 expectations.

The impact of COVID-19 on international travel significantly altered the near and medium-term outlook for civil aviation. In May 2020 we launched a major restructuring programme to fundamentally re-size the cost base and capital requirements of our Civil Aerospace business. In total we expect the restructuring to lead to the reduction of at least 9,000 roles by the end of 2022, most of which are in Civil Aerospace. By the end of the year, approximately 7,000 permanent and contractor roles had been removed with a significant proportion achieved through voluntary severance and natural attrition. Through these role reductions and a continued focus on costs, we expect to reduce our operating costs and capital spend by £1.3bn versus 2019 levels, with full run-rate savings realised by the end of 2022.

In 2020, $500m of bonds matured and we secured £7.3bn of additional debt and equity funding to strengthen our liquidity. Our strong liquidity position ensures that, even in a severe but plausible downside scenario (page 25) we have enough funding for our operations, business development and near-term debt maturities. In addition, in March 2021 we secured approvals for a £1.0bn increase, which we intend to leave undrawn, to the existing £2.0bn term-loan facility supported by an 80% guarantee from UK Export Finance. We are targeting at least £2.0bn from disposals by early 2022 and have already announced agreements to sell our Civil Nuclear Instrumentation and Control and Bergen Engines businesses. We expect the proceeds from the rights issue in 2020, together with business disposals and cash generated from operations over the next few years, to help us to return to a net cash position in the medium term.

Our recovery expectations

Our diversified portfolio helped to protect the Group's performance during the COVID-19 crisis, with support from governmental end-markets in Power Systems and Defence in particular. Looking ahead over the next couple of years, we are encouraged by the outlook for vaccinations and testing and we expect the rebound in global GDP and lifting of travel restrictions to drive our recovery.

Although the pace and timing of the air travel recovery remains outside our control, we have acted quickly to reset our cost base, particularly in Civil Aerospace, to deliver improved returns and greater operational efficiency. Our large engine LTSA flying hours (EFH) in 2021 are expected to increase to around 55% of 2019 levels (2020: 43%) with an acceleration in the second half as global vaccination programmes enable travel restrictions to be lifted. In 2022, our base case is for EFH to reach around 80% of 2019 levels (previously 90%). Large engine deliveries are expected to remain at the current lower levels for the next few years.

In Power Systems, the shorter-cycle nature of its business means that many of its end markets are expected to recover from the effects of the pandemic by the end of 2021 supporting our expectation that our revenues will be back to 2019 levels by 2022. In addition, our success in China is enabling us to continue to expand our business and win market share. Beyond 2021, we expect structural growth to be driven by global economic activity and the shift towards more sustainable, lower carbon power solutions, most notably hybrid-electric and hydrogen solutions as well as microgrids.

Our Defence business has a strong order book providing good visibility, with around 90% order cover for 2021, and steady growth into the medium term. With an installed base of more than 16,000 engines, we see potential to expand our aftermarket services with through-life upgrades for existing products. We expect broadly stable Defence revenues in the medium term, with strong cash conversion. Defence has substantial new programme opportunities, with good prospects in the US that could generate more than $7bn of lifetime revenue. We are also a key member of the Tempest programme in the UK.  

Well positioned for the future

Despite the challenges we faced in 2020, we continued to invest organically and acquisitively in new opportunities, focused on technologies which enable our net zero carbon ambitions as the pace of adoption of low carbon solutions accelerates.

In 2020, approximately 7% of our research and development (R&D) spending was related to low carbon technologies (2019: 4%) and 38% towards next generation engine development with the remainder spent on delivering or enhancing our current product portfolio. The engine programmes we launched in recent years are now maturing and our investment priorities are pivoting towards lower carbon solutions as well as a more equitable balance across our business units. We intend to dedicate approximately 20% of our annual R&D expenditure to low carbon solutions including small modular reactors (SMRs), hybrid, hydrogen and electric power technologies, by 2023.

We publicly affirmed our ambition to enable the sectors we serve to achieve net zero carbon by 2050 when we joined the UN Race to Zero campaign in 2020.

Outlook and financial guidance

In this challenging environment, near-term financial forecasting is more difficult and the potential range of outcomes wider. Our expectations and targets are based on the pace of delivery of our fundamental restructuring programme and our current view of the shape and timing of the recovery. 

· We expect Group FCF in the region of £(2.0)bn in 2021, based on EFH at around 55% of 2019 levels, with the outflow weighted towards the first half before the Group turns cash flow positive at some point during the second half of the year.

· Group FCF of at least £750m (excluding disposals) is achievable when EFH exceed 80%, on average, of 2019 levels for a 12-month period. We aim to reach this as early as 2022, underpinned by our cost reductions and management actions, however the exact timing is dependent on the pace of air travel recovery.

