Rolls-Royce Regulatory News (RR.)

24 February 2022

ROLLS-ROYCE HOLDINGS PLC - 2021 Full Year Results

· Improved financial performance driven by growth and cost reduction

- Underlying operating profit of £414m (statutory £513m), recovered from prior year loss

- Free cash flow substantially improved and ahead of expectations

· Delivering on our commitments

- Restructuring run-rate savings of more than £1.3bn delivered one year ahead of schedule

- Disposals on-track with total expected proceeds of around £2bn

· Investing to drive further growth and deliver sustainable value

- FY 2021 £(1.2)bn gross R&D on market-leading technology for new and existing markets

- Focused investments in net zero opportunities to deliver long-term sustainable value

Warren East, Chief Executive said: "We have improved our financial and operational performance, continued to deliver on our commitments and created a better balanced business capable of sustainable growth. We have achieved the benefits of our restructuring programme a year ahead of schedule, positioning Civil Aerospace to capitalise on increasing international travel. In Defence, we have seen growth driven by strong demand in all our markets and in Power Systems we achieved record order intake in the last quarter. The positive momentum we are generating gives us confidence both in our expectations for 2022 and our future growth. We have also made significant progress with our new businesses in electrical power and small modular reactors, both of which have the potential to create very significant long-term value. We are continuing to make disciplined investments to develop new and existing technologies, which will enable us to seize the significant commercial opportunity presented by the global energy transition driving sustainable returns."

Full Year 2021 Group financial performance

Improved financial performance driven by cost reduction and market growth

Underlying revenue from continuing operations of £10.9bn, reflected a more balanced contribution from the business units compared with the prior year. It included a positive £214m Civil Aerospace LTSA revenue catch-up compared with a £(1.1)bn negative revenue catch-up in 2020.

Underlying operating profit from continuing operations of £414m included significant cost savings from the restructuring programme, primarily in Civil Aerospace, continued resilient performance in Defence and strong growth in Power Systems as it benefitted from recovering end markets. The prior year comparative underlying loss of £(2.0)bn included £(1.3)bn of one-off charges mostly related to the impact of COVID-19 on Civil Aerospace.

Free cash outflow from continuing operations of £(1.5)bn and trading cash outflow from continuing operations of £(1.2)bn were substantially improved on the prior year helped by robust progress on cost reduction, stronger operating performance including higher flying hour receipts in Civil Aerospace and reduced capital expenditure. Working capital outflows of £(0.8)bn, which were mostly driven by concession payments and lower OE deliveries in Civil Aerospace, improved on the prior year due to the non-repeat of £(1.1)bn negative impact from the cessation of invoice factoring in 2020.

Business unit underlying performance summary

For footnotes referenced in tables on pages 2-13, see page 14.

Civil Aerospace Our fundamental restructuring programme has been largely completed resulting in higher productivity and sustainably lower costs, better suited to the current environment and positioned well for future growth. The launch of the Airbus A350 freighter in 2021 represents a significant opportunity for our Trent XWB engine, with 58 engine orders secured for the A350F since its launch. In Business Aviation, we achieved two key new selections with our Pearl 10X chosen by Dassault for the Falcon 10X and our Pearl 700 chosen by Gulfstream for the G800. In 2021, we powered 7.4m large engine flying hours, up 11% on 2020 with gradual recovery in international flying activity, which continued to be impacted by COVID-19 travel restrictions.

Defence Our longstanding commitment to strategic investments in Defence products and facilities has resulted in a strong order book and is driving longer-term sustainable growth. In 2021, we secured new work for the coming decades in the US with the award of the B-52 engine replacement contract, and we remain in a competitive process for the Future Long-Range Assault Aircraft (FLRAA) programme. Our profitability and strong cash conversion are supporting increased investment to meet the customer demand for products that deliver advances in technology and sustainability.

