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Executives

Mike Terrett - Chief Operating Officer, Executive Director, Chairman of Exports Committee and Member of Risk Committee

Andrew Shilston - Finance Director, Director and Member of Risk Committee

John Rishton - Chief Executive officer, Director, Member of Audit Committee, Member of Nominations Committee and Member of Ethics Committee

Analysts

Harry Breach - Barclays Capital

Rupinder Vig - Morgan Stanley

Rami Myerson - UBS Investment Bank

Zafar Khan - Societe Generale Cross Asset Research

David Perry - Goldman Sachs Group Inc.

Jason Adams - Nomura Securities Co. Ltd.

Sandy Morris - RBS Research

Andrew Gollan - Investec Securities (UK)

Benjamin Fidler - Deutsche Bank AG

Celine Fornaro - BofA Merrill Lynch

Edward Stacey

Rolls Royce Holdings plc (OTCPK:RYCEY) Q2 2011 Earnings Call July 28, 2011 6:00 AM ET

John Rishton

Good morning. Thank you for coming. Welcome to Rolls-Royce First Half Results. Given the very busy reporting day across our sector and the fact that this is our half-year results, we intend to keep this short and focused. I will give an overview. Andrew Shilston will then take you through the financials, and then in a break with tradition, we're going to go home, or alternatively, we could take questions.

I want to cover 3 topics before I hand over to Andrew. Firstly, share my views on our business, give you a flavor of what I've been doing since I arrived and make a few comments about the future. Secondly, highlight significant first half achievements. Then thirdly, review the key financial indicators that demonstrate the strong health of the business and the strong start that we've made to 2011.

I joined the board of Rolls-Royce as a nonexecutive in 2007. I took on the role of CEO in April of this year. My time as nonexecutive gave me a good understanding of the breadth of the business. And since taking on an executive position, I've concentrated on improving the depth of my knowledge by visiting many of our facilities and meeting with many of Rolls-Royce employees and our customers. My overview would be that this is an extraordinary company with extraordinary products and extraordinary people.

Everywhere I have been, I've met with people at all levels. And without exception, they've been proud of the company, passionate and professional with an enthusiasm I have not seen in other businesses. The customers I have met have generally been complementary about what we do and how we do it. But it is clear that on a number of occasions, we could have done better. So we need to sharpen our focus on the customer.

Rolls-Royce has a number of striking characteristics, a very long cycle business, a huge order book that provides good long-term visibility in a number of our sectors, an exceptional brand, and a strategy that has been in place for many years and has been followed consistently and proved its resilience. I supported that strategy as a nonexecutive, and I support it now as Chief Executive.

So John Rose and his team have done an amazing job over the last decade or more, transforming the business and creating choices about where we grow in the future. So I see my role, as firstly, ensuring that we deliver the promises we have already made. And as you know, we believe that revenues will double over the next decade from organic growth alone.

This is a complex and long-term task. We are investing in new facilities, new technology and recruiting new people. It is also clear that we must focus on execution, cost, cash conversion and efficiency. We must ensure that we are competitive on all fronts everywhere.

The second main element of my role is to examine the options for future growth so that we can make the right choices. So in summary, my take away from my first few months is shown on this slide: Great people, great products; right strategy; a strong balance sheet. We need to sharpen our focus on customer, cash and costs; deliver the promises that we've already made; and choices about how and where we grow in the future.

Turning to the first half of 2011. I think that there have been 2 really important decisions taken so far this year that will shape the agenda for many years to come. Firstly, the selection of the enhanced Trent XWB to be the exclusive engine to power the Airbus A350-1000. This builds our strong position in widebody aircraft and sets the stage for significant growth of those engines are delivered and operated over the next few decades. This aircraft will be a powerful long-term growth driver for our civil business and the group.

Secondly, our joint offer with Daimler for Tognum that is progressing well. This will add breadth and depth to our Marine and Energy businesses. We will bring significant systems integration and aftermarket capabilities to an already successful business. Tognum possesses a particularly strong diesel portfolio that will complement our own diesel and gas engine technologies allowing us to double the revenues of the business in much less than the decade.

In addition, we have continued to invest in refreshing and growing our facilities and strengthening our supply chain. You will assume that we've invested more than GBP 600 million on CapEx, on research and product development in the first half. These investments include the continued development of new facilities in the U.S. and Singapore, both of which have started initial production and preproduction, and the extension of our services network as we grow our global capabilities to support customers. For example, we have outnumbering[ph] centers in Holland, Poland and Namibia and further extended our civil overhaul facility in Hong Kong.

As you would have read, we are confirming the full year guidance that we gave in February for 2011 in terms of revenue and profit growth. And excluding the Tognum acquisition, the core business will generate a modest cash inflow.

As you can see from this slide, overall, a strong performance in the first half. The headlines are our record order book up 4% to GBP 61.4 billion. We won new orders of GBP 8.7 billion in the first half with around 75% coming from Civil Aerospace where we continue to take around half of the lucrative widebody market, with new orders of 4 different Trent engine types for customers in Europe, the Middle East and Asia. Orders in Marine and Energy were similar to last year. But some sectors, notably oil and gas, will be second half biased. We remain encouraged by what is going on, on both offshore exploration and production and land-based pipeline and transportation activities.

For example, investment announcements from Petrobras and BG Group make it clear that there would be good opportunities to support the development and extraction of new reserves around the world.

The order book once again serves to highlight the global nature and the rapid growth in our market position over the last few years. Today, 47% relates to Asia and the Middle East, with that element alone, now largely the entire order book just 5 years ago.

Underlying revenues grew by 4%, with services up 10% and the slight reduction in original equipment sales, mainly a function of the Marine slowdown that we had signaled earlier this year. Underlying profits grew by 28% but benefited from a well-off settlement of some U.K. defense contracts. Excluding this benefit, underlying profits were up 15%.

