Status Update

Oct 1, 2020

Hello, and welcome to the Rolls Royce Conference Call. Throughout the call, all participants will be in listen only mode and afterwards, there will be a question and answer session. Just to remind you, this conference call is being recorded. Today, I'm pleased to present Warren East, Chief Executive Stefan Daintiff, Chief Financial Officer and Isabel Greene, Head of Investor Relations. I will now hand over to Isabel to begin the call. Please go ahead with your meeting. Thank you, Keith, and good morning, everyone, and thank you for joining our call at short notice. As introduced by Keith, I've got with me this morning Warren East and Stephen Daintiff. In a moment, I'm going to hand over to Warren for some introductory remarks before we open the lines for your questions. A little disclaimer here. I mean, on the call today, we may refer to the investor presentation that was published today. It's available to download on our website. I also need to remind you that we may not be able to respond to certain questions relating to rights issue or bond offering details, that's for regulatory reasons, and we will not be able to discuss specifics of the rights issue or the bond offering themselves. We will direct you now to our announcement this morning for those answers and the prospectus for those details. Thank you, and over to Warren. Thank you, Isabelle. Good morning, everybody, and thanks for joining us. I'm pleased to be in and thanks for joining us. I'm pleased to be in a position now to update you on the plans we have to improve our liquidity headroom and reduce our level of balance sheet leverage to safeguard our business as we return to generating strong positive cash flows. For those of you looking at the slides, I am going to refer to some of the slides. And so we'll start on Page 5, which shows the package of solutions that we're proposing, and that package coming together to increase our resilience through a combination of complementary self help and external measures. Now the impact of the COVID-nineteen pandemic on our business and our industry has been unprecedented. We've said that before. And despite entering this year with excellent momentum in our operating and financial performance, and despite the rapid the rapid measures we've put in place to deliver GBP 1,000,000,000 of cash savings in 2020, we still expect to experience a free cash outflow this year of Now we acted quickly to address the impact of the pandemic because alongside that £1,000,000,000 of 1 off in year cost savings for 2020. We launched a fundamental restructuring predominantly of our Civil Aerospace business order to deliver annual pretax cash savings of GBP 1,300,000,000 by the end of 2022. And we believe this restructuring program, together with an anticipated recovery in the end markets, will help us to restore financial performance. We aim to be delivering free cash flow generation of at least GBP 750,000,000 excluding any impact of disposals as early as 2022. However, the pathway to that sustainable positive cash flow remains dependent on the recovery from COVID-nineteen, particularly with regard to long haul air travel. And there is significant uncertainty about the precise timing and the shape of this recovery. And so the possibility of delay in that does remain. And we consider it prudent, therefore, to prioritize resilience and flexibility, in particular, taking into account our reasonable worst case scenario. And as a result, today, we're announcing plans to increase our resilience through the uncertainty with a recapitalization package. We're commencing a GBP 2,000,000,000 rights issue and intend to launch a bond offering of at least £1,000,000,000 in the near future. In addition, we have agreed commitments for a new £1,000,000,000 2 year term loan and we have an indication of support in principle from UK Export Finance Bank for extension of their partial guarantee of our existing 5 year term loan to support an increase in that term loan of a further £1,000,000,000 So these additional potential loans are subject to various conditions, including importantly completion of the rights issue. So this is an integrated package. We believe that these actions coupled with targeted gross proceeds of more than £2,000,000,000 from a number of potential disposals, which we announced at our half year results in August, would enable us to navigate the uncertain macroeconomic environment. Now it's not been an easy decision to get here. We've already put in place more than £4,000,000,000 of additional borrowing facilities since the start of this crisis. But there is to the amount that we can reasonably expect solely from our banks and the bond markets without addressing the leverage as well. With approximately £3,200,000,000 of debt and credit facilities due to mature over the next 13 months and that includes the undrawn GBP 1,900,000,000 revolving credit facility, which will be canceled on completion of the rights issue. The GBP 3,000,000,000 cumulative proceeds from the