Rolls-Royce Regulatory News (RR.)

1 August 2017

ROLLS-ROYCE HOLDINGS PLC

2017 HALF YEAR RESULTS

Commenting on the results, Warren East, Chief Executive, said: "Rolls-Royce delivered encouraging year-on-year operational progress in the first six months of the year. Civil Aerospace large engine deliveries increased 27% and we made good further progress improving Trent XWB OE economics. Restructuring savings were ahead of plan. Together with a higher than expected benefit from long-term contract accounting adjustments, this resulted in a good set of results, with financial performance ahead of our expectations for the first half. Looking to the balance of the year, execution and delivery of a number of important milestones across our businesses will be key to achieving our full year expectations. Our outlook for full year profit and cash remains unchanged."

Underlying: for definition see note 2 on page 32 * translated at constant exchange rates; ** translated at actual exchange rates;

*** free cash flow defined as operating cash after capital expenditure, pensions and taxes, before payments to shareholders and investigating authorities, foreign exchange and acquisitions & disposals. The derivation of free cash flow is shown on page 24.

H1 highlights

· Reported revenue up 12% at constant exchange rates; 17% at actual exchange rates

· Reported profit before tax of £1,941m (2016 loss: £2,150m)

· Underlying revenue up 6% at constant exchange rates, led by Civil Aerospace and Power Systems

· Underlying profit before tax of £287m, up £183m (2016: £104m)

· Good profit growth in Civil Aerospace and Power Systems with Defence remaining steady; Marine continues to face challenging offshore oil and gas markets

· First half commercial and administration costs down £38m or 7%

· First half R&D spend increased to £411m (2016: £378m), underpinning key growth opportunities

· Free cash flow performance solid with a steady operating performance, helped by effective working capital management

· Interim payment to shareholders unchanged at 4.60 pence per share

Looking forward

· Outlook for full year 2017 unchanged

Warren East added: "Two years ago we set out a programme of change at Rolls-Royce to drive efficiency and sharpen our focus on execution. Our strengthened management team is making good progress in simplifying the organisation and driving the pace of necessary change to develop a more resilient and sustainable business. However, this is no time for complacency. Strong execution and a focus on delivering our customer commitments remains essential as we continue to manage in-service issues in Civil Aerospace alongside key new product introductions and increased production volumes. Our long-held commitment of investing in R&D and future technologies remains unchanged, as we look to secure the long-term success of the business, built on a solid platform of outstanding customer service and strong cash flows."

This announcement has been determined to contain inside information.

Enquiries

Investors:

John Dawson +44 20 7227 9087

Helen Harman +44 20 7227 9339

Ross Hawley +44 20 7227 9282

Media:

Richard Wray +44 20 7227 9163

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 Half Year 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 the Company and its directors accept no liability to any other person other than under English law.

Results Presentation

A presentation will be held at 09:00 (GMT) today. Details of how to join the event online are provided below. Downloadable materials will be available on the Rolls-Royce website from the start of the event.

Online webcast registration details for 1 August presentation

To register for the live webcast (including Q&A participation) please visit this link:

http://edge.media-server.com/m/p/ebfsbz7c

Please use this same link to access the webcast replay after the event.

2017 Half Year Business Highlights

Percentage or absolute change figures in this document are on a constant translational currency ('constant currency') basis unless otherwise stated.

* Based on gross revenues prior to intra-group eliminations

Civil Aerospace

· Underlying revenue up 14%, principally due to:

o Original equipment (OE): 27% increase in deliveries of Trent engines

o Services (AM): strong growth, led by in-production fleet and time & materials activities on older engines; good progress on Rolls-Royce powered aircraft transitions

· Underlying profit before financing of £173m, up from £31m in 2016; helped by aftermarket growth and a higher than expected benefit from long-term contract accounting adjustments (a net gain of £56m v 2016, including a £77m benefit arising from a change to a customer credit rating risk assessment)

· Progress on new engine programmes: ongoing flight testing of Trent 1000 TEN and Trent XWB-97; shipped first set of Trent 7000 test engines to Airbus in June

· Large engine production ramp up continuing; further work to deliver 2017 targets after solid start including good further progress improving Trent XWB OE economics

· Expect increased activity in second half related to Trent 1000 maintenance programme to address a number of technical issues; working with our customers to minimise disruption

· Full year outlook unchanged: increasing deliveries driving OE growth; aftermarket growth led by increased engine flying hours; and further cost reduction initiatives on large engine installed base

Defence Aerospace

· Underlying revenue down 4%; modest reduction in both OE sales and service revenues

· Underlying profit before financing £148m (2016: £128m); led by lower overhead costs

· Two new Service Delivery Centres announced to enhance aftermarket service offering

· Full year outlook unchanged: margins and profits expected to soften from 2016 levels

Power Systems

· Underlying revenue up 3%; led by higher OE volumes

· Underlying profit before financing £66m (2016: £13m); led by better volumes and higher gross margin

· New management revitalising the business; pursuing growth opportunities, manufacturing and product simplification; clearer performance goals

· Full year outlook: improving environment, although visibility in some markets remains limited; improved closing OE order book; improved outlook overall

Marine

· Underlying revenue down 15%; due to weak offshore markets

· Underlying profit before financing down £17m to £(31)m; lower offshore volumes more than offset first half cost savings from restructuring programmes announced over last two years

· Full year outlook: market conditions mixed; focus on operational restructuring

Nuclear

· Underlying revenue up 8%; led by increased submarine work

· Underlying profit before financing down £4m at £14m; reflecting changes in product mix and higher R&D

· Full year outlook unchanged: sustaining improved delivery performance and investing in new R&D programmes to fuel long-term growth 

Chief Executive's Review

Steady performance in the first six months of 2017

Rolls-Royce delivered encouraging year-on-year operational progress in the first six months of 2017; large engine volumes increased 27% and restructuring savings were ahead of plan. Together with a higher than expected benefit from long-term contract accounting adjustments, this resulted in a good set of results, with financial performance ahead of our expectations for the first half. At the same time we have maintained our strong investment in products and services to support our customers and reinforce opportunities for further growth in the long-term.

With further growth in the overall value of our order book, order cover remains strong. This includes orders for over 2,700 large engines in Civil Aerospace, which reflects an average five years of production including six years of cover for the Trent XWB family that power the Airbus A350. In Defence, we have maintained a healthy order book, for both original equipment (OE) and services. Power Systems has roughly 80% annualised order cover for its OE activities, a more positive situation than at the same time last year. However, Marine's order book remains weak, mainly reflecting continued softness in its offshore oil and gas markets. Nuclear continues to enjoy healthy order cover for all its submarine activities and is making progress developing its position in key international markets for its civil nuclear products and services.

