Rolls-Royce's (RYCEF) CEO Warren East on Q2 2016 Results - Earnings Call Transcript

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Rolls-Royce Holdings plc (OTCPK:RYCEF) Q2 2016 Results Earnings Conference Call July 28, 2016 3:45 AM ET

Executives

John Dawson - Head, IR

Warren East - Chief Executive

David Smith - CFO

Analysts

Christian Laughlin - Bernstein

Ben Fidler - Deutsche

Gordon Hunting - Fiske

Harry Breach - Raymond James

Rami Myerson - Investec

John Dawson

Good morning, everybody and welcome to Roll-Royce’s First Half Results for 2016. My name is John Dawson. I’m the Head of Investor Relations of Rolls-Royce. And with me here today are Warren East, our Chief Executive; and David Smith, our CFO.

Our Agenda today is as follows, Warren will kick off with some highlights of the first half. David will run then through the financials in more detail before Warren then returns to take you through some comments on our transformation agenda and priorities for the second half of the year.

The presentation should last around 35 minutes, so we will have plenty of time questions afterwards. We are conscious you need to be away by about 10’O Clock to go on a maximizing, so we are trying to make sure that finishes on time.

Before I hand it over to Warren, let me just remind you of few housekeeping matters. We are presenting the webcast today -- the presentation today and a webcast as well, and we will be able to takes questions for those of you joining us on the webcast, please submit your questions online and we will make sure that asked in room if they haven’t been asked already. Or follow that with us if we do not have time.

Please turn off your mobile devices, out of courtesy to the speakers. And finally, we will be including forward looking statements in our presentation, please refer to the slide in your pack about that. Numbers will be on a constant currency basis and that sated, and that includes our comments on guidance as well.

With that I’ll hand it over to Warren.

Warren East

Thank you very much John. Well, as he says, good morning everybody and thank you for coming. And we do understand that it’s a very busy day for results today, and you’ve come along to share some of that time with us, so that’s very much appreciated. Thank you.

Now, those of you who can remember, this is roughly where I left off in February when talking about our full-year results for 2015. And we’re going to stick with the same framework for talking about our results this morning.

The framework here is the priorities that I set for 2016 and I am going to sort of start of now and talking a little bit about the business, talk about restructuring and then I’ll pick up with the other priorities here, when I come back in a few moments after David has run us through some numbers.

For the group as a whole, the first half of 2016 I would say it’s been a steady start. Actually the business is a little bit better than we expected for profit on cash in terms of the absolute numbers as of the end of June that is largely due to timing of certain deliveries in our large civil business and a little bit in defense as well. And with saying this morning that our expectations for the full year remained absolutely as they work, which means we have still got a lot to do in the second half. However, we remain confident in those expectations for the full year, it’s driven by the schedule of production and deliveries in our civil business. The timing of few specific defense contract and also fortunately the benefit of some of the restructuring activities and simplification activities that we starting to do some of those benefits starting to come through. And that’s all pretty mu8ch in line with what I said that in beginning of May, at our AGM.

So now just have a quick look at the business some of the highlights in the first half of the year. I’ll start up with our activities in civil aerospace. Looking to new engine programs, these are engines which are not in service at moment and with going to be fueling our growth in future, we hit some important milestones as a picture of our new version of Trent 1000 engine. And at Farnborough, a couple of weeks ago, we were able to announce that that had received EASA certification. Also, in the new engine sphere our Trent 97K, this is the higher version of XWB engine that’s also been achieving its first flights on our flying test bed and things are going well there.

The big leader for our civil aerospace business, however is achieving the ramp up in volumes that we need to achieve last year, this year, next year and so on. And so in 2015, as a reminder, we deployed just over 300 large engines in total and the Trent XWB was just starting and pass of that. This year, we expect to deliver 400 large civil engines and we are on track for that having delivered a 164 in the first half. And incidentally that was just over 100 in the second quarter, we are moving the volume run rates from our from around about 30 a month to around about 40 a month, that’s happening as we speak. And so we anticipate the next couple of quarters significantly over a 100 engines per quarter, and that will take us into the round of just say over a 400 engines for the full year.

Now I’ll talk a bit more later about manufacturing lead times and what we have been achieving on improvements in manufacturing lead times and that is of course one of the drivers that enabling us to ramp the volume like that.

As I look forward at the civil aerospace business on a slightly longer term and the graph here you can see the slightly longer term view then obviously we understand this is a business which grows in the long run. There are short term perturbations, caused by external events but when you look back on those in history they don’t make a huge amount of difference for the long run picture. And we also get more perturbations when we have things like spikes and orders and that leads to in the moment a little bit more capacity in the market than the raise demand and we get perturbations there.

As I set back and look at the slightly longer term however, I see a strong order book which continues to grow in the first half of the year. I see us increasing our capacity to service that strong order book and I see some commitments from air line customers and our airframe partners. And that is putting resilience into our revenue growth for the future. Near term we have absolutely hear about high shipments of widebody airplanes, a little bit of softness in passenger kilometers and that does certainly put a more risk there in terms of risk of deferrals, risk of slowing things down. But interestingly we are not actually seeing any changes from the airlines, particularly in the routes that they are flying which is a course what really drives a engine flying hours.

And so from an aftermarket point of view, we are comfortable at the moment. From an OE point of view, if some of these risks start to materialize then what we can see at the moment at most is a little bit of re-phasing actually helping us with some of our delivery plans and easing a little bit of that pressure. And that’s what we are seeing versus anything radical, any radical changes, now obviously if we see some radical changes will be and we will be talking about it. And we will let know if we see that change.

Right now probably my -- if I wanted to talk about concern here, the concern is simply in terms about resource and the significant demands that we are currently placing on our engineering teams as they fit to help with this ramp up of volume at the same time as brings them very sophisticated new engines into production. However, things are going pretty well on that front at the moment.