rights issue and the intended bond offering announced today will largely cover those maturities and allow us to deliver disposals in a manner that ensures enhanced value for shareholders. So now let's move on to Slide 8. We've spoken a lot about the uncertainty in the timing and the shape of recovery. We believe that the base case shown here is the most probable outcome, and our large engine flying hours data over July August has tracked slightly ahead of expectations. However, has tracked slightly ahead of expectations. However, uncertainties remain around the timing and the shape of recovery, in particular given infection rates rising again, especially when you think about Europe. Our reasonable worst case scenario assumes a significant delay in recovery with engine flying hours in 2021 at only about 45% of 2019 levels. And in that event, in addition to lower large engine flying out receipts, we would expect adverse trading conditions across the rest of our business too, probably with the exception of defense, which we expect to remain resilient. So it's more detail on the reasonable worst case scenario included in the working capital statement on Page 31 of the presentation and also in the full rights issue prospectus, which should be read by the way prior to making an investment decision. It's our responsibility to prepare for the reasonable worst case and in consideration of the outcome alongside continued global and macro economic uncertainty, we've determined that it is in the best interest of shareholders to take the actions that we set out today. Slide 10 sets out the reasons why we need to rebuild our balance sheet and what our ambitions are in the medium term. We aim to restore the company to a net cash position in the coming years through a combination of £2,000,000,000 gross disposal proceeds, as we announced in our half year results, and an expected return to positive free cash flow during the second half of twenty twenty one and £2,000,000,000 rights issue announced today. This is important, this commercially, competitively and financially. The strong financial position does matter to our customers. In civil aerospace, airline customers sign multiyear service contracts with us. They want to know that we can be relied on as a long term partner and we'll love up to our side of the contract. Similarly, in civil aerospace and Defense, we're committed to long term investment cycles in order to win positions on new programs. Our customers need to know that we're resilient enough to be able to invest in those products through the cycle. And that's why we remain committed to our ambition to return to an investment grade credit rating in the medium term. And we think that we need to act now to prevent further deterioration and start the journey back to where we need to be. So Slide 14 now, moving on to Slide 14, this shows our sort of recovery path back to free cash flow generation of £750,000,000 as early as 2022, promised on our base case recovery assumptions before adjustment for any potential disposals. And we spoke about this at our interim results, so I'm not to go through it all in detail again today, but just a little bit more color on how we expect that improvement in cash generation to unfold. First, cash flow recovery is not dependent on any large working capital inflows, only on the non repeat of the working outflows that we're experiencing in 2020. And that includes the impact of our, the one time impact of our decision to cease the invoice discounting. Secondly, we expect an improvement of around GBP 2,000,000,000 in cash from Civil Aerospace Business, with engine flying hours expected to return in our base case to 90% of 2019 levels by the end of 2022, as well as improvements in time and materials work and importantly significantly lower Trent 1,000 in service costs and lower losses on installed widebody OE deliveries. Thirdly, the actions we're taking to resize our fixed cost base and reduce our capital intensity. We've reduced our headcount already by over 4,000 since we announced the cost reduction program in May, and we're confident that by 2022, we will have delivered the approximately £1,300,000,000 of annual cost benefits that we've identified. While timing and shape of the recovery is uncertain, future holds. Finally, we can see continued resilience in defense and the recovery in Power Systems, and that's expected to contribute an additional GBP 200,000,000 to 20 22 cash flows compared to 20 20 cash flows. So remember, the GBP 750,000,000 cash flow ambition still includes nonpermanent costs. Non permanent costs of approximately £300,000,000 related to reducing the size of our FX hedge book and it includes £200,000,000 to £300,000,000 related to Trent 1,000 disruption in service costs. And so those non repeat items will still be there in that £750,000,000 in 20.22. We expect our target free cash flow to grow further in the future as those temporary negative outflows diminish over time. Moving forward a little, Slide 16 and 17 are a reminder of