· Medium-term, we aim to return to a net cash position and an investment grade credit position driven by free cash generation and our planned £2.0bn disposal programme.

The near-term outlook remains uncertain and highly sensitive to the developments of the COVID-19 virus and the related measures taken by governments around the world.

This announcement has been determined to contain inside information.

LEI: 213800EC7997ZBLZJH69

Enquiries:

This announcement contains forward-looking statements. Any statements that express forecasts, expectations and projections are not guarantees of future performance and will not be updated. By their nature, these statements involve risk and uncertainty, and a number of factors could cause material differences to the actual results or developments. This report is intended to provide information to shareholders, is not designed to be relied upon by any other party, or for any other purpose and Rolls-Royce Holdings plc and its directors accept no liability to any other person other than under English law.

Results webcast and conference call

A webcast and conference call will be held at 09:00 (GMT) today. To register for the webcast, including Q&A participation, please visit: https://edge.media-server.com/mmc/p/egc88ogi

A webcast replay will be made available shortly after the event concludes on the same link.

Conference call dial-in details:

UK / International: +44 203 009 5709 / US: +1 646 787 1226

Participant passcode: 549 8743 

Downloadable materials

Please visit the Investor Relations section of the Rolls-Royce website to download PDF copies of our Results materials: https://www.rolls-royce.com/investors/results-and-events.aspx 

Photographs and broadcast-standard video are available at www.rolls-royce.com. 

The commentary and income statement below describe underlying performance, with percentage and absolute change figures presented on an organic basis, unless otherwise stated.

Summary income statement

1 Organic change at constant translational currency (constant currency) by applying 2019 average rates to 2020 numbers, and excluding M&A. All commentary is provided on an organic basis unless otherwise stated.

2 The impact of M&A was £147m on revenue and £6m on underlying operating loss.

3 2019 earnings per share has been adjusted to reflect the 2.91 bonus element of the rights issue

Note: 2019 transactions were translated at an achieved rate of £$1.53, close to the average rate of our hedge book, whereas 2020 transactions were translated at £$1.24 in the first half and £$1.33 in the second half, due to not being able to utilise our hedge book in 2020. 

· Underlying revenue: Organic change of £(3.6)bn (23)% reflected a significant fall in both OE and services revenue largely due to the impact of COVID-19 on end-market demand. Civil Aerospace was the most impacted, down £(3.0)bn (37%) including £(1,061)m of COVID-related negative LTSA catch-ups. Power Systems was down £(530)m (17%) mostly due to lower OE revenue and ITP Aero was £(240)m lower (26%) with a reduction in OE partly offset by a small increase in services. Defence revenue increased by £125m (4%), showing continuity of demand from government customers and effective measures to minimise operational disruption from COVID-19.

· Underlying gross loss: The loss of £(512)m was predominantly driven by a £(2.0)bn loss in Civil Aerospace (including £(1.3)bn of COVID-related charges), partly offset by savings from role reductions and cost mitigations. Power Systems, Defence and ITP Aero all contributed positively, with Defence achieving an increase on the prior year.

· Commercial and administration costs: reduced by £63m, reflecting some of the savings from the Group-wide focus on cost mitigations in response to COVID-19.

· Research and development costs: An increase of £43m reflected lower capitalisation due to the maturity of key aero engine programmes, partly offset by a reduction in expenditure due to our cost mitigation efforts to rephase non-critical spending.

· Underlying operating loss: The loss of £(2.0)bn reflected the gross loss and a higher R&D charge, partly offset by higher profit from joint ventures and associates and a reduction in C&A costs.

· Financing costs: Costs of £(2.0)bn included a one-off underlying finance charge of £(1.7)bn, mostly taken in the first half, to reduce the size of our USD hedge book by $11.8bn in response to a lower medium-term outlook for US$ cash receipts following COVID-19.

· Taxation: The £(39)m tax charge (2019: £(277)m) reflected the tax on overseas profits together with the fact that we have not recognised any deferred tax on UK losses arising in 2020. In addition, £(51)m of the deferred tax previously recognised on UK losses was derecognised.

Group Reported Results

Consistent with past practice, we provide both reported and underlying figures. As the Group does not generally hedge account for forecast transactions in accordance with IFRS 9 Financial Instruments, we believe underlying figures are more representative of the trading performance by excluding the impact of period-end mark-to-market adjustments. In particular, the USD:GBP hedge book has a significant impact on the reported results. In 2020, the USD:GBP spot rate moved from 1.32 to 1.36 while the EUR:GBP rate moved from 1.18 to 1.11. Underlying performance also excludes the effect of acquisition accounting and business disposals, impairment of goodwill and other non-current and current assets, and exceptional items. These are included in arriving at reported results. The adjustments between the underlying income statement and the reported income statement are set out in Note 2 to the Consolidated Financial Statements. This basis of presentation has been applied consistently.