So let’s move on to defense, that was a steady first half and a very good set up for the full year, looking forward there are opportunities for new OE over the next five to 10 years, and we are working with keeping our design as -- we are keeping fresh and working with the partners on those for as and when the opportunities materialize. But this business for the time being is mostly about what happens in the aftermarket servicing the fleet that’s out there, and getting that servicing activity more efficient and more profitable from our point of view. So we are doing things like working more closely with our defense customers, getting some of our activities physically located on the sites with some of those customers, so we can get more values out of our aftermarket business. And share that value with those customers; actually give them better service as well. And we are investing in future technology to build on the strong position, both for the aftermarket and the OE. We have a strong position today in transport and petrol and we have opportunities come back on our investments tools targeted at that.

Looking around the rest of the business, I’ll start will power systems, like in 2015, the first half of -- actually fairly close to breakeven, it reflects lower volumes and product mix where we certainly seeing higher shipments of the lower margin products. Meanwhile, our R&D focus is on higher volume applications like power gen where we can leverage our capacity and grow our market share and really capitalized on the high performance differentiation that our product have. And so we are comfortable of where we are with that business for the second half of the year.

Switching to marine, I mean it has been a very difficult period and it’s been a difficult period for quite a long time that. We are seeing some good results from the restructuring that we have been doing in marine. And we have been focusing R&D with actually increased, means it’s not hard to increase the R&D as a proportion of the revenue in our marine business, but we’ve actually stuck with the expenditure in R&D, investing in new technology there and I’m quite encouraged by the innovation that’s happening in the product portfolio. We’ve announced an investment in some new permanent magnet technology to expand the activity, few week ago. Mean while at the actual sector in oil and gas, it continues to be depressed. We seeing, people get little bit more creative, in terms of seeking opportunities offshore and slightly different applications in fishing and other non other non oil and gas applications. So I truly stimulating innovation in marine part of the business. In nuclear we’re investing, we financed some headcount increases, this is to, so that better the business that we do with the UK government on submarines and we’ve made progress there in terms of improving our project management manufacturing and deliveries from that. And we’re also exploring opportunities with modular reactors.

Switching now to the, one of those key priorities and I’ll talk about this transformation one and now before handling over to David. Back in February, I talked about the needs to address, what I call the organizational hardware, as that is the structures and organization and the software. The activities what people actually do, and we been proceeding with the left hand side of the chart hence the green tick, were we been looking at the structure of the business, simplifying the structure of the business, that’s where the initial focus is being. And we’re cost leaving the business, I’ll come up with the, some numbers in a moment. We are certainly on the track, at the top end of expectations there. Moving forward in the second half of the year, the emphasis is switching to the right hand side of the chart, we’re we attack some of the way we work, the way we share information, the way management decisions get made within the business . And that is certainly harder, and it’s a bit less tangible as well. So it’s certainly harder to talk about it, but I’ll endeavor to talk about that a bit more later in the year.

On the tangible side, we’re very much on track to deliver the GBP150 million to GBP200 million that we talked about in terms of cost reduction for the end of 2017 and going forward, so that’s what showed in the cumulative savings here. By the time we finish with 2017, we’re absolutely in the zone for GBP150 million to GBP200 million out. The type of progress we’re on so far. The initial phase, we’ve done so, we’re actually talking about achieving very to 50 million for 2016, which is at the top end of expectations and those changes will also have a knock-on effect, and will actually benefit from an additional GBP50 million, as we move into 2017. For the next steps for the reminder, it’s work in progress, we’ve identified activities that we can reduce, which we hope will deliver GBP20 million to GBP40 million of benefit in 2017 and we have some work to do to find some more in 2017 and moving into the piece which comes from the end of 2017. But I am comfortable with where we are at the moment, it’s work in progress, a little bit more to do. But six months seen, we are in pretty good shape.

Just remind on how some of that plays outs than what we’ve tried to do here is show diagrammatically the simplification of the top of the organization where we were technically new from nine businesses to five and we connected those five much more closely at the top of the business. That has really sharpen the ability for us to make decision, it’s increased accountability and raise the level of debate at the executive team.

We are starting to see some real simplification here on how we executive the business and that’s simplification is for instance measured in terms of reduced number of committees that we have to operate the business; reduced frequency; reduced numbers of people that are there at those new things. And it’s very much the start of the simplification piece. There is no shortage of opportunity here to reduce the complexity. The business is engaging well, as far as on concern they are encourage by the response that we are getting around the business stress, a good start, but it’s only a start. So overall pretty good first six months, there is still a lot to do, also the other priorities shortly meanwhile I’ll hand over t David.

David Smith

So thank you very much Warren and good morning to everyone, it’s really good to see you here. Warren has so already run through some of the operational highlights. I want to stress oversea the results were clearly down as expected versus last year, but we did end margin ahead pre-close expectations; and the business clearly responded to the rallying and call there. This outperformance was principally down to civil aerospace and created some early time deliveries and appropriate tones some spare engines together with more life cycle cost reduction and obviously a little of a an FX tailwind. We also had particularly strong end of period cash flows which was always hard to predict some increases from early delivery of second half actions. But again evidence, I think, of the business responding to the challenges that we given.

In addition marine was some negative had a good ends of the period. Both of these parts of the business have more to do with the second half phasing on any real out stream and performance or outlook, I think is something that was still cautious around. We believe that Group underlying performance remains broadly in line with the expectations that we gave you earlier in the year on a constant currency basis.

As I go through this presentation any percentage change in fact on saving value I gave will have constant effects raise and on an underlying basis. So moving onto just dividends quickly, there is no change from what we said, at a full year results. We’re halving the interim dividend for as 2015 level and so that will pay about at 4.60p. And that implies, just over 300 million total cash outflow to shareholder payments in this year in calendar 2016. And I’m taking about our balance sheet, also, SNP did adjust their rating in May and now they are in line with Moody’s and Fitch at A minus. But we still do have a very robust balance sheet and with good liquidity, it’s been helped during the year, buy the additional 500 million of revolving credit facility we raised in April, that’s now up to 2 billion. We continue to perceive a proven financial policy and while we do have some cash flows, such as the IT purchase consideration, coming up over the next 24 months or so, these are defiantly manageable.

