Rolls-Royce Holdings' (RRCEF) CEO David East on Q4 2015 Results - Earnings Call Transcript

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Rolls-Royce Holdings Plc (RRCEF) Q4 2015 Earnings Conference Call February 12, 2016 4:00 AM ET

Executives

John Dawson - Director, Investor Relations

David East - Chief Executive Officer & Director

David Smith - Chief Financial Officer & Director

Analysts

Nick Cunningham - Agency Partners

Edward Stacey - Haitong Securities

Christian Laughlin - Sanford C. Bernstein

David Perry - JPMorgan Securities

Jaime Rowbotham - Morgan Stanley & Co.

Rami Myerson - Investec Bank Plc

Benjamin Fidler - Deutsche Bank

Celine Fornaro - Merrill Lynch

John Dawson

Excellent. Okay. Well, it looks like everybody's in. So, good morning, ladies and gentlemen, and welcome to - you're all here in London and to those joining on our webcast presentation today.

My name is John Dawson. I'm the Head of Investor Relations for Rolls-Royce, and it is my pleasure to welcome you and to introduce Warren East, our Chief Executive; and David Smith, our Group Finance Director.

The running order of today is as follows. So, following - Warren will take you through the highlights of 2015. David Smith will then review our financial results in more detail and take you through some additional business disclosures. Warren will then return to share some further thoughts on the next steps we're going to be taking. We'll then turn the proceedings over to questions.

We have quite a lot to cover, so we're expecting the presentation to run for about 40 minutes to 45 minutes, but we've allowed time for questions at the end. We will be able to field some questions from the webcast, so if you wish to submit a question, please enter it into the system and one of the IR team will read it out. If we don't get a chance to cover all those questions, we'll make sure we follow up with you later.

There were no planned safety alerts, so if the alarms do go off, just follow the signs and exit the building in an orderly fashion. Worth saying we may also include some forward-looking statements, so please refer to the disclosures in the back of our results pack.

Finally, before we begin, could I just ask you to make sure you've turned off all your mobile phones and other devices.

Thank you. And without further ado, I'll hand you over to Warren.

David East

Great. Thank you, John, and good morning, everybody. The last time I was presenting in this room, it was actually to a bunch of lawyers at The London Patent Summit. So, this morning is much more interesting. And it's actually going to be a little bit longer than our usual presentation as well because, as promised in November, we're including a little bit more disclosure, and David's going to take you through that in a few moments.

I'll start off, however, just with having a quick review of 2015, some of my thoughts on that as well. So, we've delivered 2015 in line with the expectations that we set out earlier in the year, with revenue at just under £13.5 billion. That produced a gross margin of just over £3 billion. And I think we're well known that that was driven by the reduction in gross margin there driven by weakness in our Marine sector and through various mix effects in our Civil Aerospace sector. So, the underlying profit was down as well. And that had an effect on the operating margin.

I think the cash at the - at the very, very end of the year, the cash did surprise us slightly on the upside, ahead of our expectations in November. And David's going to cover that shortly. I think news this morning, although we did again talk about this in November, as far as dividend is concerned, it's very important that we make the transformations that we've been talking about in this business happen. And those transformations do require investment and that does put pressure on cash.

At the same time, we need to retain a healthy balance sheet, which gives us flexibility and preserves our credit rating. And so, the board has decided that we will halve the payment to shareholders - for the final payment for 2015 and halve the interim payment for 2016. But it is our intention to keep that under review. And subject to the short-term cash requirements, we intend to rebuild that, which reflects mine and the board's confidence in the future cash generation of the business. So, that dividend move is important for us.

Now, I just wanted to share some of my thoughts on what really went on in 2015, but I don't seem to be able to - there we go - kind of advance the slide. And I'll start - and I think there were some good things and some bad things. So, I'll start with the things that went well in the markets in which we operate. In the civil market, we saw Trent XWB, our new engine, do its first full year of service. And we've passed that milestone now. The ramp-up in production that we foresee over the coming years, we're well positioned for that.

Overall, in Q4 last year, we delivered nearly 100 engines, including XWB, that's on the back of large engines. That's out of a total of just over 300 for the year. So, you can see the trajectory developing there, the capacity is in place as a result of the investment that we've been making. So, we're now very well positioned to exploit that new capacity and deal with the XWB ramp-up.

Our Trent 1000 TEN, the latest version of the Trent 1000 engine, we did incur a few extra costs there to push that through tests during 2015, but that's now happened. And it's clear that we've made a major advance with the Trent 1000 TEN, and we're very, very pleased with the performance of that engine and that positions us very well to gain market share on the platform for that engine, on the 787.

So, from an orders point of view, it was also a strong year for new orders in civil sector. Clearly, the highlight was probably the Trent 900 engine order from Emirates half-way through the year, but also towards the back-end of the year with orders from the Chinese airlines. And you saw some noise by that as well. So, overall, we delivered just over 300 large civil engines and we took orders for nearly 500 large civil engines during the year. The backlog is therefore up and it's up about 4%, which is good.

Switching to Defence Aerospace. I think the story there, revenue slightly down. There is weakness in demand there, particularly in helicopters and some of our transport business. But, in spite of that, there was a modest increase in the profit from that group, and that's been driven by the effectiveness of the cost activities that we've been undertaking there. So, that I think was a highlight for that business.

Moving around the other parts of the business, in Power Systems, now that was a very good result for the full year. There was a strong mix effect across - in playing into different end applications there. And a strong finish to the year and a strong finish in terms of taking orders as we look forward as well. So, we're quite well positioned now going into 2016 in Power Systems.

In Marine, we all know that our business is exposed to the offshore sector. And we all know that there are serious problems in the offshore sector driven by the price of oil. But we have taken swift action on cost reduction. There's some very challenging reorganizations going on. But the folks in the business there have really taken - they've grasped that metal and getting on with it, and I found that very - very encouraging.

And in Nuclear, we've had some very steady performance. So group-wide, there have been some good news stories in 2015. I think we're going to have to change the battery in this thing at some stage. And can you just advance that one instead? There we go. Thank you.

But, of course, it hasn't all been glorious. I do understand there were some issues in 2015 and these issues emerged. We talked a lot about them in the second half of 2015, changes in the Civil Aerospace market, and in particular, how we communicated about those changes over the period. Now, some of that was directly linked to the speed and complexity of decision-making within our organization, and that's highlighted to me that we're just not nimble enough and we need to do something about it.

Some of that is associated with sort of how we're integrated together and how we work together within the business, and that's a real issue; part of our transformation program is addressing that. Another part of our transformation program is addressing the thing which became very stark with our announcement in November, the fact that our fixed cost base is simply too high, it makes us very sensitive to market changes and that's not acceptable, and we are doing something about it.

And underlying all of that, of course, the famous TotalCare accounting complexity. Now, when I look at that, there's nothing intrinsically wrong with it, absolutely nothing particularly in steady state. But clearly, when we move from one business model to another, it doesn't handle that transition very well and compounding that, I understand we haven't done a very good job at explaining it. So these are the issues which emerged in 2015, some good things and some bad things.

So, my first month in the business last July, I have to say, it was an interesting month, to say the least. And at the end of July, I had established five goals for the remaining part of 2015, and these are the five goals. It was to sort of thoroughly understand the business, the products, the processes, the management structure we had to try to identify areas of improvement; at the same time, keep the wheels turning on the business. And we delivered what we said we were going to deliver in 2015, and we've not changed our outlook for 2016 this morning. So, that was also done.

And we are making progress on working out how to communicate better, and you're going to see some of that from David's talk in a moment or two. And there's a lot more to be done, and another one of my objectives was to work out what those priorities for 2016 would be. And I'll come back and talk about those priorities in a moment when David has just talked through some of the numbers.

So, with that, I'll hand over to David at this stage.

David Smith

So, thank you, Warren, and good morning to everybody. Well, I hope you found the statement informative, as we provide greater disclosure and context. We've also included within this presentation further slides to paint a clearer picture as we navigate through some of the challenging market conditions, the product transitions in Civil Aerospace, and our significant transformation program.

As Warren said, I should warn you that this will make it a longer commentary than normal given the introduction of the new disclosures, but I think we've improved how we talk about expectations both for the current year, and I hope we're, therefore, meeting - as we meet with many of you on our road show, help you to progress your understanding of those new disclosures as well.