Power Systems End market demand increased significantly for our Power Systems business in the second half of 2021 as the impacts of COVID-19 reduced. Order intake accelerated, with record order intake in the fourth quarter, driving book to bill of 1.2x in 2021 and good order cover for 2022. Significant awards included a power solution for a hyperscale data centre customer and a first-of-a-kind net zero microgrid which will combine fuel cells and hydrogen combustion engines for the Port of Duisburg in Germany.

New Markets We have created a new reporting segment for our early-stage businesses with high growth potential, focused on addressing new market opportunities being created by the transition to net zero. Rolls-Royce SMR reached a major milestone with grant funding and new equity investors supporting entry into the UK's Generic Design Assessment (GDA) process. Rolls-Royce Electrical achieved key product advances with a world speed record for our all-electric aircraft. We believe our two New Markets businesses could generate more than £5bn combined annual revenue by the early 2030s. Delivering on our commitments

We have met our £1.3bn run-rate savings target a year ahead of schedule and delivered on our Group restructuring commitment with the removal of more than 9,000 roles from continuing operations. Our focus now is on ensuring the benefits are sustained. Our restructuring programme has fundamentally changed the way we work in our Civil Aerospace business, reducing the size of the business by around a third and creating a more productive, more efficient business poised for future growth.

We are committed to rebuilding our balance sheet. We have announced four disposals which are expected to generate around £2bn in proceeds (including retained cash). Three of the disposals have completed, two in 2021 and the other one since the start of 2022. The final and largest of the disposals, ITP Aero, is progressing well and we expect completion in the first half of 2022. Disposal proceeds, together with underlying free cash flow generation from the Group, will be used to reduce net debt, in line with our ambition to return to an investment grade credit profile in the medium term.

Our liquidity position is strong with £7.1bn of liquidity including £2.6bn in cash at the end of the year after repaying the 2021 €750m bond and the £300m Covid Corporate Financing Facility (CCFF) commercial paper. Net debt was £(5.2)bn including leases (2020:£(3.6)bn). Net debt excluding leases was £(3.4)bn (2020:£(1.5)bn).

Some of our loan facilities place restrictions and conditions on payments to shareholders. The restrictions mean no shareholder payment will be made for 2021. From 2023, the Board may recommend shareholder payments, subject to satisfaction of the conditions and our consideration of progress made to strengthen the balance sheet. We aim to be able to recommend shareholder payments in the medium term.

Investing to drive growth and deliver sustainable value

Our technology and engineering expertise gives us a critical role in enabling the transition to a low carbon global economy. We are focused on producing the technology breakthroughs society needs to decarbonise the global economy and capture the economic opportunity this transition represents. We are doing that by making our existing products compatible with net zero and pioneering new technologies that can meet accelerating demand for net zero power, as well as identifying additional applications for our current portfolio of technologies. Our investment in small modular reactors (SMRs) and electrical propulsion create net zero solutions and opportunities in new end markets, as we aim to maximise the future market potential for our technological and industrial solutions and products.

In 2021, our gross R&D costs totalled £(1.2)bn (2020:£(1.2)bn), £366m of which was paid for by contributions from third parties. Our continued prioritisation of targeted investment, even in the most challenging years, drove commercial success in 2021 including the Pearl engine selections, the B-52 engine replacement contract, the first all-hydrogen microgrid, a world speed record for electric flight and entry into the UK GDA for our SMRs.

Outlook and financial guidance

We are well positioned for the anticipated growth in our end markets as the impact of the COVID-19 pandemic eases. This, along with continued good contribution from Defence, gives us confidence that we will see positive momentum in our financial performance in 2022 despite the challenges and risks around the pace of market recovery, global supply chain disruption and rising inflation. We expectlow-to-mid-single digit revenue growth and we expect our operating profit margin to be broadly unchanged as underlying operational improvement is balanced with increased engineering spend to develop sustainable growth opportunities. We expect to generate modestly positive free cash flow in 2022, seasonally weighted towards the second half of the year.