The balance sheet remains strong. We finished the period with nearly GBP 1.5 billion of cash after GBP 82 million outflow from the start of the year. Average net cash fell to GBP 780 million.

Reflecting our confidence and the strength and resilience of the business, the outlook for growth over the next few years and the opportunities we have to drive performance by focusing relentlessly on execution, we have increased the first half payment to shareholders by 8%.

So in summary, a strong first half. We are well positioned and confident about the future. I believe that we must sharpen our focus on customers, cost and cash, deliver the promises that have been made that will double the revenues over the next decade and we have choices to make about future growth. Thank you.

Andrew Shilston

Right. Good morning. The flavor of this section is very much a case, I think, of -- this is largely all in line with guidance. So I'm going to be fairly brief, and I know there's a lot on stage. You've got a lot of other companies to look at. As usual, I'll focus on the underlying results. The headline result is somewhat more eye-catching with the usual revaluation movements in this half-year have been quite heavily positive. But all that details in the handout just to reconcile between the headline numbers and what I'm going to talk about here.

First of all, this familiar chart is looking at how profits have moved from one half year to the next, taking foreign exchange, first of all. Back in February, we said we would have the benefit of that 6p to 9p improvement in the achieve rate for use our hedge book over the full year and there's no change to that guidance.

In the first half of the year, we had benefit from the hedge book of about GBP 36 million, and that was offset by a small translation negative of about GBP 13 million. I mentioned that simply because we don't forecast translation differences, and that is a change to what would affect previous guidance. That's small GBP 13 million number.

With regard to R&D, compared to previous guidance, we expect the full year to be up around GBP 20 million, something like that. About 3 quarters of that is spent in some of it is accounting effects. We knew obviously that R&D this year, there'd be a heavier charge than last year, that guidance we gave back in February. And that's mostly to do with the mix of activity moving away from the Trent 1000 to the engine for the Airbus A350.

With regard to operating income, there's no change to full year guidance, so that negative there is exactly as we expected. And then we'd move to the one-off items on the right-hand side, the industrial Trent provision that we've made last year was a one-off. I think John's already alluded to that. And we have been in conversation with the MOD on contract terminations, and there are some benefit arising from that as well, and I'll touch on that in the defense sector in a moment.

So turning to the civil business. First of all, a continuing, very strong widebody aircraft story. There's a lot of really good data in the back of the appendices about market share by aircraft type, which I won't go into detail now. I think you're familiar with that. But if you add it all up, we have a very strong market share story to tell of at least 50% in aggregate across the whole market, with much greater market share in some other product types, for example, the Airbus A350.

Now we talked about installed thrust as a proxy for value. We've done that, I think, for quite some time now. Just to give you a sense of the strength of this trend story that's emerging or will emerge over the next few years, we have about GBP 140 million of installed thrust in a Trent fleet today. And if you look at the next 20 years and assume we get about 50% of the market, then we should deliver about another GBP 700 million of thrust over the next 20 years. And that isn't all in the distant future, we would double Trent deliveries in the next 5 years. So a very powerful story there coming through.

Services revenues, we guided that the full year would be up around 6% or 7%. We're not changing that because remember that in 2010, we had that Aviall logistics deal which has meant that's the year-on-year growth figure looks a little lower than it would if you had excluded that. And if you un-pick that services growth, we've had good double-digit growth in our large engine TotalCare business, and a slightly slower growth in the smaller engines and time material business. Yes, there is some recovery in time material activity, but to an extent this is going to happen later in the year as the arisings go through the overhaul shops.

Worth just pointing out, I think, that because of the nature of our aftermarket business, because it is so long-term contract based, it tends to be more stable than some other companies who I think have been reporting quite significant quarter-on-quarter gains in their time material business. The beauty of our long-term contract model is that we're much more stable and we get paid on an hourly basis, not on shop visits. And that's a great benefit, I think, both to the customer and to us because it produces predictability.

Profits-to-date are more or less as we expected. And compared to previous guidance, we will see a small effect from the nuclear disaster in Japan that has caused some disruption to our supply chains and delayed deliveries into the factories and also delayed some overhaul activity. And that's going to cost us about GBP 10 million of whereabouts over the full year, and there are some slightly higher R&D costs as well. And finally, there's no change to our guidance from the effects of the Trent 900 event last year. So that's in line with what we said before.

Turning to Defense. On the 2 new development programs, we're getting through the key milestones that some of the TP400 for the European A400M military transport aircraft and the stable engine likewise, the JSF development is proceeding satisfactorily. Work has largely stopped on the alternative engine for the Joint Strike Fighter. While GE and ourselves consider our options, this is the program that isn't completely stopped in the language that's used in the United States. Because if that happens, all the tooling and everything else is destroyed if that has not happened. So I think there's still further conversations to be had between GE and ourselves and the U.S. government about where this program goes. But for the time being, funding has been stopped.

Transport sector continues to be very strong. The theme, I think, we've talked about for quite a number of half-year periods over the last 2 or 3 years. And we're also pursuing export opportunities and service ideas to offset U.K. and U.S. slowdown in some procurement programs. Obviously, the first half is dominated by the profit effect of settling these contracts that were canceled by the U.K. MOD, and I think BAE was in similar position. They talked about that earlier on today. So other than this one-off, the full year will be largely as we expected in profit terms.

Now turning to Marine. Some good news in the Naval sector. We had talked a lot about that, usually that we've won, as you can see here, the first order on the Littoral Combat Ship program for 10 ships which is a major foothold for us now in the U.S. Navy. And in the U.K., we've had confirmation that the U.K. government will support the next generation nuclear reactor, the PWR3 reactor, for the next generation of nuclear subs, and that is a very, very long-term business as well.