So, let me turn now to the review of 2015, and during this, when I give a percentage figure, I'm going to be doing that at constant FX rates unless I specify otherwise. So, starting with the group highlights. As Warren said, 2000 (sic) [2015] was a solid trading performance given the outlook, deteriorating in some of our key markets, particularly Marine. Our trading outlook for 2016 is also unchanged from the one that we shared in November. Our order book grew 4%, particularly in Aerospace, including the record $9 billion order from Emirates, but there's no surprise that our Marine order intake was very weak.

While revenues held up well after adjusting for FX, profit before tax declined by 12%, and that included two credits for an intellectual property settlement and an R&D credit. Our free cash flow also reduced from last year. On the shareholder payment, as Warren said, I think it's essential that we take a disciplined approach to our financial policy here and manage both the expectation of our shareholders in a balanced way, and I believe that the 50% reduction is a prudent and measured response to what we see before us and the current macro environment.

So, group revenue, and this is the comparison to 2014. Underlying group revenue declined by 1%, with growth in Civil Aerospace offsetting weakness in Marine. OE revenue fell by 5%, but was partially offset by a 4% increase in service revenue, particularly in Civil. FX translation effects totaled £414 million, and that took 3% off the revenue line and primarily reflected weaker European currencies.

So, turning now to profit. The underlying result was in line with the guidance range of £1.325 billion to £1.475 billion that we gave at the half year, albeit at the lower end when I adjust for the two credit items that I've already mentioned. There were significant reductions in Marine and Civil profits of similar absolute amounts year-over-year and a more modest decline in Power Systems.

The impacts by business driver were primarily from gross margin, £311 million gross margin reduction. I'm going to talk about that in more detail as I go through each of the businesses. A small overall improvement in C&A costs.

On R&D, we did invest further on R&D for the new Trent programs, plus the work that we're doing on the next-generation technologies across a number of our businesses. And that together increased the net R&D charge by £83 million for the year. And within that, the R&D spend was up by about 5%. And there was also a significant decline in capitalization of R&D, and an increase in amortization and further higher development cost contributions. So, those net brought about this £83 million increase in the charge.

On restructuring, we had a lower underlying restructuring charge for the year at £108 million, less than 2014. That was principally because we took the charges, as you know, for the big programs at the end of 2014 that we announced before November.

And as I mentioned, we benefited from a £58 million gain on intellectual property and £19 million for an R&D credit in nuclear. FX wasn't a major factor for profits net in the year.

So, let's move now to cash flow. Free cash flow for the year was £179 million. As Warren said, that was ahead of our expectations, principally due to customer seats coming very late in the year, which we've been expecting in 2016. So, those will naturally reverse early in this year and our outlook reflects that.

Having added back depreciation and amortization, which is slightly down from last year, the most significant movements were as follows. So within net working capital of £544 million negative, that was predominantly around a £406 million increase in the civil long-term contract balance, which now stands at £2.2 billion. There were also higher trade receivables, but that was offset by a reduction in inventory. And our inventory turns improved to 3.4 times.

Our cash spend on capital expenditure was £479 million, that was lower than the prior year, but it still included new test facilities together with the turbine blade and disc manufacturing and other production facility upgrades that we've been talking about.

Our intangibles additions of just over £400 million were principally within Civil Aerospace and included the growth in contractual aftermarket rights that comes from additional unlinked engine sales, and further beyond that are certification software and development costs.

And then, finally, the other, the £229 million was one of the main drivers of cash outflow. And that essentially is because we took the restructuring provisions in 2014, and the cash came out in 2015. So, we get, therefore, to a trading cash flow of £385 million and that was then further reduced by £160 million of tax payments, and £46 million of pension contributions over and above the profit charge within the profit number. And that gets you to the £179 million for the year. So, cash conversion was down year-over-year, from 54% to 27%. And I'll just to remind you again that we do cash conversion on trading cash flow compared to profit.

Turning now to our balance sheet. We've maintained a strong investment grade credit rating. We've worked very hard at this. Standard & Poor's updated their rating in January. We moved to an A- outlook while Moody's have maintained their current rating at A3 stable. And that did follow very detailed discussions with the two agencies, who I believe took a very constructive and considered approach to our more challenged outlook.

Also last year, following the October refinancing and the debt raise, we've now total liquidity of around £5 billion, and also extended our average maturity out to over six years. Our plans for this year include redeeming a couple of smaller facilities, which total just over £200 million. And we obviously had that in mind when we raised the $1.5 billion bond in October.

So, I'll come back to FX hedging in a moment, but I wanted to go straight to the shareholder payment. And as Warren said, the board has taken the decision now to halve the level of the final payment to shareholders when compared to last year's final payment. And to do this again at the 2016 interim stage against the 2015 interim. So, as a consequence going forward, cumulatively, this will have reduced by 50% the shareholder payments over the next 12 months.

As we pay both interim and final in the subsequent year to when they're declared our 2015 cash wasn't affected by this decision, but clearly, 2016 cash below trading cash flow will benefit. Beyond this future dividend policy, we'll have a stronger relationship with our cash generation capabilities as noted in the statement. I think Warren has already covered that quite well.

In terms of foreign exchange translation. So, just to remind you, our main foreign exchange exposures are really within the Aerospace division where we hedged our net U.S. dollar loan position against pounds and euros respectively. And at year-end, we had a hedge book on the dollar of $29 billion, which is roughly five years of cover.

We also have a $3 billion roughly euro-dollar hedge book, which is around three years of cover. And the objective of our FX hedging policy is to reduce FX volatility over time, and smooth the achieved rates over that period. It's a very conservative policy. It sets maximum and minimal levels of hedging. And it allows us to take advantage of attractive FX rates while not exceeding certain cover ratios. We do build flexibility in the instruments that we used to do the hedging, and that manage changes in forecast exposure in any one period through order pull aheads or delays.

Consequently, in my view analysis of the hedge book straight by calendar year is not particularly relevant. I don't believe that's particularly helpful. And we've told you here, what the average hedge book rates is over the whole hedge period.

So, let's move on now to the business reviews, starting with Civil. Consistent with the plans that we laid out in November. We have enhanced the financial disclosures for all of our reporting segments. And within Civil Aerospace in particular, we provided some additional revenue segmentation and a trading cash flow breakdown for the first time.

So, starting with revenue. For Civil, our revenues increased by 3%. We saw growth in the aftermarket revenues. And that was partly offset by a reduction in OE sales. And that's largely down to reduced corporate engine volumes as opposed to widebody. The services growth did include £189 million of TotalCare retrospective adjustments. And I'm going to back to that at a moment. We saw the similar number of large engines in 2015 as we did in 2014, just over 300 in each case, but our corporate engine volumes fell back because of weaker customer demand. The impact of foreign exchange on Civil was £105 million adverse and that made about a point of difference on the numbers as well.

So, Civil Aerospace revenue. Let's break that down now, and look at the performance in the various categories, as we said we would do in November. And I'll also be giving or our views on 2016 based on the same segmentation. So, revenue from large engines linked and other, which includes spare engines, reduced by 11%. And that reflected the reduction in the Trent 700 and Trent 900 production volumes, and was partly offset by the increase linked to Trent 1000 sales. Unlinked installed large engines increased by 29% albeit from quite a low base, and largely reflected the higher deliveries of unlinked Trent XWBs for the Airbus A350.

We had good OE revenue growth within corporate from the recently launched BR725, which powers the Gulfstream 650ER, but this was more than offset by lower volumes of other products as we saw weaker demand in the sector due to weaker demand for Russia, Brazil, China, et cetera.

Revenues from our V2500 original equipment sales, so, these are the modules we provide into the consortium, also reduced on the back of lower volumes. So, the airframer is starting to migrate now, obviously, to the A320neo production. And that impacted us last year as it will further this year and next year.

As part of our work on refining the disclosures, we've also made a change to the breakdown that we give you on reported 2014 revenue. And that resulted in £198 million movement to reclassification between aftermarket and OE sales. While it doesn't have any impact on the accounting or the business or group level, I think it does give a better alignment of the reporting that we do to you to how the accounting actually works on those long-term contracts.

So, turning now to Civil revenue aftermarket. The large engine aftermarket revenues were up by 17%. That was driven by increased flying hours from the growing fleet of our newly-installed Trents, but offset by lower utilization on the older Trent 800s, Trent 500s and RB211s as we talked about in the last couple of meetings.