Group underlying revenue increased 6% on a constant currency basis led by growth in both original equipment (up 5%) and aftermarket services revenues (up 8%). Civil Aerospace made a strong contribution (up 14%) on the back of a 27% increase in large engine deliveries together with good engine flying hour and associated revenue growth from the larger installed base. While Defence revenue was down slightly, Power Systems and Nuclear reported positive revenue growth of 3% and 8% respectively. This was partly offset by further weakness in the trading conditions in Marine's offshore oil and gas markets, resulting in its revenue being 15% lower.

Compared to 2016, underlying profit before finance charges and tax was higher at £345m (2016: £158m), largely reflecting the revenue improvement, our focus on cost management and long-term contract accounting adjustments. Within this, Civil Aerospace improved to £173m (2016: £31m), including the benefit of a favourable change to a customer credit risk assessment; Defence Aerospace delivered £148m (2016: £128m); Power Systems improved to £66m (2016: £13m); Marine generated a loss of £(31)m (2016: £(13)m loss) and Nuclear delivered £14m (2016: £18m). More detail on each business is included in the Operational Review.

After underlying financing costs of £58m (2016: £54m), underlying profit before tax was £287m (2016: £104m). After an underlying tax charge of £81m (2016: £27m), underlying profit for the period was £206m (2016: £77m). With an average 1,834m shares in issue, underlying earnings per share were 11.23p (2016: 4.20p).

Since the end of 2016, the value of sterling relative to the US dollar strengthened by around 5% to the end of the first half, compared to the prior period in which sterling depreciated by around 10%. As a result, we have recognised a net £1.4bn non-cash mark-to-market favourable valuation adjustment for all our derivative contracts (2016: £2.2bn charge). The valuation adjustment was the principal reason for the reported financing gain of £1,470m (2016: £(2,386)m charge) and reported profit before tax being £1,941m (2016: £(2,150)m loss).

On a reported basis, the tax charge of £360m (2016: £378m credit) resulted in a reported profit for the year of £1,581m (2016: £(1,772)m loss). Reported earnings per share were 86.21p (2016: (96.72)p).

A full reconciliation of underlying to reported profit can be found in note 2 from page 32 onwards.

The free cash outflow for the first half was £339m (2016: outflow of £414m1), better than expected reflecting a steady operating performance, supported by a higher level of working capital management, by around £180m, which was the significant contributor to the year-on-year improvement.

A more detailed review of financial performance is included in the Group Trading Summary and the Financial Review.

Our good progress has been underpinned by our clear focus on four simple priorities for 2017

Our 2017 priorities are four-fold: to strengthen our focus on engineering, operational and aftermarket excellence to drive long-term profitable growth; to sustain our transformation progress; to further rebuild trust and confidence in Rolls-Royce across key stakeholders; and to define an appropriate vision for the business and the best way we can deliver sustainable shareholder value.

We have made steady progress towards all four objectives in the first six months of 2017.

One: Focus on engineering, operational and aftermarket excellence starting to deliver tangible benefits

We have maintained our focus on delivering against the engineering excellence commitments that will secure our future growth and performance improvements. In Civil Aerospace this included delivering key milestones towards entry into service for the new Trent 1000 TEN, Trent XWB-97 and Trent 7000. In addition, testing of our new power gearbox design for civil large engines has proceeded well, and we continued to develop next generation engine technologies for different Advance architectures. In the first six months of the year, Power Systems has started a major product rationalisation programme to simplify the customer offering and deliver significant benefits to manufacturing operations. In Marine, we successfully trialled our first unmanned operation system, using a remote operated harbour vessel.

In operations, we have invested a further £89m (£67m in 2016, cumulative £1.5bn since 2011) in transforming our manufacturing footprint across the business. This has enabled the Civil Aerospace business to continue to make solid progress on its major production increase - with first half deliveries of large engines up by 27% over the same period in 2016 (2017: 209, 2016: 164). At the same time, the investment paves the way for overall reductions in the impact of OE installed engines sold at prices below manufacturing cost - a key target over the next few years. In Defence, we made good progress with the modernisation of our Indianapolis facility which will help reduce costs and improve delivery performance of both original equipment and spares to support higher standards of customer service. In Marine, implementation of the restructuring announced in December 2016 has proceeded well. As a result, by the end of 2017 we expect the overall Marine headcount to be down by around 30% compared to end 2014. During the first six months of 2017, our Nuclear business has sustained the improvements made to deliver performance on its key submarine programmes with delivery against commitments recording a significant improvement over the same period in 2016.

The focus on improving aftermarket excellence continues to be driven across our businesses by customer needs as well as through the broader transformation activities. In Civil Aerospace, this has resulted in a progressive extension to the framework of our engine overhaul services offering, including the introduction of our CareStore, the roll out of LessorCare™ and further demand for SelectCare™ and TotalCare® Flex®. Rolls-Royce powered aircraft transitions also improved further following the introduction of a dedicated team in 2015. As a result, since the end of 2016, 17 Trent 700 powered Airbus A330s and 6 Trent 800 powered Boeing 777s have found new homes.

Since 2016, we have been undertaking a proactive maintenance programme on the Trent 1000 to address a number of technical issues. We will be working closely with our customers to ensure any disruption is minimised as far as possible. In order to reduce the impact on our customers, we have redesigned key elements of the service programme, through various 'lean' improvement initiatives to reduce lead-times, thereby getting the engines back into operation quicker.

In Defence, we opened two new dedicated Service Delivery Centres in Lossiemouth and Bangalore, to support the RAF and Indian Air Force respectively with improved response times and a greater proportion of issues being resolved on-wing. In June, we entered into a new partnership with Aviall to leverage its route to market for a range of defence aftermarket spares and services. Our Marine business also entered into its first 'power by the hour' contract with Norlines. Power Systems has sought to leverage the long-standing experience in Civil Aerospace to take better advantage of its significant installed base of engines. Work is underway to develop a service offering for customers around lifecycle monitoring and support. With an increasing focus on life-cycle costs and a broader use of digital solutions for engine monitoring, this initiative should steadily develop a new growth market through better proactive service management and as more 'digitally' enabled engines and systems are delivered.

Two: On track to deliver 2017 and 2018 transformation benefits

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 stated target was to deliver incremental gross cost savings of between £150m and £200m per annum, with the full benefits accruing from the end of 2017 onwards.

Against these commitments we have made a better than expected start. Savings achieved in 2016 were above target at over £60m, with fixed costs reduced further by over £50m in the first half of this year. This momentum will contribute to achieving total incremental benefits for the year at between £80-110m, with further benefits of £30m-60m to be delivered in 2018. Overall, we remain on track to achieve the committed fixed cost reduction of over £200m by the end of 2017.