Results webcast and conference call

A webcast will be held at 08:30 (GMT) today and details of how to join are provided below. Conference call details are also available for those who would prefer to dial-in. Downloadable materials will also be available on the Investor Relations section of the Rolls-Royce website.

Webcast details

To register for the webcast, including Q&A participation, please visit the following link: https://edge.media-server.com/mmc/p/gi4zqu9m  

Please use this same link to access the webcast replay which will be made available shortly after the event concludes.

Conference call details

UK dial-in: 0207 192 8338/ US dial-in: +1 646 741 3167

International dial-in for all participants: +44 207 192 8338

Participant passcode: 784 4816#

Downloadable materials

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

Enquiries:

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

A PDF copy of this report can be downloaded from www.rolls-royce.com/investors.

This results 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.

LSE: RR.; ADR: RYCEY; LEI: 213800EC7997ZBLZJH69

Statutory Income Statement

Statutory revenue of £11.2bn was 2% lower compared with 2020 driven by a decline in Civil Aerospace revenue, due to lower OE deliveries and shop visit volumes. Revenue included a £214m positive LTSA catch-up in Civil Aerospace compared with a £(1.1)bn negative revenue catch-up in the prior year. Defence benefitted from increased spare parts and spare engine sales. Power Systems revenues were driven by our more resilient end markets, with increased demand for Services from our defence and industrial customers.

Gross profit returned to profit of £2.1bn compared with a prior year loss of £(187)m reflecting growth and cost discipline as well as substantial cost savings and productivity gains delivered by the restructuring programme. Gross profit also included a £105m provision reversal in relation to the Trent 1000 engine programme (2020: £620m) and a £256m positive LTSA catch-up in 2021. The prior year comparative included £(1.8)bn of net charges relating to negative LTSA catch-ups, impairments and write-offs.

Operating profit improved significantly to £513m from a prior year £(2.0)bn loss. Research & Development costs were £(778)m down 35% from 2020 as a consequence of one-off impairments in the prior year. Commercial & Administrative costs of £(890)m were 15% higher than the prior year (2020:£(771)m), which benefitted from a one-off pension credit partly offset by a restructuring provision.

Loss before taxation of £(294)m included £(538)m net fair value losses on derivative contracts, £(245)m net interest payable and a net £56m profit from disposals.

Profit from continuing operations of £124m included a tax credit of £418m, (2020: tax charge £302m), which mostly related to movements in deferred tax balances due to the impact of the UK tax rate change from 19% to 25%, effective from April 2023. The tax charge in 2020 was mostly driven by the derecognition of some of the deferred tax asset on UK losses previously recognised, partly offset by a credit relating to the change in the UK tax rate from 17% to 19%.

Earnings per share of 1.48p (2020: (51.81)p) reflected the improvement in profit and an increase in weighted average number of shares compared with the prior year to reflect the full year impact of the bonus element of the rights issue completed in November 2020.

Statutory Balance Sheet

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

Intangible assets: Net decrease of £(150)m included additions of £223m primarily related to programme development in Civil Aerospace and Power Systems, and investment in the development of software applications across the business. There was an adverse foreign exchange impact of £(146)m and amortisation for the year was £(281)m.

Property, plant and equipment: Net decrease of £(186)m included additions of £299m, more than offset by £(439)m of depreciation and a foreign exchange impact of £(63)m. Additions were £254m lower than prior year as a result of focus on prioritisation of business critical infrastructure projects and focus on reducing capital intensity.

Right-of-use assets: Net reduction of £(187)m was driven by £(272)m depreciation charged in the year partly offset by additions of £82m.

Contract assets and liabilities: The £109m movement in net liability balance was mainly driven by the utilisation of deposits, foreign exchange movements and invoiced LTSA receipts in Civil Aerospace exceeding revenue recognised in the year, partly offset by £214m LTSA catch-ups.