These 2015 aftermarket revenues also benefited from the non-recurring £189 million refinement that we made in 2015 to the way we measure our valuation risk contingency, which, effectively, is the way that we look at credit on airlines. And that improves the granularity of the credit analysis.

For example, we can now, under our new policy, apply a full 100% haircut to a specific contract value if we perceive customer default is more likely, but we've reduced contingency rates for stronger credit airlines. And the net effect of those adjustments have been considered as we gave our updates earlier last year.

Our installed base of corporate engines continue to grow, however, and contributed to also to a 13% increase in service revenues on corporate. As expected, our revenues from the regional aftermarket business declined reflecting retirements and reduced utilization of our fleets primarily by North American operators.

This will continue as we move forward as we discussed again last year. The aftermarket revenues for the V2500 are actually broadly unchanged in the year. Now those will increase over time as we also discussed previously.

Civil Aerospace gross margin. So this is the first slide in our new format, now that we're providing greater disclosure around the elements of profit within each of our business segments. Gross margin for Civil reduced by £139 million to £1.5 billion in 2015. And the main trading factors here were the reduction in the linked OE Trent 700 sales, the weaker performance in corporate jet sales and the declining regional aftermarket. And that was partially offset by growth, as I mentioned previously, in installed base of Trents.

The margin also benefited from catch-up contract accounting adjustments. And they totaled £222 million in absolute terms for the year as set out in the statement. And the comprises the methodology refinements I've just mentioned, the £189 million, plus £140 million of in-year life cycle cost improvements, partially offset by £107 million of other operational factors. So, a total of £222 million. And that compares to £150 million last year, which is where we get the £72 million year-over-year effect.

These different items were all broadly expected at the half year and reflected in the guidance we gave at that time. And on the waterfall slide in front of you, as I said, this produces a year-over-year movement of £72 million. So, the £189 million of catch-up, the £117 million of net movements over 2014 from the life cycle costs and operational factors.

We also had, in addition to that, an £84 million year-over-year movement on the Trent 1000, and that follows some detailed and positive engine analysis on the first service. This was recorded as a £65 million in-year benefit by reversing a balance sheet provision that we'd taken to previously impair contractual aftermarket rights.

So, a lot there, but hopefully that's providing more granularity. Turning now, therefore, to the overall civil profit movement. In addition to that gross margin move, we had some big swings in both net R&D and restructuring costs, and that's consistent with civil share of the group analysis that I covered earlier. And primarily driven by the spend obviously on the Trent 7000, and the spend as we approach flight testing on the -TEN and the XWB-97K. Entry into service of the XW-84k [XWB-84k] also had an effect not on spend but through capitalization and amortization of R&D.

So, again a new slide here, trading cash flow for Civil Aerospace. So, Civil Aerospace for the year was breakeven and that compared to roughly £181 million inflow in 2014. It was up about £48 million however, before we take account of working capital movements. The £130 million lower underlying profit was a clear driver.

We also had a slight reduction in the level of total care net debt to gross in the year, and an increasing contractual aftermarket rights additions. The year-on-year change of £268 million in working capital was effectively down to timing differences of payments to suppliers and an increased drawdown of deposits in 2015.

Other significant movements include around £110 million of lower CapEx as we slowed down major development efforts in 2014, £135 million of lower certification and development costs and £29 million higher D&A

Right. Now, let's turn now to the outlook. Again, with Civil, this is a slide format that I shared with you in November and follows the segmentation disclosure that we gave on 2015. For OE revenues, we expect an increase in the large engine revenues. Overall, there'll be an increase in widebody engine deliveries from just over 300 to around 400 engines in 2016, led by higher volumes on Trent 900 and XWB deliveries, offsetting somewhat the decline in Trent 700 production we've talked about many times before.

Other dynamics within OE revenue include the market-led corporate jet declines and the ongoing reduction in V2500 module revenues.

Within the aftermarket, I'd expect large engine to be slightly lower year-on-year as increased revenue from our growing installed base is offset with the aftermarket headwinds that we discussed in July and November. And this is after excluding the non-repeat catch up on the risk methodologies, so the £189 million. We've taken that out of this analysis.

Corporate jets are expected to be broadly flat while regional aftermarket revenues will continue their decline and V2500 aftermarket revenue should be broadly unchanged to slightly up in 2016, reflecting the expected maintenance activity on our modules.

On this slide, really, I just wanted to remind you, again, of what we told you before in terms of the profit headwinds that we see for the Civil business, which, in aggregate, comes to a net £550 million. This is unchanged from the expectation that we gave previously, and we don't see any reason to change that absent any external market conditions or rate changes from the airframes.

Turning now to cash flow outlook and looking at trading cash flow outlook. This is - I struggled a little bit with this slide, so bear with me. We start with identifying the £550 million of headwinds impacting profit. So this will reduce cash flow, and that's why we've shown it with a downward pointing arrow. So, that's the logic here. The downward-pointing arrow shows a reduction in cash flow, not a change in the magnitude of the figure.

We would expect an increase in the net debt of 2016 as linked high-margin Trent 700s are delivered, but not to the magnitude of this year. This movement is expected to be as much related to cost improvements coming through and renewed activity in linked programs as being from any other adjustments. We've therefore shown that with an upward arrow as it's less of a drain in 2015, the growth is less than the prior year.

We'd expect the Civil debt to peak to be around £2.5 billion as we continue to be more confident over achievable lifecycle cost improvements coming from the successful launches and further services. As a quick reminder, the net debt figure in the group balance sheet was - is a little bit lower than the Civil number because there's some negatives in other business. It was about £39 million last year.

The cost balance will also increase in 2016 because we saw more unlinked engines. But while volumes arise, we're also looking for some improvements in unit costs, which will moderate that growth to be about the same as it was in 2015.

One of my personal challenges to the business is to improve the various inputs to trade working capital, particularly, better inventory turns through leaner manufacturing techniques and supply chain improvements. We'd expect this to improve cash flow for the year.

And then, finally, within Other, there will be an increased spend on development cost certifications and PPE as we ramp up production capability, and that will reduce cash flow. So, overall, we'd expect trading cash flow to be negative in 2016 compared to the breakeven in 2015. And that will form a significant portion of the group movement in cash flow we've indicated for the year.

So, turning now to Defence. The Defence revenue chart shows a 5% decline split pretty evenly between OE and Services. By category, the lower OE volumes were due to slower volumes in helicopter and trainers, partially offset by growth in transport and patrol and combat.

Lower volumes in helicopter-related spares also impacted on Service revenues, although revenues were supported by higher volumes related to long-term service contracts on combat aircraft. The FX impact was around £67 million, so relatively modest.

For the gross margin analysis, we've pretty well immersed the revenue profile together with a one-off margin improvement on existing long-term service contracts. These LTSA improvements reflect changed flying patterns and improved cost on various combat platforms. And just to note, the benefit in 2015 was sort of an exceptionally high level, representing an increase of £47 million over 2014. We don't think that that's going to be repeat in 2016. This helpful overall gross margin - this helped overall gross margin, however, which improved from 27.4% to 28.4% for the year.

In terms of the profit overview then, underlying profit performance rose by 4% from the prior year. There was a £20 million in R&D cost and that reflects some of the increased investments we're making in next-generation technology platforms. Offsetting that was a lower restructuring cost again because some of the major downsizing exercise came in 2014.

So, the outlook for Defence, we're very positive still on this. So, pretty positive still on this about the long-term outlook. Defence includes a high proportion of revenues from availability-based service contracts, where we've had significant experience in maximizing productivity and returns. However, short term, there is going to be some operating market pressure over the next few years. As a consequence, both the pricing pressure, some increased R&D and also the operational restructuring that we announced in Indianapolis.

Ongoing free cash flow is, however, expected to remain strong, although at a lower level due to some of those investments. There was a drag for at least a couple of years. The benefits of the modern plants on a significantly smaller footprint will be very notable when those come through.

Power Systems. Turning to Power Systems. Underlying revenue of £2.6 billion was 3% lower. That comprised lower OE revenue, offset partially by a small rise in service revenue. The FX impact was - of around 10% was significant. It was due to the euro weakness coinciding especially with higher sales activities later on in the year.

