Annual Financial Report

23rd Feb 2011 16:44

February 23, 2011

Rolls-Royce Group plc

Publication of the Annual report 2010

Rolls-Royce Group plc announces that its Annual report for the year ended 31 December 2010 is now available on the Company's website:

www.rolls-royce.com

Printed copies of this document will be posted to shareholders on or around 22 March 2011. A copy of the above document has been submitted to the National Storage Mechanism and will shortly be available for inspection at: www.Hemscott.com/nsm.do.

In accordance with paragraph 6.3.5 of the Disclosure and Transparency Rules weset out below a management report extracted from the Annual report in uneditedfull text. Accordingly, page references in the text below refer to page numbersin the Annual report. Our final results announcement issued on February 10,2011 contained a condensed set of financial statements and a description of theprincipal risks and uncertainties facing the business.The Annual General Meeting (AGM) of the Company will take place at 11.00am onFriday May 6, 2010 at The Queen Elizabeth II Conference Centre, BroadSanctuary, Westminster, London SW1P 3EE. It will be followed by a meetingconvened by the High Court to consider a scheme of arrangement (Scheme) underPart 26 of the Companies Act 2006. The Scheme will introduce a new holdingcompany for the Group and will generate appropriate reserves which will allowit to continue its progressive shareholder payment policy and the Company'spractice of providing cash returns to shareholders in the most efficient mannerthrough the issue and redemption of C Shares. Further details of the Schemewill be provided in due course.

The financial calendar for the next twelve months is set out below:

Financial calendar 2011-2012 Ex entitlement to C Shares April 20, 2011

Record date for entitlement to C Shares April 26, 2011 AGM, Queen Elizabeth II Conference Centre, London 11.00am May 6, 2011 Court Meeting, Queen Elizabeth II Conference Centre, London 11.30am May 6, 2011 Record date for dividend payable on C Shares June 3, 2011 Deadline for receipt of C Share elections 5.00pm June 6, 2011 Allotment of C Shares July 1, 2011 Payment of C Share redemption monies July 5, 2011 Purchase of ordinary shares for CRIP participants By July 12, 2011 Announcement of interim results July 28, 2011 Ex entitlement to C Shares October 26, 2011 Record date for entitlement to C Shares October 28, 2011 Deadline for receipt of C Share elections 5.00pm December

5, 2011 2011 Financial year end December 31, 2011 Allotment of C Shares January 3, 2012

Payment of C Share redemption monies January 5, 2012 Purchase of ordinary shares for CRIP participants By January 13, 2012 Preliminary announcement - 2011 full year results February, 2012

2011 Annual report published March, 2012 Enquiries: Investor relations: Mark Alflatt Director of Financial Communications Rolls-Royce plc Tel: +44 (0)20 7227 9285 [email protected] BUSINESS REVIEWChairman's statementThe Group conducts business on a global basis and has customers in 120countries. It is this broad customer base, coupled with an extensive productand services portfolio, which underpins our success. We have continued to growour order book in 2010 to £59.2 billion. Underlying profits before taxincreased by four per cent to £955 million.

We are proposing a final payment to shareholders of 9.6 pence per share, bringing the full year payment to 16 pence per share. This is an increase of 6.7 per cent and reflects the Board's continuing confidence in the Group's business.

International trade tensions, uneven growth, fiscal tightening and currency instability have combined to make the economic environment uncertain. In these circumstances it is important to have a balanced business portfolio. This Annual report records that our three businesses outside civil aerospace - marine, defence aerospace and energy - have all grown underlying profits at double digit rates during 2010, adding to the resilience of the business.

We continue to benefit from the high barriers to entry which are a consequenceof our long-term investments and the businesses in which we are involved. Ourhigh-technology products and services require sophisticated systems integrationand are hard to replicate. We continuously explore new ways in whichtechnologies developed in one part of our business can be applied in others,reinforcing this strong market position.As well as meeting the challenges of the marketplace in 2010, Rolls-Royce hashad to manage the high profile failure of a Trent 900 engine on a Qantas AirbusA380. Rolls-Royce behaved as you would expect of a highly proficientengineering company. We identified the problem quickly, and applied ourselvesto the swift return of the fleet to normal operation. I would like to thank ourcustomers for their support, and recognise the tremendous efforts ofRolls-Royce management and staff in responding so professionally to this veryregrettable incident. The safety of our products has always been, and alwayswill be our first priority.We are committed to conducting business to the highest standards, and toenriching the societies in which we live and work. As well as creatingemployment and generating wealth, we invest heavily and consistently inimproving the environmental performance of our products. Through our ownresearch, and in collaboration with universities around the world, we aredriving innovation and extending the boundaries of human knowledge. Ourtraining programmes raise levels of skills and capability and set new standardsof engineering excellence. Rolls-Royce people around the world are directlyinvolved in community projects and voluntary activities, contributing to thecommunities in which we operate.This year we took further steps to embed our Global Code of Business Ethics.Rolls-Royce is a responsible Group and we are committed to ensuring that weconduct business appropriately and to the highest levels of integrity. In orderto ensure that we achieve best practice, our procedures and training programmesare continually reviewed and involve all our employees.We have continued to invest in our own people through training and developmentprogrammes. These programmes operate worldwide, including from dedicatedtraining facilities in the UK and US. These facilities are used to run a rangeof programmes for our worldwide workforce and for our customers.The Board is committed to improving our environmental performance across allbusiness sectors. Continuous investment in the gas turbine engine, the coreproduct for Rolls-Royce, has progressively improved fuel efficiency and willcontinue to do so. The new Trent XWB, for example, will be 16 per cent morefuel efficient than the first Trent aero engine to enter service 15 years ago.This means less cost for our customers as well as lower emissions. Theapplication of gas turbines and efficient diesel engines in the marine sectoralso offers the possibility of significant reductions in emissions at sea. Aswell as developing core technologies, the Group is exploring other low carbonenergy sources including civil nuclear power, fuel cell technology and tidalpower.In 2011, we are proposing to introduce a new holding company for the Group.This will enable us to continue our progressive shareholder payment policy andprovide cash returns to shareholders in the most efficient manner through theissue and redemption of C Shares.Rolls-Royce supports a wide range of charitable causes with particular emphasison the armed forces benevolent funds and educational programmes involved withscience and engineering.This year's Rolls-Royce Science Prize was won by a team from Teesdale School,County Durham for their design project to enhance the lives of animals in theirlocal zoo. They received their award of £20,000 from John Rose at an awardsdinner attended by senior industry leaders, academics and government ministers.The Science Prize attracts entrants from thousands of schools across the UK.I would like to thank all our management and employees very much for theirloyalty and hard work during the past year. Our results are a testament to thefocus and commitment I see demonstrated in every part of the business and atall levels of the organisation. I am constantly impressed by the initiativeshown by Rolls-Royce people in seizing opportunities and responding to theneeds of our customers.Once again the Group benefited from the wise counsel of the InternationalAdvisory Board (IAB ) during 2010. This Board, whose membership is set outlater in this report, was established in 2006 to help provide a broadperspective on issues such as global political developments, business risks andopportunities and economic trends. The advice they give is extremely valuableto us as we develop our global footprint and become more international in ouroutlook and behaviour. I would like to thank the members of the IAB for theirwork during the year in providing such high-level strategic advice.

I would also like to thank my fellow directors for their superb support and hard work over the past year.

There is of course one very important tribute to be paid by the Board andeveryone else in Rolls-Royce to our Chief Executive, John Rose, who hasannounced his decision to retire at the end of March this year. John has beenChief Executive for 15 years, during which time he has done the mostextraordinary job. He has transformed Rolls-Royce into a world-class companyoperating on a global stage. His strategic vision has led to the constructionof a resilient business with a powerful portfolio of internationallycompetitive products and services. His leadership and tenacity have helpedestablish a platform from which we expect revenues to double in the decadeahead. We owe John a huge debt of gratitude for what he has done for theCompany, not only as Chief Executive, but during his career of 27 years withRolls-Royce.John has also been a driving force in public policy, championing the cause ofhigh value added manufacturing and services. He argued for the importance ofrebalancing the UK economy long before it became fashionable to do so. I amsure he will continue to be a powerful advocate for the importance of science,technology and maths, and of the importance of technical education in anation's ability to generate wealth.John Rose will be succeeded as Chief Executive by John Rishton, who iscurrently the Chief Executive Officer of the Dutch based, global retail groupRoyal Ahold. John Rishton has been a member of the Rolls-Royce Board for fouryears. As well as knowing Rolls-Royce well, John has a deep understanding ofthe aviation industry gained as Chief Financial Officer at British Airways. Healso has manufacturing experience gathered from a number of senior positions atFord. I have come to know John Rishton well. He is an outstanding individual,with experience as the successful Chief Executive of a global publicly listedcompany. He is an instinctive team player, and was the unanimous choice of theBoard. I am certain he will prove himself a distinguished Chief Executive ofRolls-Royce when he takes up his new role at the end of March this year.The technologies that Rolls-Royce deploys are at the frontiers of engineering.We continue to invest in the long-term growth of our Group. We enjoy thelong-term support of our large customer base and suppliers, and we willcontinue to broaden our portfolio organically or by acquisition in our coresectors. We intend to maintain a strong balance sheet and a single A creditrating which we believe provides the foundation for the long-term growth of ourbusinesses.A great company is built by first class, passionate and highly skilled people.We have these in Rolls-Royce and I believe that we will continue to improve ourbusiness and deliver excellent value for all our shareholders.Simon RobertsonChairmanFebruary 9, 2011Chief Executive's review

This is my fifteenth and final Chief Executive's review, and so it is a particular pleasure to report that Rolls-Royce has delivered a strong performance in 2010 despite challenging economic conditions.

Underlying revenue has grown seven per cent to £10.9 billion and underlyingprofit before tax has increased by four per cent to £955 million. Our financialposition has also continued to improve with average net cash balances reaching£960 million, an improvement of £325 million over the same period in 2009. Thisdemonstrates once again the strength and resilience of the Group and theprogress that we have made in recent years. It is a measure of this progressthat the civil, defence and marine businesses now each generate underlyingprofits of more than £300 million.

I was an early pessimist about the condition of the world economy and I expect to be a late optimist. The situation remains fragile, recovery has been asymmetric and the global financial system retains the capacity to surprise unpleasantly. However, our consistent investment in a broad portfolio of products and services and our strong customer relationships have given us access to a wide range of global markets.

This breadth has allowed Rolls-Royce to maintain progress through the downturnand the disruption to the world economy which began in 2007. Since then thebusiness has grown its order book, revenues, profits and average net cash, andincreased payments to shareholders while at the same time we have invested morethan £4 billion in the business. Total Shareholder Return (TSR) during thisperiod has been 27 per cent, which compares to an average TSR of four per centfor the FTSE All Share index.