Working capital: The £1,458m net current asset position was £994m higher than prior year, due to a £0.7bn reduction in payables driven mostly by Civil Aerospace, including a £0.5bn reduction in concessions payable as payments significantly exceeded new concessions accrued in the year, alongside a modest reduction in trade payables due to the timing and volume of supplier payments. We also made the final financial penalty payment of £156m related to agreements reached in January 2017. Inventory increased by £0.2bn, mostly in Power Systems and Defence, to support 2022 sales.

Provisions: The £325m decrease primarily reflected the utilisation and reversal of restructuring provisions of £212m as the restructuring programme nears completion, utilisation of Trent 1000 provision of £199m, partly offset by £82m of contract loss provision net of reversals. 

Net debt: Increased from £(3.6)bn to £(5.1)bn primarily driven by free cash outflow of £(1.5)bn.

Net post-retirement scheme deficits: £448m movement driven by an increase in the UK scheme surplus reflecting company contributions and actuarial gains and a decrease in the overseas schemes deficit mainly attributable to actuarial gains and foreign exchange.

Taxation: The net tax asset increased by £547m, most of which (£344m) related to remeasurement of the opening UK deferred tax balances due to the UK tax rate change from 19% to 25% effective from April 2023. In addition, there was an increase in the deferred tax asset on unrealised losses on derivatives (£96m) and certain other UK deferred tax assets (£126m) reflecting tax relief that will be taken in the future, based on profit forecasts.

Underlying Income Statement

Underlying revenue of £10.9bn reflected a more balanced contribution from our business units. Services revenue increased 7% while OE fell 11%. Services revenue included a £214m Civil Aerospace LTSA revenue catch-ups compared with £(1.1)bn in the prior year.

Underlying gross profit of £2.0bn reflected the benefit of cost reductions and a £256m Civil Aerospace LTSA catch-up. The prior year loss of £(613)m included £(1.3)bn of one-off COVID-19 related charges, mainly relating to negative Civil Aerospace LTSA catch-ups.

Underlying operating profit was £414m, with a return to profit reflecting the higher gross profit in the year partly offset by  lower contribution from JVs and associates.

Underlying profit before taxation of £36m reflected net financing costs of £(378)m with higher charges relating to interest bearing debt compared with the prior year. In 2020, a £(1.7)bn one-off underlying finance charge was taken to close out over hedged positions on the USD hedge book.

Underlying profit for the year of £10m included a tax charge of £(26)m (2020: £(46)m). The tax charge reflects the tax arising on overseas profits and increases in other deferred tax assets. Deferred tax has not been recognised on current year UK tax losses. The tax charge in 2020 included the impact of derecognising some of the deferred tax asset previously recognised on UK tax losses.

Underlying earnings per share of 0.11p reflected the improvement in profit and an increase in weighted average number of shares compared with the prior year to reflect the full year impact of the bonus element of the rights issue completed in November 2020.

Group Funds Flow Statement 11

Key changes in the funds flow items are described below:

Expenditure on intangible assets: Expenditure of £(185)m included £(104)m capitalised Research & Development (2020: £(232)m), which was lower than prior year reflecting the mix of spend across Civil Aerospace engine programmes.

Capital expenditure: Investment of £(311)m was £268m lower than prior year as a result of continued focus on prioritisation of business critical infrastructure projects and focus on reducing capital intensity in Civil Aerospace in line with the cost reduction programme.

Increase in inventory: The £169m increase in the year was primarily driven by planned inventory build in Defence and Power Systems to meet expected sales volumes, and the impact of global supply chain disruption on Power Systems.

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

The movement of £(641)m was primarily driven by Civil Aerospace and included a significant volume of concession payments during the year as well as a reduction in trade payables driven by timing and volume of supplier payments. In addition, deposits were utilised in Civil and Defence as we continued to execute on customer contracts.