Reconciliation between underlying and reported results

The most significant items included in the reported income statement, but not in underlying, are summarised below.

1 The impact of measuring revenues and costs and the impact of valuation of assets and liabilities using the period end exchange rate rather than the achieved rate or the exchange rate that is expected to be achieved by the use of the hedge book increased reported revenues by £61m (2019: £1,137m) and reduced loss before financing and taxation by £998m (2019: increased profit by £145m). Underlying financing excludes the impact of revaluing monetary assets and liabilities at the period end exchange rate.

2 The underlying results exclude the fair value changes on derivative contracts held for trading. These fair value changes are subsequently recognised in the underlying results when the contracts are settled.

3 In response to the deterioration in the medium-term outlook caused by COVID-19 and the related reduction in anticipated net US Dollar cash inflows, the Group has taken action to reduce the size of the US Dollar hedge book by $11.8bn predominately by transacting offsetting foreign exchange forward contracts across 2020-2026, resulting in a £1,689m charge to underlying results. The £1,503m included in unrealised loss (shown above) is the net cost of closing out the over-hedged position in future years. The cost related to future years has been included within the underlying performance. It is reversed in arriving at reported performance on the basis that, the cumulative fair value changes on these derivative contracts are recognised as they arise.

4 In 2020, the Group incurred a cash outflow of £186m as a result of closing out $1.2bn of the $11.8bn hedge book reduction and a cash outflow of £16m to settle an over-hedged jet fuel position. The realised loss of £202m is included in underlying financing costs.

5 Includes the losses on hedge ineffectiveness in the year of £11m (2019: losses £13m) and net fair value losses of £75m (2019: profit £14m) on any interest rate swaps not designated into hedging relationships for accounting purposes.

6 In 2019, abnormal wastage costs were recorded in respect of the Trent 1000, related to remediation shop visit costs, customer disruption costs and contract losses. During the year, the total estimated Trent 1000 abnormal wastage costs have reduced by £620m as a result of COVID-19 made up of £390m (a gross provision release of £560m, offset by the impact of expected actual exchange rates and the share of the costs borne by RRSAs) related to remediation shop visit costs and customer disruption costs and an improvement of £230m in the position on contract losses.

7 Discount rates have increased on exceptional contract loss provisions in relation to the Trent 900 and Trent 1000.

8 At 31 December 2020, the Group recorded an exceptional restructuring charge of £489m following the announcement on 20 May 2020 to reshape and resize the Group due to the financial and operational impact of COVID-19 (see note 21 for more detail).

9 The Group has assessed the carrying value of its assets given the financial and operational impact of COVID-19 on the Group's future cash flow forecasts. Consequently, a number of impairments and write-offs have been recorded at 31 December 2020. Impairments comprise: intangible assets £567m, mainly related to programme intangibles; property, plant and equipment £318m (including £219m related to site rationalisation); right-of-use assets £384m, comprising engines of £311m, £69m of site rationalisation and £4m of other impairments; and a £24m impairment on the carrying value of investments held.

10 Other write-offs include £149m of participation fees in contract assets, £2m in provisions for site rationalisation, offset by £(27)m for RRSA deferred cost contributions in payables. These write-offs are primarily a result of the impact of COVID-19.

11 The effect of acquisition accounting includes the amortisation of intangible assets arising on previous acquisitions.

12 The Group recorded a past service gain of £308m (of which £248m was recorded at 30 June 2020) following changes to the pension benefits under the terms of the Rolls-Royce UK Pension Fund (RRUKPF), a defined benefit scheme. In respect of the £248m gain recorded at 30 June 2020, £127m was subsequently recognised as actuarial losses through other comprehensive income at 31 December 2020 - see note 2 and 22.

13 Gains/(losses) arising on the acquisitions and disposals of businesses includes the acquisition of Qinous GmbH (increasing the Group's shareholding from 24% to 100%), the sale of the North America Civil Nuclear business, the sale of the Knowledge Management Systems business and the sale of Trigno Energy Srl.

Tax affecting these adjustments resulted in a tax charge of £(220)m (2019: £(143)m). The charges in 2020 and 2019 are mainly due to the non-recognition of deferred tax on UK losses arising in those years. The charge in 2020 includes a tax credit of £160m in respect of the change in the UK tax rate and a tax charge of £(276)m relating to the derecognition of some of the deferred tax asset on UK losses previously recognised. The 2019 charge included £(86)m relating to the derecognition of UK deferred tax assets on foreign exchange and commodity financial assets and liabilities.