Turning next to group revenue, the group level our OE revenue fell by 5%. That was due, fairly equally, to civil aerospace headwinds and much larger offshore market declines that we talked about marine. Likewise our services were 5% lower for broadly similar reasons that we’ve explained before. In fact throughout these slides, you can see that the first half outcome really does reflects the headwinds, we identified, during last year and we confirmed the full year results presentation in February. We have see some positive impacts of translational FX on revenue basis that added a 183 million, I’ll talk more about this in a moment as well.

Turning next to group profit, the headwinds we’ve discussed really did a lower gross margins, you can see that fairly dramatically on this slide and were the core-factors in the decline in group profit before tax. In other parts of the income statement, the differences were relatively small, and mainly related to non recurrence or repeated cost and benefits from last year. And that is included 39 million, on repeat of underlying restructuring cost, as the 24 aerospace program is now largely implemented. May be I’ll just add that the transformation program and the Indianapolis redevelopment program have been booked in the first half as exceptional cost and we can come back to that.

Similarly, the non-repeat of a 24 million finance benefit that saw last year on dividend hedging in 2015, contribute it to financing cost staying up above 35 million versus last year. We’re also in line the moment with our remuneration targets for the year. At this point we’re creating bonus in line with that policy and that does impact C&A, which is why you see an increase in C&A and part of that comes through in the gross margin is well. So here is I usual bridge from profit to cash flow. On an absolute basis, the main drivers were a 235 million increase in networking capital, the included a 149 million increase in TotalCare net debtor to 2.36 billion, and together with inventory buildup in preparation for the rise in second half production. We did see some offsets just FX related, and favorable effects of translation of net foreign receivable and payables. We had just over 300 million of CapEx spend during the quarter, a part of which was actually payment for 2015 invoices. And of the 232 million increases in tangibles, you can see here, 90 million came from cost and net moment after amortization was 71 million, taking a balance in the period to 460 of period end and the rest of the intangibles moment, primarily related to higher R&D capitalization. So cash flow mostly that’s what we expected at this point in y primarily because of the work on working capital, and it’s certainly help by earlier customer see similar delivery, for instance of those spare engines and also some forecast OE concession payments which slipped in to the second half and a pull ahead therefore some of our second half cash actions. Thinking about the year-over-year which is an actually on the chart, profit was clearly down, CapEx spend was only up marginally. And the net long term credit of balance increased by about 176 million year-over-year, and we did see as I said a strong favorable move in net working capital.

So before I turn to the divisional review, I should probably touch a little bit on foreign exchange. At yearend we had 29 billion of dollar cover, and the average hedge book rate was about 159. And as I said that hedges our dollar exposure which is currently about 5 billion to 6 billion and will increase overtime as we see volumes increase, this absolute exposure -- sorry will increase the overtime as volumes increase.

We have been taking sort of beginning of the year, but before and after the Brexit vote advantage of the weaker pound in terms of adding to that hedge position and we have now at the end of June increase to about 29 billion up to 35 billion, that’s still well within our normal time lines. And so over the next five or six years, that equivalent cover that’s about five or six years equivalent cover, it’s spread over a longer period than that, because we hedge progressively and the most recent transactions were clearly being struck at much better forward rates than sort of 135 to 140 range. And that has brought our average hedge rate down. So the average hedge rate in the hedge book at the end of the quarter ended up for 157 as its price of 159 at the end of last year.

All our hedges, as I said, are taken in line with the policy of kind of low volatility and moving a margin over time. So there won’t be any affects flips in the forward rates. And we will continue to take our longer dated cover up as we use existing dos. So in fact that this means we are likely to see a gradual decline in the long term effective rate in any one year. And therefore, I was just -- for those we are modeling our long terms rates in the outer years, I would be cautious about describing too much value to these short-term spot movements that we’re seeing. Of course we all know that those could come back at some stage in any case. So there are a lot of movements going on through foreign exchange caused by sterling weakness. It is running through maybe a couple of others where that impacts on the business, particularly around transaction impacts. And also in translation there is more detail in the appendices to the press release, as the recent significant changes make us much more pronounced.

So on revenue now, we would expect roughly a 600 million translational impact for the year. Its current spot rates continue at the point they were in June 30th, and the profit effect would be about 60 million as a price to 40 million we are talking about previously. We have also adjusted our long term planning right, so this is the rates of which we both do a sort of long term decision making but it also gets since through the long term content accounting. And that’s reflected, therefore, primarily in civil aerospace and we will continue to review that. That added, as it says here, about 35 million to civil profit. And it also changed the order book buyback 2.1 billion, in terms of the valuation of the order book. And then finally sort of the big numbers that, the non cash margin market moment, just on the hedge book itself, which does hit our reported profits by nearly 2.2billion on our derivative contracts. This has very little impact on us, and we don’t get concerned by this figure, and nor should you, as it will be fully offsets, as those contract mature. There will be underlying hedges which are being, underlying transactions which are being hedged. So in conclusion, while we’re a truly a net beneficiary of the recent FX moments, so our conservative long term hedging strategy and translational exposures make our in-year benefits relatively modest. Right turning now to the divisional commentary, we’ve provided the same breakdowns as last year in the statement, in the interest of time given, it’s such busy day, we cut back some of the charts today, but you do have them in the appendices, and I’m just going to focus on the key points for each division.