Three: Rebuilding trust and confidence; further clarity on cash drivers and IFRS 15 transition

The first half of 2017 finished ahead of our expectations, helped by better than expected long-term contract accounting adjustments, and external expectations have remained largely unchanged for the year as a whole. While we have made some improvements to our forecasting and understanding of business drivers, more work needs to be done to increase resilience, and we are bringing more resource and expertise into this area.

Simon Kirby and Stephen Daintith, our new COO and CFO respectively, are further developing the work done on Key Performance Indicators, particularly around cost, working capital and cash drivers. As set out in our presentation today, these new KPIs will be progressively embedded into our external reporting to sharpen our focus and help demonstrate the value of wider financial and non-financial performance improvements.

As highlighted in 2016, 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. In November 2016, we provided a detailed representation of our 2015 financial results for Civil Aerospace and today are presenting a similar analysis for 2016. Building a good understanding of the year-on-year drivers of change in our financial results should help analysts and investors to make the transition when we formally change to the new standard from 1 January 2018. Full details of today's update are included as an appendix to this half year results statement and repeated in a separate disclosure on our investor relations website.

Four: Vision and shareholder value work on track for update by end 2017

Looking to the long term, we have committed to providing an update to our long-standing company vision. With key senior leadership changes completed, including new appointments such as our new Chief Technology Officer announced in April, and the consequential reorganisation of our engineering and technology functions, we can now accelerate the work we started to refresh our long-term goals as a business. Our objective remains to provide an update by the end of 2017.

Acquisition of outstanding 53.1% stake in Industria de Turbo Propulsores SA (ITP)

In the first half of 2017, we announced that we had received approvals from the US and EU regulatory bodies for the acquisition of ITP. As a result, the only remaining approval needed is from the Spanish authorities. All other aspects of the transaction, including payment options, are unchanged from those set out in November 2016.

Agreement reached with investigating authorities in January 2017

In January 2017, we announced that we had reached agreement with investigating authorities in the UK, US and Brazil related to charges of bribery and corruption involving intermediaries in a number of overseas markets, concerns about which the company passed to the UK's Serious Fraud Office from 2012 onwards. This has involved entering into Deferred Prosecution Agreements (DPAs) in the UK and the US and a Leniency Agreement in Brazil. We have agreed to pay fines and costs totalling £671m, of which £267m was paid in the first half of 2017 with the Brazilian payment of around $25m due in the second half of the year. Full details of the agreements can be found on our website, including copies of the statements made in January 2017.

Shareholder payments

Our dividend policy, as stated in February 2016, sets out how we intend to rebuild the payment to shareholders to an appropriate level, subject to the short-term cash needs of the business. We are continuing to invest in future growth, as we ramp up engine production and complete our important new product introductions over the next few years. At the same time, we need to sustain a healthy balance sheet to ensure we have the financial flexibility to maintain a strong investment grade credit rating. As a result, the proposed interim payment for 2017 is unchanged at 4.60 pence per share. As in past payments, the distribution will be in the form of C Shares. Further details are included on page 43 at the end of this statement.

Outlook for the balance of 2017

Our overall outlook for 2017 is unchanged from that set out in February 2017. While we have had an encouraging start, we have a great deal of work to do to deliver our overall expectations for the year. Key deliverables in the second half of the year include our Civil Aerospace delivery ramp up, new product introductions and managing installed fleet performance. While the outlook for Power Systems appears more positive, our Marine business remains challenged. As a result, we remain cautiously optimistic for the year as a whole.

Individual outlooks are provided for each business in the Operating Review.

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 strength of customer demand for these which are reflected in our substantial order book. While we have near-term challenges and some key execution priorities, these constants provide us with confidence in a strong, profitable and cash-generative future.

The progressive roll-out of new engines, led in particular by the Trent XWB, 1000 TEN and 7000, together with a growing aftermarket, is expected to drive significant revenue growth over the next ten years as we build toward a 50%-plus share of the in-service widebody passenger aircraft market. As a result, we remain confident that the important investments we are making to transition our production will create a resilient platform from which to drive customer service and strong cash flows, together with the current investments in new products and the streamlining of our existing product portfolios across the group to ensure we are providing high value, cost-competitive products into our target end markets.

Board update

During the first six months of the year there have been a number of changes to the Board. In April, Stephen Daintith joined the Board as our new Chief Financial Officer. In May, following our AGM, Colin Smith and John McAdam stepped down from the Board. In June, we announced the appointment of Beverly Goulet, an executive with 24 years of experience at American Airlines. She joined the Board with effect from 3 July 2017 and will be a member of the Nominations and Governance Committee and the Audit Committee.

Group Trading Summary

The commentary in this section relates to the Group's operating segments and so, in line with the requirements of accounting standards, is provided on an underlying basis, consistent with the measurement basis used by the Group in its segmental reporting.

Order book and order intake

Overall, new orders marginally exceeded deliveries. As previously highlighted, we are now transitioning from a period of unprecedented above-trend order book growth in Civil Aerospace (roughly 90% of our order book backlog by value) to one of operational delivery. As a result, overall growth in our order book is expected to moderate from here as we deliver against this significant backlog. To an extent this is reflected in our first half order book which increased by £1.4bn to £82.7bn.

The opening order book has been restated by £1.5bn reflecting a methodology change in the rates used to translate order books - moving from long term planning rates to period spot rates - for overseas subsidiaries. The change in methodology will better reflect the economics of the order books for the subsidiaries affected.

Key Civil Aerospace orders included major wins with Singapore Airlines and Ethiopian Airlines. The Defence Aerospace order book benefited from a change in the foreign exchange rate used to translate the closing order book. Otherwise the defence order book would have been 3% lower, reflecting the steady delivery of new engines against prior year order commitments. Power Systems order book grew by 7%, led by good demand for various industrial and defence applications. Order intake in our Marine business was again soft, as a result of the continuing weak offshore market, but higher than the same period in 2016. Order intake in our Nuclear business was higher as a result of submarine programme activity.

Underlying trading

Underlying group revenue rose 6% in H1 2017 compared to 2016, reflecting growth in both original equipment revenue (up 5%) and services (up 8%), led by Civil Aerospace and Power Systems in particular. By business, Civil Aerospace revenue increased 14%, Defence Aerospace revenue was down 4%, Power Systems revenue increased 3%, Marine revenue decreased 15% and Nuclear revenue increased 8%.

Underlying profit before financing of £345m (2016: £158m) was 98% higher, led by significant improvements in Civil Aerospace and Power Systems which offset a weaker performance in Marine. The improved Civil Aerospace profit of £173m (2016: £31m) largely reflected good growth in aftermarket revenues and margins and a higher than expected benefit from long-term contract accounting adjustments, including a one-off £77m benefit from a change to a customer credit risk assessment. The improved Defence Aerospace profit of £148m (2016: £128m) largely reflected lower overhead costs. Power Systems profit of £66m (2016: £13m) reflected improved volumes, mix and the benefits of transformation savings from their RRPS 2018 programme. Lower volumes contributed to the Marine loss of £(31)m (2016: £(13)m). Nuclear profit was £14m (2016: £18m) due to the previously announced increase in investment required to develop new products to help drive future growth.