Investing for the long term

During 2010, we have continued our programme of investment, funding world-classfacilities in all major geographies, providing capacity for future growth,contributing to improved productivity and delivering products with operationallives which may well extend to half a century. We remain confident in ourability to double revenues in the coming decade through organic growth alone.However, we also have the management and financial capability to accelerategrowth through acquisition and partnership.

Strategy

Our consistent strategy, applied over many years, has helped deliver a more broadly based, better balanced and more resilient portfolio. This strategy has five key elements:

• address four global markets, civil aerospace, defence aerospace, marine andenergy;• invest in technology, infrastructure and capability;• develop a competitive portfolio of products and services;• grow market share and our installed product base; and• add value for customers through the provision of product-related services.We have high barriers to entry as a result of the technology required for thedesign, systems integration, manufacture and support of our products. Inaddition, we work hard to transfer intellectual property, products andinnovation across businesses to achieve competitive advantage in the marketswhich we serve.

An increasingly global business

The business today is the consequence of decisions and investments made overmany years. When I first joined the Company in 1984, Rolls-Royce had a narrowproduct range and its business was mainly UK focused with some presence in theUS. This position has changed fundamentally. We are now able to tradesuccessfully on a global basis and are developing our presence around theworld. This brings us closer to customers and allows us access to funding andskills. Our customer insight and our ability to develop technologies andintegrate them into complex power systems, give us access to markets wheredemand remains strong for the products and services that we provide.The decision to locate the head office of our marine business in Singapore willhave a profound impact on our ability to develop a global view. We now manageabout one third of our revenue from Singapore, a further third from NorthAmerica and the balance from the United Kingdom and Europe. This means thatmanagement teams, running businesses that in themselves are the size of FTSE100 companies, will think about challenges and opportunities from a differentperspective. This will be of huge benefit to the Group as we respond tocustomer requirements and competition.In 2010, rapid progress was made in the construction of our major new aerospacefacilities at Crosspointe in the US to manufacture discs and at Seletar inSingapore where we will assemble and test large civil engines and manufacturewide-chord fan blades. During the year, we also opened a new Mechanical Testcomplex at Dahlewitz in Germany to conduct testing for our businessesworldwide.We continue to expand our marine services. We already have 34 facilities aroundthe world and the network is growing fast, ensuring that our locations matchour customers' requirements. Of course our supply chain has also becomeincreasingly global with around 8,000 suppliers in North and South America,Europe and Asia. We continue to invest in improving our supply chainmanagement, to integrate these suppliers into our worldwide operations and toimprove our quality and capabilities.

Our business today

Our business is conducted through four major customer focused businesses:

Civil aerospace

We have seen signs of recovery in the civil aerospace sector, although thestrength of this recovery varies between regions. Nonetheless, we havecontinued to sign significant new orders, particularly with customers based inAsia and the Middle East. This includes two individual orders worth more than £1 billion from China and the Middle East. In all, new orders amounted to£7.5 billion during 2010, demonstrating the continued confidence of ourcustomers in our portfolio.The two new members of the Trent family continued their development programmesthrough 2010. The Trent 1000 is powering the Boeing 787 on the aircraft'sflight test schedule. The engine for the Airbus A350 XWB , which is due toenter service in 2013, ran for the first time in June. This promises to be themost successful member of the Trent family with 1,150 engines already on order.Across the portfolio, our order book requires us to more than double our outputof Trent engines by the middle of this decade.An uncontained disc release occurred on a Trent 900 engine on board a Qantasoperated Airbus A380 in November 2010. This regrettable incident attractedwidespread attention. Uncontained disc failures happen with a frequency ofabout once a year on the world's large civil aircraft fleet. However, this wasthe first time an event of this nature had occurred on a large civilRolls-Royce engine since 1994. The safety of our products is our highestpriority and each time a serious incident happens Rolls-Royce and the aviationindustry learns lessons. These are embedded in the rigorous certificationrequirements, safety procedures and standards of regulation which make flyingan extraordinarily safe form of transport. In line with this regime,Rolls-Royce worked closely with the regulators, Airbus and our customers to putin place an effective inspection programme, to identify root cause and toachieve a rapid return of the Trent 900 fleet to normal operation.

Marine

The growth of our marine business over the past decade has been a major featurein the broadening of our portfolio. In that time revenues have grown by sixtimes, and we now have equipment on board 30,000 vessels. This growth is aconsequence of our focus on power systems integration for increasingly complexand efficient vessels.

Rolls-Royce has a strong position in the offshore support industry with production facilities in nine countries and a growing support network. The acquisition of ODIM ASA during 2010, has added significantly to our systems capability and gives us greater access to the growing markets of seismic surveying and subsea deepwater installation. This will be particularly important as oil and gas exploration moves into ever deeper waters, for instance in Brazil, where more complex and capable vessels are required.

Our naval business secured a breakthrough order from the US Navy to power tenLittoral Combat Ships with MT 30 marine gas turbine engines. This representsthe largest naval surface vessel contract the Group has signed. In the UK,all six Type 45 Destroyers for the Royal Navy have now been launched, equippedwith our highly-efficient WR-21 gas turbine power system.In the merchant sector, our technology enables us to respond to the growingdemand for improved environmental performance of marine engines. As just oneexample of this, in 2010 we signed a contract for the world's largest gas-powered ferry which will operate in the environmentally sensitive coastalwaters of Norway, fuelled by liquefied natural gas. This technologydramatically reduces CO2 emissions and virtually eliminates soot and sulphur emissions.

Defence aerospace

Our defence aerospace business is highly diversified with 160 customers in morethan 100 countries. Despite the pressure on public spending in its traditionalmarkets we continue to benefit from our investment in a broad product andservices portfolio, all of which have global applications. In particular, wesee growth opportunities in emerging economies in Asia, the Middle East andSouth America.In the UK, the Strategic Defence and Security Review has impacted a number oflong-standing programmes, including the Harrier jump jet, which was taken outof service during 2010. However, new products and our substantial serviceactivities will both ensure the resilience of this part of the defence businessand create opportunities.New European collaborative ventures are progressing well and are expected tohave a strong export market. In particular, the TP400 turboprop on the AirbusA400M has now successfully completed 3,000 hours of flight testing. Rolls-Royceis also the leading supplier of engines for transport aircraft globally,powering large fleets such as the C-130, C-130J, Spartan C-27 and Osprey V-22.In the US, the government approved 2010 funding for the development of the F136engine for the Joint Strike Fighter. We believe this is an important programmenot just for the aircraft but to ensure competition and value for taxpayers andcustomers.

We are also involved in major research projects such as Adoptive Versatile Engine Technology (ADVENT), which is designed to significantly reduce fuel consumption. These position us well for future military programmes.

Energy and nuclear

Our energy business has two main activities. These are supplying power to the oil and gas sector and the provision of power generation products and services.

Rolls-Royce has been a major supplier of power systems for rigs and platformssince the earliest days of offshore oil and gas production. Our gas turbinesand compressors operate in harsh conditions and remote locations on behalf ofmajor oil companies. For example, our industrial RB211, Avon and Trent unitsare now employed on 60 major pipelines around the world. New discoveries andthe associated distribution of their output are creating strong demand for ourproducts and services.The power generation market continues to be restrained by weak demand forelectricity in our traditional markets. However, we have secured significantnew orders in emerging economies including India and Venezuela and we see goodopportunities for long-term growth for both our gas turbine and reciprocating engine portfolio. It is clear that future developments in this sector arelikely to be driven by the need for affordable, efficient, distributedmulti-fuel systems. Our gas turbine and reciprocating engine portfolio providesa good basis to address these markets.In addition, over the past decade, the Group has invested in new technologiessuch as tidal power and fuel cells. During 2010, we conducted a full scale testof a tidal power turbine, anchored on the sea bed off the coast of Scotland.This has generated 500kW at full power and has been successfully linked intothe national grid.We continue to expand our activities in civil nuclear power generation. During2010, we secured contracts to provide nuclear safety systems in France and inChina and have developed supply relationships with reactor vendors andutilities both in the UK and globally. These areas of investment enable us toaddress the particular requirements of low or zero carbon power generation withsolutions that build on our core capabilities.

Strength through teamwork

The successful development of our portfolio depends critically on world-classpeople and teamwork. The global nature of our business means that our peoplemust work effectively across time zones, geographies and cultures. Of the38,900 men and women we employ, 45 per cent are now based outside the UK. Thismakes communications and shared values critical.

This year we built on the success of our annual strategy storyboard with a televised presentation to most of the senior managers in the Group. The managers who attended this event have been responsible for presenting the storyboard to every employee of the Group. This has enabled people at all levels and in every location in the organisation to understand our objectives and to feed back their own thoughts.

We believe that effective recruitment and continuous training are critical toour success. This year, we recruited 220 apprentices and over 300 graduatesfrom 25 countries. We devote significant resource to the continuous developmentand training of our people. Over the past five years the Group has committed £150 million to this area alone. Our UK Apprenticeship scheme has been awarded Beacon Status by the Office for Standards in Education (Ofsted) and we have schemes of similar quality globally.

We benefit from the diversity that our global presence brings, recognising that a clear understanding of developing customer requirements, world-class technology and exceptional teamwork are the keys to our future success.