Movement in underlying Civil Aerospace net LTSA creditor: In 2021, there was a £66m increase in the net LTSA balance as invoiced flying hour receipts exceeded revenues recognised. This reflected an improvement in invoiced flying hour receipts as air traffic recovered during the year offset by higher revenues due to materially improved LTSA catch-ups compared to the prior year.

Movement on provisions: The £(136)m movement primarily reflected a decrease in the Trent 1000 provision driven by provision utilisation, including customer disruption costs settled and remediation shop visit costs.

Cash flows on settlement of excess derivative contracts: Relates to the cash settlement costs in the year for the offsetting foreign exchange contracts that were entered into to reduce the size of the US Dollar hedge book in 2020. The cash settlement costs of £1.7bn occur across 2020-2026, of which £1.0bn remains to be paid in future years.

Fees and interest: The net payment of £(259)m in the year was higher than the prior year, reflecting £(197)m of net interest paid (2020: £(75)m).

Contributions to defined benefit pensions: In 2021, cash contributions were £92m higher than the pensions charge in the income statement (2020: £160m lower) reflecting payment deferrals from 2020 into the first quarter of 2021.

Taxation: Net cash tax payments in 2021 were £(185)m (2020: £(231)m). The decrease is mainly due to timing, with additional payments arising in 2020.

Disposals and acquisitions: The £49m inflow related to proceeds associated with disposal activity partly offset by the costs incurred on acquisition and disposal activity.

Exceptional restructuring: Payments of £(231)m related to the restructuring programme and associated initiatives.

Payment of financial penalties: The final payment of £(156)m relating to the deferred prosecution agreement (DPA) in the UK was made in January 2021.

Other underlying adjustments: Outflow of £(23)m includes timing of cash flows on a prior period disposal where we retain the responsibility for collecting cash before passing it on to the acquirer, along with other smaller items.

Net cash flow from changes in borrowings and lease liabilities: During the year, we drew down on a £2.0bn loan which is supported by an 80% guarantee from UK Export Finance. £300m of commercial paper under the Covid Corporate Financing Facility and €750m (£639m) loan notes were repaid in line with repayment terms.

Civil Aerospace financial performance significantly improved due to the successful restructuring programme, gradual market recovery and non-repeat of largely COVID-19 related one-time charges in 2020. Large engine LTSA flying hours were up 11% compared with 2020 with the second half EFH up 57% year on year as COVID-19 vaccination programmes enabled most key routes to reopen on reduced volumes. Fewer large engines were required to fulfil customer build schedules, but sales of spare engines increased. Business aviation OE deliveries were down as we are transitioning to newer engines programmes, which are growing well from a low base.

- Underlying revenue of £4.5bn, down 10% on the prior year. OE revenue of £1.6bn was down 29% reflecting the reduction in engine deliveries. Services revenue of £2.9bn was up 6% on the prior year and included £214m positive LTSA catch-ups (2020: £(1.1)bn), partly offset by lower shop visit volumes and reduced contribution from the V2500 engine programme.

- Underlying gross profit of £474m improved from a £(2.0)bn loss in 2020, driven by strong operating cost performance resulting from restructuring savings as well as positive LTSA catch-ups of £256m. The prior year loss included £(1.3)bn of one-off charges and £(0.6)bn relating to USD purchases and under recovery of fixed costs.

- Underlying operating loss of £(172)m was significantly better than the prior year. This improvement reflected the increase in gross profit partly offset by the higher R&D charge and lower contribution from JVs and associates.

- Trading cash outflow was £(1.7)bn, a substantial improvement on 2020 reflecting higher EFH receipts, lower operating costs, capex and working capital as well as the non-repeat of £(1.0)bn from invoice factoring cessation in 2020. Working capital cash flow included large engine OE concession payments that reduced the concession liability by £474m (2020: £219m increase).