Group Funds Flow

Free cash flow

Group free cash outflow of £(4,185)m deteriorated from a £873m inflow in 2019. The key drivers of this outflow were significantly lower engine flying hour receipts as global travel dramatically declined and working capital outflows, including the decision to cease invoice discounting, as our OE and aftermarket volumes declined. Trent 1000 in-services cash costs were £(524)m (2019: £(578)m).

1 The derivation of the summary funds flow statement above from the reported cash flow statement is included on page 60.

Key changes in the funds flow items are described below:

Depreciation, amortisation and impairments: The decrease of £(117)m was largely driven by lower overall additions across intangible assets and property, plant and equipment as a result of management actions to reduce cash expenditure and a £102m adjustment to residual value guarantees which is non-cash and increased underlying operating profit.

Lease payments (capital plus interest): Lease payments were higher than prior year largely due to changes in FX achieved rates used to convert US dollar lease payments into GBP.

Additions of intangible assets: Expenditure included £(232)m capitalised R&D (2019: £481m), lower than 2019 due to completion of capitalisation of the Trent 1000 and Pearl 15 engine R&D, reflecting the maturity of these programmes, and no further capitalisation on the Pearl 700 programme.

Purchases of property, plant and equipment: Investment was lower than 2019 primarily as a result of management actions to reduce cash costs to mitigate the impact of COVID-19.

Decrease in inventory: The £588m decrease in 2020 (2019: £(43)m increase) was led by COVID-19 driven demand reductions as well as significant improvement measures delivered in Civil Aerospace, partly offset by certain actions to safeguard necessary parts supply in 2021.

Movement in receivables/payables/contract balances (excluding Civil LTSA):

The £(2,207)m movement in 2020 reflected:

· £0.4bn increase in receivables reflecting the decision to cease invoice discounting (£(1.1)bn increase), partly offset by significantly lower trading activity especially in Civil Aerospace.

· £1.8bn reduction in payables reflecting lower amounts owed to suppliers, JVs and Risk and Revenue Share Partners (RRSPs) due to COVID-19 led demand reductions. In addition, reduction in OE deposits reflecting utilisation in Civil Aerospace. This was partly offset by new deposits in Defence and an increase in the Civil Aerospace OE engine concessions payable, due to aircraft delivery delays and associated concession payment deferrals.

Movement in underlying Civil Aerospace net LTSA balance: The LTSA net balance increased by £479m. There was a significant reduction in widebody and regional invoiced engine flying hour receipts during 2020 due to lower flying activity, resulting in a £(582)m underlying reduction to the net LTSA balance as revenues traded exceeded invoiced flying hour receipts. However, this was more than offset by the impact of £1,061m of contract catch-ups, principally driven by a forecast reduction in engine flying hour receipts due to the COVID-19 pandemic, which reduced revenue recognised during the year.

Movement on provisions: The £(195)m movement reflected a decrease in the provision balance driven by Trent 1000 provision utilisation during the period partly offset by new provisions charges (details on page 10), largely as a result of COVID-19 which include the impact from the up-front recognition of future losses on a small number of loss-making Civil Aerospace contracts.

Interest: The net payment of £(75)m in 2020 was £2m higher than prior year, reflecting movements in the overall total amount of debt and interest rates. £5.3bn of additional debt was raised during 2020. At 31 December 2020, £5.5bn of total debt was undrawn.

Contributions to defined benefit pensions: Cash contributions were £160m lower than the charge on the income statement (2019: £9m higher). The £169m year-on-year movement reflected early payment in 2019 of contributions due in 2020 and deferral of certain 2020 contributions into 2021.

Taxation: The cash tax payments in 2020 were £(231)m compared to £(175)m in 2019. The increase reflected higher payments in Germany, largely due to timing.

Payments to shareholders: The £(92)m interim dividend was announced in August 2019 and paid in January 2020. Reflecting the Group's financial priorities and the challenging macro environment, the Board did not recommend a final dividend in respect of 2019.

Rights issue: In November 2020, a 10:3 rights issue raised net proceeds of £1,972m.

Acquisitions and disposals: Net costs of £(119)m included the acquisitions of Qinous, Kinolt and Servowatch; offset by disposal proceeds related to Civil Nuclear North America, Knowledge Management Systems, Trigno, Exostar and a L'Orange earn-out adjustment and M&A costs.

Exceptional Group restructuring: Payments of £(323)m relating to the 2020 fundamental restructuring programme were made in 2020, of which £55m related to restructuring capital expenditure.

Payment of financial penalties: The penultimate payment of £(135)m relating to the deferred prosecution agreement (DPA) was made in January 2020.

Other underlying adjustments: Outflow of £(33)m includes timing of cash flows on a prior period disposal where the Group retains the responsibility for collecting cash before passing it on to the acquirer.