Prospects

The long-term disciplined application of our strategy has created a broadportfolio of products, services and capabilities that ensures a wide range ofoptions for future growth. The expected doubling of revenue over the nextdecade is underpinned by a record order book, which gives good visibility ofthe future, and a strong balance sheet which enables us to invest in thepeople, technology and capability that will enhance competitiveness.In the short term we expect demand in some markets to remain subdued. However,we have access to the faster growing global markets and our large installedbase allows us to benefit from an increasing emphasis on the services we canprovide to our customers.Last September, when I announced my intention to retire, I said there werethree considerations that made me comfortable with my decision: I knowRolls-Royce is in a strong position with more choices than we have had in thepast; we have a world-class team; and I am confident in the Board's appointmentof John Rishton as my successor. He will be an outstanding Chief Executive.Rolls-Royce has been my working life for 27 years. Wherever I have gone in theworld, I have always been proud to be Chief Executive of this Company. It hasbeen an extraordinary privilege to work with so many outstanding people and tocontribute to the development of a business that has been at the forefront ofengineering and technology for over 100 years. I wish Rolls-Royce, itsemployees and its shareholders continued success.Sir John RoseChief ExecutiveFebruary 9, 2011REVIEW OF OPERATIONSCivil aerospaceKey financial data 2006 2007 2008 2009 2010Underlying revenue £m 3,907 4,038 4,502 4,481 4,919 +15% +3% +11% 0% +10%

Underlying profit before financing £m 519 564 566

493 392 +14% +9% 0% -13% -20%Net assets £m 2,165 2,468 330 2,694 2,727

Other key performance indicators

2006 2007 2008 2009 2010Order book £bn 20.0 35.9 43.5 47.0 48.5 +5% +80% +21% +8% +3%Engine deliveries 856 851 987 844 846

Underlying service revenues £m 2,310 2,554 2,726 2,626 3,027Underlying service revenues % 59 63 61 59 62Percentage of fleet under management 48 55 57

59 70

The civil aerospace business powers over 30 types of commercial aircraft andhas a strong position in all sectors of the market: widebody, narrowbody andcorporate and regional aircraft. Over 13,000 engines are currently in servicewith 650 airlines, freight operators and lessors and 4,000 corporate operators.A Rolls-Royce powered aircraft takes off or lands every 2.5 seconds.The airline industry has shown recovery in 2010, (after significant losses in2008 and 2009) with above-average passenger and cargo traffic growth and areturn to profit for many airlines. Business jet flights also increased,although not to the levels before the downturn. Large cabin business aircraftdeliveries, where Rolls-Royce has a strong position, have been more resilient,driven by demand in Asia and Europe, although the US market remains weak. Thesmall- and mid-size aircraft sectors, which are concentrated in the US market,continued to be subdued.WidebodyWe made good progress with the latest members of the Trent engine family, theTrent XWB and Trent 1000. The Trent XWB will power the Airbus A350 XWB and ranfor the first time in June - fulfilling a schedule commitment we made fouryears ago. Seven engines will run in 2011 as part of a comprehensive testprogramme.The Trent 1000, which powers the Boeing 787 Dreamliner, has accumulated morethan 2,000 hours of test flight time on four aircraft. The engine won severalnew orders in 2010, taking the total on order to nearly 550. The aircraft isnow expected to enter service in the third quarter of 2011.

The business continues to work closely with both large aircraft manufacturers, Airbus and Boeing, to support these programmes.

Of the Trent engines already in service, the Trent 700 confirmed its marketleading position on the Airbus A330. It has won more than 90 per cent of ordersannounced in 2010 and more than 70 per cent in the past five years. Orders wereparticularly strong in the second half of 2010, with US$5 billion of businessannounced since the start of July.Rolls-Royce continued to enjoy success in growth markets. In China, Air China,China Eastern and Cathay Pacific selected Trent XWB and Trent 700 engines. InSouth East Asia, Thai Airways and Garuda ordered Trent 700s, and in the MiddleEast, Emirates and Egyptair extended TotalCare service agreements and Tunisairbecame a new member of the Trent family, ordering Trent 700s.

A Trent 900 engine suffered a significant failure on a Qantas Airbus A380. The cause of this failure, which was specific to the Trent 900 and related to a

component in the turbine area, was quickly established and addressed. The A380 fleet has returned to normal operation.

Narrowbody

In the narrowbody market the V2500 engine, produced by International AeroEngines (IAE) in which Rolls-Royce is a major partner, delivered 371 engines in2010, its highest ever production level. IAE gained significant contract awardsfrom Sichuan Airlines, Vietnam Airlines, TAM Airlines, BOC Airlines and ChinaSouthern. There are now more than 4,500 V2500 engines flying with more than

190customers worldwide.Corporate and regionalIn the small- and medium-size engine market the BR725 remains on schedule forentry into service on the Gulfstream G650 in 2012, following an exemplaryflight and engine test programme. The first Embraer Legacy 650 large executivejet, powered by the new Rolls-Royce AE 3007A2 engine, was delivered to a MiddleEast customer in December.Services

Revenues from TotalCare long-term support agreements remained resilient in2010. The proportion of Trent engines in service with TotalCare reached morethan 90 per cent, while time and materials activity showed some recovery in thesecond half of the year. Overall reliability of the Rolls-Royce engine fleetcontinued to improve with Trent engines achieving on average one million hoursbetween in-flight shut downs, a rate 20 times better than that required by theregulators for approval of Extended Range Twin Operations.

Future

The business continues to plan for the future, with new two-shaft andthree-shaft engines. The Advance2 and Advance3 technology programmes are beingdriven to support the potential for new engine requirements in the latter partof the decade. The business is also continuing its research into open rotortechnology, which we believe could provide a step change in engine performance.

Construction work at the Seletar large engine assembly complex in Singapore is well advanced and is scheduled to open in 2012. Work at the new Crosspointe facility in Virginia, US, is also proceeding to plan.

While economic prospects remain uncertain in many countries for 2011, trafficgrowth is improving and we expect to see it return to its historic average offive per cent per annum.Oil prices have remained generally high, encouraging airlines to retire olderaircraft during the economic downturn. The Rolls-Royce powered fleet isrelatively young and as a result, more fuel efficient. We are benefiting fromthe upturn as hours flown under TotalCare agreements continue to grow. Thisunderlines the value of our balanced services and products business model.

Defence aerospace Key financial data 2006 2007 2008 2009 2010Underlying revenue £m 1,601 1,673 1,686 2,010 2,123 +13% +4% +1% +19% +6%Underlying profit before financing £m 193 199 223 253 309 +7% +3% +12% +13% +22%Net assets £m 20 (172) (197) (345) (523)

Other key performance indicators

2006 2007 2008 2009 2010Order book £bn 3.2 4.4 5.5 6.5 6.5 -3% +38% +25% +18% 0%Engine deliveries 514 495 517 662 710Underlying service revenues £m 853 877 947 1,046

1,103

Underlying service revenues % 53 52 56 52

52

Percentage of fleet under management 11 11 12 16 18

Rolls-Royce is the world's second largest provider of defence aero-engine products and services, with 18,000 engines in service for 160 customers in 103 countries. Our engines power aircraft in all sectors: transport, combat, reconnaissance, training, helicopters and unmanned aerial vehicles.

There continues to be pressure on defence spending in our key markets in Europeand the US. However, our broad product portfolio and strong service and supportposition on many of the new and established defence aircraft programmes havecontinued to provide protection against the changes in defence spending bythese important customers.

We still see growth opportunities in these markets and, in addition, we are well positioned to secure growth from emerging economies in Asia, the Middle East and South America.

TransportRolls-Royce consolidated its position as a world leader in the transport marketas our AE 2100 engine for the Lockheed Martin C-130J transport aircraftcontinued to register orders with existing customers, such as the US Air Force,while the global fleet expanded with the Indian Air Force taking delivery ofits first aircraft.

The Airbus A400M military transport aircraft enjoyed a year of flight test success with its TP400 engines achieving more than 3,000 flying hours and completing the final bench test requirements, thereby clearing the path to certification.

In 2011, we expect to begin flight testing with the US Air Force for the certification of the T56 engine enhancement kit for the C-130. This will provide significant fuel savings, a substantial improvement to engine reliability and improved hot day/high-altitude performance over the existing engine fleet.

CombatIn the combat sector our twin contributions to the Lockheed Martin F-35programme continue to make significant progress in the test phase. The uniqueshort take-off and vertical landing (STOVL) Rolls-Royce LiftSystem® powered theF-35B variant aircraft to its first vertical landing in March 2010. It is nowready for Initial Service Release in advance of the first customer deliveriesto the US Marine Corps, scheduled for 2011.The F136 engine programme for the F-35 Joint Strike Fighter has continued toillustrate the benefits of its advanced design and technologies, which areuniquely tailored for the requirements of the aircraft. Six production-standardF136 engines have been tested during 2010 and the programme is making excellentprogress on the path to first flight.

Trainers

In India, the Government placed an order for a second tranche of Adour-powered Hawk Advanced Jet Trainers, worth up to £200 million.

Helicopters

In the helicopter market we were awarded a multi-million dollar contract by theUS Army to design and develop a dual-channel, full authority, digital enginecontrol (FADEC) for the M250-powered OH-58 Kiowa Warrior helicopter. We alsoreceived the US Army Kiowa Warrior Supplier Excellence Award.

In addition, the LHTEC CTS800 engine, which powered three first flights in 2009, achieved the milestone of 50,000 in-service flying hours.

Services

The success of our services business continued in 2010, attracting majorcontracts worth around £1.5 billion. Among these was an extension of thelong-term support for the RB199 engines powering the UK's Tornado fleet, andMissionCareâ„¢ contracts to provide availability-based engine support for V-22Osprey transport aircraft and the C-130J in service with the US. The US Navyagain renewed its support agreement for Adour F405 engines in the T-45 Goshawktrainer. The Canadian Air Force's AE 2100 engines are now also part of theMissionCare fleet.

Future

We continue to make good progress on the US Air Force Adaptive Versatile EngineTechnology (ADVENT) demonstrator programme. It is designed to reduce fuelconsumption significantly, enabling extended mission ranges and loiter times.In December, we completed the fan rig tests and work continues in preparationfor the core and engine demonstrator phases of the programme.Our Unmanned Air Systems portfolio was further increased by the roll out of theBAE Systems Taranis technology demonstrator powered by the Adour engine. Wecontinue to invest in performance improvements of established fleets such asthe Northrop Grumman Global Hawk which is powered by our AE 3007.Despite the budget cuts in traditional geographical markets, the defencebusiness has the opportunity to compete in a global market potentially wortharound US$430 billion over the next 20 years. Many of our customer requirementsfor the next ten years are already contracted and there are key exportopportunities for programmes across all market sectors.MarineKey financial data 2006 2007 2008 2009 2010Underlying revenue £m 1,299 1,548 2,204 2,589 2,591 +18% +19% +42% +17% +0%Underlying profit before financing £m 101 113 183 263 332 +13% +12% +62% +44% +26%Net assets £m 619 563 488 641 815

Other key performance indicators

2006 2007 2008 2009 2010Order book £bn 2.4 4.7 5.2 3.5 3.0 +41% +96% +11% -33% -16%

Underlying service revenues £m 487 545 712 785

872

Underlying service revenues % 37 35 32 30

34

Rolls-Royce has a world-leading range of capabilities in the marine market,encompassing the design, supply and support of power and propulsion systems. We are leaders in the integration of technologically complex, mission criticalsystems for offshore oil and gas, merchant and naval vessels.Rolls-Royce has more than 2,500 marine customers and has equipment installed onover 30,000 vessels worldwide, including those of 70 navies. The marinebusiness had another strong year, despite lingering macroeconomic uncertaintyand a sluggish recovery in new shipbuilding activity. Service opportunitiescontinued to increase as a result both of the large number of vesselsincorporating Rolls-Royce equipment entering the market in recent years and our expanding services network.

Revenues proved to be resilient in 2010 despite a slowdown in original equipment orders. Growth was driven by our aftermarket services and ongoing success in the offshore market. As a result, marine profit has increased by 26 per cent in 2010.