Turning to other areas of Marine. We're definitely past the inflection point on orders in the oil and gas sector, that's the -- or what we call the offshore market. Well, it's taking a little bit longer than normal to get customers to sign on the dotted line, but there's no point. Sorry, there's -- it's clearly -- it's quite clear that the inflection point has been passed. And so we'll see some turnaround, some significant turnaround in original equipment deliveries in Marine. They were down about 25% for the half-year. They'll recover quite strongly over the second half of the year. So overall, we will be down about 10% in Marine, which is plus or minus what we've guided back in February.

And services are growing at a good double-digit rate, about 11%. And that's based on all the work we've been putting into dock side presence around the world which has been very successful. We're just pointing out here, I think, that we're not involved in the big bulk carrier market container ship market. I think 1 or 2 other companies in this sector have had some issues in that piece of the market place. We're not in that. Our gain is in specialized vessels, particularly involved with the oil and gas industry, which, as you've heard already, it's pretty busy deep water, offshore exploration and production.

The margins are benefiting from a greater percentage proportion of services and the revenue mix. But overall, there's no real change to guidance for the full year.

Turning to the last of 4 divisions. Energy, we continued to invest to improve products and in new businesses of some nuclear fuel cells entitled[ph] power. We still believe civil nuclear is worth pursuing despite the Fukushima disaster in Japan. And the reason for that is our capability is unique, and we're developing plans with the key reactor vendors and all the other participants in the market. And I think that the quality of our brand, together with our capability is meaning that we've got access to all the key players in that marketplace.

Now as in oil and gas in Marine, order inquiry is picking up, but current revenue growth is mostly from services. So half-year profit compared to last year clearly benefited from non-recurrence of the refit costs on the industrial Trents that didn't recur. And for the full year, we expect slightly lower profits than we've previously guided, mostly due to slightly softer OE, some new civil nuclear spend and some other people rated costs, bid costs and the like.

A brief update on Tognum. We're very pleased with the take-up of the joint bid for Tognum. We've achieved very nearly 95% in aggregate acceptances year-to-date which is good. The regulatory process, especially with regard to the antitrust clearances, is going very well, and we would expect completion sometime in the autumn. And after that, we will follow on with the process to squeeze out the minorities.

And all that timeline is laid out in the appendix so that you can see how that's all going to work. And in terms of the financials this year, there'll be no significant effect on our numbers because completion happens later on in the year. We've only got half of the business and that's the bid costs, so there wouldn't be much effect. But clearly, from the 1st of January next year, we will get the full benefit of half of Tognum's earnings incorporated into our numbers. Now the precise accounting cosmetics of that will change as we go through, and I won't go into that detail now. But economically, we will have an entitlement to half of the earnings of that company in terms of the way the accounts are presented.

The other thing that I think is worth mentioning is, that although we can't formally have detailed conversations with the Tognum management until this transaction completes, together with Daimler, there's no doubt that there is unanimity between Daimler, ourselves and Tognum about what needs to be done to move this whole business forward. And we're starting this conversations in the most detailed way that we're permitted, subject to not having completed the transaction.

In terms of our balance sheet, as ever, a strong balance sheet is a key part of Rolls-Royce story. You can see here, we've got sufficient resources to pay for our share of the Tognum acquisition from our own internal resources. We don't need to raise any more money, and the credit rating is secure. The rating agencies know about the Tognum acquisition. They've had a look at it, and our credit rating is unchanged. The average cash figure is down about a little bit on the first half last year. And that's largely because of the effect of the ODIM acquisition which was about GBP 150 million. There's a much greater effect on the first half of this year than it did in the first half of last year in terms of how the averages are calculated. Customer financing and supplier financing positions are largely unchanged. And finally, there are some changes to the methods of calculating pension liabilities and U.S. healthcare liabilities that appear in the notes in the headline to underlying reconciliation. Now these are economic benefits that will be beneficial to the company over many, many years, but we've not included them in the underlying results.

Looking at cash flow, we're still investing heavily, as you can see here. There's no doubt that industrializing the growth in Trent deliveries over the next 5 years is going to require some physical investment that is reflected here in the financials. The breakdown is all in the press release. The breakdown between intangibles, and fixed assets and so forth. It's all in the handout. But for the full year, we expect to spend something like GBP 800 million. That's currently our expectation. Working capital is a big subject. As I've said before, and I think the gross working capital balance in aggregate add up to something like GBP 14 billion. So you can see that relatively small movements in these numbers can have an effect on the business. What's been happening in the first half is that we've had some modest inventory build. As we anticipate the entry into service with the Gulfstream G650 and Boeing 787, and then you add to that the disruptive effect from the nuclear disaster in Japan and the knock-on effects in our supply chain, inventories in aggregate have gone up to something like GBP 200 million at the half-year. Now some of that will unwind by the full year, but you can see that's one of the reasons why we've got a small negative on working capital. The M&A line relates to the purchase of a small number of Tognum shares. Clearly, that number is going to be a lot bigger at the full year, but if you ignore that, we expect a modest cash inflow for the full year.

So to summarize, full year guidance, we expect mid-single-digit overall increase in revenues where we're only held back a little bit by small to slight decline in Marine. The Civil business, we expect to recover strongly, as I've said earlier. The tone is definitely getting better in Marine and Energy from oil and gas demand and the order flow rising from that. Although profits are likely to be flat for the full year.

The one-off item in Defense is largely offset by the small translation difference that I've alluded to, some R&D costs and the impact from Japan, all of those effects occurring in other businesses. So net-net, there's no overall change to guidance and profits. And we expect a small cash inflow if we put Tognum investment to one side.

So that's the end of the formal comments, and I think we'll now take questions.

Question-and-Answer Session

John Rishton

We'd be happy to take questions. If you could say your name, who you work for, and wait for the microphones that will be coming around. And I will try to manage your questions, taking as best I can. So who would like to answer the first question? Right at the very front.