Commercial and administrative costs of £531m were £38m lower reflecting the benefits of transformation initiatives and lower legal costs, following resolution of the long-standing review by investigating authorities in January 2017, although partially offset by rising costs, mainly due to inflation.

Underlying restructuring was £(8)m (2016: £(6)m). Charges relating to the transformation activity launched in November 2015 are treated as exceptional in light of the scale of the programme. An exceptional charge of £18m for this programme was taken in H1 2017 (2016: £53m). The in-period benefits of cost savings arising from this programme in H1 2017 were around £50m.

The R&D charge increased by £6m on a constant currency basis, reflecting an increase in spend offset by an increase in the level of capitalisation as several engine programmes approach entry into service.

Free cash flow

Cash capital expenditure in the first half of 2017 was £378m (2016: £307m), £71m higher than the prior year, largely reflecting phasing of payments for aerospace footprint and capacity investments. Cash taxes were £71m (2016: £62m). The cash cost of defined benefit pension schemes in excess of the operating profit charge was £12m (2016: £10m).

Overall, the free cash outflow for the first half year was £(339)m (2016: £(4141)m outflow). This was better than expected, reflecting a steady operating performance supported by a higher level of working capital management, by around £180m, principally in receivables, which was the significant contributor to the year-on-year outperformance. Other than this, our cash flow performance was largely as expected and reflected the higher cash outflows related to increased engine production and higher capital investment, partially offset by the increased cash revenues driven by aftermarket growth.

The TotalCare net asset movement from 2016 year end was £119m. The TotalCare net asset is now £2.6bn, in line with the expected peak of around £2.5-2.7bn.

Net debt and foreign currency

The Group is committed to maintaining a robust balance sheet with a strong, 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+/stable outlook and Moody's reconfirmed its A3 rating but moved to a negative outlook in February 2017.

During H1 2017, the Group's net debt position increased from £712m to £931m, reflecting the £339m free cash outflow, £85m of shareholder payments and £267m paid to investigating authorities, as set out earlier in this statement.

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 transactional foreign exchange exposure. Flexibility is built into some of 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 growing net US dollar income (currently around $5bn per year) which is converted into GBP. Since the end of the year a modest amount of net additional hedging has been added to cover our future revenues. As a result the nominal value of the US dollar hedge book as at 30 June 2017 was $39bn (end 2016: $38bn). Consequently, the average rate in the hedge book reduced to £/$1.54 (December 2016: £/$1.55). Improvements in our achieved rate, as a result of the current weakness of GBP, are likely to benefit revenue and profit in the longer term. However, with a high level of cover for the next few years built into our hedging arrangements, we do not expect there to be any meaningful benefit to our financial results for the next few years from improvements in our achieved hedge rate.

Group technical factors for 2017

All figures are at constant translational currencies unless otherwise stated.

Should foreign exchange rates for the full year remain unchanged from those seen recently, the movements from 2016 rates would improve full year underlying revenues by around £400m and improve underlying profit before tax by around £40m.

There is no change in our guidance on finance charges. Overall underlying finance charges in 2017 are expected to be in the region of £100-110m, partly reflecting the higher level of gross and net debt.

There is no change in our guidance on our underlying effective tax rate. Given the sensitivity of the underlying tax rate to a number of factors, including the impact of weak marine offshore markets, the underlying effective tax rate for 2017 is expected to be between 25-30%, reflecting the high proportion of taxable profit expected to be generated in higher tax rate regions.

We now expect our capital expenditure for the full year to be modestly higher and in the region of £700m, (2016: £626m) as we invest in additional aftermarket customer support and infrastructure.

Our expectation for Net R&D spend is unchanged and remains in the region of £950m in 2017, largely reflecting investment related to the completion of important new product launches in Civil Aerospace.

There is no change to our full year free cash flow guidance; to be similar to that achieved in 2016.

Footnotes from pages 1 to 10

#1 from page 4 and page 9: Re-stated to include a £(15)m exceptional restructuring cash outflow excluded at H1 2016 from free cash flow 

Operational Review: Civil Aerospace

References to year-on-year change in the Operational Review are underlying and at constant translational currencies, unless otherwise stated.

Financial overview

Overall, underlying revenue for Civil Aerospace increased 14%. The 12% increase in original equipment (OE) revenue was underpinned by the ramp up in large engine deliveries which more than offset the continuing decline in business jet engines and V2500 module sales. Service revenues increased 15%, led by flying hour revenues from the growing in-production Trent engine fleet.

*2016 H1 figures have been restated to reflect refinements in allocations

Large engines: linked and other OE revenue was 15% higher reflecting increased sales of Trent 900s for Airbus A380s and Trent 700s for Airbus A330s partly offset by a lower level of Trent 1000 deliveries for the Boeing 787. Sales of spare engines to joint ventures in large engine: linked and other generated revenue of £20m (2016 H1: £36m).

The most significant revenue increase was within large engine: unlinked installed which was 63% higher, led by Trent XWB volume growth to support the Airbus A350 production ramp.

Large engine service revenue growth of 17% reflects 15% growth in flying hours from our in-production Trent engines together with a higher level of time and material business from mature engines, and a year-on-year improvement in contract accounting effects of £46m. Together, these more than offset the reduction in flying hour revenues from retirements and lower utilisation of older engines.

The expected decline in revenue for business aviation OE, largely from reduced BR710 engine sales, reflects the transition to non-Rolls-Royce powered platforms. Volumes of the newer BR725 engine, which powers the Gulfstream G650 and G650ER, remained stable. Overall OE revenues for business aviation reduced 27% whereas business aviation service revenues grew 21% through a combination of fleet growth, price escalation and new CorporateCare® business from engines already in service.

Service revenue from our regional jet engines remained stable. Whilst utilisation of Rolls-Royce powered regional aircraft held up better than our initial expectations, we continue to expect declining revenues from our regional fleet over the next few years as older aircraft retire.

Revenues from OE modules and engine assemblies for the V2500 programme declined by 20%, reflecting the production slow-down as Airbus continues to transition from the A320 classic to the A320neo. V2500 service revenues were 13% higher driven by an increase in spare part sales and higher repair and overhaul activity. Revenue from flying hour payments was broadly flat with price escalation offsetting the reduction in flying hours as older aircraft retire.

Overall gross margins for Civil Aerospace were 14.8% (2016: 12.6%). The main drivers of the year-on-year increase in margin were the growth in service revenues from in-production large engines, a higher level of 'time and material' service activity on mature engines and the year-on-year improvement in long-term contract accounting adjustments of £56m. These were partly offset by a reduction in business jet engine sales, reduced utilisation of Trent 500 and RB211 engines and £12m of provisions related to a specific customer contract. Gross margin from spare engine sales to joint ventures contributed £19m (2016: £22m), including realisation of profit deferred from sales in earlier periods.