Starting with civil aerospace, both the revenue streams were down around 5% for OE, this was principally due to lower linked Trent 700 sales and to lower corporate sales of the BR7 engine, on a after markets, we did see a significant increase in our in-production Trent fleet, recorded, roughly, a.15% increase in installed base and flying hours. But this was more than offset by the reduced activity particularly on time and materials that we talked about before, on the Trent 500; the Trent 800; and also, the RB211 and regional jets. Turning to the revenue mix itself, linked engine revenues were 3% and that was helped by deliveries, high deliveries of the Trend 900 and the Trent 1000 as well offset by that lower Trent 700 delivery picture. XWB deliveries also helped drive the improvement in unlinked sales. We saw lower business aviation as that already referred to. And V2500 module volumes were lower; and that reflects the decline volumes ahead of the airframe transitions away from Rolls-Royce engines. If we turn now to the aftermarket revenue mix, declines in the large engines were driven as I just said by lower activity in the legacy fleets particularly on time and materials. This was mitigated by a 4% rate in thrust and the 15% engine flying hours growth from the in production Trent fleet that I’ve described.

While business aviation aftermarket activity was pretty stable actually in the period the regional aftermarket continued its downward trajectory, and, as an offset, we saw higher V2500 aftermarket revenues. Turning to gross margin, starting with the volume and trading margin bars, the significant proportion really came from the Trent 700 headwinds that we talked about last year. These are around 130 million of negative impact, along with aftermarket headwinds from the legacy fleets. This is very consistent, as we’ve said with the guidance, we gave you last year. Turning to long term contract accounting adjustments. You can read a fuller description of this on page 4, above the statement. In absolute terms the mix of all of this is actually relatively small, it produces the net 23 million reduction, compared to a 48 million positive last year, so 71 million, year over year effect. And within that, there are five specific catch-up elements, 6% of the year-over-year was due to a gain that we had year around on the risk policy adjustments that we talked about and that was, if you remember 189 million in the full year but 66 million in the first half.

We also saw a 64 million negative affect from higher technical cost and that was various in-service related programs particularly around the Trent 1000 and the Trent 700. And we saw a life cycle cost reductions of 35 million which was a 10 million improvement from what we have said in the prior. And then as I mentioned earlier there was a 35 million impact from the change in our long term planning rates for foreign exchange. And then 14 million, basically of all other which are primarily a whole series of operational and commercial factors.

Turning, therefore, to the full picture, so beyond that large movement in growth margin or fairly limited movements that we increase in C&A with actually more than explained by the incentives accruals as described lower R&D was lowered due to increase capitalization for the Trent 1000-TEN engine. And we saw lower underlying restructuring charges, as I said the management reorganizations has been built as exceptional. So the end result was a profit of 31 million and stand 91% from the prior, also a 22 million or 31 million after FX. The overall profit was high than we had expected for the first half which has been focus from modest loss, however this was largely due to the timing effects that I described right at the beginning.

So in the second half we are going to continue to face some of these legacy headwinds through the second half of the year. But we would expect the stronger performance overall in line with expectations with headwinds mitigated through increased delivers, including profitable spare again; and positive results from dedicated focus on improving life cycle cost in main service fleet.

Turning now to defense, so this is the simplified slide, defense revenues were marginally lower with strength in OE revenues offset by some weakness in spare parts, principally, again the legacy products. This product mix did have a negative effects on gross margin and an in addition we booked a 31 million charge versus for both incremental expenditure and expect expenditure around the whole improvement program on A400M, so this is our affords to trying to help the consortium in getting over some of the technically problems that we have obviously seeing on the gear box and other areas.

Restructuring cost was lower, as the focus is not switch to the upgrading of the Indianapolis site which we are treating as exceptional. So the net defense profit is 123 million, that’s down 61 million from last year about half of that was due to the TP400 charge that we took.

Looking forward into the second half we expect performance will be supportive by growing engine deliveries particular of the A2100 and while we have some headwinds from supporting the TP400 as I said we are trying to mitigate that in terms of a full year effect.

Turning to power systems, power system have a solid start for the year. We did see slow oil and gas sales and also a little bit on the rail and enable side and that impacted OE revenues and particularly also aftermarket in terms of the service side of oil and gas. But the segments on such as construction and agriculture and power generation, we are actually consider we are stronger than the year ago. As I said service revenues were affected by lower activities particularly in the energy and commodity sectors. So the adverse mix of all these movements on top of the smallish decline in revenue, did mean that we saw lower gross margin, but that was partly offset by slightly lower spend on R&D and therefore the profits impact of all of that was relatively modest: a GBP6 million decline to GBP11 million profit. In terms of resilience we won’t be immune clearly to the challenging markets dynamics. That’s very evident I think from peers. But our revenue base certainly has strength in the high speed markets which helps us here. So whilst some short cycle sectors are hard to gauge at the moment the order book coverage is over 80% in some of the longest cycle partsof the business and particularly in higher margin sectors.

So this is broadly consistent with the prior year and remains cautious to positive outlook for the full year to power systems but undoubtedly, there is much to do in the second half on both revenue and cost. So I think on marine given the market environment -- I think actually marine had a pretty creditable first half and was a little better or perhaps less bad than we had expected. But order weakness was there, and included cancelations, particularly being a future of the optional market.

And OE revenues reflected pretty low volumes; while services were little more resilient, but still at subdued level so this isn’t really surprising. I think, as services do tend to lag the OE market a little bit by nine to twelve months. In contrast, actually, naval and merchant segments actually held up pretty well and we did okay on order intake on naval as well.

So the teams worked pretty hard to try and find opportunities in adjacent markets to offset some of the direct up show offshore side. And within gross margin the significant impact was really from volume rather than any decline in trading margin. There was also no reoccurrence of the GBP30 million contract provision if you remember that we took last year. So I think overall marines’ loss of GBP14 million which was down GBP18 million from the small profit last year, was a pretty good result. And while our original guidance may now seem a little over-pessimistic as the business is continue to work hard on rationalization efforts. It does I think still reflect caution in the market price the risk towards the further cancellations and I think it is right to continue to be a bit prudent here.