Outlook

Industry forecasters expect a continuation of the gradual improvement in international travel in 2022 with an acceleration in flying hours as COVID-19 related border restrictions are lifted. We will remain focused on actions within our control, keeping costs low and maintaining the recent productivity gains as shop visits increase. This, along with an expected increase in spare engine sales, would support modest revenue growth and improved profitability in 2022, as well as a substantial improvement in trading cash flow. 

Our Defence business continued to perform well with strong demand for OE and services driving growth in all our end markets: combat, transport, submarines and naval. Disciplined investment is pivotal to the long-term sustainable growth opportunities that will shape our Defence business for decades into the future. Our targeted investment in our facilities in North America as well as product development has supported recent growth in order intake and revenues. Our largest customers, the US DoD and the UK MoD, remain committed to the modernisation of their fleets with a particular focus on technology and an accelerating interest in reducing their carbon footprint.

- Order intake was £2.3bn with a book-to-bill of 0.7x. Our order book is strong following several years' of high intake with a five year average book-to-bill of 1.1x and 85% order cover for 2022. In 2021 we secured a key award with the US DoD for the replacement engine programme for the B-52 aircraft, with an initial value of $0.5bn and total OE programme value of $2.6bn.

- Underlying revenue increased by 5% to £3.4bn, with services revenue up 6% and OE revenue up 3%. Sales benefitted from strong sales of parts in our export markets in Asia and Middle East.

- Underlying gross profit of £721m was 9% higher than the prior year and the gross margin expanded 0.9%pt to 21.4%. This was driven by a positive mix towards higher margin spare parts and spare engine sales.

- Underlying operating profit was £457m, an increase of 3% compared with 2020. This profit growth occurred despite a 28% increase in R&D spend to support the UK Future Combat programme and targeted investment in growth opportunities in North America to support continued long-term product development.

- Trading cash flow was £377m, representing a cash conversion of over 80%. The prior year trading cash flow included adverse impact from the timing of cash deposit receipts.

Outlook

We expect continued modest revenue growth in 2022 with a strong order book cover securing near term activity in all our end markets. Our increased investment will support growth in programmes related to future projects and recent awards, as well as product development to help the transition to net zero. We do expect a return to more usual levels of spare engines and spare parts sales in 2022.

The effects of COVID-19 on our end markets lessened over the course of 2021 and we recorded a strong increase in order intake in the second half of 2021, especially in power generation with orders for data centres and infrastructure projects. The transition to net zero power is a significant opportunity with the mission critical power for data centres, power for construction and infrastructure, and marine solutions leading the demand for net zero carbon solutions. Along with many manufacturing businesses, global supply chain disruption impacted the availability of some parts and components in the second half of 2021. Challenges are likely to persist into 2022 until additional capacity has been created.

- Order intake of £3.3bn was 24% higher than the prior year, with record order intake in the fourth quarter and a book-to-bill ratio of 1.2x in the year. Order growth was strongest in marine, defence and power generation end markets. The customer interest in net zero carbon solutions is accelerating and our investment in decarbonising our solutions is critical to our future growth.

- Underlying revenue of £2.7bn was up 3%. Aftermarket services grew 10% as product utilisation increased in our end markets, and OE was broadly flat. Sales were strongest in industrial and power generation end markets, partly offset by lower activity in China.

- Underlying gross profit grew by 18% to £778m and gross margin increased by 3.6%pt. This included an increase in higher-margin aftermarket spare parts as well as improved utilisation in our manufacturing facilities and lower warranty costs.

- Underlying operating profit was £242m, up 37%. Operating margin of 8.8% was 2.2%pts higher than the prior year, reflecting the positive mix of activity and increased volumes. The increase in commercial and administrative costs reflected an increase in employee costs, partly due to the non-repeat of government support received in the prior year.

- Trading cash flow was £219m (2020:£162m), representing a cash conversion of about 90%.