In respect of long-term contract accounting adjustments, in the first half of 2017 these totalled a net gain of £33m. The net charge in 2016 of £(23)m included a £35m benefit from a 5 cent change to the estimated long-term US dollar to sterling exchange rate, which brought our own planning rate within updated external benchmark long-term forecast data.

The £33m net gain included a £40m benefit (2016: benefit of £35m) from life-cycle cost improvements, partially offset by technical costs of £(59)m (2016: £(55)m), the largest component of which was for additional maintenance activity on the Trent 1000, and a net £52m benefit (2016: a charge of £(38)m) from other operational changes which included a £77m benefit arising from a change to a customer credit rating risk assessment.

Since 2016, we have been undertaking a proactive maintenance programme on the Trent 1000 to address a number of technical issues. We will be working closely with our customers to ensure any disruption is minimised in so far as possible. A provision has been taken in respect of related costs and is included in the increased technical costs set out above and specific customer contract provision set out above.

Costs below gross margin were £5m lower than the previous year. Within this, R&D charges of £263m were £3m higher. This reflected an increase in the level of spend on several new programmes ahead of entry into service together with reduced development cost contributions from risk and revenue sharing partners. These were partially offset by increased R&D capitalisation on the Trent XWB-97.

Underlying commercial and administrative and other costs were £5m lower than 2016, with cost reduction benefits offsetting inflationary effects. Restructuring costs of £6m were £4m higher, and profits from joint ventures and associates were £7m higher, £11m higher at actual exchange rates.

Overall, profit before financing and tax was £125m higher, led by the growth in gross margins. Taking account of foreign exchange effects, underlying profit before financing and tax was £173m (2016: £31m).

TotalCare net assets and Contractual Aftermarket Rights

TotalCare net assets increased in H1 2017 by £119m at actual exchange rates (2016: £149m) to £2.6bn reflecting accounting for new "linked" engines of £265m (2016: £202m) and contract accounting adjustments taken in the year of £33m (2016: £(23)m), offset by net other items of £(179)m (2016: £(30)m).

The CARs balance increased by £113m (2016: increase of £71m) to £687m, largely reflecting higher sales of unlinked Trent XWB engines partly offset by further progress improving Trent XWB OE economics.

Investment and business development

Order intake in the first half of 2017 was £7.0bn (2016: £7.9bn including a £2.1bn uplift from the change in the long-term planning rate). As a result the closing order book was £73.3bn, up £1.3bn (up 2% from 2016 year-end), including inflation effects on historic orders where appropriate price escalation applies.

Significant orders during the first half included an order valued at $1.5bn at list prices from Ethiopian Airlines, which included Trent XWB engines for 10 new Airbus A350 XWB aircraft as well as extending TotalCare coverage for 14 of the same aircraft already on order. Singapore Airlines selected Trent 1000 engines covered by TotalCare to power 19 Boeing 787 Dreamliner aircraft in a deal valued at $1.7bn at list prices.

Investment in Civil Aerospace continues to target improvements in the three core areas of focus; engineering excellence, operational excellence and capturing aftermarket value:

Engineering excellence remains the cornerstone of our value to Civil Aerospace customers

In the first half of 2017, we delivered some important milestones in respect of our new product introductions. In March, we powered the first test flight of the Boeing 787-10 aircraft with its Trent 1000 TEN (Thrust, Efficiency and New Technology) engine. The new engine will power all variants of the Boeing 787 Dreamliner family and draws on technologies from the Trent XWB engine and the Advance engine programme.

In June, we despatched the Trent 7000 engines which will power the first test flight of the Airbus A330neo, to Toulouse. The engine brings together experience from the Trent 700, the engine of choice for the current A330, architecture from the Trent 1000 TEN, and technology from the Trent XWB, the world's most efficient large engine flying today. The Trent XWB has now accumulated more than 500,000 engine flying hours in service and the 300th production engine has been delivered. The newest variant of the engine, the Trent XWB-97, continues to power Airbus A350-1000 flight tests and early testing is progressing well.

Looking further ahead, the Advance3 large engine demonstrator has completed assembly and is being prepared for its first run at our Derby facility. The demonstrator will test the new core architecture for future engine families and other key technologies such as Lean Burn combustion, Ceramic Matrix Composites, CastBond™ (specialist turbine manufacturing) and additive layer manufacturing or 3D printing.

At the same time, we continued to make progress with our UltraFan® engine design, with the power gearbox element of the programme starting its first power runs at its purpose-built facility in Dahlewitz, Germany in May.

Investing in new aerospace supply chain capabilities to help drive operational excellence

In June, we announced that, as part of the ongoing planned expenditure, we will invest around £150m in new and existing aerospace facilities in the UK to support the doubling of engine production and deliver on a record Civil Aerospace order book. The majority of the investment will provide a new facility for the testing of large Civil Aerospace engines in Derby.

In the same month we officially opened a new assembly line at our Dahlewitz site in Germany for Trent XWB engines, complementing the main production line in Derby. The facility, which will be delivering up to two engines a week by the end of the year, will help Rolls-Royce meet the high demand for this engine.

Aftermarket development benefiting from enhanced service capabilities and new products

Delivering outstanding service remains at the heart of Rolls-Royce's customer proposition. At the core of this are the range of long-term service packages which started with TotalCare in the late 1990s. Over the last few years we have strengthened the range of services to match the maturing of our growing fleet of engines. As part of this process, in March we introduced the CareStore, a gateway to help customers better understand our range of digitally-enabled services and make informed decisions about which services best fit their needs.

In June, we opened a new Airline Aircraft Availability Centre which will use industry-leading data analytics to plan engine operations and maintenance. The centre complements the Rolls-Royce global network of Customer Service Centres, created to work locally with customers by providing in-depth expertise in the local market. We also announced that we were 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 72 ASCs in place with key maintenance providers worldwide, enabling CorporateCare customers to benefit from streamlined administration and reduced maintenance time.

In May, we celebrated the BR710 business jet engine achieving 10 million hours of service in flight.

Civil Aerospace outlook

On a constant currency basis, we continue to expect our Civil Aerospace business to deliver modest growth in revenue and profit in 2017, supported by large engine aftermarket growth, further life-cycle cost reductions and a higher level of R&D capitalisation. Higher costs related to increased maintenance activity in respect of the Trent 1000 are included in our estimates for the second half, but should temper any upgrades to full year profit following the good start to the year. Business jet demand is expected to weaken further, as will the demand for aftermarket services to support Rolls-Royce powered regional aircraft. We continue to expect trading cash flow to be broadly unchanged year-on-year, reflecting higher volumes of OE sales at prices below manufacturing cost offsetting the positive effects of higher aftermarket cash inflows.