Net cash flow from changes in borrowings (excluding lease liabilities): During the year, the Group issued £1,972m ($1,000m, €750m and £545m) of bond notes as well as £300m of commercial paper under the Covid Corporate Financing Facility. The Group also repaid a maturing $500m (£328m) bond.

Balance sheet

1 Net working capital includes inventory, trade receivables and payables and similar assets and liabilities.

2 Net debt includes £251m (2019: £243m) of the fair value of financial instruments held to hedge the fair value of borrowings.

3 2019 adjusted for assets held for sale (HfS) (Bergen Engines AS and Civil Nuclear Instrumentation and Control business) to aid comparability.

Key drivers of balance sheet movements (adjusted for assets held for sale) were:

Intangible assets: Net decrease of £(286)m included impairments of £(579)m, mostly related to the impact of COVID-19. Additions of £364m primarily related to programme development in Civil Aerospace and investment in software applications. Acquisitions of Kinolt Group, Qinous GmbH and Servowatch Systems added £137m. There was a £137m FX impact and amortisation was £(323)m.

Property, plant and equipment: Net decrease of £(283)m included impairments of £(332)m and depreciation of £(489)m partly offset by £38m FX impact and additions of £553m. The additions were lower than the prior year as spending was limited to critical infrastructure projects. 

Right-of-use assets: Net reduction of £(596)m was driven by impairments of £(386)m, primarily of lease engines in Civil Aerospace and land and buildings as part of our footprint consolidation. The depreciation charge was £(346)m. Additions were £135m, £92m lower than the prior year.

Contract assets and liabilities: The net liability balance increased by £(186)m, of which £(417)m related to the Civil Aerospace LTSA balance and included foreign exchange of £62m and negative LTSA catch-ups of £(1,061)m. The remainder largely covered reduction in deposits in Civil Aerospace partly offset by new deposits in Defence. 

Working capital: The £570m net current asset position reflected a £1.8bn change on the prior year.

· Receivables increased by £0.4bn as a £1.1bn reduction in invoice discounting was partly offset by lower trading activity in Civil Aerospace.

· Payables reduced by £1.8bn primarily due to COVID-19 led demand reductions and comparatively stronger Q4 2019 trading activity.

· Inventory reduced by £0.5bn largely due to COVID-19 led demand reductions and parts rescheduling in Civil Aerospace partly offset by growth in Defence to protect 2021 deliveries and support the supply chain.

· The movement also included a financial penalty payment of £135m related to agreements reached with investigating authorities in January 2017.

Provisions: The £835m decrease reflected net restructuring charges of £(373)m, of which £206m was utilised in 2020 and Trent 1000 provisions utilisation and release of £541m and £560m respectively. 

Net debt: Increased to £(3.6)bn (including lease liabilities) primarily driven by free cash outflow of £(4.2)bn partly offset by £2.0bn of rights issue proceeds. 

Net financial assets and liabilities: The £164m change was primarily driven by the utilisation of derivatives of £246m partially offset by the fair value movement in currency exchange rates and other derivatives.

Net post-retirement scheme surpluses/deficits: The £(474)m movement was driven by reduction in the UK surplus reflecting changes to members' benefits as part of restructuring the UK pension, closure of the scheme and deferral of company contributions. There have also been changes in financial and demographic assumptions across both the UK and overseas schemes. See note 22.

US$ hedge book: Due to the impact of COVID-19 on Civil Aerospace our forecast future US$ receipts reduced significantly. As a result, we took the necessary decision to reduce the size of our hedge book by $11.8bn to $25bn. Our US$ hedge book runs to 2028. The total cost of closing out the over-hedged position is £(1.7)bn, of which £(186)m was incurred in 2020. The remainder of the cash outflow will be incurred over the next six years.

· Production cuts from airframer customers resulted in substantially fewer large engine deliveries in 2020. Business jet deliveries were resilient in the first half of the year but reduced during the second half as the airframers adjusted to the impact on demand from COVID-19.

· Large engine LTSA flying hours were 43% of 2019 level. Flying hour performance was significantly more robust in newer engine programmes than more mature types.

· Business aviation LTSA engine flying hours were resilient, however there was a significant reduction in both regional and V2500 flying hours.

· Large engine LTSA major service visits were 11% lower than prior year, particularly in the second half of the year when we saw a substantial reduction in activity.

· Roles reduced by approximately 5,500 (20%), with most of the departures taking place in the second half of 2020 as a result of the fundamental restructuring programme.

· Agreement reached with Airbus to extend Trent XWB-84 exclusive position on A350-900 to 2030.

· Underlying revenue reduced by 37% to £5.1bn (2019: £8.1bn). This decline was driven by the reduction in engine delivery volumes, particularly for large engines, lower aftermarket revenues reflecting fall in shop visit volumes, and included a £(1.1)bn impact from negative LTSA contract catch-ups.