David Perry - Goldman Sachs Group Inc.

I'm David Perry from Goldman Sachs. I've got 2 questions. You mentioned customer cash and cost reduction several times in your intro. Could you elaborate a little bit on the cost reduction piece? I mean, Rolls has been doing this for a long time, and normally, you might give us an update about where you think -- what you think still can be done, please? And the second question is, Rolls has this fantastic story on the widebodies coming, but that also gives you a bit of a profit headwind for the next few years. Do you think there's anything you can do to try and help overcome that profit headwind? Or it just has to work its course and we just have to be patient?

John Rishton

A couple of comments, and maybe I'll ask Mike and Andrew to add to the comments that I make. Having traveled around the business and certainly talked with Mike, Andrew and the rest of the management team, I think that there is opportunity for us to sharpen our focus a little in the areas that you talked about. So customer, cash and costs being those 3 Cs. What that means is, can we turn the dial on the attention on those a little further? And certainly, on the cash and the cost side, they have received significant attention over many years. And Mike and the team had done a terrific job. We need to keep going down that journey. And I think my observation, coming in new is that while we're making good progress on that, we need to continue to make good progress on it. And I certainly want to make sure that within the organization, those things are considered to be important to our future. But you should be under no misunderstanding that Mike and the team had done terrific job improving cost performance over many years. And this was about sharpening the focus, about turning that dial up a little bit, about making sure that everyone knows just how important it is as we start to reach a significant ramp up. Mike, would you like to add anything on that?

Mike Terrett

John. Yes, I do give an update. And because the supply chain and operational stuff has a continuity about it, it doesn't change a lot from half-to-half. There's probably what's reflected several years where inflation pressures have outstripped our efforts on productivity. But as we guided this year, productivity efforts will be offsetting inflationary pressures, which is still there, which we know about in Energy and materials. We're investing very heavily, as Andrew has just said. A lot of these facilities, both new facilities that we've invested in, new facilities that our supply chain have invested in and also new machine tools and processes going to our existing facilities. These strands of activity on the product side are coming to fruition. But clearly, in fact, as you build a new facility and put in new machine tools, there's a lag before you actually start to get the volume coming through, and the benefits and those will take some time. We're also heavily invested in IT, processes, and we've been doing this a number of years, and we're starting to accelerate that. And as John has said, our focus in the organization on delivering what we've promised and delivering that not just for the customer, but also to our business clients is something that we're really focusing on in all lines of the business. And John's encouraging us on that, and that's great.

John Rishton

In terms of your second question about the widebody, I'm going to ask Andrew to make a few comments on that. Clearly, the investments that we're making to support the ramp-up, particularly in the widebodies area, clearly the investments we're making in new products, the fact that we've had 3 new wide-bodied engines in very close succession, and the results in the cost increases as you said. But I think the beauty of this strategy that's being put in place. And the portfolio approach really shows its strength in that kind of environment where despite the economic turbulence that we've experienced over the last 4 or 5 years, despite the fact that we've had these investments, and we are set for growth, the overall group profitability and group revenues have progressed well through that period, which is why I said during the course of my presentation, that I supported the strategy when I was a nonexecutive and I continue to support it now. I think it's an extremely well thought through, well implemented and well-led strategy. So it gives a significant benefits and helps to address the kind of issues that you're talking about, which are inevitable when you are launching a significant new product. Andrew, I don't know if you'd like to?

Andrew Shilston

Well, I think my colleagues have covered most of the issues. Now what I would say on the portfolio point is that probably 4 or 5 years ago, if we were projecting forward to 2011, we wouldn't have envisaged anything like the quantity of Trent 700 engines going into production on the Airbus A330. So I think part of the answer to the new product question is the aftermarket that's growing from the installed base and the portfolio effect that's allowed us to enjoy the continuing life of what 5 years ago was considered to be an aircraft with a fairly limited life. But that's -- I think we've always said that, that we were in the market for lift, in those demands for lift in aggregate and if some programs are delayed or some capacity has delayed then older programs turned to benefits. And I think that's what will happen over the next few years.

John Rishton

Okay, the next question. We got another one right in the front.

Benjamin Fidler - Deutsche Bank AG

Ben Fidler from Deutsche Bank. Three questions, please. Firstly, one for you John, which is I just want to understand your aspirations and goals about where you think the margins might be capable of getting in the Civil Aerospace business? And today around 10% somewhere below most of your peers in that area. What are your sort of own aspirations might be for that? The second question was, just to understand, one for Andrew really, your guidance for Marine being unchanged for the full year which based on my scribbled notes from February seems to imply flat sales, flat EBIT, implication flat margin. You did a brilliant margin in the first half, 15% in the marine. I'm just wondering why that unwinds so much at the margin level in H2 or whether it's just conservatism? And the third question was, just to understand the R&D implications of the extra development work you're going to have to do for the 350-1000 engine, and where that leaves R&D and how we should think about that for the next couple of years?

John Rishton

Let me take the first one, and maybe ask Andrew to answer on 2 and 3. I think, in terms of margins, if I look at our margins, look at all our competitors margins, if I look at the future potential revenue growth that we've talked about, it would be disappointing if we didn't improve them over time. In terms of aspirations, I'm certainly not going to get into where I would hope, like or want them to be in this meeting. But as you would expect internally, that's something that we talk about quite a bit. But certainly, with the doubling of revenues, we would hope that they would improve. Andrew?

Andrew Shilston

And I think on the Marine margin, probably the answer is that the margin expansion in the first half is because of the greater proportion of aftermarket, which gives us a higher margin rate. And what I said was that OE would recover quite significantly in the second half, so that mix is going to work slightly to our disfavor in the second half. In terms of R&D, if you've inferred from my comment about R&D this year that, that's associated with the A350, that's not case. It's more bits and pieces across the whole business. And what we've always said, looking at the R&D in total, is that it's the portfolio points that for example, as the engine for the Boeing 787 goes into service, you've got more engineering time to address the engine for the Airbus A350. So when you look at it in aggregate, as the old programs mature you have more resource available for new. So I don't think you should assume that what we've said in the past on R&D is really going to change in terms of overall numbers.