Operational Review: Defence Aerospace

\* Translational foreign exchange impact **2016 year end comparative, restated for a methodology change - see page 8

Financial Overview

Underlying revenue of £1,048m was down 4% on a constant exchange rate basis (5% higher than the prior year at actual exchange rates). Original equipment sales were down 4%, principally due to lower EJ200 export sales following the completion of the Saudi Typhoon contract in 2016. Service revenues were also 4% lower than the prior year, mainly due to lower one-off revenue from some of our long-term service contracts, particularly as a consequence of the retirement of the UK MoD's Gnome-powered Sea King fleet in 2016. Lower revenue from spare part sales on some legacy programmes was offset by increased overhaul activity for LiftSystem™ and for EJ200 engines in service with the Royal Saudi Air Force.

Gross margin was unchanged on a constant exchange rate basis (up £19m at actual exchange rates) reflecting lower volumes partially offset by the non-repeat of £31m of one-off costs for the TP400 programme in 2016. Catch-up adjustments on existing long-term contracts reflected cost improvements totalling £16m, down £29m on the prior year due to the completion of contracts in 2016 and lower benefits from US contracts.

Overall R&D costs of £30m were similar to the prior year as the business continued to invest in future programme development, while restructuring costs were lower due to reduced level of severance costs. Underlying commercial and administrative costs and other costs were lower than prior year.

As a result, profit before financing and tax of £148m was 5% higher than the prior period.

Investment and business development

Order intake for H1 2017 was £928m (2016: £743m), with new orders principally for aftermarket contracts. During the first six months we won aftermarket contracts in the US worth around $600m, including some major renewals with the US Department of Defence, supporting engine fleets powering C-130, V-22 and T-45 aircraft. Other contract wins included a legacy spares order from the Indian Air Force and smaller orders relating to other programmes. The Defence Aerospace order book closed at £4.3bn.

In respect of engineering excellence, led in Defence by product innovation, we saw very positive early operational performance of our T56 Series 3.5 technology insertion in the US NOAA P-3 fleet, and the kits continue to generate significant international interest for legacy P-3 and C-130 aircraft with orders expected in the second half of 2017. A new special operations version of the C-130J was launched in June at the Paris Air Show, alongside the debut of the new LM-100J civil variant of the aircraft.

In May, we announced a new joint venture agreement with Kale, the Turkish industrial conglomerate, to develop an engine solution for Turkey's TF-X combat programme, should they wish to pursue a new local option for engine provision.

Development work continued on the Anglo French Future Combat Air System programme and we announced a partnership with Purdue University in Indiana, which will help design and test components for our next generation engine component programmes.

The major upgrading of the Indianapolis facility, the core driver of operational excellence in Defence, passed another milestone with the first production cell, focused on turbines, coming on line. The overall programme remains on track and will deliver significant operational efficiencies and greater flexibility in our largest defence facility.

Aftermarket excellence initiatives have focused on deepening existing customer relationships with enhanced services. In the first half of the year, we opened a further two Service Delivery Centres (SDCs) at RAF Lossiemouth in Scotland and in Bangalore in India. We are preparing for further SDC facilities to be opened over the coming year as we expand our programme following a positive customer response to this approach. The LiftSystem continues to perform well on the F-35B Lightning II, with the aircraft making its first international operational deployment with the US Marine Corps to Japan.

In June, a significant service supply agreement was signed with Aviall, a Boeing Company, in relation to the distribution of engine spares for all defence variants of the global AE engine fleet. This multi-year agreement extends their offering to cover thousands of engines and is expected to significantly improve availability and logistics for our customers, enabling us to secure efficiencies and additional aftermarket demand.

Defence Aerospace outlook

The longer-term outlook remains stable, with margins and profits expected to soften modestly from the recent high levels, reflecting infrastructure and R&D investments to support long-term growth.

The outlook for 2017 is unchanged. While revenues are expected to be broadly unchanged overall, we expect full year profit to be lower than in 2016, reflecting the non-repeat of the significant level of long-term contract accounting benefits which occurred in the prior year.

Operational Review: Power Systems

Financial overview

Underlying revenue of £1,233m increased 3% (14% at actual exchange rates). Original equipment growth of 5% reflected Chinese demand for PowerGen equipment and recovery in several industrial markets, including construction, agricultural and rail. Continued development of our REMAN (remanufacture) activities supported the 1% increase in service revenues. While some industrial and power generation markets improved, other markets were less buoyant, with government related activity lower year on year and marine offshore markets continuing to be impacted by low oil prices.

Overall, gross margins increased to 25.9% (2016: 23.4%) reflecting higher production volumes and better factory utilisation together with some improvements in customer and product mix.

Commercial & administrative costs were £6m lower, led by headcount reductions and other efficiency savings arising from the RRPS 2018 transformation programme which more than offset inflationary headwinds. R&D costs were £7m lower, reflecting the more efficient deployment of resources on future product development activity.

As a result, the improved trading performance was the most significant contributor to the increase in underlying profit before financing and tax to £66m (2016: £13m).

Investment and business development

Order intake of £1.4bn (2016: £1.2bn) was 6% higher than 2016 at constant foreign exchange, with the year-on-year increase reflecting several notable orders from governments for land and naval based equipment, higher demand from PowerGen customers in Asia and rising European orders for construction and agricultural products.

Product launches in the first half include a diesel genset (a self-contained combination of an engine and a generator) with increased output for emergency and prime power applications which is able to operate in hot climates. Demand for our recently launched propulsion systems which meet the latest emissions standards has also been strong.

Notable orders include ones from market leaders KATO and JCB as we entered the industrial excavator market with our MTU series 1000 engines. In addition a project agreement, also for MTU series 1000 - 1500 engines, was signed with agricultural machinery manufacturer Claas for the supply of 4,000 to 5,000 engines per annum, together with a follow up order for a US defence project and a large order for MTU series 4000 engines for a US data centre.

Turning to broader business developments, our Asian activities saw good progress with the official registration of the joint venture with Yuchai Machinery in advance of production of MTU series 4000 diesel engines under licence, planned for 2018 and targeting off-highway opportunities. An agreement was also signed with Garden Reach Shipbuilders & Engineers Ltd for final assembly in India of MTU series 4000 engines plus options for the local production of parts.

Within the services business, long term contracts were won for mining vehicles in Zambia and with Mediterranean ferry operator Virtu Ferries. In addition, leveraging the longstanding experience in Civil Aerospace, we have established a digital solutions unit which will focus on creating digital value adding services.