And partly, OE decline was impacted by strong governmental business in the prior year where we've had several significant project orders but also reflected the negative oil and gas market. More positively, the luxury yacht business grew strongly and we also saw growth in construction and agriculture helped by demand for new emissions regulation compliant products. The order book at the end of the year was broadly unchanged at £1.9 billion, reflecting quite a diverse set of end markets and a resilience particularly within the defense sector.

For gross margin, looking at this gross margin waterfall, the drivers of its kind from 2014 really fall into three buckets. Firstly, lower overall volumes impacted by about £20 million. And that was broadly offset by a decline in warranty costs in the prior year where we'd encountered some previous technical challenges which we've now been successfully able to overcome.

Overall, the £41 million impact of pricing pressure and adverse mix, business mix on margins such as, for example, lower naval mix but higher agricultural sales was the most significant influence on our gross margin for the year.

And then the overview on profit, other than the gross margin just discussed, the other slightly material event was the FX impact of the sterling-euro movement, which was £22 million for the year which is a drag on the reported numbers. So turning now to the outlook. The outlook is steady. As we stand here today, the outlook remains positive, supported by a healthy order book for a number of key markets.

So turning to Marine. The revenue and gross margin slides for Marine show just how challenging this market environment has been for us. OE sales were down 19% while service revenues were more robust but still 10% lower. The large FX impact was from the movements in the Norwegian kroner in particular.

The order book fell sharply during the year from £1.6 billion to £1.1 billion with very weak order take in the offshore parts of the business. And this reflected the fact that ship owners in both offshore and to some extent merchants segments are significantly reducing their activity both in terms of replacement vessels but also deferring overhaul and maintenance work.

The merchant business did make some progress, however, in specialist areas such as wind farm support vessels, but overall the markets are subdued. The naval business was also down a little particularly in spare volumes, but continued actually to focus on long-term development work and deliveries such as for the U.S. and UK Navy.

In terms of gross margin then, the decline in volumes including some cancelled contracts placed increased pressure and further strain on our gross margins. Together, these produced a negative £139 million movements in gross profit. These included some financial charges which were - a provision related to offshore - an offshore customer contract terminated due to market decisions as well as some other smaller contracts. And the product quality provision that we took in 2014 wasn't repeated this year. So while we take all these factors into account, total gross margins declined to £286 million, as I said, that was a £139 million lower at constant FX.

And really that's the story for Marine. Because we're operating effectively, very close to breakeven in Marine now, that relatively small drop in revenue produced quite a significant drop in gross margin and therefore, a big drop in underlying profit of 94% reflecting the gross margin impact. This was partially offset by some improved C&A costs as we reduced direct - indirect head count and footprint, especially in the second half of the year. But also, we therefore incurred some higher restructuring costs as well. During the year, we announced two large restructuring programs, and that will lead to the reduction of around 1,000 employees in operations and back office functions. We're well through this process now.

So, the Marine outlook, with continuing volatility in the oil markets, I think it's very unlikely that the offshore market will see much improvement and confidence in activity within 2016. As a result, we are continuing to focus on the positioning of the business and addressing its cost base. As Warren discussed in November, part of the cost savings will derive from the programs, but we will be investing some of that back into additional R&D. We'll also seek to develop further relationships and make inroads into the Asian merchant marketplace. Naval is likely to fare better, with some long-term contracts reflecting the great stability of the business.

For the Nuclear business, underlying revenues increased by 9% with OE revenues up 12% and service revenues up 7%. The OE growth came particularly from the Vanguard refueling project together with a Finnish instrument and controls upgrade. Within services, growth came through the refueling project and also a broader spread of Civil projects. Gross margin was lower due to the submarine servicing program and the impact of recognizing revenues where we passed through some subcontractor costs to the project manager at zero margin.

At the profit level, lower R&D expenditure was largely due to the R&D credit. This included a retrospective element back to 2013 where we elected to join the R&D credits regime for the first time for the submarine business. While having no impact on profit after tax, it did move £19 million of credits from the tax charge up to the R&D charge. Overall, the outlook for the Nuclear business remains steady.

So, I'd just like to comment on some more technical elements within our business; in addition to the segment analysis that we've provided you we also actually created an Other category this time, which contains some smaller residual retained assets relating to the energy business; they were previously reported within Nuclear. The value of those isn't particularly material, but we think it helps to split them out. We've also included within that the one-time gain that we saw last year from the intellectual property gain. So, I hope that will make things a little clearer as well.

On finance charges, in 2015, the finance charge number benefited from around £34 million of intra-group dividend hedging. And that was mainly associated with prior year M&A activities. So, the true comparison is really the £94 million to £90 million to £110 million that we're showing on this slide. And we split - the £90 million to £100 split is roughly two-thirds between interests and a third within commercial arrangements.

Our effective tax rate will rise from a 24.5% level in 2015 to probably around 26% in 2016. And that's actually just being driven by the mix of where we make profits into higher tax regions. CapEx will be focused on our Aerospace transformation activity, including the Indianapolis investments. We expect this to increase a little bit from last year's £494 million.

Our net R&D spend will continue on new development programs as we complete some significant new product launches such as the 97k XWB, and we expect net R&D spend should be broadly unchanged or slightly lower.

For free cash flows in 2015, we did come out ahead of expectations, probably £200 million plus ahead of expectations. And that's been led by strong cash receipts including the IP receipt that we got and good management at year-end of inventories. This reflects how varied our cash flows can be at any one moment in time. For 2016, I believe that we'll be in line with our previous expectations of a modest overall outflow somewhere in the £100 million to £300 million negative range.

So thank you for your patience. I know that was a longer presentation. In conclusion, the full-year results were in line with our earlier expectations, albeit at the bottom end of the range. That reflected the challenging oil and gas markets and the transition effects in civil aerospace. Both of these we see continuing throughout this year.

However, from what we know, as we stand here today, our outlook for 2016 is unchanged. With the prudent financial policy and actions we've taken in 2015, we have a stronger balance sheet, a significant growing market share, particularly in our key Aerospace markets, and a transformation plan set to deliver meaningful and sustainable savings. And it is for that reason I remain very positive on the long-term future of this business.

I'm going to now hand back to Warren.

David East

Thank you, David. Thanks very much. Well, there was a lot of information there. But I hope that helps you all to better understand our business, set it in the context of all the other information that you're able to get about the market in which we're operating. So I'm just going to share a few thoughts now on 2016 and what we're going to be doing in 2016.

In November, we've got this slide up outlining our vision and strategy. And I said at that time that the actual articulation that you see here on the slides is work in progress, but the thrust of what's said here is correct. And that remains the case as we go into 2016.

Now, I finished the first part of the presentation talking about five goals for 2015. And the last one of those was to establish our priorities for 2016. So these are our priorities for 2016. And alongside the five goals in 2015, I quickly realized that we needed to add more pace and simplicity into this business. And so, for 2016, we've just got three priorities.

And actually the first of those three priorities is to strength our focus on the three strategic themes that I talked about in November that is, engineering excellence. This business is all about our engineering excellence. And what we need to do now is strengthen our operational excellence. And together those two will enable our strong business model to really work. And that's all about leveraging the installed base. So the first priority for 2016 is to focus our efforts on those three strategic themes.

The second one is the transformation program that I announced in November together with the transformations, which were in-flight both in our Aerospace business, improving our industrial base and the like, that absolutely we need to continue, and we need to get off to a good start in the transformation program I announced in November. 2016 is going to be a pivotal year, and getting off to a good start on that is essential.

And the third point - the third priority for 2016 is about rebuilding trust and confidence in our long-term growth prospects. This is a fantastic business. We are playing into structurally growing markets. We have a great set of products and technologies that people actually want to buy. And all the transformation we're talking about is about improving our profitability, fundamentally. And what's missing is the confidence. And so it's a priority to rebuild that.

So I'll start on the left-hand side of the slide with the first of the three strategic themes. Now, the first one is engineering excellence. Rolls-Royce is all about engineering excellence, and the example here on the left of the slide is showing how we're making our contribution to improving the emission performance of airplanes over the next several decades. And already over the last several years, we've moved from - from 2000, we've moved to well over 10% improvement on the 2000 original carbon emissions with Trent XWB. And with the new engine programs that we have in flight at Rolls-Royce, then you can see that we're making really big strides through our engineering excellence.

But it's not just about the underlying technology and the products that we design. It's also about the technology that goes into how we make these products and how we make the components for these products, our manufacturing technology too. We don't do all of that ourselves. Some of that is done in partnership with other companies and with universities. And this is an example of one such manufacturing technology center.