Finally for nuclear, we did see the nuclear business is actually improved in revenue terms in the first half, that was led primarily by strong growth and OE activity in the submarines business, which manufactured program-phasing. We had some delivery challenges to overcome and these did depress our margins a bit. And so the submarines business is very, very focused on achieving cost-effective, on-time deliveries at the moment for their core customer.

Overall nuclear profit is GBP17 million was marginally down on last year. On the civil nuclear side we are seeing quite a lot of good business opportunities at the moment, particularly instrumentation in controls in China one of markets. So the long term outlook for our nuclear business actually looks remains pretty positive. We have also, as has been described in the press a bit, started to make some modest investment in development work around small modular reactors. That clearly depends on government decisions but we think we are very well positioned and want to continue to support this, what could be a very interesting market opportunity for us.

Covering our technical factors our guidance basically remains the same we do expect higher net R&D spend, because its GBP900,000 as we sort of very full program of delivery milestones, as Warren described, on the new projects. So I am just going to finish on some comments around the impending arrival of IFRS 15. I say impending, although the implementation is still two years off. It does feel appropriate to introduce this topic at this point, given its likely significant to reported results. And I wanted to give you my best view as to the framework, which will likely to apply now in Rolls-Royce, coming from our own initial and tentative conclusions from some very detail work, we been doing. We’re trying to see, consistency across the aerospace sector on this, although there will be some detail difference in interpretation, I think we’re getting quite close to that and overall recognition, is now going to be linked much more to the actual timing of provision of goods and services, rather than smooth over the lifetime of service contracts. The one clear and firm constant that I want to really emphasize that it doesn’t change the cash flow perform. And therefore the embedded value of the business and you hear us, this again and again, really isn’t impacted by this change. Our initial conclusions as two principals, as what likely to change, is that we’ll no longer apply the contractual aftermarkets or CARs concept. So we’ll no longer essentially capitalize engine losses.

We also wouldn’t in future between linked and unlinked contracts as you know that’s partly happening anyway, because of changes in market mix, but we would actually move away from that treatment. And for both OE and aftermarket, the timing of revenue recognition and offsetting concessions, we changed to an input basis in other words, cost, with consequences that will have some different profit and loss effects. So as result, all of the OE revenues, massive concessions will be recognized at the time and sale, and therefore we would see no longer, the pull ahead of profit from some of the linked accounting, that we seen in the cost, ahead of cash flow. TotalCare would be recognized over the contract term with higher margins therefore because; we’re taking the concessions up front. And catch-up adjustments and contingencies are also likely to be smaller, while the impact on time and materials probably largely on change so where we still have to work through them.

So, I thought, it would be helpful to give some overview of the impacts on the balance sheet and the profit and loss, this really is a high level. This is the very detailed set of changes that we’re going to make, as we’ve said, we’ll have some balance sheet transition adjustments, as we all essentially move to a completely new set of accounting policies; and the CARs and TotalCare net debtor balances of April are going to be eliminate least significant reduce. Going forward, we’re likely, therefore, to see a greater focus, actually, on the TotalCare creditor line. Because, unfortunately, we’re not going to get a complete alignment, even with this between profits and cash, but we’ll get a much close alignment.

A number of consequences are within the profit and loss account. First, the changes to OE profit recognition mean that the full cost of any engine build, as I’ve said will be taken in the first year and this underlines really the importance of our focus on improving our unit cost position for cash purposes, which will significantly reduce this cash losses, right in time. And then secondly the removal of the CARs balance, since we no longer going to be capitalizing losses. We won’t have any amortization charge either. The most complex area, that we’re working through, to be able to give a more coherent aggregated view of the results, is the removal of linked accounting and the changing of revenue recognition point. This will effect timing and margins and will be quite contracts specific and will come to with a likely time for an IFRS teach-in, which I envisage to be during quarter four, when we’re able to do that. But in the meanwhile, I hope we give you some help, some leadership, really I think and helping you understand these principles; and, actually, how they’re probably going to apply to the whole industry. And finally I just like to reiterate once both of these does not affect cash.

So to just to sum up, wrap up let me summarize our half one performance. Overall this was in line or ahead of the expectation growth for the first half but as whole it’s stronger, but we don’t think that this is going to come through in term of full year effect. So while the phasing in civil and marine brought forward a little of half two performance, we have made good progress and we have made good progress in mitigating market weaknesses, there is still a lot to do in the second half. We are making good progress on cost. We put an strong cash performance. Clearly FX is now bit of a tailwind, although we also have some technical offsets -- technical issues like TP400 to offset. And finally, I think we got a reasonable position, so the focus now is clearly on the second half and our ability to execute on our orders and our strategy in order to deliver full year expectations.

So thank you very much and now back to Warren.

Warren East

Thanks David. I’ll try to be fairly brief. You can see a number of slides in the pack but I’ll try and go fairly swiftly over this next few.

I hope you appreciated the communication about there about IFRS 15 and our desire to get ahead in stock engaging and talking about that. And I suppose that’s really speaking to the box on the far right-hand side of the slide here. And I am not going to talk any more about the box on the far right-hand side of the slide. That’s really for you to judge.

I am going to talk a little bit about what we are doing on priority one, focusing on our three key areas. These three key areas essentially, what we do engineering excellence, how we do it operational excellence and how we deploy that in our business through our business model and are the biggest lever we have there is using our installed base of engines. So there are many actions in all of these three areas is that we could take and the way these slides to build up, that you can imagine an each one of these things in each one of these boxes there are some actions. And they accumulate in terms of benefits to the business and what I am going to do is just pick on a few examples in each of these areas.