Our transformation programme is on track and is delivering results across all work streams, generating reductions in headcount, material costs and to our footprint. The changes we have made to our organisational structure together with lean processes implementation are facilitating better customer focus which is in turn helping to grow our revenues and achieve a more balanced profile across the year. We are also making good progress on our product portfolio simplification activity.

Power Systems outlook

The long-term outlook for Power Systems remains positive. Demand for its products looks set to grow steadily led by strong growth in key sectors where standalone power generation remains mission-critical. Together with new initiatives around product simplification and new market development, the businesses transformation programme will deliver progressive improvements

The outlook for 2017 remains cautiously positive, following a good first half which in part reflects efforts to rebalance profitability across the year. As a result, supported by a solid order book with good order coverage in several key longer cycle markets, albeit with limited visibility for our important service activity, we expect to achieve a second-half performance broadly consistent with the strong finish to 2016.

Operational Review: Marine

\* Translational foreign exchange impact **2016 year end comparative, restated for a methodology change - see page 8

Financial overview

Underlying revenue of £524m was 15% lower. Within this, original equipment revenues were down 22% and service revenues declined 6%. This was primarily due to the ongoing weakness within the offshore market, but also some softness in the merchant markets through over-capacity in cargo-carrying vessels. Within the weak overall revenues there were some highlights including delivery of several major orders secured in 2016, including the diesel gensets for the UK's new polar research ship, RRS Sir David Attenborough.

Gross margins decreased 190 basis points to just under 18% and overall gross margin was £94m, £25m lower than in 2016 on a constant exchange rate basis. While margins declined due to volumes, foreign exchange and product mix, the impact was partly offset by cost reduction programmes, particularly for OE, and the impact of the headcount reduction programme benefitting both trading margin and overheads.

R&D spend increased, mainly due to higher design spend on ship intelligence. Commercial and Administrative costs were over 12% lower at £101m.

As a result, the business reported an overall underlying loss before financing and tax of £(31)m, compared to a loss of £(13)m in 2016.

Investment and business development

The order book declined 9% during the first half of this year, despite an improved order intake compared to the first half of 2016. (2017: £449m v 2016: £362m). Offshore demand remained very weak, reflecting the impact of the continued low oil price and reduced investment by oil majors and their key suppliers. Service revenues were more stable, but remain at historically low levels.

Our Marine business did have some success in merchant opportunities outside of oil-related markets, including orders for equipment for ferries and fishing vessels. The Naval business secured a number of significant contract wins, including power, propulsion and handling systems for the US Coastguard's new fleet of offshore patrol cutters, and MT30 gas turbines for the Republic of Korea Navy. The start of sea trials by the Royal Navy's new aircraft carrier, HMS Queen Elizabeth was also a significant milestone for the business.

To help develop future products and capabilities, we have increased our investment in R&D to focus on reshaping the Marine product portfolio, as shipping shifts from mechanical to electrical and the adoption of digital technologies. Examples include the launch of a new Energy Management solution to drive down ship operating costs, and the first power-by-the-hour contract for two cargo ships for Norlines. There was also further uptake of our Autocrossing system, which automatically controls vessel speed and optimises energy use.

Progress in our strategy for developing remote and autonomous ship operation included securing third-party funding to help develop a centre in Finland to focus on future land-based control centres, and establishing a Fleet Management Centre in Norway for remote optimisation of ship operation. A contract was also signed with global towage operator Svitzer to jointly test remote manoeuvring of commercial vessels, following a successful first demonstration.

Marine restructuring activities remain on track, including the programme of actions announced last December which target a further significant headcount reduction and £45-50m of annualised savings. As a result, by the end of 2017 we expect the overall Marine headcount to be down by around 30% compared to end 2014.

Other cost actions have included further simplifying the organisation, streamlining processes and operations across the value chain and the closure of the Shanghai factory. The investment in our Rauma facility is on track and will create a world-class assembly and test capability for propulsion products.

Marine outlook

We expect the outlook for our traditional offshore markets to remain challenging throughout 2017 and to only start to stabilise in 2018; we expect to benefit from a strong efficiency and internal cost focus when offshore markets eventually start to recover. The range of factors expected to influence future growth in marine markets include digitalisation, autonomy, electrification and increased focus on environmental and safety aspects amongst others. This is reflected in our strategy, ongoing transformation and investment focus.

In the near-term, with prevailing markets remaining weak our expectations for the second half of the year are more cautious. Transformation and restructuring savings should partially offset market challenges. As a result, we now expect the reported loss to be similar to the second half of 2016.

Operational Review: Nuclear

Financial overview

Underlying revenue increased 8%, with solid performances across both submarine and civil nuclear activities. This reflected the phasing of activities on several long term contracts as well as improved trading across all civil nuclear businesses.

Gross margin was unchanged at 14.3%. Below gross margin there was no R&D credit in the first half (2016: £3m). In addition, led by investment in small modular reactors, the R&D charge was £10m higher than the prior year. These were partly offset by savings in commercial and administrative costs driven by transformation initiatives.

As a result, underlying profit before financing was £4m lower than the prior year, at £14m.

Investment and business developments

The order book remained relatively steady at £2.0bn, reflecting the nature of the nuclear business with the majority of the order book being the long term contracts under UK government procurement arrangements.

During the first half, submarine activities focused on performance improvement initiatives to support long-term contracts for the UK Royal Navy's nuclear submarine fleet, including delivery of the nuclear propulsion system to power the Astute class submarines. This included signing the contract for the 6th of 7 Astute boats.

We also made good progress in the de-fuelling programme at HMS Vulcan Naval Reactor Test Establishment. In addition, significant work was undertaken with our programme partners to agree a new delivery model for the new Dreadnought class deterrent submarines.

The civil nuclear business, which focuses on multi-year engineering projects and specialist technical services, saw steady growth. In the UK, we started early work on Hinkley Point C, for which we are the preferred bidder to deliver heat exchangers, waste treatment systems and emergency diesel generators.

Internationally, the Instrumentation and Controls business focused on delivery of long-term safety-critical retrofit contracts in France and Finland, as well as developing our access to new build markets.

Progress in our global business development activities were reflected in three notable successes. In China we strengthened our collaboration both for the domestic and export market for Instrumentation and Controls. This included signing of a Letter of Intent to develop our instrumentation and controls business with CTEC (CGN) and securing orders within the current China build programme at Tianwan 5 and 6. In May, we made good progress developing our digital services business in North America, with the award of a contract to support Canada's largest nuclear utility operator, Bruce Power, with digital analytical tools designed to optimise the operational lifetime of nuclear plants. Finally, in June we were selected as preferred bidder for Instrumentation and Controls supply to a new Russian-designed reactor at Fennovoima's Hanhikivi nuclear power plant in Finland, due for completion in 2024.