Now, such facilities as those, of course, help us with our second priority, about driving operational excellence. And those sorts of things are already making a difference. And for instance, in 2015 in our Aerospace products, we achieved a product cost reduction overall of nearly 2%. Some of that came about through better collaboration and partnership with our external suppliers and some of it came by really being able to tightly constrain our cost increases against upward pressure caused by lower utilization of new facilities and inflation. We managed to constrain that against those pressures to 1%. So, overall, an almost 2% improvement in product cost in the year.

A real example of that would be this component, wide-chord fan blade, where by applying some of the manufacturing technology I talked about a moment ago, by basically increasing the amount of automation around one particular critical process, this is quite innovative patented technology. But it enables us to get much, much better consistency, reducing scrap, reducing processing time, producing an overall improvement of 6% in that component cost. So the whole transformation, of course, is the sum of many such projects, but these projects are happening.

In November, I talked about a new form of 80/20 rule, where we're able to produce 80% more components in 20% less footprint. And I talked in November about our aspirations with those goals for 2020, actually 2015 was a pretty good year on that journey. In 2014, the footprint actually went up as we invested in new facilities. But in 2015, we began to come down on this trajectory towards 2020. And so 11% reduction versus our 2013 base achieved by the end of 2015. And that was at the same time as, if you will recall the first part of the presentation when I talked about our volumes being on an increasing trajectory.

Although, the year-on-year volumes look pretty flat there, as I said. By the time we got to Q4, we were pushing out engines at a much higher rate on that journey to 80% more by 2020. So good progress in operational excellence as well, and we need to keep focusing on that as we go through 2015.

Now, the third strategic theme is the installed base. And the big thing about the installed base is that we are in the middle of a transition. We're in the middle of this period, if you take from, say, 2015 to 2025 then we're more than doubling the number of large engines in our installed base. And that obviously puts big pressure on our repair and overhaul network. And it puts big pressure on because we need more capacity, but also because we need more flexibility. So we have made changes in our repair and overhaul network. And we've made changes to increase that capacity, to increase that flexibility and actually, as a consequence as well to increase the competition within the network and so provide better value.

But it isn't just more engines that are out there, there's a change in the nature of those engines. Because if we look between 2005 and 2025, we're increasing by a factor of 100, more than 100, the number of engines that are over 10 years old. And when the engine gets older than it needs different type of maintenance. Customers need a different type of care. And so not only are we changing the structure of our network, we're changing the business models associated with that to deliver better value for our customers as they deal with older engines. And that better value, of course, is then shared with us and makes our business more resilient.

The second priority for 2016 is all about transformation, and I talked about this a lot at the end of last year. We have, since then, installed a transformation team. We've got our team up and running, it's building - we're adding people to that as we speak. And that team is going to ensure governance over all the programs, not just the new program that we announced in November but, actually, making sure that we really deliver on the programs that have already been started.

And it's important that this team achieves a really enduring impact on the business with this transformation activity, and that's what they're doing through process simplification and making sure that our cost reductions are sustainable. And they're also helping to update how we manage that with our key performance indicators. By the time we're done then we'll have much more robust management of, not only the transformation process, but much more robust management of our ongoing performance.

So what's actually happening in all these transformation programs, well, we put this slide up in November, this is a snapshot of the programs announced prior to November, one program in the Aerospace markets and one in Marine. And they are on track come the end of November. And the good news is that reviewing the programs then it looks like there's possibly a modest upside in the benefits that we get from the Aerospace program. The one going on in Marine is at an earlier stage, but that is also on track. So we're on track to deliver these programs.

If I look to the new program - sorry, not quite yet. In the Power Systems parts of our business, we kicked off a new program in the back half or in the back quarter of the year and this is quite an over reaching one. This is looking at all the processes and capabilities that we have in our Power Systems business, it's looking at the market opportunities, making sure that the products are better aligned with the market opportunities and looking at the actual operational performance and how we can improve that. That's underway now, a few months underway, we've got seven work streams up and running on that and I think this part of our business offers great potential.

Now, to the program that we announced in November, we are off to a good start. It's a mixture - if you remember in November, I talked about organizational hardware, that's really the sort of structure of the business, an organizational software which is about the processes and behaviors that you wrap around the organization.

And we've got off to a good start. We've made some structural changes already. We've already identified about half of the target that we set out in November and we've established the cost to achieve that for 2016 looks like it's going to be somewhere between £75 million and £100 million.

But as we go from Q1 into Q2, we'll be moving from structure more into the processes, from the organizational hardware into the organizational software and we'll be doing that, most of the planning for that will be done in Q2. And by the time we get to the end of Q2, we'll be able to update you on progress as we go into implementation on that in the second half of the year.

I think we can now move on to the third goal for 2016. This is about rebuilding trust. Now, this is a hard one. It's obviously going to take some time. I hope we're making our first steps and I hope you've seen the first steps with an improved disclosure and you've seen example of that this morning. Not only what we produce in the slides and what we produce in the release, I hope you're going to see us more open in our discussions. When you talk with us, I hope you'll see us more open and ready to discuss the challenges and opportunities that we have.

Now, to that end, a quick update on where - so where are we on that November program? We set out this timeline in November. I think we're done with the analysis, we're done with the prioritizing, we've got the team up and running. I just talked about some of the initial costings. We're making progress on that. We're starting to develop measures, measures addressing things like unit cost improvements. There will be measures addressing things like cycle time improvement, and we will be communicating along with that time line that we set out during this year.

Crucial to rebuilding confidence and trust, of course, is keeping an eye on the ball, so that we actually realize some of this great future potential. We deliver what we say we're actually going to deliver. And there is tremendous underlying growth in our long-term market. We can see passenger volumes set to continue to increase. I mean, yes, these things will wobble around a bit year-on-year. But over multiple years there is a very solid underpin to our growing market. The quality of our products and our technology is there. You can see that in our growing market share. And the fact that our customers actually want to buy this, you can see in our growing order book. So what we need to do is keep up our investment in R&D to fuel the sort of innovation, some of which I talked about a moment ago, to complete the transformation in our supply chain internally, and improve the collaboration with our external suppliers.

And our backlog is already starting to reflect the value of our products. I'm very confident that our pricing is robust. And our visibility, of course, is good for the long term. Of course, there will be some short-term fluctuations. But you can see evidence which is there to support our confidence in the long-term strength of the business.

Now, there are opportunities in the portfolio as we discussed in November. My focus for 2016 is much more operational, but the opportunities are there. Remember, what we said in November, 75% of this business is very well positioned from a competitive and market attractiveness point of view. Clearly, there is stuff we can do to improve some of the other parts of the portfolio, and we've not forgotten that. We will be getting on with it.

So what sort of things can we do to improve those other - business in those other parts of the portfolio? Well, within our Power Systems and Marine sectors, we talked about improving value-added products and services. By looking at the systems and the products in that portfolio that actually worked together, we're able to pull through sales and make a difference.

To drive the cost competitiveness, yes, there are certain parts of the business where we need to really focus on driving the cost competitiveness. But that can be achieved and, for instance, improvements that we're now making in some of the project management within parts of our nuclear business, not only improving the delivery for customers but, of course, removing a lot of the cost because we're removing a lot of the rework. And strengthening our routes to market, we're already seeing examples of that happening and being reflected in the order book in our Power Systems business.

In Aerospace, it really does remain the fact that installed thrust is a good proxy for aftermarket revenue potential. Now, Installed thrust is all about volume, number of airplanes that are there and the price per flying hour. The price per flying hour increases with thrust because more thrust means more passengers means more value for our customers. And you can see we remain on that cusp of really seriously increasing the size of the installed base. And I think some of the data points that I highlighted earlier in the presentation about how the volumes of orders taken last year compared with the deliveries going out of the door accurately reflect the fact that we're on that cusp.

So that's why we shared these slides with you in November. That's why we're confident about the cash generation of the business. I'm confident that the analysis is robust based on what we can see today, what we can see in our order book, what we can see in our pricing, what we can see in our expected costs, what we can see in the expected utilization from our facilities. And so today, at just over a 30% market share with a journey to a 50% market share, this is what continues to fuel our confidence and what I hope will improve some of the confidence that's out there.