So it’s look like a engineering excellence to start with. Our engineering excellence is it’s the collected of the experience, knowledge, skills, technique know how, there has been built up in Rolls-Royce well over 50 years and actually deploying that. It’s potentially hugely beneficial for our business. But deploying that sort of stuff which has been built up a quite a long period of time, it’s quite challenging because there is a lot of just look at the people’s head. And in particular quite a lot of it is historically been locked up, if not in people’s head, on pieces of paper. And so here is an example where digitizing some of product definition. So that knowledge can be transferred and it can be transferred around different parts of the globe where we are carrying our different activities, it can be carried between different teams to get more efficient and effective re-use of that knowledge. Now we think when we complete this project then we will be able to reduce the time it takes to develop our new product by the order of about 20%. And we will have completed that project it’s going to take several years by around about 2020. Now as you can imagine my first question on this how can we do it a bit sooner? I’ll continue to push on that and creative, collective brains at Rolls-Royce will work on how we can realize this benefit a little sooner. But that’s an example of one of the things that we are doing now, switching to the operational excellence I mentioned that the start to the presentation one of the tools that we have on disposal to be able to deliver on this ramp up of volume, doubling of volume run rate of our large civil engines, is to reduce the amount of time actually takes us to make one of them. As we have put XWB engines into Derbyso we have moved some of our Trent1000 production to Singapore. And over a period of several months we have worked -- we have had lean workshops with everybody brainstorming, on how they can reduce, how they can -- the cycle time make that operation more efficient. After about four months so far we have taken about 25% little bit under 25% away from the lead time that it takes to assemble 21,000 in Singapore. The good news is that we think we can this quite a bit further,an 15% to 20% coming out on that particular engine. We think we can then take some of those techniques and apply them back on XWBand possibly make a very significant lead time reduction on how long it takes us to build an XWB. And it’s not materializes then that’s making a huge impact on the available capacity and you can see why that’s a quite a powerful tool and enabling us to deal with volume ramp that we have to deal with.

There are opportunities in other parts of business as well and I am not going to all of these examples in the interests of time but applying the same source of methodology in other parts of our business, this is the source of improvements in meantime that we are seeing in terms of the activity in power systems business.

Now again -- or moving, rather to, away from the engineering and operational excellence and thinking about how we effectively utilize the asset that we haveout there, whichis our installed base. One of the issue is which people have been talking about increasingly over the last 12 months has been the maturing of the fleet of engines that we have out there airplanes being parked and so on. Now it is a normal thing that airplanes start-off with one owner. And after some period of years they move onto another owner. It’s a second hand market develops. Now typically people keep their airplanes for eight to twelve years and so after about eight years they start to become a phenomenon. We have a relatively young fleet of Trent engines. We have got an old fleet of RB211s that’s coming to the end of its life, but our new Trent engines are relatively young. And you can see in 2010, we only had about 200 of these, that were eight years or older. Today, we’ve got about 800, that are eight year or older, I mean 2020 we will have about 900 that are eight years or older. And once you get into that eight years or older phase then there’s a propensity to start thinking of that transitioning from new to second hand, they come second hand transition to a new owner. That can take about six months, just for the aircraft to be refitted , and so, six months out of flying, this is a potential downward pressure on our aftermarket revenue, so if we can do something about moving our transition, that’s a good thing, for our aftermarket revenue and it’s going to become increasingly important as we look forward. So we’ve introduced a dedicated team, to work with finances, to work with lease companies, to work with our airline customers and the good news is, that since introducing this team , at the beginning of this year, then we become much more effective as transitioning aero planes from one owner to another, compared with the corresponding period last year.

Again in, leveraging the installed a base a few weeks ago at Farnborough, is we, some of you might have seen us announce a partnership with Microsoft. And this is where, we’re working to take our product knowledge, customers knowledge, industry knowledge, combined that with data from engine health monitoring and do some analysis, use some analysis tools, predictive tools, and improve the customers operation, we release some values, that we can release some value for our customers and potentially share some of that value in our service business. We’ve deliberately chosen not to invent all our own here, but work with technology partners, like Microsoft, so that we have an open architecture for digital activity. And so, at Farnborough we announced that partnership, and we’re looking forward to applying that around the industry and civil area space, and we looking at applying to other fleet operators, in sectors like marine and combining some of that, with some of the our smart-ship innovation that we’re doing in marine.

I’m sorry, I’m running a little bit fast over some of these, so we can talk about in later. Before we close, it’s important just for sort of put ITP in context. And that, I think the context is largely about librating our installed base and we move closer to ITP, we’ve been working with them as a risk and revenue sharing partner for many years. We moved a little bit closer last year, and if especially if we look forward to XWB and Trent 1000 volume, ramps, they become more as a partner. Our joint venture partner, chose to exercise put option, absolutely the timing was there choice not ours, but directionally, this is quite a desirable thing, as we can consolidate more of the high value, that is there in both OE and aftermarket. Now as I look at add up all the Trent engines that ITP have been working with this on and particularly looking to the Trent 1000 and XWB. We can see an increase of moving 10% in the values that we now consolidate and aftermarket revenues coming in. So quick remainder before I close, we do have some legacy issues, we are making good progress I think and that is behavioral changes into the organization and best practice in this sort of thing. We’ve got no significant announcements to make in terms of any enquiries, but just to remind that that’s still out there.

Our second half priorities to deliver on what we save within a deliver maintains and progress on the transformation that I talked about earlier, hopefully continue with a more open dialog with the outside world and back at the ranch will be concentrating on this three strategic priorities that drive value.

With that we will move on to questions and answers. Well, questions and we will try to answer. Thank you.

Question-and-Answer Session

Q - Christian Laughlin

Christian Laughlin, Bernstein. Two questions from me, please. First one, particularly for Warren, in regards to your ongoing review, what have you learned over the last six months, incrementally? And how have these insights influenced what your vision is shaping up to be for the future of the Company? That’s the first one.

And then secondly, around the production ramp, in particular, with XSB over the next five years, how confident do you feel about the bottom part of the supply chain? And what I mean around forgings and castings, where, in particular, Rolls-Royce, as well as GE and Pratt & Whitney, are relying on some of the same suppliers to support respective production ramps over the next few years. How’s your confidence level about that part of the supply chain being able to keep up?