Benjamin Fidler - Deutsche Bank AG

So just confirming, it came from that resource is R&D stays flat as opposed to?

Andrew Shilston

Well, as you know, we don't give multiyear guidance, but what I'm telling you, there's not going to be a significant change to resource levels, no.

John Rishton

If I could just raise up on the A350 exclusive, I think that's a really, really important win for Rolls-Royce. Lastly, we look at that as a very positive thing that really enhances our position on the widebody market and in the total A350 fleet as well. So perhaps I think it's exceptionally positive, positive position to be in. Let's go to the next question.

Zafar Khan - Societe Generale Cross Asset Research

It's Zafar Khan from Societe Generale. One for you John, just trying to understand really your strategy on the engines for the narrow body. It clearly, very well defined strategy on the widebody, very good position, but I'm really struggling to understand really where you're going to go in the narrow body. So if you could help us with that, I'd be very grateful.

John Rishton

Okay. On the narrowbody, a couple of comments. First of all, I think that our decision not to go on the reengined Airbus was a sensible decision from a business case perspective. If we're way up to where we want to invest our money on the returns that we can make, our view was from a simple financial basis, that there was areas that we could do better on. So I think that was a sensible and rational decision. In terms of what Boeing now seemed to be saying about reengining rather than a new aircraft, as you're all aware, CFM is certainly exclusive on the 737. And my understanding, but it is only my understanding, would be that, that wouldn't change with the reengining. So that doesn't alter the position going forward. So that's where we are, are comfortable with the position that we're on, on the neo. If you look further ahead for new aircraft, I think we would take naturally, as you would expect, take a serious look at that, and would envisage that, that would be something we would be interested in. So the fact that we're not on the neo [ph] and nothing's changed on the 737, you shouldn't read into that, that, that's not part of the market that we wouldn't be interested in. But I'm comfortable personally with the position that we're currently in, in that market. When I look at the other things that we invested our money in and our position on the widebody, for example, also across a broader spectrum. So if you take into account the Marine business and the Tognum acquisition, those kind of things, for me, it's a rational and sensible business decision.

Zafar Khan - Societe Generale Cross Asset Research

So should I assume that you are still interested in the smaller engine, and narrowbody is still very much part of the longer-term plan?

John Rishton

Yes. You should take into account the fact that that's a part of the market that is an important part of the market and is certainly one that we would look very seriously at as in when new aircraft are considered. You shouldn't take into account -- you should not draw the conclusion that because we're not on the reengining that we have exited that market. That would be completely the wrong conclusion to draw from that.

Celine Fornaro - BofA Merrill Lynch

Celine Fornaro, Bank of America Merrill Lynch. Two questions, if I may, on services. The first one is on the aftermarket for Civil Aerospace, the guidance for the full year. So on H1, you grew probably slightly better than your average full year guidance. Why should we expect a slowdown in H2? Is there a specific reason for that? And also if you could just give a bit more color on the performance between the large engines on time and material, and maybe the business jet if that's coming back. Or we're seeing the first [indiscernible]? And the second question, still on services, in the Marine business, is given the strong growth by the OE recovering, how should we think about the split, services versus OE, where it is today and where is it going? And also, when you open these new centers in services, how quickly after that do you generate service business or you gain market share?

John Rishton

Thank you for that series of questions. Andrew, if you could help me out with those that would be excellent.

Andrew Shilston

Okay, well, let's pick up on the Civil Aerospace aftermarket, first of all. I did point out that we had the Aviall deal in the second half of last year, which when you're looking at the year-on-year growth, it will tend to depress that percentage for the second half of the year. So I think that's probably the answer to that point. In terms of small engines, I don't think there's anything more to the guidance I've already given. I mean, we expect good double-digit growth in our large engine TotalCare business. In smaller engines, it's fairly flat and we're seeing some of the older V2500 engines or the older aircraft gradually going out of service, maintenance events perhaps are stretching out. I think, Safran was seeing some of that. And in other respects on business jets, it's pretty much steady as she goes. So I think that's why despite the fact that the large engine story is very strong, when you add it all up and produce the overall civil business result, it's down around 6% to 7%. And looking at Marine, well, I think the story on services is pretty clear, that it's growing at a nice double-digit rate. There's every reason to assume we can continue to make that grow just by virtue of the greater dockside presence and the growth in the installed base. And so we don't really target any split of OE and aftermarket. It is what it is. It's just a result. And I think I suggested that the tone in OE is getting better. So OE in Marine in the second half will be better than the first half,, and obviously we'll update that guidance in the New Year as we look into 2012. In terms of the new centers that we put into our service network, the benefit is pretty rapid because mostly it derives from putting service engineers on the dockside and the service engineers get into the vessels pretty quickly. And so they are earning money almost from the date that you commission the factory. So that's quite a nice position to be in. It's not a heavy investment, heavy long-term payback story, it's all quite short cycle.

Edward Stacey

It's Ed Stacey from Espirito Santo. Just one question, and it's for John. On the 3 Cs, the customer, one, and the need to sharpen the focus on the customer, I guess, in the last sort of 12, 18 months, we had the event on the A380, and maybe that sort of raises some issues. But we probably think of that as being kind of an extraordinary event. In more general terms, is there something you're doing wrong currently in the way that you support your customers, something you need to change? Could you maybe give an example of what you mean by the need to sharpen the focus on the customer?