Just want to remind people, there are a few legacy issues and we haven't forgotten those, and we are committed to ensuring the promise of the Rolls-Royce brand, which means, we're doing everything we can to cooperate about these legacy issues. We have addressed them. We continue to address the underlying factors behind the issues and we're absolutely totally firm on zero tolerance to anything untoward.

So in summary, the messages I want to leave this morning, we delivered what we said we were going to deliver in 2015. We're not changing anything about our expectations to 2016. We do understand the issues that we face within our business and we are dealing with them and we're injecting some pace into the way in which we're dealing with them, and I remain very confident in the future as we play into growing markets, growing our market share, and take steps to grow our profitability.

So with that, we'll take some questions. Thank you.

Question-and-Answer Session

A - David East

So, who went first? Starting in the middle row here. You have to arbitrate, I was looking at the chair not...

Nick Cunningham

Thanks. Nick Cunningham from Agency Partners. First of all, thanks for the extra disclosure. Although, I think it'll be a mixed blessing because I'm probably going to lose the next month rebuilding the model. Question on the point you were making about better value for owners of older engines. I mean, does that roughly translate to lower pricing for, say, maintaining 15 year old plus engines? And does that have any effect on the business case when you're looking at, say, an Airbus A380neo with a Trent 9000 or whatever it is.

And then second even broader question, if you like, in the absence of external surprises or sort of macro issues you were mentioning, there's a big caveat. Looking at the moving parts that you do know about within the group, would they make 2016 the worst year in terms of profitability and cash flow? Do those known bits start to get better in 2017? Thank you.

David East

Okay. So the question about the aftermarket and the new models that we've introduced in the aftermarket and delivering extra value. The point here is to better match the customer needs. If we've got an old engine that customers are only going to keep for a relatively limited period of time, then tying in a long period of service agreement doesn't make sense.

More of a sort of pay-as-you-go makes it much easier for the customer. And for us being able to deliver on that through not necessarily supplying totally new parts, but being able to sort of recycle parts from older engines improves our costs at dealing with that. So it's a genuine sort of win-win. And it's trying to be flexible and understanding the position from our customers' point of view. I believe if we're delivering real value like that then we stand a much better chance when it comes to the front-end than signing up the longer-term agreements in the first place.

The actual impact that that has on things like the A380neo program - well, the A380neo program, of course, completely the other end of the timeline. And it doesn't have an impact as far as our business case is concerned because when we do our business cases, we're only taking into account the first part of the life cycle of the engine when we're building our business cases.

David Smith

So, Nick, on your question, I mean, I think this is very consistent that - as you said, there are always external factors and I've been pretty clear I'm not betting on improvement in the offshore marine outlook in the near future, but we are taking action on the cost of the marine business. And essentially, I think, all the things that we're doing, as we've discussed before, are addressing two or three different issues. One is we've got to get the cost right as we ramp up the Trent ramp. We are dealing with the industrial footprint there, the cost improvements of that are going to start coming through as we go through the rest of this decade. We're dealing with the issues that we see in Marine. Warren showed a slide with the RR-PS program. It's actually a really well-thought through program and they're looking at revenue, cost and the business structure issues as well.

So, my view, 2016 is where we start transitioning from dealing with a lot of legacy issues to getting ahead of the curve on driving the business. And we will start seeing the benefits of that both lifted by growing aftermarket revenues in Civil as the installed base grows, but also lifted by the benefits of the cost improvements that come through.

And we clearly have to work hard at that because the macro environment is not kind to anybody at the moment. And we're cautious about that, but we think, as I say, we've been through all the plans, again, for 2016 and we're very comfortable we've got that in the right place. But 2016 is about delivering on those plans and driving that transformation that will improve 2017, 2018, 2019, 2020.

David East

Hi.

Edward Stacey

Hello. It's Ed Stacey from Haitong. Two questions. The first one is on the risk provisioning in that Civil gross margin slide, £189 million of benefit to 2015. I just wanted to check whether that was historical risk provisioning that have been taken, that have been excessive, and so you're still getting a one-off write-back? Or whether that £189 million is sort an ongoing benefit? Annually, you're going to book £189 million less of provisioning.

And then the second question is the 2016 guidance - and apologies if I've missed something that you actually told us, but is IAE and the profit contribution - because you've given us additional detail on IAE revenues, but I wondered if I've missed something there and what the profit was? I mean, is it more than half of the Civil division profit for 2016 is IAE? Thanks.

David Smith

So, on the risk provisioning, so effectively three years ago, we put in both a both an accounting policy and a methodology for looking at credit risks, so effectively, our risk on airline contracts from the credit risk of those airlines. And we had a policy that was almost directly derived from the credit ratings. Our accountants for a couple of years have been flagging that as a bit cautious. We said that we would look at it after three years, and we did that during this year. And we concluded actually we were being overcautious on the higher credit rating airlines, but under-cautious on some of the higher-risk airlines. I'm certainly not going to give you any names. And therefore, the policy was both overcautious and not very well focused. So we've changed the policy. Now, the outcome of that is this one-time change in the risk provision, but it will fluctuate over time. So if we see a general trend in credit around airlines, that's going to change that number over time, but the policy is I think a much better way to think about the credit risk on these long-term contracts.

The second question around IAE, I mean, we've discussed this a few times in terms of the profitability. You're right. It is over half of the Civil profit this year. The revenue, as we've discussed before, is in three parts: the modules that we supply which is obviously now going to decline to zero over the next couple of years, the revenue from spare parts that we provide and then our ongoing MRO activity around those as well. Both of the latter will increase a bit over time. But IAE is a significant part of the Civil profit because we're quite close to breakeven on Civil at the moment.

Edward Stacey

Thank you.

David East

Let's go here. We go back there first, and then maybe - we've got one at the back and then...

Christian Laughlin

Thank you. Good morning. Christian Laughlin from Bernstein. Two questions for me, please. Firstly, Warren, specifically for you, with regards to the ongoing strategic review. I was just wondering if you can add any color or commentary on, incrementally, what you have learned since November. It's kind of like a broad open-question there, I guess on that.

And then secondly, David, you had mentioned in your presentation that inventory turns particularly in 2016 and the implication is onward in 2017 and 2018 are an area of focus for operational improvement with respect to working capital management cash flow, et cetera. And so I was just wondering, if you could kind of add some color as to what provides the comfort or confidence in trying to tackle issues like inventory turns, or just in general, being very aggressive in performance improvement during a time where you are doubling production and delivery of large commercial engines over the next five years? How do you balance going after cost and say, trimming some fat, against the risk of scheduled risk and execution?

David East

I'll answer those, one, two. I mean, on strategic review, I think I've been fairly clear that this is a background activity and we must set that as a context. I mean, basically, the focus for right now and for 2016 is on operational activity, it's on improving the operational performance of our business. Now, as I said in November, it turns out that it's absolutely impossible really to separate that from thinking about the way the portfolio is built up. But that doesn't mean to say that we're diving right into the portfolio and changing bits here and there. So my brain cycles spent on the portfolio versus brain cycles spent on the operational transformation are very heavily weighted in favor of the operational transformation at the moment.

That said, since November, specifically, my understanding of the opportunities that we have in front of us in our Power Systems business, I would say, has definitely improved. I'm actually feeling a lot more optimistic that by applying the efforts that we're applying from an operational point of view into that part of the business, we can make that an interesting opportunity.

And also, my understanding of some of the detail of the product portfolio in our Marine business and how some of those system components work with other parts of our business, or not, as the case may be, I would say, has improved. And as and when we sort of are able to spend a bit more time on that strategically, then probably my own understanding of that has improved. But it's not really a priority for now.

David Smith

So on the second part of your question. I mean, I will answer that in sort of two parts. Firstly, I don't think anybody who sort of goes around our businesses would say that we are where we want to be on inventory performance. One of my board members told me that yesterday, so I agree with it. So, I think from a lean systems point of view, we have lots of opportunity within the business. We're at sort of just under 3.5, which I turn around and say, that's about 100 days. There are certainly people who are able to operate at 60 to 75 days. Whether that's investing best we can debate. But that's more like sort of five turns.

So we have plenty of opportunity here. And it's the lean manufacturing that will really drive that. And as we change our industrial footprint, if we don't get it right now, clearly, we'll lock in inefficient practices for a long time. So this is actually the time to do it.