OffshoreThe design of offshore vessels and the high-technology equipment they employ iscentral to our business today, and we continued our strong performance in thissector. This was largely based on the success of our specialist UT Designvessels and ability to integrate sophisticated systems into complex ships. Thelatter part of 2010 saw a slight rebound in orders for highly specialisedoffshore vessels, highlighted by the first order for the innovative UT 790wave-piercing series. This new design improves stability and crew safety, while minimising environmental impact.During 2010, we completed the acquisition of ODIM. The advanced automatedhandling solutions ODIM brings to our marine business has further extended ourcapabilities in the range of vessels and equipment we supply to support oil andgas customers in areas such as seismic surveys, deepwater installation, wellintervention and other subsea operations.

As the oil and gas industry continues to explore ever deeper waters, the capabilities that the business now has in these highly-skilled areas will mean that we continue to be a strong partner for our offshore exploration and production customers.

Naval

Our naval business had a strong year, with significant activity in the UK, theUS and South Korea. In early 2011, we received an order from Lockheed Martinfor the provision of MT30s, the world's most powerful gas turbine, togetherwith Kamewa waterjets, to power a further ten US Navy Littoral Combat Ships.This is the largest surface fleet order ever achieved by Rolls-Royce. Wecontinued to deliver power and propulsion equipment for the UK's new QueenElizabeth class aircraft carriers.

Merchant

We invest in technology that addresses the need for more efficient marine powerand propulsion systems. This is primarily through the reduction of exhaust gasemissions and improvements in ship design. Our Bergen gas engines alreadysurpass International Maritime Organization (IMO) limits for NOx emissions, andseveral orders for these cleaner engines were secured for specialist coastalvessels and ferries in 2010.We believe that our strong focus on environment and safety technology will beincreasingly attractive to customers, resulting in new business opportunitiesin the merchant and specialist vessel sector.

Services

Our services revenues grew by 11 per cent in 2010, now representing 34 per centof total marine revenue, and we have continued to develop both capacity andcapability to realise the significant opportunity that our increasing installedbase represents.Our global pool of service engineers increased by 20 per cent during the yearand we have further extended our service centre network with four facilitiesacross Europe and Africa being expanded or opened.We have enhanced our range of equipment upgrades and successfully introduced aninnovative underwater repair service that reduces vessel downtime and increasesour ability to support customers operating in remote locations. In addition, weare continuing to develop equipment health monitoring capabilities, leveragingproven expertise in other Group sectors.

Future

Our strong profit performance in 2010 was a result of delivery of existing orders combined with continued growth in service related activity.

Although new orders in equipment reduced in 2010, there was some recovery inthe second half of the year. This, combined with anticipated further growth inservices, provides us with good visibility of revenues in 2011.EnergyKey financial data 2006 2007 2008 2009 2010Underlying revenue £m 546 558 755 1,028 1,233 +2% +2% +35% +36% +20%

Underlying profit before financing £m (18) 5 (2) 24

27 -1900% +128% -140% +1300% +13%Net assets £m 387 370 392 533 434

Other key performance indicators

2006 2007 2008 2009 2010Order book £bn 0.5 0.9 1.3 1.3 1.2 +25% +80% +44% 0% -8%Engine deliveries 87 78 106 87 95

Underlying service revenues £m 251 289 370 470

542

Underlying service revenues % 46 52 49 46

44

Percentage of fleet under management 6 7 9 10 10

The energy business supplies gas turbines, compressors and diesel power unitsto customers around the world. The business is a world leader in the supply ofpower for onshore and offshore oil and gas applications. Our developing civilnuclear capability has further strengthened our position in the powergeneration market.The energy business delivered a strong performance in 2010 with underlyingrevenue of £1.2 billion, an increase of 20 per cent over 2009, and profitgrowth of 13 per cent as the business delivered a strong second half recoveryto offset the £26 million charge taken in the first half of the year related tothe industrial Trent engine. During 2010, the land-based diesel power businesswas integrated into energy, increasing revenue by £140 million.Oil prices continued to strengthen during the year and, as a result, bidactivity increased in the oil and gas sector, although it is also the case thata number of potential projects were delayed. The traditional power generationmarket for the Trent continues to be depressed by the low demand forelectricity in developed countries. However, the business has been successfulin securing new unit orders for both the Trent gas turbine and Bergenreciprocating engines in countries where significant power shortfalls exist,with major orders received from Bangladesh, India, and Venezuela.

Orders for land-based diesel and gas engine power generation applications tripled in 2010 when compared to the preceding two years. A packaging partnership for the industrial Trent was agreed with STX in South Korea, further broadening territorial coverage.

Services

Demand for aftermarket products and services again grew strongly with anotherrecord year delivering revenue of £542 million, an increase of 15 per cent over2009. Including the land-based diesel units there are now a total of 662 units,or 33 per cent of the fleet under long-term service agreements. Operatorscontinue to benefit from product upgrades that incorporate the latesttechnology, including the Avon 200 upgrade, which was introduced in 2006 andhas now been delivered to more than 24 customers.

Developments

Investment in low carbon technology products continued with the ongoingdevelopment of fuel cell technology. In tidal generation the 500kWdemonstration unit at the European Marine Energy Centre in the Orkney Islandssuccessfully achieved its technical milestones, generating in excess of 50MWhin the process and earning a Renewable Offset Credit under the UK Government'stariff regime. Plans are now underway to build a 1MW unit that will provide thebasis for a commercially available product.

Nuclear

During 2010, we continued to progress plans for a UK nuclear manufacturing baseand announced the opening of two new nuclear-specific University TechnologyCentres (UTCs), located at Imperial College London and the University ofManchester. Rolls-Royce is also a lead partner in the UK Government's NuclearAdvanced Manufacturing Research Centre (NAMRC) facility, which is due to openin September 2011.

The business further extended its nuclear manufacturing skills base through the integration of Canada-based ODIM Numet, specialising in engineering, manufacturing and through-life support of nuclear island systems.

In India, a Memorandum of Understanding was signed with Larsen & Toubro Ltd fora collaborative approach to address new nuclear build markets both in India andinternationally. At the beginning of 2011, Rolls-Royce signed an agreement tocollaborate with Nuclear Power Delivery UK consortium on its plans to deploythe Westinghouse nuclear reactor in the UK.

The nuclear instrumentation and control business performed well in 2010, establishing a solid platform for global growth across Central and Eastern Europe, China and India. It is also delivering 20 safety instrumentation and control systems for eight new plants in China.

FutureTraditionally a strong oil price has resulted in increased business fororiginal equipment in the oil and gas sector. We would therefore expect themarket to continue to strengthen for products and services if the oil priceremains relatively high. In power generation we now have a broad range ofsystems to offer and this puts us in a position of strength to take advantageof any market upturn. We will also continue to explore opportunities inemerging economies.Engineering and technologyKey performance indicators 2006 2007 2008 2009 2010

Gross research and development expenditure £m 747 824 885 864 923Net research and development expenditure £m 395 454 490 471 506Net research and development charge £m 370

381 403 379 422 Net research and development expenditure % of underlying revenue 5.4 5.8 5.4 4.7 4.7

In 2010, Rolls-Royce invested a total of £923 million in gross research anddevelopment, of which £506 million was funded from Group resources. Researchand development are fundamental to our future success, providing technologiesand intellectual property that allow us to compete on a global basis in highlycompetitive markets.The Group's engineering and technology activities are undertaken by close to10,000 product, engineering and technology specialists covering more than 40major programmes. The activity is global with main engineering centres locatedin the UK, US, Germany, the Nordic countries, Singapore and India.

Research

Our advanced research is supported through our worldwide network of 28Rolls-Royce University Technology Centres, working across a range of specialistsubject areas such as materials, noise, vibration and combustion. Two newcentres for nuclear technology at Imperial College London and at the Universityof Manchester were added during the year.During 2010, we strengthened our new Advanced Technology Centre (ATC) inSingapore which is developing manufacturing and electrical systems andhigh-power computing capabilities. Work began on the new, dedicated home forthe ATC as part of the Seletar development. We opened our new Mechanical TestOperations Centre in Dahlewitz, Germany, during the year. This centre providesmechanical testing capability for all areas of the Group. Building on thesuccess of our membership of the Advanced Manufacturing Research Centre (AMRC),we continue to increase our focus on advanced manufacturing. In the UK, weopened the Advanced Fabrication Research Centre at Strathclyde, Scotland, andthe Nuclear Advanced Manufacturing Research Centre project was launched. We arealso establishing the Commonwealth Centre for Advanced Manufacturing (CCAM) atthe Crosspointe complex in the Commonwealth of Virginia, USA.In 2010, we established the Manufacturing Technology Centre (MTC) in Coventry,UK. MTC will be the largest in the network of AMRCs when it opens in 2011.Technology programmes in the areas of high integrity joining, intelligentautomation, advanced fixturing and net shape powder manufacture have alreadybeen launched through MTC partnerships with founder members Rolls-Royce, Airbusand Aero Engine Controls.Environmental performanceFurther improving the environmental performance of our products and operationsis a key driver for research and development in Rolls-Royce. We completed thefirst build of the Environmentally Friendly Engine, and the second build of ourmid-size technology demonstrator engine, E3E, was tested successfully inGermany. The E3E, two-shaft core demonstrated, amongst other successes,critical operability throughout the flight envelope up to 38,000ft, for thenovel lean-burn combustor.The European STREAMLINE programme led by Rolls-Royce was launched in 2010. Theproject includes 22 partners in eight countries and focuses on demonstratingradical new marine propulsion concepts, aimed at delivering increases inefficiency of at least 15 per cent. We achieved notable engineering successesin each of our key business sectors in 2010.

Civil aerospace

In the civil aerospace business, the first Trent XWB engine went to test onschedule in June, running to 100,000lbs of thrust later in the year. Flighttesting of the BR725 for the new Gulfstream G650 progressed well and has nowachieved 1,000 hours. The Trent 1000 flight test programme for the Boeing 787continued, although Boeing announced in early 2011 that the entry into servicefor the aircraft would be further delayed until later in 2011.2010 also brought a number of challenges to the civil aerospace business. Theeruption of a volcano in Iceland in April 2010 resulted in significantdisruption to the aviation industry. Our engineering team took a leading roleand worked in a systematic way to assist the airlines and industry regulatorson this issue. Towards the end of 2010, a Trent 900 suffered a high-profilefailure on a Qantas A380, which initiated a significant and urgent responsefrom the engineering team in order to return to normal operations.

Marine

In 2010, the marine business acquired ODIM and we have successfully integrated theengineers of this business into the Rolls-Royce engineering community. ODIM'speople have a wealth of skills and technological knowledge. We anticipate theacquisition will enhance our offshore capability significantly. Marine sold the first offshore vessel with a wave-piercing design (UT 754 WP) for delivery in 2012 and the Dynamic Positioning Release 3 (DP3) successfully passed concept design review.