· Underlying gross loss of £(2.0)bn, £(2.6)bn lower than 2019. This reflected:

£(1.3)bn of largely COVID-related one-time charges:

o LTSA catch-ups: £(974)m impact to profit from negative LTSA catch-ups, mainly driven by a forecast reduction in engine flying hour receipts as a result of COVID-19 and principally impacting mature engine programmes;

o up-front recognition of future losses: primarily due to COVID-19 certain contracts have either become loss-making or have seen an increase in expected losses, driving a £(213)m charge; and

o £(86)m charge: reflecting specific customer provisions due to the impact of COVID-19 on the civil aviation industry and our customers' financial positions.

A material reduction in trading performance, primarily reflecting the impact of COVID-19:

o a substantial reduction in large engine aftermarket, driven by lower shop visit volumes, adverse margin mix on LTSA shop visits, and reduced time & materials (T&M) profits;

o lower OE profits from business aviation and reduced volumes of large spare engine sales, which offset the benefit from lower installed widebody engine volumes; and

o a material impact in 2020 from under-recovery of fixed costs.

· Commercial and administration costs were relatively unchanged year-over-year, with cost reduction actions delivered in the year reflected more heavily in cost of sales and R&D spend.

· Research and development costs of £(436)m reflected a significant reduction in capitalisation during the period due to the maturity of key aero engine programmes partly offset by a reduction in expenditure due to the reducing investment burden on our new engine programmes and the rephasing of some R&D spending in light of COVID-19. Spending continued to shift towards next-generation gas turbine technology and low carbon solutions such as electric and hybrid-electric aircraft.

· Underlying operating loss of £(2.6)bn reflected the fall in gross profit and slightly higher R&D charge, partly offset by an increase in profits from joint ventures and associates.

· Trading cash flow was a £(4.6)bn outflow during the year (2019: £419m inflow). This deterioration was driven by significantly lower engine flying hour receipts as well as a material working capital outflow, including the one-time impact from the cessation of invoice factoring in 2020.

· Trent 1000 and Trent XWB update: During 2020 in-service cash costs on Trent 1000 were in line with guidance at £(524)m and in June we reached our goal of zero aircraft on ground (AoG) due to the durability issues. There was a £620m exceptional credit reflecting a £390m net improvement in the outlook for future in-service cash costs, alongside a £230m improvement in expected future losses on our small number of loss-making contracts primarily due to the impact of COVID-19 on flying activity. Early identification and action regarding durability issues on the Trent XWB announced in August 2020 did not result in any grounded aircraft and it was not necessary to provide for any material additional costs in the year.

Outlook

The near-term environment for Civil Aerospace remains highly uncertain. We continue to plan for a range of recovery scenarios, including the risk of further setbacks to the recovery in air travel caused by new strains of the COVID-19 virus. However, our central assumption is for a gradual market recovery in 2021, with a slow start to the year but accelerating in the second half as global vaccine roll-outs progress and travel restrictions ease.

We anticipate large engine flying hours of approximately 55% of 2019 levels in 2021 (2020: 43%), with a strong second-half weighting as the recovery accelerates, and approximately 80% of 2019 levels in 2022. Engine deliveries will remain low with 200 to 250 large engines and 100 to 150 business jet engine deliveries planned for 2021.

Our severe but plausible downside scenario assumes approximately 45% EFH in 2021 and 70% in 2022, both compared to the 2019 level. More details on page 25. 

1 The underlying results for 2019 have been restated to reclassify Bergen Engines AS and the Civil Nuclear Instrumentation and Control business as non-core.

2 The impact of M&A was £55m on revenue and £nil on underlying operating profit.

Diversified end market exposure resulted in a relatively resilient performance for Power Systems. Lower economic activity and reduced utilisation of the installed base of engines due to COVID-19 caused a substantial drop in commercial and industrial markets. However, governmental demand remained intact and we grew strongly in China, where economic conditions were better.

· Order intake of £2.7bn was 17% lower year-on-year, a book-to-bill of 1.0x during 2020. Commercial marine was impacted by lower tourism and yacht production facility closures, while economic uncertainty led to a deferral of capital spending across power generation and industrial customers. However, there were signs of recovery in order intake in the second half and the underlying demand in key areas including mission-critical back-up generation remained strong.

· Underlying revenue reduced by 17% to £2,745m. This reflected a fall in industrial and power generation revenues, with marine relatively stable due to strong governmental demand. OE revenue was down 21% while Services were more resilient, down just 6%.

· Underlying gross profit of £681m was 25% lower year-over-year. This reflects the lower sales, reduced factory utilisation, and an adverse mix effect due to the sharper fall in high-margin aftermarket spare parts.

· Commercial and administration costs fell 6% to £(337)m primarily reflecting management actions to mitigate costs.