Outlook

Looking ahead to 2022, we see continued strong demand growth from our customers supported by global economic growth and the transition to lower carbon solutions. We expect good revenue growth in 2022 helped by the strong order intake, partly offset by the current global supply chain constraints. Higher activity levels will drive improved profitability partly offset by increased Research & Development investment as we pursue net zero growth opportunities. Cash conversion is expected to be lower in 2022 as we focus on inventory and supply chain management to mitigate the impact of industry-wide disruption.

New Markets is our new reporting segment for our early-stage businesses, with high growth potential, focused on addressing the opportunities being created by the transition to net zero and solving the climate change challenge. There are two businesses currently in this segment: Rolls-Royce SMR and Rolls-Royce Electrical. These businesses leverage our existing, in-depth engineering expertise and capabilities to develop new sustainable products for future markets.

Rolls-Royce SMR secured £490m of funding in 2021 (including approximately £50m from Rolls-Royce), with receipts phased over the next few years to align with the future cash spend profile. This investment will help support our SMR design through the multi-year UK Generic Design Assessment (GDA) process. First orders for SMRs are not dependent on the completion of the GDA and are anticipated within the next few years.

In Rolls-Royce Electrical, we broke two world speed records for all-electric flight in our Spirit of Innovation aircraft and our eVTOL partners received multi-billion dollar pre-orders for their eVTOL programmes.

Over the next five years, we expect cumulative R&D investment in Rolls-Royce SMR and Rolls-Royce Electrical of over £1.0bn to be funded by third-party grants and investments as well as self-funded cash investment of over £0.5bn. New markets are more challenging to forecast due to the pace of customer demand growth and regulation, however the potential opportunities for these businesses are significant and we believe they could generate more than £5bn combined annual revenue by the early 2030s.

- Underlying revenue of £2m came from Rolls-Royce Electrical sales relating to marine engineering services and propulsion systems. Both Rolls-Royce Electrical and Rolls-Royce SMR are early-stage businesses in their investment phase, with significant future revenue generating potential in the 2030s.

- Underlying operating loss of £(70)m increased from the prior year comparative as we increased the pace of investment in both Rolls-Royce SMR and Rolls-Royce Electrical. The increased investment is critical to the development of the products that will drive our net zero growth in the future and is in line with our plans. R&D costs of £(68)m included £(16)m on the design development to ready our SMRs to enter the UK GDA process and £(52)m on electrical propulsion technology.

- Trading cash flow of £(56)m was lower than operating losses mainly due to the receipt of funding for the SMR programme.

Outlook

Our financial performance in 2022 will show a significant increase in Research & Development costs as we invest to develop our products and grow our businesses in these exciting new markets. Cash outflow is expected to be approximately £100m better than the underlying operating loss in 2022, mainly due to the phased receipt of secured third party equity investment in Rolls-Royce SMR.

Notes to financial tables and commentary on pages 1-13:

1 Organic change at constant translational currency (constant currency) applying full year 2020 average rates to 2021, excluding M&A. All commentary is provided on an organic basis unless otherwise stated.

2 The underlying results for Civil Aerospace for 31 December 2020 have been restated to reflect the changes to activity during 2021 due to the transfer of the Hucknall site and associated fabrications activities to ITP Aero.

3 The underlying results of Civil Aerospace, Defence and Power Systems for 31 December 2020 have been restated to reclassify the results of the Group's small modular reactor (SMR) and new electrical power solutions as New Markets and UK Civil Nuclear as Other businesses.

4 Other businesses include the results of the Bergen Engines AS business, the results of the Civil Nuclear Instrumentation & Control business, the results of the North America Civil Nuclear business (until the date of disposal on 31 January 2020) and the results of the Knowledge Management System business (until the date of disposal on 3 February 2020). The trading results of the UK Civil Nuclear business have also been included in other businesses.