Defence aerospace

In defence aerospace, the STOVL variant of the Lockheed Martin F-35 LightningII, equipped with the Rolls-Royce LiftSystem®, successfully completed aflawless first hover and vertical landing in March 2010. The pace of the F136engine development programme accelerated significantly during 2010 with six newtest engines delivered during the year. Approximately 900 test hours werecompleted according to plan for the F136 programme in 2010. The programme alsocontinued its successful history of meeting contractual milestones with thefirst STOVL propulsion system delivered to test, on time.LibertyWorks® in Indianapolis continues to perform well on the ADVENTdemonstrator programme; rig testing demonstrated fan performance as expectedand with a favourable stability margin. Work continues in preparation for thecore and engine demonstrator phases of the programme.

In 2010, Robinson Helicopter obtained FAA certification for the RR300-powered R66 helicopter and commenced customer deliveries.

Energy

We continue to develop our business activities in the civil nuclear market and also continued with further investment in nuclear engineers and in infrastructure.

Our first tidal stream generator was deployed offshore of the Orkney Islands. Amajor milestone was reached on November 10,2010 when the turbine generated 500kW at full power for the first time at the test site. The turbine is now beingoperated unrestricted with several periods of fully automatic 24-hour operationand has achieved all requirements to gain a renewable obligation certificate.OperationsKey performance indicators 2006 2007 2008 2009 2010Capital expenditure £m 303 304 283 291 361

Underlying revenue per employee* £000 182 194 211 233

259

* Calculated on a three-year rolling basis

We continue to invest in operational capability to enable the long-term growthplans of the Group to be executed. Our strong positions in growing markets,represented by a record order book, together with increasing services activity,place a demand on us to deliver world-class operational excellence from modernand efficient facilities.There has been significant uncertainty in the economic environment during thelast two years and our supply chain has performed well throughout this volatileperiod, with an increasing emphasis on productivity, flexibility and execution.The 2010 results reflect this performance through a marginal reduction ininventory and progress in productivity, reflected by an improvement in revenueper employee.Our global operational network is a highly integrated activity including ourown facilities, partners and other external suppliers feeding the gas turbineapplications in all four businesses. In addition, we are managing substantialglobal supply chains to support our growing range of marine and nuclearactivities.

Delivering excellence

During 2010, we have continued to focus on operational excellence with our programme of investments to improve current productivity and support the inevitable growth embedded in the order book.

We work in partnership with our external partners and suppliers to reducewaste, improve designs and introduce better manufacturing methods for new andexisting products. Our achievements have helped offset inflationary pressuresin 2010, however, there remains more to do. Creating simple, scalable processesand a culture of `right first time' are key to operational excellence and willhelp achieve cost reductions in every aspect of our operations.The ongoing drive to reduce inventory provided further benefits in 2010. We areestablishing systematic changes that can transform working capital managementand, in time, release cash.Investing for growth2009 proved to be a year of firsts with an unprecedented number of newprogrammes reaching first flight or launch. In 2010 the work to support theseprogrammes progressed well. In June 2010, the first Trent XWB engine ran forthe first time, in line with the plans we set out four years ago. Flight testwork progressed on the new Trent 1000 for the Boeing 787 and the TP400 for theAirbus A400M transport aircraft. In marine, we introduced a new wave-piercingdesign of offshore support vessel, and in energy we launched the upgradedindustrial RB211, the -H63.Our success at winning business in the wide-bodied aircraft market means weexpect to more than double the number of Trent engines being delivered by themiddle of this decade. To manage this change in volume, investment in newfacilities, tooling and capability continued during 2010. Building work hasprogressed as planned on the Crosspointe facility in Virginia, US, and atSeletar Aerospace Park in Singapore. With the external building work broadlycomplete, both are on target to be in operation by 2011 and 2012 respectively.We opened the new Mechanical Test Operations Centre at Dahlewitz, Germany, anda new facility to support the F-35 LiftFan® assembly in Indianapolis, US. Wealso expanded the civil aerospace repair and overhaul joint venture, SingaporeAero Engine Services Limited, increasing capacity to 250 large engines peryear.In the UK, the new disc manufacturing plant in Sunderland is progressing toplan and, in addition, we are supporting the development of four advancedmanufacturing research centres. Two similar centres are being developed outsidethe UK. All of these will help improve manufacturing performance across thesupply chain. Additional manufacturing capacity, for the submarines and civilnuclear businesses, is being added to our existing facilities in Derby.

People and capability

We are committed to investing in, and developing, our people to equip them withthe skills required to meet the challenges and opportunities we face as thebusiness grows. Through our ethics, health and safety programmes, we arehelping our people to make the right decisions and ensuring that the safety ofour people and products are at the forefront of our minds and actions. In 2010,we continued to invest heavily in information and technology across the Group.Investments in Product Lifecycle Management (PLM), Computer Aided ProcessPlanning (CAPP) and Manufacturing Execution Systems (MES) are key to providingthe tools to enable effectiveness and efficiency.

Future

Our journey to create a global, best-in-class, and fully integrated operationsfunction is well underway. While economic uncertainty seems likely to continue,our priorities remain to improve the effectiveness of our delivery and ensurewe are well placed to meet the operational demands of the future.ServicesKey performance indicators 2006 2007 2008 2009 2010Underlying revenue £m 3,901 4,265

4,755 4,927 5,544 Underlying services as a percentage of Group revenue 53% 55% 52% 49% 51%

Rolls-Royce provides power systems for applications that routinely operate inparticularly harsh environments, often with years between intervention. Serviceactivities provide over one half of the Group's revenues, having increased tenper cent compound over the past ten years.As the original equipment manufacturer, Rolls-Royce is best placed to providemission critical support, long-term product care and well planned maintenanceon behalf of customers in each of the markets we serve. The Group's servicecapabilities include field maintenance and support services, the provision ofreplacement parts, equipment overhaul services, component repair, datamanagement, equipment leasing and inventory management. These are typicallypackaged together and sold as long-term support agreements such as ourTotalCare suite. We work closely with customers to align each service packageto their operational needs, helping to maximise the availability and efficientoperation of the equipment on their behalf.

Civil aerospace

We have 76 per cent of the large engine fleet and 92 per cent of the in-serviceTrent fleet now managed under TotalCare. We also have 900 corporate andbusiness jet aircraft enrolled in CorporateCare®, the equivalent offering forthis market sector. In 2010, operational planning has been further enhancedacross the Trent family of engines with the adoption of sophisticated proactiveengine life management policies. These combine our technical knowledge with theservice data on each individual engine to enable each customer to manage theirwhole fleet in a more predictable manner. Our network of On-Wing Carefacilities supported over 3,500 events globally in 25 different countries.

Defence aerospace

We continued to develop MissionCareâ„¢ provision worldwide and service presence on military bases. A long-term service agreement was signed with Lockheed Martin to support the Canadian Air Force fleet of C-130J military transport aircraft. New contracts were also signed with the UK Ministry of Defence to increase the scope of support for the frontline Tornado and Typhoon fighter aircraft operations. In 2010, Rolls-Royce completed 500,000 flight hours of MissionCare support for the Adour engines that power the US Navy's T-45 training aircraft.

Energy

We secured further long-term service agreements which, together with theadditional 38 new gas turbine units that became operational during 2010, meanthe number of gas turbines under long-term service agreements is approaching350. Additionally, a number of long-term service agreements were renewed, themost significant being with Total in the North Sea supporting 14 gas turbinepackages on two platforms for a period of ten years. We continue to develop theservice infrastructure to support the growth of the Rolls-Royce fleet in China,India, Brazil, Malaysia and Russia, along with extending the global footprintof the business with expanding operations in West Africa and Central Asia.2010 also saw the 20-year anniversary of the Rolls Wood Group repair andoverhaul joint venture. The Rolls Wood joint venture continues to maintain itsposition as the major supplier of repair and overhaul services for Rolls-Royceindustrial gas turbine engines. The scope of the joint venture was expanded inthe year with the official opening of a facility in Malaysia in partnershipwith OTEC.

Marine

Service opportunities have continued to increase in marine as a result of thelarge number of vessels with Rolls-Royce equipment installed, now totallingover 30,000 vessels worldwide. As this installed base of equipment continues togrow, we are actively expanding our support capacity and capability and nowhave over 30 dedicated marine service centres serving customers across Northand South America, Africa, Europe, the Middle East, Asia and Oceania. Marinecustomers seek to have their ships serviced close to where they primarilyoperate, and we continued our expansion by adding around 200 service engineersglobally. We continue to expand our service capabilities and in 2010 wecompleted more than 50 successful underwater intervention repair services whichenabled major propulsion overhauls to be completed without the need for timeconsuming dry docking.FutureThe Group invested over £26 million this year in developing and restructuringour wholly-owned gas turbine repair and overhaul network, which will deliversignificant improvements in operational performance and customer satisfaction.2010 also saw the celebration of ten years of Rolls-Royce ownership of theOakland repair and overhaul facility in the US.

Our component repair business continues to grow rapidly and delivered £150 million in benefit across all sectors in 2010.

Asset optimisation service development has advanced strongly, led by theOptimized Systems and Solutions Inc. (OSyS) business. OSyS has expanded ourin-service diagnostic, risk management and predictive capabilities. ThroughOSyS, we continue to advance the health monitoring services and capabilitiesalready applied successfully to aircraft engines and energy systems with morethan 8,900 assets being monitored.

Market outlook

The Group operates in four long-term global markets - civil and defence aerospace, marine and energy. These markets create a total opportunity worth in excess of US$2 trillion over the next 20 years and:

• have very high barriers to entry; offer the opportunity for organic growth;• feature extraordinarily long programme lives, usually measured in decades;• can only be addressed through significant investments in technology,infrastructure and capability; and• create a significant opportunity for extended customer relationships withrevenues from aftermarket services similar in size to original equipmentrevenues.

Civil aerospace

The Group produces a 20-year global market outlook, which covers passenger andcargo jets, corporate and regional aircraft. We predict that, over the next 20years 137,000 engines, worth over US$800 billion, will be required for morethan 63,000 commercial aircraft and business jets.The forecast predicts faster growth rates for long-haul markets and thosemarkets to, from and within Asia. These markets will continue to benefit frommore liberal air service agreements, which boost demand. Factors affectingdemand include GDP growth, aircraft productivity, operating costs,environmental issues and the number of aircraft retirements. While the marketcan be temporarily disrupted by external events, such as war, acts ofterrorism, or economic downturns, it has, in the past, always returned to itslong-term growth trend. In addition to the demand for engines, the Groupforecasts a market opportunity worth US$600 billion for the provision ofproduct-related aftermarket services.