Warren East

So your first question, I am afraid, we could go on all morning. But basically, I have continued to learn and I am encourage by the amount of opportunity there is, so for simplifying and taking activity as, I mean some of those numbers that we have put out there on the slide, okay. They are almost anecdotes, but actually some of them are the results of a lot of hard works for a lot of people as the period of time. But that is fantastic improvements. If we are able to really realize that late time transfer, what we proven on Trent 1000 and transfer that to XWB that’s sort of equivalent to almost doubling our capacity with no incremental of additional cost. It’s just material. So I have been hugely encouraged by that over the last six months. So I suppose, it’s been more of a quantification of the opportunities that I felt that was there in the first place. As I say, if we go on all morning there is a lots of that.

In terms of about the supply chain, we are talking about a significant increase in volume for us and to be industry as a whole. But when it compared with the other activities in some of these companies do, it’s not actually that significant an increase in volume. We work closely with these companies and there are always challenges in terms of actual deliveries, but we have teams embedded in these suppliers that work with them on a day-to-day basis and solve the problems as an when they arrived, I am not pretending that they are no issues, but I am comfortable with the way in which we interrupt with the suppliers at an engineering level.

Ben Fidler

Good morning, it’s Ben Fidler, from Deutsche. A couple of questions please. Are you able to share with this how many spare engines you delivered in the first half, and what that was year-over-year? You mentioned that was quite of significant driven of the growth that will be helpful. And secondly, I see you have increased TotalCare net debtor guidance by about $100 million to $200 million over the next 12 months, does that mean we should be thinking that several profits will be $100 million to $200 million higher than what we were previously expecting over the next 12 months? And the third question, I know on the accounting stuff and thank you very much for the early heads up on that, I think it’s been a fascinating part of the release this morning, the profit effects my head is not big enough to understand that for some time but just picking with the easier part which is the revenue effect, are you able to give us any indication of how much in civil aero this could see a revenue impact from both the OE as you no longer have that future pull forward, and secondly on the shop visits which you won’t be booking? On the revenues you won’t be booking until shop visit with a lot of fleet still being relatively young as you demonstrated in your slide 49. Presumably anything less from five years on that chart, isn’t going to actually benefit going through the revenue line under IFRS15 on shop visits? Just any sort of steer on that would be very helpful, at least to understand some revenue guiding effects in civil? Thank you.

David Smith

Why don’t I try that in reverse order, while I try and find the spare engine number? So, yes, in terms of IFRS15, I don’t want to get into numbers. It’s complex, Ben, and I think we are all going to be challenged by this. The combination of -- the fact that we have some engines already currently in service like Trent 700, the effects will be different from new engines like XWB, it means that we have to go back and look at this actually on contract-by- contract basis and work our way through that in creating the RRSP tails and all that sort of thing. Your main point that there is going to be timing difference so I completely agree with. And that’s one of the things that we need to understand better in terms of four new projects in particular the later booking of revenue. So I am not able to quantify that at the moment and that is what we are working through.

In terms of the TC effect, so part of this is what we have already actually seen which is to long term planning rate did have an effect so that those come through the TCA net debtor. We also expect, probably, some higher overall impacts on life time cost improvements in the second half and that’s offsetting within civil of their issues that we have are particularly on the engineering spend that we have seen increased. So yes the risk going to be a change in the mix of civil profit but not to net improvement when we take all that in to accounts and that’s why we have adjusted the TCA range a little bit because as you obviously figured some of those effects come through in the TCA net debtor.

Helen, can you help me. I know it’s in here but…

UnidentifiedCompany Representative

It’s just small number Ben, there are a few more…

Warren East

I think it was more a reflection of XWB is a new engine, airlines are taking this engine for the first time, we need to put more spare engines around so that we can satisfy that.

David Smith

We will see more in the second half, so the second half effect is quite a bit bigger, because in the first half, we sold three XWB spare engines, something like. We’re going to see a lot more from that in the second half.

John Dawson

So we have a question from the webcast, if I may, from David Perry. It’s a question for Warren. There have been described press reports that Rolls-Royce could achieve significantly higher cost savings then the formal plan currently in place. Could you comment on these reports, please?

Warren East

Yes, obviously I’ve seen those reports, and talked about them with journalists, this is performance gap between ourselves and, if you like, people seen as the market leaders. And first point and I think, number one difference between our civil aerospace profitability and that of our number one competitor is driven by the difference in maturity of our fleets. We have a young fleet, the proportion of aftermarket, which is relatively profitable compared with OE, which is relatively less profitable, is skewed in our case, more to the OE, then it’s in the case of our number one competitors. When you put two pieces together, they are going to be significantly more profitable, then we are. So some of it is a business model maturity factor, the rest of it is indeed performance gap and that performance gap that I see no reason, why we come close and that’s what our transformation program is about. In terms of quantifying it we quantified the savings that we expect to be able to make for the end of 2017, we’re reporting this morning, we’re very pleased with the progress over the six months. The top end of our expectations in terms of that trajectory. And as when we communicate, we probably end up, we probably will, as David said, IFRS teach-in, and we probably need to do an update, as we get towards the backend of this year. As how we’re doing on the transformation program then, and may be we’ll talk about rolling the targets a little bit further out. But, for now, I would like to concentrate on actually delivering, what we’ve said, we’re going to deliver.

As and when we can talk about fresh targets, we will, but I don’t think the performance gap is another reasonable performance gap to think about closing.

Gordon Hunting

Gordon Hunting, Fiske. On something quite specific on the TP400, why aren’t the blames put to GE FiatAveo; why do you have to pay? Secondly Pratt’s have also got a problem on planetary gear boxes, whereas you have fantastic expertise on the J35 and the S35bB, why can’t you profitably help those other two manufacturers to sort out their problems?