John Rishton

I don't think there's anything we're doing wrong in terms of our customer. And again, if I go back to the success the business has had in terms of winning business in all sectors, it's quite clear that we have good relationships with our customers. And as I said when I've met -- most of the customers that I've met have all been very complimentary. So what do I mean? I mean, that I think as with all things, there are some things that we can sharpen up on and there are some things that we need to improve around. And some of it is in quite some detail. I think, coming from a different business background, I come from a business-to-consumer background rather than a business-to-business background, and in those businesses, the organizations tend to be more customer in their mind in everything they do. So I think there's a little bit of -- it isn't quite the same in a business-to-business, which I understand, but I think that there's some areas that we can tweak, some areas that we can improve our attention on our customers. And in discussing that with my colleagues, I think there's a general view that, that is the case. But this doesn't mean that anything was necessarily wrong. I think this is an area that we can improve and get better out rather than it's wrong so we must change it. I think we do it, generally, very, very well. So in many ways, I go back to the answer that I gave on costs, which is an area why I just like to turn up the dial a little bit and turn up a little bit of attention and put a little bit more focus on that area than maybe there has been. That doesn't mean it was bad or wrong in the past.

Rami Myerson - UBS Investment Bank

Rami Myerson from UBS. Just 2 quick questions. You talked about inflection point in Marine. And on the order intake in Marine activity and order interest, can you just tell us what you're seeing so far year-to-date and potentially the interest going forward to the end of the year? And if I understood correctly, there's an Advance2, Advance3 -- or Advantage2 [ph], Advantage3 [ph] engines that are currently under development for the narrowbody, after Boeing's decision to reengine with the CFM LEAP-X engine, does that mean that, that has been pushed to the right and development of that will be deferred until you see the potential for new narrowbody aircraft?

John Rishton

Let's start with the second one first. Mike, I don't know if you want to make some comments about that.

Mike Terrett

Yes. Basically, Advantage [ph], we have technology programs and the technologies that we develop are applicable at different thrusts. So clearly, in our compressors to the buy-ins and so on. And so the programs that we have feed all of our programs for Civil and Defense, but certainly, across all the Civil portfolio. So we don't see change in our technology programs at all as a result of this. And the other thing to remind everybody is the Trent XWB is demonstrating now the world's most efficient performance from the data that we have. So in terms of technology, we're actually living the cutting edge of that on a daily basis. And the technology that lies behind future developments has applications in current programs, as well as in future programs.

Andrew Shilston

Just on the Marine order point. I think actually if you look at the press release, there's probably all that we need to say on that subject. But just to pick out a few highlights. We took GBP 1 billion worth of orders in the first half. And the point about the Marine business is that it's quite fragmented. It's not like the Civil Aerospace business where individual orders can be worth very large amounts of money. They were financed individually. Marine orders tend to be small and they aggregate after quite big numbers. But just some examples here, about the UT design and system integration packages, the oil and gas sector, we won more than GBP 100 million of orders in 4 or 5 different countries all over the world. And this is another example here, an order for 6 UT offshore supply vessels by the Blue Sea Group. So there's a lot going on, and it's all over the world and what's driving this is the same thing, it's activity in the deepwater oil and gas sector, which is driven partly by the oil price and partly by the fact that there are very few places that oil companies can invest to own oil reserves other than offshore.

Rupinder Vig - Morgan Stanley

Rupinder Vig from Morgan Stanley. Two questions, perhaps one for John, first. Going back to the 3 Cs, when we think about cash, how quickly should we see get to see improvements in cash, given we've got ongoing headwinds such as new program investment, we've got the inventory build that we talked about? So how near-term an objective can that be to sharpen on cash if you like? And then a question for Mike, perhaps on the operational side. We've talked today about doubling Trent production in 5 years. Are the resources in place to be able to do that? What else needs to happen? So what are the big challenges from that perspective to be able to get to a stage where you can double the production 5 years on Trent?

John Rishton

One of the danger of being the new guys, as soon as you mention something, it becomes sort of the flavor of the month internally and externally. So let me reemphasize, this isn't about sharpening our focus, just pushing a little harder on it. I mean, one of the things that, if I read any of your reports over a long period of time that you would talk about, I think, is cash and cash conversion. So I don't think I'm sort of breaking new boundaries by suggesting that we could maybe increase our focus on cash. I know clearly a number of areas that we can look to, and there's clearly a number of headwinds that we have faced, some that we will continue to face. So the question is: How do you get the organization more interested in cash? And again, this is about sharpening the focus rather than turning a switch that was off. Andrew and the team have been very focused on cash, but nevertheless, bring a scenario that we could usefully get some more people within the organization more interested in, and that would be beneficial. So again, sort of [indiscernible] in terms sort of you've already termed it the 3 Cs. I can already read tomorrow's reports. Thank you very much, indeed. Again, this is about sort of my views and just increasing the emphasis in a few places on a few topics. None of which, in my view, would surprise you in the slightest if I read your reports in total. Mike?