our strong foundation in Civil Aerospace established over decades of investments in engineering and design. We've recently completed a multiyear investment cycle. We've got 4 wide body engine programs that have been launched since 2010, which have taken our market share of in service widebody passenger planes up from 26% 10 years ago to 38% by December 2019. Our share of the order book is even stronger at 55% in December 2019. And our investment overall in our Civil Aerospace fleet means that by the end of 2019, we had more than 5,000 installed wide body engines with an average age of less than 9 years. And so most of the planes that we power are the newer, more economic, lower carbon footprint planes than our customers and their passengers want to use. As our engine programs mature, the investment needs reduce, of course, manufacturing efficiency improves, pricing increases and the risk of in service issues diminishes. And all of that creates a significant inflection in the financial performance. We think that we were already actually reaching that pivot point before COVID-nineteen. But despite the current disruption, these underlying value drivers will continue to have a positive impact on our business performance. Now we tend to focus a lot on wide body. Our business aviation has been less impacted by COVID-nineteen than the commercial aviation. For those people that can afford it, business jets enable passengers to mix less with other travelers and have more control over their flight plans. And we've got over 7,000 engines installed on business jets, and our strong product positions, mean that that gives us 30% more than 30% of the market by value. And this is an area of civil aerospace that's often overlooked when we talk about our performance, but it's a key pillar of our strategy, an area where we've seen more resilience through the COVID-nineteen pandemic. On Slide 18, we sent out the ambition for the future beyond 20 22. In addition to the embedded value in civil aerospace, we can see potential for underlying growth in both in defense. And in addition, we're competing for new business to drive growth in defense into the longer term on programs that will be running for several decades into the future. And in Power Systems, we're well positioned in key growth areas such as mission critical backup power. We're also driving market share in high growth markets through our expansion in China and India. And as a result, we think Power Systems can grow at a 5% to 10% underlying revenue CAGR from 2021. Underpinning all of that growth beyond 2022, the world is shifting ever more towards a net zero carbon economy. And the breadth of our engineering expertise and our established access to a range of end markets means that we're well positioned to play a crucial role in the transition, through increasingly efficient gas turbine engines in aerospace, through innovating with hybrid products in power systems, and that's actually paving the way for sustainable aviation as well through hybrid technology in aviation. And also, we're working on sustainable aviation fuels. So once we achieve our aim of restoring financial returns in a more appropriate balance sheet, we'll be accelerating these aspects of our strategy, and you'll see substantial growth in that starting to happen by 2025. So to sum up, over the last 6 months, we've taken swift actions to minimize our cash outflow, restructure our business and position it for the future in response to both the short term and medium term impact of the pandemic. We believe that the restructuring program, alongside an anticipated recovery in our end markets, will help us to restore financial performance. But there is significant uncertainty around the precise timing and the shape of the recovery from COVID-nineteen. And as a result, we do consider it prudent to prioritize resilience and flexibility. We thought carefully about the capital needs that we'll have over the next few years and raising additional capital at this time will provide us with 3 key things: improved financial resilience and more liquidity headroom across 2021 in order to weather the macroeconomic risks before we return to strong cash generation, which is expected as early as 2022, an improved level of balance sheet leverage, supporting disciplined execution and investment to ensure that we can maximize value from our existing capabilities. And thirdly, flexibility to allow us to pursue disposals in a manner that delivers value for shareholders. So we've positioned the group long term to benefit from the new technologies that we have focused on sustainable power. We thought carefully about the size and the shape of this integrated package to ensure that this is sufficient to secure us against the downside risk and also that it supports our deleveraging towards a net cash position over an acceptable time horizon. And as a result, we see this as a final major step in our balance sheet repair. The focus is now on executing our turnaround and securing the disposal proceeds.