Defence aerospace

The Group forecasts that demand for military engines will be worth US$160 billion over the next 20 years. This outlook was moderated, slightly

based on US and European budget pressures. The largest single market is expected to be the US, followed by Europe and the Far East. Within Asia, demand will bedominated by Japan, South Korea and India. Trends are driven by the scale ofdefence budgets and geopolitical developments around the world. As in theGroup's other business sectors, programme lives are long and there is asignificant opportunity to support equipment with aftermarket services,estimated at US$270 billion over the same period. Customers' budget constraintsand their need to increase the value they derive from their assets haveaccelerated the move in this direction.

Marine

The Group forecasts a demand for marine power and propulsion systems valued atUS$215 billion over the next 20 years. Demand will be greatest in thecommercial sector, where the shipping of raw materials, finished goods andpeople, in addition to oil and gas exploration and production activity, playcrucial roles in the world economy. These activities require large fleets ofspecialised and increasingly sophisticated ships, which have to be continuallyrenewed and supported to remain operationally efficient. Merchant and offshoremarkets are rarely at the same stage of the business cycle, which helps toreduce overall volatility. Whilst naval markets are driven by differentconsiderations, customers are similarly seeking to get more from their budgets,leading to increasing demand for integrated systems and through-life supportarrangements. As in the Group's other markets, marine aftermarket services areexpected to generate significant opportunities, with demand forecasted atUS$125 billion over the next 20 years.

Energy

The International Energy Agency has forecast that over the next 20 years, theworldwide demand for oil will grow by more than 18 per cent, for gas by 44 percent and for energy by more than 30 per cent. To satisfy this demand, therewill be a growing requirement for aero-derivative gas turbines in variousapplications. The Group's 20-year forecast values the total aero-derivative gasturbine sales in the oil and gas and power generation sectors at more thanUS$70 billion. Over this period, demand for associated aftermarket services isexpected to be around US$50 billion. While the oil and gas market is large andgrowing, demand for aero-derivative gas turbines in the power generationsegment is twice that of oil and gas.

Finance Director's review

The trading performance in 2010 met the expectations of the Board and theguidance provided throughout the year, delivering a seven per cent increase inunderlying Group revenues with underlying profit before taxes up four per centto £955 million. There was a cash inflow of £258 million in the year deliveringa period end net cash balance in excess of £1.5 billion.These achievements came in a period that saw the broader environment remainingdifficult and unpredictable with significant macro-economic, industry andCompany-specific challenges throughout 2010. It was especially pleasing thatfurther significant milestones on major new programmes, considerable investmentin product development and continued expansion of the global facilities andsupply chain were also delivered along with a resilient trading outturn. Thisperformance continues to highlight the strength of the portfolio and thebenefits of the long-term and disciplined application of the power systemsstrategy.All of our businesses have been affected by the economic factors that have beenprevalent in the last few years and that have had an impact on our competitors.However, the Group has significant advantages in the diversity of itsbusinesses, both by sector and geographical dispersal. The age of our installedfleet of products, the strong positions we hold on current and future majorprogrammes, together with the Group's services revenues have all helped todeliver significant progress in the last three years. This is demonstrated by:growth in the order book of 29 per cent; increase in underlying revenues of 39 per cent; and growth in underlying profits of 19 per cent; all of whichsupported a 23 per cent improvement in payments to shareholders over the sameperiod. Throughout this time, the portfolio has continued to evolve withinvestments totalling more than £4 billion in product development,acquisitions, capacity and facilities. This establishes a strong platform forlong-term growth in revenue and productivity and hence profitability.The results were affected by the movements in foreign exchange rates through2010, especially the GBP/USD and the GBP/EUR which are explained below. TheGroup has maintained a strong financial position throughout the year andcontinues to hold strong credit ratings from both Standard & Poor's (A-,Stable) and Moody's (A3, Stable). At the year end, the Group held gross cashbalances of £3.2 billion with £1.7 billion of outstanding debt commitments - anet cash position in excess of £1.5 billion with the average net cash positionhaving improved by £325 million to £960 million in 2010.The maturities of the Group's existing bond facilities, at around £1.7 billion,are well spread with the €750 million Eurobond due in the first half of 2011,as shown in the chart below. The Group had a further £450 million in termfunding available to it that was undrawn at the year end. The Group essentiallycompleted the refinancing of the 2011 Eurobond via the successful ten year £500million GBP bond issued in the first half of 2009, the proceeds of which arecurrently held on term deposit and will be available to settle the 2011 bondwhen it falls due. There are no other material maturities until 2013.

Foreign exchange effects on published results

Whilst continuing to influence the Group's published results in 2010, currencymovements were less distortive than in prior years given that average and spotrates for the GBP/USD and GBP/EUR remained in a relatively narrow rangethroughout the year, as shown in the table below.Market exchange rates 2009 2010 USD per GBP - Year end spot rate 1.615 1.566 - Average spot rate 1.566 1.543 EUR per GBP - Year end spot rate 1.126 1.167 - Average spot rate 1.123 1.167

These movements have influenced both the reported income statement and the cashflow and closing net cash position (as set out in the cash flow statement andnote 2 in the financial statements) in the following ways:

Income statement

The most important impact was the end of year mark to market of outstanding financial instruments (foreign exchange contracts, interest rate, commodity and jet fuel swaps). The principal adjustments related to the GBP/USD hedge book.

The impact of this mark to market is included in net financing in the incomestatement and caused a net £432 million loss, contributing to a publishedprofit before tax of £702 million. These adjustments are non-cash, accountingadjustments required under IAS 39 Financial Instruments: Recognition andMeasurement. As a result, reported earnings do not reflect the economicsubstance of derivatives that have been settled in the financial year, but doinclude the unrealised gains and losses on derivatives that will only affectcash flows when they are settled at some point in the future to match tradingcash flows.Underlying earnings are presented on a basis that shows the economic substanceof the Group's hedging strategies in respect of transactional exchange ratesand commodity price movements. Further details and information are includedwithin the section on key performance indicators on page 22 and in notes 2 and5 of the financial statements.Underlying profit before tax of £955 million benefited from £74 million offoreign exchange benefits compared to 2009. The achieved rate on selling USDincome was around nine cents better in 2010 than 2009 and is expected toimprove by a similar level in 2011. In 2010 these better achieved ratescontributed £72 million of transactional benefits. In addition, the improvementin the average GBP-USD of three cents contributed net translation benefitstotalling £2 million to underlying profit before tax in the year.

Cash flow and balance sheet

The Group maintains a number of currency cash balances which vary throughoutthe financial year. These net cash balances were improved by the effects ofretranslation, causing an improvement of £17 million in the 2010 cash flow andhence the closing balance sheet net cash position.

Summary

The Group's revenues increased by six per cent in 2010 to £11,085 million with86 per cent of revenues from customers outside the UK. Underlying revenues grewseven per cent in 2010, consisting of a three per cent improvement in originalequipment revenues with services growing 13 per cent including double digitservices growth in civil aerospace, marine and energy and a five per centimprovement in defence. Services activities represented 51 per cent ofunderlying Group revenues in 2010.• Underlying revenues in the civil aerospace segment grew ten per cent to £4,919 million (2009 £4,481 million) with a 15 per cent improvement in servicerevenues and a two per cent improvement in revenues from original equipment.New engine deliveries were stable at 846 (2009 844 engines) and included arecord 371 V2500 engines for the Airbus A320 family of aircraft, and a smallrecovery in engine deliveries for corporate and regional applications. Trentdeliveries for widebody commercial aircraft totalled 185 engines including arecord number, 139, of Trent 700, for the Airbus A330 aircraft. The overalltotal was held back by delayed entry to service and slower production ramp upin major new applications (the Boeing 787 and Airbus A380 respectively).Services revenues grew strongly reflecting three key elements: the completionof a spares distribution and logistics arrangement with Aviall Inc, and thedisposal of associated spares inventory which contributed around one third ofthe annual services growth; the effect of better USD achieved foreign exchangerates which represented around one third of the service improvement; and theongoing utilisation and some limited recovery in discretionary serviceactivity.• Underlying defence aerospace revenues grew by six per cent to £2,123 million(2009 £2,010 million) supported by strong growth in deliveries for the militarytransport sector. New equipment revenues grew six per cent and servicesrevenues increased by five per cent over 2009. The portfolio proved to beresilient despite some modest effects from the completion of the StrategicDefence and Security Review (SDSR) in the UK and is expected to grow revenuesat a similar overall rate in 2011.• Underlying revenues in the marine business were stable in 2010 at £2,591 million (2009 £2,589 million) reflecting a five per cent decline from original equipment, as the subdued order cycle began to impact deliveries. This was offset by further services growth, with underlying revenues 11 per cent higherin the year benefiting from a growing installed base and new services centrescommencing operation around the world.• The energy business made significant progress again in 2010 with a 20 percent growth in underlying revenue to £1,233 million (2009 £1,028 million), andis now more than 60 per cent higher than 2008.Underlying profit margins before financing costs reduced slightly from 9.7 percent in 2009 to 9.3 per cent in 2010. The reduction in margin reflected changesin revenue mix, higher levels of research and development charges, increasingcosts associated with the launch phase of major new programmes. In addition,the performance reflected the net impact of a number of positive and negativeone-off items in the year including the Aviall distribution agreement and costsassociated with the Trent 900 failure on an Airbus A380 in 2010 which offsetimprovements in operational performance and productivity and the benefits ofbetter achieved foreign exchange rates in the period.Underlying financing costs reduced by £13 million to £55 million (2009 £68 million), primarily a function of lower finance costs associated with financial risk and revenue sharing partnerships as one of the major arrangements came to an end in late 2009. Restructuring charges in 2010 totalled £46 million down £9 million from the prior year. These costs are included within operating costs.

A final payment to shareholders of 9.60 pence per share, in the form of C Shares, is proposed, making a total of 16.00 pence per share, a 6.7 per cent increase over the 2009 total.

Order book

The order book at December 31, 2010, at constant exchange rates, has remainedresilient at £59.2 billion (2009 £58.3 billion). This included firm businessthat had been announced but for which contracts had not yet been signed of £4.5 billion (2009 £6.8 billion).Aftermarket services agreements, including TotalCare® packages, represented 31per cent of the order book, having increased by more than 40 per cent in thelast three years. These are long-term contracts where only the first sevenyears' revenue is included in the order book.

Aftermarket services

The Group continues to be successful in developing its aftermarket servicesactivities. These grew by 13 per cent on an underlying basis in 2010,reflecting increasing installed base of products across all four markets,expansion of the global services network, especially in the marine sector, andsome encouraging signs of improving trends in the discretionary service spendin some large civil engine programmes. Underlying services accounted for 51 percent of the Group revenues in 2010.In particular, TotalCare packages in civil aerospace now cover 70 per cent, byvalue, of the installed fleet. TotalCare packages cover long-term management ofthe maintenance and associated logistics for our engines and systems,monitoring the equipment in service to deliver the system availability ourcustomers require with predictable costs. The pricing of such contractsreflects their long-term nature. Revenues and costs are recognised based on thestage of completion of the contract, generally measured by reference to flyinghours. The overall net position of assets and liabilities on the balance sheetfor TotalCare packages was an asset of £920 million (2009 £970 million).