Mike Terrett

Thank you. Well, it's a big subject to talk about, preparation for the growth in Trent. But just 2 things to put into context. First of all, the significant ramp-up of new product is clearly the Trent 1000 and the Trent XWB, although that is not a substantial ramp-up still on the Trent 700, as was mentioned earlier. So as you know from the airframer's requirements, that ramp-up is starting now on and we really start in a couple of years time on the XWB. So it's not sort of a totally immediate thing to ramp up to the full rates. I'll talk about the factories that we are building around what we call our make components because I can paint that picture more simply. But also our suppliers, our partners are putting in similar investments. So let's just talk about 3 major make components first. The fan blade and the assembly of the engine is clearly make. We clearly make the turbine blades and we clearly make their rotating disks. And in those 3 areas, we've announced investments, and some are now complete to affectively duplicate capacity, but also duplicate it with modern methods and modern processes, which we'll also read across into our older facilities. So I'll just give you a quick update on those. In Crosspointe, Virginia, we are making disks and that factory opened this first half. We produce parts. These are production parts, and they're going through the production proving process. But there are production parts that will fly. So that's a brand-new facility in Virginia, the U.S.A. and it looks great. In Singapore, we have 2 major facilities, as well as a hub complex, on what is actually a stunning aerospace parking suite in Singapore. That will be officially opened next year. But at the moment, we're stocking it with machine tools and a production proved in the processes to do 2 things. One is to make wide-chord fan blades for the Trent, which is clearly our iconic feature, and the thing you see as you get on an airplane. And secondly, to assemble a large Trent engines. And again, total effective doubling, doubling and more of existing capacity, which we'd also invest in, in the U.K. And both of those are coming along really well, and we'll ramp into production in line with the requirements for engines for the aeroplanes. We're also building a facility up in northeastern England to replace essentially an older facility in Sunderland, again, making disks. And we have announced that we will be investing in turbine blade machining capacity again in the U.K. So we are investing and when we go around the world, we can see our partners investing and we can see our supply chain. We've carefully selected on these new programs to be a smaller number of bigger more capable players, and it's a big task. You have to put the factories in place. You have to fill the machine tools, then you recruit, improve the processes and the hardware then follows. And we're pretty excited with the progress but it's a big task for us.

Andrew Gollan - Investec Securities (UK)

Andrew Gollan from Investec. Two questions, please. The first one, easy financial one for Andrew. The hedge book has gone off a little bit. Can you tell us what the average hedge rate is compared to the end of 2010? First question. And secondly, I think you mentioned with regard to Tognum, that you expect to double the revenues in a shorter period in 10 years. Does that -- are we talking about the combined businesses here? Or are we talking about what you're expecting for perhaps Rolls-Royce Marine and the other assets before you put them together with Tognum assets?

John Rishton

I'll take the second one first. We talked about the total business Tognum, doubling that in less than 10 years. Andrew, do you want to talk about the hedge book?

Andrew Shilston

Yes, by all means. And there's some information actually in the press release under Note F. But just for the benefit of the audience, the hedge book is now just over $20 billion. The average book rate is about $1.60 in the hedge book. And for those of you with the [indiscernible], you'll see that's fairly close to the forward rates that are currently available in the market

Jason Adams - Nomura Securities Co. Ltd.

Jason Adams from Nomura. Just 2 questions, the first on for you, John, on the Energy business. When you look at this business, do you think it's at a scale now where you're confident of growing it organically and delivering margins that would be acceptable to your shareholders? Or do you think this one could be a focus for bolt-on acquisitions and you need to get the scale up to compete? I'm wondering how you feel about the size of that business. The second one for you, Andrew, on Civil Aerospace. You mentioned that the disruption caused by Japan is impacting profits by GBP 10 million, R&D is a little bit higher than expected, and then perhaps maybe there is even a negative translation impact that you didn't forecast, but yet you maintained guidance. So can we infer that perhaps the first half of the year delivered a little bit better trading than expected? And if so, where did that slight upside surprise come from within Civil Aero?

John Rishton

Thanks, Jason. Energy business, a couple of comments from me. First of all, clearly, the Energy business is smaller than the other areas. Secondly, the financial returns are, I think, the euphemism is disappointing, and we need to address that. So I think that the first thing that I would say is that we need to address the financial returns that we're getting from our Energy business and we need to think carefully about how we can do that. As I said in my speech, the oil and gas part of that business looks pretty good, the power generation, less so. So we need to address that, the first thing. The second thing is that clearly the acquisition we're making in Tognum is significant for the Energy business in total and that will bring, to a certain extent, some scale. But of course, it's in a different part of the business, so it's the diesel engines part rather than the simple gas turbine. So what I would say is, one, for our existing Energy business, we need to fix the financials and that's sort of something that I take on and will look at very carefully. Exactly how we can do that, whether that is, a, we need to be bigger or a different answer, we'll see. Secondly, the acquisition of Tognum will bring some scale to the Energy business, but in a slightly different way. Andrew?

Andrew Shilston

Yes, I think looking at the Civil business, we're in danger of micro-analyzing a very large business. This is a business that can generate profits over a full year of close to GBP 0.5 billion. And we're talking about 10 or 15 million items here, which realistically a morass than a noise[ph]. So I don't think there's any sort of more detail in which to give you the about first half. What I would say is that, again, perhaps we're being trying to be too precise with guidance. We did say back in February that we would expect the Civil business to produce results about 25% up for the full year. I think you can see the chart, we've said 20% to 25%. Frankly, realistically, there isn't any change to guidance. I think we're trying to be too precise here in the outcome. The difference of a few percentage points in profitability in the Civil businesses is not capable of being forecasted, given the huge array of products we have, the huge array of transactions, it's all in the noise.

Sandy Morris - RBS Research

It's Sandy Morris from RBS. And I'm trying to avoid circling back and asking the same question about margins. But if we just were to look at Civil Aerospace, notwithstanding that we have rounding errors, the mix was pretty adverse in the first half. We had more R&D, we understand, in this business, but the margin is holding up pretty well in those circumstances. Mike, in the meantime, is busy starting up factories left, right and center. And in the meantime, he's got launch programs going through. I mean, without trying to ask the margin question again, there is a lot there that one could be encouraged by, for the future. If Mike or someone would help elaborate quite how challenging these startups may be, it would be helpful, please.

John Rishton

Well, I'll let Mike take it, but as I said earlier, I would agree with your synopsis, which is why it would be disappointing if we double our revenues and we don't improve the margins. Mike, do you want to make some comments?