· Research and development costs of £(167)m were focused on the investment in lower carbon areas across our portfolio. This includes our expanding gas engine family, electric and hybrid-electric solutions (supported by the acquisition of battery storage company Qinous), and hydrogen solutions, such as our new co-operation with Daimler on hydrogen fuel cells.

· Underlying operating profit of £178m with a margin of 6.5%, 4.9%pts lower than prior year, reflecting the drop in gross profit, partly offset by the improvements in C&A and R&D.

Outlook

Uncertainty remains over the near-term economic outlook. However, based on Power Systems' short-cycle exposures and the growth potential in key markets such as China, we expect an improvement in order intake during the first half of 2021, converting into a recovery in sales from the second half of the year with revenues returning to approximately 2019 levels in 2022. Longer term there are significant growth opportunities for Power Systems across both existing activities (notably in mission-critical back-up power and expansion in China) and in new low carbon solutions such as microgrids, hydrogen and hybrid-electric power solutions. 

Defence had a strong year, with resilient financial performance despite the COVID-19 pandemic. Government customers remained supportive throughout the year, and effective business continuity plans were enacted to minimise the disruptions experienced to the supply chain and facilities.

· Order intake was £2.4bn, representing a book-to-bill ratio of 0.7x. This follows on from a record order intake of £5.3bn in 2019 (1.6x book-to-bill) and an average book to bill ratio of 1.2x between 2015 and 2019. Order cover for 2021 is in excess of 90% and the healthy order book currently represents approximately 2.3 years of Defence sales.

· Underlying revenue increased by 4% to £3.4bn. This was largely driven by higher LiftSystem aftermarket revenues as the in-fleet service expands together with international sales of the EJ200 engine powering the Eurofighter Typhoon. Naval sales and UK parts sales also improved compared to the prior year.

· Underlying gross profit of £686m was 3% higher year-over-year. This reflects the higher sales volumes, with gross margin relatively stable at 20.4%.

· Commercial and administration costs were 4% lower year-on-year at £(151)m despite the underlying business growth.

· Research and development costs fell by £9m despite an increase in expenditure on key strategic programmes in the period to support new growth opportunities.

· Underlying operating profit increased by 8% to £448m, with margins 0.5%pts higher. This reflected the stronger gross profit and modestly lower C&A and R&D charges outlined above.

Outlook

We anticipate another good year for Defence in 2021. Revenue is expected to be stable, with a strong level of order cover coming into the year. Operating margins are also expected to be broadly flat at approximately 13%. We continue to pursue large opportunities in the US which would drive a step-change in growth prospects for Defence, notably the B-52 engine replacement programme for the US Air Force and the Future Vertical Long Range Assault Aircraft competition for the US Army. We also continue to progress Project Tempest in UK air combat. Finally, we are investing in adjacent technologies such as small engines and directed energy power systems in order to drive further medium-term growth.

Due to ITP Aero's significant exposure to civil aviation, which accounted for around 70% of its revenues in 2020, performance was heavily negatively impacted by the COVID-19 pandemic.

· Underlying revenue was £705m, down 26% versus 2019, primarily reflecting lower engine (OE) volumes on civil programmes, particularly in widebody. Defence OE revenue was more resilient, supported by EJ200 orders. Service revenue increased 8%.

· Commercial and administration costs of £(38)m were 40% lower year-on-year, including some benefit from management actions to reduce discretionary costs, with headcount 13% lower at the year-end compared to 2019.

· Research and development costs were £6m lower in the period mainly due to phasing of projects.

· Underlying operating profit of £68m, 39% lower year-on-year, reflecting the lower OE revenues and under-utilisation of the fixed cost base.

Outlook 

We expect some stabilisation in 2021 followed by a recovery in our performance from 2022 onwards reflecting the wider recovery in commercial aerospace as well as the outcomes from our actions to reduce costs to improve profitability. We remain focused on cost savings, including the workforce capacity adjustment of approximately 15% globally from 2019 levels, which is already well underway and will be completed by the end of the first half of 2021. Our planned sale of ITP Aero is progressing well with ongoing conversations with a number of potential buyers.

Condensed consolidated financial statements

Condensed consolidated income statement

For the year ended 31 December 2020

1 Included within cost of sales, commercial and administrative costs and research and development costs are: exceptional items relating to impairments and write-offs arising as a result of the financial and operational impact of COVID-19 plus other market driven events; impairments and provisions related to the fundamental restructuring activity announced on 20 May 2020 to reshape and resize the Group have also been recorded; and reflecting the impact of COVID-19 and the work we have performed to reduce fleet AOG levels and improve the availability of spare engines, the Trent 1000 provision has been reduced. In the prior year, exceptional charges related to the Trent 1000 and Trent 900 Civil Aerospace programmes and restructuring costs were included within cost of sales and commercial and administrative costs. Further details can be found in note 2.