But you make a very, very good point about competing priorities. So just in that case, as we want to develop lower cost sources, we extend our supply chain so we've got to watch that balance as well. And particularly as you say, as we ramp production, it's extremely important that we meet our customers' delivery schedule. Now, in my experience, that's a virtual circle, not a trade-off, because if you can get much more effective delivery into schedule, it means you've actually fixed a lot of the issues which create the inventory and the buffers in the system. So they are not trade-offs. They're reinforcing things.

But it's clear, our priority has to be to make sure that we can deliver to schedule as we go at this ramp and we are doing that and we'll continue to really focus on that. And we will be making that one of our really key metrics that we measure people's performance on as well.

Christian Laughlin

That's helpful. Thanks.

David East

I think we're at the back there.

David Perry

Hello. Is the mic working? Yeah. It's David Perry from JPMorgan right on the back row. I've got two questions. One on Civil Aero and one rather broad one on everything that's short cycle. Just on Civil Aero - and I really hope I'm not going to make myself look silly here, that I've missed something obvious. I'm just trying to understand the guidance because it seems - you've told us there's £550 million of headwinds, but there's £80 million of cost savings, and yet the profit guidance seems to be very clearly £550 million down. So I'm not sure where the savings are. And certainly, the guidance you've given today does appear to be below the consensus that you disseminated yourselves in Civil Aero. So if you could just explain that to me.

Secondly, as a broader question, if I take the shorter-cycle businesses, and I would include in that the oil and gas piece of Marine, a lot of what Tognum does and business jets, it feels like the world has changed quite a bit since November 2015, for the worse in all those markets. And yet your guidance is unchanged. Is that because you were extremely prudent, you think, in November? Or do you think you're just being a bit optimistic in terms of what you're expecting now? Thank you.

David Smith

So, on the first bit, you're right, we have cost savings coming through. But as I said, I think we will see a lower level of one-time adjustments coming from contract accounting, so that's a bit of a negative from profit. So the £550 million is still we feel about right.

Now, there's a little tweak on that, I guess, in that we've also said within the statement, we didn't have it on the slide, that we think the transformation program will probably deliver something between - so I'm talking about the program that we announced in November, an incremental saving of £30 million to £50 million. We haven't allocated that by the businesses at the moment because we're still working through that. So that will provide a little bit of support also to the Civil business. So, overall, I think the numbers are still about right for Civil.

In terms of the macro environment, I would agree with you. I mean, after I think just the first three days of the year caused me to shudder a little bit in terms of all the things that people are talking about around the world. And certainly, we've seen that over the last week or so in terms of the concern about financial markets as well. So, yes, there are, but I think we took a pretty deep view when we came out with the outlook in November around how we saw the Marine market. We've not assumed any uplift from the oil and gas sector there. Oil and gas is, remember, a relatively small part of RR-PS's revenue. I know it's less than 10%; I actually think it's closer to 5% at the moment. So it really is Marine that's affected by that.

And we took a more conservative view on how we saw the legacy Trent business developing based on what we were seeing during the second quarter. I think we probably got ahead of everybody there because I think some of the things that we said and told you about have now been demonstrated I think by some of the external evidence. And certainly, we took a more conservative view on the corporate jet market which, again, I think is being reinforced with what the airframers are saying now.

So all of that, we've taken into account. We've been around it. We've been around it in a lot of detail. And we didn't want to change the outlook based on what we see. Clearly, we understand our responsibility if we do think it's changed to tell you about that, but we absolutely don't see the need to do anything at the moment.

David East

Yeah. Let's stay at the back for a bit and then we need to come down to this corner at the front.

Jaime Rowbotham

Thanks. It's Jamie Rowbotham from Morgan Stanley. Two questions, please. David, very useful to get the trading cash flow table for the Civil division and understand why you think that goes into negative territory in 2016. I just wondered, given further CARs additions linked to XWB in 2017, do you think we're looking at another step down year-on-year in 2017 or can it flat line or can it start to inflect the trading cash flow in Civil?

And the second question, a bit of a follow on from David's, but just focusing specifically on Power Systems. In 2014, I think the order book grew a little bit from £1.9 billion to £2 billion, and yet in 2015, ex-FX, revenues fell £72 million and profit by £37 million. In 2015, the order book has actually come down a little bit from - I mean, we're talking small beer, but £2 billion back to £1.9 billion, and yet you're projecting growth in revenues and profits. Again, what sort of drives the confidence there and where do you think that growth is coming? Is it in mining, is it in agriculture, construction, rail, any color, or is it linked to the workshare programs you've talked about? Any color would be much appreciated. Thanks.

David Smith

On Civil trading cash flow, I'm not going to get drawn into giving you 2017 guidance I wasn't planning to do. But the dynamics are going to be favorable because we will start getting the benefits coming through of the cost improvements as I was describing earlier. We'll start picking up further engine flying hours on the Trent installed growth. So, you're absolutely right. There will still be negatives going in from CARs. We're working on bringing the cost per engine down, which will mitigate that somewhat. And we'll actually see - we'll see some benefit in 2016 versus 2015 from that source as well. But absolutely, we will be inflecting to more positive views, but I'm going to stop short of giving any specific numbers, certainly around 2017.

On your RRPS question, this unfortunately is one that you have to go into a bit more detail because of the mix of businesses, so some of the shorter-order book and longer-order book contracts. And I think the - there's actually positives actually in the order book even though the absolute number has gone down because we are seeing stronger order book coming in in some of the shorter cycle business. Things like power generation, for instance, which aren't necessary longer contracts that have replaced some of the governmental business we saw.

Power Systems has got an order book over quite a wide variety of end sectors. That area of power generation is certainly a positive one for us at the moment. We see some upside in some other areas. Warren mentioned the locomotive businesses. That's a very successful product line. And I think there will be some positives also in some of the defense-related businesses for MTU. So - and as I said, oil and gas is actually quite a small part of their business at the moment, so the commodity exposure is quite low. So, I think, yes, their absolute number is about the same, but we are actually quite positive that we'll see some revenue and profit growth in 2016.

David East

Okay. I think - we're over here.

Rami Myerson

Good morning. Rami Myerson from Investec. Three questions. First, on the new maintenance facilities in the maintenance - not new maintenance, but maintenance contracts that you've announced and the way you split the facilities. Will these new facilities be able to part out existing engines by themselves? Will they be able to develop their own techniques to fix second-hand spare parts or - are they going to compete on labor only and of course, all the spares will be coming out of Derby. And all, of course, encourage a secondhand market in your engines.

Second question is just on pricing because we've heard anecdotes that there's a lot of pressure on pricing on wide-bodies. The market looks like it's becoming more saturated, increasing path to wide bodies. And what's the comment on A330 CO, and of course the low oil price environment? And lastly, just on the Defence Aerospace, is the increase in revenues related to increased flying of the export customers in the Middle East or is it increased flying of RAF aircraft?

David East

Okay. On the increased flexibility within the repair and overhaul network. Then, I mean, today, the individual companies are able to sort of move around the activity that they're doing. And absolutely, we're seeing some doing more of a sort of reconditioning of old parts. And the structural change we made was more about the geographic region in which these people operate rather than the scope of activity that they're actually doing.

And that geographic region means that somebody in Asia, for instance, can service our customer from Europe and vice versa, which was not the case previously. So, that's where the sort of flexibility comes in or the increased flexibility comes in. And it actually increases the competition as well, which probably stimulates some of the more creative thinking for the former.

Question about sort of general softness in wide-body concerns about over-capacity and the like. Then there are some very specific issues associated with some of the aircrafts that are parked at the moment. They're specific to individual airlines. What we see is underlying growth continuing in the demand for a number of people who are flying and the amount of flying that they're doing. We saw that happening throughout 2015 through to the end of 2015. And even in China, we're seeing continued growth there.

So I think I sort of fall back on some of the fundamentals to understand how we're not getting a basic imbalance between the rate at which the industry is able to supply new capacity and the rate at which the industry is able to consume it. In the detail, there are certain airlines and certain planes which it gets a bit out of balance. And sometimes as evidenced in the numbers we talked about in November, we get a little but caught in the crossfire.

Rami Myerson

And have you seen any impact on pricing?

David East

In terms of pricing, it's always competitive out there. And where we are competing engines, then yes, we're seeing competition. But I wouldn't say it in any way directly correlated to some of the issues that we're seeing in part aircraft. We have to work hard with the customers that we have, but we are placing second hand aircraft. And we're basing second hand aircraft at a sort of absolutely competitive rate.