Cash

There was a cash inflow in the year of £258 million (2009 £183 million outflow)and an improvement in average net cash balances to £960 million (2009 £635 million). A modest increase in operating profits combined with a strong working capital performance offset more than £800 million in investment in productdevelopment, operational facilities and tooling and the acquisition of ODIM ASAin the period.These total cash investments of £842 million (2009 £688 million) in intangibleassets, property, plant and equipment and acquisitions together with paymentsto shareholders of £266 million (2009 £250 million) and tax payments of £168million (2009 £119 million) represented the major cash outflows in the period.

The net cash balance at the year end was £1,533 million (2009 £1,275 million).

Taxation

The overall tax charge on the profit before tax was £159 million (2009 £740 million), a rate of 22.6 per cent (2009 25.0 per cent).

The tax charge on underlying profit was £236 million (2009 £187 million) a rate of 24.7 per cent (2009 20.4 per cent).

The overall tax charge was reduced by £29 million in respect of the expectedbenefit of the UK research and development tax credit. The underlying tax rateis expected to be around 25 per cent in 2011.The operation of most tax systems, including the availability of specific taxdeductions, means that there is often a delay between the Group tax charge andthe related tax payments, to the benefit of cash flow.The Group operates internationally and is subject to tax in many differingjurisdictions. As a consequence, the Group is routinely subject to tax auditsand examinations which, by their nature, can take a considerable period toconclude. Provision is made for known issues based on management'sinterpretation of country-specific legislation and the likely outcome ofnegotiation or litigation. The Group believes that it has a duty toshareholders to seek to minimise its tax burden but to do so in a manner whichis consistent with its commercial objectives and meets its legal obligationsand ethical standards. While every effort is made to maximise the taxefficiency of its business transactions, the Group does not use artificialstructures in its tax planning. The Group has regard for the intention of thelegislation concerned rather than just the wording itself. The Group iscommitted to building open relationships with tax authorities and to followinga policy of full disclosure in order to effect the timely settlement of its taxaffairs and to remove uncertainty in its business transactions. Whereappropriate, the Group enters into consultation with tax authorities to helpshape proposed legislation and future tax policy.

Transactions between Rolls-Royce subsidiaries and associates in different jurisdictions are conducted on an arms-length basis and priced as if the transactions were between unrelated entities, in compliance with the OECD Model Tax Convention and the laws of the relevant jurisdictions.

Before entering into a transaction the Group makes every effort to determinethe tax effect of that transaction with as much certainty as possible. To theextent that advance rulings and clearances are available from tax authorities,in areas of uncertainty, the Group will seek to obtain them and adhere to theirterms.Pensions

The changes made to the Group's UK pension schemes over the last few years haveenabled the deficit to remain stable and modest. The charges for pensions arecalculated in accordance with the requirements of IAS 19 Employee Benefits. TheGroup's principal UK defined benefit schemes employ a lower risk investmentstrategy in which the interest rate and inflation risks are largely hedged andthe exposure to equities has reduced to less than 20 per cent of scheme assets.As reported last year, the primary objective of the revised investment strategyis to reduce the volatility of the pension schemes to enable greater stabilityin the funding requirements. Over the last two years our three major definedbenefit pension schemes have increased the assumed life expectancy of membersand pensioners but, even after allowing for these changes, the overall fundinglevel across these schemes has improved.Further information and details of the pensions' charge and the defined benefitschemes' assets and liabilities are shown in note 18 to the financialstatements. The net deficit, after taking account of deferred tax, was £593 million (2009 £590 million). Changes in this net position are affected by theassumptions made in valuing the liabilities and the market performance of theassets.InvestmentsThe Group continues to subject all investments to rigorous examination of risksand future cash flows to ensure that they create shareholder value. All majorinvestments require Board approval.The Group has a portfolio of projects at different stages of their life cycles.Discounted cash flow analysis of the remaining life of projects is performed ona regular basis. Sales of engines in production are assessed against criteriain the original development programme to ensure that overall value is enhanced.Gross research and development (R&D) investment amounted to £923 million (2009 £864 million). Net research and development charged to the income statement was £422 million (2009 £379 million). The level of self-funded investment inresearch and development is expected to remain at approximately four to fiveper cent of Group revenues in the future. The impact of this investment on theincome statement will reflect the mix and maturity of individual developmentprogrammes and will result in an increase in the level of net research anddevelopment charged within the income statement in 2011.The continued development and replacement of operational facilities contributedto the total expenditure in property, plant and equipment of £361 million (2009£291 million). Investment in 2011 is anticipated to be increased compared tothe 2010 level as the investments in new facilities in the US and Singaporecontinue.

Investment in training was £33 million (2009 £24 million).

Intangible assets

The Group carried forward £2,884 million (2009 £2,472 million) of intangibleassets. This comprised purchased goodwill of £1,108 million, enginecertification costs and participation fees of £496 million, developmentexpenditure of £630 million, recoverable engine costs of £346 million and otherintangible assets of £304 million. Expenditure on intangible assets is expectedto reduce modestly in 2011, largely as a result of the status of developmentprogrammes. Intangible assets of £211 million arose during the year as a resultof the acquisition of ODIM ASA.The carrying values of the intangible assets are assessed for impairmentagainst the present value of forecast cash flows generated by the intangibleasset. The principal risks remain reductions in assumed market share, programmetimings, increases in unit cost assumptions and adverse movements in discountrates. There have been no impairments in 2010. Further details are given innote 8.

Partnerships

The development of effective partnerships continues to be a key feature of theGroup's long-term strategy. Major partnerships are of two types: joint venturesand risk and revenue sharing partnerships.

Joint ventures

Joint ventures are an integral part of our business. They are involved inengineering, manufacturing, repair and overhaul, and financial services. Theyare also common business structures for companies participating ininternational, collaborative defence projects. They share risk and investment,bring expertise and access to markets and provide external objectivity. Some ofour joint ventures have become substantial businesses. A major proportion ofthe debt of the joint ventures is secured on the assets of the respectivecompanies and is non-recourse to the Group.

Risk and revenue sharing partnerships (RRSPs)

RRSPs have enabled the Group to build a broad portfolio of engines, thereby reducing the exposure of the business to individual product risk. The primary financial benefit is a reduction of the burden of R&D expenditure on new programmes.

The related R&D expenditure is expensed through the income statement and theinitial programme receipts from partners, which reimburse the Group for past R&D expenditure, are also recorded in the income statement, as other operatingincome.RRSP agreements are a standard form of co-operation in the civil aero-engineindustry. They bring benefits to the engine manufacturer and the partner.Specifically, for the engine manufacturer, they bring some or all of thefollowing benefits: additional financial and engineering resource; sharing ofrisk; and initial programme contribution. As appropriate, the partner alsosupplies components and as consideration for these components, receives a shareof the long-term revenues generated by the engine programme in proportion toits purchased programme share.

The sharing of risk is fundamental to RRSP agreements. Partners share financial investment in the programme, typically through:

• market risk as they receive their return from future sales;• currency risk as their returns are denominated in US dollars;• sales financing obligations;• warranty costs; and• where they are manufacturing or development partners, technical and cost risk.

Partners that do not undertake development work or supply components are referred to as financial RRSPs and are accounted for as financial instruments as described in the accounting policies on page 90.

In 2010, the Group received other operating income of £95 million (2009 £89 million).

Payments to RRSPs are recorded within cost of sales and increase as the relatedprogramme sales increase. These payments amounted to £198 million (2009 £231million).The classification of financial RRSPs as financial instruments has resulted ina liability of £266 million (2009 £363 million) being recorded in the balancesheet and an associated underlying financing cost of £13 million (2009 £25million) recorded in the income statement.

The Group also receives government launch investment in respect of certain programmes. The treatment of this investment is similar to non-financial RRSPs.

Risk management

The Board has an established, structured approach to risk management. The riskcommittee (see page 64) has accountability for the system of risk managementand reporting the key risks and associated mitigating actions. The Director ofRisk reports to the Finance Director. The Group's policy is to preserve theresources upon which its continuing reputation, viability and profitability arebuilt, to enable the corporate objectives to be achieved through the operationof the Rolls-Royce business processes. Risks are formally identified andrecorded in a corporate risk register and its subsidiary registers within thebusinesses. These are reviewed and updated on a regular basis, with riskmitigation plans identified for key risks. Principal risks and uncertaintiesare identified on pages 26 to 27 and certain financial risks are describedbelow.

Financial risk

The Group uses various financial instruments in order to manage the exposuresthat arise from its business operations as a result of movements in financialmarkets. All treasury activities are focused on the management and hedging ofrisk. It is the Group's policy not to trade financial instruments or to engagein speculative financial transactions.During the year the Group reviewed and amended its credit and short term cashinvestment policies to reflect the state of the credit market and to ensure theGroup can continue to lay-off market risks associated with its business. As aresult, the Group has revised the minimum publicly assigned long-term creditrating requirements for transacting financial instruments with a counterpartyfrom Standard & Poor's `A- ` to `BBB+' (or the equivalent ratings from Moody'sand/or Fitch) to reflect the general lower level of ratings within the bankingsector.

Deposits and investments in other debt instruments continue to require a short-term rating from Standard & Poor's of `A-1' (or the equivalent ratings from Moody's and/or Fitch).

The most significant economic and market risks continue to be movements in foreign currency exchange rates, interest rates and commodity prices. The Board regularly reviews the Group's exposures and financial risk management and a specialist committee also considers these in detail.

All such exposures are managed by the Group Treasury function, which reports tothe Finance Director and which operates within written policies approved by theBoard and within the internal control framework described on page 65.

Currency risk

The Group is exposed to movements in exchange rates for both foreign currencytransactions and the translation of net assets and income statements of foreignsubsidiaries.The Group regards its interests in overseas subsidiary companies as long-terminvestments and manages its translational exposures through the currencymatching of assets and liabilities where applicable. The matching is reviewedregularly, with appropriate risk mitigation performed where material mismatchesarise.