2 Cost of sales includes a charge for expected credit losses of £119m (2019: £54m).

3 North America Civil Nuclear business was disposed of on 31 January 2020, Knowledge Management System business was disposed of on 3 February 2020, Trigno Energy Srl was disposed of on 7 May 2020 and Exostar LLC was disposed of on 6 July 2020. Qinous GmbH was acquired on 15 January 2020, Kinolt Group S.A was acquired on 1 July 2020 and Servowatch Systems Limited was acquired on 7 December 2020. Sales proceeds on a prior period disposal has been adjusted during the year. Commercial Marine was disposed of on 1 April 2019 and Rolls-Royce Power Development Limited was disposed of on 15 April 2019. Further details can be found in note 24.

4 Included within financing costs are fair value changes on derivative contracts. Further details can be found in notes 2 and 4.

5 (Loss)/profit before taxation disclosed on a statutory and underlying basis. Further details can be found in note 2.

6 The comparative figures for earnings per share and payments to shareholders per share have been adjusted to reflect the bonus element of the rights issue - see note 6. As a result of the COVID-19 pandemic, the Directors cancelled the proposed final payment to shareholders of 2.4p (adjusted) per share.

Condensed consolidated statement of comprehensive income

For the year ended 31 December 2020

1 Included in actuarial movements in post-retirement schemes is an experience loss of £188m which includes the impact of updated membership data and members leaving on voluntary severance. Included in the prior period is an asset re-measurement net loss estimated at £600m following the agreement to transfer the future pension obligation of circa 33,000 pensioners in the UK scheme to Legal & General Assurance Society Limited. See note 22 for further information.

Condensed consolidated balance sheet

At 31 December 2020

Condensed consolidated cash flow statement

For the year ended 31 December 2020

Condensed consolidated cash flow statement continued

For the year ended 31 December 2020

1 During the year, the Group received £47m from the British Government as part of the UK furlough scheme. This was recognised within operating loss.

2 Where the cost of meeting residual value guarantees is less than that previously estimated, as costs have been mitigated or liabilities waived by the lessor, the lease liability has been remeasured. Where the value of this remeasurement exceeds the value of the right-of-use asset, the reduction in the lease liability is credited to cost of sales.

3  Relates to penalties paid on agreements with investigating bodies.

4 Includes £5m adjustment of cash consideration on prior period disposal paid during the year. Further detail is provided in note 24.

5 Repayment of loans includes repayment of the £2.5bn revolving credit facility. Proceeds for increase in loans includes the drawdown of £2.5bn revolving credit facility, proceeds of £2.0bn from new unsecured loan notes and £0.3bn cash received from the Covid Corporate Financing Facility (CCFF). Further detail is provided in note 19.

6 The impact of COVID-19 on the aerospace industry resulted in a deterioration in net US Dollar receipts across the Group leading to a net US Dollar outflow in the period. During the year, the Group incurred a cash outflow of £186m as a result of needing to buy US Dollars to settle $1,211m of foreign exchange contracts that were originally in place to sell US Dollar receipts. The Group also incurred a cash outflow of £16m to settle excess jet fuel hedges. Further detail is provided in notes 2 and 4.

7 Expenses of £79m, of which £1m was unpaid at 31 December 2020, and the cost of the Employee Share Trust subscribing for the new shares of £10m have been deducted off the gross proceeds of £2,060m.

8 The Group considers overdrafts (repayable on demand) and cash held for sale 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 flow statement.

In deriving the consolidated cash flow statement, movements in balance sheet line items have been adjusted for non-cash items. The cash flow in the period includes the sale of goods and services to joint ventures and associates - see note 12.

1 In 2019, the Group reclassified £79m as borrowings previously included in other financial liabilities. These borrowings mature during periods up to 2029.

Condensed consolidated cash flow statement continued

For the year ended 31 December 2020

The movement in net debt (defined by the Group as including the items shown below) is as follows:

1 Fair value of swaps hedging fixed rate borrowings reflects the impact of derivatives on repayments of the principal amount of debt. Net debt therefore includes the fair value of derivatives included in fair value hedges (2020 £293m, 2019 £229m) and the element of fair value relating to exchange differences on the underlying principal of derivatives in cash flow hedges (2020 £(42)m and 2019 £nil). During the year, the Group reclassified £14m relating to the fair value of derivatives for which hedge accounting was not applied as these relate to the future payments of interest only.

2 In 2019, the Group reclassified £79m as borrowings previously included in other financial liabilities. These borrowings mature during periods up to 2029.

3 Includes Trent 1000 insurance receipts of £173m.

1

Condensed consolidated statement of changes in equity

For the year ended 31 December 2020