David Smith

Yeah. I'd just add. I mean, clearly, the area that we have seen the most pricing pressure was on the A330 CO. And we talked about that. And that was a big impact on the £250 million headwind that we talked for the Trent 700. So, that's clearly an area where we have - but I think on the A350 perspective, Trent 7000, A330neo, I don't see any evidence of that at the moment.

On your last point, I mean, last year, it was really around UK combat, but I think we will some more Middle-East-related benefit in 2016, Rami.

David East

Well, let's go here and...

Benjamin Fidler

Yes. Ben Fidler from Deutsche, three questions, please. Sorry if they're a bit nitty-gritty. Thank you for the ultimate guidance on where the TCP net debtor comes out. I just wondered for CARs, which I think is about £400 million at the year-end 2015. Where do we see that ultimately peaking and when?

The second question was just, again, on - thanks for the new disclosure. On the C&A allocation to Civil Aerospace, just a question about the order of magnitude of that number. It seems that the central admin cost allocation in Civil Aerospace is about the same as Marine, for example. Marine is 11% group sales, Civil Aero is 60%-ish in group sales. Just trying to understand why that apparent allocation is in place.

And then maybe if you could deal with this, I'll come back with a third question, because it's a bit more complicated.

David Smith

Okay.

David East

I'll deal with that one.

David Smith

On CARs, so interestingly, the CARs growth last year was a combination of Trent 1000, which is actually about half of it and a smaller number on XWB and some Trent 700, obviously, because of the lower pricing that we got on the COs coming through. So, we will see, as I think was mentioned on the slide, about the same level of CARs growth in 2016 of slightly higher. So, it's a combination of higher volume but actually better unit cost, so the two are beginning to mitigate.

So, over time, this better unit cost is going to be the thing that creates the peak. And as I've said previously, I think that that's going to peak probably around the sort of 2020-2021 range. If I try to give you an estimate now, I'd probably be where I think I might have mentioned the numbers before, in the sort of £1 billion, £1.1 billion sort of level. But it's going to be volume increase, but each year, better cost position that will essentially get us to a peak situation, and then obviously that will start falling off. Remember, every year also within the CARs growth, there's a negative because we're obviously amortizing a bit, and that will start growing over time as well.

David East

On the C&A?

David Smith

Oh, sorry. Yeah. On C&A, actually, a larger part of the C&A then maybe is implied is actually within Civil itself. So, this is Civil's own C&A to run the Civil business. They do get clearly an allocation of central services, accounting, and things like that. But the larger part of Civil C&A is actually what they're spending to run their business. It is much lower as a percentage of revenue than Marine or Power Systems, for instance. You can easily do the math on that now. And that's a real focus actually because that's quite a large platform of what the RRPS program is trying to address. That clearly is a higher percentage. So, it tells us that we need to do more work in those areas. So, the allocation methodology, if anything that's essential is fairly standard. It's much more about what it actually takes to run the businesses.

Benjamin Fidler

It's great to hear that there are some good efficiency there in Civil. Gross margin in Civil, if I can now come back to that, just to clarify - and sorry if you've mentioned this already and I missed it. So, that gross margin, the gross profit number, the £1.526 billion includes the £200 million IE earnouts. It includes the TCP net debt to growth of £400 million-or-so correct, and the CARs movement of £160 million is included in that number. Is that right?

David Smith

Yes, yes, yes.

Benjamin Fidler

Doesn't appear lower down...

David Smith

I'm staring at Helen, but yes, yes.

Benjamin Fidler

So, if I take those numbers to try and get a sort of, life is never perfect, but a broadly comparable, let's call it, a unit accounting type approach. Your gross profit about £750 million for Civil, which is an 11% gross margin in 2015. That's coming down quite materially in 2016 with the £550 million headwinds you talked about. Your high IP business, you got 53% of your revenues that are already in services, decent services mix. I'm just wondering why those gross margins are where they are and certainly about Warren's comment about pricing is robust. I'm just, in my mind, trying to reconcile all of these data points, I'm getting confused.

David Smith

So, forgive me. I may be answered slightly differently to the way that you've constructed the question, but hopefully helpful. Yes, yes, IE is a part of that; we talked about that earlier, part of the £1.5 billion. A large part of the rest of that is essentially the gross margin on our aftermarket business whether it's in TCA or spare parts or T&M contracts. And we've talked before about margins there being in the 30% to 40% range, across that range of businesses. So that's a large part of the rest of it.

When you then go to the - and clearly, there's some profit contribution from the corporate jets. When you look at the wide-body market at the moment and think where we are, you can see it very obviously in the CARs in terms of the unlinked contracts and the losses on those, which as you say, are contributing to gross margin in a negative sense. But - sorry, they're not contributing in a negative sense because they go into balance sheet, but they are negative because we're having to amortize some CARs each year.

When you looked at the linked part of that and think about, well, how is that linked part made up? It's essentially the same concept in the sense that we have losses on the original linked engine sales that go into the contract packs. And then we pull ahead effectively some of the contract aftermarket revenues on those linked sales, and some of that goes into the revenue that we've booked in there for the margin we booked at the beginning on those linked engine sales.

So, because we still got quite a negative cost position on the XWB and the Trent 1000 and we will have on the 7000 in terms of unit cost because we're not at the learning curve. The net effect of all that is negative to the business at the moment. And therefore, the fact that we now have the Trent - this is a long explanation, I know - but the Trent 700, I'm sensing, it's overall now, but the Trent 700 margins coming down as well because of the pricing pressure means the overall gross margin contribution at the moment of that large engine business is relatively small within the £1.5 billion.

And that's really what has to change over the next five years. As we get the cost structure right, we improve the unit cost of those engines, we get the benefit coming through the aftermarket on the installed base. That's the thing that's really going to swing over the next few years.

Does that help? It's a different way of answering your question.

Benjamin Fidler

No, it's helps a lot. I suppose pooling it all together and keeping a big picture, what is the right ultimate long-term gross margin for your sort of business?

David Smith

Well, you can now see across the businesses it sort of ranged, apart from I think Nuclear, in the sort of 20% to 25%. We clearly have to get that up if we're going to get EBIT margins, where they should be, which is sort of in the mid-teens long-term. So, you can walk backwards a little bit from how much we spend on R&D, how much we spend on C&A to work out where that gross margin has to be to be able to deliver that kind of profit level. But clearly, it needs to be north of where it is at the moment.

David East

I think we're going to have to just say that was the penultimate question. We've got one more from the middle there and then that's going to have to be the last one. Your hand up, Celine? Get a microphone.

Celine Fornaro

Thank you. So, I've got one question, which is regarding the CapEx and how you think about this investment. Now, if you look over the last 10 years, I think Rolls has spent around £4 billion and even plus on that on CapEx. And it just feels that we always hear every year there's new plants, new facilities and upgrading, and it's been for a while. So, how do we judge or how do you judge that the investments that have been made in 2008 or 2009 were actually the appropriate ones and are now paying off because we're still here in 2016? Do you need to do new plans, refurbish old facilities, and et cetera, et cetera? How do we make traction on this because it was a huge number?

David East

Yeah. And I think the numbers are what the numbers are over that period of time. But actually, we haven't specifically changed what we're about doing. A lot of what we're talking about today is actually following through on a lot of what was talked about in 2008 and 2009. It is the same facilities. We now sort of talking about some of the facilities that the programs kicked off in that time, they're coming to fruition now.

Yes. We have kicked off some additional one. So, for instance, the rationalizing of the footprint in Indianapolis, we only made that decision earlier in 2015. We started working on it before and we have plans to work on that before, but we only kicked it off in 2015.

It will take until the next several years to finish that. So, you'll still hear us talking about it. But it's - this is in around between 2010 and 2020 one program of industrial transformation that is changing the nature of our facilities. And so, I think, by the time we get to 2020 and we've finished this transformation, we'll be very well positioned looking forward.

Are we going to continue with manufacturing technology research that I put in that presentation a few moments ago? Absolutely, we will. Will some of that involve CapEx? Absolutely, it will. But we think we're rightsizing the footprint for being a competitive business in 2020 and beyond.

David East

I think we have rather overrun, and so, we're going to have to finish at that point. But thank you all very much for your attention.

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