The Group has exposure to a number of foreign currencies. The most significant transactional currency exposures are USD to GBP and USD to EUR. The Group manages its exposure to movements in exchange rates at two levels:

i) Revenues and costs are currency matched where it is economic to do so. TheGroup actively seeks to source suppliers with the relevant currency cost baseto avoid the risk or to flow down the risk to those suppliers that are capableof managing it. Currency risk is also a prime consideration when deciding whereto locate new facilities. US dollar income converted into sterling represented19 per cent of Group revenues in 2010 (2009 23 per cent). US dollar incomeconverted into euros represented four per cent of Group revenues in 2010 (2009two per cent).ii) Residual currency exposure is hedged via the financial markets. The Groupoperates a hedging policy using a variety of financial instruments with theobjective of minimising the impact of fluctuations in exchange rates on futuretransactions and cash flows.

The permitted range of the amount of cover taken is determined by the written policies set by the Board, based on known and forecast income levels.

The forward cover is managed within the parameters of these policies in order to achieve the Group's objectives, having regard to the Group's view of long-term exchange rates. Forward cover is in the form of standard foreign exchange contracts and instruments on which the exchange rates achieved are dependent on future interest rates.

The Group may also write currency options against a portion of the unhedgeddollar income at a rate which is consistent with the Group's long-term targetrate. At the end of 2010 the Group had US$20.9 billion of forward cover (2009US$18.8 billion).The consequence of this policy has been to maintain relatively stable long-termforeign exchange rates. Note 16 to the financial statements includes the impactof revaluing forward currency contracts at market values on December 31, 2010,showing a negative value of £336 million (2009 negative value of £144 million)which will fluctuate with exchange rates over time. The Group has entered intothese forward contracts as part of the hedging policy, described above, inorder to mitigate the impact of volatile exchange rates.

Interest rate risk

The Group uses fixed rate bonds and floating rate debt as funding sources. TheGroup's policy is to maintain a proportion of its debt at fixed rates ofinterest having regard to the prevailing interest rate outlook. To implementthis policy the Group may utilise a combination of interest-rate swaps,forward-rate agreements and interest-rate caps to manage the exposure.

Commodity risk

The Group has an ongoing exposure to the price of jet fuel and base metals arising from business operations. The Group's objective is to minimise the impact of price fluctuations. The exposure is hedged, on a similar basis to that adopted for currency risks, in accordance with parameters contained in written policies set by the Board.

Counterparty credit risk

The Group has an established policy for managing counterparty credit risk. Acommon framework exists to measure, report and control exposures tocounterparties across the Group using value-at-risk and fair-value techniques.The Group assigns an internal credit rating to each counterparty, which isassessed with reference to publicly available credit information, such as thatprovided by Fitch, Moody's, Standard & Poor's, and other recognised marketsources, and is reviewed regularly.

Funding and liquidity

The Group finances its operations through a mixture of shareholders' funds, bank borrowings, bonds, notes and finance leases. The Group borrows in the major global markets in a range of currencies and employs derivatives where appropriate to generate the desired currency and interest rate profile.

The Group's objective is to hold financial investments and maintain undrawncommitted facilities at a level sufficient to ensure that the Group hasavailable funds to meet its medium-term capital and funding obligations and tomeet any unforeseen obligations and opportunities. The Group holds cash andshort-term investments which, together with the undrawn committed facilities,enable it to manage its liquidity risk.Short-term investments are generally held as bank deposits or in `AAA' ratedmoney market funds. The Group operates a conservative investment policy whichlimits investments to high quality instruments with a short-term credit ratingof `A-1' from Standard & Poor's or better (or the equivalent ratings fromMoody's and/or Fitch). Counterparty diversification is achieved with suitablerisk-adjusted concentration limits. Investment decisions are refined through asystem of monitoring real-time equity and credit-default swap (CDS) pricemovements of potential investment counterparties which are compared to otherrelevant benchmark indices and then risk-weighted accordingly.The Group's borrowing facilities decreased during 2010 following the maturityof a US$187 million US private placement. As at December 31, 2010 the Group hadtotal committed borrowing facilities of £2.10 billion (2009 £2.15 billion). Theproceeds of the £500 million bond issue in 2009 are anticipated to be fullyused to pay down the debt maturities occurring in 2011. The maturity profile ofthe borrowing facilities is staggered to ensure that refinancing levels aremanageable in the context of the business and market conditions.

There are no rating triggers contained in any of the Group's facilities that could require the Group to accelerate or repay any facility for a given movement in the Group's credit rating.

The Group's £250 million bank revolving credit facility contains a rating pricegrid, which determines the borrowing margin for a given credit rating. TheGroup's current borrowing margin would be 20 basis points (bp) over sterlingLIBOR if drawn. The borrowing margin on this facility increases byapproximately 5bp per one notch rating downgrade, up to a maximum borrowingmargin of 55bp. The facility was not drawn during 2010.

There are no rating price grids contained in the Group's other borrowing facilities.

The Group continues to have access to all the major global debt markets.

Credit rating

The Group subscribes to both Moody's Investors Service and Standard & Poor'sfor its official publicised credit ratings. As at December 31, 2010 the Group'sassigned long-term credit ratings were:Rating agency Rating Outlook Category Moody's A3 Stable Investment grade

Standard & Poor's A- Stable Investment grade

As a long-term business, the Group attaches significant importance to maintaining an investment grade credit rating, which it views as necessary for the business to operate effectively.

The Group's objective is to maintain an `A' category investment grade credit rating from both agencies.

Sales financingIn connection with the sale of its products, the Group will, on some occasions,provide financing support for its customers. This may involve the Groupguaranteeing financing for customers, providing asset-value guarantees (AVGs)on aircraft for a proportion of their expected future value, or entering intoleasing transactions.The Group manages and monitors its sales finance related exposures to customersand products within written policies approved by the Board and within theinternal framework described in the corporate governance section. Thecontingent liabilities represent the maximum discounted aggregate gross and netexposure that the Group has in respect of delivered aircraft, regardless of thepoint in time at which such exposures may arise.The Group uses Ascend Worldwide Limited as an independent appraiser to valueits security portfolio at both the half year and year end. Ascend providesspecific values (both current and forecast future values) for each asset in thesecurity portfolio. These values are then used to assess the Group's netexposure.

The permitted levels of gross and net exposure are limited in aggregate, by counterparty, by product type and by calendar year. At the year end, the gross level of commitments on delivered aircraft was US$991 million, comprising US$618 million for AVGs and US$373 million for credit guarantees.

The Board regularly reviews the Group's sales finance related exposures and risk management activities. Each financing commitment is subject to a credit and asset review process and prior approval in accordance with Board delegations of authority.

The Group operates a sophisticated risk-pricing model to assess risk and exposure. Costs and exposures associated with providing financing support are incorporated in any decision to secure new business.

The Group seeks to minimise the level of exposure from sales finance commitments by:

• the use of third-party non-recourse debt where appropriate; • the transfer, sale, or reinsurance of risks; and • ensuring the proportionate flow down of risk and exposure to relevant RRSPs.

Each of the above forms an active part of the Group's exposure management process.

Where exposures arise, the strategy has been, and continues to be, to assumewhere possible liquid forms of financing commitment that may be sold ortransferred to third parties when the opportunity arises. Note 22 to thefinancial statements describes the Group's contingent liabilities. There wereno material changes to the Group's gross and net contingent liabilities during2010.Accounting standards

The consolidated financial statements have been prepared in accordance withInternational Financial Reporting Standards (IFRS), as adopted by the EU. In2010, the changes that have had the most significant effect on the Group'sfinancial statements are the revisions to IFRS 3 Business Combinations andamendments to IAS 27 Consolidated and Separate Financial Statements. Theseamendments affect the accounting for acquisitions and transactions withnon-controlling interests and have been applied to the acquisition of ODIM ASA(see note 24). There is no retrospective impact.

A summary of other less significant changes, and those which have not been adopted in 2010, is included within the accounting policies in note 1 to the consolidated financial statements.

Regulatory developments

In response to the financial crisis, governments and regulators around theworld are considering various regulatory reforms to the financial markets withthe aim of improving transparency and reducing systemic risk. While theproposed reforms are predominantly directed at financial institutions, some ofthem may have implications for non-financial institutions.In particular, proposals by both US and European regulators to reform theOver-the-Counter (OTC) derivatives market could have implications for the Groupin terms of future funding requirements and increased cash flow volatility, ifparties to future OTC derivative transactions were required to clear suchtransactions via an exchange or central clearing and be required to post cashcollateral to reduce counterparty risk.

Share price

During the year the Company's share price increased by 29 per cent from 483.5p to 623p, compared to an eight per cent increase in the FTSE aerospace and defence sector and a nine per cent increase in the FTSE 100. The Company's shares ranged in price from 473.4p in January to 654.5p in November.

The number of ordinary shares in issue at the end of the year was 1,872 million, an increase of 18 million relating to the issue of shares for share option schemes. The average number of ordinary shares in issue (excluding ordinary shares held under trust) was 1,846 million (2009 1,845 million).

Andrew ShilstonFinance DirectorFebruary 9, 2011

Responsibility statement of the directors on the Annual report

The Responsibility Statement below has been extracted in unedited text from theCompany's full Annual report for the year ended 31 December 2010. Certain partsof the Annual report are not included within this announcement.

Each of the persons who is a director at the date of approval of this report confirms that to the best of his or her knowledge:

i) each of the Group and parent company financial statements, prepared inaccordance with IFRS and UK Accounting Standards respectively, gives a true andfair view of the assets, liabilities, financial position and profit or loss ofthe issuer and the undertakings included in the consolidation taken as a whole; andii) the Directors' report on pages 1 to 82 includes a fair review of thedevelopment and performance of the business and the position of the Company andthe undertakings included in the consolidation taken as a whole, together witha description of the principal risks and uncertainties that they face.By order of the BoardTim RaynerGeneral Counsel and Company SecretaryFebruary 9, 2011

Cautionary statement regarding forward-looking statements

This announcement contains certain forward-looking statements. Theseforward-looking statements can be identified by the fact that they do notrelate only to historical or current facts. In particular, all statements thatexpress forecasts, expectations and projections with respect to future matters,including trends in results of operations, margins, growth rates, overallmarket trends, the impact of interest or exchange rates, the availability offinancing to the Company, anticipated cost savings or synergies and thecompletion of the Company's strategic transactions, are forward-lookingstatements. By their nature, these statements and forecasts involve risk anduncertainty because they relate to events and depend on circumstances that mayor may not occur in the future. There are a number of factors that could causeactual results or developments to differ materially from those expressed orimplied by these forward-looking statements and forecasts. The forward-lookingstatements reflect the knowledge and information available at February 9, 2010,the date of signing of the Annual report, and will not be updated during theyear. Nothing in this announcement should be construed as a profit forecast.This announcement contains non-statutory accounts within the meaning of section435 of the Companies Act 2006. The statutory accounts for the year ended 31December 2010, upon which an unqualified audit opinion has been given and whichdid not contain a statement under Section 498(2) or 498(3) of the CompaniesAct 2006, will be filed in due course with the Registrar of Companies.

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