We have continued to develop our small modular reactor R&D programme, working with potential partners on a whole-plant design. Market interest remains positive as large scale reactor programmes continue to suffer from ongoing investment and programme challenges. We remain of the firm belief that these smaller, more flexible units offer the potential for lower cost and more flexible power generation in future decades and directly build on the knowledge and specialist skills of our Nuclear business.

Nuclear outlook

The long-term outlook for Nuclear remains solid with a steady outlook for submarines, supported by the recent confirmation of the ongoing investment in the UK's Dreadnought class deterrent. Improving revenues will largely be driven by renewed activities in the civil market, particularly in the UK and China, which provide encouraging growth opportunities.

In the near-term, while revenues and gross margins are expected to be largely unchanged year-on-year, full year profit is expected to be roughly half that delivered in 2016, largely reflecting the increase in R&D spend.

Financial review

Underlying income statement

Segmental analysis

Underlying revenue and underlying profit before financing are discussed in the Business Highlights (page 3), the Group Trading Summary (page 8) and the Operational Reviews (from page 11).

Underlying financing costs increased by £4m to £58m. Net interest payable reduced by £4m to £31m largely due to repayment of a bond in 2016 on which the Group was paying a higher than average rate of interest. Other underlying financing costs increased by £8m to £27m.

Underlying taxation was £81m, an underlying tax rate of 28.2% compared with 26.0% in 2016. The primary reason for the increase is the non-recognition of deferred tax assets on losses in Norway, reflecting the continued uncertainty in the oil & gas market.

Underlying EPS increased from 4.20p to 11.23p, in line with profit for the period.

Payments to shareholders are made in the form of C Shares, details of which are set out on page 43. An interim payment of 4.6p per share will be made.

Reported income statement

The changes in 2017 resulting from underlying trading are described in the previous sections.

Consistent with past practice and IFRS, the Group provides both reported and underlying figures. We believe underlying figures are more representative of the trading performance, by excluding the impact of period-end mark-to-market adjustments, principally the GBP:USD hedge book. In addition, post-retirement financing and the effects of acquisition accounting are excluded. The adjustments between the underlying income statement and the reported income statement are set out below and in more detail in note 2 to the Condensed 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.

Profit before financing

The impact of measuring revenues and costs at spot rates rather than rates achieved on hedging transactions. This increased revenues by £701m (2016: £319m) and increased profit before financing by £223m (2016: £207m).

The effects of acquisition accounting £62m (2016: £62m), principally relating to the amortisation of intangible assets arising on the acquisition of Power Systems in 2013.

Exceptional restructuring costs of £31m (2016: £68m). These are costs associated with the substantial closure or exit of a site, facility or activity, largely as a result of the ongoing transformation programme.

Financing and taxation

The mark-to-market adjustments on the Group's hedge book of £1,526m (2016: £(2,326)m). These reflect: the large hedge book held by the Group (e.g. GBP:US$39bn); and the strengthening of sterling against the US dollar. At each period end, our foreign exchange hedge book is included in the balance sheet at fair value (mark-to-market) and the movement in the period included in reported financing costs.

Appropriate tax rates are applied to these additional items included in the reported results, leading to an additional tax charge of £279m (2016: credit of £405m), largely as a result of the mark-to-market adjustments. This leads to an effective tax rate of 18.5% (2016: 17.6%).

Summary balance sheet

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

2 Net funds includes £302m (2016 £358m) of the fair value of financial instruments which are held to hedge the fair value of borrowings.

3 Other includes other investments and deferred tax assets and liabilities.

Intangible assets (note 8) increased by £189m mainly due to additions of £375m (partially offset by amortisation charge of £208m). The additions primarily relate to £139m of contractual aftermarket rights, £84m of development expenditure and £79m of certification and participation fees.

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 9) decreased by £43m. Additions of £209m were offset by depreciation of £221m. Exchange differences were £(22)m.

Movements in net funds are shown overleaf.

Investments in joint ventures and associates increased by £6m.

Net post-retirement scheme deficits (note 11) have increased by £92m largely due to movements on discount rates in the period.

The UK plan comprises 85% of the gross liabilities and 95% of the gross assets and has a surplus of £1,229m. There was a £125m reduction in the surplus in H1 due to plan assets underperforming liabilities measured on an IAS19 basis (which discounts liabilities at a AA bond rate). 90% of pension assets are in low risk investments to match liabilities; this has been key to protecting our funding position in low yield environment.

The overseas plans comprise 15% of the gross liabilities and 5% of the gross assets. The deficit of £1,350m (IAS19 basis) is principally made up of unfunded US healthcare/pension plans (£534m) and German unfunded pension plans (£728m).

Provisions largely relate to warranties and guarantees provided to secure the sale of OE and services. The decrease of £25m includes additional charges of £139m, principally for warranty and guarantees and other provisions, offset by utilisation of £125m and unused amounts of £39m.

Net financial assets and liabilities relate to the fair value of foreign exchange, commodity and interest rate contracts and financial RRSAs, set out in detail in note 10. All contracts continue to be held for hedging purposes. The fair value of foreign exchange derivatives is a financial liability of £3.8bn, a decrease of £1.8bn in the period, mainly a result of the strengthening of sterling.

The US$ hedge book increased by 4% to US$39.2bn. This represents around six years of net exposure and has an average book rate of £1 to US$1.54.

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 12. 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.

Summary funds flow statement

1 2016 £(15)m exceptional restructuring expenditure has been re-presented to be included in free cash flow

Movement in working capital - the £110m decrease includes higher levels of inventory to support the progressive ramp up in Civil Aerospace's large engine production and higher Civil Aerospace long-term contract balances, offset by a higher level of working capital management, by around £180m, principally in receivables.

Expenditure on property, plant and equipment and intangibles - the increase largely reflects higher capital spend (£71m), IT and Marine intangibles (£88m) and contractual aftermarket rights (£50m).

Pensions - UK contributions were £90m (2016: £88m), including £15m financed by employees under salary sacrifice arrangements. A statutory funding valuation currently being conducted as at 31 March 2017 is expected to show material surplus. No deficit funding is anticipated and the new contribution schedule is expected to take effect from 2018. Overseas contributions were £40m (2016: £40m). Some modest increases in contributions to overseas schemes have been offset by changes in exchange rates.

Shareholder payments - the change in shareholder payments reflects the difference between the 2015 and 2016 interim payments, which are paid in the following January.

The derivation of the summary funds flow statement above from the reported cash flow statement is included in note 14.

Condensed consolidated financial statements

Condensed consolidated income statement

For the half-year ended 30 June 2017

2 In 2016 (full year), 'commercial and administrative costs' include £671m for financial penalties from agreements with investigating bodies.

All activities comprise continuing operations.

Condensed consolidated statement of comprehensive income

For the half-year ended 30 June 2017

Condensed consolidated balance sheet

At 30 June 2017

Condensed consolidated cash flow statement

For the half-year ended 30 June 2017

* 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 flow statement

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