5 2020 figures have been adjusted to reflect ITP Aero being classified as a disposal group held for sale since 30 June 2021; the Group's investment in Airtanker Holdings Limited being classified as a non-current asset held for sale since 13 September 2021; and certain tangible assets related to the Group's site rationalisation activities being classified as held for sale at 31 December 2021.

6 Relates to Bergen Engines AS and the Civil Nuclear Instrumentation & Control business which were classified as disposal groups held for sale at 31 December 2020. Both disposals were completed in 2021.

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

8 Net debt includes £37m (2020: £251m) of the fair value of derivatives included in fair value hedges and the element of fair value relating to exchange differences on the underlying principal of derivatives in cash flow hedges. Net debt has been adjusted to exclude net debt held for sale.

9 Underlying performance excludes the impact of year-end mark-to-market adjustments, the effect of acquisition accounting and business disposals, impairment of goodwill and other non-current and current assets, and exceptional items. Adjustments between the underlying income statement and the statutory income statement are set out in note 2 in the Condensed Consolidated Financial Statements on page 33.

10 M&A includes 2020 Power Systems acquisitions comprising of Kinolt Group S.A and Servowatch Systems Limited (SSL).

11 The derivation of the summary funds flow statement from the statutory cash flow statement is included on page 53.

A reconciliation of alternative performance measures to their statutory equivalent is provided on pages 55 to 56.

Statutory results were referred to as "reported" results in the 2020 full year results statement.

Condensed consolidated financial statements

Condensed consolidated income statement

For the year ended 31 December 2021

1 The comparative figures have been restated to reflect ITP Aero being classified as a discontinued operation. The respective notes to the financial statements have also been restated on this basis. Further detail can be found in note 22.

2 Cost of sales includes a charge for expected credit losses of £124m (2020: £119m). Further details can be found in note 12.

3 Included within financing are fair value changes on derivative contracts. Further details can be found in notes 2, 4 and 16.

Condensed consolidated statement of comprehensive income

For the year ended 31 December 2021

Condensed consolidated balance sheet

At 31 December 2021

Condensed consolidated cash flow statement

For the year ended 31 December 2021

Condensed consolidated cash flow statement continued

For the year ended 31 December 2021

1 During the year, the Group received £11m (2020: £47m) from the British Government as part of the UK furlough scheme. This was recognised within operating profit/(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. To the extent that 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 Repayment of loans includes repayment of £300m commercial paper under the Covid Corporate Financing Facility (CCFF) and €750m (£639m) loan notes in line with repayment terms. Proceeds from increase in loans includes the drawdown of a £2,000m loan (supported by an 80% guarantee from UK Export Finance). Further details are provided in note 17.

5 During the year, the Group incurred a cash outflow of £452m as a result of settling foreign exchange contracts that were originally in place to sell $3,184m receipts. Further detail is provided in note 4.

6 Relates to NCI investment received in the year, in respect of Rolls-Royce SMR Limited. Following the formation of Rolls-Royce SMR Limited during the year, and in line with the shareholder agreements, £30m investment was received by Rolls-Royce SMR Limited.

7 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 condensed consolidated cash flow statement, movements in balance sheet line items have been adjusted for non-cash items. The cash flow in the year includes the sale of goods and services to joint ventures and associates.

Condensed consolidated cash flow statement continued

For the year ended 31 December 2021

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

1 Reclassifications include the transfer of ITP Aero to held for sale and fees of £29m paid in previous periods for the £2,000m loan (supported by an 80% guarantee from UK Export Finance) that have been reclassified to borrowings on the drawdown of the facility during the current period.

2 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 (2021: £114m, 2020: £293m) and the element of fair value relating to exchange differences on the underlying principal of derivatives in cash flow hedges (2021: £(77)m, 2020: £(42)m).

3 As at 31 December 2021, net debt excluding lease liabilities was £(3,400)m (2020: £(1,533)m).

Condensed consolidated statement of changes in equity

For the year ended 31 December 2021