Mike Terrett

But I think I started explaining what we do around the world. I mean, when you're introducing new products, if you -- everybody will understand if you increase the volumes through a factory. You're going to get some fixed overhead [ph] absorption benefits, as well as the opportunity to drive productivity out. Actually, as you introduce the new product, you also have to actually put it through an proving process, take it down the learning curve, makes sure that everything is set up on relatively smaller volumes. So there is a challenge in doing that. That is in the mix. We're also -- as I said, services revenues are growing, so that's helpful, but we're also launching products. And I mentioned the Trent, but we're also launching the BR725, which is going into volume production now, so that's again in the BR710 world, which is still strong volumes. We're suddenly adding a new product, which is in the family, but nevertheless, we have to learn it out. So in the Civil business, generally, there are learner challenges through our factories. And those factories are shared factories, would also put in TP400 and the LiftFan through those factories as well. [Indiscernible] So it's a great challenge to have. It's one that we enjoy enormously. But in a supply chain, you've got to manage new product, you have to manage old product and legacy products, and that's all in the mix. I'm trying to disentangle it on a half-year, half-year basis. It's not easy to do it in a simple way because it's part of a general mix, which is, I think, a point Andrew has made a number of times. I don't know if that helps put a bit of color on the world that we live in, but it's a good challenge to have.

Harry Breach - Barclays Capital

Harry Breach here from Barclays Capital. I'll just ask 2 questions without 3 subparts to each. Firstly, Andrew, you touched earlier on the Civil section about time materials being below the large engine TCA growth in the first half. So should we be thinking about that as being sort of flattish? And what's the sort of profile looking like? You said better in the second half. Does that mean up to the level of the large engine TCA revenue growth we've seen? And then turning over to Mike. Mike, there's been a lot of focus that, I suppose, this year really on the supply chain management and the ramp up. It's probably getting to be pretty top of the list of concerns. What can we take away to make us feel more comfortable that part shortages and the supply chain broadly, given how large and complex that is, can be better managed this time to mitigate shortage quality schedule issues compared with previous ramps? Is there anything tangible we can sort of think about to make us feel better about it?

Andrew Shilston

Right. Well, let me take the first questions on the time material piece of our civil aftermarket. I think your characterization of the timing material performance in the first half as flattish is the one I'm happy with. In terms of the second half, there's no doubt that the number of arisings of bookings, if you like, in the overall base network is increasing. But I don't think that's going to cause the sort of double-digit increase that we've seen in the large engine long-term support contracts. And it's because there's a very large installed base of engines, about 30%, as you know, around time materials. And so there are some areas of the fleet that are looking better. For example, the 524 engines, I think, we've talked with 1 or 2 operators, we're seeing more demand for those overhauls. But then a quite a large number of engines where there may be little change in the second half. So I don't think you should expect a sort of double-digit necessarily upturn in the second half on time materials, but there will be some improvement.

Mike Terrett

Okay. On the ramp-up. I think if you're referring back to the challenges everybody faced in the last big cycle turn of 2004, I think there needs to be a bit of context here in that prior to 2004, there was enormous dip in civil as a result of 9/11 and the Iraq War and SARS. And the ramp-up that occurred was just to a large extent, a ramp-up in existing products and existing supply chains that came on very quickly, most of you remember. We've been planning this ramp-up in civil for some time. And rather sadly, we've had to wait a little bit on the 787 and the A380 delays, but we've had plenty visibility. We've had a lot of planning tools in place. We've carefully selected our suppliers and have worked with more production readiness, and continue to do so. And so it's -- and we've also hedged our materials probably far more extensively than we did back in 2004. Now having said that, it is one of those things that -- and if you were in my job, you'll lie awake and worry about it, which is the right thing to be doing. And constant attention to detail with suppliers, planning, making sure we're close to them, particular attention to making sure the parts are production-ready and are learnt out and the processes are capable. So those sorts of things, we're heavily engaged in our production readiness programs, and we'll continue to do so.

David Perry - Goldman Sachs Group Inc.

David Perry again. Can I just come back to Energy? Just trying to understand the lower guidance. Andrew, I think in your presentation, you said it was -- the guidance was lower because of softer OE nuclear costs, and I think you said people costs, as I was scribbling away. Can you just elaborate on that? Have you started doing some restructuring already?

Andrew Shilston

No, it's not restructuring. I mean, we're talking quite small numbers here in the overall scheme of things. It's largely to do with just having people to bid for new work. I mean, before you win orders, you need people to address the market, so I think that's really what I'm talking about. It's not restructuring.

David Perry - Goldman Sachs Group Inc.

Sorry. I'm not sure I understood you. So you said before you bid, you need people?

Andrew Shilston

Before you win orders, you have to have people to respond to requests for RFPs, request for proposals. You have to have people to address the market, so those are creating costs without revenue. And you have to incur that cost before you win new orders.

David Perry - Goldman Sachs Group Inc.

And you're talking about power gen or oil and gas?

Andrew Shilston

Well, it's principally, I mean, it's in both. I mean, perhaps oil and gas has been more buoyant. As I said, the order inquiry level has definitely picked up. We have been bidding for power gen work both from a diesel side and gas turbines. And it does require a certain amount of effort, so I think it's across both businesses, really.

Benjamin Fidler - Deutsche Bank AG

Just one final one for me, which was maybe I missed it in the press release somewhere. But I just wondered if you could update us, Andrew, on what the TCP net debt was at the end of the first half?

Andrew Shilston

Well, I'm so pleased, Ben, that you've asked me that question. And I think you'll find the answer in the press release. And I will refer you to the note in a moment when I have found it. And it is on Note F, Page 11 of the press release. And the short answer is there's not much change.

John Rishton

So hopefully, that's discouraged any more questions. Are there any more? Okay, well, thanks very much for coming here again this morning. Just to summarize again. It was a strong first half. I think we're well positioned and confident about the future. And certainly, my first few months in this company has been a terrific experience. And I look forward to seeing you again at the full year. Thank you very much, indeed.

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