Warren East

On the specific of the TP400, it’s not a question of asking for any inadequacies called by other people. It’s a question of us as part of the consortium, helping our customer to solve a problem, I mean for instance, one of the things our team has done over the last several months is vastly reduced the cycle time to take one of these engines and service it, mainly by removing the need to take the engine off the wing and to actually create some apparatus which enables us to service it on the wing. Hence, reduce the cycle time from about three weeks to about two days. And that’s great as far as the customer’s concern it’s actually great as far as we concerned as well. But it does cost. And fairly it’s a cost of developing some of that sort of stuff that we book today. We haven’t taken the cost of somebody else’s problems.

UnidentifiedAnalyst

A very mundane question, when did last change of planning rate?

David Smith

It was actually about a decade ago. And we review it every year, and I felt given our actual experience on the right side of the last 20 years, I couldn’t justify these unit where it was, and that was something we discuss with our auditors as well, so I think that was the right decision to make.

Unidentified Analyst

If I remember correctly, the last adjustment probably came when the hedge book was at about 183 or something.

David Smith

It was around that numbers, Sandy. But when we look at the data, it was fairly clear that we needed to make a change. We are not necessarily even responding to these short-terms spot movements, it was much more just to progression of what we seen in the last few years.

Unidentified Analyst

Thank you. And then I mean we are in a hurry, but on fascinated by this Trent 1000 thing, but while I am fascinated business the technical cost that go on and on, I mean things happens. But I am really fascinated by this Singapore thing, because I can understand how you get a lead time change in Singapore because we kind of also made our life more difficult but putting it’s in Singapore, for that to be to able to bring XWB down 50% that would be astonishing.

David Smith

As I said in terms of how I prevent it basically. If we make across what the changes that we have made to the processes and procedures then that’s what we can achieve. It’s unproven at the main, because we haven’t that come across. And it’s goes a bit of a random. I think what is defiantly in there, however is but the improvement is very significant, sort of potential improvements very significant.

Unidentified Analyst

It’s just fascinating.

David Smith

Yes.

Unidentified Analyst

And then will that going into numbers in IFRS 15 but TotalCare. I can’t imagine it’s going to change things where we make or assemble, I don’t believe these people can work at TotalCare. But in terms of our commercial approach, is that going to change do you thing the business for the better in terms of focus on cash or focus on profits or whatever? Thank you.

David Smith

I think it completely underlying that focus on cash that we have been trying to actually change over the last couple of years in the business anyway. I made the point, the way to mitigate the cause affect to get the cash flow as quickly as possibly can. But equally managing the whole cash is going to be very important here. So I think it will help internally because it’s removing some of the barriers are internally in terms of just to understanding the number, I think it will help externally, because of getting a closer alignment of profit and cash over time. But absolutely running the business and trying to improve cash conversion is a clear imperative, whether we have the accounting change or not, to be quite on us but that gives added impetus to it.

John Dawson

We have got one from the webcast. Just a one more question from the webcast in the time we have got available. Apologies, we do need to finish at 10, to give your chance to get onto other meetings. So this is a question from Chris Hallum on the new accounting basis will you still disclose all the various elements that you are currently intended disclosure down to engine flying hour payments and engine losses et cetera that you set out back in February?

David Smith

I certainly don’t see its moving away from the enhanced disclosure. It may be as we look at standard further there is some other things we want to describe as well so it’s a clearly one of the things that we all have to think about our these types of model the shop visit outside of things. So I think it’s a bit early to get into that yet but there will be implications like that we need to think about this.

John Dawson

We have got another -- I think we’ve probably got time for another couple from around the floor.

Harry Breach

It’s Harry Breach from Raymond James. Three quick ones. Firstly can you help us think a little bit about where we are with the part Trent 800 situation, where in terms of -- how many of those moved during the first half and broadly, where the parked fleet is that?

Secondly just looking at civil aerospace now I’m very slow on the uptake at the best of times, but aftermarket change at constant effects negative 5% in the first half and I think David you called out T&M down on the 500, 800 RB211 RJs. Given that T&M I think last time I recall seeing a comp was about 27% of overall aftermarket at civil and presumably the TCA side grew in line with flying hours on the Trent fleet, does that imply T&M was down really quite hard, like 20% year-on-year?

David Smith

T&M was down and what I think in roughly revenue terms it was around the 100 million or something like that.

Harry Breach

The final one was just about marine I appreciate the oil prices moved up a little bit it’s not long since it bottomed, just one if you are seeing any early signs sort of behavioral changes from your offshore customers, any signs of bottoming now?

Warren East

Okay, I’ll answer that one and then get back to the 300, 800. The answer on marine is that -- it does appear that we are moving along the bottom rather than getting worse. I think the change in behavior is that we are not seeing through the declines. But if you think about it service point of view people have still got plenty of spare boats out there to go and remove components from to service the ones that they actually want to use. On the Trent 800 then we are making good progress I think I put on the slide the effectiveness of the team there in terms of getting airplanes back into service and I believe the numbers that we are talking about ran by 13 airplanes are being that place in the first half. And we have a further 28 where owners have been identified. And that’s a big improvement compared with where we were a year ago.

Overall it’s a bit shy of 10% I believe.

Rami Myerson

Rami Myerson for Investec. Just two questions on the working capital. There has been a lot of discussion in the last few weeks about a deterioration in terms of payment to suppliers. I’m just curious if some of the improvement in working capital was due to the delayed payments to some of your supplier and if you’re planning and changing terms?

David Smith

No, there was an effect. Actually, there were some FX effects, as, I think, I mentioned on payables, but not from terms. We’ve actually, or we may have done already I can’t remember exactly the timing, we’re issuing a new policy and we’re absolutely coming on both within the new voluntary, the new version of the voluntary code that the government has encouraged, particularly around earlier payments to smaller suppliers as well.

John Dawson

With that, I’m afraid, we have reached 10 o’clock. And so we’re going to call a halt to the general Q&A there, so those who want to rush off can rush. And probably do one or two questions as we’re leaving as well. Thank you very much, everybody.

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